Advance Auto Parts Inc (AAP) Q3 2023 Earnings Call Transcript

Good morning and thank you for joining us to discuss our Q3 2023 results. I'm joined by Gene Lee, our Interim Executive Chair; Shane O'Kelly, President and Chief Executive Officer; and Tony Iskander, Interim Chief Financial Officer. Following Shane and Tony's prepared remarks, we will turn our attention to answering your questions. Before we begin, please be advised that remarks today will contain forward-looking statements. All statements other than statements of historical fact are forward-looking statements, including but not limited to statements regarding our ongoing strategic and operational review, initiatives, plans, projections, and future performance. Actual results could differ materially from those projected or implied by the forward-looking statements. Additional information about factors that could cause actual results to differ can be found under the captions Forward-Looking Statements and Risk Factors in our most recent Form 10-K and subsequent filings made with the commission. Now let me turn the call over to Shane.

Good morning, everyone, and thank you for joining us. I'm pleased to be here for my first earnings call as the CEO of Advance. We have several topics to discuss with you this morning. But before I begin, I'd like to thank all of Advance's team members who I've come to know during my first 60 days with the company. During that time, I visited our stores across multiple markets, met with numerous customers, spent time in our distribution centers, got to know our Carquest Independence, and attended our Annual Vendor Summit where I had the chance to meet with many of our major suppliers. Through all of this, I came away impressed with the passion and dedication of our frontline team members and I remain optimistic about the future of the company. In addition to spending time in the field, I have partnered closely with the Board and Management team to make progress on our strategic and operational review. As the new CEO, I place a premium on capabilities learned during my time in the military. This includes aligning the company around fewer measurable goals while ensuring discipline and accountability in the process to achieve those goals. During my review of Advance, we identified the need to simplify our overall strategy while also improving execution, both of which will create value. Consistent with that, we are moving forward with a sense of urgency to help stabilize the company and return to profitable growth. Today, we are announcing decisive actions that we have initiated to achieve these objectives. Those actions are: number one, the initiation of a sale process for Worldpac; number two, the initiation of a separate sales process for our Canadian business; number three, significant cost reductions; number four, reinvestment in the field; and number five, the appointment of a new CFO as well as other organizational updates. These decisive actions are further reinforced with a renewed and vigorous commitment to selling auto parts, which is our core business. This includes eliminating numerous initiatives that were distracting us from a clear focus on the most fundamental aspects of our business. We believe our success will come from disciplined execution across the blended box model, where we service both professional installers and DIY customers from our Advance and Carquest locations. Let's take a moment to further describe our five decisive actions, beginning with the decision to initiate the sale process for Worldpac. Worldpac is a high-performing business and, as you know, is very different from our core blended box model. As we get back to the fundamentals of servicing our professional and DIY customers, we view now as the right time to simplify our model. The Worldpac business still operates relatively independently from Advance, and we believe that the sale process will not create a distraction. Next, let's talk about our business in Canada, which goes to market under the Carquest banner. Today, we are announcing a separate sale process for that business. Like Worldpac, our Canadian business also runs largely independently and predominantly serves professional customers. We do not believe this sales process will cause a distraction for our US business. Third, as part of our operational review, we have launched a new cost reduction program that we expect will generate a minimum of $150 million in savings on an annualized basis. These savings will be primarily driven by simplifying our organizational structure, minimizing duplicative efforts, and eliminating investments that are not core to supporting our frontline team members and customers. Fourth, while we expect to see the benefits of these cost reductions beginning next year, we recognize that we must take action to improve the retention of our frontline teams and ensure we have experienced team members to serve our customers. In line with this, we expect to reinvest approximately $50 million of our savings back into the business inclusive of wages and training enhancements. In fact, we began making changes to our frontline compensation structure in Q3 and are already seeing a reduction in turnover in targeted frontline roles. And fifth, following a robust search, I am pleased to announce that we have appointed a new CFO. We're thrilled that Ryan Grimsland will be joining the Advance family from Lowe's to lead our finance organization. Ryan has more than 20 years of experience leading high-performing teams and omni-channel retail businesses serving both Pro and DIY customers. He has a strong track record of driving organizational improvements while implementing best practices to resolve complex issues. I look forward to Ryan joining us later this month and partnering with him and the entire leadership team to drive the needed change for Advance. In addition to our CFO announcement, we've taken action to streamline our management structure. We have reorganized parts of my leadership team and transitioned responsibilities for our marketing, merchandising, and e-commerce functions to the appropriate leaders in our organization, who will drive enhanced collaboration and accountability. We have made additional organizational adjustments in several other areas to help us operate more effectively. I would also note, as part of our strategic review, we are taking a disciplined approach to the evaluation of all assets, including corporate stores, independently owned Carquest locations, and our distribution network, all to enhance productivity. This may include the rationalization of unprofitable assets to better allocate resources focused on core fundamentals. We are early in this process and expect to share more as we progress in the thorough evaluation of our entire business. As I emphasized earlier, we are sharpening our focus on the fundamentals. As an example, last month, we held our annual Partner Growth Summit and our team spent a few days with hundreds of representatives from key suppliers, who are critical to how we better serve our customers. This annual event is a valuable opportunity for us to collaborate and share updates on our strategy. This year's summit was a great venue for us to articulate to our vendors how we are turning the page as an organization and we are excited to return to growth with their partnership. We recognize that having the right inventory availability is crucial for our team members' ability to serve customers, which would not be possible without the strong support of our vendor partners. Finally, before I hand the call off to Tony, I'd like to thank him for his dedication and incredible work over the past few months serving as our Interim CFO, in addition to his role as Treasurer. His servant leadership has been instrumental across our finance organization. I look forward to continuing to partner with Tony as we build Advance and capture the immense opportunity ahead of us. With that, I'd like to now turn the call over to Tony to discuss our Q3 results and provide an update on our outlook for the full year.

Thanks, Shane, and good morning. I would also like to thank all our team members for their continued dedication and focus on the customer. In Q3, our net sales of $2.7 billion increased 2.9% compared with Q3 2022, due to continued strength across our professional business. Comparable store sales increased 1.2%. All our regions were positive during the quarter with the West, Florida, and Northeast regions posting mid-single-digit growth. From a category perspective, we saw strength in filters, engine management, motor oil, and batteries. Importantly, we've delivered meaningful growth in heating and cooling as we significantly improved our in-stock levels year-over-year. In terms of the cadence of the quarter, both Pro and DIY omni-channel saw strength in the first two periods and softened in the last four weeks of the quarter. Our Pro business was positive throughout Q3 and outperformed DIY omni-channel as transactions continued to improve and were up mid-single digits from the previous year on top of the improvement in Q2. As expected, average ticket in Pro was down slightly as part of our ongoing efforts to maintain competitive price targets. However, units have increased slightly year-over-year. DIY omni-channel average ticket was up mid-single-digit with transactions down low single-digit in Q3. Before turning to the balance of our P&L, we've made strong progress towards remediating the material weakness and as part of our diligence in this process, we uncovered non-material issues with our previously reported financial results. The balance of our financial results will compare our Q3 actual results to the corrective results for the prior year. The remediation of our material weakness remains a top priority. Despite improving top-line trends, our gross profit margin was negatively impacted by several factors and deleveraged 830 basis points compared with Q3 2022. First, in line with the decisive actions Shane highlighted earlier and as part of our operational review of the business, we implemented a change in estimate regarding our excess inventory reserve and incurred a one-time impact of approximately $119 million. Further, like previous quarters, we experienced approximately $80 million in higher product costs that were not fully covered by pricing actions as we sustained our CPI targets. In addition, wage inflation and increased volume resulted in elevated supply chain expenses. These headwinds were partially offset by a reduction in LIFO-related expenses as we recognized the $56 million benefit this quarter compared with $67 million of expense in the same period last year. While SG&A dollars in the quarter increased year-over-year as a percent of net sales, SG&A leveraged nearly 30 basis points. Our Q3 operating income margin deleveraged approximately 810 basis points compared with the prior year quarter. As you saw in our release this morning and as Shane discussed, we are taking action to significantly reduce costs in the business that have increased faster than sales over the past few years. We expect to see the full annualized saving of a minimum of $150 million in 2024, with approximately $50 million reinvested in our frontline team members. Diluted loss per share was $0.82 in Q3 compared with diluted earnings per share of $1.92 in the prior year quarter. Free cash flow in the quarter was an inflow of $148 million and year-to-date was an outflow of nearly $157 million. As we continue to focus on our working capital metrics, our AP ratio expanded 470 basis points from Q2 2023 to 79.8%. Before turning to guidance, let me touch on supply chain finance. We have maintained a similar level of capacity in our supply chain finance program, thanks to the strong bank partners that continue to support us and our vendors. As you saw in our release this morning, we are updating our full-year guidance. We are adjusting the top end of our net and comparable store sales ranges. However, as mentioned, there are several one-time factors impacting margins in the back half of the year. This includes the change in our excess inventory estimate in Q3 and costs we expect to incur related to our organizational restructuring in Q4. Accordingly, we are reducing our operating income margin, diluted EPS, and free cash flow guidance ranges. We are taking decisive actions to improve our cost structure now and we'll continue to evaluate further opportunities as we make additional progress on our strategic and operational review. As a result, we are updating our 2023 guidance ranges to include net sales of $11.25 billion to $11.3 billion, comparable store sales of minus 0.5% to flat, GAAP operating income margin of 1.8% to 2%, income tax rate of 25%, diluted earnings per share of $1.40 to $1.80, capital expenditures of $200 million to $250 million, positive free cash flow of $50 million to $100 million, and 55 to 65 new store and branch openings. With that, I'd like to turn the call back to Shane.

As I mentioned earlier, we recognize there is substantial work to be done and are focused on executing a strategy centered on our customers and our frontline team members, while continuing to look at additional opportunities to simplify our operations. We are taking and will continue to take decisive action to stabilize the business and position Advance for long-term sustainable success. All of us at Advance, the Board, and the entire Management team are committed to returning to profitable growth and creating value for shareholders. I look forward to providing you with further updates on our next earnings call. I would now like to open it up to address your questions.

Thank you. Our first question today goes to Michael Lasser of UBS. Michael, please go ahead, your line is open.

Good morning. Thank you so much for taking my question. Shane, I know it's been very early in your tenure at Advance Auto Parts, but there are so many moving pieces in the business right now. As you think about the long term, what's the realistic operating margin for the core business, excluding some of the businesses that you're looking to sell, and it seems like the implied gross margin is going to settle around the 41% range, is that the correct run rate that we should think about for the long-term?

Hey, Michael, thanks for the question. It's too early for me to set what the long-term operating income looks like for this company, other than to say that I'm optimistic about where it can go and that if we implement these five decisive actions, they'll all help in boosting where we sit there. As for margins, it's early days, but we are absolutely focused on where we can increase the margins and we'll be looking to do that in 2024. Just one other small comment there, a way to help think about making that happen is with our organizational structure where one dimension of that is having merchandising via direct report to me, and I view that as a critical component for managing margin in a retail company.

Okay. And my follow-up question is are you seeing any impact from the negative credit rating downgrade and how are you thinking about capital needs of the business? If anything, you could comment on around the size of Worldpac or the Canadian business that will help as you go through the process?

So a lot there, I'm going to ask Tony to comment, but we don't have liquidity issues or issues on supply chain financing. I'm not going to comment on the size of Worldpac or Canada; we've engaged Centerview to manage that process, and interested parties can reach out to them. But Tony, can you tell us about the liquidity and financing?

Yeah. Hey, Michael, good to talk to you again. As you heard in my prepared remarks, we have continued to maintain the same level, or very similar levels, for our supply chain finance program, which really supports our vendors and our finance programs. So we're not seeing any impact, and as you saw in our earnings release, we continue to grow cash flow, our cash balance on the balance sheet grew, and we did not have any outstanding on the revolver as we have paid that down during the quarter.

Thank you very much.

And the last thing, there is no urgency around the sale of Worldpac or Canada; they are both good businesses. This is really around our strategy and what we want to focus on as a company going forward, which is that domestic blended box model.

Understood. Thank you very much and good luck.

Thank you. And our next question goes to Chris Horvers of JPMorgan. Chris, please go ahead, your line is open.

Hi, good morning. It's Christian Carlino on for Chris. I guess, stepping back, how would you characterize what went wrong with the supply chain and any color on the path forward in terms of the timeline or the cost to fix it? You laid out the timeline for the cost saves, but it seems like you'll also be paring back maybe some of the smaller Carquest DCs. So, will you then need to add more modern or better-located facilities, or is it more on the operational front fixing the inventory management process?

So a lot there, thanks for the question. The first thing I'll say is, our supply chain stems from the two entities from Carquest and from Advance. That'll be one of the next areas where I'll be putting focus is really around validating the design of our future supply chain, and as we do that, there'll be some rationalizations, there may be some facility additions, but we're comfortable, we'll develop that plan as we go forward. In terms of availability, those efforts can be discrete from what occurs on the actual supply chain design, and there's been a lot of work going on there, which we've improved across a number of areas, focusing on undercar, engine management, heating and cooling, brakes, and that comes from the pick-and-shovel work going on with the merchandise and inventory teams.

Got it. That's helpful and then just one quick one on the guide. What are you including for the one-time reorganization costs in Q4? And then I guess also, in terms of how you're managing the supply chain finance program, is the implication that you're maybe giving suppliers back some margin in exchange for holding the payable days somewhat constant? How should we think about the puts and takes there?

Yeah, two good questions. So first, let's address the supply chain financing. We are not seeing that kind of impact in our programs. We have very strong bank partners and we have tremendous support from our key vendors; we are not seeing any of that at this time. So in terms of that, we feel good. In terms of the guide in the back half, we have not laid out the impact from the restructuring; it is included in our guide. We're really not commenting on that just due to the sensitivity around our team members as we kick this off.

Yeah. Those reorganization dimensions are taking place this week and we want to be sensitive to our associates. That's a difficult process for any company to go through.

Got it. That makes sense. I appreciate that.

Thank you. The next question goes to Elizabeth Suzuki of Bank of America Merrill Lynch. Elizabeth, please go ahead, your line is open.

Great. Thank you. Just a question on the decision to increase the new store opening pace. I mean, particularly in the context of simplifying the business and preserving cash flow. Just curious what you're seeing in terms of new store profitability and whether that's been exceeding your expectations?

Yeah. So hey, Liz, good to talk to you again. We increased that based on a couple of opportunities that we have had in terms of opening stores or accelerating some of those new store openings. So we believe that, you know, we will continue to be very prudent in our approach to new stores and we will continue to focus on asset productivity that we've talked about the last two quarters, and that's an important part of our business.

I have a question about the businesses you plan to sell and the ones you acquired back in 2014. I'm considering how those assets have developed and whether you could provide insight since you are selling the Canadian segment of the Carquest business while retaining the US segment and selling the Worldpac segment of the GPI acquisition. I'm trying to understand the size and scope of those businesses for our analysis.

Yeah, we don't do segment reporting. So not prepared to break those out now. But just reiterating, they are both good businesses and that sales processes we're just starting that now. So we'll do price discovery with potential suitors; no requirement to sell the business if we're not satisfied with what we see in the market, and so we're just starting that now.

Okay, fair enough. Thank you.

Thank you. The next question goes to Steven Zaccone of Citigroup. Steven, please go ahead, your line is open.

Good morning. Thanks very much for taking my question. To follow up on the prior question, could you please talk about the Worldpac business? Is it much higher than reported operating margin that you have today and then help us think about the priorities for the cash proceeds from these sales? How would you rank using that cash?

Yeah, so good question. Unfortunately, back on the segment reporting, not going to talk about the business other than to say it's a great business. We don't have a requirement to sell it. Selling it lets us simplify our approach going forward, which is that blended box model. Your question on the proceeds is a good one. First and always in a business, if you have the economic dollars from an event like this, we're going to deploy it to initiatives that clear our internal rates for what we want to do with the business. So there's investment for our business, the growth of the remaining business; we're excited about that. Secondly, always prudent to deploy funds to strengthen the balance sheet, so that becomes an option for the proceeds. And then third, we can look at shareholders and where excess capital might be returned to that. Those would be the three major efforts of how we think about that.

Okay. I understood. My follow-up question is just on the DIFM side. So with your fresh perspective on the business, why do you think the core Advance business has been losing share in DIFM? Specifically, average ticket has been a bit of a drag. How long do you expect that to be a drag on the Pro side of the business?

Yeah, so I'm going to ask Tony to break out a bit of flavor on our DIY versus DIFM performance, but know that, you know, my focus coming into the organization is to take those decisive actions that help us simplify the business and then provide the focus at that store level for both the DIY and DIFM customer. And as we do that, I think that's where we gain success. But, Tony, can you just characterize what you're seeing on DIFM right now?

Yeah, correct. So as you've heard us talk about the last two to three quarters, we continue to focus on a very targeted CPI number. And as part of that, that will bring down our average ticket. And as a result, though, our transactions continue to increase.

Okay, thanks very much.

Thank you. The next question goes to Greg Melich of Evercore ISI. Greg, please go ahead, your line is open.

Greg, can you hear us? You can go ahead and switch to the next one.

Thank you. The next question goes to Bret Jordan of Jefferies. Bret, please go ahead, your line is open.

Good morning, everyone. As we look at the business with a fresh perspective, it's clear that the perception has been a blend of various supply chain systems. How close are we to having a consolidated supply chain across all stores, excluding Worldpac? We've made significant progress from a system standpoint.

You know, so the supply chain team is diligently on task for that. And for me that, you think about the five decisive actions we've covered, that's where my immediate focus is. Our pivot to supply chain shortly after that, and my sense is we'll come back to you on future calls on what the timeline looks like, but we're working on it. It's not something that will be done overnight, but confident that we can get to a unified supply chain for the company.

Okay. And then I guess on Worldpac, you know, what do you see I guess a dis-synergy in the sale? Were there common customers or sales to Advance that were a result of your having the Worldpac business that you might lose, or is it relatively separate?

So it is a different business and it runs as a separate business. So I really don't foresee dis-synergies there, but what I see for us is as we sell that business is a simplification of our focus. And going back to the fundamentals, we're going to sell auto parts out of a blended box model. We think that's a good recipe for success. And as we do that, Worldpac doesn't fit in that future model, so we will explore the sales process, which we're kicking off today.

Okay. And a quick housekeeping for Tony, what was the price contribution to comp, what was inflation versus traffic?

Yes, so I think that's for Tony. Yes, so in terms of price inflation, we priced just enough to cover a portion of costs. So it was very minimal to our comp in the third quarter.

Okay, thanks.

Thank you. The next question goes to Scot Ciccarelli of Truist. Scott, please go ahead, your line is open.

Good morning, everyone. Scot Ciccarelli. I wanted to ask about the restatements regarding the idea that where there's smoke there's fire. What gives you confidence that there aren't larger issues in your historical financials? It seems that what you disclosed today was found after a relatively short period for the new finance team. Could we end up in a situation where further investigation uncovers more issues?

Thanks, Scot. Tony here. You know, remediating the material weakness is our top priority in finance, and we continue to dig in. We are committed to getting this material weakness remediated and behind us as quick as possible. It is possible, but it is possible to not either. So, we'll continue to share as we find more information, but we will keep you abreast of that material weakness remediation as well.

Got it. And then can you repeat the comments you made on LIFO? Did your numbers this quarter actually include a sizable year-over-year benefit from LIFO? Is that what I heard?

That's correct, Scot.

Got it. Okay. Thank you very much.

Thank you. The next question goes to Simeon Gutman of Morgan Stanley. Simeon, please go ahead, your line is open.

Hey, guys. This is Jackie Sussman on for Simeon. Thanks so much for taking our question. You guys mentioned in your prepared remarks that some of the cost savings will go towards reinvesting to improve employee retention. In your view, has Advance done enough to retain its best people, and what are some areas for improvement that you see, or conversely, areas where you feel like you're executing pretty well?

So as I've been in the field, I'm impressed with our frontline associates. We have energized team members engaging every day, doing their level best to take care of customers. What we found is in certain key positions in the company, where we were from a wage perspective was below where we want it to be. So we've started to make some of those investments and we see correspondingly where we make the investment, the turnover has reduced. We think taking some of the monies from the cost reduction and putting that into wage will help further reduce turnover for key positions, but the initiative will extend beyond wage and as our field team and our HR teams work together, we also think that training, career pathing, and showing folks how they can develop over time with Advance, that's all part of it as well. The idea is that for our frontline associates, as they come in, they're energized to be here and then they feel they can have their career with the company and they can see where they can go. So that's all part of the program that we're putting together, and the early read from early investments is that it's doing exactly what we wanted to do.

Got you. That's super helpful. And just one more kind of housekeeping question, you know, regarding the cost savings that you mentioned. Where will that kind of fit in across the P&L? Is that mostly on the SG&A side or almost on gross as well? I mean, if you can give some color on that? Thank you.

Yeah. It's predominantly in SG&A; you'll see most of that savings come through there.

Great. Thanks so much.

Next year, of course. Yeah.

Thank you. The next question goes to Chris Bottiglieri of BNP Paribas. Chris, please go ahead. Your line is open.

Hey, everybody, thanks for taking the questions. I was hoping you could elaborate more on this inventory write-down. I appreciate you guys are cleaning the accounting up. I think it's really great to see it's someone like concerns for a while now, but this is all related to the capitalized supply chain costs that it has been growing for years, and beyond kind of the one-time write-down, was there some over-earning in prior periods because of this adjustment? Just wanted to understand what the impact is going forward?

Yeah. Hey Chris, it's Tony. Good to talk to you. We changed the way we estimate excess inventory, and as a result, we took a one-time change or charge to our P&L of $119 million. It is not relevant to say that it's part of the capitalized supply chain costs. The capitalized supply chain costs continue; those are in and out as a result of how much inventory by yourself, so this is just a result of our change in estimate.

Got you. Okay, that's really helpful. And then the second, what do you think the right SG&A growth rate of this business is moving forward? It seems like peers are ramping up their investment in terms of SG&A per store. I think it's great that you're reinvesting $50 million of the $150 million, but one on all $150. Like how do you think about reinvestment? It seems like if you're cutting costs, and your peers are accelerating investments, it's one of the challenges the business has faced the last five years?

So I'll start. Yeah, it's a good question. I'll start and ask Tony to comment. We're not suggesting through this cost cutting that we're not going to reinvest in the business or not going to invest in the business going forward. This was really around looking at the current state of the business and where we're spending money and where we were heavy or where we weren't getting productivity, but we will absolutely be investing for growth in the future; I think that's a key part of it. And then on SG&A, the way I think about just the retail businesses in general is we want to be creating leverage as we go forward. But Tony, if you have any character on how we think about that, that would be great.

Over the past few years, our SG&A costs have increased at a faster rate than our revenue. The actions we are announcing today are not aimed at stopping investments in our stores or the overall business. Instead, they focus on discontinuing certain projects and concentrating on the essential aspects of the business, which is the approach we are taking with this cost reduction program.

Got it. That's all helpful. Thank you for the color.

Thank you. The next question goes to Steven Forbes of Guggenheim Partners. Steven, please go ahead, your line is open.

Good morning, Shane, Tony. Shane, I wanted to revisit the decision to sell Worldpac. Really, if we could just take a step back, Shane. So early on into the 100-day review process, why such urgency and the message and the decision to sell the Worldpac asset? What is the urgency really stemming from?

Yeah. So first, I don't want you to think that these are knee-jerk decisions. The benefit of counsel and continuity from our Executive Chair, Gene, also talking with statured leaders in the company in terms of assessing what the right direction is, so that perspective doesn't just come from me being in the business for 60 days. What I do bring in terms of fresh eyes is a validation of that perspective and then a bias for action, and I think that's really important. One of the things that this company needed to do to reset is to make the decisions that will set us on the trajectory for success going forward. It doesn't mean I have all the answers, I readily admit, it doesn't mean that in some of these initiatives that we won't make mistakes, and where we do, we'll correct, of course. But clearly, as you looked at the performance of the company over time, which I did before I came in, it's clear that where we were with our status quo activities wasn't working, and so that's where that comes from. We think strategically, going forward, the blended box model is a tenant for our success.

And then, I appreciate that, Shane. Just a quick follow-up. I realize you're not providing financial color on the assets for sale, but I'm not sure if you can maybe help reframe what the remaining assets would be free cash flowing this year, right as we sort of think through the $50 million to $100 million guidance for the full year. What is the core asset free cash flow positive this year?

Yeah. Since we don't segment report, we can't break that out for you. We don't anticipate the sale to happen this year. So the $50 million to $100 million is inclusive of our consolidated financial operations.

Thank you.

Thank you. The next question goes to Seth Basham of Wedbush. Seth, please go ahead, your line is open.

Thank you very much. Good morning. I would like to ask about the gross margin. Can you provide more insight into the decrease in gross margin from last quarter to this quarter? Even when excluding the inventory charge, we noticed a decline. I'm trying to better understand the factors affecting your gross margin.

Yeah, I'll take that. So when you look at the, when you exclude the inventory, there's a couple of key factors. One is we continue to not cover costs with price; costs are what we called out. That's the predominantly the bigger chunk excluding the inventory. We've also seen some additional deleverage in our supply chain costs, but the predominant cost structure is really coming from not covering costs. The other thing that I'd add to that is really the channel mix, as we continue to see our Pro rebound that does have lower margin than our DIY business.

So on a per unit basis, are you seeing your costs continue to rise? And is that partly due to higher financing costs for your vendors on the supply chain financing program?

No, we're not, it's not that; there's inflationary costs that are already built in but we are not building an additional price to cover that cost.

All right. Thank you very much.

Thank you. The next question goes to Zach Fadem of Wells Fargo. Zach, please go ahead, your line is open.

Hey, good morning. So first of all, Shane, congrats on the first earnings call. So the question that, could you talk a bit about the game plan for growing your do-it-for-me business today, whether you think the current 60-40-ish do-it-for-me DIY mix is optimal? And then as you think about balancing growth and profitability, should we expect a culling of the business to remove less profitable customers, or is there a plan to prioritize the top line over profitability? Any color there?

Great. So let's talk about those each in turn. First on growing the Pro, we certainly want to have the Pro be a prominent part of our growth, and the way you do that is engagement in the market. It starts with the CPPs in the stores. Those are our store-based Pro representatives, also our field-based representatives, our camps, and we've done some moves in terms of how we're organizing that Pro part of our business under Junior Ward. So we've made some streamlined moves, and in particular, as we get ready to divest Worldpac. So that will help us on the Pro side of the house, and we'll have that focus there. Obviously, it also means we got to have the right parts on hand for the Pros. In this business, you want to be the first call, and that's where we're aligning our efforts so that as our Pro customers need product, they call us, and we go ahead and get it. As it relates to how we think about less profitable customers, I can just put this broadly under just an effort around asset assessment and utilization across the company. We just need to look at how we operate and where we operate and make rational decisions about where we can grow and grow profitably. I don't want to just do topline without the expense of contributing operating income; I think that's important. So that's what we're looking to get Advance back on a trajectory of consistent profitable growth. And as we look at all of our assets, inclusive of our stores, supply chain, how we merchandise, and then who we sell to, I think it's appropriate to make logical decisions about each of those to get to that profitable growth.

Got it. I appreciate the color there. And then I think you suggested that your operating margin is expected to grow in 2024, so just curious if you could talk a little bit about the makeup there in more detail with respect to top-line growth versus margin recovery versus structural changes like taking Worldpac and other costs out of the business?

Yeah, I think it's too soon to start talking about 2024 in terms of margin. You know, we'll come back to you in February and provide you a lot of additional color. What we have said so far is, you know, the cost reduction program that we have announced today, that will benefit from full run rate in 2024. So, but more to come in February as we continue down the strategic and operational review of our business.

Got it. Thanks for the time.

Thank you.

Thank you. The next question goes to Priya Ohri-Gupta of Barclays. Priya, please go ahead, your line is open.

Hi. Thank you for taking our question. This is Orges in for Priya. We would like to know if you are currently considering obtaining a Fitch rating. Thank you.

Yeah. As we continue to assess our overall capital structure, we will always consider what makes the most sense for the business. You know if we decide to solicit a Fitch rating for public, we will announce that in the future. At this time, we are maintaining what we have today; we are focused on turning our business and we continue to improve our cash flow and working capital metrics that you've seen us announce this quarter.

Thank you.

Thank you. The next question goes to Michael Montani of Evercore ISI. Michael, please go ahead, your line is open.

Hey, good morning. This is Mike Montani on for Greg Melich. Thanks for taking the questions. I just wanted to ask, first off, on the cash flow side, if you could discuss the plans to inflect that positive for the full year. I think you're running about $150 million negative through the first three quarters. So it's probably something simple, but how do you get that inflected positive in the fourth quarter?

Yeah, as you've seen over the last two quarters, we continue to generate positive cash flow each of those quarters. As we continue to focus on the business, focus on sales, and our working capital, metrics continue to improve. We expect that to continue into Q4 at this time based on what we know, and that's what we are looking at based on the recovery of all of our working capital, as well as higher sales that you've seen in Q2 and Q3.

Got it. And then if I could just follow up on the sales line. You did mention some deterioration in the final period, was curious if you could discuss if that's continued into the fourth quarter and also, if there's any color in terms of what the DIY that slowed versus Pro or what would have driven this slowdown?

Yeah, we're very conscious of the DIY consumer and the pressures that they're facing. But as we started the fourth quarter, we're actually tracking slightly better in the first four weeks, but we know that we have a challenging December ahead of us, given the lack of last year where we had a significantly colder period than we are expecting this year. But we continue to be very conscious of the DIY consumer and we expect Pro to continue to remain positive as well.

Thank you.

Thank you. Our final question goes to Andrew of Oppenheimer. Andrew, please go ahead, your line is open.

Hey, it's Brian Nagel from Oppenheimer here. Thanks for taking our questions. We appreciate it. So a couple of questions. First off, just with respect to the competitive environment, given this transformation, if you will, and Advance now is pretty well documented. Are you seeing anything change competitively, whether from your larger competitors or some of your smaller competitors, particularly on the professional side? And then my second question, Shane, you've laid out welcome first off, and then you laid out just some initial steps here in the transformation of Advance. Should we be expecting as analysts and investors watching the company, should we be expecting at some point in the not-too-distant future your kind of a longer-term operating plan from you and your team, indicating where this business could ultimately head?

Thank you, Brian. Regarding the competitive landscape, we are clearly in a market with several capable larger and smaller players. However, what stands out to me in these early days is the enthusiasm within our team. We have excellent frontline team members who seem ready for clarity in our focus. As we implement these decisive actions, that enthusiasm will manifest into success. We are empowering our frontline to thrive with our customers, which will aid us in this competitive environment. It's early to discuss potential economic progress, but from a philosophical and engagement standpoint, adopting a field-first mentality will foster momentum for us. As for the long-term plan, I'm still outlining my first 60 days and will also consider the long-term direction for the business, which includes both the initiatives we're currently pursuing and future areas I will be exploring.

That is all the questions we have today. Thank you all for joining us. We're grateful for your continued support. Wish you all a very Happy Thanksgiving next week and look forward to sharing more in February. Have a nice day.

Thank you. This now concludes today's call. Thank you for joining. You may now disconnect your lines.