Welcome to the Advance Auto Parts Third Quarter 2021 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. Please go ahead..

Good morning, and thank you for joining us to discuss our Q3 2021 results that we've highlighted in our earnings release yesterday. I'm joined today by Tom Greco, our President and Chief Executive Officer; and Jeff Shepherd, our Executive Vice President and Chief Financial Officer.

Following their prepared remarks, we will turn our attention to answering your questions. Before we begin, please be advised that our remarks today may contain forward-looking statements.

All statements, other than statements of historical facts, are forward-looking statements, including, but not limited to, statements regarding our initiatives, plans, projections, and future performance. Actual results could differ materially from those projected or implied by the forward-looking statements.

Additional information about factors that could cause actual results to differ, can be found under the captions forward-looking statements and risk factors in our most recent annual report on Form 10-K and subsequent filings made with the commission. Now, let me turn the call over to Tom Greco..

Thanks, Elisabeth, and good morning to all of you joining us today. As always, we hope that you and your families are healthy and safe. I'd like to start by thanking the Advance team and Carquest independents for their hard work and perseverance through these challenging times.

Their continued dedication to provide outstanding service to our customers allowed us to deliver another quarter of top line sales growth, adjusted margin expansion, and a double-digit increase in earnings per share. We've been investing in both our team and our business over multiple years to transform and better leverage Advance's assets.

In Q3, this helped enable us to comp the comp on top of our strongest quarterly comparable store sales growth of 2020. Specifically, we delivered comp store sales growth of 3.1% while sustaining an identical two-year stock of 13.3% compared with Q2.

As expected, this was led by the continued recovery of our professional business and a gradual improvement in key urban markets. By putting DIY consumers and pro-customers at the center of every decision we made, we've been able to respond quickly to evolving needs.

In Q3, this was highlighted by an overall channel shift back to professional and a return to stores for DIYers.

Within professional, we're seeing increasing strength in certain geographies, which like the rest of the country last year, has the ongoing return to office of professional workers in large urban market catches up with the rest of the country.

Our diversified digital and physical asset base has enabled us to respond rapidly to these changing channel dynamics in the current environment. In addition, we also delivered significant improvement in our adjusted gross margin rate of 246 basis points, led by our category management initiatives.

Our adjusted SG&A costs as a percentage of net sales were 209 basis points higher as we lapped the unique quarter in Q3 2020. As we discussed over the past year, our SG&A costs were much lower than normal in Q2 and Q3 of 2020.

This was due to an unusually high DIY sales mix and actions we took last year during the initial stages of the pandemic which were not repeated. Overall, we delivered adjusted operating income margin expansion of 37 basis points to 10.4% versus Q3 2020.

Adjusted diluted EPS of $3.21 increased 21.6% compared with Q3 2020 and 31% compared with the same period of 2019. Our year-to-date adjusted earnings per share are up approximately 50% compared with 2020.

Year-to-date, our balance sheet remains strong with a 19% increase in free cash flow to $734 million while returning a record $953 million to our shareholders through a combination of share repurchases and quarterly cash dividends.

Consistent with the front half of the year, there were several industry-related factors, coupled with operational improvements, contributing to our sales growth and margin expansion in Q3.

As discussed in our April Investor Presentation, the three primary external drivers that the industry demand are still improving versus prior year, and the outlook remains positive. The car park continues to grow slightly. The fleet is aging, and perhaps most importantly, vehicle miles driven continue to improve versus both 2020 and 2019.

More broadly, the chip shortage continues to impact availability of new vehicles and is contributing to a surge in used car sales. This benefits our industry as consumers are repairing and maintaining their vehicles longer.

As we all know, over the last 18 months, the pandemic changed consumer behavior across our industry, which led to a surge in DIY omnichannel growth in 2020, while the professional business declined.

However, as the economy continues to reopen, with miles driven steadily increasing, our professional business is now consistently exceeding pre-pandemic levels, as discussed last quarter. Regional performance was led by the Southwest and West.

Category growth was led by breaks, motor oil, and filters, as miles driven reliant categories improved versus a softer 2020. We also saw continued strength in DieHard battery, which led the way on a two-year stock basis.

Each of these categories performed well as a result of the diligent planning between our merchant and supply chain teams enabling a strong competitive position despite global supply chain disruption.

At the same time, we experienced challenges in Q3 as we strategically transitioned tens of thousands of undercar and engine management SKUs to own brand. Importantly, these in-stock positions are now significantly improved and we are confident these initiatives will help drive future margin expansion.

Overall, comp sales were positive in all three periods of Q3, led by professional. DIY omnichannel delivered slightly positive comp growth in Q3, while lapping high double-digit growth in the prior year. Within professional, we navigated a very challenging global supply chain environment to allow us to say yes to our customers.

The investments we've made in our supply chain, inventory positioning, and in our dynamic assortment tool helped put us in a favorable position competitively. We've implemented the dynamic assortment tool in all Company-owned U.S. stores, as well as over 800 independent locations.

Our MyAdvance portal and embedded Advance Pro catalog continues to be a differentiator for us while driving online profit. Our online sales to professional customers continues to grow as we strengthen the speed and functionality of Advance Pro. We remain committed to providing our industry-leading assortment parts for all professional customers.

This will help enable us to grow the first call status and increase share of wallet in a very fragmented market. In addition, we expanded DieHard to our professional customers. Following a recent independent consumer survey, DieHard stake disclaims as America's Most Trusted auto battery.

During Q3, we announced a multi-year agreement with our national customer, Bridgestone, to sell DieHard battery in more than 2,200 tire and vehicle service centers across the U.S. With this system-wide roll-out during Q3, we replaced their previous battery provider, making us the exclusive battery supplier across all Bridgestone locations.

In terms of our independent business, we added 16 net new independent Carquest stores in the quarter, bringing our total to 44 net new this year. We continue to grow our independent business through differentiated offerings for our Carquest partners, including our new Carquest by Advance banner program, which we announced earlier this month.

As we continue to build and strengthen the Advance brand and our DIY business, Carquest by Advance adds DIY relevance for our Carquest branded independent partners while providing incremental traffic and margin opportunities.

We've recently enrolled this new initiative out to our independent partners and looked forward to further expansion over time for both new and existing Carquest independents. Transitioning to DIY omnichannel, comparable store sales were slightly positive in Q3.

As you all recall, our DIY omnichannel business reported strong double-digit comp sales growth in Q3 2020. We continue to enhance our offerings and execute our long-term strategy to differentiate our DIY business and increase market share.

In Q3, we continued to leverage our Speed Perks loyalty program as VIP membership grew by 13% and our number of elite members representing the highest tier of customer spend increased 21%. Last year, the launch of our Advance Same Day suite of services helped enable a huge surge in e-commerce growth.

This year, as DIYers returned to our stores, in-store sales growth led our DIY sales growth. Part of this was expected due to a planned reduction in inefficient online discounts, which significantly increased gross margins. Turning to margin expansion, we again increased our adjusted operating income margin in the quarter.

Like Q2, this was driven by category management actions within gross margin, where our key initiatives played a role. First, we're realizing benefits from our new strategic pricing tools and capabilities. Like other companies, we're experiencing higher-than-expected inflation.

However, our team has been able to respond rapidly in this dynamic environment as industry pricing remains rational. Behind strategic sourcing, vendor income was positive versus the previous year with continued strong sales growth.

Finally, double-digit revenue growth in OEM brands outpaced our overall growth in the quarter as we expanded the Carquest brand into new categories. Carquest products have a lower price per unit than comparable branded products, which reduced comp and net sales growth in the quarter as expected.

At the same time, the margin rate for owned brands is much higher and contributed to the Q3 adjusted gross margin expansion. Shifting to supply chain, we continue to make progress on our productivity initiatives.

In Q3, the benefits from these initiatives were more than offset by widely documented disruptions and inflationary pressure within the global supply chain. As a result, we did not leverage supply chain in the quarter. We completed the roll-out across banner replenishment, or CBR for the originally planned group of stores in the quarter.

The completion of this milestone is driving cost savings through a reduction of 10 miles from our DC's to stores. Over the course of our implementation, our team identified additional stores that will be added over time. Secondly, we're continuing the implementation of our new Warehouse Management System or WMS.

This is helping to deliver further improvements in fill-rate, on-hand accuracy, and productivity. We successfully transitioned to our new WMS in approximately 36% of our distribution center network as measured by unit volume.

As previously communicated, we followed WMS with a new Labor Management System or LMS which drives standardization and productivity. We're on track to complete the WMS and LMS implementations by the end of 2023 as discussed in April.

Further, our consolidation efforts to integrate Worldpac and Autopart International, known as AI, are also on track to be completed by early next year. This is enabling accelerated growth, gross margin expansion, and SG&A savings.

Gross margin expenses here come behind the expanded distribution of AI, high-margin owned brand products, such as Shocks and Struts to the larger Worldpac customer base.

Finally, as we expand our store footprint, we're also enhancing our supply chain capabilities on the West Coast with the addition of a much larger and more modern DC in San Bernardino. This facility will serve as a consolidation point for supplier shipments to the Western U.S. and enable rapid e-commerce delivery.

In addition, we began to work to consolidate our DC network in the Greater Toronto area. 2 separate distribution centers, 1 Carquest and 1 Worldpac, will be transitioned into a single brand-new facility that will allow us to better serve growing demand in the Ontario market.

Turning to SG&A, we continue to execute our initiatives both sales and profit per store, along with the reduction of corporate SG&A. As previewed on our Q2 call, we also faced both planned and unplanned inflationary cost pressure versus the prior year in Q3.

SG&A headwinds include higher-than-planned store labor cost-per-hour, higher incentive compensation, and increased delivery costs associated with the recovery of our professional business. Jeff (ph) will discuss these and other SG&A details in a few minutes.

We remain on track with our sales and profit-per-store initiative, including our average sales per store objective of $1.8 million per store by 2023. In terms of new locations year-to-date, we've opened up 19 stores, 6 new Worldpac branches, and converted 44 net new locations to the Carquest Independent family.

This puts our net new locations at 69, including stores, branches, and independents during the first 3 quarters. Separately, we're actively working to convert the 109 locations in California we announced in April. However, we are experiencing construction-related delays primarily due to a much slower than normal permanent process.

This is attributable to more stringent guidelines associated with COVID-19, which were exacerbated by the surge of the Delta variant.

We now expect the majority of the store openings planned for 2021 to shift into 2022 As a result, we are incurring start-up costs within SG&A for the balance of the year, while realizing less than planned revenue and income. The good news is we remain confident that once converted, these stores will be accretive to our growth trajectory.

The final area of margin expansion is reducing our corporate and other SG&A costs. We began to realize some of the cost benefits related to the restructuring of our corporate functions announced earlier this year in addition to savings from our continued focus on team member safety.

In Q3, we saw a 22% reduction in our total recordable injury rate compared with the prior year. Our last time injury rate improved 14% compared with the same period in 2020. Our focus on team member safety is only one component of our ESG agenda at Advance.

Our vision, advancing a world in motion, is demonstrated by the objective we outlined last April to deliver top quartile total shareholder return in the 2021 through 2023 time-frame. While delivering this goal, we're also focused on ESG.

As part of this commitment, we launched our first materiality assessment earlier this year to help prioritize ESG initiatives. During Q3, we completed this assessment and are working to finalize the findings. The results will be incorporated in our 2021 Corporate Sustainability Report which we expect to publish in mid-2022.

Before turning the call over to Jeff, I want to recognize all team members and generous customers for their contribution to our recent American Heart Association campaign. This year, we introduced a new technology solution in stores that allows customers to round up at the point of sale.

This made it even easier for customers to participate and help us achieve our record-setting campaign of $1.7 million. The mission of this organization is important to all of us across the Advance family. And I want to personally thank everyone for helping making this our most successful campaign to date.

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

Thanks, Tom, and good morning. I would like to start by thanking our team members who prioritizes the health and safety of our customers and fellow team members while continuing to deliver exceptional results during uncertain and challenging times. In Q3, our net sales increased 3.1% to $2.6 billion.

Adjusted gross profit margin improved 246 basis points to 46.2%. Primarily, the result of our ongoing category management initiatives, including strategic pricing, strategic sourcing, owned brand expansion, and favorable product mix.

Consistent with the last quarter, these were partially offset by inflationary products and supply chain costs, as well as the unfavorable channel mix. In the quarter, same skew inflation was approximately 3.6%, which was above our plans entering the year and was by far the largest headwind we had to overcome within gross profit.

We're working with all our supplier partners to mitigate costs where possible. Year-to-date adjusted gross margin improved 184 basis points compared with the same period of 2020. As expected, our Q3 SG&A expenses increased due to several factors we discussed earlier in the year.

As a percent of net sales, our adjusted SG&A deleveraged by 209 basis points, driven primarily by labor costs, which included a meaningful cost per hour increase, as well as higher incentive compensation compared to the prior year.

In addition, we incurred higher delivery expenses related to serving our professional customers and approximately $10 million in start-up costs related to the conversion of our California locations in Q3.

Year-to-date, SG&A [Indiscernible] percent of net sales is relatively flat compared to the same period 2020, increasing 9 basis points year-over-year. While we've reduced our COVID-19 related costs by $13 million year-to-date, the health and safety of our team members and customers continues to be our top priority.

Our adjusted operating income increased to $274 million in Q3 compared to $256 million one year ago. On a rate basis, our adjusted OI margin expanded by 37 basis points to 10.4%. Finally, our adjusted diluted earnings per share increased 21.6% to $3.21 compared to $2.64 in Q3 of 2020. Compared with 2019, adjusted diluted EPS was up 31% in the quarter.

Our free cash flow for the first 9 months of the year was $734 million, an increase of 19% versus last year. This increase was primarily driven by improvements in our operating income, as well as our continued focus on working capital metrics, including our account pillow ratio, which expanded 351 basis points versus Q3 2020.

Year-to-date for Q3, our capital investments were a $191 million. We continue to focus on maintaining sufficient liquidity while returning excess cash to shareholders. In Q3, we returned approximately $228 million to our shareholders through the repurchase of 1.1 million shares at an average price of $205.65.

Year-to-date, we returned approximately $792 million to our shareholders. Through the repurchase of nearly $4.2 million shares at an average price of a $189.43. Since restarting our share repurchase program in Q3 of 2018, we returned over $2 billion in share repurchases at an average share price of approximately $164.

Additionally, we paid a cash dividend of $1 per share in the quarter, totaling $63 million. As we mentioned in our press release yesterday, our Board once again approved a quarterly cash dividend of $1 per share.

We remain confident in our ability to generate meaningful cash from our business and expect to return excess cash to our shareholders in a balanced approach between dividends and buybacks. As you saw in yesterday's 8-K filing with the SEC, we recently closed the refinancing of our new 5-year revolving credit facility.

The prior facility was set to mature in January of 2023. When the bank markets had returned to pre -pandemic levels, we took the opportunity to secure our liquidity for another five-years. This included improved pricing and terms, while also increasing the overall facility size to $1.2 billion. We have strong relationships with our banks.

And this commitment allows us to secure our future financial flexibility. More details with facility can be found in our 8-K filing. Turning to our updated full-year outlook. We are increasing 2021 sales and profit guidance to reflect the positive results year-to-date, and our expectations for the balance of the year.

Through the first 4 weeks of Q4, we'll continuing to sales strength in our 2-year step remaining in line with what we delivered in the last 2 quarters. This guidance incorporates continued top-line strength, ongoing inflationary headwinds, and up to an additional $10 million in start-up costs in Q4 related to our West Coast expansion.

As discussed, the construction environment in California remains challenging. Resulting in the reduction of our guidance for new store openings and capital expenditures.

As a result, we're updating our full-year 2021 guidance to net sales of $10.9 billion to $10.95 billion, comparable store sales of 9.5% to 10%, adjusted operating income margin rate of 9.4% to 9.5%, a minimum of 30 new stores this year, a minimum of $275 million in CapEx and a minimum of $725 million in free cash flow.

In summary, we're very excited about our current momentum. We remain focused on the execution of the long-term strategy while delivering top quartile total shareholder return over the 2021-to-2023-time frame. Now, let's open the call for your questions.

Operator?.

[Operator Instructions] And your first question comes from the line of Michael Lasser from UBS. Your line is open..

Good morning. Thanks a lot for taking my question. The two-year stacks were steady this quarter versus last quarter, but the implied DIFM comp at Advance realized this quarter was lower than its competitors.

What would be causing your share to lag in this environment, especially as you leveraged to the geographies that are going to recover probably faster than other areas?.

Hey, good morning, Michael. Well, first of all, on the geography front, our leading geography is for the West and Southwest, which are two of our smaller regions. We're really excited about our performance out there. We're gaining share out there, but they're smaller.

We haven't seen the Northeast come back at the level we would have liked on a two-year stack basis. So that's kind of the geography point. I think just to go back to the framework we shared in April, we're targeting top quartile total shareholder return. And there's three components to that. The first one is comp sales and it's very important.

I mean, we've got 7% of the industry sales and we want to grow above the market and comp sales are very important. The second is to significantly expand our margins. And the third is to return a substantial amount of cash back to our shareholders. We think we've got a unique opportunity as a Company.

With top quartile, we said we would deliver 20% to 22% total shareholder return over the next couple of years and we delivered about 22% EPS growth in the quarter. So, we think that's going to stock up really well. I will say that we wish our comp sales would have been higher in the quarter.

And I think the thing that we called out in the script pertain to a couple of categories that we made a pretty big change in. I think our supply chain and merchant team did a terrific job on the sourcing front, in terms of brakes and batteries and filters. We had a very strong quarter on those categories.

In terms of engine management, and steering, and suspension, we transitioned tens of thousands of SKUs in the quarter to Carquest own brand. And given the current global supply chain environment, it was just challenging. They've got -- our in-stocks were just not where we wanted them to be overall.

And in the end, I think, in the quarter, the category changes we made ended up giving us some short-term pain in the quarter, but it's definitely for long-term gain. This is a huge move for us. We're in much better shape now than we were this summer. And our customers love this product. It's a great product at OE quality. It's selling extremely well.

Our in-stock rates are improving and obviously, we love the margin rates. So, we didn't like the in-stocks this summer on those categories, but the move is highly consistent with our plan to drive total shareholder return and we believe that it will be a big margin driver for us next year into 2022..

Understood.

My follow-up question, have those issues already been addressed such that they are having less of an impact on the business? And more significantly, what's the path to the 2023 operating margin target? Should the margin expansion be pretty consistent in 2022 and 2023? Or are you expecting more or like a hockey stick inflection in 2023, given some of the moving dynamics that are going on?.

Sure, I'll take the first one. I would say we're in much better shape on those categories. I don't think we're where we want to be at this point, but we're in much better shape and it's improving every week. I'll let Jeff talk to the cadence of our margin expansion going forward..

Yeah, sure. In terms of overall margin expansion over the next couple of years, first of all, we'll provide guidance for '22 here in February, but overall, the way we are thinking about it is relatively consistent growth from our margin expansion initiatives.

Now, some are faster than others, but in the aggregate, we expect contributions relatively evenly over '22 and '23..

Thank you so much..

Your next question comes from the line of Bobby Griffin from Raymond James. Your line is open..

Hi, everyone. This is Mitch Ingles filling in for Bobby. Congrats on another nice quarter. So, your gross margin rate at LIFO impact has improved roughly 250 basis points over the past two quarters, which is impressive given the current retail environment.

How should we think about your growth margin performance in 4Q, and how that correlate to your FY '21 either rate outlook of 9.4% to 9.5%?.

Yeah, sure. I'll start with the second part first. What we've said really going into the back half is our margin expansion overall was going to be led by gross margin, largely in line with those category management initiatives that we just talked about. So that's really going to be the contributing factor.

SG&A, we've said at this point is either going to be flat or a slight headwind. So, we really think the growth that we're going to see this year is all up in gross margin. Fourth quarter, largely a lot of the same. We think the - we have the pricing power to sustain. We're going to continue with our strategic sourcing.

And as Tom just mentioned, with the challenges behind us, we're going to continue to see benefits from the own brand expansion..

Got it. Thanks, Jeff. And then as a follow up, inventory levels are likely not optimal given all the supply constraints across retail.

How much of this is actually pressuring sales? And what I'm getting at is are customers simply substituting out-of-stock product with in-stock product? Or is it actually hurting the conversion rate? So any insight here would be helpful. Thank you..

Sure. I will take that one, Bobby. I mean, first of all, as I mentioned, on the big categories, breaks, batteries, we've been in good shape the whole time. In fact, I would say, we've been advantaged competitively on those categories.

And for sure, we're seeing that as we start this quarter, steering and suspension, engine management, and big, big DIFM categories. We're really pleased that that's coming back in. And in some cases, certainly in the summer where we are making the transition and we didn't have something, that -- we would have lost that sale.

I don't know that we were able to pick up everything that we would have liked in the summer. But as that comes back in, we're starting to see those categories bounce back nicely. And obviously, there's certain occasions where you've got an application and you've got an alternative for, but there are others where you just don't.

So, the moral of the story is, I think we're in much better shape now than we were in the third quarter and we're seeing that in our early performance..

Great to hear. Thanks for the color..

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

Hi, good morning. It's Christian on for Chris. On the long-term margin outlook, you had spoken to 280 to 290 basis points of inflation in your 2023 margin target.

How are you thinking about both the magnitude of that as well as the mix of SG&A and gross margin impact?.

Yeah. Certainly, as we looked at it in the short-term, we'd be exceeding that in terms of the inflation that we're seeing across the P&L. So that's the combination of input costs, product costs, transportation, wages, fuel, what have you. So, if we were to go back now and look at it, I think we would be adding more to that.

But we also have opportunities in the form of really the category management. And in particular, we've been extremely pleased with our ability to pass this on in the form of price. So our strategic pricing has been proven to be able to offset that so far. .

Got it. That's really helpful.

And then in terms of the monthly cadence, could you speak to how DIY and do it for me trended through the quarter? And any comments on whether price and increasing inflation drove an acceleration in trends through the quarter?.

Sure, well, the short answer is DIFM is continuing to recover as we expected, but we are encouraged by the strength and resiliency of the DIY business which has pretty consistently performed above our expectations throughout the year. And the pro, once again, wasn't a surprise.

We felt that it was going to lead the way as people return to offices and school and started to travel again for both personal and business. These consumer dynamics that were created by the pandemic, created an increased need for people having their vehicle that has a positive on miles-driven and on our industry overall.

But in terms of DIY, we've seen some interesting and also positive trends. You've got consumers picking up hobbies that -- like they're detailing their cars. You've got people keeping their cars longer because they can't find a new one. They're buying recreational vehicles to visit parts of the country they never seen before.

And even in urban markets, you've got some people that have bought cars because there are no longer comfortable with -- with mass transit. So, it's difficult to say how sticky some of these trends are going to be. But we're seeing robust demand across both DIY and DIFM. And we're excited by that. It's a very good time for the industry..

Thank you for that and best of luck..

Thanks..

Our next question comes from the line of Simeon Gutman from Morgan Stanley. Your line is open..

Hi. This is Jackie Sussman on for Simeon. We were wondering, we saw that operating income grew 7% to 8% in quarter 3 on a 3% comp. And if you continue to comp around this level, can EBIT dollar growth be even stronger? I guess the reason we're asking is to hit that high end of the 10.5 to 12.5 margin guidance by '23.

Does EBIT need to grow quicker? Thanks so much..

Yeah, first of all, just looking into the last quarter here, we've incorporated with the continued top-line strength that we saw for the first 4 weeks. We're also balancing that would be ongoing inflationary headwinds and then up to another $10 million of startup costs in the fourth quarter related to our West Coast expansion.

So, we maintained the first 4 weeks. We believe there will be upside to the full-year results for 2021. I would keep in mind though that our fourth quarter is historically the most volatile. So, we're being cautious there. Over the longer term, again I would take you back to the April investor event.

We're laser-focused on our margin expansion initiatives and we're very confident that as we continue to execute those it will provide us with the margin rates that we're looking for. That will get us well into that 10.5% to 12.5%..

Great, thanks so much. And just a quick follow-up. How should we think about supply-chain costs in the context of achieving that 10.5% to 12.5% EBITDA margin targets? Does it preclude from hitting the high end? Thanks so much..

Well, we're continuing to execute our plans on supply chain. Each of the big initiatives we have are going to play a role in taking unnecessary costs out of our supply chain. As we highlighted in the prepared remarks, we are seeing inflation in basically wages in distribution centers, traffic and freight that are above what we expected.

But that's not going to stop us from executing our plan. We're going to continue to execute all the initiatives. Supply chain is a big part of taking costs out of our system. And well, we're going to execute those plans over the next couple of years..

Thanks so much. Congrats on a great quarter..

Thanks..

Your next question comes from the line of Zachary Fadem from Wells Fargo. Your line is open..

Hey, good morning.

Tom, can we start with your commentary about DIY turning positive in the quarter, but first of all, did this include every period in the quarter as well as the quarter as a whole, and then in terms of broader DIY demand, is it fair to say that DIY has improved on a 2-year basis or is that trend decelerating?.

Well, first of all, the cadence as we talked about in our prepared remarks, that was pretty consistent. Through the quarter we did see some acceleration towards the end of the quarter. In terms of DIY overall, as I mentioned a minute ago, really, really pleased with the resiliency of it. It's really fun in there.

A lot of the initiatives that we put in place over the last couple of years, including the launch of DieHard, our battery business continues to perform well at the big category within DIY. Our Speed Perks loyalty program is gaining momentum. Our percent of transactions increased in the quarter.

And I think our field team is really executing well on the DIY initiatives. So, I'm not going to comment on the 2-year stock specifically, but it's been very resilient and we're very pleased with how it's going and we're going to continue to drive the highlights as an important part of our equation..

Got it.

And then on the impact of accelerating inflation, can you talk about any changes you're seeing to consumer behavior, volume, or trade down, as well as the competitive pricing landscape, and in your mind, is there a level of inflation out there, where it gets to be too much and the consumer starts to push back?.

Well, obviously, it's particularly in DIY where you do have an economically challenged customer, we're very cautious about that top exerted to your point.

The thing that I feel good about is as we've made some transition into own brand products, were able to offer products at a lower price point than we give people some options, right? To potentially purchase something that was more expensive from a national branded standpoint.

So, I mentioned that if the change was during in suspension and engine management, we've got a terrific product that got a lower price point. So that gives the customer some options, that honestly, we didn't have before. And we have the advantage of that being a much higher margin than the alternatives. So, I am concerned about it.

We're going to watch it very closely. We want to make sure that when we're driving these initiatives, that we're wary of what's the implication going to be on the price point. There's a comp get, when the customer trades down, you got a lower price per unit on some of these owned brand products.

But it gives the customer an alternative and it gives you an incremental transaction that you might not have otherwise been able to achieve..

It makes sense. I appreciate the time..

Thank you..

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

Hey, good morning, guys..

Good morning..

You're at 3.6% same skew inflation a low end of the peer range, which is running 4 to 5s.

How do you see the cadence of the inflation, are you still picking up price as your supply chain costs are passed through? Could you talk about where you see inflation maybe being into the fourth quarter and first half of '23 up '22?.

Yes. We definitely think the inflation is going to continue and it's going to be higher going into the 4th quarter. We are still seeing those cost increases coming through, so we absolutely anticipate that it will be higher. It will be higher than the 3.6 that we called out in the third quarter.

For the year, we're still very comfortable with the range that we put out there, 2% to 4%. We're working through '22. We haven't given our guidance yet. We'll do that in February, but we certainly don't think that this turns off when the calendar turns to 2022. So certainly, in the first half it's going to continue to be a challenge.

But we're going to continue to work through that. And we think we still have pricing capabilities thoughts about that..

Okay, great. And on the chassis topic, it did sound like that was tough in the quarter, sounds like it resolved itself.

But do you have any ability to quantify maybe what the impact in chassis out-of-stock was on your top?.

Yeah. I mean, we're not going to break that out, Brad, what I can tell you is there's two elements there. There's the price per unit trade-down, right, which was meaningful in the quarter. Once again, the absolute dollars and the profit margin per unit, the profit margin rate per unit is very attractive, but the net sales per unit is just lower.

And then on the in-stock front, we made -- it's literally tens of thousands of skews as we mentioned. So, we made the change, we debated this as we exited last year and into this year, we knew it was going to be a big change.

We're in the middle of a pandemic, the supply chain was a question mark a little bit, but the reality is we wanted to get this behind us. It's an important margin driver for our future margin expansion plans. It's a big TSR driver for us and we're pleased that we're able to put these -- make that change in the time-frame that we did..

I guess on the in-stock topic, if you think about your fill rates today versus where they were through the quarter, could you talk about the cadence of fill rates and maybe where we are versus target right now?.

Yeah, it's definitely moved up significantly. Since the middle of the summer, it's been steadily improving. Every week it gets better. I mean, obviously we've commissioned new suppliers that come in and make the Carquest product. And again, I'm going to reiterate, this is a terrific product. Our customers and our field team loved the product.

So, in terms of customer receptiveness, it's been extremely high, the return rates are much lower. So, when we get it in across the board, we're in very good shape.

So, there was a significant improvement though to your question, from say, August, which is probably when it was the most challenged, into now, which as evidenced by our quarter-to-date sales. We feel pretty good about where we are now with a little bit of room to go -- to get it to where we want to be..

Okay.

That statement applies to all inventory or just the chassis category August to present?.

It's really -- think about chassis and also engine management, that's the other big one..

Got it.

But if you looked at -- if you just said inventory in general, would you say it is improving your total in-stocks?.

Yes. Our inventory is strong on categories like brakes, batteries, filters, as I mentioned. I think relatively speaking, we track this versus peers all the time. And we feel very good about those categories. It was really the categories where we made this huge transition that we're most challenged..

Great. Thank you..

Your next question comes from the line of Seth Basham from Wedbush. Your line is open..

Thanks a lot. And good morning. My question is around the implied operating margin for the fourth quarter implies a bit more of a step-down than is typical this time of the year from the third quarter to the fourth quarter, at least on a pre -pandemic basis.

Are there any things you can point to that are driving a more material step-down in operating margin sequentially?.

Overall, we're just trying to be very cautious in terms of how we approach the fourth quarter. As I said earlier, it's historically volatile.

We do know we're going to have a startup cost in the fourth quarter similar to what we saw on the third quarter, which is not something you would have seen last year, and we think that could be up to $10 million. So that would certainly be something that we have contemplated as part of that fourth quarter.

But as we said, we got off to a great start and certainly if we were to maintain that -- maintain the first 4 weeks, we believe there would certainly be upside. Right now, we're just being very cautious given the volatility of the fourth quarter..

Yeah, thank you. And my follow-up question is around capitalized supply chain cost, it has been an important driver of gross margin in recent quarters, and I think you called it out this quarter.

Can you give some insight into what's happening with that metric and how to think about it over the next couple of quarters?.

Strategic pricing, strategic sourcing, and the introduction of the owned brands. These are all things that we have a lot of control over. We feel really good about it..

Great to hear. Thanks a lot, and good luck..

Thanks Seth..

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

Thanks for taking the question. I just wanted to ask on the fourth quarter guidance. I was getting to around a 4 to 4.5 comp being implied which suggests maybe a 1% to 3% comp for the rest of the quarter.

Just want to see if there's anything in particular, we should be mindful of? Or if it speaks more to the volatility that you all have been mentioning?.

Yes, it really speaks to the volatility. Like I said, we want to be cautious going into the fourth quarter. It's our lowest revenue quarter of the year, so when you've got a fixed cost and SG&A like we have, having that lower top-line revenue makes it a little bit harder to flow it through. And we just want to be cautious.

We've seen volatility in the past. And while we're off to a great start, we would respond makes so that we're being cautious as we finish out the year..

Thanks. And then for the follow-up, if I could on the 3rd quarter comp.

Can you give some extra color in terms of what happened with transaction counts as possible for DIY and DIFM? Was the 3-1 comp basically, all the 3-6 inflation or was there also some impact there as well?.

Well, our transactions were down in the quarter primarily due to DIY, which is the majority of our total transactions, Michael. If you remember last year, we had very robust transaction growth in DIY. On the pro side, our sales per account up double-digits.

And if I look at our transactions with the largest segments of account, it was up significantly on both the 1 and 2-year basis. The big strategic accounts are TechNet customers. We're really pleased to be growing our share wallet with our biggest accounts because that really drives more loyalty.

It means we're selling more of the whole job to the customer. There's obviously a lot of variables that go in to transaction growth, changing vehicle technology, shifting channel dynamics. We love to get the whole job in one transaction for our pro customers, which is always the goal.

So, we're very focused on growing both transactions and dollars per transaction. But that's what happened in the quarter..

Great. Thanks for taking the question and good luck..

Thanks, Michael..

And we have reached our allotted time for questions. Mr. Tom Greco, I turn the call back over to you for some closing remarks..

Well, thanks for joining us today. We're very excited to finish up the year strong, the industry fundamentals are healthy, and we're continuing to execute against our long-term strategic plans. And we also have a lot to be grateful for.

I'd like to take a moment to recognize and thank all of our nation's military heroes for their service, including the thousands of Advance team members who currently or have previously served. Advance is proud to honor these men and women through their incredible events as one our service team network posted last week.

As we continue to celebrate our veterans through our continued partnership with organizations that helps support service members including building homes for heroes. With that, take care, stay healthy, and safe. And I wish you and your families a happy Thanksgiving holiday.

We are grateful for your ongoing support and we look forward to sharing our 2021 results and 2022 guidance in February. Thank you..

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