Welcome to the Advance Auto Parts Third Quarter 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..

Good morning, and thank you for joining us to discuss our Q3 results. I'm joined by Tom Greco, President and Chief Executive Officer; and Jeff Shepherd, 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 remarks today will contain forward-looking statements. All statements, other than statements of historical fact are forward-looking statements, including, but not limited to, statements regarding 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 caption 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..

extensive parts availability, excellent customer service both online and in their shops as well as consistent and reliable delivery. As we strive to improve customer service and delivery reliability, we recognize our Professional customers' weekend car counts are growing as a percent of their overall business.

During the quarter, we deployed new delivery software to leverage the gig economy as well as our extensive vehicle fleet. This enables us to improve delivery speed and consistency on the weekend when our Pro customers are relying on us while reducing fixed costs over time.

As we build additional capabilities in our Advance and Carquest Professional B2B platforms, our online penetration has reached record levels.

Strategic partnerships are also enabling us to drive our connected shop initiative, which enables customers to access tools and data resources, generate faster repair order approvals, deliver higher conversion rates and improve shop efficiency.

With our connected shop, Advance Pro and Carquest Pro are directly integrated into Tekmetric, our exclusive partner and industry-leading shop management system. This powerful workflow combination allows our Pro shops to purchase parts and drop them directly into repair shop work orders quickly and easily.

With the integration of our diagnostic and service information, MotoLogic, we have a powerful operating platform for our customers that helps drive shop efficiencies and increases work order conversion rates. For DIY omnichannel in Q3, our highly regarded owned brands are a differentiator for Advance.

Specific to DieHard, we continue to build this brand and delivered another quarter of double-digit sales growth. This ongoing strength is due in part to the combination of strong consumer regard and our commitment to building brand equity with innovation.

Our latest product innovation launched earlier this year is the exclusive first-to-market DieHard xEV battery, optimized for the growing number of hybrid and electric vehicles on the road. The combination of trust, reliability and innovation for DieHard sets us apart.

In addition, the enhancement of Speed Perks through the launch of Gas Rewards has been a highlight for DIY this year and is helping drive increased loyalty. Year-to-date, Active Speed Perks members have increased to over 13 million.

In Q3, Speed Perks as a percent of both sales and transactions significantly increased compared with the prior year quarter. In addition to the double-digit growth in new members, we're also delivering double-digit growth in graduations to our VIP and Elite tiers. Finally, we're making meaningful progress on expanding our footprint.

Altogether, we opened 37 new locations this quarter, bringing our total to 115 new locations year-to-date. We expect that we will be within our guidance range of 125 to 150 new stores and branches for 2022. This will be the largest number of new locations we've opened in 8 years.

I'll now shift to the progress we're making to capitalize on our margin expansion opportunity. We continue to execute our category management strategy, which includes having the right brands, quality products and the optimal mix of good, better and best options.

In addition, growing owned brands and implementing strategic pricing actions to cover cost increases are key enablers of margin expansion. Our new strategic pricing capabilities also enable us to respond with targeted and precise actions.

This means we can both eliminate unprofitable discounts to improve gross margin rate and, at the same time, make calculated investments elsewhere to drive sales. Within supply chain, we're ramping up the new San Bernardino DC to increase capacity to support our West Coast expansion.

This DC will be a critical consolidation point for supplier shipments and enhance our e-commerce capabilities. Our new Toronto DC went live shipping in late October and is now fully operational. In this DC, we have both Worldpac and Carquest parts, which consolidates two buildings in Toronto and the surrounding Southern Ontario area to 1 large DC.

We've also completed a major expansion of the DC in Thomson, Georgia, increasing the size by 40% and optimizing the building layout to significantly improve productivity. While these investments drive growth and productivity, we're also exiting four DCs as planned.

In summary, while this was a difficult quarter for Advance, Comp sales and adjusted operating income margins were generally in line with our expectations. And based on our updated guidance, we'll deliver the second consecutive year of net sales growth and adjusted operating margin expansion.

However, we're not satisfied with relative top line performance versus the industry this year and are taking measured deliberate actions to accelerate growth in 2023.

It's important to reinforce that we still see significant opportunity to drive total shareholder return over the long term through sales growth, margin expansion and returning excess cash to shareholders. I'll now turn the call over to Jeff to review Q3 financials and updated outlook for the balance of the year.

Jeff?.

minimum CapEx of $350 million; minimum free cash flow of $300 million; and share repurchases of up to $600 million. With that, let's open the phone lines to questions.

Operator?.

[Operator Instructions] Your first question is from the line of Christopher Horvers with JPMorgan..

It's Christian Carlino on for Chris. Just trying to better understand the decision to build inventory.

Are there particular regions or categories where you were previously starved? And how should we think about the margin implications putting those extra units to work?.

first of all, getting more inventory closer to the customer was a key opportunity, and we also talked about relative price. But the much larger opportunity is inventory availability and getting parts closer to the customers. So the focus is really on a couple of areas.

First of all, the categories that we transitioned over the last couple of years to owned brand. These are big categories. That's where a lot of the underperformance was in Professional. We're making sure that we've improve our on-hand position on those categories. We're still not exactly where we want them to be.

We spend a lot of time with our suppliers and our team on this, and we're focused on making sure that we're in a really strong position on these categories we've transitioned. We benefited from the owned brand margin expansion. Now we need to get the top line going in some of those categories.

We're also adding some depth to high-velocity SKUs and also some breadth to certain applications and getting them closer to the market. So we feel the inventory investment is really important for us to accelerate our growth, which is the #1 priority we have right now..

Got it. That's really helpful.

And then I guess on the capitalized inventory costs, could you speak to your level of visibility going into the first half of next year? And should the headwinds abate in the first half?.

Yes. So as it relates to our LIFO costs, you'll see it later on, but we had about $67 million of LIFO costs in the third quarter. We expect that to continue into the fourth quarter. Fourth quarter will largely look like it did last year. So that's going to put us on track to have capitalized costs in sort of the $275 million to $300 million range.

Under the assumption that costs are going to come down over the back half of the year, we would largely recognize these over the first half of 2023. So that's the way we're looking at it right now.

Obviously, it's a very dynamic situation, having a good understanding in terms of what these products or input costs are going to do and how they're going to shape up over the balance of '23. .

Your next question is from the line of Simeon Gutman with Morgan Stanley. .

I wanted to ask about pricing. You made the business healthier over the last few years because you've taken out these price match overrides. And I think it sounds like you've been more disciplined in general. So can you talk about pricing? Your peers have obviously engaged in some discounting. You haven't used that lever.

And I know you're, I guess, attacking the problem with inventory. But curious how you think about price versus assortment or depth of inventory..

Simeon, so our analysis suggests that the majority of the underperformance in Pro is driven by availability and inventory positioning. So you're right on interpreting that. It's -- availability is the #1 driver of choice for the professional installers. And as we said many times, price is much lower down the list.

So in general, we are continuing to execute our category management strategy and much of that remains the same. So we are going to remain very disciplined in how we price in the marketplace. We have so much more in terms of sophisticated tools to manage pricing than we did when all of us arrived here a few years ago.

So I feel really good about where we're positioned there. The new capabilities allow us to price by region, by market, by channel, by store. So we're still focused on removing unprofitable discounts in really in all channels. So that doesn't change.

I think what is new is we successfully tested some surgical pricing actions in some of the more challenged categories, and we're going to essentially continue to do that and expand that more broadly. Our goal overall is to price to cover cost increases.

However, we're going to make some investments in key categories where we expect to drive incremental top line growth..

Okay. And then my follow-up is a little bit of clarification on the prior question. If you're buying more inventory, wouldn't that -- that would lower capitalized costs, at least for the first part -- in theory, I think if that's right, that would help your gross margins earlier on.

And may be too early for this, but can you give us any type of preview for gross margin broadly next year balancing, the capitalized cost against I don't know if it's LIFO or other factors along with your initiatives, the direction for growth. I think you've said it should still be up in that direction next year.

Just curious if you can comment on that?.

Yes. I mean, certainly, those costs are going to come off the balance sheet over the balance of next year.

We think this is going to be a challenging headwind for us as we go into '23 and try to continue to grow our margins, both the product cost as well as the capitalized costs, whether it's freight costs being capitalized, whether it's supply chain costs being capitalized.

That will land on the balance sheet with the inventory as we acquire it and will come off over the balance of next year. Again, we think most of this will roll off in the first half of the year.

We will give an update on 2023 in terms of how we're thinking about our margins, but we know that this is going to be a significant headwind as we go into next year..

Your next question is from the line of Kate McShane with Goldman Sachs..

This is [Mark Jordan] on for Kate. Just wondering if you can talk about your category management initiative and specifically the removal of these unprofitable discounts.

How far along you are moving those discounts? And how much of a headwind it might have been to comps in the quarter?.

Well, we're really pleased with the progress we've made on category management over the last couple of years. It's the single biggest driver of gross margin. It's been a huge contributor to the fact that right up until Q3, we had expanded margins overall for nine straight quarters. So the execution of that plan continues. There's a couple of elements.

There's strategic sourcing. There's the owned brand penetration, which improved in the quarter. We were up a couple of hundred basis points in terms of our owned brand penetration. . And then on the pricing front, as I mentioned on the previous question, we're being very surgical in how we act.

So we're able to remove unprofitable discounts where it doesn't make sense, and we're able to invest where we need to in order to drive profitable top line growth. So it's really leveraging all the tools that we put in place over the past couple of years.

This was the single biggest driver of the margin expansion plan that we laid out over the last couple of years, and we're continuing to execute against it..

Your next question is from the line of Elizabeth Suzuki with Bank of America. Okay. We will move on to the next question that comes from the line of Steven Zaccone with Citigroup..

A question on the owned brand impact to same-store sales.

How do you expect that to trend in the fourth quarter? And should that continue to be a drag into next year? At what point is that kind of in the baseline?.

Sure. Well, we've been expanding for several quarters now, as you know. We called out roughly 80 basis points of net sales and 90 of comp sales. And the big categories that are contributing are the ones that we've been transitioning, which is engine management and under car. So we still have a ways to go yet in terms of our reaching our goals there.

So we would expect that to continue on. But it's -- it's a comp sales headwind, but it's a good thing in that we are driving significant improvement in gross margin. And that's the opportunity for us. I mean, margin expansion remains very, very important to us, and this is a key part of that. The good thing here is our customers love this product.

I mean, we're building strong brands. is a terrific brand. It had another great quarter. We're at the #1 highly regarded -- most highly regarded battery in the country. We've extended that into other categories such as tools. And then the Carquest brand is very popular with professional installers.

The quality that we put in place for our Carquest product is very much respected by our customers. We have a much lower return rates. So it's a very positive story. And we'll take the comp sales on a long with obviously, the margin expansion that we're getting from it..

Okay. Then second question, more of a strategic question. So you plan on accelerating growth in 2023 because of the potential share loss you've seen.

What does that mean for the strategic importance of margin expansion next year? I know you're not providing guidance, but given your commentary about the difficulty in achieving that margin rate that you previously talked about for 2023, should we be thinking a pause in margin expansion is the right way to think about the model for '23?.

comp sales growth, expand margins and returning excess cash to shareholders. And we also established six financial metrics associated with that TSR drivers. In 2021, we performed really well against the TSR drivers and all six of those metrics we achieved. We ended up in the top quartile in terms of TSR performance relative to the S&P.

We're now -- up until now, we had nine straight quarters of sales growth and margin expansion. As we got into 2022, the macroeconomic and competitive environment changed and it really impacted us in the third quarter.

While we expect to expand margins full year this year and we've already returned about $900 million in cash to shareholders, our 2022 sales are below our expectations. And we are taking the actions now to address that underperformance.

So as we look forward to 2023, to your direct question, we believe we can get inside the '23 ranges on most of the metrics that we outlined. However, the margin rate and EPS ranges are really dependent on the competitive environment that we'll see in 2023, which is hard to predict right now.

And if the competitive environment, in Professional particularly, looks like it does in 2022, achieving the low end of the range of those two areas, margin rate and earnings per share is unlikely.

Now if we look beyond 2023, we're building a plan that will include all the key elements of the current TSR agenda, and we're going to continue to target top quartile TSR growth including all of those elements. So we still have plenty of upside to drive TSR going forward.

We're just being cautious about 2023 given the competitive environment that we're in right now..

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

This is Atul Maheswari on for Michael Lasser. Advance has taken a lot of steps over the years to improve its business, yet it seems like the pace of market share losses are now accelerating.

Why do you think that is the case? And are some of the factors that are causing the underperformance simply structural in nature and cannot be fixed?.

Well, as we said earlier, we've done a pretty deep dive on what drove the underperformance. We performed well right up until the third quarter in terms of our agenda. Our strategy is unique.

Our goal is to drive total shareholder return through comp sales and margin expansion and returning excess cash to shareholders, which has worked well for us up until the third quarter. We're not happy that we didn't expand margins in the third quarter, but I am very pleased that the team has worked very hard at accelerating growth going forward.

And that's where we're focused in 2023. The underperformance, we've identified a couple of key areas, and that is to get more targeted inventory investment closer to the customer and take some surgical pricing actions. And that will help us get our top line where it needs to be. .

Got it. That's very helpful. And as a follow-up question, I had one on your inventory investments. So you're looking for inventory investments going forward. At the same time, the inventory growth has outpaced sales growth for a while now.

So does that mean that there are certain categories where you have the inventory but simply not the right inventory? And if you could provide color on what categories those are?.

Sure. The focus is in a couple of areas, as I mentioned earlier. We want to make sure that we get these large categories that we've transitioned to owned brand over the past couple of years to an on-hand rate that we're comfortable with. And while we've improved over the last year, we're still not where we need to be in these big categories.

So that's job one. We're also improving the depth of high-velocity SKUs and getting those closer to the customer; and then, in some cases, adding breadth that's closer to the customer.

So it's really through our analysis of the Professional channel, how we're positioned in the market, what's our assortment rate, what's our close rate? We've done a very deep dive on where we are, and we're confident that the plans we're building are going to help us accelerate growth in 2023..

Your next question is from the line of Zach Fadem with Wells Fargo..

Can you walk through the mechanics around the FX hit in a little more detail? And considering this is primarily a domestic business in terms of your sales, maybe talk through transaction versus translation impact.

And how should we think about the Q4 impact and anything lingering into 2023?.

Yes, sure. So first of all, the impact is completely transaction versus translation, and it really comes from two sources. The first and more significant is our -- we have a Taiwanese purchasing entity that's domiciled in Taiwan. And so what it does is essentially purchases inventory and gets it over to us so we can sell it here in the U.S.

And what that does is it creates sort of a one side of the exposure because there aren't any receivables to naturally offset that. So it's a Taiwanese dollar entity purchasing inventory in currencies including the U.S. dollar. The Taiwanese dollar has weakened substantially in the quarter against the U.S.

dollar, and that's what's created this exposure which, quite frankly, is not something we've seen in the past. We've known we've had this exposure forever, but we haven't seen this level of change between either the Taiwanese dollar or the other impact, which was the Canadian dollar. On the Canadian dollar side, it's really a similar story.

We do purchase in Canada, which is a Canadian dollar functional entity and it's buying certain inventory in U.S. dollars. The Canadian dollar also weakened against the U.S. dollar. But a similar story, while we do have receivables in Canada, those are all in Canadian dollars, you don't get that natural hedge.

We don't do any hedging here as an organization, quite frankly, because we haven't needed to. And so we didn't anticipate this level of change between the U.S. dollar and those two foreign currencies. That's what drove to the $0.20 decrease in our EPS in the third quarter.

The easy way to think about the fourth quarter is you can look at the midpoint of EPS between our Q -- our August guidance and our current guidance. You'll see we're estimating another $0.10 of EPS in the fourth quarter..

Got it. That's helpful.

And then with your Q4 operating margin outlook implying about 130 basis points of expansion, can you walk through the SG&A levers here in a little bit more detail that give you confidence in the sharp year-over-year improvement from here? And then how should we think about SG&A leverage as we move our way through 2023?.

So the fourth quarter -- there's a couple of things that are going to drive this significantly. The first is the start-up costs associated with our footprint expansion, namely in California. We're going to be lapping that. We've opened 37 stores here in the third quarter.

We've got a robust agenda to open stores in the fourth quarter and get well within our range of about 125 to 150 stores. And that will help give us the leverage on the SG&A related to new stores. The other is really just we're starting to lap the wage inflation that we saw in the fourth quarter.

So on a year-over-year basis, that starts to even out and help us out on a year-over-year basis. So those are going to be the two primary drivers. Now keep in mind, fourth quarter is incredibly volatile. And so we're going to be managing our costs very, very closely, certainly our store labor costs.

In addition to that, looking very closely at travel and any other discretionary costs that we really don't think we need going into the last 12 weeks of the year here. So it's going to be a combination of those that really give us the confidence that we're going to leverage SG&A in the fourth quarter.

Looking to 2023, we'll give you more guidance as we work through our AOP in February, but we will be lapping a number of these costs and we're going to take that into consideration as we put together our plan for next year..

Your next question is from the line of David Bellinger with MKM Partners. .

Just following up on that last one. So on the annual guidance, you lowered the EPS range about $0.30 at the midpoint. Based on your comments just now, so that the FX headwind was $0.20 in Q3, expected another $0.10 in Q4.

So just absent the FX factor, is there anything else really changing in your fundamental view? Or should we just think about this guide down being all FX-driven and the underlying fundamentals Q3 to Q4 not really seeing any change?.

Look, the short answer is yes. I mean, it's entirely driven by the FX and that's the $0.30 that you've called out, $0.20 in Q3 and $0.10 in Q4. Everything else is in line with the expectations and the guide that we put out in August, which is why we haven't changed the rest of the P&L guide, if you will, for Q4..

Got it. And then just my follow-up here. Any comment on sales trends through the quarter? And then implied in that Q4 guide, I think there's a pretty wide range of outcomes there. You'd be slightly positive all the way down to negative 4% on the comps.

So can you give us some indication of where trends are through mid-November? I know we're hearing some overall softening in retail sales in recent weeks.

Are you seeing any of that show up in your business?.

David, well, first of all, just to round out Q3, our strongest period of the quarter was the last period. So we saw improvement in the summer. We talked about making sure that we are removing these unprofitable discounts, that, that was going to have a bigger impact and would dissipate over time. So we expect that will happen.

As we get into the fourth quarter, this is a highly volatile quarter. That's really the origin of the guide. This is a very resilient industry. You've heard that from us before. We expect that the category will continue to grow at the rates that it has been growing. It's been a robust year for the industry. We just need to be growing faster in Advance.

That's why we're taking the actions that we're taking. So relative to what you're hearing about in total retail, we're not seeing that. I think that you'll continue to see strength in the automotive aftermarket. The DIY segment performed well at the end of the quarter for us.

So we feel like the industry performance will continue to be strong, with the caveat that the fourth quarter is our smallest of the year and it has the most volatility..

Your next question is from the line of Mike Montani with Evercore ISI..

It's Mike on for Greg Melich. Just wanted to ask if I could, first off, just for some additional color, if you could share it in terms of the comp trend for DIY versus Pro as well as ticket versus transaction count? And then I had a follow-up question..

Sure. I'll start with the channels. We basically said DIY, Pro were in line with each other, which would imply actually an acceleration of DIY for us in the quarter. And we're actually pretty happy with what's going on in DIY. We're strengthening. Our expansion in the West has helped us there. We are gaining a lot of market share in our West market.

We're going to continue to focus on DIY. It's a very important part of our business. DieHard continues to do well. So overall, we saw strengthening in DIY. Where we saw weakness relative to the second quarter was in Professional. And that's why we're taking the actions that we're taking, targeted inventory investment, surgical pricing actions.

So really DIY is getting -- got stronger for us, Pro got weaker overall. Ticket versus transaction, more of the same versus the second quarter, Mike. Our tickets were down in both Pro and DIY. And obviously, transactions continue to grow in terms of average ticket. So that's the tail to take there..

Got you. And then just on the market share front, just wanted to hit on, number one, if you can give some updates to the progress that you've been seeing for the Pep Boys converted stores.

And then number two was you had mentioned increasing inventory availability, so I was wondering if there was anything you could share in terms of industry benchmark fill rates versus yourselves to help us kind of gauge what kind of improvement we could anticipate from the additional coverage?.

Sure. A couple of things in your question there. So on the Pep Boys conversion, Jeff called out, this is going to be the largest number of new store opens Advance has had in many, many years. So we've got that grooved much more so. We've got a new Head of our Field Operations, Junior Word, he is a terrific leader. He started out in stores 20 years ago.

He's done all the key jobs inside of Advance. He's distinguished himself. He's done this before. So we're very excited to have Junior take on the role of leading the field organization, including those stores that we're converting in the West. So each period, our market share grows. In those West stores, we still got lots of room for growth out there.

So more to come there. .

Second question was, Mike, again, remind me?.

Sorry, just on the fill rates, I guess, on shelf availability..

Yes. So what we've seen there, we really expected the on-hand rate, which is the ultimate measure, right, in the stores themselves. Do you have it when the customer calls to get better in those categories that we converted. And it just hasn't. So I mean, we obviously have targets for each category. We also have targets by velocity bands.

So A SKUs, B SKUs, C SKUs, et cetera. So what I can tell you is we've worked very collaboratively with our suppliers on this topic. And they've been extremely helpful. We stood up a number of new suppliers, literally all over the globe to enable this expansion.

And as we said earlier, we're very pleased with the margin expansion and the quality of the products. We're still not happy with where we are in terms of our on-hand rates. So all I can tell you is we're below where we need to be, and that is the focus is to get to better on-hand rates in these key categories.

And as I said earlier, there are some other things we're doing with inventory as well. But the biggest one are to get our on-hand rate up in these converted categories owned brand..

Your next question is from the line of Seth Basham with Wedbush Securities..

Tom, maybe you could just provide a little bit more perspective on what changed in terms of the competitive environment to drive these inventory and price investment decisions here.

Was there a significant change in the third quarter? And then relatedly, do you expect the competitive reaction to these moves?.

Well, first of all, we were executing our strategy, as you know, Seth, and -- which is a different strategy than our peers. I think, obviously, the inventory investments that have been made inside the industry and the widely documented pricing investments were out there.

And as it started to have a greater impact on us, I think that's when we had to respond. And we're responding with primarily targeted inventory investments. That's the biggest one. That's where we really are focused here because we believe that's the most important thing, getting the right part in the right place at the right time.

So we will take those actions, and we think that's going to have a big impact on improving our growth in 2023. The pricing piece, because of our tools, we're able to respond surgically. It's not as important to our customers as the availability is. So we're going to be very thoughtful and disciplined about that pricing piece.

But we are going to take some actions to respond to that. In terms of competitive response, we'll see what happens there. But we're optimistic that the inventory investment that we're making will accelerate our performance in these key categories, which has really been a drag on us over the course of the year. ..

Got it. And as a follow-up, can you talk about the investments in these key categories being ones that you had been focused on migrating more to private label.

Does that mean that you need to be more aggressive in bringing national brand inventory back in these categories?.

Generally speaking, we are very pleased with where our assortment is in the categories. Where we're focused is getting the on-hand rates where they need to be. So it's not that we are -- we have a brand issue necessarily. It's really more about getting the right part in the right place at the right time..

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

Do you have any data to support the commercial customers' enthusiasm for the private label products? I mean, maybe sort of a turnover in A SKUs, assuming that's a category you probably have in stock, the velocity of that product versus your prior strategy.

Would you add a bit more national branded product in that mix?.

We do. I mean, we have the -- essentially, when we have it, Bret, we -- the close rates are very strong. The return rates are much lower. So we do have a positive reaction from our customers on this. So it really is more about on-hand rate. ..

Okay. And then a question, I guess, as far as what inning in the inventory really appearing to manage your inventories down until recently.

So I guess when we think about going into '23, where do you see the inventory build being or how out of stock are you, I guess, is the question?.

Yes. As we look at it right now, and our analysis would suggest that we need to make investments that -- we've made some in Q3, and we need to make some more in Q4.

Obviously, that's dynamic and we'll continue to assess that, but that's the way we're looking at it right now is it's really a back half investment to get that availability as close to the customer as possible..

I'll add one thing to that, Bret. I mean, as we looked at this earlier in the year, we obviously knew we were consolidating suppliers, we were reducing some redundancy in our SKU base. So there was a belief that, that inventory could come down in the back half.

And through the analysis we've done, we just -- we've got to refine that and adjust that assumption. ..

But Q4 will likely be the inventory growth period in which one we're not going to be growing too much, not going to be a use of cash in '23 as much..

Well, yes. We're investing in the inventory here in the back half. Obviously, depending on the terms, you'll get some carryover into Q4, and we will take that into consideration as we're generating our free cash flow assumptions for next year. .

Your next question is from the line of Mitch Ingles with Raymond James..

This is Mitchell Ingles on for Bobby Griffin. I hope you're all well.

So to start, could you give us an update on your Canadian operations? How do you see the Carquest and Worldpac Canadian operations fit into your long-term plans? With the recent ForEx impact, is this business overall dilutive today to your performance? And how should we think about ForEx exposure going into 2023?.

We see a lot of opportunity with our Canadian business. We made a big investment up there in the distribution center that is now carrying the Worldpac and Carquest parts. It is not dilutive to our overall business. It is a strong performing business.

And we believe that we're going to be able to grow that business significantly as we've made a pretty big change up there in Ontario, which is the largest market. You mentioned the ForEx, I mean, obviously, it dropped down to a level that we haven't seen in a while.

But over time, there's a lot of room for growth for us up in Canada, and we're going to continue to drive that growth. And we expect 2023 to be a very strong year up there. We've got the largest assortment of parts in Southern Ontario in that building.

So a combination of OE parts from Worldpac, our owned brand portfolio of DieHard and Carquest, it's a great national brand. So optimistic about Canada for 2023..

Got it.

And then as a follow-up, as you now expand your store footprint again this year, fastest growth in eight years, how should we think about the comp sales benefit as these new stores grow into your comp base? And should we expect similar opening cadence next year?.

Yes. I mean, we're working through our store count for next year, but our plan is to expand our footprint. We think we have a number of opportunities both in terms of infill where we have a lot of density in areas where we have a lot of opportunity, namely out West. So we're going to work through that.

In terms of comp, we absolutely expect that to give us a lift next year. It does take time. These stores generally reach their maturity over a 3- to 4-year time frame. So we expect that to be an ongoing benefit, as we continue to open stores, it will continue to build on to our comp store base. ..

Your next question comes from the line of Chris Bottiglieri with BNP Paribas..

So first one is like just given the competitive dynamics in Pro and you’re unhappy as to market share dynamics, I wonder if you could consider the idea that focusing on margin expansion could be a distraction that is offsetting a lot of your hard work and significant accomplishments.

Have you considered adjusting the TSR algorithm to focus on EBIT dollar growth rather than rate?.

finishing in the top quartile in 2021 was driven by sales growth, margin expansion and returning excess cash. This year, we clearly have not performed at the sales level that we would have liked, particularly over the last 2 quarters. So as we look ahead, we're factoring that into the equation.

But over time, we still have a very significant opportunity to expand margins. Margins remains very, very important. And we're not adjusting how we're looking at building long-term shareholder value, which remains significant for Advance.

And that's a combination of driving sales growth, making sure that our margins continue to expand over time and returning excess cash. So the equation will remain the same, and we will continue to target top quartile TSR growth. ..

Got you. And then a follow-up question on kind of price investments. It seems like your peers have taken price investments. I think both have lower Pro mix than you do. And it seems like the gross margin headwinds, at least for one of them, seem to be somewhere in the 75 basis point to 100 basis point headwind rate.

How do you think about the level of price investment and margin reinvestment you need to make comparable price investments? Are there certain categories where you feel like you're further behind and you don't need quite as much of a price investment? Like how do you just frame the size of this investment?.

Good question, Chris. I mean, we use the word surgical for a reason. The tools that we've built and the team that we have to manage pricing is at the highest level we've ever had in this company. And we are very confident that we can make decisions here that are right for the business.

And that includes removing unnecessary discounts where it makes sense, redeploying resources to our highest growth and largest strategic customers and then, at the same time, making surgical price investments in very specific categories and even in the case of stores. So the analysis we've done has been very granular.

And we know where we need to make those price investments. Our overall goal continues to be priced to cover margin rate. That is the goal. Obviously, the competitive environment plays a role in how that will unfold next year, and we intend to be very thoughtful about how we price relatively speaking.

But it remains -- our goal remains price to cover rate, and we'll see how that unfolds..

Well, thanks for joining us today. As we've discussed, Q3 did not meet our expectations in terms of top line growth, and we're not satisfied with where we're positioned at the moment. However, we continue to believe we have significant opportunity to drive long-term TSR growth.

As we build our plans for 2023, we're taking measured steps to accelerate growth while pursuing our margin expansion initiatives. We look forward to sharing our expectations for 2023 in February. In addition, we have a lot to be grateful for during this season of giving thanks, including celebrating Veterans Day last week.

And I'd like to take a moment to recognize and thank all of the nation's military heroes for their service, including the thousands of Advance team members who currently or have previously served. We're grateful for your ongoing support, and I want to wish you and your families a happy Thanksgiving holiday.

We look forward to sharing our 2022 results and 2023 guidance in February. Thank you..

This does conclude the Advanced Auto Parts third quarter conference call. We thank you for your participation. You may now disconnect..