Welcome to the Advance 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.

Elisabeth Eisleben - Senior Vice President, Communications and Investor Relations

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 detail 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.

Tom Greco - President and Chief Executive Officer

Thanks, Elisabeth, 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 in our network of Carquest Independent for their dedication throughout the year. With an unrelenting focus on delivering against our strategic priorities, 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 in 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 and 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 it's quarterly dividend in 2006.

Before I turn the call over to Jeff for more details on our financial performance. I want to highlight the operational performance improvements we implemented in 2019, as well as several exciting new initiatives planned for this year, which we expect to enable ongoing top line growth and adjusted OI margin expansion in 2020 and beyond. In Q4, our professional business led our growth rate, highlighted by Worldpac, Canada and our Carquest Independent businesses. As we continue to bring all our professional assets under one roof, we remain focused on providing best-in-class parts availability; improving order to delivery speed and consistency; and strengthening our overall value proposition to our customers.

This includes ongoing enhancements to our one-stop shop professional online platform MyAdvance, as well as improvements to our best-in-class online B2B catalog, Advance Pro. MyAdvance improves the customer experience with fully integrated access to promotions, product information, our pro rewards program, but of reconciliation and key performance indicators. This enables us to leverage customer data to drive engagement, while improving visibility to enroll promotions and customer involvement.

Additionally, we expanded the categories included in the roll out of dynamic assortment with 50 categories now rolled out across nearly 4,000 stores representing over 50% of our back room sales. Dynamic assortment is continuing to improve stock and close rates in key categories. Once fully implemented, we expect dynamic assortment to drive top line improvements through a better understanding of customer demand and utilizing multiple data points to improve availability and help ensure that we have the right part in the right place at the right time.

In terms of our DIY omni-channel business, we had a challenging Q4, particularly in the North. That said, the heavy lifting, we did in the back half of 2019 has resulted in a much stronger DIY plan for 2020, which we believe will build momentum throughout the year. There are four primary areas of focus here: one, launch DieHard; two, build awareness; three, drive loyalty and four, execute with excellence.

But first we're very excited about launching the iconic DieHard brand throughout the Advance network in 2020. DieHard is the number one battery brand among all customers and presents us with several ways we believe we can differentiate our offering and drive increased customer traffic to our retail stores. Our goal of DieHard is to build on its strong reputation, creating a differentiated value proposition, while we're confident the addition of DieHard to our industry-leading assortment will drive incremental growth for DIY omni-channel. We also see the potential to leverage DieHard with our professional customers and Independent Carquest partners. In the future we also believe there is a significant opportunity for brand extension into other categories and geographic expansion of DieHard. Without question both the Advance team and our Carquest Independent are very excited about DieHard.

Second, we're focused on significantly improving awareness of Advance. Our unaided awareness improved in 2019, but still lags our primary competitors by a wide margin. Our 2020 plans are highlighted by a new marketing campaign, including a significant increase in media, which we sourced from pre-existing, lower performing marketing spend. We're confident this new advertising will differentiate the Advance brand over time.

Additionally, we're very excited to leverage our recently announced partnership with Penske Racing and our new driver Ryan Blaney. We'll also continue to drive awareness by improving our digital experience as we know that most transactions start online. Our DIY online business continued to grow traffic and transactions, resulting in double-digit e-commerce growth in both Q4 and the full-year. Our team is also making progress on the expansion of product offerings on walmart.com, including the addition of product reviews that facilitate a frictionless experience for our customers.

Third, we continue to make progress on our loyalty program Speed Perks, and we're excited about the launch of our new mobile app or DIYs in Q1. Our app will make Speed Perks and our mobile experience even more accessible to our loyal customers. When we relaunched Speed Perks 2.0 mid-year under 25% of our DIY transactions were Speed Perks transactions at that point. We finished the year at close to 36%, this enables us to leverage first-party data to personalize our offerings.

In Q4, we added close to 1 million new Speed Perks members, finishing Q4 at close to 12 million active members. In addition, we saw increasing graduation rates from one spending tier to the next. We'll continue to build loyalty behind Speed Perks by leveraging personalization and communicating directly with our customers.

Fourth, our field team continues to improve on key execution metrics, including units per transaction, weekend coverage and Net Promoter Score. In 2020, we plan to improve both the quality and execution of our automotive training for our team members, while improving the customer experience for buy online, pickup in store. The fact that our turnover in front line customer facing role decline in both 2018 and 2019, that's helped us improve execution overall.

In terms of category performance, our Q4 growth was led by brakes, batteries and filters. Due to a weak December, we underperformed on winter-related products, such as starters and alternators, as well as radiators. Geographically, our regional performance was highly vary with our Midwest, West and Central regions delivering mid single-digit growth in Q4, and the largest sales increases on both a one and two-year stack, compared to prior years. These geographies significantly outperformed our weakest geographies in the quarter with our Great Lakes, Northeast and Mid-Atlantic regions trailing the top performing regions by over 600 basis points on average.

To summarize our growth initiatives, we've elevated our focus on differentiating and improving the customer experience for both our Pro and DIY omni-channel business. We remain relentlessly focused on delighting the customer across all of our businesses. Our Pro business continues to build momentum across all banners and we continue to integrate key platform to simplify and improve the customer experience across Advance Pro and MyAdvance. In terms of DIY omni-channel, while it remains a work in progress, we have the strongest marketing calendar of activity on DIY omni-channel in years, with a plan to launch Diehard, build awareness, increase loyalty, and improve execution.

Moving onto our key pillars of margin expansion for 2020 and beyond. Our first priority is to improve sales and profit per store. This includes optimizing our existing footprint, expanding where we're under penetrated, and closing unproductive or underperforming assets where appropriate. Starting with our largest business on the professional side, our team continues to expand our professional footprint to drive share growth. In 2019, we opened 17 new Worldpac branches and continue to add new Carquest Independent locations. In addition to the growth of our existing locations and sourcing new opportunities, our team has also started the consolidation of our Worldpac and Autopart International banners to deliver improved productivity and product assortment across our professional business. This effort will continue throughout 2020.

In addition, behind consistent gradual improvements in execution across our Advance and Carquest stores, our average sales per store has increased from $1.5 million at the end of 2017 to roughly $1.6 million per store at the end of 2019. We're confident we'll continue this growth and are on track to achieve our goal of $1.8 million per store over time. Separately, we continue to address more structural opportunities within our retail stores, which includes a strengthened store refresh program and the ongoing optimization of our store footprint. We expect the actions we're taking to improve sales and profit per store will benefit both DIY and Pro.

Our second margin expansion priority is within our supply chain, and I'm pleased to say we're now in full execution mode on this critical area of our transformation. Our supply chain team has done a thorough review of our entire footprint and we're now executing plans that we believe will significantly enhance our enterprise-wide supply chain. With 50 distribution centers today, we have a clear opportunity to further rationalize our footprint over the coming years. Importantly, we will work to optimize the network while improving our service to customers. It's imperative that our DCs have the right part in the right place at the right time, so we win more often.

One of our major supply chain productivity initiatives is cross banner replenishment, which we began to deploy in late 2019. Following the successful lead markets, we're now beginning to scale this capability throughout our DC and expect to be completed by mid-2021. Once fully implemented, we expect we will improve product availability, drive turns, and deliver significant cost productivity.

In addition, we are continuing to invest in the consolidation of several Warehouse Management Systems or WMS for short, the one system across our Advance and Carquest network, which as you can imagine is a significant undertaking. When we began our supply chain transformation, we were dealing with multiple WMS systems, along with extensive manual processes and high turnover in our DCs. Not only is our turnover down significantly in our DCs, our safety performance and engagement scores are now trending in a positive direction. Well, it took time to build the right team and stabilize operations before we introduced a new WMS system, I'm confident we now have the right team in place to help us further our transformation progress.

Importantly, our team recently completed the first conversion to our new WMS platform in one of our largest DC, and that DC is off to a terrific start. We expect this initiative coupled with the implementation of a new labor management system will allow us to run common across our DCs. So we can provide better product availability at more optimal inventory turns and costs. We're currently on track with our supply chain agenda, and I'm excited for what this will deliver in 2020 and beyond.

Our third pillar of margin expansion focus is on category management. Here we've implemented a standardized approach across key categories to facilitate material cost optimization, own brand expansion, and unit and profit growth through strategic pricing. This has been a highly collaborative effort with our supplier partners. In terms of material cost optimization, while unplanned tariffs reduce the benefit of our performance in 2019, we made good progress on MCL, both in Q4 and for the full-year.

For own brand expansion, we began to roll out additional Carquest branded products in the back half of 2019. We're working to ensure the highest of quality in our Carquest brand roll out as this brand resonates so strongly with our professional garages. In parallel, we have been exploring own brand opportunities for DIY with our suppliers, with DieHard being the best example of this to-date.

Finally, we expect to deploy our new pricing platform by mid-year. This will enable single price execution across all channels to provide consistent and more efficient management of our pricing. A big benefit of this new capability will be the ability to centrally price right down the store level if needed.

Finally, SG&A productivity rounds off the fourth pillar of our margin expansion. SG&A was a highlight of our 2019 performance as our team continues to make excellent progress in managing our costs. In the fourth quarter, we were able to leverage our labor-related costs, including store labor as a percent of sales, in spite of wage inflation and lower-than-expected sale. This was largely driven by the improvements from our new store level labor management system, which we rolled out in Q3.

Additionally, our diligent efforts to build a culture of safety is becoming ingrained in how our team members work, leading to a reduction in our liabilities and claims expenses across the organization, which benefited the quarter and the year. In fact, we lowered our total recordable injury rate by 8% in 2019 and our LTIR or Lost Time Injury Rate, which represents the worst safety incidents was reduced by an impressive 17%, compared to 2018.

Finally, we continue to make progress on rent in the quarter and in the year. For the full-year, we leveraged our occupancy in base rent by roughly 20 basis points. To wrap up, our SG&A performance we made good progress across multiple lines, enabling us to leverage SG&A to drive margin expansion, while at the same time we made significant investments in technology, e-commerce and supply chain in 2019.

In summary, 2019 was a year of continued progress for AAP, as we registered another year of top line growth and margin expansion, while making important long-term investments. In terms of our outlook for 2020, we previously discussed that this year would be similar to 2019 in terms of investment requirements. With that said, some additional items for you to keep in mind. First, as you probably know, we've just experienced the warmest January in history, which is expected to impact demand in the front half of the year. From an AAP standpoint, we also expect the elevated coupon investment we're making in our loyalty platform to continue in the front half of 2020.

On the positive side of the equation, industry dynamics remain very attractive. This includes continued increases in the car park, miles driven, as well as an increase in vehicles greater than seven years old. All of these are projected to have a favorable impact on demand throughout 2020. Further, we also expect our Pro and DIY initiatives to build top line momentum through the year.

Finally, I'm confident in our team's ability to continue our margin expansion trajectory and deliver further progress against our strategic objectives in 2020. All of these factors are contemplated in the full-year guidance we introduced in our press release this morning.

In summary, we remain very excited about the tremendous opportunity ahead to fully unlock the potential of AAP, and we're committed to driving consistent improvement across the enterprise over the next several years.

With that, I'll turn it over to Jeff for details on our financial performance.

Jeff Shepherd - Executive Vice President and Chief Financial Officer

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 enable us to leverage expenses every quarter. In Q4, we leveraged labor-related costs, and once again reduced our insurance and claims expense, the 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 adjusted operating margin was 8.2% for 2019, which increased 36 basis points, compared to the full-year of 2018. Adjusted diluted EPS increased 14.9% to $8.19, compared to $7.13 at the end of 2018.

Moving to free cash flow. We delivered $597 million in 2019, which was lower than our expectations. Factors negatively impacting working capital includes higher-than-expected increases in both our receivables and inventory. We also realized an unfavorable payment term mix within vendor payables. This was driven by an increase in Worldpac inventory, associated with the opening of Worldpac branches, which carry shorter payment terms, as well as an unfavorable mix impact within Advance and Carquest vendor payables. These factors resulted in higher cash outflows at year-end than we previously modeled.

Consistent with increasing capital spend throughout 2019, our capex in Q4 was $101 million, bringing the full-year spend to $270 million, an increase of 39.4% year-over-year. As we have previously discussed, our investments are primarily focused on information technology and supply chain projects. And in 2019, more than 60% of our capital spend was concentrated on these two critical areas.

Our IT initiatives continue to address long-standing lack of investment in critical systems and back office integrations, which we expect to continue in 2020 and beyond. Nearly one-third of our IT spend in 2019 focus on customer-facing systems, and I'm pleased with the near completion of our NextGen store system upgrade across our footprint. In addition, throughout 2019, our team worked diligently on our finance ERP project, which integrates our back office finance systems. We went live with our first release in this new system at the start of our fiscal 2020, and I'm confident the continued roll out of this initiative will create significant efficiencies across our organization.

In addition, our supply chain team worked relentlessly throughout the year to stabilize existing operations. We invested in DC improvements in 2019, with additional plans for 2020, including network upgrades and continued roll out of our single warehouse management system across our legacy Advance and Carquest network to enable improved accuracy and efficiencies within the distribution centers.

In line with our financial priorities to maintain an investment grade rating, invest in the business and opportunistically return capital to shareholders. Under our current share repurchase program, we repurchased nearly $11 million of Advance stock during the fourth quarter, and a total of approximately $487 million for the year. Importantly, we remain confident in our ability to generate meaningful cash from the business.

As you saw yesterday, we are pleased to announce our Board has approved a meaningful improvement to our quarterly dividend, which was increased from $0.06 to $0.25. We're committed to a balanced approach in returning capital to our shareholders, while making important investments to drive our transformation. As we begin 2020, we remain focused on our strategic objectives and discipline in our execution to deliver against our financial priorities.

With that said, this morning, we introduced our 53-week full-year 2020 guidance for several key metrics; including net sales of $9.88 billion to $10.1 billion; comparable store sales growth of flat to 2%; adjusted operating income margin expansion of 20 basis points to 50 basis points; capital expenditures of $275 million to $325 million; focusing on continued IT and supply chain investments. The 2020 tax rate is expected to be 24% to 26%, and as we continue our disciplined approach to cash management, we expect to deliver a minimum free cash flow of $600 million.

As a reminder, 2020 includes the 53rd week. Our financial outlook provided today includes an estimated $125 million to $150 million in net sales, and approximately 10 basis points to 20 basis points of margin expansion from the 53rd week contribution.

In summary, I want to reiterate our gratitude that Tom began with today to all our team members and independent partners for their efforts throughout 2019, which enabled our continued progress toward our transformation objectives. We remain committed to further improvements in 2020 to remain disciplined in our approach to capitalize on the significant opportunity still ahead for AAP.

With that, let's open the call to address your questions, operator?

Question & Answers

Operator

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

Matt McClintock - Raymond James - Analyst

Yes. Good morning, everyone. Tom, I was wondering about the initial guidance for 2020. Just the 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?

Tom Greco - President and Chief Executive Officer

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 '19 and '20 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 time frame, and we factored in the impact of what - at least at this point is an extremely mild winter, compared it to other years, you guys have written about some of this 2017, 2012, it was one of the warmest in history for North America this year December-January. And given our Northern footprint, we 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 in 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 vehicle is about seven years and greater is growing. So those are all positive impact and that will benefit the whole year.

Separately, obviously we've got a number of top line initiatives across Pro and DIY that will build throughout the year including - pardon me, 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.

Matt McClintock - Raymond James - Analyst

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

Tom Greco - President and Chief Executive Officer

Sure. Well, as we've talked when we issued the original press release, there is 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, so we're excited about that also.

But 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 build out the launch plan for DieHard, and needless to say, it will benefit us more in the back half of the year than the front half.

Matt McClintock - Raymond James - Analyst

I appreciate the color. Best of luck.

Tom Greco - President and Chief Executive Officer

Thank you.

Operator

Seth Sigman with Credit Suisse. Your line is open.

Seth Sigman - Credit Suisse - Analyst

Hey guys, good morning. Thanks for taking the question. Just - I'm going to ask a couple of 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 this - 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.

Tom Greco - President and Chief Executive Officer

Yes. And good morning, Seth. I'll take the first one I'll flip it the second question over to Jeff. In terms of December - October, November, December, I mean, it wasn't that different at the national level. We did see a slowdown in December, but it was a market difference geographically, as we called out in our script. First of all, in the West, in the Midwest, in Central, there - 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?

Jeff Shepherd - Executive Vice President and Chief Financial Officer

Yes, sure. I'll start with the fourth quarter, Seth, and then work into the guidance for 2020. Fourth quarter, you saw SG&A improved a 125 basis points. Three broad categories, the labor and labor-related, we did leverage store labor in the fourth quarter. We saw some improvements in our marketing programs as Jason McDonnell 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 improvement in insurance and claims, and this is 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 it - actuarial valuation to estimate out into the future what do 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 My Day. 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.

Now 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. We - at this point, we think we're going to see more of the improvement in our margin - in 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 of 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.

Seth Sigman - Credit Suisse - Analyst

Okay. Great. Thank you for all the color. Appreciate it.

Jeff Shepherd - Executive Vice President and Chief Financial Officer

Welcome.

Operator

Michael Lasser with UBS. Your line is open.

Atul Maheswari - UBS - Analyst

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?

Tom Greco - President and Chief Executive Officer

Yes. 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.

Atul Maheswari - UBS - Analyst

Got it, and 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 zero - 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?

Tom Greco - President and Chief Executive Officer

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

Atul Maheswari - UBS - Analyst

Thank you.

Operator

Simeon Gutman with Morgan Stanley. Your line is open.

Michael Kessler - Morgan Stanley - Analyst

Hey guys. This is Michael Kessler on for Simeon. Thanks for taking our questions. First, I just wanted to ask about the comp relative to the operating margin growth expectation for 2020. It seems like comp is a fair guide given the backdrop and still guiding to solid margin expansion. I just want 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? Do you think you can get it regardless of the top line?

Tom Greco - President and Chief Executive Officer

Sure. Well, first of all, we're excited about the fact that in the fourth quarter we delivered margin expansion amid a quarter where we - 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 re-pointing a store at a distribution center that's closer to the store than the previous one, so that's in full roll out 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 there for us 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 were software tool that we're standing up in the middle of 2020 that will enable us to price 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 their sales dependent, whether that's the integration of our back office platforms, improves 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 depend as it might be in other companies.

Michael Kessler - Morgan Stanley - Analyst

Great. Thanks. Appreciate that and the color. And just as a follow-up. So we've been hearing that some suppliers are advising, you know, 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 a little less exposed to DIY than some of your competitors, but could you comment on what you're seeing or hearing thus far and whether there is any contingency you're building in at your guidance for any disruptions?

Tom Greco - President and Chief Executive Officer

Yes, 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 even 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 closely. But at the moment, we don't see any impact in supply disruption from us - for us in 2020. But it's obviously a very dynamic situation and we've got to continue to monitor it very closely.

Michael Kessler - Morgan Stanley - Analyst

Great. Thank you.

Operator

Seth Basham with Wedbush Securities. Your line is open.

Seth Basham - Wedbush Securities - Analyst

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

Tom Greco - President and Chief Executive Officer

Sure, Seth. I mean, 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 has 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 cover 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. I mean, 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 will help us improve our availability and obviously standardize the actions are going on in those DCs. We've talked about Worldpac and AI separately, which is also part of this invest to make it better chapter.

And then third, we talked 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.

Seth Basham - Wedbush Securities - Analyst

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?

Tom Greco - President and Chief Executive Officer

Yes, I mean, 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, I mean, 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 will improve in the back half, but the supply chain is relatively uniform through the year.

Seth Basham - Wedbush Securities - Analyst

Thank you very much.

Operator

Scot Ciccarelli with RBC. Your line is open.

Sullivan - RBC Capital Markets - Analyst

Hi, good morning. This is actually Sullivan [Phonetic] calls on for Scot. Thanks for taking our question. So just quick one on, just wanted to get to know if you can sort of quantify the gross margin comp impact during the quarter from the coupon redemption?

Tom Greco - President and Chief Executive Officer

Yes, 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.

Sullivan - RBC Capital Markets - Analyst

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

Tom Greco - President and Chief Executive Officer

Yes, what we said was that we did, 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 as 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 1 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.

Sullivan - RBC Capital Markets - Analyst

Got it. Thanks, guys.

Operator

Daniel Imbro with Stephens, Incorporated. Your line is open.

Daniel Imbro - Stephens Inc - Analyst

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?

Jeff Shepherd - Executive Vice President and Chief Financial Officer

Yes, 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'd be costs, whether it'd be packaging, whether it'd 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.

Daniel Imbro - Stephens Inc - Analyst

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?

Tom Greco - President and Chief Executive Officer

Yes, 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 time frame. 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.

Daniel Imbro - Stephens Inc - Analyst

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

Operator

Michael Montani with Evercore ISI. Your line is open.

Antonio Tabet - Evercore ISI - Analyst

Hi, this is actually Antonio filling in for Mike. I just want to shift gears a little bit to talk about multi-channel. 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.

Tom Greco - President and Chief Executive Officer

Yes. 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.

Antonio Tabet - Evercore ISI - Analyst

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?

Tom Greco - President and Chief Executive Officer

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.

Antonio Tabet - Evercore ISI - Analyst

Got it. Thanks, guys.

Operator

Bret Jordan with Jefferies. Your line is open.

Bret Jordan - Jefferies - Analyst

Hey, good morning, guys.

Tom Greco - President and Chief Executive Officer

Good morning, Bret.

Bret Jordan - Jefferies - Analyst

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

Jeff Shepherd - Executive Vice President and Chief Financial Officer

Yes, 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.

Bret Jordan - Jefferies - Analyst

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

Jeff Shepherd - Executive Vice President and Chief Financial Officer

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

Bret Jordan - Jefferies - Analyst

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?

Tom Greco - President and Chief Executive Officer

Yes. 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, etc. 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 repointed 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 - yes, I don't think - Jeff - yes, we'll have to get back to you on that, on owned versus lease. We'll get back to you on that. We've [Speech Overlap]

Bret Jordan - Jefferies - Analyst

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?

Tom Greco - President and Chief Executive Officer

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.

Bret Jordan - Jefferies - Analyst

Thank you.

Operator

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

Tom Greco - President and Chief Executive Officer

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.

Operator

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ADVANCE AUTO PARTS INC

Q4 2019

Earnings Transcript

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