Advance Auto Parts Inc Q4 FY2025 Earnings Call

Welcome to the Advance Auto Parts Fourth Quarter and Full Year 2025 Earnings Conference Call. I would now like to turn it over to Lavesh Hemnani, Vice President of Investor Relations.

Good morning, and thank you for participating in today's call. I'm joined by Shane O'Kelly, President and Chief Executive Officer; and Ryan Grimsland, Executive Vice President and Chief Financial Officer. During today's call, we will be referencing slides which have been posted to the Investor Relations website. Before we begin, please be advised that management's 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 initiatives, plans, projections, goals, guidance and expectations for the future. Actual results could differ materially from those projected or implied by the forward-looking statements. Additional information can be found under forward-looking statements in our earnings release and risk factors in our most recent Form 10-K and subsequent filings made with the SEC. Shane will begin today's call with an update on the business and our strategic priorities. Later, Ryan will discuss results for the fourth quarter and full year 2025 and provide guidance for 2026. Following management's prepared remarks, we will open the line for questions. Now let me turn the call over to our CEO, Shane O'Kelly.

Thank you, Lavesh, and good morning, everyone. I want to begin today's call by thanking our Frontline team for all of their hard work in 2025. During the year, we laid the foundation to build a better future for the company and create long-term value for our shareholders. We are undergoing a significant transformation focused on the fundamentals of selling auto parts through initiatives guided by the voice of our customer. These efforts are beginning to improve our competitive position and are translating to stronger financial performance. In 2025, we returned to positive comparable sales growth after three consecutive years of negative results. We also expanded adjusted operating income margin by over 200 basis points from near breakeven levels while also navigating a volatile external environment. Our journey has just begun, and the early progress is being recognized by vendor partners, customers, and team members. During 2026, we will continue to execute actions aimed at enhancing parts availability and customer service by building on the foundation established in 2025. We expect these efforts to deliver stronger financial performance in 2026, including an acceleration in comparable sales growth to the 1% to 2% range and expansion in adjusted operating income margin to the 3.8% to 4.5% range, and a return to positive free cash flow. We expect to generate approximately $100 million in free cash flow in 2026 while allocating more capital to strategic projects and store investments. The progress made by our team in 2025 has created positive momentum that we are carrying into this year, and I am confident in our ability to succeed in 2026. Before I provide an overview of our strategic priorities for this year, let's recap 2025. We entered the year with a renewed emphasis on the blended box and establishing Advance as a consistent, reliable auto parts provider for both Pro and DIY customers. Our team is already driving results through comprehensive actions taken last year. For example, number one, we rationalized our asset footprint by exiting underperforming locations, including over 500 corporate stores and 200 independents. We achieved this with minimal disruption to our day-to-day operations and saved approximately $70 million in operating costs. Number two, we expanded our assortment by 100,000 new SKUs. We improved store availability to the high 90% range from the low 90% range at the start of 2025, and we also reduced product costs by more than 70 basis points. Number three, we increased our average speed of delivery to Pro customers by cutting more than 10 minutes in delivery time from an average of over 50 minutes at the start of 2025. Number four, we moved with speed to substantially complete the consolidation of our distribution center network. We now operate 16 distribution centers in the U.S. compared to nearly 40 DCs at the end of 2023. And number five, we opened 14 new market hubs and now operate 33 market hub locations. We also opened 35 new stores to further enhance density in our strongest markets, and we invested nearly $90 million in store infrastructure upgrades at more than 1,600 stores. Throughout the year, we also navigated a series of external challenges, including a volatile tariff and consumer spending environment. We maintained focus on executing actions to improve availability and service. This enabled us to deliver positive performance in the Pro channel, which strengthened throughout the year. We are progressing on our strategic plan with a stronger balance sheet, having proactively accessed the capital markets during 2025. As we move forward, we will continue to prioritize actions within our control to improve operational performance. In recent months, we have also strengthened key leadership positions through internal promotions and the addition of talented external expertise. These include: Anthony Sarlanis, former Regional Vice President of our Northeast Operations, who was promoted to Senior Vice President of the Pro business. He has been with Advance for over 15 years and brings more than 20 years of automotive experience to the role. Kunal Das, our former Chief Data Officer, now promoted to Chief Technology Officer. His team has led the development of proprietary AI tools to improve our day-to-day execution. Ron Gilbert, who joined Advance in December as Senior Vice President of Supply Chain, bringing more than 20 years of experience in supply chain logistics with a track record of delivering operational efficiencies in complex systems. And Tony Hurst, who joined Advance in January as Senior Vice President of U.S. Stores, has over 25 years of field leadership and store transformation experience across Pro and DIY, with a proven record of simplifying work for the front line. The caliber of our leadership team reinforces my confidence in our ability to grow transaction volumes through strong customer service and deliver greater productivity in our store and distribution center operations. Since late 2023, we have acted decisively to stabilize the business, conduct a comprehensive review of operational productivity, sell noncore assets, and develop a strategic plan. To date, this team has delivered approximately 500 basis points of adjusted operating margin expansion. We continue to believe that our goal of 7% adjusted operating income margin with a mid-40% gross margin is appropriate medium-term targets for the company. As a reminder, about half of our identified margin opportunity is tied to merchandising excellence with the balance being driven by supply chain and store operations. I am pleased with the progress being made in unlocking this margin opportunity. We concluded 2025 with an adjusted operating income margin of 2.5%. For 2026, we are targeting an additional 130 to 200 basis points of expansion to the 3.8% to 4.5% range. This guidance includes an approximate 45% gross margin rate, which showcases success against our initiatives on the path to a 7% operating margin target. Our goal is to deliver consistent progress on our plan to narrow our margin gap to the industry. We currently believe that we can deliver at least another 100 basis points of margin expansion in 2027, which would mark the third straight year of 100 basis points or more of expansion. Although this pace would imply an outcome below our previous target of achieving 7% in 2027, it is important to note that this is not the result of any change to the execution of our strategic plan. Rather, we are being prudent about two factors as we consider the expected time frame for achieving our goals. First, initiatives across our three strategic pillars are progressing at varying rates. We have made strong progress in merchandising and completed the consolidation of distribution centers. We are now in the early stages of implementing supply chain and store labor productivity initiatives. I am excited to welcome new leaders overseeing the implementation of these activities. We expect our investments in 2026 to enable further margin expansion in 2027 and beyond. And second, top-line momentum has lagged original expectations. Our pace of same-store sales growth has been impacted in part by external economic factors that have resulted in a softer consumer spending environment. While we are pleased with the strong positive comps in our Pro business, including traction with Main Street Pros, we still have a lot of opportunities ahead as we continue to improve availability and service metrics. I want to reiterate, I am pleased with the progress being made on our strategic plan. I remain confident in the ability of our team to deliver against our operational and financial goals. Our quality of execution is improving, and we expect 2026 to be a pivotal year on the path of long-term value creation. Next, let's turn to an update on our strategic plan. As I've indicated previously, our strategy is unchanged and built on three pillars that are supported by targeted initiatives to deliver long-term profitable growth. Turning to our key priorities for 2026, which build on the foundational improvements achieved in 2025. Merchandising excellence is expected to be the largest contributor of margin expansion during the year, and our four merchandising initiatives for the year include: first, in 2025, we began repositioning Advance as a trusted long-term growth partner. Our focus on operational excellence and streamlining legacy processes has signaled to the vendors that Advance is here for the long term. In 2026, we expect to further deepen our vendor partnerships to jointly grow our businesses. We are doing this through strategic business planning, exploring supply consolidation, eliminating non-value-add supply chain costs, engaging in training opportunities for the field, and collaborating on joint marketing efforts. We expect this to translate to better cost opportunities and stronger margins in the year. Second, in 2025, our pricing decisions were made largely in reaction to new tariff programs. However, we still focused on offering compelling value to our customers through fewer, bigger, and bolder promotions. During 2026, we expect to deploy a new pricing matrix, which provides our team better intelligence of market-based pricing by channel and by SKU. Our goal is to offer competitive pricing while continuing to operate rationally in the marketplace. We expect the combination of smarter pricing supplemented with seasonally relevant promotions to drive stronger customer engagement and support repeat purchases. Third, 2025 was an important year for our assortment. We addressed product gaps and also improved brand coverage and application job quantities for parts in our stores. We did this by using a specialized data-driven approach as well as improving internal processes and incorporating feedback from customers to develop a new assortment framework that was fully rolled out to all stores last year. This work has expanded parts coverage for brands we carried previously and also enabled us to introduce new brands. Our success with the brake category is a great example of this. Entering 2025, we were running negative comps in brakes, and we finished the year with strong positive comp growth, showing how deep vendor relationships, targeted SKU placements, and thorough market planning can help win market share. While we moved fast in 2025 to address parts coverage, we believe we have additional opportunities to amplify our efforts. In 2026, we plan to invest in systems that help us dynamically balance inventory across the network to support stronger financial returns on inventory. We will also continue to expand the universe of parts carried in our network and optimize the presentation of SKUs in our stores. This includes accessing opportunities to provide more value for our customers. We are excited to launch our new owned oil and fluids brand, ARGOS. As a 94-year-old company, we are pleased to back our legacy with a new owned brand in a top maintenance category. This brand was born out of extensive research. Customers ranked affordability, reliability, and strength as top product attributes they value. ARGOS offers engine protection and performance comparable to national brands at a price that provides meaningful savings, which will be valued by both Pro and DIY customers. And fourth, earlier this month, we modernized our DIY loyalty program with the launch of Advance Rewards to replace the prior Speed Perks program. Approximately 60% of our DIY transactions are driven by our loyal customer base of approximately 16 million active members. The new program now provides a refreshed tiered point structure that rewards customers as they spend more with us. With Advance Rewards, members will be able to experience exclusive vendor offers, bonus points promotions, sweepstakes, and other exciting new features. Based on customer feedback, we discontinued unproductive offers like Fuel Rewards and enhanced the flexibility to redeem coupons, which are very frequently used for purchases in key maintenance categories. The new Advance Rewards also gives us more tools to engage with our customers, which we believe will help drive transaction growth in the DIY channel. Turning to supply chain. We are on track to complete the consolidation of our distribution centers and expect to operate a total of 15 DCs in the U.S. by the end of this year. We believe our DC network is well positioned to support strong service levels and the continued growth of our multi-echelon network. Consolidating DCs is a difficult undertaking, and we have done so without major disruption to our 4,000-plus store network. Over the past two years, we have gone from operating 38 DCs in the U.S. to 16 DCs currently, and I want to thank our supply chain team for their efforts over the last two years. Throughout 2026, we are going to be focused on simplifying and standardizing DC operations along with testing and launching labor performance and transportation management tools. We expect our supply chain productivity initiatives to support gross margin expansion in 2027 and beyond. While consolidating the DCs over the past two years, we have also accelerated our pace of market hub openings, which serve as an additional distribution node in our network with the retail storefront. A market hub typically carries between 75,000 and 85,000 SKUs and expands same-day parts availability for a service area of about 60 to 90 stores. At the end of 2025, we had 33 market hubs, and we currently plan to add 10 to 15 market hubs in 2026. Most of these openings will be greenfield buildings serving as new points of distribution in markets where they open. We believe that this strategic expansion will enhance our ability to provide additional hard parts coverage in the previously underserved regions while creating incremental opportunities to gain market share. Next, I will provide an update on key priorities for store operations. We are elevating the experience for our team members through training and simplification of tasks. We have launched targeted programs to provide customized short-duration training that combines product knowledge and sales behaviors to better serve customers. Our analysis shows a positive correlation in sales performance for stores following the completion of the training programs. We are also beginning to simplify store tasks and streamline communication with stores to help our team members prioritize only the most critical activities. We are investing in industry-leading tools like Zebra Devices to increase team member efficiency while allocating payroll hours to support market-specific customer needs. In addition to these resources, we are continuing to allocate capital to store infrastructure upgrades as part of a multiyear asset management plan. In 2026, we plan to upgrade more than 1,000 stores. We are also improving service standards in our stores. We launched our new store operating model across all stores in Q4. We believe that this operating model supports better allocation of labor hours and vehicles while strengthening collaboration between our customer-facing outside sales team and our internal store teams. To drive consistency in service, our teams are being held accountable to two primary metrics. The first one is NPS, which strives for continuous improvement in customer service, and the second is time to serve, where we target under 40 minutes for delivery time for Pro orders. With the right training, service standards, and clear metrics for tracking performance, we expect to improve labor utilization and grow our business. While it is still early in the implementation of newer operating standards in our stores, we are seeing signs of improved performance. For example, our efforts to gain share across Main Street Pro are translating to stronger positive comps in that segment. Within DIY, our focus on selling behaviors is driving greater unit productivity with a sequential acceleration in DIY units per transaction in Q4. While we still have considerable work ahead of us, we are pleased with the direction in which we are moving. We believe that an improvement in service standards will also support enhanced productivity of new stores. In 2026, we plan to open 40 to 45 stores and 10 to 15 market hubs as we march toward our goal of opening more than 100 new distribution points over the next two years. In closing, I want to recognize the Advance team once again for their hard work and commitment to delivering progress. We remain focused on prioritizing actions to drive sustained improvement over the long term. I'll now hand the call over to Ryan to discuss our financials.

Thank you, Shane, and good morning, everyone. I want to begin by thanking our Frontline associates for their commitment to serving our customers and delivering a strong finish to 2025. For the fourth quarter, net sales from continuing operations were approximately $2 billion, which declined 1% compared to last year. This is mainly attributable to the store optimization activity completed in Q1 of 2025. Comparable sales grew 1.1% in the fourth quarter. Following a softer start to the quarter, transactions improved during the last eight weeks, resulting in positive comparable sales growth over that time frame. In fact, outside of weather-related comparisons, our business has been averaging low single-digit positive comps over the last six months, reflecting operational stability as we execute our strategic plan. Brakes, undercar components, and engine management led performance, indicating progress in improving coverage and availability of hard parts. Ticket was positive for the quarter and driven by a combination of better unit productivity and higher average prices. Our Frontline team has been focused on providing complete job solutions to our customers, and I want to thank them as their efforts have translated to an acceleration in units per transaction on a one- and two-year basis. Overall, average ticket was still below expectations due to some discrete factors. First, same SKU inflation came in just under 3%. This was about 100 basis points lighter than expected due to successful tariff-related negotiations, which were still underway at the start of the quarter. And second, during Q4, we accelerated the transition of some front-room assortment to introduce new brands following recent supplier changes and to support the planned launch of our new own brand ARGOS. These transitions led to a higher-than-expected markdown headwind of about 50 basis points, impacting comps. This activity has been completed and is not expected to impact Q1 results. Looking at channel performance, our Pro business grew by nearly 4% during the quarter, with sales strengthening throughout the quarter on both a one- and two-year basis. Trends in DIY remain volatile, leading to a low single-digit percent decline in comps. We believe this is largely a continuation of the market trends we have experienced all year. Our core consumer group has been adjusting purchasing habits in response to rising prices. Moving to margins. Adjusted gross profit from continuing operations was $873 million, or 44.2% of net sales, resulting in nearly 530 basis points of gross margin expansion compared to the same period last year. During the quarter, we cycled through approximately 280 basis points of atypical margin headwinds related to our restructuring activity last year. The balance of margin expansion was driven by savings associated with our footprint optimization activity and benefits from our strategic sourcing initiatives. Additionally, LIFO expense came in at $56 million for the quarter, which was lower than previously expected. Adjusted SG&A from continuing operations was $800 million, or 40.5% of net sales, resulting in nearly 340 basis points leverage. This was consistent with expectations for a high single-digit percent expense decline and driven by the reduction in stores compared to last year. As a result, adjusted operating income from continuing operations was $73 million, or 3.7% of net sales, resulting in nearly 870 basis points of year-over-year operating margin expansion. Our Q4 results also include an extra operating week, which contributed $132 million in net sales and $9 million in adjusted operating income. Adjusted diluted earnings per share from continuing operations for the quarter was $0.86 compared to a loss of $1.18 last year. The extra week added $0.08 to fourth quarter EPS. Moving to an update on full year 2025 results. Net sales from continuing operations declined 5% to $8.6 billion, primarily due to store optimization activity that was completed during Q1 2025. Comparable sales grew just under 1% for the year, marking our return to positive comparable sales growth. Both channels improved compared to last year. Our Pro business grew in the low single-digit range, while DIY declined in the low single-digit range. Same SKU inflation contributed about 140 basis points to ticket growth for the year. Adjusted gross profit from continuing operations was $3.8 billion, or 43.9% of net sales, resulting in about 165 basis points of gross margin expansion compared to last year. During the year, we cycled through approximately 90 basis points of atypical margin headwinds related to our restructuring activity from last year. Adjusted SG&A from continuing operations was $3.6 billion, or 41.4% of net sales, resulting in about 50 basis points of leverage driven by operating fewer stores compared to last year. As a result, adjusted operating income from continuing operations was $216 million, or 2.5% of net sales, resulting in 210 basis points of year-over-year operating margin expansion. Adjusted diluted earnings per share from continuing operations was $2.26 for the full year 2025 compared with a loss of $0.29 for full year 2024. We ended the year with free cash flow of negative $298 million, which included approximately $140 million in cash expenses associated with our store optimization activity. The remaining outflow of approximately $160 million impacted our ability to generate positive free cash flow. About half of the variance compared to our expectations was related to a combination of Q4 business performance, timing of certain cash obligations, and the delay in receipt of tax refunds. The other half was associated with variances relative to our expectations for timing of certain inventory payables that drove approximately $80 million of cash outflow and reduced our payables balance at the end of the year. Separately, we also lowered the usage of our supplier financing program to $2.5 billion from $2.7 billion last quarter. We entered 2026 with a solid balance sheet, including more than $3 billion in cash and $1 billion undrawn revolving facility, which is more than sufficient to support approximately $2.5 billion in supplier financing payables over the long term. Our net debt leverage improved to 2.4x at the end of the year compared to 2.6x last quarter and is in line with our targeted range of 2 to 2.5x. Turning to 2026 guidance. We expect net sales to decline slightly year-over-year, mainly driven by two nonrecurring items from 2025. First, we generated $51 million in liquidation sales in Q1 last year. And second, Q4 included an extra week, which generated $132 million in net sales. In aggregate, both items drive over 200 basis points of headwind to sales growth. Excluding these nonrecurring items, we expect underlying net sales to grow in the range of approximately 1% to 2%. This includes comparable sales growth of 1% to 2% and about 10 to 20 basis points of pressure related to sales normalization at independent locations following a reduction in locations last year. We expect positive comp growth in each quarter with a stronger first half owing to easier comparisons. Same SKU inflation is currently planned in the 2% to 3% range for the full year and assumes no change in the current tariff environment. In terms of channel performance, we expect Pro to outperform DIY, with both channels contributing positively to comp growth, which is expected to be driven by gradual improvement in transactions. With initiatives focused on enhancing availability and service levels, we are excited to get back on the path of consistently delivering positive comparable sales growth and expect our strategic plan to ultimately position us to gain market share in the future. Moving to margins. We expect adjusted operating income margin between 3.8% and 4.5% for 2026, resulting in 130 to 200 basis points of year-over-year margin expansion. We are forecasting gross margin expansion in the range of 110 to 150 basis points to approximately 45%. This margin expansion includes about 20 basis points of year-over-year favorability from cycling nonrecurring items from 2025. The balance of the expansion is expected to be driven by merchandising initiatives related to strategic vendor sourcing and optimization of pricing and promotions. The benefits from merchandising initiatives will be partially offset by investments to improve productivity in our supply chain operations following the completion of the consolidation phase of our DC network. Based on the progress of our initiatives, we expect the gross margin rate to build throughout the year, starting with Q1 gross margin in the 44% to 45% range. Regarding SG&A, we expect reported full-year expenses to be down year-over-year, contributing 20 to 50 basis points of leverage. Specifically regarding Q1, SG&A expense is planned to be down in the 3% to 4% range as we cycle through the store closure activity from last year. Full-year 2025 SG&A expense included about $90 million of nonrecurring items to support liquidation sales in the extra week, which is expected to drive about 20 basis points of favorability in 2026. Adjusting for the nonrecurring expense, SG&A is planned to be higher year-over-year with modest leverage driven by positive comp sales growth. We expect to deploy savings generated from better in-store task management, better resource allocation, and a reduction in indirect spending to fund general wage inflation, store opening expenses, and strategic labor investments in priority markets. As Shane indicated, we have completed the rollout of our new store operating model, which has enabled us to position labor and truck resources based on volume. As we move forward, we will continue to look for opportunities to further optimize payroll hours to enable our team members to dedicate more time to customer service by minimizing time spent on tasking. Moving to other items in our guidance. We expect adjusted diluted EPS in the range of $2.40 to $3.10. Pretax interest expense for full-year 2026 is planned at approximately $210 million, which is expected to be partially offset by interest income of approximately $80 million. We expect to increase capital expenditures in 2026 to approximately $300 million, with spending allocated to new stores and greenfield market hub growth, store infrastructure upgrades, and strategic investments. Finally, with respect to cash flow, we expect to generate approximately $100 million in free cash flow for the year, supported by stronger comp sales and profitability. Our free cash flow guidance includes modest carryover spending of $10 million to $20 million related to our store optimization activity. To conclude, I want to thank the Frontline team for their contributions, which supported solid financial results in 2025. During 2026, we expect our initiatives to provide added financial momentum to narrow our operating margin gap to the industry.

Thank you, Ryan. During 2026, we are building on the foundation established last year with a clear focus on executing our strategy to deliver improved operational performance. I'd like to close by thanking the Advance Auto Parts team for all of their hard work and commitment to serving our customers. Thank you. Operator, we can now open the line for questions.

And our first question today comes from Chris Horvers from JPMorgan.

So my first question is, why is your inflation so much lower than what your peers have reported, specifically Zone and O'Reilly. One could interpret this two ways: A, where you're pricing below the market, which I don't think that's what's happening; or perhaps simply your prices were too high before all this inflation came in, and when you came into the company, and you were forced to narrow the gap. I guess it could also be sourcing differences, but again, sort of the market price is the market price. So if you could help us out there.

Yes, Chris, I appreciate that. It's Ryan. Our SKU inflation seems to be similar to our peers, although we have some comparison challenges for 2025. We are reflecting on some pricing investments from the previous year that have now concluded. For 2025, we reported around 3% for the third and fourth quarters, which aligns somewhat with industry standards. However, it was slightly lower than our expectations for the fourth quarter due to ongoing negotiations regarding tariffs. The 1.4% inflation in 2025 is significantly influenced by the previous year's pricing investments.

Chris, it's Shane. Just to add, you mentioned first, are we pricing below the market? And your hypothesis is that we're not. That's not our strategy. It's a competitive market, but a rational market, and we participate in that way. We are using AI to do better with our promotions as to when we do a promotion and on what products and where we do it. So that can help us a bit, but we're a rational player in the market.

We monitor our pricing relative to everyone else, and we want to make sure we're competitive every day. We're not doing anything inconsistent with that.

And then my follow-up question is on the decision to reduce your supply chain financing in the fourth quarter. I guess one of the hallmarks of this industry is that the vendors finance essentially all of the inventory. So what drove that decision? Was there anything on the other side because your free cash flow did come in lower than expected because of the reasons that you laid out, Ryan? Was there any sort of push from the other side because of the free cash flow dynamics? Or is it something to do with perhaps sort of the margin versus rate negotiation that's implicit in these arrangements?

Yes, good question. So about half that change in free cash flow from anticipation was due to lowering the payables, as we mentioned earlier. We're always going to look to see if it makes sense from an economic standpoint to reduce supply chain finance. But only when it makes sense, we're really happy with our program, especially after the structure we put in place this past summer. It's a very stable program, significant capacity in that program. But it was more about leveling the payables based on the new purchases that we have, based on the sourcing of those and the negotiations we've had. As a reminder, this past year, we've had 500 stores we've closed. We accelerated purchases on inventory ahead of the tariffs. We accelerated our assortment work into our top 50 DMAs. So a lot of moving pieces. On top of that, the merchant organization has been transitioning and working through many PLRs with different vendors as we've executed our strategic sourcing work, and we've yielded really good progress on the margin side. All of that mixes differently sometimes from a payables balance. And I think it's more about the mix of our purchases and where the true payables balance should be that caused a reduction in Q4. We'll continue to look for opportunities there if it makes economic sense to do that. But we're still sitting close to 80% of our COGS is on supply chain finance. We think right now, where we are with our vendors, we're in a good position, 2.4x to 2.6x is the right target range to ebb and flow on supply chain finance.

Last point there, just on a big picture level, we had our annual conference Accelerate down in Orlando this year. And I would submit that our vendor relations are the best they've ever been. I continually meet with senior leaders from vendors who are behind our comeback and supporting us and the degree to which we're now working on innovative programs to help us grow. I feel great about the vendor community and Advance Auto Parts.

The next question comes from Seth Sigman from Barclays.

Nice progress. I wanted to ask first about the real estate. Can you talk about the impact that the store closings had on comps and margins in 2025? And then I guess, how are you thinking about the opportunity to optimize the store portfolio further from here? And maybe just in general, what are you seeing in terms of the gap in performance across the store base?

Yes. So good question. The liquidation impact was about $51 million on the year. So we kind of walked the bridge to walk that back off of there, to give you a sense of what that looks like. So a little bit of an impact there. We also cycled over that; we had some liquidation impact in '24 in Q4 as well that had a little bit of a drag on that. No further closures we expect. So growing our new stores, we're significantly growing those new stores. Shane, you might want to...

Yes. So when I came to the company, we had multiple real estate departments. Worldpac had a real estate department, independents, supply chain stores. And so we weren't cohesive about how and where we thought about building out in a market and opening a store. And you think about everything from construction or leases to fixtures to grand opening protocols. And so we've had a lot of effort going on. We've got a unified real estate program under a single leader. In '25, we opened a total of 35 NSOs. This year, we'll do 40 to 45. By the way, we're opening NSOs in both the U.S. and Canada. And as we do that, think about in the wake of the closures, we think store density is important. So in the wake of the closures, we're number one or number two in 75% of our markets. So we want to expand concentrically in those markets where we have existing density and move down the road to the next part of the market. And we think that's a good play because it leverages the existing store base, the outside sales, the Pro customer relationships, the DC connectivity. And so we're getting better at it, and we're pleased with where we're going.

And Seth, just to make sure we clarify, the closing stores were not in our comp numbers that we reported out. They are in our year-over-year. So that's why just giving you the dollar impact versus the comp impact.

Was there a meaningful impact to the rest of the store base from closing those stores in terms of sales transfer?

Yes. Pro comps did benefit but still positive even after the benefit. So we did have transfer sales from the Pro business that transferred to the new stores, actually outperformed our original expectations going into that work. But still, Pro is positive even if you back that out.

Okay, and my other follow-up was just thinking about the 7% margin target. The prior guidance was for a lot of the margin progression to be back-end weighted and the annual gains would ramp really in the out years. Guidance now seems to imply bigger gains maybe upfront, and it's great that you're executing what you laid out for '25, and it seems like for '26 as well but maybe more gradual margin gains going forward. I guess what really drives that difference in the cadence? And I'm just wondering, is there any indication that maybe there's more reinvestment that's required here? Or is it just harder than you thought?

Yes, I appreciate the question. I still believe that a 7% medium-term target is appropriate, and we are pleased with our progress so far, particularly in merchandise excellence, which has helped us achieve a 45% gross profit margin; this is largely due to the efforts of our merchandising team. To recap, we are aiming for a 500 basis point improvement, with about half of that coming from merchandise excellence, which we started focusing on earnestly this past year. There are two additional components to consider. As we mentioned, the improvements will be more significant in the later periods, particularly in supply chain, which has been the most affected in this regard due to the need to complete consolidation efforts. We are currently reducing our distribution centers down to 16, with a target of 15 by the end of next year. Once this consolidation is achieved, we will focus on increasing productivity within those facilities. Ron is on board and actively engaged in this process, which will take some time. The store operations pillar is also crucial, and we see 2026 as a major investment year for both supply chain and store operations, with benefits expected to follow.

Yes. Regarding the pillars, as Ryan mentioned, we're pleased with the progress. We're focusing on what we can control and advancing in merchandising, supply chain, and store operations. There's a lot of positive developments in store operations related to labor productivity and task simplification. We're investing in store technology, including servers, POS systems, and Zebra Devices. We've improved the appearance of 1,600 stores last year with updates like paint, HVAC, parking lots, signage, and racking. We're on track to enhance another 1,000 stores this year, creating a better environment for both our team members and customers. Overall, our aim is to make incremental improvements in the business each year.

And since those two big pillars, the supply chain and store operations, is a big investment year, a lot going on in those areas, '26 will really help inform what we really believe that cadence to be going forward, but we want to see '26 play out a little bit so we can have a better-informed perspective. If you look at the bridge we put out around our guidance, we're being very specific. We know we have line of sight to those numbers. That's why we gave a little more detail on that bridge, and we want to be able to continue to do that as we march towards 7%.

The next question comes from Simeon Gutman from Morgan Stanley.

Great job on the margin improvements so far. My first question is about margins. Considering the gross margin gains and the SG&A leverage, can you discuss the execution risks involved? Do you have clear visibility on the strategic sourcing deals you've already secured, or is there a need for further execution to achieve that level of gross margin throughout the year? I have the same question regarding SG&A. How will you improve service and availability while keeping SG&A growth so modest for '26?

Yes, Simeon, great. I'll start and let Shane chime in. On the merchandising side, we have clear visibility and made significant progress this year. Some of the benefits will carry over into next year. While there's still some work to do, our merchandising team, led by Bruce Starnes, has excelled in executing our plans, meeting our expectations. Some aspects are already secured for the upcoming year, while others are still in development. In fact, discussions are already beginning for 2027. The execution has been strong, and we're pleased with the progress. Regarding the other two areas we discussed, we are making great strides in consolidating our supply chain this year, which will provide long-term benefits to our cost of goods sold as we become more efficient. Is there anything you'd like to add?

Yes, I would just say it's a mix. There are vendor contracts that we've signed that will create benefits. So that's not just line of sight, but we think we can tuck that in the run rate. But then we have discussions with the vendor where we haven't signed it but feel good about it. I would highlight Smriti's assortment work where last year, we improved backroom availability, and we made sure we had left and rights that were matching brands, and we had full kits for different products. She's going to continue doing that. We're doing a better job as it relates to planograms and price changes. There are certainly things that we have that we feel we can count on as it relates to going forward, but there are also things that we still have to achieve, but we have a plan against how we're going to go about it. I'll just touch on it; you heard it from Ryan. We feel good about the leaders who sit in the seats. From my perspective, we are done making changes on the core leadership team. If you look at the executives that we now have in place, you'll see a mix. You see some internal promotions, you see some external hires, but they're each focused on those fundamentals in their particular area. That gives me confidence around where we're going on your line of sight question.

And Simeon, just to talk about the SG&A question. A lot of the SG&A reduction, one has come from the rationalization of our store footprint in DCs but also indirect spend. We went through an initiative and really worked through indirect spend. For example, we're able to mitigate, not all, but a good portion of inflation seen in our general liabilities, health insurance, and also getting more productive in the spend. The spend has not been all that productive. We talked about reallocating our trucks to make sure they meet the right volume base. We've talked about how we walked into a store and they've got three trucks, two of them haven't been started in months and don't start. They just need to get reallocated or reduced. We found opportunities to reduce SG&A where it wasn't being productive. Now if you look on a like-for-like, so remove the cost of SG&A to support the liquidation sales, it's about $90 million; we're actually slightly increasing SG&A next year. We're investing in labor. We're investing in new stores. We're investing in training. We're investing in the service element and reduction of tasks within our stores. If we can reduce tasks that our associates are working on that are not productive and we can put more hours in front of a customer, that will benefit us. That's where we're investing SG&A next year.

Okay. A quick follow-up, the $100 million of free cash expected with the $300 million of CapEx, so roughly $400 million of operating cash. I'm sorry if I missed it, but can you just bridge your net income to get to that operating cash?

Yes. We are increasing net income and your operating cash flow is approximately correct; it's about $350 million in operating income. Payables and working capital should be relatively neutral. However, due to the timing and seasonality of our free cash flow, you can expect a cash outflow in Q1 followed by inflows from Q2 to Q4. Keep in mind there are closure expenses from our previous restructuring, estimated at $10 million to $20 million, that will carry over into next year. Initially, we anticipated around $150 million in cash outflow for strategic initiatives and store closures, with $10 million to $20 million shifting over. We realized about $140 million this past year, with the $10 million to $20 million related to leases and exiting old stores. You should anticipate less volatility compared to last year.

The next question comes from Scot Ciccarelli from Truist.

This is Shervin speaking on behalf of Scott. You mentioned that there are external macro factors impacting sales. Can you provide a specific estimate of the sales headwind from DIY included in your guidance? Besides your smarter pricing strategy, are there other initiatives you are implementing to help realize what I believe is pent-up demand resulting from previous maintenance delays?

Yes. Let me discuss the macro environment and what we're doing. The health of the consumer looks good with our industry benefiting from factors like the number of cars, miles driven, and the age of the fleet. Recently, we've seen some negative spending trends among low and mid-income consumers, particularly in general merchandise. However, the positive aspect is that 90% of our industry focuses on brake and repair services, which helps us. Overall, consumer sentiment in those income brackets has been down, reflecting in their spending on general merchandise. In terms of our DIY segment, we have several key initiatives underway. We've revamped our loyalty program, now called Advance Rewards, which has 16 million members. We eliminated costly parts of the old program that didn’t drive loyalty or sales, like the Fuel Rewards component. We also enhanced usability and introduced tier-based coupons along with easier redemption processes. Additionally, we launched our own brand of oil and performance fluids called ARGOS, which I’m very excited about. Having years of experience in the oil industry, I know the importance of product quality and having a brand that we can control. Previously, we used a different brand that incurred royalties and was tied to a parent company facing financial issues. With ARGOS, we can directly respond to consumer preferences for reliability, value, and product strength. This brand will complement our existing private brands, including Carquest and DieHard, which together make up about half of our sales. We're also working on various aspects of marketing, e-commerce, product assortment enhancements, training, and improving the store experience, all aimed at better serving our DIY customers moving forward.

I'll just add a couple of data points as we think about it. Both Pro and DIY, we expect to contribute positively to comp growth with Pro outpacing DIY. A couple of things as we think about trends going into the year. First, last year, we spent a lot of time focusing on the Pro and getting the assortment right. You are now seeing us start to do and execute initiatives that we believe will have a positive impact on DIY. Just coming out of the quarter into Q1, DIY trends have remained stable to what we saw in Q4, in Q1 specifically. We did see improvement sequentially throughout the quarter in our comp performance. In fact, the last period of P13 in Q4 was our highest Pro comp of the year. Some of the work that we're doing, the initiatives around assortment, we're seeing that take hold. So we're excited about the performance in Pro, but we also want to make traction on DIY in the year.

That's all helpful. And really quickly, you also mentioned on the call you could see another 100 basis points of operating income expansion in '27. Just curious what comp assumption that's on? Just trying to better understand the sales and earnings leverage relationship.

Yes, not necessarily giving guidance on the comp percent for that, but I would expect low single digits that we've given in the past.

The next question comes from Bret Jordan at Jefferies.

On the private label strategy, given the fact that you're rolling out ARGOS, are you expecting to drive private label higher than that 50% of your sales mix?

No. Bret, I would say it should remain consistent. I mean, it's replacing a brand that we kind of considered a private label, so kind of within that. It may inch up a little bit higher because we actually think this is a really good brand that can get some penetration. We think it's the right value offering in there. I think we'll be more competitive in that space. Maybe some minor movement, but we don't have any plans necessarily to significantly increase private penetration. We go category by category and what makes sense for the consumer and having the right assortment and brands for them.

Great. And then on market hubs, could you remind us how many of your hubs that you have today were converted Carquest DCs versus greenfield and maybe what the pipeline of greenfield looks like? I think you said you're going to add 10, but maybe give us some sort of feeling as far as timing and what these things look like physically.

Yes, Bret, more than 20 of our market hubs are conversions. So a good portion of them. We just started opening up our first greenfields this year, really excited about the greenfields. Going forward, the majority of those market hubs will be greenfield locations.

Okay. And I guess when you think about the pipeline, which you have for identified properties and sort of you talked about 75,000 to 85,000 SKUs, what do we think about for like a square footage and what kind of capital goes into this box?

Yes. The market hubs on average are roughly $2 million, but that does vary depending on whether that's like a build or a lease or takeover, so it varies. But right now, they average about $2 million for a market hub from a CapEx expense standpoint.

The next question comes from Kate McShane of Goldman Sachs.

This is Mark Jordan on for Kate McShane. As we think about the comp guidance of 1% to 2% for the year, can you break down how you think about ticket and transactions? Because I think if we look at the expectations for same SKU inflation to be 2% to 3%, I think that suggests either other impacts to ticket or some transaction pressure in the year.

Yes. I mean, for the most part, the DIY transactions, we'd expect to be pressured and continued. Obviously, there's inflation embedded in this. We talked about inflation. So there is a negative DIY transaction, not inconsistent with what we've seen in 2025. But we'd like to see and continue to drive positive transactions. We want to drive transaction growth in the Pro as well. I would expect this is a slightly low single-digit transaction and inflation driving it positive. But really, the pressure is on the DIY side there. Nothing significantly different from the trends that we see today.

Okay, perfect. And then as we think about the cadence throughout the year, obviously, first half is stronger due to the inflation benefits. But how should we think about maybe some tailwinds from the recent weather events? Are you seeing anything quarter-to-date on transactions that maybe looks encouraging?

The weather has been a mixed bag for us. While some weather categories have shown positive signs, others have been negatively impacted. Overall, it has remained fairly neutral to this point. Our trends this quarter align with our guidance, and we are seeing solid performance. Specific items, like batteries, are doing well, but we are facing challenges with maintenance items, particularly due to cooler weather. We anticipate improvements as weather conditions stabilize. The Northeast and Mid-Atlantic regions have been affected by recent storms. Before the storm, we experienced a sales buildup, but post-storm, some stores were closed, which has contributed to the situation. Once we overcome the closures, we expect to see some recovery related to the weather. Currently, our performance is tracking within our guidance range.

Our final question today will come from Zach Fadem of Wells Fargo.

I want to make sure I understand your vendor finance commentary is. It sounds like you're taking suppliers off the program and generating better gross margins from those vendors, but that also translates to weaker free cash flow due to the impact of payables. So first of all, is that right? And is that the game plan going forward from here?

Yes, there has been no effect on gross margin so far. We do not have a specific target or strategy for this. We appreciate our supply chain finance program and our vendors are satisfied with it. It has remained stable following the changes we implemented last year. This is more of a lever and option we can utilize as we engage with vendors and reassess our negotiations. The supply chain finance program is established and we are pleased with it. There is no focused effort suggesting a change in our approach.

Got it. And then a couple of clarifications or housekeeping items. First of all, any expectation for LIFO capitalized inventory costs in Q1 and '26? Same thing with restructuring costs in Q1 or '26. And it also sounds like Pro comps benefited in '25 from store closures. Any quantification there as we think about '26?

Yes. On LIFO, in '25, we had about 40 basis points of headwind. In '26, in our guidance, we expect about 50 basis points of headwind. In Q1 specifically, we're expecting about $30 million of headwind related to LIFO. The warehouse capitalization cost in there we expect to be flat as we expect inventory to be roughly flat year-over-year. So don't expect an impact on that. But LIFO expense for '26, which is in our guidance, about 50 basis points of headwind that we will see. On the other one, we haven't quantified externally what it is. We did get Pro transfer sales in our comps this past year. Pro would still have been positive net of that transfer sales. We like how the team executed moving those accounts to the new sister stores. They did a great job in maintaining the service levels with those Pro customers and actually overdelivered on our expectations on it; our initiatives have really helped.

This concludes today's Q&A session. So I'll hand the call back to CEO, Shane O'Kelly, for any closing comments.

Thank you, everybody, for participating in today's call. More importantly, thank you to all of the Advance Auto Parts team members. It's their hard work that we rely on to deliver the results. We appreciate everything that they do. We look forward to sharing our Q1 results in May, and stay tuned for those when they come. Thanks, everybody. Take care. Bye-bye.

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