Welcome to the Advanced Auto Parts fourth quarter and full-year 2019 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

Good morning. And thank you for joining us to discuss our fourth quarter and full-year 2019 results. I'm joined by Tom Greco, our President and Chief Executive Officer, and Jeff Shepherd, our Executive Vice President and Chief Financial Officer. Following their prepared remarks, we will turn our attention to answering your questions. Before we begin, please be advised that our comments today include forward-looking statements as defined by the Private Securities Litigation Reform Act of 1995. Actual results may differ materially from those projected in such statements due to a number of risks and uncertainties, which are described in the Risk Factors section in the company's filings with the Securities and Exchange Commission, and we maintain no duty to update forward-looking statements made. Additionally, our comments today include certain non-GAAP financial measures. We believe providing these measures helps investors gain a more complete understanding of our results and is consistent with how management views our financial results. Please refer to our quarterly press release and accompanying financial statements issued today for additional details regarding the forward-looking statements and reconciliations of these non-GAAP financial measures to the most comparable GAAP measures referenced in today's call. The content of this call will be governed by the information contained in our earnings release and related financial statements. Now, let me turn the call over to Tom Greco.

Thanks, Elizabeth. And good morning. And thank all of you for joining us to discuss our Q4 and full-year 2019 results. I want to begin by recognizing and thanking every single AAP team member and our network of Carquest independents for their dedication throughout the year. With an unrelenting focus on delivering against our strategic priority, we made progress on many initiatives throughout 2019 and we plan to continue strengthening the company as we begin 2020. In Q4, we delivered our seventh consecutive quarter of top line growth, with an increase of net sales to $2.1 billion and comparable store sales up slightly compared to the prior year. We also expanded our adjusted operating income margin rate by 106 basis points in the quarter. This focused effort to deliver margin expansion with lower-than-anticipated sales growth translated to adjusted diluted earnings per share of $1.64, an increase of 40.2% in Q4. In the quarter, we also completed our acquisition of the iconic DieHard brand, which we're excited to add to our industry-leading assortment of national brands, OE parts and own brands. For the full-year 2019, our net sales increased 1.3% to $9.7 billion, with comparable store sales growth of 1.1%. We delivered adjusted operating margin expansion of 36 basis points year-over-year, adjusted diluted earnings per share growth of 14.9% and generated $597 million in free cash flow. Following our second consecutive year of sales growth, margin expansion, and strong cash generation, as well as our confidence in ongoing improvements in 2020 and beyond, our board approved the first increase to our quarterly cash dividend since the 2014 acquisition. In fact, this was the first increase since AAP introduced its quarterly dividend in 2006. Before I turn the call over to Jeff for more details on our financial performance, I want to…

Thank you, Tom. And good morning, everyone. In the fourth quarter, our adjusted gross profit was approximately $929 million, which was essentially flat compared to the prior-year quarter. Adjusted gross profit margin of 44% declined 19 basis points from the prior-year quarter, primarily driven by LIFO headwinds, as well as the expected headwinds from continued investment in our enhanced loyalty program Speed Perks 2.0. These headwinds were partially offset by pricing actions taken in the quarter. Our adjusted SG&A was approximately $779 million in Q4 2019 compared to approximately $802 million in Q4 2018. As a percentage of net sales, our adjusted SG&A expenses improved by 125 basis points to 36.9%. I'm pleased with our team members' dedication to control costs throughout 2019, which enabled us to leverage expenses every quarter. In Q4, we leveraged labor-related costs and once again reduced our insurance and claims expense at key training programs and focus on safety drove improvements across the organization. Adjusted operating income in Q4 was $150 million, which improved nearly 18% compared to the prior-year quarter. Our adjusted OI margin rate increased 106 basis points to 7.1% in the quarter. Adjusted diluted EPS for Q4 was $1.64, an increase of 40.2%. For the full year, net sales were $9.7 billion, an increase of 1.3% compared to 2018, and comp sales improved 1.1%. Adjusted gross profit for the year increased 1.1% to $4.3 billion and adjusted gross profit margin decreased 12 basis points to 44%. Adjusted SG&A for the year was flat compared to 2018 at $3.5 billion. On a rate basis, our full-year adjusted SG&A was 35.8%, which was an improvement of 48 basis points compared to the previous year. Adjusted operating income for the year was $795 million, an increase of 6% compared to the end of 2018. Our…

Certainly. [Operator Instructions]. Matt McClintock with Raymond James. Your line is open.

Yes. Good morning, everyone. Tom, I was wondering about the initial guidance for 2020. Just comp expectation is 0% to 2%. Can you kind of give us an idea of how you factored in the warm weather from December into that expectation?

Sure. Good morning, Matt. So, let me provide some color on that. First of all, we're very dedicated to the long-term strategic objectives we've laid out before, and that includes some investments this year that we're making as we communicated in the past, both 2019 and 2020 being somewhat similar in that regard. And those investments are designed to enable top line growth and additional margin expansion down the road. So, as we looked at the sales guide, we did a lot of work on the December/January timeframe and we factored in the impact of what at least at this point is an extremely mild winter compared to other years. You guys have written about some of the 2017, 2012. It was one of the warmest in history for North America this year, December/January. And given our northern footprint, we've valued the impact that's going to have on top line sales really in the front half of the year. Considering this, and the fact that it's very early in the year, we're being prudent on the sales guidance. That said, there's a lot we're very excited about for 2020 and longer term on the sales front. As you've heard from others, the industry drivers of demand are very positive. The car park is continuing to grow. We're going to cross $280 million this year. Miles driven continues to increase. And the vehicles in the sweet spot – in addition to that, the vehicles about seven years and greater is growing. So, those are all positive impacts and that'll benefit the whole year. Separately, obviously, we've got a number of top line initiatives across pro and DIY that we'll build throughout the year, including our launch of DieHard. So, in terms of margin expansion and cash flow, our plans are very robust and we're continuing to execute against them. So, that was kind of the thinking that went into sales. The building blocks of our plan are continuing to work nicely together. We've got a great team that's poised to deliver against the guidance. We've delivered sales growth and margin expansion two years in a row and we intend to do that again in 2020.

And then, just as a follow-up on DieHard specifically, can you talk through how we should conceptualize the launch? How you plan about going about launching it and how we should think about the benefit from that launch? Thanks.

Sure. Well, as we talked when we issued the original press release, there's a tremendous amount of strategic and financial rationale for us behind DieHard. It gives us the opportunity to really differentiate within particularly inside of DIY. As you know, DIY traffic is our number one customer and business issue. And all the work that we've done says that DieHard can really help us with that. It enables us to differentiate with DIY customers. Brands matter to DIY customers. And we'll be able to differentiate there. We also plan to build out a unique position on pro with DieHard capital. And so, we're excited about that also. As you think about the launch, we're not communicating any specific timing or anything like that right now, but we're obviously working very diligently to buildout the launch plan for DieHard. And needless to say, it'll benefit us more in the back half of the year than the front half.

I appreciate the color. Best of luck.

Thank you.

Seth Sigman with Credit Suisse, your line is open.

Hey, guys. Good morning. Thanks for taking the question. I'm going to ask a couple upfront. Just the Q4 cadence, obviously, December was very challenging. I'd love to just see your observations what you guys were seeing prior to that because it seems like, seasonally, it should have been in a better place. So, just any color on how the quarter was performing prior to the December slowdown? And then, just second, as you think about the guidance, the margin guidance for 2020, up 10 basis points to 30 basis points excluding the extra week, can you just break that down a little bit more between gross margin and SG&A? And just that SG&A piece, related to the fourth quarter, the sustainability of some of the benefits that you saw this past quarter, any color on that? That'd be helpful. Thank you.

Yeah. Good morning, Seth. I'll take the first one. I'll flip the second question over to Jeff. In terms of October, November, December, it wasn't that different at the national level. We did see a slowdown in December, but it was a marked difference geographically, as we called out in our script. First of all, in the West, in the Midwest, in Central, it was very cold in October. We had a very strong October, November in those geographies. We didn't get that benefit necessarily in the Northeast, Mid-Atlantic and Great Lakes. And as we got into December, when it was much warmer in those geographies, that really pulled down our business in December overall. So, I think the headline there is the difference. The distribution was quite wide geographically for us in the quarter. As we said, over 600 basis points between the top three and bottom three. Jeff, do you want to cover off the other?

Yeah, sure. I'll start with the fourth quarter, Seth, and then work into the guidance for 2020. Fourth quarter, you saw SG&A improved 125 basis points. Three broad categories. Labor, labor related, we did leverage store labor in the fourth quarter. We saw some improvements in our marketing program as Jason McDonell comes in and looks at some of the underperforming spend. We pulled back on some of that. And then, for the fourth quarter in a row, we've seen improvements in insurance and claims, and this was really some favorability around some of our actuarial assessments. So, throughout the year, what we've seen is improvements in both the volume of claims and the severity of claims. And those are two key contributors to an actuarial valuation to estimate out into the future what you think your costs are going to be. Those are going to come down, albeit slow. So, that sort of gets into 2020. We think we're going to continue to see improvements in the areas of labor, of supply – sorry, of safety. Safety, what I just discussed. Labor, we're going to continue to leverage myday. We believe we can continue to see improvements there. We have integrations going on in the back office. We've talked about the ERP. We're going to see second half savings there. And we're also integrating AI and Worldpac. So, as we continue to get synergies around that, we'll see savings in SG&A. Stepping back to 2020, as we think about where we're going to see the expansion, we do think we're going to see savings, but we also have a significant amount of investment. Similar to what we guided last year, we're going to continue to have OpEx investment this year in marketing, in people, in supply chain and in IT. At this point, we think we're going to see more of the improvement in our margin and gross margin. And that's largely driven by two factors. First is the supply chain. And we've been working on this for a couple years now. And we said it was going to take more time. We're going to start to see those improvements in supply chain in 2020. And then, the second is category management, which is a combination of MCO, material cost optimization, private label and pricing. And the combination of those items, we really think we're going to see the benefit as we sit here today, more in gross margin and less in SG&A as we take on some of those OpEx investments within SG&A.

Okay, great. Thank you for all the color. Appreciate it.

Welcome.

Michael Lasser with UBS, your line is open.

Good morning. This is Atul Maheswari on for Michael Lasser. Thanks a lot for taking our questions. First question is on the weather commentary. So, why have you factored in the weather impacting only the front half of the year? Back in 2017, when we kind of had a similar mild winter, I believe it led to subdued sales for the industry throughout the year. So, why would this be any different?

Yeah, we didn't actually find that. We did the work, category by category, geography by geography. We compared the differences. We did see it in the second quarter, but we did not see an impact in the back half of those years, at least for our sales.

Got it. It's very helpful. And as my follow-up question, can you talk about the current trends in the first quarter? Basically, where are you tracking compared to your flat to 2% comp guidance for the full year? Basically, I'm better trying to understand the degree of acceleration needed in the back half to achieve this guidance?

Yeah, we're not going to comment on in-quarter performance. But, obviously, we did say that January was very warm. So, implied in our guide is acceleration in the back half of the year.

Thank you.

Simeon Gutman with Morgan Stanley, your line is open.

Hey, guys. This is Michael Kessler on for Simeon. Thanks for taking our questions. First, just wanted to ask about the comp relative to the operating margin growth expectation for 2020. It seems like composite, a fair guide given the backdrop. And still guiding to solid margin expansion. I just wanted to ask you, how confident are you that you can achieve that, given potentially a lower comp with the weather headwinds? And how much of the margin expansion, especially on gross margin, is really not even dependent on sales growth and you think you can get it regardless of the top line?

Sure. Well, first of all, we're excited about the fact that, in the fourth quarter, we delivered margin expansion amid a quarter where our sales were lower than we expected. So, we've always known we've got a tremendous opportunity to expand margins. We've been working on our agenda for a couple of years now. And the four big territories that we have for margin expansion, the majority of that upside is not sales dependent. So, if you think about supply chain, we're going to essentially roll out cross banner replenishment, which is nothing more than repointing a store at a distribution center that's closer to the store than the previous one. So, that's in full rollout right now. We're standing up a warehouse management system platform that will enable us to standardize our labor management throughout the supply chain. That is not sales dependent. We're integrating Worldpac and AI, as Jeff just mentioned. Big opportunity for us there to not only save money, but also to improve our assortment offering and availability to our customers. But most of the supply chain agenda has nothing to do with any sales dependency. Separately, we're rolling out, inside of category management, our own brand platform. Jeff has stood up a pricing function. We've got a new pricing platform that we're – a software tool that we're standing up in the middle of 2020. It will enable us to price at – right down to store level and price regionally, which we can't do today. So, again, not necessarily sales dependent. And then, SG&A, Jeff just covered, but really nothing inside of there is sales dependent, whether that's the integration of our back office platforms, improved safety performance, indirect procurement, improving our performance on medical, all of those things are going to happen independent of sales. So, I think the key point is, obviously, we want our sales to grow as rapidly as possible and we remain focused on building on our plans there, but our opportunity to expand margins is not as sales dependent as it might be in other companies.

Great, thanks. Appreciate that color. And just as a follow-up, so we've been hearing that some suppliers are advising some of the major DIY auto distributors that the parts supply out of China could be constrained by what we're seeing with coronavirus. I know you guys are a little less exposed to DIY than some of your competitors. But could you comment at all on what you're seeing or hearing thus far and whether there's any contingency you're building into your guidance for any disruptions?

Yeah. Well, first of all, from a business standpoint, to be clear, our guide does not contemplate any impact from the coronavirus, as you said. It's pretty much a level playing field. All of the major players in our industry source from China. But erven compared to other industries, auto parts is relatively low. I think we've communicated in the past, at least at Advance, we're in the teens roughly in terms of products sourced from China. We have several months of inventory depending on the product. We've got, obviously, our own infrastructure here in the US. We've also got a distribution center that has additional inventory in Shanghai. So, we're going to continue to monitor it closely. But at the moment, we don't see any impact in supply disruption for us in 2020. But it's, obviously, a very dynamic situation and we've got to continue to monitor it very closely.

Right, thank you.

Seth Basham with Wedbush Securities, your line is open.

Good morning. My question is around your supply chain progress. Clearly, you're making a lot of progress, integrating your supply chain. If you'd give us some perspective on types of financial benefits and other things that you're realizing from the DC that you've converted thus far, that would be really helpful.

Sure, Seth. First of all, I'm really excited about what Reuben Slone and his team are doing inside of supply chain. Again, it's taken us longer than we might have liked. But we're not only improving the effectiveness, the efficiency of the supply chain, the effectiveness is going up as well. And as you know, it's one of our biggest opportunities to not only expand margins, but improve availability. So, I think he has really three big chapters that they're focused on. The first is driving execution where there's been a number of leadership upgrades and a focus on reducing turnover in those DCs, which we made a lot of progress on in 2019. I believe we'll continue to make progress on in 2020. The second is we call invest to make it better. I covered those a minute ago. But, again, that's really changing the physics, if you will, of our supply chain. DC optimization, cross banner replenishment, driving execution through the WMS system. And I actually was at our first distribution center that we've stood up, the new WMS system, very exciting. As we indicated in our prepared remarks, we've had multiple warehouse management systems, a lot of manual processes. And to go to a single warehouse management system across the entire Advance/Carquest network has huge upside for us. It'll help us improve our availability and, obviously, standardize the actions that are going on in those DCs. We talked about Worldpac and AI separately, which is also part of this invest to make it better chapter. And then, third, we talk about innovation. And in there, we've got things like our DC automation projects that we're working on. So, the value of the supply chain productivity agenda is significant. I think we've indicated it's right there at the top of our opportunities to expand margins. And I'm very confident in our ability to improve within supply chain. And not only expand margins, as I said, but to improve availability and drive top line growth as a result.

That's really helpful. And just as a follow-up, as you think about the financial benefits from the supply chain initiatives, do you expect them to ramp through the year 2020? And similarly, would that mean that gross margin improvement over the year should also ramp?

Yeah. We're now at a point where we expect to leverage supply chain through the year. And I think it's pretty evenly distributed throughout the year in the case of supply chain and in other areas. Jeff mentioned the coupon investment that we've made inside of Speed Perks. That's mostly a front-half investment on the gross margin side of the house. So, that'll improve in the back half, but supply chain is relatively uniform through the year.

Thank you very much.

Scot Ciccarelli with RBC, your line is open.

Hi, good morning. This is actually Gustavo Gonzalez on for Scot. So, just a quick one on – just wanted to know if you can sort of quantify the gross margin and comp impact during the quarter from the coupon redemption.

Yeah, what we've said is that it was similar to what we experienced in the third quarter. We're not going to break it out specifically, but think about a comparable number on a rate basis. And so, it had a comparable impact on our net sales gross margin than we saw in the third quarter,

Got it. That's helpful. And then, anything on just – sort of on a go-forward basis, just kind of mentioned it's going to impact the first half year. Is it going to be similar kind of decelerating or to what degree? That would be helpful.

Yeah, what we said was that – obviously, the coupons associated with the original Speed Perks platform are no longer available. So, they're expired. So, we're seeing less redemption than we did in the back half of the year. It's still greater than we saw at the beginning of 2019. But it's less on a rate basis. But we think this is an important investment for us to be making. It gives us – we were able to add new members. As we said, we added about a million members to Speed Perks. We also are seeing less – if you think about traction, retention and graduation, so we're attracting new members in, about a million in the quarter. We're losing less people, so our net number is continuing to grow. And then, we're graduating people up the tiers, and that allows us to personalize and leverage first-party data. So, very excited about Speed Perks and its ability to improve our loyalty with our most loyal customers.

Got it. Thanks, guys.

Daniel Imbro with Stephens, Inc., your line is open.

Hey, good morning, guys. Thanks for taking our questions. Jeff, one for you. Starting on MCO, it was a big success, it sounds like, in the fourth quarter, helped kind of limit the gross margin degradation. I think about a year ago, you guys said you're about 80% through capturing the material cost optimization savings. How far along are we today in terms of capturing those savings? And should that tailwind diminish through 2020 or have you guys unlocked more opportunity there?

Yeah, sure. The material cost optimization is really an iterative process. So, we have been through all of our categories. So, we're in the process now of going back through certain categories that, maybe a year ago, we've already been through, but we're looking at all of the various aspects, whether it be costs, whether it be packaging, whether it be supply chain financing. We still think we have a significant opportunity there. And so, we're going to continue to do that on an ongoing basis. And we're also looking at it at an enterprise level. Because when we first started, kind of the first round, AAP/CQ was our focus. We're now going back as an enterprise focus to bring in AI and Worldpac. So, again, really going to iterate on that. We believe we're going to continue to see benefits to that in 2020 and beyond.

Helpful. And then, maybe just follow-up to an earlier question. Tom, I think you mentioned and talked to the cadence of gross margin expansion in 2020. But as we take a step back and think further, when should we see the full run rate savings from the multiple warehouse systems and the new systems there? Is that a first half of 2021 time frame or kind of when should that be full run rate in the cost?

Yeah, I think inside of – the different initiatives, right, have different timelines, Daniel. So, in terms of DC optimization, that's going to spread out over a couple of years. Okay? That's two to three years. In terms of cross banner replenishment, we expect to complete that by the middle of 2021. Okay? So, that's essentially 18 months out. We're in the process of pointing stores at a more freight logical location right now and we're just kind of going through that market by market and we'll realize the full benefit by that time frame. In terms of the warehouse management system, that's going to take a little bit longer than that. We've, obviously, got to make sure that we've got everything ready. We're going through that market by market as well. We stood up one building. That's more like 2022, 2023 timeframe. We haven't landed on the final date there. It depends on how quickly we're able to make the transition with these DCs and the training and everything that needs to go there. Worldpac/Auto Part International integration, early 2021. So, you've got a combination of things there. But as I said, we will leverage the supply chain this year. And next year, we expect to leverage supply chain and then get the full benefit. I think you'll see into – 2022, you're going to see the full benefit of most of the big initiatives.

Got it. That's helpful. Thanks, guys.

Michael Montani with Evercore ISI, your line is open.

Hi, this is actually Antonio filling in for Mike. I just want to shift gears a little bit to talk about multichannel. So, also, can you give a breakdown – before that, can you give a breakdown of how the DIY consumer is performing? Because I know, earlier, you mentioned commercial is strong, but also from the walmart.com partnership, are you seeing a meaningful impact to the DIY segment? Thanks.

Yeah. First of all, in terms of DIY, in isolation – I'm going to take DIY in total. We did improve in the back half of 2019 versus where we were in the front half. We do attribute at least part of that to the launch of Speed Perks. There's so much upside there yet for us that we're going to really tap into this year based on all the big initiatives that we've put in place that we're still very focused on the improvements there, but we did improve in the back half of the year. Walmart is not a meaningful number yet, and we're continuing to work with the Walmart team. , they've been a great partner on this. What we're very focused on is making sure the customer experience is best-in-class. And as we go through each initiative with them, we've got to ensure that the online experiences working for our DIYer and, obviously, the fulfillment experience is working well. So, we're adding those categories, those SKUs where we feel comfortable with that and they feel comfortable with that. And when we're ready to launch, we've got to make sure that the customer experience is right before we launch the different categories, I guess is the key point.

All right. And just a quick follow-up to that. Is it fair to say that some of that benefit you're seeing there will be realized in 2020? Or is this more of a long-term initiative that you'll see in 2021, for example?

We'll definitely see some benefit in 2020. But to your point, this is very much a multi-year long-term partnership with Walmart. And with all the initiatives that we have going on and they have going on, we're making sure the customer experience is best-in-class. That's kind of at the center of everything we do when we meet together with that team. We're very focused on making sure that the customer experience is where it needs to be.

Got it. Thanks, guys.

Bret Jordan with Jefferies, your line is open.

Hey, good morning, guys.

Good morning, Bret.

Could you talk about what you saw from inflation in the fourth quarter and what you're expecting inflation impact on 2020 to be?

Yeah, sure. In terms of pricing inflation, we saw right around, on a like-for-like SKU, about 2.8%. And we're modeling for 2020 about 2% from a pricing inflation standpoint.

And that 2% will be skewed to the first half before you lap the tariffs or is that sort of evenly equated?

Yes. Yeah. So, that's including – tariffs are sort of the same.

Okay. And then, a question on DC optimization. As you start rolling out some of the cross banner, what do you see the right number of DCs being? If you've got 50 in three years, what's that count? And how many of the DCs you see in the future do you currently own or what kind of DC buildout might you require?

Yeah. First of all, we're not going to provide a specific number there, Bret, obviously. We've announced these DC closures very thoughtfully. And we've got our own people in those buildings. We want to make sure that we do it the right way, et cetera. So, we're not going to break any of that out. But, obviously, there is a big opportunity for us to further rationalize inside of our network. And we do that by looking at the sales in the out years and geographically, how can we ensure that we don't have a service challenge. We did close Armonk in New York and repoint stores at relevant DCs and that's gone very smoothly. So, we've now – I think we're up to four in total that we've closed to date. And we've got it down. So, it's just a matter of phasing that out over time. So, you'll hear more about that when we have something to say and we've had our chance to speak to our people first. In terms of own – yeah, I don't – Jeff – yeah, we'll have to get back to you on that, on owned versus lease. We'll get back to you on that.

The question was more what's in the portfolio. If you see a 30-DC network in three years, are there DCs that you're going to need to build out or do you have most of what you need to rationalize your distribution?

We do feel we have most of what we need. Keep in mind, we also have Worldpac out there in places like California. So, as Bob starts to integrate the assortment across all the banners, we look at all of the assets of the company. So, it's not just red and blue, if you will.

Thank you.

There are no further questions at this time. I would now like to turn the call back over to the presenters for closing remarks.

Well, thanks to everyone for joining us this morning. 2019 was an important year in our journey. And as you heard this morning, we're making progress toward our long-term objectives, including consistent, gradual improvements to enable meaningful top line growth, margin expansion and strong cash generation. I'm confident in our team's ability to deliver further progress in 2020 and beyond. Thanks for joining.

This concludes today's conference call. We thank you for your participation. You may now disconnect.