Earnings Call
Advance Auto Parts Inc (AAP)
Earnings Call Transcript - AAP Q1 2024
Operator, Operator
Welcome to the Advance Auto Parts First Quarter 2024 conference call. Before we begin, Elisabeth Eisleben, Senior Vice President, Communications and Investor Relations will make a brief statement concerning forward-looking statements that will be discussed on this call.
Elisabeth Eisleben, Senior Vice President, Communications and Investor Relations
Good morning, and thank you for joining us to discuss our Q1 2024 results. I'm joined today by Shane O'Kelly, President and Chief Executive Officer, and Ryan Grimsland, Executive Vice President and Chief Financial Officer. Following Shane and Ryan'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 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 forward-looking statements and the factors that could cause actual results to differ can be found under the captions, forward-looking statements in our earnings release, 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 O'Kelly.
Shane O'Kelly, President and Chief Executive Officer
Thanks, Elisabeth. Good morning and thank you for joining us for our first quarter earnings call. Before we review the quarter, I would like to thank the entire Advance team for their continued dedication to serving our customers. Their passion and commitment make a difference each and every day. The year started off slower than anticipated across the industry. At Advance, we saw a negative impact from weather, coupled with a challenged consumer who is experiencing diminished purchasing power, higher credit card debt, and uncertainty about the balance of the year in terms of macro conditions. As a result, our Q1 performance was lower than expected with comps down 20 basis points year-over-year. On a positive note, our professional business saw low single-digit improvements in both comp and transactions. We believe that winning in pro is important to our overall strategy and are pursuing that business across multiple segments, including up and down the street customers, strategic accounts, Carquest Independence and Worldpac. Regarding up and down the street customers, we are putting additional focus this year on winning with those accounts and recapturing lost customers. In terms of our turnaround, we continue to execute against our previously outlined decisive actions designed to simplify our business. Those decisive actions are, number one, continuing the sale process for Worldpac. Number two, reducing our costs to become more competitive while investing a portion of those savings back into the front line. Number three, making organizational changes to position us for success. Number four, improving the productivity of all assets. And number five, consolidating our supply chain. We believe these actions will have a long-term positive impact on our business. And let me share a few important updates on each. Starting with the potential sale of Worldpac, we are well underway with that process. We are very pleased to have healthy interest and we are looking to conclude the process before we report our second quarter results. As a reminder, we previously discussed the potential sale of our Canadian business and will evaluate that once the Worldpac sale is complete. Second, reducing and controlling costs is a major focus and we are beginning to see benefits from the actions we took in the fourth quarter. We delivered on the $150 million in annualized savings outlined on our previous calls. This is evidenced by a reduction in our year-over-year SG&A of $21 million in this quarter, despite a softer top line. We're also beginning to see benefits from the $50 million reinvested into our frontline, including a more than 50% reduction in our district manager turnover. We expect to see improvement in other key roles throughout the year. In addition, our indirect purchasing team is executing against our recently launched initiative to reduce a minimum of $50 million on an annualized basis. We have finished the diagnostic stage and are targeting reduced indirect expenditures in areas such as technology, transportation costs, and corporate contracts. We expect to see the bulk of the savings beginning in 2025. Next, regarding our third decisive action on organizational changes, we are excited to announce that Bruce Starnes is joining the Advance team as Executive Vice President and Chief Merchant. This is part of an orderly succession plan, and in this role, Bruce will lead all aspects of our merchandising function. Bruce is an auto enthusiast and brings deep merchandising experience, having recently served at Target for nearly 20 years, most recently as Senior Vice President of Merchandising Capabilities and Operations. The expertise of one of our newest Board members, Tom Seboldt, who has over 30 years as a merchandising leader in the automotive aftermarket industry, will also help speed Bruce's onboarding. Bruce will be partnering with our outgoing chief merchant Ken Bush who will remain in an advisory role to help ensure continuity in the merchandising function. We want to congratulate Ken on his upcoming retirement after nearly 20 years with the company and we want to welcome Bruce to the Advance Auto Parts family. Turning to our fourth decisive action regarding our asset productivity across the company. Improving this remains a top priority and includes both company stores and independently owned Carquest locations. In the first quarter, we closed 17 underperforming stores and opened seven new stores. Last quarter, we shared that we had notified over 100 Carquest independent locations that we were removing them from our program. We completed this action in Q1. In addition, our IT team's focus on POS system reliability is enabling significant in-store productivity improvements for team members, and that's impacting their ability to better serve our customers. We will continue our efforts to elevate existing store operations across Advance and drive profitable growth. The last area I wanted to discuss in regard to our asset productivity is inventory. We have had recent success with the implementation of our new merchandising system. We put new leaders in charge of the project along with additional accountability on the work plan, resulting in the achievement of several key milestones in Q1. This new system will overhaul key merchandising processes including planogram sets and store replenishment. In the first quarter, we added 130,000 SKUs in the new system across nearly 500 suppliers. By the end of the second quarter, we expect all of our actively replenished SKUs to be converted to the new system, which is well ahead of our previous expectations to be complete by the end of the year. This is one of several steps to enhance inventory availability and productivity. And finally, our fifth decisive action to consolidate our supply chain is underway with the long-term goal of operating as a single unified network. We've now mapped what this network will look like, and I'd like to take a few minutes to describe its components and our incremental progress. We expect our unified network to have 14 large DCs. We currently have 13 of the required replenishment DCs needed and are scouting the location for the 14th. These 14 facilities averaging approximately 550,000 square feet each will serve as our nationwide replenishment nodes. The next component of the unified network will be market hubs. As discussed last quarter, this is a new node of our network, and we recently completed a successful pilot. Our market hubs will have an average SKU count of more than 80,000 and will enhance our existing hub network. There are three ways that we will be adding market hubs. Number one, converting existing stores with sufficient footprint. Number two, converting smaller existing DCs. And number three, green-fielding new locations. We have completed four store to market hub conversions, utilizing the learnings from our successful pilot. By the end of 2024, we expect to have at least 20 market hubs in operation, including approximately half from the conversion of existing DCs. Three of these DC conversions are already underway. Those are Baton Rouge, Raleigh, and Memphis, and we expect to complete all of them by the end of the third quarter. Importantly, by using existing stores that have sufficient footprint and converting smaller legacy DCs, we believe we can accelerate this initiative with more rigor than if we were to green-field all locations. The third component of our unified network includes over 300 existing hubs that we currently operate. These hub locations currently serve and will continue to serve as sources for expanded availability for surrounding stores. On average, they have approximately 35,000 SKUs on hand compared with approximately 23,000 in our traditional blended box stores. The performance of our hubs and market hubs reinforces the benefit of having parts closer to customers. We expect the development of this unified network to take time and are planning to have the 14 large DCs and at least 60 market hubs added to our existing network of hubs by the end of 2026. Let me also provide a brief update on our implementation of our warehouse management system or WMS across our DC network. This is a key enabler of our unification and last quarter we indicated that there were three facilities still to convert. We have recently completed the implementation at our Delaware, Ohio DC and expect to complete the remaining two by the end of the year. While we are making early progress with all of our decisive actions, we recognize that we have substantial work to improve the performance of our business. Our entire team is committed to fostering a disciplined approach in all functions, leading to increased accountability and internal clarity of our goals. Turning to the broader macro environment, we are fortunate to operate in an attractive, needs-based industry with stable fundamentals. However, we recognize that our business will still likely feel negative impacts as customers show signs of financial distress and if macro conditions deteriorate. Even with that backdrop, we are improving execution by remaining focused on our decisive action. We know this turnaround will take time, but I am encouraged every time I visit a store or DC and meet the team members who take care of our customers. We have established clear priorities and our leadership team is energized to deliver on our goals. Now I would like to turn the call over to Ryan to review our financial performance in the quarter.
Ryan Grimsland, Executive Vice President and Chief Financial Officer
Thanks, Shane, and good morning everyone. Before I move to our financials, I would also like to thank our almost 70,000 team members for their continued dedication and hard work throughout the quarter. Q1 was challenging from a year-over-year perspective. However, we have instilled renewed P&L discipline and rigor and remain confident in our ability to capitalize on the significant opportunity ahead. In the first quarter, net sales of $3.4 billion decreased 0.3% compared with Q1 2023. The decrease was primarily driven by the reduction of Independence and store closures of about $11 million as we continue our focus on improving asset productivity. Comparable store sales decreased 0.2%. While we still have room for improvement in our assortment and availability levels, we are encouraged by the actions we have taken and relative to our Pro business, helped contribute to positive transactions and comp growth in the quarter. As anticipated, we saw continued pressure on DIY in Q1, resulting in low single-digit negative comparable store sales. From a category perspective, we saw strength in batteries as well as filters and engine management driven by improved availability. In the quarter, we experienced particular softness in several categories as we are seeing consumers adjust their buying behavior and looking to stretch every dollar they spend. This was evidenced by a year-over-year decline in discretionary categories as well as deferred maintenance in the quarter, such as brakes, which are often purchased in combination with tire maintenance and installations, which have been down across the industry. The West and Midwest were our top performing regions, while the Mid-Atlantic Southeast, including Texas and Florida were our most challenged. As Shane mentioned, the weather impacted our sales as the country experienced a slower start to the spring season. In Q1, gross profit was $1.4 billion, or 42% of net sales, which declined 82 basis points from the prior year quarter. The deleverage was primarily driven by cost not fully offset by price. In terms of price, we've also been reassessing our relative position in the market, as well as our approach to strategic pricing. We recognize circumstances where we have been notably uncompetitive and have been making appropriate adjustments focused on categories with higher visibility and elasticity. In Q1, we actioned on 8,500 SKUs, an investment of approximately $40 million on an annualized basis. We are committed to driving accountability to achieve and remain competitively priced. I'm confident the restructuring to align our pricing and merchandising teams will help provide the appropriate discipline to ensure success. In Q2, we continue our merchandising excellence initiative, including securing lower pricing from our vendors, assessing our assortment and its availability, as well as reviewing how we are priced in the market. Despite all these efforts, we believe that we will see pressure in Q2 as the consumer will likely face continued uncertainty impacting our top line. In addition, we will be lapping last year's actions, which will cause margin rates to be significantly more challenged than Q1. We expect to begin seeing improvement in the back half of the year as we will have cycled the prior year's pricing initiatives and begin to see an acceleration on units. In addition, we expect that our supply chain consolidation and ongoing merchandising productivity efforts, including key front room category resets and backroom hard part line reviews that were completed in Q1 will positively contribute to our supplier partner negotiations. In addition to pricing, warehouse capitalization costs and the planned investment in our DC consolidation negatively impacted gross margin in the quarter. Our overall supply chain productivity partially offset the deleverage driven by improved lines per hour, replenishment frequency, reduction of independent locations, and the previously announced closure of our Asheville DC. SG&A was $1.3 billion in Q1 2024, down $21 million compared with Q1 2023 and improved 48 basis points as a percent of our net sales. This was driven by cost saving efforts we discussed earlier and included a significant reduction in corporate expenditures and headcount executed in Q4 last year. Additionally, we have had one-time gain from an asset sale in Florida. As discussed previously, we are reinvesting a portion of these savings back into our frontline team members, which partially offset the savings we realized this quarter. We experienced higher year-over-year professional fees primarily related to continued remediation of our material weakness, which was a headwind to SG&A in Q1. Finally, similar to many retailers, we experienced ongoing inflationary pressure related to overall wages, occupancy costs, and transaction expenses. Our Q1 operating income margin decreased 34 basis points compared with the prior year quarter. In terms of the second quarter, we believe that this will be our toughest margin quarter of the year as a result of pricing actions taken last year that we are lapping. However, as the year progresses, we expect to see stronger margin improvement in the back half. Diluted earnings per share were $0.67 in Q1 compared with $0.81 in the prior year quarter. EPS was primarily impacted by the decrease in operating margin as well as a $0.05 impact related to discrete tax items associated with stock-based compensation. We have significantly increased the discipline around our capital spending process, focused on investing in high-return initiatives aligned with our decisive actions. As a result, our Q1 2024 capital expenditures were $49 million compared with $90 million in Q1 of 2023. Free cash flow for the quarter was an outflow of $46 million compared with an outflow of $470 million in the prior year quarter. This was primarily driven by lapping the timing of payables in Q1 of the previous year. Our full year guidance remains unchanged. We are committed to executing against our decisive actions and believe they will enable steady performance improvement across Advance. Before I turn the call back to Shane and Q&A, I want to provide an update on our internal control remediation efforts. We continue to ensure we have the appropriate experienced personnel as we backfilled open roles and hired approximately 30 experienced personnel with the requisite accounting and internal controls knowledge and experience. We made some important hires in the first quarter who are quickly onboarded and are making progress in their roles. In addition, we've added redundant and compensating internal controls to enhance our internal control structure. We have been thoroughly testing our remedial efforts and are committed to completing the remediation. As you will see in our Form 10-Q, a prior significant deficiency identified in Q4 2023 has been elevated to a material weakness in a discrete area of controls. Similar to our material weakness regarding staffing, we are robustly testing to ensure our controls are working as designed over an appropriate amount of time. Our internal control environment remains a top priority for us, and we look forward to updating you on the completion of our remediation. And now I'll turn it over to Shane.
Shane O'Kelly, President and Chief Executive Officer
Thank you, Ryan. We have significant work to do in terms of turning around the business, but I am confident we are on the right path. I want to once again thank our team members for their unwavering dedication to supporting our customers while adapting to the challenges we face during the quarter. And in the wake of Memorial Day, it's always appropriate to reflect on the contributions of the brave men and women who gave their lives in the service of our country. With that, I would like to open it up to address your questions. Operator?
Operator, Operator
And our first question today comes from Bret Jordan at Jefferies. Bret, your line is open. Please go ahead.
Bret Jordan, Analyst
Hey, good morning guys.
Shane O'Kelly, President and Chief Executive Officer
Good morning, Bret.
Bret Jordan, Analyst
Did you talk about the cadence of the first five months that gives you comfort in your maintaining the comp guide for the year?
Ryan Grimsland, Executive Vice President and Chief Financial Officer
Yeah, I think the cadence, I think we started out a little bit slower due to weather. It started to pick up throughout the quarter. I think Q2, we're seeing similar trends from Q1, but really expect the back half of the year we'll have more favorable compares. And some of the initiatives we're putting in place, Bret, we are expecting to see that continue to bear fruit, especially as we've seen in the Pro business coming out of Q1.
Shane O'Kelly, President and Chief Executive Officer
Yeah, as I think about it, positive Pro comp and transactions, I think we'll look to continue doing that. As Ryan mentioned, we've got initiatives specifically targeting Pros, notably up and down the street customers. But I also think on the DIY side, the US consumer is facing a bit of an inflection point as they look at their personal debt loads, as they look at where their purchasing power is. So I think there's some reticence there in terms of how they're spending. And so we think that continues as well.
Bret Jordan, Analyst
Great. And then on the Pro side, national account versus up and down the street, the positive comp you saw in the first quarter was there much difference between those two segments?
Ryan Grimsland, Executive Vice President and Chief Financial Officer
We don't typically provide specifics on those two, but we did experience positive growth and positive comparisons.
Bret Jordan, Analyst
In both sides?
Ryan Grimsland, Executive Vice President and Chief Financial Officer
Yep.
Bret Jordan, Analyst
Okay. Thank you.
Operator, Operator
The next question comes from Michael Lasser from UBS. Michael, your line is open. Please go ahead.
Michael Lasser, Analyst
Good morning. Thank you so much for taking my question. The challenging outcome with DIY, how are you thinking about that segment over the course of the year? And what are going to be the key drivers that improve the performance of DIY sales from here?
Shane O'Kelly, President and Chief Executive Officer
So I think there's a macro story here, and good morning Michael, that affects where the consumer goes. I think the US consumer, the good news is there's a needs-based function for our business. And so those staples where you can't put off doing things, e.g., my car won't start, it needs a new battery. So we'll continue to see those kinds of plays. But there's also a tendency now for consumers to defer maintenance if they can as they wrestle with their checkbooks at the end of the month. I don't see anything changing that in the near term. And so I think the trend that we see continues. We're obviously doing a number of things in terms of how we get to them. We've done some creative marketing programs. We're using our website. We do training with our in-store associates in terms of how they greet customers and understand needs and do appropriate attachment sales. So there's certainly not a lack of activity on our part to make sure we're maximizing opportunities where we interact with consumers. But I just think fundamentally, at a macro level, there's a bit of a, as I said before, an inflection point.
Michael Lasser, Analyst
Okay. My follow-up question is on the Worldpac sale. Is there any risk that it won't close or won't be announced in the second quarter and can you give us some sense of what your guidance might look like for this year, if you were to close the deal before the end of the year? Obviously, the intent of the question is to get some sense of how the underlying AAP business is doing outside of Worldpac, so we can have a thesis to understand what the transformation is looking like there? Thank you.
Shane O'Kelly, President and Chief Executive Officer
Yeah. So, great question, Michael, and certainly understandable that you'd want to get behind that. We don't do segment reporting and I've used an expression in the 40 acquisitions that I've done, a deal is not a deal until a deal is a deal. So when we have something to announce, we will absolutely announce it. But I'll just go to the big picture, which I think is important for everybody, just got to respect the process. So we're very happy with where we are. We're in the middle of it. We believe we'll have it wrapped up before our next earnings announcement, and that's what we've got. And as soon as something is different, e.g., we complete the transaction, we'll let you know, and then we'll look to Ryan to pick what RemainCo looks like.
Ryan Grimsland, Executive Vice President and Chief Financial Officer
We want to provide that perspective, but we need to wait until a decision is made. Once we have that, if we have a transaction, we will update our guidance and projections for the RemainCo.
Michael Lasser, Analyst
Thank you very much.
Shane O'Kelly, President and Chief Executive Officer
Thank you.
Operator, Operator
The next question comes from Simeon Gutman from Morgan Stanley. Simeon, your line is open. Please go ahead.
Simeon Gutman, Analyst
Good morning everyone. Shane, I’d like to ask one more question about Worldpac and will respect the process. Can I know if the decision to sell it is still deemed the right one for the business, or is it influenced by the price? Additionally, regarding the positive low single-digit growth I heard for commercial, does that include Worldpac, or are you separating that out in your communications to the Street?
Shane O'Kelly, President and Chief Executive Officer
You want to take that?
Ryan Grimsland, Executive Vice President and Chief Financial Officer
Yeah. So, Simeon, appreciate that. We're not going to speak about Worldpac versus the rest of the business at this time. We are in the midst of working through the process here. So we'll keep that off the table until we have something where we can't speak to them. We are happy with our Pro business. We are happy with the process and where it's at to date and we'll be able to give you more updates as we actually affirm something up. The decision on this one is still, from a strategic standpoint, we still have the same strategy. We're focused on the blended box and Worldpac is not necessarily tied to that decision. That’s why we’re exploring this opportunity, and we'll continue to explore. We're happy with the where it's at right now.
Shane O'Kelly, President and Chief Executive Officer
Yeah, thanks for asking the question. Yeah, thank you. Go ahead.
Simeon Gutman, Analyst
Sorry, I wanted to follow up about the new merchant you hired. I’m curious about the opportunities in merchandising. Is the SKU mix properly aligned with the vehicle population? Additionally, as you consider supply chain consolidation, if there are changes in merchandising, will that affect the timing or sequencing with supply chain? Are these two separate activities?
Shane O'Kelly, President and Chief Executive Officer
I appreciate your question. We're excited to welcome Bruce Starnes to the team. There are a few key points to discuss. First, his leadership style and enthusiasm for automobiles are essential to us. He's gained valuable merchandising experience at Target, and it's been great to get to know him throughout this process. Regarding the transition, Tom Seboldt will assist Bruce as he joins our team; he brings 30 years of merchant experience. Additionally, Ken Bush will be available during the transition as he approaches retirement, ensuring a smooth handover. We're eager to see Bruce influence the merchandising team, and we'll continually assess our product mix to ensure we have the right parts available for our customers. There is a vast array of auto parts to consider. This work won't interfere with our supply chain activities, which are progressing quickly. Steve Szilagyi, our supply chain leader, has been developing our plan for about a year and is now focused on establishing our large distribution center and implementing a warehouse management system along with market hubs in our operations. As this evolves, we can make changes to our product assortment regularly within our business.
Simeon Gutman, Analyst
Thanks, good luck.
Shane O'Kelly, President and Chief Executive Officer
Thank you.
Operator, Operator
The next question comes from Greg Melich from Evercore ISI. Greg, your line is open. Please go ahead.
Greg Melich, Analyst
Hi, thanks. I wanted to follow up on inflation, deflation and specifically the price investment you referenced. So could you just help frame the 8,500 SKUs? What percentage of the total SKUs that is and the $40 million investment assuming that's about 30 or 40 bps a year of deflation. Is the whole box still have a little bit of inflation? Or how would you frame that?
Shane O'Kelly, President and Chief Executive Officer
The $40 million investment was driven by our internal data evaluations and customer feedback. Our Pro and consumer customers indicated that we were not competitive in the market. This is a key point because the industry acts in a rational manner, and we aim to do the same. However, when our pricing does not align with market conditions, we took the necessary steps to ensure our prices are competitive, allowing us to be seen as a legitimate purchasing option for customers. The 8,500 SKUs represent a relatively small percentage of our total offerings. Ryan, feel free to add more.
Ryan Grimsland, Executive Vice President and Chief Financial Officer
Yeah, Greg, I mean, it's about 3% of the enterprise SKU count right now. I think if we looked at Advance only it's about 8%. So it's not a significant portion of the overall, but it is just making sure that we get competitive in key areas.
Shane O'Kelly, President and Chief Executive Officer
Yeah. I would use the term disinflation. So I don't think we've hit deflation, but certainly, that tempo of inflation has metered.
Greg Melich, Analyst
Thanks, and good luck.
Shane O'Kelly, President and Chief Executive Officer
Thank you.
Operator, Operator
The next question comes from Scot Ciccarelli from Truist. Scot, your line is open. Please go ahead.
Scot Ciccarelli, Analyst
Good morning, guys. Can you provide any more color on the amount of margin pressure you're expecting for 2Q, just given the moving pieces out there? And then help us understand the bridge to getting to better margins in the back half.
Shane O'Kelly, President and Chief Executive Officer
Yeah, absolutely. So we are going to see a little bit more pressure in Q2. Some of these pricing actions we've taken are going to cycle a full quarter, and there's probably some more that we need to take to get competitive across the board. So we'll take additional pricing actions where it makes sense to be competitive in the marketplace. So we expect to see margin rate decelerate in Q2. Also, we're cycling last year where price was a lever that was pulled last year in Q2. And so we're cycling that. So it's not as much about, A, we're just bringing prices down, but it's also about the comparison year-over-year. In Q1 of last year, it wasn't as much of a price action. In fact, they were actually trying a little bit to get more competitive last year in Q1. So the cycle in comparison wasn't as significant. But in Q2, we're comparing against some pricing actions last year. So that kind of compounds on it. I'm not going to give specifics guide around the quarter, but I would say you would expect that rate from Q1 to decelerate. Now what we're doing, a couple of things. One is all the PLRs that we've done in the first part of the year, we're going to start to see the benefit of those take place in the back half of the year. We're going to see the unit start to take on. We have seen where we've made changes in price, we started to see some of the unit start to take hold. That takes a little bit of time as consumers start to see that. So we'll see some of that. And then we're continuing to work with our supplier partners on cost-out that's going to help impact the second half of the year. And then as our supply chain consolidation takes hold, we'll see some of that benefit start to hit in the back half of the year. So these things take a little bit of time to come up in the back half. We also have better comparisons in the back half than we do in the first half. We mentioned that going into the year that our first half would be more pressured than the back half really due to some of these pricing actions we're cycling and comparing against. Hopefully, that was helpful, Scot.
Scot Ciccarelli, Analyst
Super helpful. Just to clarify though, like you do expect 2Q operating margin could be lower than your 1Q operating margin?
Shane O'Kelly, President and Chief Executive Officer
Yeah. Year-over-year.
Scot Ciccarelli, Analyst
That's sequential.
Shane O'Kelly, President and Chief Executive Officer
Yeah. I mean from a year-over-year basis, the deleverage, yeah.
Scot Ciccarelli, Analyst
Got it. Understood. Thank you.
Shane O'Kelly, President and Chief Executive Officer
Thanks, Scot.
Operator, Operator
The next question comes from Chris Horvers at JPMorgan. Chris, your line is open. Please go ahead.
Christian Carlino, Analyst
Hi, good morning. It's Christian Carlino on for Chris. Are you thinking about what structural gross margins might look like any differently now that you're investing in price or presumably this has been part of the plan and you still have visibility to eclipsing that 42% over the near medium term, once you recapture some of the one-time costs from last year? Thanks.
Shane O'Kelly, President and Chief Executive Officer
Yes, this is definitely part of the plan as we continue to explore competitively priced options, and we remain committed to our guidance for the year, with a clear outlook. We are still confident about where we expect to finish the year, considering the macroeconomic environment. This is part of our strategy, and we will invest in areas where we can stay competitive.
Ryan Grimsland, Executive Vice President and Chief Financial Officer
Yeah. I think the pricing actions are modest, and there's the other side of that equation, which is what our merchant team can do working with our vendors to make sure they're securing the appropriate source costs for our product. So I think we've got some opportunity there, and we'll look for Bruce as he comes on board to start putting programs in place for that.
Christian Carlino, Analyst
Got it. That's helpful. And understanding there's not much to update us on the transaction at this point, could you speak to how you're thinking about the potential use of proceeds from the sale? Is there a level of leverage where you'd be more comfortable stepping up the investments in the DC conversions or some of the other turnaround efforts you're undertaking?
Shane O'Kelly, President and Chief Executive Officer
We are considering three main uses for the proceeds. First, our Treasurer, Tony Iskander, will work on reducing the company's debt. This involves evaluating our various debt tranches to determine which ones we could pay off, which is a significant priority. Second, we are consulting with our functional areas to identify opportunities to expedite investments in initiatives that are already in progress. For instance, in our supply chain, we have ongoing developments for new market hubs and a large distribution center network build-out, where funds could be directed. In technology, we are addressing the stability of our point-of-sale systems, especially since some stores are still using older systems, and we could unify those systems. Lastly, we see potential in enhancing our new store opening capabilities and improving the condition of our stores. These three areas are our top priorities for investing the proceeds. Lastly, we will also consider our shareholders in this process.
Christian Carlino, Analyst
Got it. Thank you very much. Best of luck.
Operator, Operator
The next question comes from Zach Fadem from Wells Fargo. Zach, your line is open. Please go ahead.
Zach Fadem, Analyst
Hey, good morning. Can you talk a bit more about the game plan for market hub conversions? You mentioned some successful pilots Curious what you saw that gave you confidence and any early color you can share in terms of what you would expect in terms of lifts on the Pro or DIY customer.
Shane O'Kelly, President and Chief Executive Officer
Yes, we see this trend in the industry. The idea is that having parts closer to customers and being more responsive leads to more orders. We assessed our ability to deliver parts in various time frames, such as 30 minutes, two hours, four hours, same day, and next day. We identified a notable gap in the parts we can supply within those time frames. To address this, we explored ways to enhance our competitiveness. A market hub brings parts closer to customers, allowing faster delivery from other hubs or stores instead of from the distribution center. Our distribution center operates in two ways: it handles replenishment orders to stores regularly and has a quick delivery program for one-off requests, which is traditionally costly and time-consuming. By utilizing the hub, we can expedite delivery to stores compared to sourcing from the distribution center. We have observed an increase in sales at the hub, and surrounding stores, about 100 in total, are now receiving better service than when they solely depended on the distribution center. This is the fundamental concept. Additionally, being a fast follower in business can be a successful strategy. The positive outcomes of our pilots and the success of the market hub concept in other areas further support this approach.
Zach Fadem, Analyst
Got it. Thanks for the color. And then a couple of clarification questions. First, on the gain on the SG&A line, any quantification of the impact there and then second, any color on the slight notch up in the high end of your '24 sales outlook?
Ryan Grimsland, Executive Vice President and Chief Financial Officer
Yeah, Zach. I appreciate you bringing that up. When the press release was issued, we noticed immediately the error, we're going to send an amendment out. We are confirming our guide at the top end of that sales guide should be 11.4%, not 11.5%. The rest of the numbers are accurate. So you should see that come through shortly. As far as the gain, the gain was $18 million in the quarter. It was also implied in our guide that was a P1 gain.
Zach Fadem, Analyst
Got it. Appreciate the time guys.
Shane O'Kelly, President and Chief Executive Officer
Likewise. Thank you.
Operator, Operator
The next question comes from Aaron Reed at Northcoast Research. Aaron, your line is open. Please go ahead.
Aaron Reed, Analyst
Yeah. Thanks for taking my call. I just wanted to follow up on the sale of Worldpac, and it sounds like you had the initiative once the proceeds come in, it's the amount of reducing debt, really improving some of the stores. And it sounds like an additional component is possibly returning funds to shareholders. My question is, is that going to be largely dependent on the price that you get for it? Or is this something to where it's an order tier or debt first and then store improvement, if it's going to be, I mean how should we look at that allocation when that's all said and done?
Shane O'Kelly, President and Chief Executive Officer
Yeah. I'll start and then Ryan and Tony can join us this morning, he can jump in. Debt first. I think that is the best early use of proceeds and so we'd go there. And again, Tony and Ryan will figure out exactly where we draw the line in terms of how much we would pay off. Our sense though is that there's monies for all three of those potential use buckets based on our assessment of Worldpac's value. But gentlemen?
Tony Iskander, Treasurer
Yeah. So, hey Aaron, good to talk to you again. We would first put money towards deleveraging, getting back and getting closer to our leverage targets that we've talked about publicly of closer to 2.5 times over time. We would also put money towards our initiative, some of what Shane and Ryan talked about earlier in our prepared remarks. And of course, anything excess would go back to shareholders, and we would look to do that over time as well.
Ryan Grimsland, Executive Vice President and Chief Financial Officer
Yeah, Aaron, I think the biggest thing is we're going to be prudent on this one as well and the timing and sequencing of that. We know this is a multiyear turnaround for the company. And so the first debt priority of paying down the debt and then investing in the business for the turnaround are the top priorities for us.
Aaron Reed, Analyst
Okay. Great. Thanks. And then I guess just a follow-up question to go a little closer, you’re trying to get that closer to that target debt ratio. Does that mean that you don't believe that with the sale and allocation will be able to fully achieve your target debt ratio?
Tony Iskander, Treasurer
Yeah. Aaron, we're not ready to talk about the actual dollar amounts that we would get from the transaction. So we'll wait to be able to share that when and if we do have a transaction, if that's all right.
Aaron Reed, Analyst
Yeah, great. Thank you very much.
Tony Iskander, Treasurer
Appreciate it. Thanks, Aaron.
Operator, Operator
The next question comes from Steven Forbes of Guggenheim Partners. Steven, your line is open. Please go ahead.
Rene Marin, Analyst
Good morning. This is Rene Marin on for Steve Forbes. I want to focus on the DC to market conversions. Can you help us think through the KPIs you are focused on as you think through the ROI of such progress and whether these conversions can drive the improvement you need? Thank you.
Shane O'Kelly, President and Chief Executive Officer
I missed the very last part of your sentence. If you could just say that one more time, please?
Rene Marin, Analyst
Yeah. And whether these conversions are driving the improvement you need?
Shane O'Kelly, President and Chief Executive Officer
As we evaluate key metrics, sales per square foot, service interval for available SKUs, and sales are all crucial, in addition to the cost of conversion and ongoing operating expenses. These metrics are fundamental to our operations. Qualitatively, one challenge we've faced is our previous decision to treat all distribution centers (DCs) equally. We have 38 DCs serving our locations, but the size differences among them have led to significant inequities in replenishment for stores. For example, some store managers might be supported by a one-million-square-foot DC a few hours away, while others have a 100,000-square-foot DC servicing them. This size discrepancy fundamentally alters the breadth and depth of resources available to each store, despite labeling all DCs as replenishment nodes. Additionally, we treated all DCs as intake nodes, requiring vendors to ship to all 38, which meant some DCs could handle truckloads while others could only manage smaller shipments. This structural approach is not ideal for supply chain operation. In light of these challenges, our new market hub initiative involves utilizing 40,000 to 50,000 square feet, sourced from various avenues, including larger stores, DC conversions, and new locations. We're targeting approximately 80,000 SKUs, which is the optimal number for our operations. For the DCs we are converting, we have secured long-term leases at favorable rates. We plan to partition the necessary space and sublease the remainder, and in some cases, we might exit the facilities entirely. This approach helps us establish baseline economics for our operations. We won't employ mechanization due to the associated ongoing maintenance and operating costs, opting instead for a traditional racking and picking model. Our operational cost considerations and service provisions align well, but fundamentally, we aim to shift vendor shipping from 38 DCs to just 14 larger DCs. This change will ensure every store has access to the full range of resources, which is highly beneficial for us.
Rene Marin, Analyst
Thank you.
Operator, Operator
The next question comes from Max Rakhlenko from TD Securities. Max, your line is open. Please go ahead.
Max Rakhlenko, Analyst
Great. Thanks a lot. So first, the 8,500 price action SKUs, is that the biggest chunk of the SKUs? Or is it that just the start and the SKU count could ultimately look quite a bit bigger over time?
Shane O'Kelly, President and Chief Executive Officer
So, one of the things that we did in the company is we moved pricing into merchandising. So previously, those had been disjointed functions. And so the way I think about pricing is we want to be competitive. We don't want to lead the market down. We don't want to be inappropriately highly priced to where our customers don't want to buy from us. And I mentioned before, we think it's a logical industry with good conduct. And so what you can expect from us is good merchants will be talking to their vendors to make sure that we're sourcing at the right cost. I think we have opportunities there. And good merchants are looking at their portfolio. In some instances, they'll say, hey, I think were higher relative to the market and we move down. In other instances, they're going to say, actually, we have opportunity to move price up. I think the key message you could take away from us is that we'll have capable pricing teams working very closely with merchants to be at the market, and we'll look to make sure we're sourcing to hit the margins that we need to hit.
Ryan Grimsland, Executive Vice President and Chief Financial Officer
Yeah. Max, I'll add that of those 8,500 SKUs, we actually increased prices on some of them. This is about aligning pricing across the portfolio. Most of the SKUs had their prices decreased to remain competitive, but we did raise some prices as well. It's about 3% of the overall enterprise SKUs and 8% of Advance. As Shane mentioned, we expect that number to rise as the new merchant comes in and as merchandising progresses. I'm confident there will be more opportunities to adjust prices.
Max Rakhlenko, Analyst
Got it. It's very helpful. And then can you speak to a competitive environment and progress you're making with your up and down the street accounts? And then what are some of the key initiatives besides price? And how should we think about the cadence of acceleration as the year goes on?
Shane O'Kelly, President and Chief Executive Officer
Throughout our 92-year history, we believe that participating in the Pro customer market is essential for us. We have a wealth of capabilities in this area, and we're undertaking a variety of initiatives. Firstly, we've enhanced the compensation program for our outside sales team, known as CAMS. We're making investments in the frontline roles, including CAMS and commercial parts pros, who act as the in-store connection for Pro customers. These investments involve improving compensation, providing training, and creating career development pathways. We are also actively analyzing our market, focusing on the proximity of stores to Pro customers, understanding our penetration with these customers, their visit frequency, and the products we offer them. Additionally, we have TechNet, which is a warranty service and capability resource for our Pro customers. Our Pro website, equipment program, and recognition trips are also part of our broad range of offerings tailored to meet Pro customer needs. We are effectively organizing and highlighting these aspects, and we are optimistic about the progress we are making.
Max Rakhlenko, Analyst
Great. Thanks a lot. Best regards.
Shane O'Kelly, President and Chief Executive Officer
Thank you.
Operator, Operator
The next question comes from Chris Bottiglieri from BNP Paribas. Chris, your line is open. Please go ahead.
Chris Bottiglieri, Analyst
Thank you for taking my question. I have a couple of clarifications. Was the $18 million related to a sales leaseback or something different? Also, regarding Worldpac, do the accounting controls or remediation affect the sale? Does this need to be resolved first in order for the financials to be credible? I'm just curious if this is impacting the asset sale.
Shane O'Kelly, President and Chief Executive Officer
Yeah, Chris. No, the Worldpac piece is not going to impact the transaction there from that perspective. That's kind of kept separate from a sale gain on asset with sale leaseback. Yeah.
Chris Bottiglieri, Analyst
Sale leaseback. Okay. And then just the last one, the capitalized supply chain costs you called out this quarter, can you quantify that and tell us what you're thinking in terms of like Q2 and the back half, that's something that should persist or not?
Ryan Grimsland, Executive Vice President and Chief Financial Officer
From an overall inflation standpoint, we expect it to be quite moderate for the remainder of the year in terms of product inflation rates. As mentioned in our initial guidance, we indicated that we wouldn’t fully capitalize on all inflation for the year due to pricing actions we planned to implement, and we will continue to do so throughout the year. In fact, in our guidance, we mentioned that inflation in the industry would be about 1%, and we anticipate it will remain around that level.
Chris Bottiglieri, Analyst
Yeah, okay. Thank you.
Operator, Operator
The next question comes from Carrick Irwin from Barclays. Carrick, please go ahead. Your line is open.
Seth Sigman, Analyst
Hey, guys. It's Seth Sigman. Hopefully, you could hear me.
Shane O'Kelly, President and Chief Executive Officer
Hey, Seth.
Seth Sigman, Analyst
I have a follow-up on a previous question. First, sorry for any confusion. I have two quick follow-ups, and I’ll ask them both at once. Regarding the guidance for Q2, I'm trying to understand more about the year-over-year pressure on operating margin. Can you provide more insight? Is it mostly related to gross margin, SG&A, or a combination of both? Additionally, my other question is about the store footprint. It seems like the pace of closures is increasing. What is your perspective on this? Do you have an estimate of the total number of store closures, and can you share any insights on the characteristics of the units being closed? Thank you.
Ryan Grimsland, Executive Vice President and Chief Financial Officer
The pressure in the second quarter will primarily impact our gross margin. This pressure is mainly due to our pricing strategies from last year, as well as the timing of our efforts to reduce costs and improve product costs and supply chain efficiencies. Additionally, there will be a gradual adjustment as consumers become aware of our competitive pricing. As a result, we will mostly see the effects reflected in our gross profit.
Shane O'Kelly, President and Chief Executive Officer
I'll discuss the store closing. Thank you for the question. First, we aren't specifically looking to shut down a certain number of stores; it's all part of our assessment of asset productivity. We are evaluating our entire network and considering each asset's contribution to the company. Our initial focus is on whether we can improve store performance, which is our preferred approach. We review management performance, as well as our Pro initiatives and the effectiveness of the sales team in that area. Our first response to a store's performance is to determine if we can make it a successful location. However, in some situations, based on our regional market share, closing becomes a viable option if the numbers don’t add up. We don’t disclose a specific figure for potential closures; it's a continuous management process that is one of the tools we use. Opening new stores is also in that toolbox. While we haven't provided a specific number for new store openings, I want to highlight the significant improvements our real estate team has made. We’ve consolidated real estate under one leader and refined our management processes regarding buying versus leasing, site selection, and the timeline for establishing new facilities. We are seeing a much more streamlined process for new store openings, and we plan to leverage this moving forward.
Rene Marin, Analyst
Thank you.
Elisabeth Eisleben, Senior Vice President, Communications and Investor Relations
All right. Thank you all so much for joining us this morning. That is all the questions we've received. We appreciate your time and continued support. I look forward to updating you again after we report Q2. Have a nice day.
Operator, Operator
This concludes today's call. Thank you very much for your attendance. You may now disconnect your lines.