Title

Presentation

Operator: Good morning, and welcome to the Advance Auto Parts’ Second Quarter 2023 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: Good morning, and thank you for joining us to discuss our Q2 2023 results. I’m joined by Gene Lee, Interim Executive Chair; Tom Greco, President and Chief Executive Officer; and Tony Iskander, Interim Chief Financial Officer. Following their prepared remarks, we will turn our attention to answering your questions. Before we begin, please be advised that remarks today will contain forward-looking statements. All statements other than statements of historical facts are forward-looking statements, including but not limited to, statements regarding our leadership transition, 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 Form 10-K and subsequent filings made with the commission. Now let me turn the call over to Gene Lee.

Gene Lee: Good morning, everyone, and thank you for joining us. I’m pleased to be able to join the call today and speak with all of you. I’ll turn the call over to Tom and Tony shortly to review the second quarter results and outlook for the remainder of the year. But before I do that, I’d like to take a moment to address the announcements we made this morning regarding new leadership and a comprehensive strategic and operational review, as well as provide some of my own perspectives on the business, the work that we have ahead of us and the actions we are taking. Following a thorough search, the Board has named Shane O’Kelly as President, Chief Executive Officer and Director of Advance Auto Parts, effective September 11. We are pleased to have identified an individual of Shane’s caliber to join Advance and have him come on Board as we are undertaking the operational and strategic review of the business.

Together with our financial advisor, Centerview Partners, we are committed to evaluating the full spectrum of alternatives and opportunities to increase shareholder value and ensure the long-term success of Advance, and I’m confident Shane will add valuable insight to this review. Shane is a highly accomplished customer centric executive with more than 30 years of operational, strategic development, integration and complex supply chain experience. He has a proven record of success developing high performing teams and cultures to drive results. He joined Advance from HD Supply, where he has served as CEO since 2020, following the company’s acquisition by the Home Depot. Prior to HD Supply, Shane was CEO of Interline Brands, which also operated as the Home Depot Pro.

We are confident that Shane brings the right skill set, discipline, and expertise to lead Advance into the future. I plan to remain in the Interim Executive Chair role through the end of the year to work alongside Shane and the management team. I look forward to welcoming him to [Raleigh] (ph) in September. Until Shane’s official start date, Tom will continue to serve as President and CEO. Thereafter, he will serve as an advisor to help ensure seamless transition of leadership responsibilities. On behalf of the entire Board, I thank Tom for his many contributions to Advance, which notably includes the culture he has built with highly skilled and committed team members and a talented bench of leaders. We also announced today Tony Iskander as Interim Chief Financial Officer.

Tony brings more than 25 years of finance and accounting expertise to the role, and has served as the company’s Senior Vice President, Finance and Treasurer since 2020. We are beginning a search to identify the company’s next permanent CFO and are pleased to have someone with Tony’s experience to step into the role on an interim basis. We are also pleased to have Tony on the call today to review Q2 results along with Tom. Since expanding my role to serve as Interim Executive Chair and partnering more closely with the leadership team, I am taking a deeper dive into the business and our strategy. As a Board, we recognize that there is significant work to be done. We are conducting the operational and strategic review to develop a long-term strategy to deliver best-in-class shareholder value.

We are executing a number of operational improvements, including inventory optimization initiatives, improving asset productivity across the enterprise, investment in our frontline organization to reduce turnover and discipline cost controls, which we expect to benefit the cost structure and working capital while strengthening Advance for a long-term. However, we know there’s more work to be done and the team is focused on building on these actions and looking for ways to drive even stronger performance and enhance value. The company is providing updated full-year 2023 guidance today, which considers recent performance and balance of the year expectations. I would note that after Shane joins next month, I expect to work closely with him on the business plan to ensure we capitalize on both Advance’s near-term and long-term potential.

With that, I’ll now turn the call over to Tom.

Tom Greco: Thanks Gene, and good morning, everyone. Before I start, I want to express my sincere appreciation to the Board for all their support over the last seven years. I look forward to working with Gene, Shane and Tony to enable a seamless transition. As I turn to our Q2 results, I also want to thank all of our team members for their relentless focus on serving our customers. Coming into the quarter, we knew Q2 was going to be challenging, and that the investments we’re making in both inventory to help improve availability and strategic pricing to maintain competitive price targets would build through the year. On our Q1 earnings call, we talked about moving with urgency with a back-to-basics approach and a heightened focus on execution, and this is how we approach the quarter.

We delivered net sales growth in the quarter. However, the balance of our Q2 financial metrics remain challenged. As Gene noted, while we’re executing some operational improvements, there are further actions that need to be taken to accelerate profitable growth. I’ll speak to our sales and transactions in the quarter, and Tony will speak to the key drivers behind our results in more detail. Before that, I’d like to touch briefly on steps we’ve taken recently to better support our people. During the quarter, we made investments to more strongly position Advance in attracting and retaining high-caliber talent in our frontline roles. More specifically, we implemented compensation increases for key roles in our stores and supply chain. In our Customer Support center, we’re also making investments this year, to help retain high-caliber talent.

We know that having the right compensation in place for our organization is critical to maintaining our strong culture and delivering operational excellence, and we’ve already seen reduced turnover. Turning to net sales. We saw growth in both DIY omnichannel and DIFM during Q2, with DIY omnichannel outperforming DIFM through continued e-commerce momentum which delivered another quarter of double-digit growth. From a category perspective, motor oil, batteries, brakes and engine management led the growth in Q2. DieHard continues to perform very well, and gained unit share within batteries once again in the quarter. Meanwhile, improved availability on our Carquest brand resulted in further owned brand penetration in the quarter. Regionally, our sales growth was once again led by the West.

In terms of comparable store sales, the decline of 0.6% was primarily driven by negative comparable store sales in Pro. However, we saw sequential improvement in each period in both Pro and DIY with the last four weeks of Q2 registering slightly positive comparable store sales growth overall. Our topline sales continued to improve into the third quarter, as we delivered low-single-digit comparable sales growth during the first four weeks. Our performance benefited from the initiatives we’ve talked about earlier this year to drive improved transactions in both DIY omnichannel and Pro. First, our improved availability was driven by the inventory investments we made along with year-to-date improvements in supply chain fill rates and store on-hand rates.

As in-stocks improved in the quarter, we saw sequential sales growth in key hard parts categories. Second, our category management actions continued in Q2 to ensure we sustained competitive price targets. In addition, we’ve discussed in the past the opportunity to increase owned brand penetration to improve margins. As discussed on the May call, we launched a sales campaign in Q2. This was primarily targeted at accelerating the transition to Carquest branded products, as well as reducing slower moving inventory in our network. Finally, our field team is now in full stride executing a Pro customer activation plan highlighted by increasing customer sales calls and ensuring a high level of accountability to grow weekly customer counts and drive share of wallet gains with existing customers.

Our actions resulted in sequential improvement in transactions in Q2 compared to Q1 in both Pro and DIY. While DIY omnichannel transactions were down slightly in Q2 versus the prior year, average ticket was up mid-single-digits. We continue to make progress increasing loyalty with DIY consumers as evidenced by ongoing traction with our Speed Perks program which grew by approximately 15% and ended the quarter with nearly 15 million active members. Our Speed Perks percentage of transactions continues to climb and hit over 48% in the quarter, a 420 basis point increase from this time last year. I’d like to commend our field team for their strong execution at Speed Perks and their dedication to strengthening our value proposition for DIY consumers.

Specific to Pro, we remain committed to delivering a best-in-class customer experience. Transactions moved back into positive territory in Q2, an improvement versus Q1. As expected, average ticket was down slightly as we sustained our focus on maintaining competitive price targets and the execution of the targeted sales campaign I just mentioned. Within both strategic accounts in TechNet, we saw improved performance in the quarter and TechNet grew to almost 17,000 members. In summary, the actions we’ve taken to improve availability, sustain competitive pricing, and enhance our service helped us drive share of wallet gains and improve our call status with Pro installers, including the very important up and down the street business. With that, I’ll turn the call over to Tony to review some of the drivers behind our second quarter results and provide an update on our outlook for the full-year.

Tony?

Tony Iskander: Thanks, Tom, and good morning. I would first like to thank the Board and Tom for their confidence in me. I would also like to thank all our team members for their continued dedication and focus on the customer. In Q2, our net sales increased 0.8% compared with Q2 2022, and comparable store sales decreased 0.6%. Gross profit margin deleveraged 174 basis points compared to the prior year, primarily driven by higher product costs, and supply chain deleverage. Sustaining competitive price targets contributed to transaction growth in the quarter, however, this resulted in the majority of gross margin headwinds. Additionally, we experienced higher supply chain costs that were driven by investments in our distribution center team members, as well as positioning more parts closer to the customer.

We expect these investments will help further improve retention and drive productivity. SG&A as a percent of net sales deleveraged year-over-year due to labor related inflation, which includes investments in store payroll. As a result of gross margin and SG&A headwinds, our Q2 operating income margin deleveraged 256 basis points compared with the previous year. Our lower operating income combined with higher interest expense resulted in diluted earnings per share of $1.43 compared to $2.38 in Q2 2022. Free cash flow through the end of Q2 was an outflow of $309 million. In Q2, we had an inflow of $150 million. We finished the quarter with a cash balance of $277 million and $95 million outstanding on the revolver. While we’re in compliant with all of that covenants we amended the interest coverage ratio in our credit agreement.

In terms of full-year guidance, we are slightly increasing our outlook for both net and comparable store sales based on recent trends and continued progress in the professional sales channel. We are reducing our outlook for operating income margin rates, diluted earnings per share and free cash flow. We now expect deleverage in gross margin rates in the back half, this is primarily due to our commitments to maintain competitive price targets and our expectation that channel mix will remain a headwind as professional continues to strengthen. In addition, as we highlighted earlier, we are accelerating the sell down of products and categories to expedite the transition to higher margin owned brands. In terms of SG&A, we expect the compensation investments we are making in our team as well as certain non-recurring costs, primarily related to the leadership changes announced this morning, will result in slight SG&A deleverage in the back half.

These headwinds will be partially offset by cost savings we expect to realize from our corporate restructuring earlier in the year. We now expect our SG&A rates [as a mid] (ph) point will be slightly below the back half of last year. All of these factors have been considered in our full-year updated guidance, which includes net sales of $11.250 billion to $11.350 billion, comparable store sales of minus 0.5% to positive 0.5%, GAAP operating income margin of 4.0% to 4.3%, income tax rate of 25%, diluted earnings per share of $4.50 to $5.10, capital expenditures of $200 million to $250 million, a range of $150 million to $250 million in free cash flow and 40 to 60 new store and branch openings. With that, let’s open it up for questions. Operator?

Operator: Thank you. [Operator Instructions] Our first question comes from Simeon Gutman from Morgan Stanley. Your line is now open. Please go ahead.

Simeon Gutman: Good morning, everyone. I’ll have a question and a follow-up. And I guess this is to Tom Gene and Tony. First, on Worldpac. I wanted to ask how deeply it’s integrated into Advance, and then if you can talk about the synergy with the business today?

Tom Greco: Hey. Good morning, Simeon. Obviously, we still run Worldpac as the design that they’ve had initially, they did integrate Auto Part International into Worldpac. We are able to source parts from Worldpac, our enterprise catalog is visible to all of our customers. So in that respect, it’s integrated. But overall, they still run the business relatively independently. And it’s continues to perform very well.

Simeon Gutman: Okay. And then the follow-up is, if you look at and I’m going to isolate it to a couple of areas, merchandising, supply chain, and operations. If we’re to diagnose the biggest priorities of enhancement, especially as new leadership looks at this business, where do you think the biggest opportunity exists between those? And then as a solution, do you think it’s combination of P&L investments in capital, or does it wait to one side or the other?

Gene Lee: Good morning, Simeon. This is Gene. I think, that’s what the strategic review is all about. Looking at a different parts of our organization and trying to determine where is the biggest leverage point. So I think it’s not right for me to answer that question. I think that’s a question for Shane to figure out as soon as he gets on board, I think the way you’ve framed it is a good way to frame it. And then I think what we need to do is determine how do we prioritize what initiatives will give us the biggest payback as quick as possible. And I would say that will be in Shane’s 90-day agenda along with me. But I don’t really want to commit to which one of the three is where the investment needs to be made.

Operator: Thanks, Simeon. Our next question comes from Greg Melich from Evercore ISI. Your line is now open. Please go ahead.

Greg Melich: Hi. Thanks, good morning. Given the investments in both people, and not passing through pricing, I guess I have two parts to one question, which is, what are your inflation assumptions in topline for the back half? And then second, could you fill us in on how much payroll is growing year-on-year both in the first half and then in the plan for the back half?

Tom Greco: Good morning, Greg. Yes. So we expect low-single-digits on the pricing front and, wage inflation is more like mid-single.

Greg Melich: And that low single digit on pricing inflation, how does that — what’s the cadence through the year? Was that, like, high-singles in the first quarter? And then gets to zero or low-singles in the fourth quarter?

Tom Greco: Yes. We were more like mid-single early in the year. It’s gradually coming down. We do have a lot of work, we’re doing on sourcing and through the category management work, which will, help us a little bit with that in the back half, but it’s a very gradual reduction through the year. We also have a freight benefit in the back half, as you know, I’m sure that you’re seeing that in other parts of the, rev retail overall.

Operator: Thanks, Greg. Our next question comes from Michael Lasser from UBS. Your line is now open. Please go ahead.

Michael Lasser: Good morning. Thanks a lot for taking my questions. Number one, can you give us a rough approximation of the sales and profitability of the Worldpac as it stands today?

Tom Greco: Yes. No. We haven’t broken that out, Michael.

Michael Lasser: My follow-up question, Tom, is, as you think about the pricing environment, is it that, Advance has just had to play a significant amount of ketchup, and it’s price gaps with the peers in the space has been widened. And so it’s constantly having to make these price investments because of these wide gaps, or are you seeing further, are you seeing further decreases in prices across the space that you’re having to invest in. And to what degree is this happening more so among national accounts versus up and down the street account?

Tom Greco: There’s a lot there, Michael. I’ll do my best here. First of all, I think you’re characterized it fairly well. In the back half of last year, we did see our price indices move above the market, to places that we didn’t like and run acceptable to us. So we are — we did start correcting that early this year, and it’s sustain through the year. The other factor that’s important to note is we called out the accelerated sell down of products that we’re transitioning to the Carquest brand in the back half. And, that is something that is going to weigh on gross margin in the back half. It’s neutral on dollars, but it 30 to 35 basis points of rate in the back half. So, that’s also a factor. The good part of that is, we’re transitioning out of inventory that we’ve already paid for, and we’re moving into higher margin products with terms.

So know, it’s going to have a benefit for us down the road, but those are the two big wild cards on the, or big factors rather on the pricing front. National accounts versus up and down the street, there’s really not a lot of difference there in terms of what we’ve seen. This has been a rational industry for a long time, and I expect it will be going forward.

Operator: Thanks, Michael. Our next question comes from Elizabeth Suzuki from Bank of America. Your line is now open. Please go ahead.

Elizabeth Suzuki: Great. Thank you. I just wanted to clarify on the margin guidance. So, you mentioned you expect to deleverage gross margin in the back half and then some slight SG&A deleverage in the back half, but then there was a comment about, some of those headwinds being partially offset by cost savings and the SG&A rate being slightly below the back half of last year. So, I just wanted to understand whether SG&A was going to be a headwind or a tailwind to margin in the second half of this year?

Tom Greco: Good morning, Liz. It’s a slight headwind. So, it’s a little bit above last year, and it’s based on the investments we’re making in our people. We’ve really prioritized the customer and our people. And as Gene mentioned, that opens the door for the operational review to really look for ways to more efficiently and effectively flow through to the bottom line.

Elizabeth Suzuki: Okay. So, more of the margin headwinds going to be on the growth side. And then, theoretically going forward as owned brands become a larger percentage of your total that should result in some gross margin expansion in the years ahead? I mean, this is all pending, whatever the strategic review comes out with, but just thinking about that one piece of the gross margin story.

Tom Greco: Yes. That correct. In the back half, we expect more to leverage from gross margin. And as I just mentioned to Michael, 30, 35 basis points of that is this accelerated transition of products into CQ.

Elizabeth Suzuki: Great. Thank you.

Operator: Our next question comes from Chris Horvers from JPMorgan. Chris, your line is now open. Please go ahead.

Chris Horvers: Thanks. Good morning. So, following up on an earlier question, the improvement that you’ve seen in the business in the last eight weeks, was that, I guess, to what degree did the DIY business improve? And then on the Pro side, you mentioned both national accounts and up and down the street business improved, but, was it weighted to one side versus the other side of the Pro?

Tom Greco: Yes. Good morning, Chris. Yes, we’re pleased with DIY. It’s our third consecutive quarter of growing comp sales in DIY, and it did improve in the quarter. So, the availability investments that we’re making benefit DIY too. Our e-commerce business is performing well. Pro, did has improved more, as you know, in the last half of 2022, we slipped in Pro. So, disproportionately in the last several weeks Pro has improved better. And, the national accounts versus up and down the street, we’re seeing improvement in both. So, there is good progress there. TechNet is performing better. So, really, all of our professional businesses benefiting from the actions we’re taking, and I will call out, that the field is doing a very good job executing as well. They’re getting out there, meeting with the garages, moving up the call list, all the things that we need to do to win the business with our installers up and down the street and national accounts.

Chris Horvers: Got it. And then, there’s a lot of questions around Worldpac sizing the business, the margins of the business, is it as a potential way to create shareholder value. I guess, can you talk out loud for us as you think about the strategic relevance of having Worldpac in the argument from the start of the acquisition and through your tenure as always been the expansiveness of the catalog, the one-stop shop, that Worldpac brings on top of what Advance brings. So, what do you lose? And then secondly, is there any cash flow dynamics that we’re concerned about here, obviously your free cash flow guidance has come down, does it — are you concerned that, this could start to unwind some of the vendor financing programs that you have in-place and there’s some compelling reason to create cash flow, and better sort of financial leverage on the balance sheet?

Gene Lee: Hi, this is Gene. Yes, there was a real lot in that question. I’m not sure where to get to all of it, but let me just start off with, I think the first part of the question asking about Worldpac’s role in the organization. I think Tom, should — can give us opinion on that, but this is going to be, Shane’s decision on how — and after we do the strategic and operational review, he is going to need to be the one who decides what role Worldpac plays in the organization, whether you integrate it or you don’t integrate it, run as a separate business and how does it play with all the other assets in the organization. So, I think that’s really, it’s important. Now, I think Tom can give his opinion on how he thinks about the business, but this is going to be a Shane decision as we move forward.

Tom Greco: Sure. So, I mean, the big thing Chris is the enterprise assortment. It gives us a broader assortment than anybody in the industry. Obviously, we’ve got national brands, we’ve got our own brand line-up, which we’re very proud of. And then, obviously, the OE products that Worldpac brings to the table, gives us up to 350,000 in market stock parts. So, that that gives us an advantage there, and we’re able to leverage that through all of the banners that we sell to the customer. So, that’s the big thing. But, again, as Gene said, we’ve got to go through the review, and find new ways to flow through profitability to the bottom line. So, that’ll come out of the review.

Chris Horvers: And then anything on the balance sheet side?

Tony Iskander: Hi, Chris. This is Tony. So, we’re not seeing any changes in our supplier finance programs or any attractiveness in there. So, we disclosed that and you’ll read more about that in the queue later today.

Chris Horvers: Got it. Thanks, very much.

Operator: Thanks, Chris. Our next question comes from Bret Jordan from Jefferies. Bret, your line is now open. Please go ahead.

Bret Jordan: Hi, good morning, guys. On the Carquest private label strategy, I guess you’ve been losing some commercial market share in the last quarters and obviously are talking about price investment now around the brand. I guess, is that something that’s either is the commercial perception of that an issue in the share loss or is an availability issue in the share loss?

Tom Greco: I think, if you look the back of last year and into the first part of this year, it was primarily availability, Bret, as you highlighted, a minute ago. But I do think our availability improvements that we’ve made there have been, the biggest driver of the change. Our on-hand rates are up very nicely in the key categories we transition, which you know, engine management, undercar, etcetera. And that’s been the bigger driver, and we expect that to continue to be a benefit for us in the back half. Our professional installers love the Carquest brand. Our brakes are the best. We have the best brake program in the business. And, transitioning these products has been very difficult. It’s taken us more time than we would like. But once we get them in and, the customer gets a chance to install them, this is a product that we get repeat business off of.

Bret Jordan: Okay. And then a follow-up question on that supplier base. I guess, yes, obviously, the fact the payables program given the leverage ratio might be under some pressure. But in the transition to more private label, is that going to support the payables or those vendors willing to take a longer term than maybe a national brand would?

Tom Greco: I mean, we obviously factor in all those changes, Bret. When we make change from a national brand to Carquest we know what the change in the terms are. So, we factor all that in. And it’s part of the calculus, right, when we make the decision. We look at the margin rate. We look at the quality. We look at the vendor itself, most of which our OE providers so they make a very high quality product and then we evaluate the terms. So, it’s a holistic decision that we’re making in terms of selecting our suppliers.

Bret Jordan: Okay. I guess from the forecast on cash flow for the year, where do you see the payables ratio getting down to? I guess as we add another couple of EBIT quarters that might have your leverage ratio above 3?

Tony Iskander: Yes. As you saw from Q1 to Q2, it’s starting to go up. And we expect it to continue to increase over time as we get some of those investments, behind us and then we continue to build and replenish. So, we actually believe that the AP ratio will continue to expand.

Bret Jordan: Okay, great. Thank you.

Tom Greco: Thanks, Bret.

Operator: Thanks, Bret. Our next question comes from Seth Sigman from Barclays. Seth, your line is now open. Please go ahead.

Seth Sigman: Hi, good morning, everyone. I wanted to follow-up on the gross margin. It sounds like part of the issue is pricing to cover the costs, but I’m curious, why is that so different for AAP? And I’m curious, are you still seeing incremental cost pressures in COGS, or is this really a function of — you had elevated product and supply chain costs last year. Some of that was capitalized into inventory or on the balance sheet. It’s just flowing through now as the inventory turns. And if that’s right, do you have visibility into when that starts to normalize through this year?

Tom Greco: I think that the earlier question sort of answered that one, Seth, which is, we did see our pricing elevate above the market in the back half of last year, and we are addressing that as we go into this year. And you’ll see that through the back half. So, we’re committed to holistic solution here. We want to make sure availability gets better. Our visibility of our parts is better, and service and delivery continues to improve. And, we are going to sustain the price index. We’ll continue to stay focused on that. But as we get into, obviously, further out, you’ll see that normalize.

Seth Sigman: Okay. So, if we look at the EBIT margin outlook for the second half of the year, you did lower it, but it looks like the year-over-year change will be down less than, I guess, in the first half of the year. Can you just help us contextualize what may be driving that improvement trend in the second half of the year?

Tom Greco: Yes, sure. I mean, for sure on the gross margin side, we mentioned freight earlier. Freight becomes a tailwind for us in the back half. Some of our category management initiatives begin to benefit us in the back half. And just year-over-year, price versus cost is not as a punitive, as it was in the front half of the year. We’ve got more sales. So, there’s less supply chain, the leverage on the gross margin side. As we said, SG&A is smaller. We’re going to have, be slightly above last year’s rate on SG&A, which involves the investments we’re making in our team to make sure that we reduce turnover in the stores and really keep all the great people we have here in the corporate office. So, those are the two drivers, and both of them are going to get better than they were in the front half.

Seth Sigman: Got it. Alright. Thank you.

Operator: Thanks, Seth. Our net question comes from Steven Zaccone from Citigroup. Steven, your line is now open. Please go ahead.

Steven Zaccone: Great. Good morning. Thanks very much for taking my question and, congrats on the CEO announcement. I guess, Gene, my question is for you. As you take a more active role in the business, I’m curious for your assessment of how long it will take for this business to return to profitable growth. I know Shane will come in and it seems like he has a lot to figure out. But from your seat, do you think of this as a one year invest-to-grow margin strategy, or is this something that’s more multi-year in nature?

Gene Lee: Well, I think it’s less than one year. I mean, I think that, we should start seeing incremental improvement, pretty quickly here. There’s some really good actions that are being taken right now, especially around the operational front. I think we’re doing a much better job today up and down the street with our professional customers. I think we’re operating at the store level much better. I think we’re making significant improvements in supply chain. And more importantly, I think, when you think about our strategy with our top 4000 products that we’re calling never out, we’ve made great progress there too. So, I think that we are — I think that the price-to-inflation gap will continue to grow. And as we move forward, we should actually be able to price to cover inflation after we wrap.

Therefore, you’re not going to see the same kind of deleverage in the gross margin line. And so I think that we’re going to start seeing improvement pretty quickly. We’ve been working hard the last 90 to 120 days on some, I think some focused initiatives that are starting to come through for us. We’re seeing that in the sales line. We’re excited every morning that we’re seeing some sales growth. So, I think as we get past the back half of the year, we will actually see price at inflation or slightly above inflation, and then we can get to start to leveraging both gross margin and gross profit and our SG&A.

Steven Zaccone: That’s great. Thank you for that detail. And then, just to follow-up because there’s been several questions clearly Worldpac, but I was curious with the operational and strategic review. Is it fair to conclude that includes the potential for asset divestitures?

Gene Lee: I think there’s a range of options, that we have to consider. We sit here today, we think Worldpac is a great asset. And as I think about all our assets, I think the number one issue in our organization today is asset productivity. So, we need to evaluate the productivity of all of our assets, including Worldpac. We need to understand what’s the potential of all those assets? How do they fit organizationally? And how to best operationalize those assets? To me, that’s what the comprehensive, strategic review is all about. And I think there’s going to be more focus on the operational review because we have a lot of opportunity there to improve our processes and procedures from end-to-end. And I think that’s really over time where the cost savings will come is through improving those processes and procedures.

And I think Tom, mentioned earlier, and we’re working hard on our category management. We have an outside consultant working with us, and we’re making some really great progress that I think will show some positive results into 2024. And I’m excited about that, but there’s other opportunities. And what I’ve been referring to as the value chain, to evaluate all our processes and procedures. So, I would say we have a wide range of options. Everything is on the table but I think we need to truly understand Shane needs to truly understand what’s the potential of all these assets and how do they fit in and how we best operationalize them.

Steven Zaccone: Great. Thank you for all the detail. Best of luck.

Operator: Thanks, Steven. Our next question comes from Steven Forbes from Guggenheim Partners. Steven, your line is now open. Please go ahead.

Steven Forbes: Good morning. I have a two-part question on capital spending. So first, given the reduction in spending plans, year-to-date, you know, from the start of the year, can you help us better understand what the team has pulled back on? And then the second part is, as we think about sort of more normalized capital spending, ratios looking out, and any initial thoughts on what the go forward spend rate should be.

Tony Iskander: Yeah. Thanks again. Good morning, Steven. This is Tony. As you’ll recall in the first quarter, we had a higher number of new store openings, and we brought that down in our guide after the first quarter. And that’s primarily driving the reduction in capital spend. On a go forward basis, that’s what the strategic review is going to help us identify.

Steven Forbes: Thank you.

Operator: Thanks, Steven. Our next question comes from Kate McShane from Goldman Sachs. Kate, your line is now open. Please go ahead.

Kate McShane: Hi, thanks. Good morning. Thank you for taking our question. We just had a simple question about your view on current inventory levels and in stocks. And if there are any categories where you still think your inventory is not where you want it to be and when you can expect to maybe be more in line there?

Tom Greco: Yeah. So, we feel pretty good, Kate, about the inventory levels. We’ve done, as Gene mentioned the real intense focus on their highest velocity SKUs and making sure that we’re in stock on those items. We’ve added some depth to the highest velocity SKUs in the stores and the distribution centers. That’s paying dividends. And we’ve also added coverage or breadth. which is also helping. We measure that by virtue of our on hand rates and our close rates, which are both growing significantly. So, we feel very good, and the categories themselves that are benefiting the most are the ones that we were weak on last year. So, the transition that was made. We had a lot of different suppliers that we’re involved with. Those suppliers have really stepped up, and we’re grateful for that.

Our suppliers are really important to us we’re starting to really make some gains in those categories, and there’s still a lot of room for us to grow from there. So there’s nothing uniformly good or uniformly negative at this point. We’ve grown in aggregate and each of those categories are moving up nicely.

Kate McShane: Thank you.

Operator: Thanks, Kate. Our next question comes from Brian Nagel from Oppenheimer. Brian, your line is now open. Please go ahead.

Brian Nagel: Hi. Good morning. So, my first question, bit of a follow-up to prior question, but if you look at the improving business you’ve seen lately, improving sales you’ve seen lately. How you step back, it’s how much of that is internal efforts on the part of Advance versus maybe a solidifying backdrop within the sector.

Tom Greco: Yeah. I mean, it’s that’s difficult to say, Brian. Obviously, we don’t we don’t really get to see that until our peers will report more comparable time frame. I mean, we see DIY, which we feel really good about comparatively, but the pro channel is the one I’m referencing. So, we really need to see how everybody else performs. It’s been extremely hot this summer. So, we are seeing strength in those categories, you’d expect heating and cooling, obviously. But overall, as we talk to our suppliers, particularly the ones in our parts categories, we are doing much better. So, we feel we feel good about the actions we’re taking, and we’re going to continue to execute against them.

Gene Lee: Hey, Brian. It’s Gene. I just want to — I wanted to say that, what I have seen is that the team is taking a specific action, and we’re seeing a specific result because of that action. So, I think Tom is correct. We need to see the backdrop. But what I can see from when I say is tell me we’re going to do something, we do it and then we get a reaction from that. That’s positive in my mind.

Brian Nagel: That’s helpful. I appreciate it. And then my follow-up question, in your prepared comments, you talked about I guess, a shift you made in a debt covenant if I said that correctly. So, I guess the question is maybe you can articulate what you did there. To what extent that affords you more flexibility? And could there be other similar type adjustments being made here to the debt structure of the company?

Tony Iskander: Hi, Brian. This is Tony. I’ll take that. As I mentioned in the prepared remarks, we’ve adjusted our interest coverage ratio, that provides a little bit of relief, primarily due to the higher interest expense that we carried earlier in the year. We did not adjust the leverage ratio. Those are our two primary covenants. We’re confident in that, and it gives us a further financial flexibility should we need it.

Brian Nagel: Got it. Thanks, Tony. I appreciate it.

Tony Iskander: Thanks, Brian.

Gene Lee: Thanks, Brian.

Operator: Thanks, Brian. Our next question comes from Scot Ciccarelli from Truist. Scot, your line is now open. Please go ahead.

Scot Ciccarelli : Good morning, guys. I know you talked about, improving sales trends the last call 6, 8 weeks, but you posted negative comps in the first half. Can you help us understand why you would slightly raise the full year comp estimate? Is it just a matter of kind of the latest momentum, or is there something else you’re expecting that play out in the back half?

Tom Greco: It really is, the momentum we’ve seen in in recent weeks, Scot, obviously the fourth quarter is always volatile. So, we have to keep that in mind, and we did finish the year strong on DIY in the fourth quarter last year. But based on everything we’ve seen, we track as you guys do the multi-year comps, the multi-year sales, everything that we’re doing, we feel very good about our guidance on sales.

Scot Ciccarelli : Okay. And then secondly, I know Tony talked about expectations for payables inventory to improve during the course of the year. But, I think someone asked about it. Is there any kind of target ratio for end of year? I don’t think I caught that.

Tony Iskander: Now we haven’t identified a targeted ratio, but we’d expect to see improvement in that accounts payable to inventory ratio throughout the year and into next year.

Scot Ciccarelli : And no magnitude you can provide us?

Tony Iskander: Not today.

Scot Ciccarelli : Okay. Thank you.

Operator: Thanks, Scot. Our next question comes from Seth Basham from Wedbush. Seth, your line is now open. Please go ahead.

Seth Basham: Thanks a lot, and good morning. Within your professional business, are you currently seeing more gross margin rate pressure in national accounts or up or down the street customers?

Tom Greco: Yeah. I mean, it’s really when we look at the competitive price index, Seth, we look at it in multiple ways, obviously. And so we are matching with our targeted in each of those channels. So, there’s no major difference between the two.

Seth Basham: Got it. And then, in terms of your balance sheet with the decline free cash flow, do you see risk that your credit rating could be down rating from investment grade?

Gene Lee: Yeah. So, we can’t speak on behalf of the agencies, but we are in active dialogue with them all the time. We do believe that the free cash flow that you see in the year is reflective of the inventory investments we’ve made. And if you look at in prior years, we do believe that that’s a good indication of what this company can return to.

Operator: Thanks, Seth. Our next question comes from Zach Fadem from Wells Fargo. Zach, your line is now open. Please go ahead.

Zachary Fadem: Hi. Good morning. Is there any extra color you can provide on how the up and down the street business has been performing relative to your national accounts? And just from an infrastructure perspective, can you talk about what you think your competitive advantages and disadvantages are today for serving these particular customers relative to your peers?

Tom Greco: First of all, the up and down the street business, as we mentioned earlier, I mean, there’s a lot of customers, Zach. We look at how many customers we’re selling to every week. We look at the dollars per customer every week, and we are seeing progress there. I think longer term, our belief is that the larger strategic accounts are going to grow faster than the up and down the street business. But, at the moment we are seeing strength on both sides of that business. And can you repeat the second part of your question again? I just want to make sure I understood it right.

Zachary Fadem: Yeah. What do you think your advantages or disadvantages are hard for serving these particular customers versus your peers?

Tom Greco: I think it’s similar to what we’ve said. I think it’s similar on both sides of the business. I mean, it’s about having an enterprise assortment. We’ve got a great footprint. We’ve got terrific brands and high quality parts. And we’re going to continue to leverage our availability, our visibility of our products, our service and delivery. We grew up in the professional business. Carquest is a professional brand, and we’ll continue to leverage all of the things that we have to win the professional business. As Gene said, the idea from here is to improve the asset productivity of our business and ensure that as we drive growth, we’re able to flow it through better to the bottom line.

Zachary Fadem: Got it. And I know that the strategic review is ongoing. So, the answer to this question may change, but as you come through all the short-term noise this year around your P&L, pricing, investment etcetera. Can you talk through what you think the right structural EBIT margin is for this business over the long-term?

Tony Iskander: I think that — as we sit here today, that’s impossible to pinpoint. What I believe today is I get more involved in and this is — there’s a lot of room for incremental improvement year-over-year. We do have some structural differences then to our other big competitors. I think they’re well documented. But we know that we can improve from where we are today significantly. And I think putting a number out there is unfair to Shane and the rest of the management team. We need to go through more so the operational review to understand what the true opportunities are to service our customers and take care of our team members and provide the best service we can to every one of our customers. That’s got to be the goal long-term.

Operator: Thanks, Zach. Our next question comes from Michael Baker from DA Davidson. Michael, your line is now open. Please go ahead.

Michael Baker: Okay. Thanks. Gene, if I could just follow-up on that last point, can you remind what do you see as the structural differences between your margin structure and the other guys. We know there’s different rent versus own situation, which may be drags down your margins a little bit versus competitors, but even if you look at it on like an EBITDAR basis, there’s a huge gap and that gap is widened over time. So, what are the structural differences besides you guys rent more stores, than they do?

Gene Lee: Well, I think it’s the mix of the business. Remember, we’ve got a very large business inside our business, which is the independence which the margin structure is very, very different, but it’s a very lucrative business. I would say the biggest thing that impacts our margins overall is the asset productivity. Right? We’re doing approximately 1.7 a box and the other guys are doing approximately 2.3, 2.4. So, I mean, if you just look at that productivity increase it just to 2 million what it does to our margins. The flow through on that additional sales is fantastic. And, also when you look at the way our distribution centers are set up, that’s a huge structural disadvantage that will need to be addressed at some point.

How that gets prioritized? I don’t know today, but it needs to be dealt with. And so, I keep reverting back to and I describe as asset productivity. Our assets are not productive enough to create the right margin structure. Then you get into own versus rent channel mix, our independent business, but the first priority is to improve the productivity of all the assets. That will then have the biggest impact on margins.

Michael Baker: Yeah. I completely agree. And I would say that some of that isn’t necessarily structural. So that’s the opportunity. If I could ask one other question, I guess that was my follow-up to the first question. Is my main question. Talk to us about, the qualities that you thought made Shane O’Kelly the right pick. Is it his distribution capabilities or operational capabilities? It’s been a while since — I assume you looked at auto — people who are in the auto parts business, how much does that factor in, or how much did you consider that and what made Shane better than anyone within the business?

Gene Lee: Yeah. I think a great question. I mean, we had a comprehensive search. Right? We talked to a lot of people and by far, Shane was the best person for this role when you think about his experience set. He’s a very disciplined, thoughtful leader who has been in the professional channel most of his career, but it had exposure to big box retail, a lot of good process and procedures he’s been a part of. I think that he is a car enthusiast. He is sold into the channel before. He loves the business. And I think his leadership style is perfect for where we are in our journey and what we need. I would say that, as we talk to people that had industry experience, people that were most interesting at non-competes, and they’re very difficult to get out of their current position because of the non-competes.

But even so, when it was all said and done, Shane O’Kelly was by far our best candidate for this role in the current situation. He’s well educated, strong discipline background, and he’s just a thoughtful human being with a real focus on customers. And so we’re excited to have the opportunity to bring in a leader like Shane. We’re very pleased that we’re able to do it as quickly as we’re able to do it to identify someone with his skill and talents. And the succession committee did a fantastic job getting us to this point, and we can’t wait for him to be involved.

Operator: Thanks, Michael. Our next question comes from Daniel Imbro from Stephens. Daniel, your line is now open. Please go ahead.

Joe Enderlin: Hey, guys. This is Joe Enderlin on for Daniel. Thanks for taking our question. You mentioned earlier that you think your internal actions are driving improvements in sales. Are you seeing the sales accelerate in the categories you’re specifically investing in price or is it more of a broader acceleration that may suggest a better weather backdrop?

Tom Greco: Good morning. First of all, the drivers really start with availability. I mean, the availability improvements are much more closely correlated to the improvement in sales. And in particular in those categories where we have big opportunities to improve versus last year, and that’s engine management, and heating, cooling, and under par. So, what we are seeing a very close connection. Gene said it well. There’s an action that we’re taking and then we see the corresponding lift. And it’s building through the year. The price indices that we are targeting we have a terrific team in the pricing area. They look at our pricing every week and every category, and we do look very closely at those elasticities. I mean, this category is honestly less elastic than many categories in retail because pricing is either third or fourth and the decision criteria for the installer, but you can’t ignore it. So, that’s really what we’re doing there.

Joe Enderlin: Got it. That’s very helpful. Thank you. As a follow-up, looking at retention. Could you provide some color maybe on how turnover has trended recently? Are you finding it more difficult to retain talent on the Pro side or distribution side?

Tom Greco: Yes. Good question. I mean, we obviously measure it in our supply chain and in our stores. So, I’ll start with the stores that there’s, some roles in our stores that are just vitally important. Every role is critical, but when you think about the general managers, our terrific general managers in the stores, the DMs, the commercial parts pros, that turnover was extremely high when I started here many years ago. It came down significantly. And in the last year and a half, it started to go back up. So, we started to address it directly, towards the tail end of last year. We are seeing that come down. In supply chain, same story, Steve, who’s our new head of supply chain, has done a very good job addressing turnover and supply chain, and that one has come down significantly in the last six months.

So, again as Gene said, when your turnover’s coming down, you’re able to execute better. And we are executing better in our supply chain, and we’re executing better in our stores, and we’re going to stay committed to retaining that slightly important frontline talent that serves our customer every day.

Operator: Thanks, [Daniel] (sic) Joe. We have no further questions at this time. So with that, I will hand back to Elisabeth Eisleben for final remarks.

Elisabeth Eisleben: Yes. Thank you all for joining us today. We look forward to welcoming Shane here in a couple of weeks and speaking with you all again in November. Have a great day.

Operator: This concludes today’s call. You may now disconnect your lines. Thank you for joining.