Welcome to the Advance Auto Parts First Quarter 2022 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 today's call.

Good morning, and thank you for joining us to discuss our Q1 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 remarks today will contain forward-looking statements. All statements other than statements of historical facts are forward-looking statements, including, but not limited to, statements regarding our initiatives, plans, projections and future performance. Actual results could differ materially from those projected or implied by the forward-looking statements. Additional information about factors that could cause actual results to differ can be found under the captions, Forward-Looking Statements and Risk Factors in our most recent annual report on Form 10-K and subsequent filings made with the commission. Now let me turn the call over to Tom Greco.

Thanks, Elisabeth, and good morning to everyone joining us today as we review our Q1 results and discuss progress against our long-term strategic initiatives. Before we begin, I'd like to thank our entire team and independent partners for their dedication throughout Q1.Let me start with three key themes surrounding the first quarter. First, we delivered our eighth consecutive quarter of growth in comparable store sales, adjusted operating income dollars and adjusted earnings per share. In addition, we did this while lapping the height of last year's stimulus and an inflationary macro environment. Second, our strategic initiatives are gaining traction to deliver top quartile total shareholder return over the long term. And third, our financial strength provides for continued investment in our business while returning cash to shareholders. Stepping back, we began the year as many companies did, amid uncertainty. In our industry, it was unclear how substantial broad-based inflation was going to impact consumer demand in 2022. With rising fuel prices with the use of vehicle miles driven and what the real benefit was from economic stimulus. In particular to the 2021 stimulus, we had to estimate how much this benefited our core DIY consumers. More specifically, what role did this significant cash injection play in temporarily spiking DIY demand in Q1 2021. Through the first 10 weeks of 2022, we had a strong start. At that point, year-to-date comparable store sales were up mid-single digits. The final six weeks of our quarter were more challenging than we expected, with comparable sales declining mid-single digits, driven by DIY. While we knew this timeframe included the most substantial lot of economic stimulus from the previous year, we also had a slow start to the spring selling season, primarily in northern geographies due to colder and wetter weather than the previous year.…

Thanks, Tom, and good morning. I would also like to thank all our team members for their dedication and resilience to quickly adapt to the current environment, which has remained volatile. In Q1, our net sales of $3.4 billion increased 1.3% compared to Q1 of 2021. This was primarily driven by growth in our professional business, including Carquest independently owned locations. Adjusted gross profit margin expanded 231 basis points to 47.1%, driven primarily by improvements of strategic pricing actions, as well as expansion of our own brand portfolio. These were partially offset by ongoing inflationary costs in both category and channel mix. Same SKU inflation in Q1 increased 7.1%, which was higher than we expected when we began the year. In addition, inflationary headwinds from higher wages and fuel costs within supply chain in the quarter more than offset our productivity gains from ongoing initiatives. The unfavorable channel mix in the quarter resulted from the professional business outpacing DIY growth. Our Q1 adjusted SG&A was $1.3 billion or 38.1% of net sales. This compares to 35.8% of net sales in Q1 of 2021. Like previous quarters, this was primarily driven by inflationary headwinds led by store payroll, as well as continued increases in fuel costs. We also incurred approximately $20 million of startup costs related to our California expansion. In Q2, we expect further investment and anticipate this will normalize in the back half of the year. As expected, pro outperformed DIY contributing incremental delivery costs. These headwinds were partially offset by a year-over-year decrease in COVID-19-related expenses, savings from actions we took over the past couple of years to lower SG&A expenses, including corporate restructuring and rent reductions, as well as lower incentive compensation due to the record results in the prior year. Our Q1 adjusted operating income was…

[Operator Instructions] And your first question comes from the line of Simeon Gutman from Morgan Stanley. Your line is open.

Good morning, everyone. So my first question is on the backdrop. I realize there was some weather. Are you surprised by the sensitivity of the industry to this weather and maybe the macro given the used car business has been so strong, prices are up, the fleet is aging? It just felt like the drivers were in place to power through some of them. So I don't know how you think about some of these changing factors.

Simeon, I think the biggest factor in the quarter was the lap of the stimulus, and we had modeled that early in the year. I think we did in general, a pretty good job of modeling that. But weather is a short-term swing, as you know, that can swing business from the first quarter in our case to the second quarter. That's moderated as we said. And we're back within our annual guide. So I mean other than the fact that the spring came a little bit later than we expected. I mean the quarter top line came in around what we had modeled.

And then as a follow-up, with regard to fuel prices or fuel cost, can you talk about how quickly you're managing them? How quickly our industry price is changing? And does it seem like there's a pass-through that's being rationally passed through into prices as given the current environment?

Yes, sure. So when we gave guidance in February, we modeled out all of the inflationary line items within our P&L. So whether it's product cost, fuel, labor, those are certainly the big 3, but there are many others. We put an assessment around that for every quarter and then obviously for the year. As we've gone through the first quarter, some we've been fairly close on and others were higher than our expectations. And we would put fuel in that category of coming in significantly higher than our expectations. In terms of ability to pass on, we feel good about that. We were certainly pleased with our gross margin results. That was led by pricing, as well as our own brand expansion, but largely pricing. So that ability to pass those costs on were evident in this quarter, so we feel good about that.

Your next question comes from the line of Christopher Horvers from JPMorgan. Your line is open.

Good morning, everyone. So looking at the first quarter, big picture, you come flat. EBIT margin was flat and cost inflation accelerated. Previously, you talked about the ability to expand margins on the flat comp. Given the inflation in fuel, what levers do you have to pull to drive margin expansion this year as it is in your guide? So said another way, what costs come out, and what self-help accelerates as we look ahead?

Yes, well, certainly, on the gross margin, we have those capabilities in place. The strategic pricing performed very well for us in the quarter. And we anticipate to continue to use that leverage. Our own brand expansion also was a very strong contributor in the quarter. And so from that standpoint, we feel good about the gross margin. Really, it's more down in the SG&A. And let me frame that up just a little bit. We really had three primary headwinds. We had inflation, we had our start-up costs associated with the California expansion and we have channel mix. And then that was offset by a combination of COVID and some of our productivity initiatives as well as lapping some of that incentive comp. Particularly on COVID, we had a year-over-year benefit of $12 million. We had a $16 million headwind last year and only $4 million in this quarter. So we did get that benefit. But that probably will be the most significant benefit we see from COVID all year, given that, that was the majority of the cost we saw for COVID in 2021. So looking forward at those three inflationary headwinds, starting with inflation, while we expect inflation to continue throughout the year, we are going to be even comparing to the back half of last year the inflation that we were seeing both in gross margin and SG&A. So the year-over-year impact is lessened. Second is channel mix. we expect further channel mix, but Chris, we expect it to normalize. So that will also come down. And then the third one are the start-up costs in California. If you remember, we really started to incur those costs in the back half of last year. And we're going to lap those costs. So that actually flips from a headwind to a tailwind in the back half of the year. So on balance, back half of the year, we still fully expect to leverage SG&A. Now as we sit here today, it looks more challenging in terms of full year leverage, but it's early in the year, but reducing the impact of these costs, along with other your typical cost savings measure, we're just looking at our full-time, part-time mix. All of that together, we certainly believe we're going to leverage SG&A in the back half, and we're going to keep working to reduce those costs.

Got it. And then -- so just a couple of follow-ups there. So on the pricing front, the fuel hits cost of goods on a lap given it ends up in inventory. And then on the SG&A, obviously, the trucks to the mechanic is causing pressure. Are you -- so are you planning to price that component in? And then on the gross margin, you're going to start to lap through higher cost inventory in the back half of the year. How do you think about the shape of gross margin as the year progresses?

Well, I'll take the first one, Chris, and I'll let Jeff speak to the lapping of the gross margin components. But we have every single key cost line model out. Obviously, I'm sure most companies do in terms of the inflation. We model it out by quarter. The big ones for us are, of course, product costs, store wages and then the fuel piece. And they all come in different times, different ways. We've obviously got the LIFO component coming off the balance sheet. So, we look at that collectively. And of course, we look at the price increases by category, we push back hard on any cost increases that we get from our suppliers. In the final analysis, we take a very strategic picture of the portfolio. And that's what we did in the first quarter, and that's what we've been doing the last several quarters to drive essentially our rates above the year-ago rate because we're able to not only price to cover but price strategically to offset any of those other inflationary costs that might come below the gross margin line. So that's essentially how we approach it. Jeff, do you want to take the other part?

Yes. And then in terms of gross margin, Chris, I think you're kind of talking about the LIFO, the cost that we have hanging up on the balance sheet. So first of all, it's important to frame the LIFO component into our broader gross margin plan. We have a comprehensive plan to improve our gross margin rate over time. Those are the category management, pricing, sourcing, what have you, as well as our supply chain improvements. And we're well aware of the costs that are on our balance sheet. We know the products and the categories driving these inflationary costs. Because we know that, we can model how and when these costs will impact us. And of course, our LIFO and gross margin improvements are incorporated into our guide. So, while we initially thought LIFO was going to be roughly in line with last year, seeing the higher inflationary costs, we've now modeled that it could be $200 million or more. But we have that contemplated into our plan.

Your next question comes from the line of Michael Lasser from UBS. Your line is open.

Good morning. Thanks a lot, of taking my question. Tom, your SG&A dollars have been growing faster on a relative basis than your peers despite your comps being a little bit lower than your peers. Do you think that this reflects AAP having underinvested in wages and other store level expenses historically? And are you at the point where you now have caught up from that underinvestment and you can have a more moderate pace of SG&A growth moving forward?

Well, Michael, first of all, we're very proud of the investments we've made in our frontline team. We've invested in our Fuel the Frontline stock ownership program for a couple of years. And as we called out, we're seeing reduced turnover because that's an important part of our value proposition, as you know. I think the big difference for us is the entry into California. For us, we get one shot to enter a big market like California. I mean it's like another country, right? And we want to make sure we get this right. We're opening 109 stores in the heart of Los Angeles and cities in and around Southern California, and we're very focused on getting that value proposition right out of the gate. They're a little more complicated than a traditional opening that we would have in an Advance store. Of course, we've got to go in there. It's adjacent to a Pep Boys garage. You've got the regulatory environment that's very different. And then it's very important that we have the very best parts people in the industry in those stores. When we open the store, it has a terrific experience for the customer. And I think that's been the big difference. We incurred those costs in the back half last year. We incurred another $20 million this quarter. The stores are going to do really well, and once they're open, they're going to make a meaningful contribution to our growth. We're gaining share out there in the West. So, this -- we're playing the long game here. We want to get this right. $20 million is a lot in the first quarter. We know that. But it was important for us to keep these team members on staff. And because it takes longer to get these stores open in California, we're just incurring the payroll, the rent, all those normal store opening costs longer than we would love -- would have liked.

My follow-up question is the big push back on this quarter and really the last few is, this quarter, the operating margin is on pace with where it was at the same point in 2019. So, it increasingly puts pressure on the forward quarters in order to achieve your longer-term goals. Is the point that you're making today, we're going to see the benefit of easier comparisons on SG&A, we're not going to have as much pressure from the start-up costs associated with California, and then we can navigate through the LIFO challenges that we're going to likely experience in the coming quarters, and that's what the market should take confidence in that we'll be able to achieve these longer-term margin expectations that we've set forth?

Well, a couple of things. I mean, I think Jeff answered the LIFO question. Let me start with the top line, though, Michael. I mean we ran a 16% 3-year stack in the quarter. Candidly, that was a little below our expectations. As we described, the spring selling season kind of shifted, we've seen that come back. So, if you look at a 16% 3-year stack, we expect somewhere between a 14% and a 16% on a full year basis, which puts us squarely into the annual sales guide. So obviously, that's an important part of our roll equation. The margin expansions are very much on track. We knew what we were going to incur in the first quarter in terms of start-up costs. We called out that the first part of this year was going to be -- sorry, gross margin driven kind of shifting into the back half where SG&A is going to play a meaningful role in our margin expansion. So we expect to deliver full year margin expansion and double-digit EPS just like we did last year. And the drag that we saw in SG&A in the first quarter, as Jeff said, eventually becomes a tailwind in the third and fourth quarter.

Your next question comes from the line of Bret Jordan from Jefferies. Your line is open.

Good morning, guys. Could you talk about, I guess, where you see your supply chain now and fill rates? Obviously, that's been a challenge during the last 12 months, but are we improving? And how far to go to full target?

Bret, we made a lot of progress in supply chain in the quarter. We're executing the initiatives that we have. I think our team did a really good job managing a tough environment. Jeff called out that we looked at the situation in China early on in the year, we knew there was going to be some potential disruption if we didn't get out ahead of it, and we did get out ahead of it. Our initiatives mitigated the impact of inflation. We finished the Worldpac, Autopart International integration. We're implementing WMS. We called that out in the quarter. And we're integrating the Advance and Carquest network. And we're starting to look for ways to bring the enterprise supply chain together. We're on track to open San Bernardino in Southern California. That's going to be a big addition for us as we open those stores in SoCal. We're opening a building up in around Toronto in Bolton. That's a growing market. The Canadian business is coming back. It was a business that lagged significantly the last couple of years because of a little bit more stringent on the COVID front. We're closing four distribution centers. We called that out. So we're streamlining our network, we're improving our service to the customer, and we're reducing cost. In fact, our fill rates, our assortment rates, we're really well positioned this summer, Bret, to deliver the top line growth that we need. So I feel very good about where we are in the supply chain, and we'll just keep executing our plan.

Okay. And then a question on pricing. I mean, there's a lot of talk about peers investing in price and obviously, with a high inflation rate. Are you having -- you seeing any competitive landscape shift out there, where it's harder to pass through the inflation you're getting on the inbound side?

Well, I mean, first of all, I mean, the one thing that I would say is it does appear to us as if it's a very rational environment out there. We're not seeing broad-based, anything irrational. There's little things that we see here and there. This is a very resilient industry. I don't know if you probably haven't seen quite an article in the journal this morning about the industry, the car park, the age of the fleet, all of those things remain very positive. And we always work hard to stay close to our professional customers. And that model is just different than traditional retail. The customers make their decisions based on availability, customer service, speed and reliability, delivery over price. So our investments are on those things. And we're very strategic about our pricing. As we've said before, we haven't been as versioned as perhaps some of our peers are, and that represents an opportunity for us. So all of these dynamics and the strategic pricing capabilities we have, we think position us very well in the current environment to drive margin expansion and top line growth.

Your next question comes from the line of Michael Montani from Evercore ISI. Your line is open.

Good morning. Thanks for taking the question. Just first off, just wanted to ask about on the consumer front, if there's any kind of noteworthy signs of trade down or if you're seeing more resiliency, broadly speaking?

Yes, great question, Mike. I mean we are really seeing our customer being resilient. First of all, we were nervous in February about the inflation of fuel and the impact that could have on miles driven. And we haven't seen an impact yet. I mean, the March numbers just came out, and we're seeing growth. I think people are getting out. And they're going out to do the things that they did prior to COVID and we're seeing some level of resiliency there. In terms of trade down, we've not seen that either. We look very closely at this. We knew this is something that is important for our investors, and we're not seeing it. So in our case, we're continuing to invest in our own brands to make sure that at the highest possible quality available for our customers. And we are seeing a shift to our own brands. But other than that, we're not seeing any kind of formal trade down, and good, better, best or anything like that.

And then the second part was just around margins. So first off, is it still kind of a 1:3 comp that's kind of required to lever SG&A into the back half, or is there enough kind of company-specific actions that are not revenue-dependent that perhaps that number is lower? And then similarly, is there a way to conceptualize things like price optimization, WMS, labor staffing, closing DCs? Like what kind of a gross tailwind is that into the back half of the year because a lot has been made about discrete headwinds. So I just wanted to think about what offsets you guys may have as well?

Yes, I'll take the first part of that. In terms of the comp, we're confident we can continue to grow our margins without the growth. It certainly helps to have the comp. Having the new stores being opened is an automatic tailwind for us. But our initiatives that we have, whether it's category management, supply chain and even the SG&A costs, we can still grow our margins. But the 1:3 is certainly helpful for us, it allows us to leverage some of that fixed cost base that we have, particularly in SG&A.

Yes, in terms of the second part of your question, we laid out a strategic plan, Mike, as you know, a year ago in April, and it highlighted specific margin expansion plans by the four big buckets that we talked about. We are executing those to the ladder. Every one of those initiatives we're measuring every period. We look at our performance, there's pluses and minuses in there. But in general, we are on track to deliver against the cost reduction efforts that we have inside of those four big buckets. The inflation that we're experiencing is obviously higher than we modeled a year ago in April. And to the extent that continues, we would expect that would be an industry-wide challenge. And in general, the plan is to continue to drive our strategic pricing initiatives to offset that.

Your next question comes from the line of Daniel Imbro from Stephens. Your line is open.

Good morning, guys. And thanks for your questions. I wanted to start, Tom, maybe on the loyalty program. Any update on the progress there with Speed Perks? I mean I think you guys have talked more about your program than peers. You've obviously signed up fuel partners last quarter. It just feels like more of a strategic focus. But are you seeing the step-up in sales in the program that you would have expected? Just trying to measure your sales growth versus others and how much of a contributor that program could be?

Well, it's early, Dan. We just rolled it out in January, but we're encouraged by what we're seeing. As we called out, our percent of transactions increased. We've graduated customers up the ladder, so we've got a percentage of transactions is now in the high 30s. I mean we think there's a lot of runway there because, again, the big win here is to get the first-party data and to personalize our offers to drive incremental top line growth. So we are making progress on Speed Perks. We want to continue to drive percent of transactions up, personalize the offer and drive market share gains associated with it. So the DIY business in aggregate at an industry level was quite pressured in the first quarter and largely due to the stimulus stack that we talked about. But we're very -- we feel good about where we are from a syndicated data standpoint and market share in DIY.

And you just mentioned that the top line growth would come from kind of personalized promotions and discounting. I guess how does that tie into your margin expansion? If sales through the loyalty program has to come with more promotions may be tied to them? I mean do you still -- can you still grow margins in that environment? Or could that pressure margin more than you anticipated?

Yes. Well, I said personalized programs I didn't necessarily say discounting. The personalization comes from an intimate knowledge of the customer knowing, obviously, the kind of vehicles they drive, their purchase frequency, where they live, whether there's a storm coming to their neck of the woods. So rather than sending generic offers across the country, we're able to get much more tailored and version with what we sent out to the customer. And that's where we're going to see our growth. You want to be relevant, right? I mean, it doesn't necessarily mean offering a huge discount. It means having a relevant offer at the right time to the right customer. And that's what Speed Perks is all about. And finally, the Gas Rewards initiative has we didn't know that there was going to be all the things that happened in 2022 when we drew up Gas Rewards. That's going to get increasingly important as the year goes on, obviously, as fuel prices continue to be high.

Got it. And then as a follow-up, Jeff, I wanted to ask on the buyback. I don't -- you already bought back 1.1 million shares, but I don't think you guys bought back any since the 4Q release. I think that's how many were bought back as of mid-February. So maybe can you talk about why you guys laid off the buyback in the back half of the quarter? And then how should we think about the cadence of repurchases moving forward as the use of cash?

Yes, we got into the market early. That was something strategically we wanted to focus on to get some of those shares out of our weighted average share count. We did buy subsequent to the end of the first quarter, another $100 million there. So we're still very much on track. That's the $350 million for the year so far on a stated goal of $500 million to $700 million. So we feel really good about it. There's obviously a lot of volatility right now, but we feel good about the $500 million to $700 million, and we're on track to achieve that.

Sorry, there are no further questions at this time. Mr. Tom Greco, I'll turn the call back over to you for some closing comments.

Well, thanks again for joining us this morning. Despite continued macroeconomic volatility, we're continuing to deliver growth for AAP and for our shareholders. This was our eighth consecutive quarter of growth in Q1. And importantly, we're executing against our long-term strategic plans, and we made progress on our initiatives to deliver top quartile total shareholder return while returning cash to our shareholders. We look forward to sharing more on our progress next quarter. But before we go and as we approach Memorial Day this weekend, I hope that we can all take a moment to recognize and honor all the great men and women who paid the ultimate sacrifice defending our country. On behalf of the entire Advance family, I'd like to express my sincere gratitude for their service as well as to their families. Thanks again, and we'll speak to you again in August.

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