Q4 2020 Advance Auto Parts Inc Earnings Call
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Welcome to the advance auto parts fourth quarter conference call before we begin Elisabeth isolated.
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 key for full year 2020 results as well as our 2021 outlet 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 plan 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 caption 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.
Thank you Elizabeth and good morning to all of you joining us today.
Hope you and your families are healthy and safe and all that we've endured over the past 12 months.
Here at advance we're.
We're incredibly grateful for the way our entire team for severe.
When the reality of COVID-19 depended on our communities in March of 2020, we.
We found ways across AAP to meet new and familiar 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 for.
First protect the health safety and wellbeing of our team members and customers.
Second preserve cash and protect the P&L during the crisis.
And third for care to be even stronger following the crisis.
Our results from 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 per.
Protective equipment and innovative ways to serve our customers.
This helped ensure that our team members and customers field states coming.
Coming in to work and to shop.
Our store and distribution center team members continuously desktop throughout the year and they are the true heroes for us.
Many obstacles for our team, we saw significant improvements and organizational health and increased engagement scores throughout the year.
Fundamentally we are building trust in the advance brand Adam 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 brands and our corporate reputation for the long term.
In Q4, we delivered comparable store sales growth of four 7% and margin expansion of 17 basis points. This includes an 82 basis points headwinds related to COVID-19.
Adjusted diluted EPS improvement of 14% to $1 87.
Including a <unk> <unk> headwind related to COVID-19.
For the full year, we delivered topline growth, resulting in record net sales of $10 1 billion.
Adjusted operating income improvement of four 1% to $827 $3 million, including a $60 million headwind related to COVID-19.
Record adjusted diluted EPS of $8 51 <unk>.
Including a 66, then headwinds 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 continued to affect channel performance in Q4 across our industry.
DIY Omni channel led the way as it has since Q2.
It's well documented that consumers are spending more of their time at home likely contributed 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 omni channel business.
Our professional business continued to recover with positive comp sales in both Q3 and Q4.
Miles driven remain below prior year in particular for higher income workers working remotely we 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 southern most regions, including both the southeast and southwest.
Meanwhile, our mid Atlantic and northeast regions remained 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 GAAP between our highest and lowest performing regions that spreads 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.
The first four weeks for 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 remains strong a trend that began with the stay at home orders last April.
Across our professional business our team continued 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.
To enable this we continued to strengthen our dynamic assortment tool, which is now live in all of 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 continued to make enhancements to our online portal my advance.
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 car quest and World class 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 <unk> platform.
We believe pro customers are recognizing and appreciating our investments to improve parts quality product availability delivery speed and the digital experience.
Hosting and higher enterprise pro online sales and share of wallet.
These actions have also enabled growth of our tech net customer base with approximately 1400, new tech nodes added in 2020.
Finally, we continued increasing our car quest independent locations in 2020, and welcoming 50 new stores.
Our independents remain a valuable component of our overall strategy and our team remains focused on further expansion.
Moving on to DIY Omni channel, we gained 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 for.
First the launch of diehard.
Building awareness in regard of advance through differentiation.
Third improving customer loyalty through speed perks and for improving store execution.
Starting with diehard despite the challenges of the pandemic our team successfully launched iron as planned.
And executed a marketing plan, unlike anything we've ever done before at AAP.
Our diehard is back campaign, featuring Bruce Willis.
Consumers know that the iconic diehard brand was back and make it now by 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 increase share of wallet.
In 2020, we drew 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 for discussion on DIY Omni channel, 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 onto 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 effective to drive four wall profit per store improvements.
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 advance and for years ago, we made a commitment to dramatically improve retention.
Continued investment in our unique fuel the frontline program with more than 22000 stock price awarded since inception, it's 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 banner 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, our WNS 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 percentage of savings from this initiative in 2022.
Moving on to category management, the expansion of our owned brand assortment is a key component.
This includes an increase of car price branded assortment in engine management and under car.
<unk> has an excellent reputation with installers and new products have been very well received by both pro customers and car Quest independents.
In 2020, we also launched our strategic pricing initiatives to enhance our capabilities, while incorporating customer decision journey insight 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 benefit in SG&A in the quarter and will enable further improvement and 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 current technology, 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 will be providing a strategic update of our long term plans on April 28.
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 for all our team members for their 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.
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 pumps earlier this year when.
When we resume these in Q4, our actual shrink rates were far better than we had anticipated book.
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 impact in our adjusted financial results that we will begin reporting in Q1 2021, excluding any benefits or expenses from LIFO and our adjusted financial measures.
We believe this adjusted it creates a more accurate picture of our operational results and was more in line with industry practices.
Our Q4, adjusted SG&A expense was $913 5 million.
On a rate basis. This represented 38 six percentage of net sales.
Paired to 36, 9% in the fourth quarter of 2019.
For the single biggest driver of this increase was $19 million from Covid related costs directly attributable to the unanticipated spike in case rates.
We also incurred higher Q for 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 Diehards that campaign.
We also incurred lease termination costs related to the ongoing optimization of our real estate footprint.
We believe we've expected investments and diehard and least 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.
Up 14% from prior year, despite a 22 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 four 1%.
The 50, <unk> week added approximately $158 million per 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 five 2% from 2019 results.
This was primarily the result of Covid related expenses discussed earlier as well as the 50 <unk> week.
We estimate the additional week resulted in a headwind of approximately one 5% to our SG&A costs in the year.
Our adjusted operating income increased four 1% to $827 3 million and our Oi margin was eight 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 related.
Related to Covid costs.
We estimate the impact of the 50 <unk> week with the tailwind from approximately $20 million toward adjusted operating income and a <unk>.
Benefit of approximately 23.
For our reported adjusted EPS for the year.
Our capital expenditures in Q4 was $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 transformational investments, we expect to make in 2020, we'll 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 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 82%.
This in addition to a $76 million tailwind associated with the cares Act.
Adjusted and 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 advance stock and.
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 a meaningful improvement in our cash position from <unk>.
From an $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 the continued payment of a 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 are encouraged by trends through the first four weeks of 2021.
With strength across our DIY omni channel 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 are pleased to provide our 'twenty one guidance based on these assumptions we outlined in our earnings release. Our 2021 guidance includes net sales in the range of 10, 1%.
For $10 3 billion.
Comparable store sales growth of 1% to 3%.
Adjusted operating income margin rate of eight 7% to eight 9% which include margin expansion of 60 to 80 basis points as compared to the 2020 adjusted operating income margin, excluding the $21 million benefit from the 50 <unk> week.
Income tax rate of 24% to 26%.
Capital expenditures of $275 million 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 the operations across our footprint for.
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.
Once again, we want to find the tremendous efforts of our team members and meeting the challenges of COVID-19, while still executing our strategic plan.
We look forward to sharing more on those plans and the investor presentation will publish in April.
Now, let's open the call for your questions operator.
Certainly at this time I would like to remind everyone in order to ask a question. Please press star one 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.
Lasser with UBS Your line is open.
Okay.
For lowering it takes a lot for taking my question. If we take the midpoint of your guide of your operating margin guidance for this year. It implies that youll have achieved around 30 basis points of annual margin expansion.
Between 2019, and 2021, recognizing that theres, some COVID-19 costs in there, but why wouldn't there be more margin expansion given the investments you've made the store closures in the eight year had started off strong with double digit comps. So far this year and if you could also talk about the <unk>.
LOE of margin over the course of this year it would be very helpful. Thank you.
Good morning, Michael.
First of all yes, we're very excited about the start of the year.
In terms of the overall margin expansion.
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 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 it's going to have a significant acceleration of margin expansion and it's going to come from.
Number of areas that we've talked about before so we're going to talk more about that on April 20th I mean, I think the biggest factor in which you described as the COVID-19 related costs 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 COVID-19 related costs and we.
Saw that late in the year it spiked significantly.
Infection rates across the country went up and we remain very focused on accelerating margin expansion once that comes out as we as we said at $60 million for the full year that that'll be a big number for us to two.
Expand our margins with.
Okay.
And my follow up.
Tom you have the advantage of having more exposure to markets that were hit harder in 'twenty 'twenty as well as exposure to recovery in the professional market, which has been slower to improve thus far so as you think about 2000 to 2021.
<unk> tier peers, how much of the GAAP are you expecting that your sales should improve more than the industry. This year.
Admittedly year, recognizing that you had guided to a 1% to three comp, but that seems pretty modest in light of these benefits that youll have especially relative to the rest of the industry.
Well for sure we definitely saw that difference last year. If you look at the the miles driven which is the most.
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 outperformed pro so both of those things we start to lap 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 quick.
Right the economy returns to those markets how quickly people start to return back to work, but there is an expectation that could be.
Those markets will outperform and net pro outperformed DIY this year. So we.
We feel we're very very well positioned in that regard.
And.
We're going to we're going to watch it very closely we have looked at the full year the lapse for each geography, and each channel and we feel very good about how we're positioned to take advantage of that risk.
The resurgence in demand in the mid Atlantic the northeast in our professional business.
Okay. Thank you very much and good luck.
Thanks Seth.
Seth Sigman 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 87 to eight nine EBIT margin I assume that excludes the impact from LIFO can you just confirm whether LIFO is expected to be a headwind or tailwind 'twenty, one and just so we're all comparing apples to apples if you exclude the LIFO benefit in 'twenty.
Looking at EBIT margin in 'twenty more like 8%, so effectively youre guiding 70 to 90 basis points of expansion I just want to confirm those numbers.
Yeah sure first of all we did exclude LIFO from the guidance that we provided in 2021.
We had that as a slight headwind as we're modeling it but it's not in the in the <unk> that we put out the guidance that we put out today.
And then Youre right as it relates to 2020, you would have to back out that $14 million that we had and 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 you look at the drivers this quarter LIFO 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.
Phasing of the benefits related supply chain and some of the other initiatives. Thank you yeah sure.
Our initiatives are really beginning to take shape. So as it relates to category management. For example, we saw improvements in both product cost as well as improvements in price and then we once again leveraged supply chain as the initiatives around cross banner replenishment or continuing to remove cost and we're taking advantage of that so in.
In addition to shrink in the LIFO is if you just called out.
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 <unk>.
The guidance.
Into 'twenty one.
A lot of those same initiatives and those are the reasons debt gross margin is going to be the driver for our margin growth. When we look at 'twenty, one compared to <unk>. 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 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 'twenty, one and those are going to be the drivers that lead our gross margin.
Very helpful.
Thank you very much.
Chris <unk> with J P. Morgan your line is open.
Thanks, Good morning, everybody.
So I guess.
Just a couple of questions on cadence.
Thinking about overall same store sales cadence over the year.
Any additional detail on how youre thinking about pro versus DIY.
Hey, good morning, Chris.
The cadence is much more volatile than the historic rate.
We're going to be pardon me.
Going to.
Be lapping a minus nine in the first quarter and then we go to a seven plus and the plus 10 and then there is variation across the channels and there is 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 highly.
<unk> low double digit growth quarter to date.
And that's prior to the widespread shutdowns that happened late period, three and in superior for.
Period, sorry, the second quarter.
Youll recall, the the professional business was still challenged DIY surged.
That we're factoring in et cetera. So.
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 have got to put some judgment against debt.
We obviously expect to get off to a great start and build on the momentum.
We're excited about the way the euro started off and we're going to continue to build from here.
Got it and then similar similar question on the margin.
Given that on the supply chain in WNS completes over the year at least for supply chain.
WNS does it does the gross margin expansion weighted more to the back half.
The inverse of that is the SG&A, our SG&A dollars were flat in the first half but up.
I am very high in the back half. So is there some inverse going on between gross margin and SG&A over the year.
Bill likely be some Chris the gross margin we to your point, we continue to see improvements steel Cross banner replenishment is a great example of that.
You take out those stem miles that you get that savings immediately we'll be completed with the 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 will continue to see that improvement throughout the year.
G&A again, thats, a little bit more tricky just with the COVID-19 costs almost all of them are in SG&A that went a little bit more difficult to predict.
Certainly we saw a surge here late in the year and early into 'twenty one.
But as we said we are modeling less COVID-19 costs in 'twenty, one as compared to $2000.
When that happens remains to be seen and then we will be lapping some difficult.