Advance Auto Parts Inc Q2 FY2021 Earnings Call

Welcome to the Advance Auto Parts Second Quarter 2021 conference call. Before we begin, I will make a brief statement concerning forward-looking statements that will be discussed on this call. We'll discuss our Q2 2021 results highlighted in our earnings release this morning. I'm joined by Tom Greco, our President and Chief Executive Officer, and Jeff Shepherd, our Executive Vice President and Chief Financial Officer. Following their prepared remarks, we'll turn our attention to answering your questions. Please be advised that our remarks today may contain forward-looking statements. All statements other than those of historical fact are forward-looking statements, including statements regarding our initiatives, plans, projections, guidance, and future performance. Actual results could differ materially from those projected or implied by the forward-looking statements. Additional information about factors that could cause actual results to differ can be found under the caption, forward-looking statements, and risk factors in our most recent annual report on Form 10-K, and subsequent filings made with the Securities and Exchange Commission. Now, let me turn the call over to Tom Greco.

Thanks, Elisabeth. Good morning. We hope you're all healthy and safe amid the ongoing pandemic and recent surge of the Delta variant. I'd like to start by thanking the entire Advance and Carquest independent family for your hard work to serve our customers throughout the quarter. It's because of you that we're reporting the positive growth in sales, profit, and earnings per share. In Q2, we continued to deliver strong financial performance on both a one- and two-year stack as we began lapping more difficult comparisons. In the quarter, we delivered comparable store sales growth of 5.8%, and adjusted operating income margin of 11.4%, an increase of 11 basis points versus 2020. As a reminder, we lapped a highly unusual quarter from 2020, where we significantly reduced hours of operation and professional delivery expenses reflective of the channel shift from pro to DIY. As we anticipated, the professional business accelerated in Q2 2021, and through our strategic initiatives, we expanded margins. Our actions offset known headwinds within SG&A and an extremely competitive environment for talent. On a two-year stack, our comparable sales improved 13.3%, and margins expanded 227 basis points compared to Q2 2019. Adjusted diluted EPS of $3.40 increased 15.3% compared to Q2 2020 and 56.7% compared to 2019. Year-to-date free cash flow more than doubled, which led to a higher than anticipated return of cash to shareholders in the first half of the year, returning $661.4 million through a combination of share repurchases and quarterly dividends. Our sales growth and margin expansion were driven by a combination of industry-related factors and internal operational improvements. The macroeconomic backdrop remained positive, as consumers benefited from government stimulus. Long-term industry drivers of demand continued to improve, including a gradual recovery in miles driven and an increase in used car sales. While we delivered positive comparable sales in all three periods of Q2, our year-over-year growth slowed late in the quarter as we lapped some of our highest growth weeks of 2020. Our category growth was led by strength in brakes, motor oil, and filters with continued momentum in key hard part professional categories. Regionally, the West led our growth benefiting from an unusually hot summer, followed by the Southwest, Northeast, and Florida. We saw double-digit growth in our professional business and a slight decline in our DIY omnichannel business. It's important to look back at 2020 to provide context regarding the shift in our channel mix. We saw abrupt shifts in consumer behavior due to the pandemic, which drove DIY growth. Our DIY online business surged as consumers shopped from home and leveraged digital services. Large box retailers also de-prioritized long-tail items, resulting in robust sales growth for our DIY business in 2020. However, this also led to a slight decline in our professional business in Q2 2020. As we began to lap this time, we leveraged our research on customer decision journeys, enabling us to adapt quickly to how customers repaired and maintained their vehicles. Our sales growth and margin expansion in Q2 demonstrate the flexibility of our diversified asset base. We began to see improving demand late in Q1 2021, resulting in double-digit comp sales growth. This improvement is directly related to the factors just discussed, along with improved mobility trends. Strategic investments are strengthening our professional customer value proposition, including improved availability and getting parts closer to the customer through our dynamic assortment machine learning platform. Within our Advance Pro catalog, we saw improved key performance indicators across the board, including increased online traffic and growth in transaction counts and average ticket. We continued to invest in our technical training programs to help installers better serve their customers. We're pleased that through the first half of the year, we added 28 net new independent Carquest stores. Additionally, we announced the planned conversion of 29 locations in the West, as Baxter Auto Parts joins the Carquest family. Our professional banners performed at or above expectations in Q2, including our Canadian business, despite stringent lockdowns. Moving to DIY omnichannel, our business performed in line with expectations. While Q2 DIY comp sales were down slightly, DIY omnichannel contributed significantly to our two-year growth. We saw a shift in consumer behavior back to in-store purchases and worked to optimize our online discounts. We remain focused on improving the DIY experience through our Speed Perks loyalty platform, with several upgrades to our mobile app. We saw positive graduation rates among our existing Speed Perks members, with our VIP membership growing by 8% and our elite members increasing 21%. Our adjusted operating income increased to $302 million compared to $282 million one year ago, and our adjusted diluted earnings per share increased 15.3% to $3.40 compared to $2.95 last year. We're optimistic as the industry-related drivers of demand indicate a favorable long-term outlook for the automotive aftermarket. We remain focused on executing our long-term strategy to grow above the market, expand margins, and return significant excess cash back to shareholders.

Thanks, Tom. Good morning. I want to echo Tom's thanks to our team members for prioritizing the health and safety of our customers and fellow team members while delivering solid results for the quarter. In Q2, our net sales increased 5.9% to $2.6 billion. Adjusted gross profit margin expanded 239 basis points to 46.4% due to our category management initiatives, including strategic sourcing, strategic pricing, and own brand expansion. We experienced favorable inventory-related costs compared to the prior year, partially offset by inflationary costs in supply chain and unfavorable channel mix. Year-to-date gross margin improved 156 basis points compared to the first half of 2020. Q2 adjusted SG&A expenses increased year-over-year, up $109 million versus 2020, which resulted in a deleverage of 228 basis points. This was due to higher incentive compensation, increased wage inflation, and incremental costs associated with normalized operations compared to Q2 2020. Our SG&A expenses increased 13.3% to $926.4 million. As a percent of net sales, SG&A was 35% compared to 32.7% in the previous year quarter. Our adjusted operating income increased to $302 million compared to $282 million one year ago. Our adjusted diluted earnings per share increased 15.3% to $3.40 compared to $2.95 in Q2 of 2020. Free cash flow for the first half of the year was $646.6 million, an increase of $338.4 million compared to last year. Our capital spending was $58.7 million for the quarter, and we expect to step up our investments in the back half of the year. Despite challenges, we returned nearly $458 million to shareholders through share repurchases and increased quarterly cash dividends. We're increasing our full-year guidance ranges, including net sales between $10.6 billion to $10.8 billion and free cash flow of a minimum of $700 million. We remain committed to delivering against our long-term strategy.

Good morning. Thanks for taking my question. Tom, your sales performance in Q2 trailed behind some in the industry. What would you attribute that to and is this a sign that it's going to be harder to realize the top-line expectations in your long-term plan?

Good morning, Michael. Contrary to your observation, we're very pleased with our sales performance in the quarter. The timing of the quarter makes a very big difference. Our quarter started on April 25 and we did not have the first 24 days of April. We had growth over 50% in those weeks, which got replaced by a couple of weeks in July. When we normalize our quarter relative to our peers, we feel very good about our sales performance.

Thanks. My follow-up question is on your operating expenses SG&A, which were up around 14% from 2019 in the quarter. How much of this was due to wages inflating more than you expected, and what can we expect for wages in the next couple of quarters?

When you compare SG&A to 2019, remember that COVID-related costs in 2021 were not present in 2019. We experienced wage inflation throughout the P&L and the wage inflation was higher than expected. Our product costs are around 2%, but from what we've seen, we believe we can continue to execute our margin expansion initiatives.

Thanks. Can you talk about if the strong inflection in gross margin is reflective of collective initiatives or if any part of it may not be repeatable?

It's directly attributable to our category management initiatives. If you take our strategic sourcing, strategic pricing, and own brand initiatives, they offset inflation of a little over 2%. We expect these initiatives to be sustainable in the back half of the year.

Thanks, guys. On the commentary regarding the DIY compares easing off, is that a fair assessment that you're running at a low single-digit one-year positive at this point?

Good morning, Chris. You're in the ballpark. Our comparable store sales are in line with Q2, which was over 13%. Our Q3 performance has shown similar trends.

I wanted to focus on the DIY business. As you've noticed a moderation in that business, do you think that's a shift to Do-It-For-Me or a decline in spending as stimulus dollars run out?

We've been pleased with DIY performance. We anticipated a shift back to Do-It-For-Me this year due to the pandemic's effect on repaired vehicle trends. We've held on to customers from last year and our DIY business has held up. Our competitive position remains strong.

I wanted to clarify your outlook for parts inflation and how you expect to manage passing costs onto customers.

We now consider inflation will be in the range of 2% to 4%. We are planning for that range to manage pricing effectively.

Demand drivers in our industry are looking positive for the back half of the year. We're seeing growth in used car sales and recovery in miles driven that should continue contributing to our parts sales.

Could you elaborate on why wage inflation was higher than expected in Q2 and any updates on turnover and average hourly wages?

Wage inflation was impacted by a challenging labor market. We're focused on keeping turnover low and investing in our team, including a unique program providing stock to front-line members. We are seeing more applicants as unemployment benefits decrease.

Regarding the Pep Boys conversions, can you provide feedback on initial performances and any issues with store approvals?

We're excited about the Pep Boys opportunities and have faced permitting challenges unique to California. We anticipate successful conversions by the end of Q1 2022 and will bring forward our initiatives and products.

On your advertising dollars in relation to DIY sales and how you're measuring ROI given channel shifts?

We measure based on P&L growth and margin expansion. Our marketing spend has been successful, particularly for initiatives like DieHard. We're seeing gross margin improvement overall, which we aim to sustain.

Can you give incremental color on transaction counts and the split between DIY and DIFM?

Pro was strong with robust ticket growth, while DIY saw a decline in transaction counts from last year. Overall, we are pleased with our performance given expectations, with average ticket strong in DIY. Thank you for joining us today. We're proud of our performance in the first half of the year, grateful for our nearly 70,000 team members dedicated to serving customers while ensuring safety during these challenging times. We're focused on executing our long-term strategy for strong, sustainable total shareholder return, and we are confident in our ability to meet our strategic initiatives. I'm also announcing the launch of our American Heart Association fundraising campaign in our stores starting September 1st. We hope you'll join us in supporting this important mission. Thank you.