Q2 2022 Advance Auto Parts Inc Earnings Call
Welcome to the advance auto parts second quarter conference call before we begin Elisabeth isolate been 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 second quarter 2022 results.
I'm joined by Tom Greco, our President and Chief Executive Officer, and Jeff Shepherd, Our executive Vice President and Chief Financial Officer.
Following their prepared remarks, we will turn our attention to answering your questions.
Before we begin please be advised that our remarks today 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 initiatives.
These 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 captions 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.
Thanks, Elizabeth and good morning, everyone.
Before we begin I'd like to thank our entire advance team and car Quest independent partners for their dedication throughout Q2.
Thanks to their relentless focus on improving the customer experience and disciplined execution of our strategy.
We delivered double digit adjusted diluted earnings per share growth in the quarter.
I'll begin my remarks today with a review of our Q2 performance as well as the factors that led to the revisions made to our full year guidance outlined in our press release.
I'll then discuss the consistent progress, we're making on our primary strategic initiatives before turning it over to Jeff to review, our Q2 financial performance, including an update on cash returns to shareholders.
In the second quarter, we remain focused on the execution of our strategy.
Consistent with this we delivered another quarter of growth in net sales and adjusted operating income underscored by adjusted operating income margin expansion.
Q2, 2022 was our ninth consecutive quarter of year over year, adjusted diluted EPS growth, including a 10% increase versus Q2 2021.
Notably Q2, adjusted diluted earnings per share of $3 74 was.
It was a quarterly record for advance auto parts and grew 72% on a three year stack when compared with Q2 2019.
We continue to invest in our business, while returning approximately $700 million in cash to our shareholders in the first half of 2022.
Our comparable store sales declined by 0.6% in Q2, while increasing 12, 7% on a three year stack.
As we're now opening new locations to expand our footprint. Our net sales grew faster than comp sales and were up <unk>, 6%.
Our deliberate moves to increase own brand penetration, which carries a lower absolute price point reduced both net and comp sales by approximately one full point with a disproportionate impact to professional.
Moving to margins. We're pleased that we were able to deliver a 166 basis point increase in our adjusted gross margin rate in Q2.
A key element of this improvement is the execution of our strategic shift to owned brands within our product mix has just mentioned, which provides a much higher margin rate.
In Q2 owned brands as a percent of overall product mix were up over 200 basis points.
As expected our elevated SG&A costs year over year, partially offset our adjusted gross margin expansion.
Overall in Q2 or 11, 7% adjusted operating income margin was the highest quarterly rate advance auto parts as reported in seven years.
I'll now shift to more details on our sales performance in the quarter and the factors that led to our updated guidance.
After a late spring contributed to a stronger sales at the start of the quarter comp sales soften and turned negative with final results below our expectations.
Merely driven by DIY.
In terms of category growth fluids, and chemicals, including motor oil as well as batteries and breaks were the top performers in Q2.
Our regional sales performance was led by the mid Atlantic and West regions.
While we contemplated several external factors when we provided our initial 2022 guidance in February increased inflationary pressures, particularly in fuel, we're well above our planned estimates in the second quarter.
Rising inflation and significant year over year cost increases are having a disproportionate impact on the discretionary spending of our core DIY consumer.
As a result, our low single digit net sales declined in the quarter and DIY drove our sales shortfall in the quarter.
There are a couple of factors to consider surrounding how a more challenging economic environment impacts the DIY customer.
First the majority of DIY jobs are considered non discretionary in this case diy's must address the problem and repair their vehicles as soon as possible.
These are what we call break fix our failure related categories.
Failure are non discretionary DIY categories like batteries and brakes performed well in Q2.
On the other hand, some categories are more discretionary and therefore can be deferred.
As an example in Q2, we saw softness in appearance chemicals, and accessories, which are some of our better performing categories. During the height of the pandemic.
As we entered the back half of 2022, we expect continued softness in DIY discretionary categories. Despite.
Recent moderation in fuel prices overall inflation, including fuel remains substantially higher than 2021, which we expect will pressure the DIY customer.
This is the primary driver of our updated guidance.
Separately as we consider our balance of year guidance and sales outlook. The biggest opportunity we have to build shareholder value is to complete the integration of AAP and grow our margins.
As we've consistently communicated we remain laser focused on these objectives and are executing our plan.
This includes a relentless focus on category management, which is our largest initiatives to drive profitable growth.
As part of category management, our new strategic pricing tools are fully implemented.
We are now leveraging the enhanced capabilities. These tools have to offer which enables us to differentiate pricing by category region store and customer.
We've also significantly improved visibility into the return on investment surrounding our discounting practices by leveraging advanced analytics to gain insights on the competitive landscape and evaluate our strategic pricing actions.
This is helping determine the quantitative and qualitative effectiveness of these actions.
On the professional side, we're now able to measure sales lift on different levels of discounting real time and at a much more granular level.
Knowing price is not the most important driver of choice for professional customers, we're becoming more disciplined and eliminating unprofitable discounts.
An important byproduct of this strategy enables us to redeploy resources to enhance our service to our most loyal and fastest growing customers.
Our disciplined pricing strategy is an important value driver, which we expect to contribute to further margin expansion over the long term.
In the short term we expect this may result in temporary sales softness in our professional business in the back half, which we factored into our updated guidance.
We firmly believe this is the right approach for AAP to drive sustainable topline growth and margin expansion.
Looking forward, while we're cautious about the consumer and macroeconomic outlook, we remain bullish on the resilience of our industry and the disciplined execution of our strategy.
At an industry level key drivers of demand remain positive, including the outlook for the car Park and aging fleet and vehicles entering the sweet spot.
A critical variable we're watching closely is miles driven which in Q2 still remains slightly above 2021 levels.
I will now briefly discuss the progress we've made on some of the drivers of total shareholder return outlined in our April 2021 strategic update.
An important driver of our CSR agenda is to deliver profitable growth, while building sustainable capabilities to drive long term competitive advantage.
Starting with professional our long term growth strategy concentrates on what our customers value most extensive parts availability and outstanding customer service and reliability of delivery.
We offer customers a comprehensive multi brand assortment of high quality national brands owned brands and OE parts.
He's of ordering as well as consistent reliable delivery.
By leveraging enterprise assets, we're strengthening our value proposition with the tools, our customers need to grow their business profitably and ensure they have the right part at the right time.
As we grow together with pro customers, we continue to add important program elements to help our customers compete.
New vehicle technologies, such as hybrid and electric along with an industry wide technician shortage creates challenges for our professional customers.
This led us to create enhanced training and technology platforms that help customers provide comprehensive repair services and recruit technicians.
Our focus to strengthen the pro customer value proposition as demonstrated by growth in our strategic accounts and technet customers.
The successful rollout of diehard batteries and professional garages continues to drive sales growth and bring new customers to these large accounts.
Car Quest branded parts are also gaining momentum as a result of their high quality evidenced by very low return and defect rates.
Separately, we are continuing to leverage <unk> best in class model for professional customers across the enterprise reliable delivery is vitally important and enables installers to more effectively schedule technicians and provide their customers with accurate service times now when an order is created we've enabled all of our ditch.
Little platforms to provide delivery times like World Pac has done for many years.
In DIY Omnichannel, our number one priority is to ensure our customers have the parts they need to do the complete job.
We continue to work on improving store in stock rates as global supply chain constraints moderate.
This includes adding more depth of parts in the front room, and leveraging our dynamic assortment tool to improve parts availability for the complete job.
Our highly regarded owned brands are a differentiator for advance specific to diehard. We continue to build this brand and delivered another quarter of double digit sales growth.
This ongoing strength is due in part to the successful launch of diehard hand, and power tools as well as our latest product innovation, the exclusive diehard EV and hybrid battery.
In terms of building awareness and increasing loyalty the enhancement of our speed perks program through the launch of gas rewards has been a highlight for DIY this year.
Our field team has dialed the execution of this initiative in 2022.
Year to date active speed perks members have increased to $13 million.
In Q2, we increased speed perks as a percent of both transactions and sales by over 300 basis points compared with the prior year quarter.
Rounding out our top line growth initiatives, we are executing our new store opening plan in the quarter, We opened 43, new locations, including the recent opening of our flagship store in downtown Los Angeles.
Our California expansion is already contributing to share gains in the west.
Year to date, we've opened 78, new locations and remain on track to deliver our annual guidance of 125 to 150, new stores and branches.
I'll now shift to the progress, we're making to capitalize on our significant margin expansion opportunity starting with category management.
Our strategic pricing strategy starts with a deep understanding of the customer decision journey for each job, including the role of price.
Obviously, the importance of price varies by both channel and job based on a variety of factors.
As we execute our strategy, we can remain competitively priced remove unprofitable discounts and drive further gross margin expansion.
Separately, we are streamlining and simplifying our supply chain to improve service and reduce cost.
We continue to rollout a single warehouse management system across the advance and conquest DC network and are on track to complete the implementation by the end of 2023.
We've also begun activating elements of our labor management suite of tools across our DC network and are beginning to see productivity benefits.
Finally in terms of SG&A, we're leveraging our labor management tool to do a better job of matching hours to transactions in our stores.
This helps improve scheduling to ensure we're there when the customer needs us and offsets rising cost per hour inflation when transaction softened.
In summary during the second quarter. We're pleased that we were able to expand adjusted operating margins and deliver a record quarter of adjusted diluted EPS.
We also returned nearly $700 million of cash to shareholders in the front half of the year.
Over the long term, we remain focused on building a stronger customer value proposition for both pro and DIY customers.
While we expect that both the consumer and retail environments will be challenging in the back half of 2022. We also believe that the continued disciplined execution of our initiatives will enable sustainable long term growth and margin expansion going forward.
I'll now turn the call over to Jeff to review, our Q2 financials and updated outlook for the balance of the year.
Jeff.
Thanks, Tom and good morning.
I'd also like to thank all our team members for their ability to quickly adapt in this unique environment.
In Q2, our net sales of $2 7 billion.
Increased six tenths of a percent compared with Q2 2021.
Driven by continued growth in our professional business and new store openings.
Our comparable store sales declined six tenths of a percent.
As Todd mentioned, both net and comp sales were reduced by approximately 100 basis points due to increase own brand penetration.
Adjusted gross profit margin expanded 166 basis points to 48% through the combination of our strategic pricing actions and the benefit of higher margins associated with owned brands.
These improvements were partially offset by continued product cost inflation.
Which was an eight 8% increase on a same SKU basis in the quarter.
Along with headwinds associated with product and channel mix.
While we realized planned cost savings and supply chain these were more than offset by wage and transportation inflation.
Our Q2, adjusted SG&A was $967 million.
Or 36, 3% of net sales.
This compares to $926 million or 35% of net sales in Q2 2021.
Our largest headwind to SG&A in the quarter was higher inflation in wages and fuel.
Additionally, we incurred anticipated startup costs related to our California expansion.
However, with over 50% of our locations open they are now contributing incremental revenue and operating income.
Finally costs related to our anticipated channel mix shift to professional were higher than a year ago.
These SG&A costs were partially offset by favorability in incentive compensation as we lap higher bonuses, resulting from our strong performance last year.
We also saw improvements from last year's productivity efforts related to our corporate restructuring and reducing our office and store footprint, along with lower COVID-19 related expenses.
As we look at SG&A going forward, we are experiencing higher inflation than we estimated when we provided our original 2022 guidance.
We now anticipate higher inflation in wages and fuel will continue in this <unk>.
Bind with a softer than expected top line will result in SG&A deleverage in Q3.
However, we remain focused on leveraging SG&A in the back half of 2022.
Our Q2 adjusted operating income was $312 8 million.
An increase of three 6% compared with Q2 2021.
Our Q2 adjusted Oi margin rate of 11, 7% was an increase of 34 basis points compared with Q2 of the prior year.
Our adjusted diluted earnings per share of $3 74.
Increased 10% compared with Q2 2021.
For the first half of the year free cash flow was $97 3 million compared.
Compared with $647 million in the first half of 2021.
This was largely driven by working capital, particularly inventory and receivables.
We expect significant improvement in working capital metrics in the back half as reflected in our updated full year guidance for free cash flow.
In addition, we continue to invest in the business and our Q2 capital expenditures were in line with expectations at $96 4 million.
Bringing our year to date capital expenditures to $211 million.
In addition to the strategic initiatives Tom reviewed we continue to return excess cash to shareholders through a combination of share repurchases and our quarterly cash dividend.
In Q2, we returned $200 million to shareholders through the repurchase of approximately 1 million shares for an average price of $199 in <unk>.
And approximately $90 million through our quarterly cash dividend.
Our board also recently approved our quarterly cash dividend of $1 50.
Importantly, despite macroeconomic pressures, we have returned $694 million to shareholders in the first half of 2022, which is more than triple what we returned in the same timeframe of 2019.
Shifting to the back half of the year. Our original guidance in February included the estimated impact of several factors such as lapping stimulus and elevated inflation <unk>.
However, we did not anticipate total inflation to be at a 40 year high.
In addition, the increases in fuel prices during the second quarter far exceeded our expectations.
As we described earlier, we're seeing evidenced these two factors are putting a strain on DIY customers.
Combined with our front half results, we're providing updated ranges for our 2022 guidance of net sales of 11 billion to $11 2 billion.
Comparable store sales of negative 1% to flat.
Adjusted operating income margin rate of nine 8% to 10%.
Adjusted diluted earnings per share of $12 75 to $13 25.
A minimum free cash flow of $700 million.
And share repurchases between $500 million and $600 million.
We're maintaining our previously provided ranges for income tax rate of 24% to 26%.
Capex range of 300 million to $350 million and new store and branch openings of 125 to 150.
To close out our prepared remarks, our goal is to deliver top quartile total shareholder return as outlined in our 2021 investor presentation.
The midpoint of our updated 2022 guide for adjusted diluted earnings per share is up 8% when compared with 2021 and represents a 60% increase to the comparable 2020 base period for our three year plan.
We remain focused on the disciplined execution of our strategic plan.
And I want to once again, thank our team for their dedication in serving our customers every day with that let's open the phone lines to questions operator.
At this time, if you'd like to ask a question. Please press Star then the number one on your telephone keypad.
Again Thats Star then the number of wanted to ask a question.
Your first question comes from the line of Christopher <unk> with Jpmorgan.
Thanks, and good morning. So my first question is can you talk a bit more about the cadence of the quarter, you've given some provide some granular detail in the past and as gas prices have receded did you reach your return to positive comps and then can you give some color on what you've seen quarter to date.
Hey, good morning, Chris.
As we talked about in our remarks.
Why it was really the driver.
Performance in the second quarter.
<unk> been looking at our sales on a multiyear stack basis for quite a while and early in the quarter or a three year stack in one year comp sales were the strongest during the quarter as we went further into it our topline slowed and it was really DIY that was the majority of the shortfall versus expectations in that timeframe, we expected that.
Three year stack for DIY to be similar to what it was in the first quarter and it just wasn't and we attribute that primarily to the broader consumer dynamics that you've heard from many others.
<unk> inflation rising fuel prices, which really pressured lower income consumers.
Cause them to make some choices on discretionary purchases and we saw that we saw discretionary categories like.
Appearance chemicals, and accessories were very soft for us in the quarter. So really with DIY that was the driver and Thats what changed as the quarter went on.
We're not going to talk about specific numbers quarter to date, but what we have done is embedded our quarter to date performance into our full year guidance, which you saw in the back half is minus two to zero.
For the back half of the year.
Got it.
You mentioned DIY it was down low single digit, presumably thats, a comp and a three year basis. It looks like DIY actually improved whereas do it for me.
Decelerate. It then that would put the do it for me up low single digits, and that's well below what others are posting in the industry and the structural growth rate of the industry. So I'm. Just curious can you can you expand more on what year you were referencing earlier around the pricing efforts.
It sounds like basically you're eliminating unprofitable customers and thats whats driving the relative performance and do it for me.
Yes, I think you have that right, Chris I mean, we.
The short answer is we're executing a very different strategy.
Right now and our strategy is to essentially to grow above the market and expand margins at the same time, we talked about the fragmentation in the industry many times.
We believe theres lots of room for us to grow above the market in the coming years, but right now the biggest opportunity. We have in advance is to complete the integration of the company and improve our margins, which is which is unique to us I think.
In the back half of the year, but that means we're going to execute our category management plan, which includes a deliberate intentional move to increase own brand penetration and we talked about this opportunity we have with strategic pricing, we built a terrific team there.
We stood the pricing.
Software package up about a year ago, we knew we could get to localized pricing and DIY and ultimately into DIY.
We're now leveraging the full capabilities of that tool and we are removing unprofitable discounts really in all trade channels, but inside of pro.
This particular action May mean, we can at least some unprofitable sales on the table in the back half. So we firmly believe this is the right strategy for us.
We recognize that we didn't grow above the market in the quarter, but we did grow margins to a quarterly record and we grew earnings per share by 72% on a three year basis. So our long term goal is to grow above the market and expand margins and that's what we're executing right now.
My final question is just as you think about.
The three year plan that you laid out and your thoughts on getting to that 10 five to $12 happen Dilip.
Delivering total shareholder returns.
You've got you've laid out.
How are you thinking about your ability to get into that range next year.
Yes, well right now obviously, we're focused on finishing 2022 and beginning 2023 as strong as possible, but let me react to the specific targets. We laid out the short answer is based on what we know today, yes. We believe we can get inside the ranges that we laid out we laid out goals for 'twenty one through 'twenty three as you.
Remember for net sales or earnings per share for margin rate in a number of other financial metrics.
We believe we can get inside the range on all of those key metrics, we do see the margin rate at this point is going to be the most challenging given the inflationary environment that we're dealing with but we still believe we can get inside of that range and we're excited about continuing to execute our plan to do that so I will reinforce this is obviously a point in time.
Assessment.
Got a lot of volatility in the current environment. There are several macroeconomic factors out there that are difficult to predict.
Right now we plan to plan to provide annual guidance as we usually do next February in 2023, and we will have a lot more insight into just exactly where were going to finish within the framework. We decided the one thing I would add Chris is we also believe that beyond 2023, there is continued opportunity for growth and margin expansion.
For us beyond that.
Got it thanks very much.
Yes.
Your next question comes from the line of Michael Lasser with UBS.
Good morning, Thanks for taking my question.
So you're adjusting.
Operating margin and gross margin were up.
GAAP gross margin was down.
Can you explain why that was the case.
Your free cash flow was under a significant amount of pressure, suggesting that that the GAAP gross margin is more a reflection of what's happening with the with the cash flow. So can you explain that as well.
Yes sure Michael.
Let me start with the.
The GAAP margin if.
If we were to include the LIFO expense into our adjusted results. We would have Deleveraged 30 basis points versus last year, which I think is what youre focused on and just in terms of context from a dollar standpoint, the LIFO benefit from an adjusted standpoint was $92 million this quarter versus last year when it was <unk>.
$39 million. So you have that increase of $53 million, but let me give you some context around this.
Really important that we framed LIFO into our broader gross margin plan and what I mean by that is we've got a very comprehensive strategy to improve our gross margin rate over time so.
Execution of our strategic pricing initiatives, we talked about a lot of that in our prepared remarks, the expansion of our owned brand portfolio optimizing supply chain and these were all the contributors that drove our 166 basis points of adjusted gross profit.
Now looking forward.
As it relates to LIFO, we know the products. We know the categories. We know the skus that are driving these inflationary costs that are sitting on our balance sheet.
And we're able to model, how and when these costs come off the balance sheet, whether it's a FIFO basis or whether it's a LIFO basis. So we have incorporated these inflationary cost and.
Related headwinds into our guide.
That includes these higher product coming off the balance sheet and it's important to note Michael that we're already seeing that today. This is not something that is looming. This is not something thats late 'twenty three 'twenty four we're experienced in Q2, we're going to experience it in Q3, and so forth and so on so.
That's all very much contemplated in what we've done in the back half guide and then once we guide in February for 2023.
Now as it relates to free cash flow.
Specific to the guide.
It's really attributable to the top line guidance that we.
We provided yesterday.
Keep in mind in the first quarter, we had free cash outflow of $170 million and we outlined all of the factors that went into that.
Largely anticipated if you look at our free cash flow discreetly in the second quarter significant improvement, we had free cash inflow of $267 million and we do anticipate that the.
The back half to be more in line with the second quarter.
It gives us the basis.
For our revised guidance of $700 million.
So we believe our receivables were going to be collecting on those we believe our inventory is going to be coming down in the back half.
Those factors along with the revised guidance is it's why we have the minimum of $700 million of free cash flow.
So my follow up question is Jeff would you expect the LIFO gross margin to turn positive this quarter or in the next Q.
And over the back half.
It's very difficult to say we are we continue to believe we're going to be in an inflationary environment in the back half.
Sequentially, we think it's going to moderate but.
Year over year in the back half, we think inflation, including product cost is going to be higher.
If we think about LIFO for example.
Had 170.
About $175 million in LIFO expense in the first half of the year, we're thinking it could be.
$2 50 to $75. So it could be another 70 $500 million more in the back half.
Okay. Thank you very much.
Your next.
Next question comes from the line of Simeon Gutman with Morgan Stanley .
Good morning, everyone.
Tom I wanted to ask about strategic pricing I wanted to ask.
Hugh I guess accelerated this strategy in the last call it quarter and in the past it feels it felt like you've done it in a way to minimize the elasticity.
Sounds like the stuff, that's happening now and maybe into the back half.
A greater impact than than what we thought or maybe it's just a timing thing.
Hey, good morning, Simeon I think the what we laid out at our Investor day about a year and a half ago was was the plan for strategic pricing over time.
We talked about lifecycle pricing, we talked about how we were going to approach that we talked about the ability to localize and it sounds like price literally bye bye.
By channel by store by customer et cetera, et cetera, and it took us a while to stand up those capabilities.
We're able to get to that on the DIY side in the early part of this year and we knew that <unk> was going to be in the back half.
These are these are difficult decisions, obviously to your point when we looked at obviously the environment has changed versus what we anticipated heading into the year.
For us it's the right strategy is to make sure.
That we are spending money very wisely as it pertains to discounting and the professional sales channel our biggest opportunity to get those margins up and we've obviously looked at the competitive landscape and what's going on.
By product type and where there are.
Where there is pressure for us. This is the right strategy for us to execute and it's definitely the long term play separately, we're continuing to build out our value proposition and pro in those areas that we think matter most of the customers, which I'm happy to speak to but that's really the approach.
Thanks, that's helpful.
And then just a follow up on the private brand penetration if we heard it right was 200 basis point year over year growth in the quarter.
As the spread between the private brand gross margin National is it about the same can you quantify it and then maybe can you just quantified the contribution it had to overall gross margin in the quarter.
Yes, we are.
We're not going to break it out specifically, but what I can tell you is within category management, we outlined three broad territories.
Strategic pricing owned brand penetration in sourcing in that order.
Own brand penetration is a significant contributor we basically laid out 180 to 200 basis points of margin expansion on our Investor day presentation. So it's the second largest and we clearly see further runway there I mean, we're definitely getting meaningful contribution to margin expansion today with our own.
Brand expansion, we expect that to continue in the back half it's going to continue into 'twenty three and candidly will continue into 2024, it's going to take a while.
And we're continuing to improve.
The overall impression of those brands Diehard is doing well car quest is doing well on the professional side. So we're very excited about it and we're going to continue to execute against it.
Okay. Thanks, Tom and good luck everyone.
Thank you.
Your next question comes from the line of Bret Jordan with Jefferies.
Hey, good morning, guys.
Good morning, good morning.
On the <unk>.
Second quarter, and then I guess the outlook for the second half what does that comps.
I guess explain in inflation versus units what was the price contribution because I guess, obviously on brand as lower price point, so maybe adjusting for mix, how does that shake out.
Yes, well units for everyone in the industry are down.
Primarily driven by DIY Brad.
We called out at the beginning of the year DIY is is about 60% of our units right. So and then those those lower price per unit.
Adams in DIY tend to.
Drive that number but Jeff.
Jeff called out are our cost inflation in the quarter, which was 88.
Eight 8%. So you should assume our pricing was slightly above that because we are.
Essentially pricing.
At least keep rate neutral or better so that's kind of where it is.
And I guess is on the second half outlook the minus two to zero I think youre lapping harder inflation compares in the second half of last year.
Yes, that's factored in we recognize that we looked at.
The broader industry, the retail landscape in total which.
As you know is we're not seeing consumption growth in the broader industry. I mean, everyone is seeing units down and all of the growth in retail is coming from pricing at this point, we looked at the industry performance, we can only see DIY and when our peers report, but we expect that transactions and units will continue to be.
Below a year ago in the back half and then obviously our own initiatives and in our case, we've got a particular initiative on on strategic pricing that thats going to impact our top line, a little bit, but it's going to drive our margin performance.
Those are the factors that went into it.
And then I guess the outlook on payables ratio in the second half.
<unk> to cash flow, where do you see that I mean, I think you were running in the <unk>, but not <unk>.
Significant expansion in the second quarter, but how do you see payables growing and does that going to be impacted by the private label. Our brand strategy is that more or less likely to get extended payables.
Yes, just from an overall payable ratio in Q1, we did some forward deployment related to inventory. So it was less impacted by payables is more impacted by the.
Increase in the inventory as we did the forward buys to avoid disruption primarily related to China Lockdowns, we talked about the Olympics, we talked about.
Chinese new year.
So that's really what's kind of pressured our AP ratio.
We did improve from Q1, we expect that to continue to improve its going to be a combination of both payables and inventory.
<unk> inventory to come down in the back half.
And that coupled with our ongoing efforts in AP, we expect to see improvement over the back half in our AP ratio.
Okay, great. Thank you.
Your next question comes from the line of Scot Ciccarelli with truest.
Good morning, guys Scot Ciccarelli.
So you guys talked about significant softness in your discretionary in DIY sales can you guys help provide some color on how big.
That segment is as a percent of mix.
Okay.
Well first of all just to make the point I think you know Scott.
The non discretionary categories are much larger right. So when we're talking about.
Our business Thats, what we love about the auto parts industry.
Batteries brag casino failure related parts are much larger but at the margin on the DIY side things like accessories and appearance chemicals are pretty pretty sizable and certainly at certain points of the year there are bigger than others in fact in Q2 so.
We definitely saw softness in those discretionary categories I think what's happening is.
The loads and it'll come.
Customer you've heard about all these quintiles and things like that from others.
Customers are obviously paying significantly more for food they are paying significantly more for gas and theyre, making choices about where they spend their discretionary money, what's a little bit difficult to tease out in DIY as part of the benefit we saw in appearance chemicals and accessories over the last couple of years was related to people being at home.
Home and having time on their hands, we believe but that will moderate as we get into the back half so.
Obviously very important categories for us we're going to continue to stay focused on them. They have been soft for the entire industry.
Over time, that's going to normalize.
Tom just to clarify for everyone. So that overall DIY, including failure related parts everything was negative with particular softness on the discretionary side is that the message we should be walking away with.
Yes.
Non discretionary discretionary were up.
The discretionary categories and pulled the number down because they were down pretty significantly.
Non discretion was up okay, Thats, all second quarter alright, thanks, guys.
Okay.
Your next question comes from the line of Seth Basham with Wedbush Securities.
Yes, Hi, this is Nathan Friedman on for Seth.
My question is following up on the 2023 operating margin target question. You. Initially provided some building blocks and category management supply chain SG&A and the negative impact from inflation relative to 2020 can you, possibly quantify what you realized to date relative to these targets how much higher inflation is relative to this plan and what if any.
<unk> is or could run ahead or behind schedule at this point in time.
Well I'll, let I'll, let Jeff speak to how much ahead of plan inflation is but I mean, the biggest bear.
<unk> is inflation I think in terms of us executing our targets Nathan we are executing our plan.
Our category management initiatives are very much on track, we still see further upside with category management as we said earlier, we're starting to execute that more version the strategic pricing platform, we're going to continue to drive owned brands.
In terms of supply chain, we're making a lot of progress I mean, we are in a position where we are now opening brand new distribution centers that are much more modern.
The team's doing a terrific job transitioning very old I would say antiquated facilities as an example, Riverside, California, we've moved into a brand new building in San Bernardino, California up near Toronto, We've moved from <unk>.
Very antiquated building, an <unk> sale to a new building in Bolton from both of those are going to be operational in the fourth quarter. So that's going to really help us improve our service to customers and reduce our cost over time. So we are executing against our supply chain initiatives also and then within SG&A, where we're executing against those initiatives. So.
We're going to continue to execute the initiatives with what has been the wildcard is the inflationary costs and things like fuel and wages, which I don't know if we can quantify Jeff, but it's a very big number versus what <unk> anticipate I can give you some color when we did the Investor day in April we said the 280 to 290 basis points, which was largely covering.
Non product inflation, we said that was embedded in our category management.
Just.
Just some data points fuel is up 50% so.
We certainly didn't contemplate that wage.
Mid mid single digits. So.
Two <unk>, what we had anticipated we did not anticipate 567% wage inflation, we did not anticipate 50% completion and fuel.
And so if we were to redraw that chart that last Red bar that we had there in April will certainly be bigger and so with the green bars to the left of it to overcome that so we can still hit our 10 five to 12 five.
Got it. Thank you for that and then my follow up is just on <unk>.
SG&A near term guide you mentioned expectations for <unk> deleverage, but I believe second half overall leverage if I heard this correctly just curious if you could provide a little bit more color on these expectations and some of the drivers just beyond the prospectively lower sales outlook. Thank you very much.
Yes, what we said originally was.
First half was going to be heavily driven by gross margin and that certainly was the case second half we're going to continue to see.
Benefits from gross margin as it relates to SG&A. Our goal is to leverage SG&A SG&A in the back half, but theres. Some puts and takes there and then so let me just give you a little bit of perspective because.
It looks a little different relative to what we expected in our full year guidance February .
We just talked about first while inflationary costs in store payroll and fuel.
Iterating sequentially. These costs are much higher than what we originally expected and look we've got to pay. These it's important that we stay competitive in wages in our stores for example, make sure. We're fully staff serving our customers know what we can do is to continue to leverage our demand driven labor tool.
We call it Monday to help offset this cost per hour inflation.
And then we still have the tailwind we're going to get the benefit from last year's the corporate restructuring we had the rent reduction initiatives.
We're lapping in the second half, we're lapping last year's investments in our California expansion and opening more of these stores. So the sales from the stores will begin to help offset the cost that we're incurring and then we do expect the benefit from last year as higher incentive compensation. So we've taken all of these factors along with the moderation of our topline.
And incorporated into our updated guidance.
Just a quick follow up on that.
Hi.
When will you be opening all of the California stores.
And we're pretty excited about the performance out there Nathan where we're focused on hitting the 125 to $1 50 guidance total. So we are balancing some of the new store openings, we have around the country with the store openings in California.
We're going to get as many of them opened this year as we can some of them may move to the first quarter, but overall very pleased with the performance out there were out there recently, we've got a partnership with the Dodgers that has really resonated with the Hispanic community, we can see our market share gains out there.
We're making a lot of progress out there I feel really good about our performance and we're going to stay focused on that market. It's a very important market as you know it's.
It's one where we have very little penetration, we've got nice overall professional business with <unk>. So that's where we're going to leverage our enterprise assets to bring that whole package together. So the DIY business that we're getting from the converted stores, but also a very very large professional opportunity in southern California. So on.
On track too to get these stores open soon and.
As I mentioned earlier, the San Bernardino DC once it's fully operational is going to help us immensely out there.
Great. Thanks for the color guys and good luck going forward.
Thanks.
Your next question comes from the line of David Bellinger, with MK and partners.
Hey, Thanks for taking the question so on the impacted sales in comps from the owned brand shift how long can that pressure linger and should this be the peak of the impact in terms of magnitude at about 100 basis points and if you could share with us anything thats embedded in the back half guidance.
Hey, good morning, David I think.
We don't see it as linger, we see it as a good thing I mean, the performance of these brands drives our margins.
And it has a lower cost per unit than the alternatives that are out there. So in this environment, where our customers are looking for value and particularly the professional garages are looking for value. This is something that they want so.
It pulls the comp sales number down for sure because you have a lower price per unit you sell a 100 units.
The alternatives that we have are priced at a higher price per unit than the owned brands, but we see that honestly potentially accelerating in the back half and then into 2023 and then it has been and will moderate over time, but we've said before that the owned brand penetration that we have is below.
We're targeting over time, but we believe below what our peers have already done for many years. So we're going to continue to focus on that and.
Continue to forge stronger relationships with our with our national brand suppliers, because they are very important to us too.
We have a very wide selection of national brands and OE parts that are extremely important to our overall value proposition. So it's a balanced approach, but the success of diehard and car quest is something that will really help us deliver on our goal of profitable growth.
Got it and my my second question, you mentioned, a couple of times better matching labor with in store traffic and demand. So what's the timeframe for getting that system fully in place and how do you size the potential labor savings attached to that.
Im really pleased with how our field team is managing this David I mean, we stood up a tool Jeff mentioned it we call it <unk>.
We were a little bit I would say, we had a pretty good sized opportunity in terms of how we how we staffed and once again.
We are rebuilding a lot of things in the company with with really great leaders.
With improved technology and improved processes around it we've got a breakfield leader the person that runs this side of the business just came out of a region Vice president job. He's got extensive experience in this area and we are using the technology tool. The way it's been designed which is to really look forward at the transaction outlook.
And obviously the lower the transactions.
The less hours you need when you need more when you see more transactions coming in you have to increase hours. So we're matching that up against.
The hours that we're that we're issuing and then we measure obviously our performance.
<unk> hours to scheduled hours and the like so.
Much more rigor around it much more success around our field team is doing a really good job of executing it obviously.
We will get past the back half we want transactions to go back up but it's just a temporary situation where the DIY business in particular, we expect to be soft on transaction in the back half and that enables us to offset cost per hour inflation as we said.
I appreciate it thanks Tom.
Your next question comes from the line of Michael Baker with D. A Davidson.
Okay. Thanks, just two questions one short term one longer term just to confirm it if you said it I apologize, but the <unk> business.
It seems like.
It was positive you said, but where was it relative to plan how did that perform versus your expectations.
Yes.
Morning, Mike.
<unk> was relatively close to plan in the second quarter.
DIY was the driver of our shortfall versus expectations and part of that was we knew we were going to be doing in DFM. We are executing a different strategy as I outlined earlier and as we look at the back half.
When we really fully implement what we're talking about here in terms of version more localized pricing and elimination of we would say unprofitable discounts in the professional channel.
Okay makes sense and then I guess I guess, it's a long term question to follow up on that.
Doing away with those unprofitable discounts in DFM, so, presumably youre, giving up share to someone as you've done. This any idea who is coming in and taking that business that you are giving up.
That's a very difficult thing to say.
We're obviously very aware of the competitive landscape and we obviously look at it by category. We look at it by product we look at it by geography. So those are the big things and by channel. So we know from an internal perspective, we balance rate.
The share of wallet opportunity, we have with each customer on the professional side with the return on investment <unk> got in some cases.
Our large strategic accounts are large tech net accounts.
Lean in heavily with those accounts and we're very very mindful of what's going on there and our goal. Obviously is to continue to continue to better serve those customers and drive share of wallet with those customers. What we're talking about here is at the margin.
Discounts that were offering to very low share of wallet customers, where we don't have a large presence and by strengthening our value proposition and focusing what we're doing in pro on those things that matter to those customers in those areas. We believe will be able to grow grow faster long term.
Okay that makes sense, but if I could follow up and maybe you can't answer this but.
If youre, giving up that business why would someone else come in and take that business is it in your view is it that they're willing to take a lower margin or does someone else have a lower cost to serve for some reason do you have do you have any view on that.
Yes.
It's obviously a difficult thing to say I mean, we don't look at it in isolation, though I want to reinforce that I mean, we.
It's not just about well this particular discount or deal that we're offering.
It doesn't.
Provide the adequate return we look at it with our longer term objective.
We have to set priorities. These are difficult decisions, they're tough decisions, but we all looked at this again multiple times. This year as we went through the year and we believe this is the right strategy for us.
Perfect. Thank you I appreciate the color.
Thank you.
Your next question comes from the line of Emily Hyde with Evercore ISI.
Oh, Hi, it's Greg Melick.
Private for ISI.
My question is really twofold, one is on pro and then the Pep boys stores. So first on the <unk>.
On the pro units.
That was up into Q.
Given inflation was was probably less than pro.
Our units units were down in Q2, Greg I think that's been a.
A bit of a multiyear trend.
Units were down.
Yes.
Part of that is just the price per unit the average selling price per unit is up significantly as you as you know so units were down.
And your second half guide would pro units also be down.
Yes.
Got it and then the second question was on the converted stores I think it was it was like a 100 some leases that you got from Pep boys, how many of those are actually converted now and we'll do it.
Is that all in the 125 to $1 50 this year.
Yes, we incorporate what we're going to open in the 125 to $1 50, I think we gave the number year to date over half.
Over half.
And in total we're at 78 I think.
Yeah. So I mean, our year to date, new store openings are on track to get to the $125 50. So yeah got it and then remind me when you. When you open those are those those aren't in the comp those or do they stay out of the comp for 13 months. When you Thats right 30 13 periods roughly.
<unk> year, but 13 periods and then once it hits that 14 period it didn't goes into cost.
So I guess, maybe a follow up on those I mean, how are those going when you get them opened.
What sort of lift are you seeing whats the mix of business showing you.
Yes, we still have a big opportunity on pro Greg I think you know that the stores themselves were primarily DIY, which is great. So.
Our business is as such.
Somewhat established bye Bye Pep boys previously so the DIY business is still the majority of the sales which is different for us typically in advanced or more 50 50, but these are much higher as a percent of sales on DIY and thats the biggest opportunity for us we've got our large.
Our national accounts that are out there that are really excited that we're opening the stores. So now we're able to service them in southern California, which we have not been able to do in the past.
So thats going to be the big opportunity for us as we get the stores open and part of it is just getting density in Metro L. A and some of the other urban market San Diego et cetera that we have out there once we get them.
The larger number of stores opened we have more density and then we can get more parts of the customer.
Got it and then I think it is hopefully a quick follow up you talked about how inflation was more than the product cost inflation in the second quarter.
We know you are cycling more inflation back half last year.
Should we expect year over year inflation sort of decelerate mid single digits on the back half is that what's in your guide.
Yes, that's a good way to think about it.
We're looking at it.
As we said sequentially coming down but year over year still up.
Got it alright, good luck guys.
Thanks, Greg.
Yes.
Your next question comes from the.
Our line of Zach <unk> with Wells Fargo.
Hey, good morning can you refresh us on your take for industry growth rates in 'twenty, two for DIY versus pro and how that evolved since your initial expectations and then as we look ahead do you think DIY and pro units can both grow in 2023.
Hey, good morning.
I mean, originally when we did our Investor day, which again was a year and a half ago, we had DIY low single.
Obviously as the year went on it was it was a stronger year in 2021 pardon me for DIY than than we'd originally anticipated. So that's when in February We said boy, we don't know on DIY in 2022, it could be more challenging.
So I think relative to our Investor day.
21, better 'twenty, two probably slightly slightly below obviously, we look at the reported numbers of peers.
And we will look at the syndicated data, which don't exactly match up I can tell you. So.
That's the short answer there, but I think DIY in the back half of this year, knowing all of the things we know today. The inflationary pressures. We think that there is going to continue to be pressure on that on the discretionary income and that's going to that's going to put pressure on DIY and the backup sorry remind me your second question again.
Do you think units can you and ROE in 2023.
Yes.
Units units is a tricky question I mean transactions.
We do think transactions can grow.
Units as a function of the complexity of a vehicle and how difficult the repairs and how parts change over time, sometimes you need fewer parts to do the same job, but its higher revenue for the job right. So, but we are focused on transactions, there and driving transactions and we do think they can grow in 'twenty three.
Got it thanks for that Tom.
And then Jeff you had called out about $20 million SG&A drag from the <unk> startup costs in Q1.
Can you talk to how that trended in Q2 and the deleverage impact.
And how you expect the drag to trend.
As we move through the second half of the year in those stores start to open.
Yes, so in the second quarter it was not as high as what we saw in Q1, obviously as we open those stores, they're not startup costs anymore, where we're getting revenue.
Associated with those stores that trend is going to continue into Q3 and into Q4 and while we expect to have start up costs are going to be significantly lower than what we saw in the back half of 2021. So net net it will be a tailwind because we won't have as much startup costs in the back half of this year as we saw <unk>.
Last year, because we really didn't have that many stores open in California last year. So that's sort of how we're thinking about that.
Got it thanks for the time guys.
Thanks.
At this time there are no further questions I'll turn the call over to Tom Greco for any closing remarks.
Well, thanks to all of you for joining us this morning, as we move into the back half of the year, we remain committed to the disciplined execution of our long term strategic plan, including profitable top line growth and sustainable margin expansion in turn we're confident that we'll be able to return meaningful value for our shareholders.
Importantly, while we are focused on transforming advance and completing the integration. We also recognize the importance of giving back to ensure we're leaving the communities we live and serve better for generations to come. This includes the kickoff of our American Heart Association fundraising campaign in stores Tomorrow. Our 'twenty. One campaign was a record fund raising year for <unk>.
Raising nearly $1 7 million to support the critical mission dedicated to fighting heart disease and stroke, where.
We're incredibly grateful for the generosity of our team members our partners and our customers who are giving back and I am really excited to get back out into the stores next week and kick off this year's campaign I would like to wish everyone, a safe and healthy end of summer and look forward to sharing more in November . Thanks for your support support of advance auto parts as we navigate the current environment.
<unk>, while continuing to deliver on our long term strategic priorities.
Thank you for participating you.
You may disconnect at this time.
Please wait the conference will begin short.
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