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

Good morning, and thank you for participating in today's call. I'm joined by Shane O'Kelly, President and Chief Executive Officer; and Ryan Grimsland, Executive Vice President and Chief Financial Officer. During today's call, we will be referencing slides which have been posted to our Investor Relations website. Before we begin, please be advised that management's remarks today will contain forward-looking statements. All statements other than statements of historical fact are forward-looking statements, including, but not limited to, statements regarding initiatives, plans, projections, guidance and expectations for the future. Actual results could differ materially from those projected or implied by the forward-looking statements. Additional information can be found under forward-looking statements in our earnings release and risk factors in our most recent Form 10-K and subsequent filings made with the SEC. Shane will begin today's call with an update on the business and our strategic priorities. Later, Ryan will discuss results for the second quarter and provide an update on full year 2025 guidance. Following management's prepared remarks, we will open the line for questions. Now let me turn over the call to our CEO, Shane O'Kelly. Shane? Shane M. O’Kelly: Thank you, Lavesh, and good morning, everyone. I would like to take a moment to express my gratitude for the hard work and dedication of the Advance team. Their focus on providing excellent customer service and driving progress in our initiatives enabled the company to deliver solid second quarter results that were in line with the upper end of our expectations. In Q2, we also achieved an important milestone in our turnaround journey with the return to profitability. This was supported by actions to optimize our store footprint and progress with our strategic initiatives. Comparable sales growth was about flat for the quarter, and our performance was driven by strength…

Thank you, Shane, and good morning, everyone. I want to begin by thanking our frontline associates for their commitment to serving our customers and delivering solid Q2 results. For the second quarter, net sales from continuing operations were $2 billion, an 8% decline compared to last year. This decline is mainly attributable to the store optimization activity that was completed during Q1. Comparable sales growth was positive 0.1% for the quarter, which included an approximately 25 basis points headwind due to the shift in timing of Easter from late Q1 into early Q2. During the second quarter, sales growth in the first 4 weeks were in line with trends exiting Q1. In the middle 4 weeks of the quarter, trends softened. We believe this was driven by higher-than-normal precipitation levels, which contributed to softer transaction growth. Sales growth was strongest in the final 4 weeks of the quarter with both DIY and Pro channels comping positive. This improvement was driven by a recovery in transactions and strength in our core hard parts business. Undercar components, engine management and the brake category led performance during the quarter. For the quarter, transactions declined in the low single-digit range, while ticket was positive and improved compared to Q1. We estimate that inflation was about 2% during the quarter and included tariff-related price adjustments that began midway through Q2. This rate of inflation was also influenced by the comparison to last year's price investments, which had pressured ticket growth last year. Looking at channel performance more broadly for the full quarter, Pro grew in the low single-digit range and accelerated compared to Q1. DIY underperformed with a low single-digit sales decline. However, Q2 DIY performance was stable compared to Q1. On a 2-year basis, both channels improved relative to Q1. Adjusted gross profit from…

[Operator Instructions] And with that, our first question comes from Bret Jordan from Jefferies.

On the revised capital structure, are you expecting cost savings given the risk spread in the factoring program has likely come down for you? Shane M. O’Kelly: Yes. I mean I think it's a good question, and Ryan can comment. You know that the discussions on the supply chain financing largely take place independently between the bank and the impacted vendor. We like to think that with our support of supply chain financing on a dollar-for-dollar basis, relative to what we had previously, which was effectively unsupported that, that would potentially have an impact. But early days, Ryan?

Yes, Bret, great question. I think putting this program in a stable place and supporting it as we bridge back to investment grade was the most important thing here. This is an important vehicle for our vendors, and ensuring that, that was in place for them as we bridge back to investment grade was critical. Getting back to investment grade is going to be the biggest impact for that. Now with this structure, we'll work with the banks and try to find opportunities where it is. But at this time, there's nothing implied in our guidance and nothing that we have to share relative to that. But I would say the program is in a better place when you have a one- to-one asset support of it. And hopefully, over time, as the business performs, the financial profile improves in the business, we could see some benefits over time, but there's nothing at this point. The biggest thing here is something that bridges us back to investment grade, because getting back to investment grade would be the critical unlock there. Shane M. O’Kelly: Last thing I'll just add there. If you look at the trajectory of what we've been doing as a company, we've looked to be proactive and decisive to position the company for success in the turnaround. So we looked at Worldpac. We made that decision, keeping Canada, adjusting our store footprint, making the decision to get to a unified supply chain, looking for where we needed to invest in the front line. So this was consistent with those moves. This is a proactive effort on our part to preserve an important program for our vendors. And so we went to the capital markets successfully to now have this support, so we can continue the program and we can continue the turnaround.

Great. And then on the CapEx, you're talking about doing a sort of an upfit of 1,000 stores. What percentage of the store base do you think needs CapEx to sort of bring it up to market standard?

Well, Bret, I mean, there's a good portion of it. I mean we went many years on a break-fix model where we were fixing things broken, we had life cycle maintenance out. Just to give you an example from an HVAC perspective, we had 80% of our HVACs beyond useful life. So it should give you a basis of kind of where the fleet was at; roofs above 50%, parking lots above 50% beyond useful life and needing repairs. So this is over the next 3 to 5 years, we'll be tackling these stores, from HVAC, roofing, paint, signage, et cetera. So we'll eventually touch all of our stores. It will end up being part of normal maintenance and life cycle management. Shane M. O’Kelly: Yes. And as we go around, obviously, we want this to be a good experience for our customers. It's also critical for our store team members. And they're working hard and the idea that the HVAC isn't working, that's not acceptable. So we're making those changes. And by the way, we're doing it in conjunction with the other pillars. And so think about our assortment planning work. So the store environment gets better, then we get the product mix adjusted and then the team member is able to say yes to the customer more frequently. There's a sort of reinforcing cycle there in terms of building momentum for the company.

The next question comes from Simeon Gutman from Morgan Stanley.

My first question, trying to keep it high level and simple. Just achieving the pickup in comp in the second half of the year, what gives you confidence in it? Can you just think us through the drivers? And then my follow-up, I'll test you on some of those assumptions.

Yes. A couple of things on the back half of the year. One is we start to see some benefit from some of the work that we've been doing. But we also have some easier comparisons in the back half of the year. Just in Q3 alone, think of we had a CrowdStrike incident, we had the hurricane impact. So we've got some back half of the year impacts to our sales that make the comparisons a little easier, but we also saw improving trends. So we saw improving 2-year comp trends coming out of Q1 into Q2. And also the later part of Q2, we saw improving trends moving into the back half of the year. So I feel like the scenarios we've got right now play within our guidance. And you can tell like if you look at 50 to 150 basis points on the full year, there is a step-up in the back half. But I'd say on a 2-year basis, it's not a material difference.

Okay. So it's more comparison than it is underlying change. And I think that's fair. One of the assumptions, it looks to us that the DIFM business would probably need to comp in at least the mid-single digits to get there. Is that too the comparison? And then I don't know if tariff pricing is more pronounced in do-it-for-me versus do-it-yourself. But can you talk about how that -- the nuance between the 2 -- I guess, your assumptions between the 2 divisions lay out through the back half of the year?

Yes. Well, the biggest thing for us when you think of DIFM, the strength in Pro continuing to grow, that's really the big driver in the underlying business. We like seeing what's coming from the Pro initiatives and the work we're doing there. From a price inflation perspective, we're looking at low to mid-single digit in the back half of the year, so 2% in Q2. And as those prices kind of continue to play out, what we're cautious on is the elasticity in the DIY consumer. And some of that really hasn't gotten into the market yet. So we're a little cautious on how the DIY consumer will respond in the back half of the year. But the underlying business really being the Pro, I think of the DMA work, the assortment work that we're putting out, we'll have that done ahead of schedule. We'll have that in Q3. So that will have a positive impact in the back half of the year as well as those top 50 DMAs. Shane, do you want to add anything? Shane M. O’Kelly: Yes. So you mentioned the Pro, the energy and the Pro team going across the spectrum of Pro customers that includes our larger accounts. That also includes a lot of effort on smaller Main Street accounts. And so the assortment work helps here. The other thing that's helping with Pro is our reduction in time to serve. And I was recently with a large customer who shops with a number of players and said, "Hey, your time to serve, we see it's under 40 minutes. And it's right there where we would get product from anybody else, and we're really happy with that". So as we continue with our store efforts on time to serve, as we continue with the assortment, as we continue with call planning and how our outside sales team members target customers, we think that all helps contribute to that. And I think Ryan said it well on the DIY side. If you look at the impact in households on things like car insurance and food, they're seeing that impact. Are there secondary, tertiary impacts coming in other tariff categories that impact their wallets? That I think is worth paying attention to as we see how the back half shapes up.

The next question comes from Michael Lasser from UBS.

As part of your transformation, there's elements that are within your control and there's elements that are not within your control. And given that mix, how close is Advance Auto to achieving the level of visibility in its near-term and short-term outlook that you would be even more comfortable with? I ask this because the gross margin for the second quarter did come in slightly below what the market was anticipating, suggesting that there's still a lack of at least visibility into some areas that will be necessary as you continue to execute against your transformation plan? Shane M. O’Kelly: I think it's a great question. And I'd answer it by saying we're comfortable maintaining what we put out for approximately 7% operating income in 2027. And that as we do that, 2025, this year and next year are really the big implementation years. So this is where we're really grinding through all of the work. And some things we have strong lines of sight and control, to use your word there, and we're making steady progress. Other areas are a little more nonlinear. So we touched on with Simeon's question, what's going to go on with the DIY consumer. But in some cases, a vendor discussion might yield benefit we might have anticipated it would be in '25, and it comes in '26. As we think about things like our store operating model and making sure that we got demand-based labor dynamically allocating across the network, that takes time to implement. So I would say we feel good about the 2027 program that we're on. And that as we get there, there's a mix of things that are nonlinear and things that we see strong progress with.

Michael, I'll just add like we track the KPIs of our initiatives really tightly. So just to give you a little bit more details on this, we track KPIs in all of our initiatives very tightly. We've been testing and piloting a bunch of them. We're starting to roll them out. We accelerate where we can. The timing of those and implementation and benefit impact, it's not perfectly linear, as Shane mentioned. You can have a negotiation with a vendor and new products coming in, when they come in, when they come out and the cost impact. Margins weren't that far off of our expectations. So we like the way we're tracking so far throughout the year. Shane M. O’Kelly: Last thing on control, the one thing that we really ensured that we had control on is the balance sheet. And the idea that we completed this debt issuance to make sure that we can continue the important program of supply chain financing through the turnaround. And now we have the means to execute against that and all of the other key initiatives.

Super helpful. My follow-up question is, in light of that and in light of what is a very dynamic environment, as you guys had rightfully pointed out, how should we as outsiders think about the linearity of the progress from here? And obviously, I ask because most Street models are anticipating 100 to 150 basis points of margin expansion for 2026, and this would be a great opportunity to help calibrate those expectations to say, hey, if indeed it will be the case, think more of the progress is going to come in 2027, especially in light of, I don't know, A, B and C, tariffs, consumer, whatever it might be.

Yes. Thanks, Michael. Well, I'll just say it's a little early for us to be able to indicate what next year will look like from a margin expansion. Obviously, you've got a goal of 7% in '27 and you would need margin expansion next year. What the magnitude and size of that, we'll come back at a later date and share with you, because we are still early in a lot of the initiative rollouts and having a better clearer idea of the timing of the impact of those next year, we'll need a little bit more time to be able to get to that. We will share that. But I would expect margin expansion. We need to get it going into 7%. And some of the things we're doing today will have positive impacts next year, absolutely. The magnitude of it, we'll come back and share with at a later date, but there is some linear progression that's needed to get to the 7% for sure. It's just what is the timing and size and magnitude of that next year, we'll come back at a later date to share. Shane M. O’Kelly: And in general, we want to have a say-do ratio that depicts, from your perspective, an understanding where we're going with the business. And so when we've got insights, we'll share them. And as we go through the decisive actions, we'll outline what we're doing there. The idea being that we'll make the progression maybe nonlinear, but continuing towards that 7% and 27%.

The next question comes from Chris Horvers from JPMorgan.

It's Christian Carlino on for Chris. What are you seeing in terms of how peers are reacting to the tariff costs starting to flow through? Presumably, the upfront cash impact would have more of the pressure on some of the independent distributors. So in addition to the work you've been doing, are you seeing a pickup in share performance? Or are peers either taking more price than you or running lower inventory levels that should lead to share gains over the coming quarters? Shane M. O’Kelly: So we see -- I mean, I read what you read. And so what I read there and then what we see in terms of what goes on with customers is a rational industry. I think players are appropriately doing actions similar to ours, which is trying to secure product at a good cost and then being rational in terms of what end pricing looks like.

I would just say, Christian, that it's been a rational environment. What we've seen from our peers, we haven't seen significant deviation in our CPI from any price actions we've taken. Competitors have taken price actions as well, and we followed suit. We are following, and that is our strategy is to follow and be a competitive price every single day.

Got it. That's helpful. And you mentioned maintaining gross margin rate where you can, but prioritizing profit dollar expansion. So are you embedding a discrete headwind, amongst other things, in gross margin from the tariffs in the back half? And if so, could you quantify that?

Yes. So we're expecting about low to mid-single-digit inflation in the back half of the year. Obviously, some of that is price related to the tariffs. We are expecting -- there's obviously multiple scenarios, and it's still kind of early to predict exactly how it all plays out. But even the changes that have happened, we're still at a blended rate of roughly 30% on tariff impacts even with the latest changes. Those prices are just starting to make it into the market. So the biggest unknown will be the demand elasticity and how that might play out in the back half of the year. But within our guidance range, those scenarios all fall within there. And it really depends on what is the elasticity, what's the impact, how does the consumer respond, how do they react, will have an impact on the range outcome.

The next question comes from Scot Ciccarelli from Truist.

So my question is, it looks like you guys are planning for low single-digit comps over the next, call it, 2 to 3 years. We have a natural SG&A inflation rate in the, call it, 2% to 3% store range. So it seems like your medium-term target of 7% is really dependent on gross margin. A, is that a fair assessment? And b, assuming it's correct, can you help size the different buckets of where that gross margin expansion should come from? It just seems like it's a lot given the comp environment.

Yes, Scot, I'll take that a little bit and then let Shane jump in as well. From a sizing perspective, yes, a larger portion of that is going to come from gross margin, and that's really 2 pieces that we've talked about in our strategic pillars. One is merchandising excellence, and that's the first cost that we're getting, improved promotions, improved pricing structure externally. We're still working through that. The team is making a lot of good progress. Our vendors are partnering with us well and being supportive as we work through that, but still a lot to do to get to '27. And this year and next year, a lot going on there. That's probably the biggest bucket that will drive it. The next biggest bucket on that continuum is our supply chain and productivity within supply chain. And we talked about our consolidation down to the big DCs, transportation costs, all of that falls into that bucket. And that is one that as we consolidate down, we'll start to see more of it. It's a later tail to that one, more into '26. And then there is still opportunity within SG&A. It's not as big as the other 2, but there is opportunity within SG&A. Shane talked about the operating model and aligning our assets and our payroll hours based on demand and the work we're doing there and understanding the right model going forward will yield benefit for us on the SG&A side as well. So there's still opportunity within SG&A. More on the SG&A will be about keeping dollars, mitigating the inflation impact, and leveraging as some of that top line comes in. Shane M. O’Kelly: Yes. And so I think your hypothesis is right, Scot, and margin, we certainly have those things to work on that Ryan alluded to. But I also think the success in this industry on the top line, which we need to be a regular participant in growth there as well is, customers ask, do you have it, yes or no? And when can I get it? And so as we go forward to 2027, top line matters. And in that regard, our assortment coverage work to make sure we've got better availability, that supply chain is getting it into the stores, and then from our store team's perspective that we have the delivery time lines to get it to the customer gives us a better chance on that do you have it and when can I get it, being able to say yes to both of those questions, which is nutritive in addition to the margin activities that Ryan relayed.

The next question comes from Seth Sigman from Barclays.

I wanted to go back to the DIY business. You talked about the performance in Q1 -- I'm sorry, in Q2 being similar to Q1. It seems like you had more inflation in the second quarter. So I'm not sure if that implies that transactions may have slowed sequentially. Maybe you could just clarify that because you also talked about signs of maybe some stabilization with that consumer. So if we can reconcile all that, I think, would be helpful.

Yes, absolutely. Well, so yes, there's some inflation in there, but we also saw transactions improve throughout the quarter. Especially at the later end of the quarter, we saw transactions in the DIY improve, not quite positive yet, but we did see it improve, which was positive for us to see. We saw on a 2-year basis, those trends continue to improve as well. We saw some key DIY categories that we were happy to see move in the right direction. So we did see progress throughout the quarter. And honestly, some of the inflationary impacts or price impacts from the tariffs are still -- while started to enter Q2, it will be interesting as they start to really mature in the back half of this year, how does that DIY consumer react to that. I mean, if you look at the maybe lower to mid-income cohorts, they are more pressured than others right now. The wages aren't necessarily fully keeping up with some of the inflation that's in there. And so there are trade-offs that they're making. And we're still seeing that. It'd be interesting to see how that plays out in the back half of the year. Shane M. O’Kelly: And then -- so you see all what Ryan is talking about. Let me just touch on things we're doing as a company to be better with DIY. So assortment and availability obviously matters. But we're doing some other interesting things. Training is a big one for us. And what we find is new team members, when we execute training, they're interested in learning it in quicker bursts. So we're working on short videos that can get people up to speed on different products, so they can ask about add-ons, they can ask clarifying questions. And then we're working across the functions in terms of how we do a promotion, where we set and stage products. We're looking at our planograms across the front room of the store where the DIY customer browses, and we're creating value events for them. We're using our Speed Perks loyalty program and engaging with those members. So there's a lot of things that we're doing granularly that we have to do inside of the macro trends, but that helps us be a little bit better when somebody comes in the store.

Got it. All right. That's super helpful. And then I just wanted to clarify on the operating margin guidance, you didn't change it for the full year. Did you actually change the composition of gross margin versus SG&A? And then more specifically, this quarter, you had the reversal of some costs that were capitalized into inventory. I'm just curious what's driving that reversal now? And if you could quantify the impact either on the quarter or the full year, what's embedded in the guidance, that would be helpful.

Yes. So on the capitalization costs, it's really inventory coming down. If you recall, Q1, we made a forward buy of inventory ahead of tariffs and also our assortment work. That obviously provides a benefit from a capitalization, because we capitalize more cost to that inventory. And as you work that inventory down, there's less inventory to capitalize against. So you see the reversal of that in the quarter. That happened in this quarter. And we expect that to actually continue through the back half of the year, and that's embedded in our guidance. So the benefits of the work we've done from cost out. Also keep in mind, the store optimization work, a lot of that impact is in COGS. Think of our supply chain nodes that we closed down that were burdening our margin rates. That $70 million that we talked about, you'll see in the back half, that's offsetting a lot of that as well, along with the work that the merchandising team has done to get cost out and improve our pricing promotion strategy. So we're able to offset that, plus we were able to do that in Q2. But I would expect that pressure. It's in our guidance for the back half of the year. From a difference between our margin rate and SG&A, our SG&A is the same. I would expect the dollars to be similar to Q2 for the rest of the year by quarter. And our margin rate, obviously, would be the plug to get back to the rate. So the rate not significantly changed. The geography between gross margin and SG&A not significantly changed.

The next question comes from Michael Montani from Evercore ISI, the final question of today's Q&A.

It's Mike Montani on for Greg Melich. I just wanted to ask, with the 2 half comp assumption implied at around 2% to 3%, should we be thinking about that as 3 to 4 points of pricing and then a point or 2 of offset from elasticity? Is that kind of what you're seeing in July? And then I just had a follow-up on your Main Street commercial accounts.

Okay. Yes. So just from an inflationary standpoint, I would say it's low to mid-single-digit inflationary. There is some elasticity impacts embedded in there as well. But keep in mind, there's a wide range of outcomes that can happen as we think about the tariffs, price changes that go in, elasticity. So I think the full range that we've provided is a good assumption. In Q2, we had about 2% price elastic -- sorry, price inflation impact. So it's not fully -- demand elasticity was relatively similar. We did see improving trends in transaction in the later part of the quarter. So as some price increases a little bit off of Q2, we'll be cautious around what the consumer -- how the consumer behaves and what the demand elasticity looks like.

Okay. And then just to follow up, with the core consumer, the Main Street consumer, it sounds like you're seeing some strength from that group, but you didn't mention as much larger wholesale accounts. And so I'm just curious, how should we think about cycling through some of the wholesale accounts that you may have lost? And when would it become more apparent with respect to the strength you're seeing from the Main Street Pro customer? Shane M. O’Kelly: Yes. So you've depicted that as an either, and I would say it's an and. We still have our large Pro accounts, and we value those relationships, and we work with them every day. And so there's not a strategy here where we're disposing of being in that space. We have great customers and enjoy being part of their ecosystem. This is, as we think about some marginal activity from our outside sales team members, prospecting smaller accounts where they might have been reluctant to do that in the past. So we're making sure that we're covering the spectrum of Pro customers, not sort of trading off one for the other.

I think a couple of things that we're really excited about in the back half of the year. The work on the Pro team has done with our Main Street, but also maintaining the relationships with our national accounts. But also the way they've worked across the organization, merchandising and the hard part work, we're really excited about how our hard parts are performing with the Pro, but also our inventory replenishment team. A lot of the assortment work we've done was more indexed towards hard parts, and that really has a benefit for our Pro customers. But that cross collaboration across the organization, we're really excited about the work that they've done there and the improvement we're seeing in hard parts.

This concludes today's Q&A session and does conclude today's call. Thank you all very much for your attendance. You may now disconnect your lines.