Q3 2022 Advance Auto Parts Inc Earnings Call
Please wait the conference will begin shortly.
[music].
Welcome to the advance auto parts third 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 Q3 results I'm joined by Tom Greco President and Chief Executive Officer, and Jeff Shepherd 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 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.
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 Q3.
In particular, our teams throughout the southeast.
Still working diligently to get their communities back to normal after the damage caused by recent hurricanes.
Our team always rise to the occasion in situations like this and I could not be prouder of how we've helped others in a time of great need.
We simply could not do what we do without our team's unwavering focus on the customer.
I'll begin my remarks today with an overview of our Q3 performance and how we're thinking about the balance of 2022.
This includes the factors that led us to reiterate our full year guidance on net sales growth comparable store sales and adjusted operating income margin, while revising adjusted diluted earnings per share and free cash flow.
Based on the updated full year guidance, we provided in our press release last night 2022 will be our second consecutive year of sales growth and adjusted operating margin expansion on the back of our strong performance in 2021.
We believe we will be one of very few retailers delivering back to back years of sales growth and adjusted operating income margin expansion.
Secondly, I'll briefly discuss some of the actions we're taking in the fourth quarter.
These actions reflect our analysis of year to date performance and were informed by our early thinking surrounding 2023.
Finally, I'll conclude with a review of the progress we're making on primary strategic initiatives before turning the call over to Jeff.
Starting with the third quarter net sales were up 0.8% and comparable store sales declined by 0.7% inline with previous expectations.
As were expanding our footprint new stores are providing incremental net sales growth.
Increasing owned brand penetration is an important part of our margin expansion plans.
However, owned brands have a lower price point, reducing net sales growth by 78 basis points and comp sales by 88 basis points in the quarter.
In terms of category growth batteries fluids, and chemicals as well as brakes were the top performers in Q3.
Regional sales performance was led by the West mid Atlantic and Florida.
Both pro and DIY Omni channel comp sales were in line with overall comp performance.
Moving to profitability. We're pleased that we were able to deliver a 98 basis point increase in our adjusted gross profit margin rate in Q3.
This was primarily driven by our focus on category management, which is our largest initiative to drive profitable growth.
Strategic pricing initiatives and higher margin rates associated with owned brands were key enablers to adjusted gross profit margin expansion.
In Q3 owned brands as a percent of total net sales were up nearly 230 basis points.
SG&A costs were up five 4% year over year, and given limited net sales growth more than offset adjusted gross margin expansion in the quarter.
Higher SG&A was primarily driven by inflationary costs.
Overall in Q3, adjusted operating income margin was nine 8%, which was down 68 basis points versus Q3 2021.
As we lapped strong net income growth in Q3 2021, adjusted diluted earnings per share of $2 84 was down 11, 5% versus the prior year quarter.
Both GAAP and adjusted diluted earnings per share included a headwind of approximately <unk> 20 per share from foreign currency impacts in Q3.
Importantly, we continued to invest in the business, while maintaining our strong commitment to capital stewardship by returning approximately $860 million in cash to shareholders through share buybacks and dividends during the first three quarters of 2022.
Turning to guidance there are a couple of factors, which led to our updates in the press release yesterday.
First we reiterated full year guidance on net sales growth comparable store sales and adjusted operating income margin rate.
We revised full year adjusted diluted earnings per share to reflect both the foreign currency headwind in Q3, along with the estimated impact in Q4.
Our full year guidance reflects an expansion of adjusted operating income margin in a range on adjusted diluted earnings per share growth of 5% to 6%.
This is on top of a 48% increase in 2021 versus 2020 on a comparative 52 week basis.
Secondly, we revised our free cash flow outlook for the year to a minimum of $300 million.
Due to updates in our working capital assumptions primarily related to inventory.
Jeff will further outline the drivers of these changes to our free cash flow guidance later.
While our full year 2022 guidance affirms that we believe we will expand margins were lagging the market and top line growth in 2022.
We're not at all satisfied with this outcome as it is inconsistent with our target of growing at or above the market over the long term.
As we develop plans for 2023 and beyond we've done a deep dive on the competitive environment and the actions necessary to accelerate growth.
From our analysis two opportunities came to the forefront, particularly in the professional sales channel.
First we have opportunities on availability in certain categories, which require inventory investment to enable us to get more skus closer to the customer.
Secondarily, while our research has consistently indicated that price is not the most important driver of choice for professional customers, we've tested and will make surgical pricing actions in certain categories to enable us to better address changes in competitive pricing dynamics.
We believe that these two the targeted inventory investment is by far the most important step needed to set us up for improved top line performance and share gains in 2023.
As you know 2023 will be the final year of a three year strategic plan, we outlined in April 'twenty, one that focused on growing at or above market expanding margins and returning excess cash to shareholders.
We established three year performance ranges for several financial metrics and an overarching goal of delivering top quartile total shareholder return.
We achieved that TSA goal for 2021 and continue to believe that we will achieve the majority of the three year goals outlined.
In terms of adjusted operating income margin rate, we've delivered significant margin expansion since the start of 2021.
We're also executing strategic initiatives to enable further margin expansion how's.
However, we now expect that reaching the targeted three year range for margin by the end of 2023 will be very challenging.
We're not satisfied that we've lagged the industry growth in 2022, and we're taking actions to accelerate growth.
If the current competitive environment in the professional sales channel extends into 2023, it will make achieving the targeted margin and earnings per share thresholds shared at the start of 2021, even more difficult.
All of that said, we remain optimistic about the fundamentals of our industry.
We also believe we will deliver against the majority of the three year goals outlined in 2021, and importantly, we're building plans to accelerate growth in 2023.
It's also critical to reinforce that margin expansion remains an integral part of our <unk> strategy.
And we believe that we still have significant opportunity to drive profitable growth over the long term.
Shifting back to 2022 and specific to our professional business in Q3 strategic.
<unk> accounts and techniques led our growth.
As discussed in August we are carefully monitoring, how and where we're investing within pro which includes deploying resources to our fastest growing and most profitable categories and customers.
Overall, we remain highly focused on what customers value most extensive parts availability excellent customer service, both online and in their shops, as well as consistent and reliable delivery.
As we strive to improve customer service and delivery reliability, we recognize our professional customers weekend car counts are growing as a percentage of their overall business.
During the quarter, we deployed new delivery software to leverage the gig economy as well as our extensive vehicle fleet.
This enables us to improve delivery speed and consistency on the weekend when our pro customers are relying on us while reducing fixed costs over time.
As we build additional capabilities in our advance and <unk> professional <unk> platforms. Our online penetration has reached record levels.
Strategic partnerships are also enabling us to drive our connected shop initiative, which enables customers to access tools and data resources generate faster repair order approvals deliver higher conversion rates and improved shop efficiency.
With our connected shop advance pro and <unk> pro are directly integrated into tech metrics, our exclusive partner and industry, leading shop management system.
This powerful workflow combination allows our pro shops to purchase parts and drop them directly into repair shop work orders quickly and easily.
With the integration of our diagnostic and service information modal logic, we have a powerful operating platform for our customers that helps drive shop efficiencies and increases work order conversion rates.
For DIY Omnichannel and Q3 are 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 combination of strong consumer regard and our commitment to building brand equity with innovation.
Our latest product innovation launched earlier this year is the exclusive first to market diehard ex EV battery Optima.
Optimized for the growing number of hybrid and electric vehicles on the road.
The combination of trust reliability and innovation for diehard sets us apart.
In addition, the enhancement of speed perks through the launch of gas rewards has been a highlight for DIY. This year and is helping drive increased loyalty.
Year to date active speed perks members have increased to over $13 million in Q3 speed perks as a percent of both sales and transactions significantly increased compared with the prior year quarter.
In addition to the double digit growth in new members. We're also delivering double digit growth in graduations to our VIP and elite tiers.
Finally, we're making meaningful progress on expanding our footprint.
Altogether, we opened 37, new locations this quarter, bringing our total to 115 new locations year to date.
We expect that we will be within our guidance range of 125 to 150, new stores and branches for 2022.
This will be the largest number of new locations, we've opened in eight years.
I'll now shift to the progress, we're making to capitalize on our margin expansion opportunity.
We continue to execute our category management strategy, which includes having the right brands quality products and the optimal mix of good better and best options.
In addition, growing owned brands and implementing strategic pricing actions to cover cost increases are key enablers of margin expansion.
Our new strategic pricing capabilities also enable us to respond with targeted and precise actions. This means we can both eliminate unprofitable discounts to improve gross margin rate and at the same time make calculated investments elsewhere to drive sales.
Within supply chain, we're ramping up the new San Bernardino DC to increase capacity to support our west coast expansion.
This DC will be a critical consolidation point for supplier shipments and enhance our e-commerce capabilities.
Our new Toronto DC went live shipping in late October and is now fully operational in this DC. We are both world pack and conquest parts, which consolidates two buildings in Toronto and the surrounding southern Ontario area to one large DC.
We've also completed a major expansion of the D. C in Thomson, Georgia, increasing the size by 40% and optimizing the building layout to significantly improve productivity.
While these investments drive growth and productivity. We're also exiting four dcs as planned.
In summary, while this was a difficult quarter for advance comp sales and adjusted operating income margins were generally in line with our expectations.
And based on our updated guidance will deliver the second consecutive year of net sales growth and adjusted operating margin expansion.
However, we're not satisfied with relative top line performance versus the industry. This year and are taking measured deliberate actions to accelerate growth in 2023.
It is important to reinforce that we still see significant opportunity to drive total shareholder return over the long term through sales growth margin expansion and returning excess cash to shareholders.
I'll now turn the call over to Jeff to review Q3 financials and updated outlook for the balance of the year.
Jeff.
Thanks, Tom and good morning, I would also like to start by thanking our team members for their hard work, while navigating this challenging environment.
In Q3, net sales of $2 $6 billion increased 8% compared with Q3 2021.
Driven by strategic pricing and new store openings.
Comparable store sales declined <unk>, 7%.
Adjusted gross profit margin expanded 98 basis points to 47, 2%.
In the quarter same SKU inflation was approximately seven 9% and we expect this to continue through the balance of the year.
Q3, adjusted SG&A of $989 million grew five 4% and was 37, 5% of net sales.
This compares to $938 million or 35, 8% of net sales in Q3 2021.
The largest SG&A headwinds in the quarter were higher inflation in store payroll medical and fuel and this coupled with softer top line performance resulted in deleverage.
It's important to note that we did not see significant headwinds from our California expansion in Q3 and expect this will contribute to SG&A leverage in Q4.
Our Q3 adjusted operating income was $258 million a decrease of five 8% compared with Q3 2021.
Our Q3, adjusted Oi margin rate was nine 8%.
A decrease of 68 basis points compared with Q3 2021.
Our adjusted diluted earnings per share of $2 84.
Decreased 11, 5% compared with our Q3 2021.
Our diluted EPS on both a GAAP and adjusted basis was negatively impacted by approximately <unk> 20 from foreign currencies.
Free cash flow year to date was $149 million compared with $734 million in the same period of 2021.
As Tom mentioned, we are making strategic inventory investments to improve availability in the back half of 2022, which are important to accelerate growth in 2023.
In addition through process and technology improvements, we are now processing AIDS and disputed payables more efficiently. These.
These changes to our working capital expectations have led to a reduction of our 2022 free cash flow guidance with inventory being the primary factor.
In addition, we continue to invest in the business in Q3 capital expenditures were $122 million.
Bringing year to date capital expenditures to $334 million.
As stated in our press release, we're increasing expectations for Capex. This year, which is primarily due to higher inflation impacting construction costs related to new store openings.
While expectations for free cash flow have changed our capital allocation priorities remain the same and we are delivering on them.
We continue to return cash to shareholders through a combination of share repurchases and our quarterly cash dividend.
And in Q3, we returned $75 million to shareholders through the repurchase of approximately 444000 shares at an average price of $168 93.
And approximately $91 million through our quarterly cash dividend.
Our board also recently approved our quarterly cash dividend of $1 50.
Year to date, we've returned approximately $860 million to shareholders in line with our capital allocation priorities.
Moving to guidance, we anticipate slight gross margin deleverage in Q4, driven by higher product costs coming off the balance sheet as expected, which will be offset by significant SG&A leverage.
This will enable full year adjusted operating income margin expansion between 20 to 40 basis points as guided in August .
We believe that we will be one of the few companies in all of retail to deliver adjusted operating income margin expansion in 2022.
In summary.
We are reiterating the following elements of our August guidance.
Net sales of 11 billion to $11 2 billion.
Comparable store sales of negative 1% to flat adjust.
Adjusted operating income margin rate of nine 8% to 10%.
Income tax rate of 24% to 26%.
And 125 to 150, new stores and branch openings.
However, we are making the following updates to adjusted diluted earnings per share of $12 60 to $12 80.
Which is entirely attributable to the estimated full year impact of foreign currency.
Minimum capex of $350 million.
Minimum free cash flow of $300 million and.
And share repurchases of up to $600 million.
With that let's open the phone lines to questions operator.
If you would like to ask a question simply press Star then the number one on your telephone keypad again, if he would like to ask a question simply press star one on your telephone keypad.
Your first question is from the line of Christopher <unk> with JP Morgan. Please go ahead.
Hi, Good morning, It's Christian currently now on for Chris.
Trying to better understand the decision to build inventory are there particular regions or categories, where you.
You were previously starved and how should we think about the margin implications, putting those extra units to work.
Well first of all.
Our goal is to grow at or above the market and we didn't achieve that in Q3. So we did a pretty deep dive on the underperformance in the and it was really concentrated in a couple of professional categories and the analysis that we did identify two primary drivers.
First of all.
Getting.
More inventory closer to the customer was a key opportunity and we also talked about relative price, but a much larger opportunity is as inventory availability and getting parts closer to the customers. So the focus is really on a couple of areas first of all.
The categories that we transitioned over the last couple of years to own brand. These are big categories, That's where a lot of the underperformance was in professional.
We're making sure that we improve our on hand position on those categories were still not exactly where we want them to be we spent a lot of time with our suppliers and our team on that and we're focused on making sure that we're in a really strong position on these categories. We have transition we benefited from the owned brand margin expansion now we need to get.
The top line going in some of those categories. We're also adding some gap to high velocity Skus and also some breath to certain applications and getting them closer to the market. So we feel the inventory investments really important for us.
To accelerate our growth, which is the number one priority we have right now.
Got it that's really helpful and then I guess.
The capitalized inventory costs.
Can you speak to your level of visibility going into the first half of next year and should the headwinds abate in the first half.
Yes, so as it relates to our LIFO costs, you'll see it later on but we had about $67 million of LIFO costs in the third quarter, we expect that to continue into the fourth quarter fourth quarter will largely look like it did last year. So that's going to put us on track to to have.
Capitalized costs and sort of the.
$2 $75 million to $300 million range under the assumption that costs are going to come down over the back half of the year, we would largely recognize these over the first half of 2023. So that's the way we're looking at it right now obviously, it's a very dynamic situation, having a good understanding in terms of what.
These products are input costs are going to do and how they're going to.
Shape up over the.
Balance of 23.
Your next question is from the line of Simeon Gutman with Morgan Stanley . Please go ahead.
Hey, everyone I wanted to ask about pricing.
You made the business healthy over the last few years, because you've taken out these price match override.
It sounds like you've been more disciplined in general.
So can you talk about pricing your peers have obviously engaged in.
Discounting.
Use that lever.
Okay.
Guess attacking the problem with inventory, but curious how you're thinking about price versus cost.
Shortly the depth of inventory.
Hey, good morning Simeon.
So our analysis suggests that the majority of the underperformance in pro is driven by availability and inventory positioning.
So youre right on interpreting that.
Availability is the number one driver of choice for the professional installers and as we've said many times price is much lower down the list.
So in general we are continuing to execute our category management strategy and much of that remains the same so we.
We are going to remain very disciplined in how we price in the marketplace.
We have we have so much more in terms of sophisticated tools to manage pricing than we did when all of US arrived here a few years ago. So I feel really good about where we're positioned there the new capabilities allow us to price by region by market by channel by store. So we're still we're still focused on removing.
Unprofitable discounts in really in all channels. So that doesn't change I think what is new is we successfully tested some surgical pricing actions and some of the more challenged categories and we're going to.
Essentially continue to do that and expand that more broadly our goal overall is to price to cover cost increases. However, we're going to make some investments in key categories.
We expect to drive incremental top line growth.
Okay. Thanks, and then my follow up.
It's a little bit of clarification on the prior question.
If youre buying more inventory.
What did that that would lower capitalized costs at least for the first part of the theory I think that's right that would help your gross margins earlier on.
And maybe too early for this but can you give us any type of preview for gross margin broadly thanks to your balancing.
The capitalized cost against.
If it's a LIFO or other other factors along with your initiatives the direction for growth I think you've said should still be up in that direction next year, just curious if you.
You can comment on that.
Yes, I mean, certainly those costs are going to come off the balance sheet over the balance of next year.
This is going to be a challenging headwind for us as.
As we go into 'twenty, three and tried to continue to grow our margins.
Both the product costs as well as the capitalized cost, whether it's freight costs being capitalized whether it's supply chain costs being capitalized.
That will land on the balance sheet with the inventory as we acquire it and will come off over the balance of next year again, we think most of this will roll off in the first half of the year.
We will give an update on 2023 in terms of how we're thinking about our margins, but we know that this is going to be a significant headwind as we go into next year.
Okay Fair enough. Thank you and good luck.
Thank you.
Your next question is from the line of Kate Mcshane with Goldman Sachs. Please go ahead.
Hi, Good morning, this is mark Jordan on for Kate.
I'm just wondering if you can talk about your category management initiative and specifically there are mobile of these unprofitable discounts how far along you are moving these discounts and how much of a headwind to comps in the quarter.
Well, we're really pleased with the progress we've made on category management over the last couple of years. It's the single biggest driver of gross margin. It's been a huge contributor to the fact that right up until Q3, we had we had expanded margins.
Overall for nine straight quarters.
So the execution of that plan continues there is a couple of elements there are strategic store, saying theres, the owned brand penetration, which improved in the quarter.
We are up a couple hundred basis points in terms of our own brand penetration and then on the pricing front as I mentioned on the previous call that question.
We're being very surgical in how we act so we're able to remove unprofitable discounts, where it doesn't make sense and we're able to invest.
Where we need to in order to drive profitable top line growth. So it's really leveraging all the tools that we put in place over the past couple of years that this was the single biggest driver of the margin expansion plan that we laid out over the last couple of years and we're continuing to execute against it.
Great. Thank you.
Your next question is from the line of Elizabeth Suzuki with Bank of America. Please go ahead.
Okay.
Elizabeth Your line is open please check to see if maybe you're on mute.
Okay, we will move on to the next question that comes from the line of Stephens <unk> with Citigroup. Please go ahead.
Thanks, very much for taking my question good morning, everyone.
Question on the owned brand impact to same store sales, how do you expect that to trend in the fourth quarter and should that continue to be a drag into next year.
That kind of in the baseline.
Sure well, we've been expanding for several quarters now as you know.
We called out roughly 80 basis points pardon me of net sales 90 of comp sales.
And the big categories that are contributing are the ones that we've been transitioning which is which is engine management and under car. So.
We still have a ways to go yet in terms of our reaching our goals. There. So we would expect that to continue on but.
It's a comp sales headwind, but it's a good thing and that we are driving.
Significant improvement in gross margin and Thats the opportunity for US I mean margin expansion remains very very important to us and this is a key part of that.
Good thing here is our customers love this product I mean, we're building strong brands Diehard is a terrific brand that had another great quarter, where we're the number one.
Highly regarded and most highly regarded battery in the country, we've extended that into other categories such as tools and then the car Quest brand is very popular with professional installers the quality that we put in place for.
For our car quest product is very much respected by our customers.
We have much lower return rates. So it's a very positive story and we will we will take the comp sales headwind along with obviously the margin expansion that we're getting from it.
Okay. Thanks.
Second question more of a strategic question. So if you plan on accelerating growth in 2023 because of.
Potential share loss, you've seen what does that mean to the strategic importance of margin expansion next year, I know youre, not providing guidance, but given your commentary about difficulty in achieving that margin rates you previously talked about for 2023.
Should we be thinking of pause in margin expansion is the right way to think about the model through 'twenty three.
Sure well, let me speak to.
The targets, we talked about it's about 18 months ago. If you recall in April of 2021.
What we did at that point was we outlined three overarching goals to drive total shareholder return.
Comp sales growth expand margins and returning excess cash to shareholders and we also established six financial metrics associated with that Tsi drivers in 2021, we performed really well against the Tsi our drivers and all six of those metrics. We achieved we ended up in the top quartile.
In terms of CSR performance relative to the S&P.
We're now up until now we had nine straight quarters of sales growth and margin expansion.
As we got into 2022.
The macroeconomic and competitive environment changed and it really impacted us in the third quarter.
While we expect to expand margins full year. This year and we've already returned about $900 million in cash to shareholders. Our 2022 sales are below our expectations and we are taking the actions now to address that underperformance. So as we look forward to 2023 to your direct question.
We believe we can get inside the 23 ranges on most of the metrics that we outlined.
However, the margin rate and EPS ranges are really dependent on the competitive environment that we'll see in 2023, which is hard to predict right now and if the competitive environment and professional particularly it looks like it does in 2022, achieving the low end of the range of those two areas Martin.
<unk> rate and earnings per share.
Unlikely now if we look beyond 2023, we're building a plan that will include all of the key elements of the current tsi, our agenda and where can it continue to target top quartile CSR growth, including all of those elements. So we still have plenty of upside to drive <unk> going forward.
Just being cautious about 2023, given the competitive environment that we're in right now.
Thank you very helpful detail.
Retail.
Your next question is from the line of Michael Lasser with UBS. Please go ahead.
Good morning. This is a tool in the history on for Michael Lasser. Thanks, a lot for taking our questions.
<unk> has taken a lot of steps over the years to improve its business yet it seems like the.
The pace of market share losses.
Are now accelerating why do you think that is the case and are some of the factors that are causing the underperformance a simpler structure and the nature and cannot be fixed.
Well as we said earlier, we've done a pretty deep dive on what drove the underperformance.
We performed well right up until the third quarter in terms of our agenda. Our strategy is unique our goal is to drive total shareholder return through comp sales and margin expansion and returning excess cash to shareholders, which has worked well for us up until the third quarter, we're not happy.
That we didnt expand margins in the third quarter, but I am very pleased that the team has worked very hard at accelerating growth going forward and that's where we're focused in 2023 the underperformance.
We've identified a couple of key areas and that is to get more.
Targeted inventory investments closer to the customer and take some surgical pricing actions and that will help us get our top line, where it needs to be.
Got it.
Any helpful and as a follow up question.
I had one on your inventory investments.
Looking for inventory investments going forward.
All at the same time, the inventory growth has outpaced <unk> growth for a while now so while second lien debt there are certain categories, where you have the inventory, but simply not the right inventory.
And if you could provide color on what categories those are.
Sure.
Lucas as Cup.
A couple of areas as I mentioned earlier, we want to make sure that we get these large categories that we've transitioned to one brand over the past couple of years, two and on hand rate that we're at.
We're comfortable with and we while we've improved over the last year, we are still not where we need to be in these big categories. So that's job one.
Also improving the depth of high velocity, skus and getting those closer to the customer and then in some cases, adding breadth that's closer to the customer. So it's really through our analysis of the professional channel how we're positioned in the market.
Our assortment right, what's our close rate we've done a very deep dive on where we are and we're confident that the plans. We are building are going to help us accelerate growth in 2023.
Thank you.
Your next question is from the line of Zach <unk> with Wells Fargo. Please go ahead.
Can you walk through the mechanics around the FX hit and a little more detail and considering this is primarily a domestic business in terms of your sales maybe talk through transaction versus translation impact and how should we think about the Q4 impact in anything lingering into 2020.
Three.
Okay.
Yes, sure. So first of all the impact is.
<unk> transaction versus translation and it really comes from two sources.
The first and then more significant is our we have a taiwanese purchasing entity that's domiciled in Taiwan.
And so what it does essentially purchases of inventory and gets it over to us. So we can sell it here in the U S.
And what that does is it creates sort of a one side of the big exposure because there arent any receivables to naturally offset that so it's a Taiwanese dollar entity.
Purchasing inventory in currencies, including the U S dollar.
Taiwanese dollar has weakened substantially in the quarter against the U S dollar and Thats whats, creating this exposure, which quite frankly is not something we've seen in the past we've known we've had this exposure.
Forever.
But we haven't seen this level of change between even the Taiwanese dollar or the other impact which was the Canadian dollar.
Canadian dollar side, it's really a similar story.
We do purchase in Canada.
Which is a Canadian dollar functional entity and its buying certain inventory in U S dollars. The Canadian dollar also weakened against the U S dollar, but a similar story, while we do have receivables in Canada. Those are all in Canadian dollars. So you don't get that natural hedge we don't do any hedging here as an organization quite frankly.
We haven't needed to.
And so we didn't anticipate this level of change between the U S dollar and those.
Those two foreign currencies, that's what drove to the 20 <unk>.
Decrease in our EPS in the third quarter.
The easy way to think about the fourth quarter as you can look at the midpoint of EPS between our cute our August guidance and our current guidance.
And Youll see were estimating another 10 cents of EPS in the fourth quarter.
Got it that's helpful. And then with your Q4 operating margin outlook, implying about a 130 basis points of expansion can you walk through the SG&A leverage here in a little bit more detail that give you confidence in the sharp year over year improvement from here and then how should we think about SG&A leverage.
As we move our way through 2023.
Yes, so the fourth quarter, there's a couple of things that are going to drive the significantly. The first is the startup costs associated with our footprint expansion, namely in California, we're going to be lapping that we've opened 37 stores here in the third quarter, we've got a robust agenda to open stores in the fourth quarter in <unk>.
Well within a range of 125 to 150 stores.
And that will help give us the leverage on the SG&A related to new stores and the other is really just where we're starting to lap.
The wage inflation.
The inflation that we saw in the fourth quarter, so on a year over year basis that starts to.
To even out.
And help us out on a year over year basis. So those are going to be the two primary drivers now keep in mind fourth quarter's incredibly volatile and.
So we're going to be managing our costs very very closely.
Certainly our store labor costs. In addition to that we're looking very closely at travel and any other discretionary costs that we really don't think we need going into the last 12 weeks of the year here. So it's going to be a combination of those that really give us the confidence that we're going to leverage SG&A in the fourth quarter.
Looking to 2023.
We'll give you more guidance as we work through our LP in February .
But we will be lapping a number of these costs and we're going to take that into consideration as we put together our plan for next year.
Got it Jeff I appreciate the time.
Sure. Thanks.
Your next question is from the line of David Bellinger with MTM and partners. Please go ahead.
Hey, Thanks for the question just following up on that last one so.
On the annual guidance you lowered the EPS range by about 30%.
At the midpoint and based on your comments just now so that the FX headwind was 20 in Q3 expected. Another 10 cents in Q4. So just absent the FX factor is there anything else really changing in your fundamental view or should we just think about this guide down being all FX driven and the underlying fundamentals Q3 to <unk>.
For not really seeing any change.
Hey look the short answer is yes, I mean, it isn't entirely driven by the FX and Thats. The 30 that you've called out 20 in Q3 and 10 in Q4 everything else.
In line with the expectations of the guide that we put out in August which is why we haven't changed the rest of the P&L Guide if you will.
For Q4.
Got it and then just my follow up here.
Any comment on sales trends through the quarter and then implied in our Q4 guide I think is a pretty wide range of outcomes there you'd be slightly positive all the way down to negative 4% on the comps. So can you give us some indication of where trends are through mid November we're hearing some overall softening in retail.
Sales in recent weeks. So are you seeing any of that show up in your business.
Hey, good morning, David well first of all just to round out Q3, our strongest period of the quarter was the last periods. So we saw improvement.
In the summer, we talked about making sure that we are removing these unprofitable discounts that that was going to have.
Bigger impact and with dissipate over time, so we expect that will happen.
As we get into the fourth quarter. This is a highly volatile quarter, that's really the origin of the guide.
This is a very resilient industry.
You've heard that from from US before we expect that the category will continue to grow at the rates that it has been growing it's been a robust year for the industry, we just need to be growing faster in advance Thats why were taking the actions that we're taking so.
Relative to what you're hearing about in total retail we're not seeing that I think that youll continue to see strength in the automotive aftermarket the DIY segment.
Performed well at the end of the quarter for us. So we feel like the industry performance will continue to be strong.
With the caveat that the fourth quarter is our smallest of the year and it has the most volatility.
Great. Thanks, Tom.
Thank you.
Your next question is from the line of Mike Montana with Evercore ISI. Please go ahead.
Hey, guys. Good morning, Thanks for taking the question, it's Mike on for Greg just wanted to ask if I could first off just for some additional color. If you could share in terms of the comp trend for DIY versus pro as well as ticket.
Ticket versus transaction Count and then I had a follow up question.
Sure I'll start with the channels.
We basically said DIY pro were in line with each other which would imply actually an acceleration of DIY for us in the quarter and we're actually pretty happy with what's going on in DIY, we're strengthening our expansion in the West has helped US there we are gaining a lot of market share.
Our west market, we're going to continue to focus on DIY. It is a very important part of our business.
<unk> continues to do well. So overall, we saw strengthening of DIY, where we saw.
Weakness relative to the second quarter was in professional and Thats why.
We're taking the actions that we're taking targeted inventory investment surgical pricing actions. So.
It really DIY is getting got stronger for us pro got weaker overall.
Versus transaction more of the same versus the second quarter, Mike our tickets were down in both pro and DIY and obviously transactions continue to to grow in terms of average average ticket. So.
The tale of the tape there.
Got you. Thank you for that and then just on the market share front.
Just wanted to hit on number one if you can give some updates to the progress that you've been seeing for the Pep boys converted stores and then number two was.
You had mentioned increasing inventory availability.
So I was wondering if there was anything you could share in terms of <unk>.
Industry benchmark fill rates versus yourselves to help us kind of gauge what kind of improvement we could anticipate from the additional coverage.
Sure.
Couple of things in your question there so on the Pep Boys conversion is Jeff called out.
This is going to be the then the heart largest number of new store openings advance has had in many many years so.
We've got that.
Grooved much more so we've got a new head of our field operations Junior worried he is a terrific leader he started out.
In stores 20 years ago, He's done all of the key jobs inside of advance. He has distinguished himself. He has done this before so we're very excited to have junior take on the role of leading the field organization, including.
Pardon me those those stores that were converting in the west so each period, our market share grows and those west stores, we still got lots of room for growth out there so more to come there.
Second question was Mike again remind me alright, just on the fill rates I guess on shelf availability.
Yeah. So.
What we've seen there.
Expected.
The on hand, right, which is the ultimate measure right in the stores themselves do you have it when the customer calls to get better in those categories that we converted and just have it. So I mean, we obviously have targets for each category. We also have targets by velocity band So as Skus BCE.
<unk> C skus etcetera, so what I can tell you is we've worked very collaboratively with our suppliers on this topic and they've been extremely helpful.
We stood up a number of new suppliers literally all over the globe to enable this expansion and as we said earlier, we're very pleased with the margin expansion and the quality of the products.
Still not happy with where we are in terms of our on hand right. So all I can tell you is we're below where we need to be and that is that that is the focus is to get.
Better on hand rates in these key categories and as I said earlier there is some other things we're doing with inventory as well, but the biggest one is to get our on hand right up in these converted categories bone brand.
Thank you.
Your next question is from the line of Seth Basham with Wedbush Securities. Please go ahead.
Thanks, a lot good morning, Tom maybe you could just provide a little bit more perspective on what changed in terms of the competitive environment to drive these inventory and price investment decisions.
Here was there a significant change in the third quarter and then Relatedly do you expect the competitive reaction to instruments.
Well first of all.
We're executing our strategy as you know staff then.
Which is a different strategy than our peers.
I think obviously the inventory investments that have been made inside the industry.
And the widely documented pricing investments were out there and as it started to have a greater impact on us I think that's when we had to respond.
And we're responding with primarily targeted inventory investments.
The biggest one that's where we really are focused here because we believe that's the most important thing getting the right part in the right place at the right time, So we will.
Take those actions and we think thats going to have a big impact on improving our growth in 2023.
The pricing piece because of our tools, we're able to respond surgically its not as important to our customers as the as the availability is so we're going to be very thoughtful and disciplined about that pricing piece, but we are going to take some actions to respond to that.
In terms of competitive response.
We'll see what happens there, but were optimistic that the inventory investment that we're making will accelerate our performance in these key categories, which has really been a drag on us over the course of the year.
Got it as follow up you talked about the investments in these key categories being ones that you had been focused on.
Migrating more to private label does that mean that you need to be more aggressive in bringing national brand inventory back in these categories.
Generally speaking we are very pleased with where our assortment is in the categories, where we're focused is getting the on hand rates, where they need to be so it's not that we are we have a brand issue necessarily it's really more about getting the right part in the right place at the <unk>.
Time.
Fair enough. Thank you.
Your next question is from the line of Bret Jordan with Jefferies. Please go ahead.
Good morning, Vince.
Do you have any more.
Or do.
Do you have any data to support the.
Commercial customers' enthusiasm for the private label products, I mean, maybe sort of a of a turnover in a skus assuming that's a category you probably have in stock the velocity of that product versus your prior strategy you had a bit more nationally branded product in that mix.
We do I mean, we have we have the Sn.
Essentially when we have that Brad.
The close rates are very strong.
The return rates are much lower so we do have a positive.
<unk> from our customers on this so it really is more about on hand right.
Okay, and then a question I guess as far as what inning in the inventory growth year at I mean, a lot of your suppliers were saying you're really appearing to manage your inventories down until until recently, so I guess, when we think about going into 'twenty three.
Or do you see the inventory build being our out of stock are you I guess is the question.
Yeah as we as we look at it right now in our analysis would suggest that we need to make investments that we've made some in Q3 and we need to make some more in Q4.
Obviously, that's dynamic and we'll continue to assess that but that's the way. We're looking at it right. Now is it's really a back half investment to get that availability is closer to the customer as possible I'll add one thing to that Brad I mean, as we as we looked at this earlier in the year. We obviously knew we were consolidating suppliers, we were reducing some redundancy.
And our SKU base. So there was a belief that that inventory could come down in the back half and through the analysis we've done.
If we just we've got a we've got to refine that and adjust that assumption.
But Q4 will likely be the inventory growth greater which one we're not going to be growing too much not going be a use of cash in 'twenty three as much.
So yes, we're investing in the inventory here in the back half obviously.
Pending on the terms, you'll get some carryover into Q4, and we will take that into consideration as we're generating our free cash flow assumptions for next year.
Okay, great. Thank you.
Your next question is from the line of Mitch Ingles with Raymond James. Please go ahead.
Hey, everyone. This is mid singles on for Bobby Griffin Hope, you're all well.
Could you give us an update on your Canadian operations.
How do you see the car quest in the World pack Canadian operational fit into your long term plans with the recent Forex impact.
As this business overall dilutive today to your performance and how should we think about forex exposure going into 2023. Thank you.
We feel a lot of opportunity with our Canadian business, we made a big investment up there in a distribution center that is now carrying.
I'll pack and conquest parts. It is not dilutive to our overall business. It is a strong performing business and we believe that we're going to be able to grow that business significantly as we've made a pretty big change up there in Ontario, which is the largest market.
You mentioned, the Forex I mean, obviously it dropped down to a level that we haven't seen in a while but over time.
There's a lot of room for growth for us up in Canada, and we're going to continue to drive that growth. We expect 2023 to be a very strong year up there we've got.
The largest assortment of parts in southern Ontario in that building. So a combination of OE parts from World Pack, our owned brand portfolio, a diehard and car quest and some great national brands, So optimistic about Canada for 2023.
Got it and then as a follow up as you know expand your store footprint again this year fastest growth in eight years, how should we think about the comp sales benefit.
These new stores roll into your comp base and should we expect.
Similar opening cadence next year. Thank you.
Yes, I mean, we're working through our store count for next year, but our plan is to expand our footprint. We think we have a number of opportunities. Both in terms of infill, where we have a lot of density in areas, where we have a lot of opportunity, namely out west So we're going to work through that.
In terms of job, we absolutely expect that to give us a lift next year. It does take time. These stores generally reached their maturity overall three to four year timeframe. So we expect that to be an ongoing benefit as we continue to open stores and we'll continue to build onto our.
Store base.
Appreciate the color thanks, guys.
Your next question comes from the line of Chris Bottler, Gary with BNP Paribas. Please go ahead.
Hey, guys. Thanks for taking the question.
So the first one is like just given the competitive dynamics in pro and Youre unhappy as market share dynamics.
I Wonder if you consider the idea that focusing on margin expansion could be distraction.
Setting a lot of your hard work and significant accomplishments have you considered adjusting the <unk> algorithm to focus on EBIT dollar growth rather than rate.
Well, we've always had a balanced approach Chris to this topic I mean, there are three levers to our tsi equation.
Finishing in the top quartile in 2021 was driven by <unk>.
Sales growth margin expansion and returning excess cash.
This year, we clearly.
Have not performed at the sales level that we would've liked particularly over the last two quarters. So as we look ahead, we're factoring that into the equation, but over time, we still have a very significant opportunity to expand margins margins.
Remains a very very important and we're not we're not adjusting.
How we're looking at building long term shareholder value, which remains significant for advance and Thats a combination of driving sales growth.
Making sure that our margins continue to expand over time and returning excess cash. So the equation will remain the same and we will continue to target top quartile CSR growth.
Got you. Thank you and then.
Follow up question on kind of price investments. It seems like your peers have taken price investments I think both have lower pro mix than you do.
It seems like the gross margin headwinds at least for one of them seem to be somewhere in the.
75 to 100 basis points.
Headwind right. How do you think about the level of price investment and margin reinvestment you need to make a comparable price investments are there certain categories, where you feel like you are further behind and you don't need quite as much of a price investment how do you just frame the size of this investment.
Good question, Chris I mean.
We use the word surgical for a reason the tools that we've built and the team that we have to manage pricing is at the highest level. We've ever had in this company and we are very confident that we can make decisions here that are right for the business and that includes removing unnecessary discounts where it may.
<unk> sense.
Redeploying resources to our highest growth and largest strategic customers and then at the same time, making surgical price investments in very specific categories and even in the case of stores. So the analysis. We've done has been very granular and we know where we need to make those price investments.
Our overall goal continues to be price to cover margin rate that is the goal obviously the competitive environment plays a role and how that will unfold next year and we intend to to be very thoughtful about how we price relatively speaking.
It remains our goal remains to price to cover right and we'll see how that unfolds.
Got you okay. Thank you.
Well, thanks for joining us today.
As we've discussed Q3 did not meet our expectations in terms of topline growth and we're not satisfied with where we're positioned at the moment.
However, we continue to believe we have significant opportunity to drive long term tsi growth as we build our plans for 2023, we're taking measured steps to accelerate growth while pursuing our margin expansion initiatives. We look forward to sharing our expectations for 2023 in February .
In addition, we have a lot to be grateful for during this season of giving thanks, including celebrating veterans day last week and I'd like to take a moment to recognize and thank all of the nation's military heroes for their service, including the thousands of advanced team members, who currently are have previously serve.
We're grateful for your ongoing support and I want to wish you and your families. A happy Thanksgiving holiday, we look forward to sharing our 2022 results and 2023 guidance in February .
<unk>.
This does conclude the advance auto parts third quarter conference call. We thank you for your participation you may now disconnect.
Please wait the conference will begin shortly.
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