Advance Auto Parts Inc.

Kelly, our President and Chief Executive Officer, and Ryan Grimland, our Executive Vice President and Chief Financial Officer. Following Shane and Ryan's prepared remarks, we will turn our attention to answering your questions. Before we begin, please be advised that remarks today will contain forward-looking statements. All statements other than statements of historical fact are forward-looking statements, including, but not limited to, statements regarding our ongoing strategic and operational review, initiatives, plans, projections, and future performance. Actual results could differ materially from those projected or implied by the forward-looking statements. Additional information about forward-looking statements and factors that could cause actual results to differ can be found under the captions, forward-looking statements in our earnings release, and risk factors in our most recent Form 10-K and subsequent filings made with the Commission. Now, let me turn the call over to Shane O'Kelly.

Thanks, Elizabeth, and good morning. Before we dive into the details of the quarter, I want to take a moment to thank the entire ADVANCE team for their dedication and continued focus on serving our customers throughout 2023. I continued to travel coast to coast during the past few months, meeting customers, meeting team members from our stores and team members from our distribution centers. I remain impressed with our team's strong work ethic and their unwavering commitment to helping our customers. I want to introduce today our new Chief Financial Officer, Ryan Grimsland. We're pleased to have Ryan on the Advanced Team, and he brings vast experience in the omni-channel retail space, serving both DIY and professional customers. His deep knowledge in finance, strategy, and transformation will undoubtedly help lead our company forward. Now, onto the decisive actions we have been taking to turn around the business. We have continued to act with a sense of urgency to stabilize the business and position the company to return to profitable growth. All of the actions we are taking are geared to help us focus on the fundamentals of selling auto parts, and we will eliminate activities that distract us from that goal. Let me be clear. Our results today are disappointing and not at all what I'm accustomed to delivering. We have spent the last several months analyzing how ADVANCE got here, and we now have a better understanding of the work required to change our trajectory. It's important to note that in recent periods, including this one, there have been several atypical items contributing to our poor financial performance. Through disciplined execution and accountability, we will tighten the fundamentals of our business, which will help reduce and then eliminate elements that introduce noise to our core performance. On our last quarter's call, we discussed decisive actions. Let's take you through those actions as well as update you on new activities the company is taking today. Number one, initiating the sales processes for WorldPAC and our Canadian business. Number two, significantly reducing our costs to remain competitive while investing a portion of those savings back into the front line. Number three, making organizational changes to position us for success. And now introducing two additional decisive actions. Number four, assessing the productivity of all assets, including CarQuest independence. And number five, the consolidation of our supply chain. Let's take a moment and further discuss each of these decisive actions. First, we initiated separate sales processes for WorldPak and Canada. We are very pleased with the interest we have received in both businesses. The WorldPAC process is underway and we are actively engaging with potential buyers. We currently expect to conclude the WorldPAC process during our second quarter and look forward to sharing more information when that occurs. As it relates to the Canadian process, this is intentionally sequenced behind WorldPAC and we have begun the internal work to explore separating the business. Next, as I discussed in our Q3 call, the company's costs have outpaced our sales growth during the past several years, which warranted changes in how we operate. In Q4, we implemented significant cost reductions by eliminating roles and initiatives that did not support our commitment to improve the fundamentals of the business, And we will realize at least $150 million of SG&A savings in 2024. We're focused on our frontline team members and are reinvesting approximately $50 million of those SG&A dollars to increase wages, bonus programs, and as well enhancing our training. This represents approximately half of the dollars planned for 2024 for our frontline with additional funding coming from sunsetting previous programs. While we continue rolling out these investments over the next several months, we note that we are already seeing year-over-year improvement in turnover reduction of key frontline roles. In addition to the Q4 cost reductions, we are now launching an additional initiative focused on our indirect spend with the goal of eliminating a minimum of 50 million on an annualized basis. We will continue to be prudent with our expense structure and are committed to building a cost-conscious culture. Going forward in every operational decision we make, if it isn't core to the business to help our frontline team members and service our customers, it's off the table. In terms of the third decisive action, I mentioned on our last call that we had streamlined our management structure and reorganized parts of my leadership team to drive collaboration and accountability. These changes further simplify our structure, and they upgrade talent in key positions to allow us to drive improvements in critical business areas. In addition to Ryan joining us as the CFO, another example of outstanding talent that we've recently hired is Elizabeth Dreyer. who joined the advanced team as our chief accounting officer and controller. Elizabeth brings a robust track record of building and leading high-performing accounting teams, and I'm confident she and Ryan will work together to create a high-performing finance function. We also recently hired a new chief data officer, Kunal Das, to significantly improve the quality, processing, and utilization of our data. In addition, we've also hired a new procurement leader who will help deliver against the indirect cost savings that I just mentioned. We've also made a number of changes within our organizational structure to better align certain departments with our strategic goals. For example, pricing is now part of merchandising. In addition, we have consolidated our real estate function from across multiple parts of the company to form a single enterprise-wide real estate team reporting directly to me. Further, our merchandising and inventory teams now directly report to me. They have been working diligently on the implementation of our new core merchandising and inventory system. We expect to complete the remainder of the vendor and SKU transitions to the new system this year. That effort involves transforming our current ordering and fulfillment processes, enabling us to move away from antiquated systems to more data-driven capabilities. The fourth decisive action, which we are introducing today, is improving the productivity of all assets in the company, including company stores and independently owned CarQuest locations. While we opened 61 stores in 2023, we do not plan to open as many this year as we focus on improving our existing store operations and driving profitable growth. In an effort to optimize our CarQuest independent business, We recently terminated our agreements with over 100 independently owned CarQuest stores, which will help improve the overall profitability of our CarQuest independent program. In addition to improved store productivity, our IT department has made notable improvements in the reliability of our store's POS systems. The improvement in our network and store system resiliency is allowing our frontline to better serve our customers. Lastly, we are announcing our fifth decisive action, which is the consolidation of our supply chain to a single, unified network. We know that our current network is inefficient and needs substantial work to improve our cost structure and inventory availability. We have long served our blended box stores via two distinct DC networks, one from the legacy CarQuest business and one from advance. The first step is completing the implementation of our warehouse management system, or WMS, across all of our large DCs. With only three DCs remaining, we will complete this by the end of the year. Step two, which we are conducting in parallel with step one, is the conversion of smaller legacy DCs from functioning as a replenishment node to operating as a market hub. With 38 DCs in our Advance and CarQuest network today, we view the smaller DCs as valuable assets that can be leveraged more efficiently as market hubs where we will forward deploy the right inventory closer to the customer. We have recently started our first DC conversion to become a market hub, and we will utilize our learnings to scale this key initiative across the network. By leveraging our current DCs, we can move faster and more cost effectively than if we green fielded a new network. Importantly, once we complete this work, we will be able to order product into fewer DCs, which will help reduce costs and improve inventory productivity. We look forward to sharing more on all of these actions as we continue to improve our blended box strategy. Before I turn it over to Ryan, the last topic I want to touch on is the macro environment. The key drivers of this industry remain strong. These include the average age of vehicles, which continues to increase and is now at 12 and a half years, as well as miles driven, both of which are projected to further increase this year. Combined with the strengthening Do It For Me demand, I'm confident that Advance can begin to capitalize on the strong fundamentals of the industry. Now I'd like to welcome and turn the call over to Ryan Grimsland, our CFO, who will review our financial performance in 2023 and discuss the 2024 guidance we provided in the release this morning. Ryan?

Thanks, Shane, and good morning. I'm pleased to be here for my first earnings call as CFO of Advance. Before I move to the financials, I would also like to thank our team members for their continued dedication, as well as the warm welcome I received from the team. Since my arrival at Advance, there are several swift changes we have made to allow for the necessary transformation of our finance function. As Shane discussed, we recently appointed Elizabeth Dreyer as our new Senior Vice President, Chief Accountant Officer, and Controller. Elizabeth's impressive track record in a variety of financial leadership roles will benefit us as we work to remediate our previously disclosed material weakness related to internal control, which I'll speak to in more detail in just a moment. In my first 90 days with Advance, I've had the privilege to meet and connect with our hardworking and talented finance and accounting teams. I'm committed to providing cohesive leadership as well as ensuring we have the needed incremental resources that will enable us to be a best-in-class retail organization. As you heard from Shane, we are focused on improving the fundamentals across the business to bring rigor, discipline, and accountability with a sense of urgency. We have begun to make changes and are committed to elevating ourselves to become a high performing team. The first step has been filling critical roles, including hiring key leaders, as well as a thorough and time intensive review of our reconciliations and processes across the company. Within this review, we've recently discovered additional work needed to fully realize the intended benefits of our finance ERP system, including potentially sunsetting certain legacy systems. The turnover of accounting personnel over the past 12 months has increased the challenge to operate as an effective finance organization. We have taken aggressive action to bring in resources around our internal controls, both hiring accounting professionals and insourcing contractors at varying levels to provide leadership and oversight. With these actions, we are making significant progress on remedying our material weakness related to people identified in early 2023. In addition, as disclosed in our release, we identified issues with certain previously reported financial results. We are correcting prior period financial results in our earnings release in upcoming Form 10-K. As you saw this morning, we filed for an extension. We do not expect the results we are discussing today to be impacted. However, we need additional time, principally to finalize our assessment of internal control over financial reporting and the related disclosures. Our financial results discussed today will compare our Q4 and full year 2023 results to the corrected results for the prior periods. Now on to our results. In the fourth quarter, our net sales of $2.5 billion decreased 0.4% compared with Q4 2022, and comparable store sales decreased 1.4%. This was primarily driven by softness in DIY throughout the quarter. but particularly in the last four weeks of the year as we lapped tougher comparisons to the prior year. However, we continue to be encouraged by our performance in PRO as we realized strong transactional growth in the quarter as a result of improved availability. The West and Northeast were our top performing regions, while the Mid-Atlantic and Midwest were our most challenged in the corner, as they were impacted by unfavorable weather. From a category perspective, As we improved our availability, we saw strength in filters, heating and cooling, and engine management. In Q4, gross profit margin of 38.6% declined 504 basis points from the prior year quarter. There are business performance issues, along with several atypical drivers that contributed to the deleverage. Inventory-related items contributed approximately 280 basis points, of which roughly 170 basis points are related to changes in estimates. and 110 basis points from inventory-related capitalization costs. In 2022, we hired an external firm to identify and recover previously earned vendor incentives over a multi-year period. This resulted in approximately 120 basis points of deleverage. Lastly, elevated supply chain costs contributed approximately 50 basis points. SG&A was $999 million in Q4 2023. compared with $960 million in Q4 2022. As a percentage of net sales, our SG&A expenses deleveraged 176 basis points to 40.6%. The deleverage was driven by a year-over-year increase in occupancy costs, labor-related expenses from our intentional investments in our frontline team members, and new store expenses. These were partially offset by previously discussed productivity actions taken in Q4. Importantly, we also incurred approximately $8 million in expenses related to our restructuring, as well as $5 million related to the strengthening of our accounting resources. These results are not indicative of how we want to run the organization. As Shane mentioned, we are reducing expenses by building a cost-conscious mindset throughout Advance. Our Q4 operating income margin deleveraged 679 basis points compared with the prior year quarter. Diluted loss per share was 59 cents in Q4 compared with $1.39 earnings in the prior year quarter. This was primarily driven by lower net income as well as higher interest expense. For full year 2023, net sales of approximately $11.3 billion increased 1.2% compared with prior year. Full year comparable store sales decreased 0.3%. Our gross profit decreased 8.3% year-over-year, and gross profit margin contracted 414 basis points to 40.1%. Inventory-related items contributed approximately 157 basis points. Cost increases were not fully covered by price, contributed approximately 74 basis points to the full-year decrease. As mentioned earlier, the initiative to recover previously earned vendor incentives negatively impacted full year gross margins by 60 basis points. Lastly, elevated supply chain costs contributed approximately 50 basis points. SG&A expense for full year 2023 increased 3.5% compared with 2022. On a rate basis, SG&A as a percentage of net sales increased 85 basis points to 39.1%. This was primarily driven by expenses growing faster than sales throughout the year as well as an incremental one-time SG&A expenses related to headcount reductions and personnel changes. Our full-year 2023 operating income decreased 82.9% to $114 million. On a rate basis, our OI margin contracted 500 basis points to 1%. Full-year earnings per share were 50 cents compared with $7.65 at the end of 2022. Our 2023 capital expenditures were $242 million compared with $424 million in 2022. The primary drivers of the reduced capital expenditures are related to fewer new store openings and IT-related expenses. We expect that our overall capital expenditures in 2024 will focus primarily on IT enhancements and supply chain optimization. We are committed to a disciplined capital allocation strategy on high return initiatives that hold our teams accountable to time, budget, and financial targets. Free cash flow for the full year was $44 million. This year-over-year reduction was due to lower net income results despite lower capital spend. Since Shane and I have joined Advance, as you would expect, we have taken a deep dive into the business. While we have moved quickly to simplify the business and taken other actions to help put the company on a trajectory for improved performance, we clearly have more work to do. We are focusing on the optimization of our supply chain assets, implementing additional cost-cutting measures, particularly with indirect spend, and improving store productivity. We believe our efforts will begin to deliver incremental improvements this year, which is factored into our 2024 guidance, while setting the stage for growth in the years to come. Our assumptions for 2024 include continued pressure on the DIY consumer, offset by DIFM improvement and modest inflation. These factors, coupled with the solid industry fundamentals Shane discussed earlier, are considered in our full-year 2024 guidance, which includes net sales of $11.3 to $11.4 billion, comparable store sales of 0 to 1%, operating income margin of 3.2 to 3.5 percent, diluted earnings per share of $3.75 to $4.25, capital expenditures of $200 to $250 million, and a minimum of $250 million in free cash flow. With that, I'd like to turn the call back over to Shane. Thanks, Ryan.