Advance Auto Parts Inc.

Welcome to the Advanced Auto Part Second Quarter 2021 Conference Call. Before we begin, Ms. Elizabeth I. Slavin, Senior Vice President, Communications and Investor Relations, will make a brief statement concerning forward-looking statements that will be discussed on this call. I will now turn the call over to Ms. Elizabeth I. Slavin. Please go ahead.

Good morning, and thank you for joining us to discuss our Q2 2021 results 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'll 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 those of historical fact are forward-looking statements, including, but not limited to, statements regarding our initiatives, plans, projections, guidance, 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 Securities and Exchange Commission. Now, let me turn the call over to Tom Greco.

Thanks, Elizabeth, and good morning. We hope you're all healthy and safe amid the ongoing pandemic and recent surge of the Delta variant. I'd like to start by thanking the entire Advanced and CarQuest independent family for your hard work to serve our customers throughout the quarter. It's because of you that we're reporting the positive growth in sales, profit, and earnings per share we're reviewing today. In Q2, we continued to deliver strong financial performance on both the one and two year stack as we began lapping more difficult comparisons. In the quarter, We delivered comparable store sales growth of 5.8%, an adjusted operating income margin of 11.4%, an increase of 11 basis points versus 2020. As a reminder, we lacked a highly unusual quarter from 2020, where we significantly reduced hours of operation and professional delivery expenses reflective of the channel shift from pro to DIY. As we anticipated, The professional business accelerated in Q2 2021, and between our ongoing strategic initiatives and additional actions, we expanded margins. Our actions offset known headwinds within SG&A and an extremely competitive environment for talent. On a two-year stack, our comp sales improved 13.3%, and margins expanded 227 basis points compared to Q2 2019. Adjusted diluted EPS of $3.40 increased 15.3% compared to Q2 2020 and 56.7% compared to 2019. Year to date, free cash flow more than doubled, which led to a higher than anticipated return of cash to shareholders in the first half of the year, returning $661.4 million through a combination of share refurchases and quarterly cash dividends. Our sales growth and margin expansion were driven by a combination of industry-related factors as well as internal operational improvements. On the industry side, the macroeconomic backdrop remained positive in the quarter as consumers benefited from the impact of government stimulus. Meanwhile, long-term industry drivers of demand continued to improve. This includes a gradual recovery in miles driven, along with an increase in used car sales, which contributes to an aging fleet. While we delivered positive comp sales in all three periods of Q2, our year-over-year growth slowed late in the quarter as we lapped some of our highest growth weeks of 2020. Our category growth was led by strength in brakes, motor oil, and filters, with continued momentum in key hard part professional categories. Regionally, the West led our growth, benefiting from an unusually hot summer, followed by the Southwest, Northeast, and Florida. To summarize channel performance, we saw double-digit growth in our professional business and a slight decline in our DIY omnichannel business. To understand the shift in our channel mix, it's important to look back at 2020 to provide context. Beginning in Q2, we saw abrupt shifts in consumer behavior across our industry due to the pandemic, resulting from the implementation of stay at home orders. This led to more consumers repairing their own vehicles, which drove DIY growth. In addition, our DIY online business surged as many consumers chose to shop from home and leverage digital services. Finally, As we discussed last year, our research indicated that large box retailers temporarily deprioritized long-tail items, such as auto parts, in response to the pandemic. These and other factors resulted in robust sales growth and market share gains for our DIY business in 2020. Contrary to historical trends, the confluence of these factors also led to a slight decline in our professional business in Q2 2020. As we began to lock this highly unusual time, we leveraged our extensive research on customer decision journeys. This enabled us to move quickly as customers shifted how they repaired and maintained their vehicles. Our sales growth and margin expansion in Q2 demonstrates the flexibility of our diversified asset base as we adapted to a very different environment in 2021. Specific to our professional business, we began to see improving demand late in Q1 2021, which continued into Q2, resulting in double-digit comp sales growth. This is directly related to the factors just discussed, along with improved mobility trends as more people returned to work and miles driven increased versus the previous year. Strategic investments are strengthening our professional customer value proposition. It starts with improved availability and getting parts closer to the customer as we leverage our dynamic assortment machine learning platform. Within our advanced pro catalog, we saw improved key performance indicators across the board, including more online traffic, increased assortment and conversion rates, and ultimately growth in transaction counts and average tickets. We also continue to invest in our technical training programs to help installers better serve their customers. Our TechNet program is also performing well as we continue to expand our North American TechNet members, providing them with a broad range of services. Each of these pro-focused initiatives has been a differentiator for ADVANCE, enabling us to increase first call status with both national strategic accounts and local independent shops. Finally, we're pleased that through the first half of the year, we added 28 net new independent CarQuest stores. We also announced the planned conversion of an additional 29 locations in the West as Baxter Auto Parts joins the CarQuest family. We're excited to combine our differentiated co-customer value proposition with an extremely strong family business, highlighted by Baxter's excellent relationships with their customers in this growing market. In summary, all of our professional banners performed at or above our expectations in Q2, including our Canadian business, despite stringent lockdowns. Moving to DIY Omnichannel, our business performed in line with expectations, considering our strong double-digit increases in 2020. While Q2 DIY comp sales were down slightly, DIY Omnichannel was still the larger contributor to our two-year growth. DLI growth versus a year ago gradually moderated throughout the quarter as some consumers returned to professional garages. Within DLI Omnichannel, we saw a shift in consumer behavior back to in-store purchases, consistent with broader retail. We've also been working to optimize and reduce inefficient online discounts. These factors, along with highly effective advertising, contributed to an increase in our DIY in-store mix and a significant increase in gross margins versus prior year. We remain focused on improving the DIY experience to increase share of wallet through our Speed Perks loyalty platform. We made several upgrades to our mobile app to make it easier for Speed Perks members to see their status and access rewards. we continue to see positive graduation rates among our existing Speed Perk members. In Q2, our VIP membership grew by 8%, and our elite members, representing the highest tier of customer spend, increased 21%. Shifting to operating income, we expanded margin in the quarter on top of significant margin expansion in Q2 2020. This was led by our category management initiatives, which drove strong gross margin expansion in the quarter. First, our work on strategic sourcing remains a key focus as consistent sales growth over several quarters resulted in an increase in supplier incentives. Secondly, we've talked about growing owned brands as a percent of our total sales. This has been a thoughtful and gradual conversion, and we began to see the benefits of several quarters of hard work in Q2. This was highlighted by our first major category conversion with steering and suspension, where we saw extremely strong unit growth for our high margin CarQuest premium products. In addition, the CQ product is highly regarded by our professional installers. With consistent high level of quality standards, they are now delivering lower defect rates and improved customer satisfaction. We also recently celebrated the one year anniversary of the DieHard battery launch. Following strong year one share gains in DIY omnichannel, we've now extended DieHard distribution into the professional sales channel, where we're off to a terrific start Further expansion of the Diehard and Carquest brands is planned for other relevant categories. In terms of strategic pricing, we've significantly improved our capabilities leveraging our new enterprise pricing platform. This platform enabled us to respond quickly as inflation escalated beyond our initial expectations for the year. Moving to supply chain, while we're continuing to execute our initiatives, we faced several unplanned, offsetting headwinds in Q2. Like most retailers, we experienced disruption within the global supply chain, wage inflation in our distribution centers, and an overall shortage of workers to process a continued high level of demand. In addition, our suppliers experienced labor challenges and raw material shortages. Despite a challenging external environment, we continue to execute our internal supply chain initiatives. This includes the implementation of our new warehouse management system, or WMS, which we're on track to complete in 2022. In the DCs that we've converted, we're delivering improvements in fill rate, on-hand accuracy, and productivity. The implementation of WMS is a critical component of our new labor management system, or LMS. Once completed, LMS will standardize operating procedures and enable performance-based compensation. We also continue to execute our Cross Banner Replenishment, or CBR, initiative, transitioning stores to the most freight logical servicing DC. In Q2, we converted nearly 150 additional stores and remain on track with the completion of the originally planned stores by the end of Q3 2021. In addition to CBR, we're on track with the integration of WorldPAC and Autopart International, which is expected to be completed early next year. Shifting to SG&A, we lapped several cost reduction actions in Q2 2020, which we knew we would not replicate in 2021. We discussed these actions on our Q2 call last year. Primarily a reduction in delivery costs as a result of a substantial channel mix shift along with the reduction in store labor costs at the beginning of the pandemic. Jeff will discuss these in more detail in a few minutes. In terms of our initiatives, we continue to make progress on sales and profit per store. Our team delivered sales per store improvement, and we remain on track to reach our goal of 1.8 million average sales per store within our timeline. Our profit per store is also growing faster than sales per store, enabling four-wall margin expansion. In addition to the positive impacts of operational improvements we've implemented to drive sales and profit per store, we've also done a lot of work pruning underperforming stores, and we're back to store growth. In the first half of the year, we opened six WorldPack branches, 12 Advance and CarQuest stores, and added 28 net new CarQuest independents, as discussed earlier. We also announced the planned conversion of 109 Pep Boys locations in California. We're very excited about our California expansion with the opening of our first group of stores scheduled this fall. The resurgence of the Delta variant has resulted in some construction related delays in our store opening schedule. We expect to complete the successful conversion of all stores to the advanced banner by the end of the first quarter 2022. Finally, we're focused on reducing our corporate and other SG&A costs, including a continued focus on safety. Our total recordable injury rate decreased 19% compared to Q2 2020 and 36% compared to Q2 2019. We're also finishing up our finance ERP consolidation, which is expected to be completed by the end of the year. Separately, we're in the early stages of integrating our merchandising systems to a single platform. Both these large-scale technology platforms are expected to drive SG&A savings over time. The last component of our SG&A cost reduction was a review of our corporate structure. In terms of the restructuring of our corporate functions announced earlier this year, savings were limited in Q2 due to the timing of the action. We expect SG&E savings associated with restructure beginning in Q3. In summary, we're very pleased with our team's dedication to caring for our customers and delivering strong financial performance in Q2. We're optimistic as the industry-related drivers of demand continue to indicate a favorable long-term outlook for the automotive aftermarket. We remain focused on executing our long-term strategy to grow above the market, expand margins, and return significant excess cash back to shareholders. Now let me pass it to Jeff to discuss more details on our financial results. Thanks, Tom, and good morning. I want to echo Tom's thanks to our team members who continue to prioritize the health and safety of our customers and their fellow team members while helping to deliver solid results for the quarter. In Q2, our net sales increased 5.9% to $2.6 billion. Adjusted gross profit margin expanded 239 basis points to 46.4%, primarily as a result of the ongoing execution of our category management initiatives, including strategic sourcing, strategic pricing, and own brand expansion. We also experienced favorable inventory-related costs versus the prior year. These benefits were partially offset by inflationary costs in supply chain and unfavorable channel mix. In the quarter, same skew inflation was approximately 2%, and we expect this will increase through the balance of the year. We're working with our supplier partners to mitigate costs where possible. Year to date, gross margin improved 156 basis points compared to the first half of 2020. As anticipated, Q2 adjusted SG&A expenses increased year over year and were up $109 million versus 2020. This deleveraged 228 basis points and was a result of three primary factors. First, our incentive compensation was much higher than the prior year, primarily in our professional business as we left a very challenging quarter in 2020 when pro sales were negative. Second, we experienced wage inflation beyond our expectations in stores. We remain focused on attracting, retaining, and developing the very best parts people in the business and will continue to be competitive. We expect both headwinds to continue in the back half of the year. Third, and as expected, we incurred incremental costs associated with professional delivery and normalized hours of operation when compared to Q2 2020. These increases in Q2 will partially offset by a decrease in COVID-19 related expenses to approximately $4 million compared to $15 million in the prior year. As a result of these factors, our SG&A expenses increased 13.3% to $926.4 million. As a percent of net sales, our SG&A was 35% compared to 32.7% in the prior year quarter. Year-to-date, SG&A as a percent of net sales improved 88 basis points compared to the first half of 2020. While we've seen a decrease in COVID-19-related costs year-to-date, the health and safety of our team members and customers will continue to be our top priority. As the current environment remains volatile and the Delta variant remains a concern, we may see increased COVID-19 expenses in the back half of the year. Our adjusted operating income increased to $302 million compared to $282 million one year ago. On a rate basis, our adjusted OI margin expanded by 11 basis points to 11.4%. Finally, our adjusted diluted earnings per share increased 15.3% to $3.40 compared to $2.95 in Q2 of 2020. Our free cash flow for the first half of the year was $646.6 million, an increase of $338.4 million compared to last year. This increase was driven in part by our operating income growth along with continued momentum in our working capital initiatives. Our capital spending was $58.7 million for the quarter and $129.6 million year-to-date. We expect our investments to ramp up in the back half of the year. And in line with our guidance, we estimate we will spend between $300 and $350 million in 2021. Due to favorable market conditions, along with our improved free cash flow in Q2, we returned nearly $458 million to our shareholders through the repurchase of 2 million shares at an average price of $197.52 and our recently increased quarterly cash dividend of $1 per share. We're pleased with our performance during the first half of the year and moving into the first four weeks of Q3 on a two year stack, our comparable store sales are in line with Q2. We're continuing to monitor the COVID-19 situation as well as other macro factors, which may put pressure on our results, including inflationary costs and commodities, wages and transportation. Based on all these factors, we're increasing our full-year 2021 guidance ranges, including net sales in the range of $10.6 to $10.8 billion, comparable store sales up 6% to 8%, and adjusted operating income margin of 9.2% to 9.4%. As you heard from Tom on our new store openings, we've encountered some delays in the construction process of converting Pep Boy stores, primarily permitting and obtaining building materials related to the ongoing pandemic. As a result, we're lowering our guidance range and now expect to open 80 to 120 new stores this year. Additionally, given the improvement of our free cash flow and our accelerated share repurchases in the first half of the year, we're also increasing our guidance for free cash flow to a minimum of $700 million and an expected range for share repurchases of $700 to $900 million. We remain committed to delivering against our long-term strategy as we execute against our plans to deliver strong and sustainable total shareholder return. Now, let's open the call for your questions. Operator?