Dyne Therapeutics Q2 2022 Earnings Call Transcript

Quartr
Provided by Quartr
August 24, 2022

There are 11 speakers on the call.

Operator

Welcome to the Advanced Auto Parts Second Quarter Conference Call. Before we begin, Elizabeth 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 2nd quarter 2022 results. I'm joined by Tom Greco, our President and Chief Executive Officer and Jeff Shepherd, our Executive Vice President and Chief Financial Officer. Following their prepared remarks, we will turn our attention to answering your questions.

Operator

Before we begin, please be advised that our 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, will begin to review our financial results. 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 ks and subsequent filings made with the commission. Now, let me turn the call over to Tom Greco.

Speaker 1

Thanks, Elizabeth, and good morning, everyone. Before we begin, I'd like to thank our entire Advance team and Carquest independent partners for their dedication throughout Q2. Thanks to their relentless focus on improving the customer experience and disciplined execution of our strategy, We delivered double digit adjusted diluted earnings per share growth in the quarter. I'll begin my remarks today with a review of our Q2 performance as well as the factors that led to the revisions made to our full year guidance outlined in our press release. I'll then discuss the consistent progress we're making on our primary strategic initiatives before turning it over to Jeff to review our Q2 financial performance, including an update on cash returns to shareholders.

Speaker 1

In the Q2, we remain focused on the execution of our strategy. Consistent with this, we delivered another quarter of growth in net sales and adjusted operating income, underscored By adjusted operating income margin expansion, Q2 2022 was our 9th consecutive quarter of year over year adjusted diluted EPS growth, including a 10% increase versus Q2 2021. Notably, Q2 adjusted diluted earnings per share of $3.74 was a quarterly record for Advanced Auto Parts and grew 72% on a 3 year stack when compared with Q2 2019. We continue to invest in our business, while returning approximately $700,000,000 in cash to our shareholders in the first half of twenty twenty two. Our comparable store sales declined by 0.6% in Q2, while increasing 12.7% on a 3 year stack.

Speaker 1

As we're now opening new locations to expand our footprint, our net sales grew faster than comp sales and were up 0.6%. Our deliberate move to increase own brand penetration, which carries a lower absolute price point, reduced both net and comp sales by approximately one full point with a disproportionate impact to professional. Moving to margins. We're pleased that we were able to deliver a 166 basis point increase and our adjusted gross margin rate in Q2. A key element of this improvement is the execution of our strategic shift to own brands within our product mix as just mentioned, which provides a much higher margin rate.

Speaker 1

In Q2, owned brands as a percent of overall product mix were up over 200 basis points. As expected, our elevated SG and A costs year over year partially offset our adjusted gross margin expansion. Overall, in Q2, our 11.7% adjusted operating income margin was the Highest quarterly rate Advanced Auto Parts has reported in 7 years. I'll now shift to more details on our sales performance in the quarter and the factors that led to our updated guidance. After a late spring contributed to a stronger sales at the start of the quarter, Comp sales softened and turned negative with final results below our expectations, primarily driven by DIY.

Speaker 1

In terms of category growth, fluids and chemicals, including motor oil as well as batteries and brakes were the top performers in Q2. Our regional sales performance was led by the Mid Atlantic and West regions. While we contemplated several external factors when we provided our initial 2022 guidance in February. Increased inflationary pressures, particularly in fuel, were well above our planned estimates in the second quarter. Rising inflation and significant year over year cost increases are having a disproportionate impact on the discretionary spending of our core DIY consumer.

Speaker 1

As a result, our low single digit net sales decline in the quarter in DIY drove our sales shortfall in the quarter. There are a couple of factors to consider surrounding how a more challenging economic environment impacts the DIY customer. 1st, the majority of DIY jobs are considered non discretionary. In this case, DIYers must address the problem and repair their vehicle as soon as possible. These are what we call break fix or failure related categories.

Speaker 1

Failure or non discretionary DIY categories like batteries and brakes performed well in Q2. On the other hand, some categories are more discretionary and therefore can be deferred. As an example, in Q2, We saw softness in appearance chemicals and accessories, which were some of our better performing categories during the height of the pandemic. As we enter the back half of twenty twenty two, we expect continued softness in DIY discretionary categories. Despite recent moderation in fuel prices, overall inflation, including fuel, remained substantially higher than 2021, which we expect will pressure the DIY customer.

Speaker 1

This is the primary driver of our updated guidance. Separately, as we consider our balance of year guidance and sales outlook, the biggest opportunity we have to build shareholder value is to complete the integration of AAP and grow our margins. As we've consistently communicated, We remain laser focused on these objectives and are executing our plan. This includes a relentless focus on category management, which is our largest initiative to drive profitable growth. As part of category management, our new strategic pricing tools are fully implemented.

Speaker 1

We're now leveraging the enhanced capabilities these tools have to offer, which enables us to differentiate pricing by category, region, store and customer. We've also significantly improved visibility into the return on investment will be discussing our discounting practices by leveraging advanced analytics to gain insights on the competitive landscape and evaluate our strategic pricing actions. This is helping determine the quantitative and qualitative effectiveness of these actions. On the professional side, we're now able to measure sales lift on different levels of discounting real time and at a much more granular level. Knowing price is not the most important driver of choice for professional customers, we're becoming more disciplined in eliminating unprofitable discounts.

Speaker 1

An important byproduct of this strategy enables us to redeploy resources to enhance our service to our most loyal and fastest growing customers. Our disciplined pricing strategy is an important value driver, which we expect to contribute to further margin expansion over the long term. In the short term, we expect this may result in temporary sales softness in our Professional business in the back half, which we factored into our updated guidance. We firmly believe this is the right approach for AAP to drive sustainable top line growth and margin expansion. Looking forward, while we're cautious about and macroeconomic outlook, we remain bullish on the resilience of our industry and the disciplined execution of our strategy.

Speaker 1

At an industry level, key drivers of demand remain positive, including the outlook for the car park, an aging fleet and vehicles entering the sweet spot. A critical variable we're watching closely is miles driven, which in Q2 still remains slightly above 2021 levels. I'll now briefly discuss the progress we've made on some of the drivers of total shareholder return outlined in our April 2021 strategic update. An important driver of our TSR agenda is to deliver profitable growth while building sustainable capabilities to drive long term competitive advantage. Starting with Professional, our long term growth strategy concentrates on what our customers value most, extensive parts availability, outstanding customer service and reliability of delivery.

Speaker 1

We offer customers a comprehensive multi brand assortment of high quality national brands, own brands and OE parts, ease of ordering as well as consistent reliable delivery. By leveraging enterprise assets, we're strengthening our value proposition with the tools our customers need to grow their business profitably And ensure they have the right part at the right time. As we grow together with Pro customers, we continue to add important program elements to help our customers compete. New vehicle technologies such as hybrid and electric, along with an industry wide technician shortage creates challenges for professional customers. This led us to create enhanced training and technology platforms that help customers provide comprehensive repair services and Recruit Technicians.

Speaker 1

Our focus to strengthen the Pro customer value proposition is demonstrated by growth in our strategic accounts and TechNet customers. The successful rollout of DieHard Batteries and Professional Garages continues to drive sales growth and bring new customers to these large accounts. Carquest branded parts are also gaining momentum as a result of their high quality, evidenced by very low return and defect rates. Separately, we're continuing to leverage Worldpac's and our team are a best in class model for professional customers across the enterprise. Reliable delivery is vitally important and enables installers to more effectively schedule technicians and provide their customers with accurate service times.

Speaker 1

Now when an order is created, We've enabled all of our digital platforms to provide delivery times like Worldpac has done for many years. In DIY omnichannel, our number one priority is to ensure our customers have the parts they need to do the complete job. We continue to work on improving store in stock rates as global supply chain constraints moderate. This includes adding more depth of parts in the front room and leveraging our dynamic assortment tools to improve parts availability for the complete job. Our highly regarded owned brands are a differentiator for Advance.

Speaker 1

Specific to Die Hard, we continue to build this brand and delivered another quarter of double digit sales growth. This ongoing strength is due in part to the successful launch of DieHard hand and power tools as well as our latest product innovation, the exclusive DieHard EV and Hybrid Battery. In terms of building awareness and increasing loyalty, the enhancement of our Speed Perks program through the launch of Gas Rewards has been a highlight for DIY this year. Our field team has dialed the execution of this initiative in 2022. Year to date active SpeedPerks members have increased to 13,000,000.

Speaker 1

In Q2, we increased SpeedPerks as a percent of both transactions and sales by over 300 basis points compared with the prior year quarter. Rounding out our top line growth initiatives, We're executing our new store opening plan. In the quarter, we opened 43 new locations, including the recent opening of our flagship store in Downtown Los Angeles. Our California expansion is already contributing to share gains in the West. Year to date, we've opened 78 new locations and remain on track to deliver our annual guidance of 125 to 150 new stores and branches.

Speaker 1

I'll now shift to the progress we're making to capitalize on our significant margin expansion opportunity, starting with category management. Our strategic pricing strategy starts with a deep understanding of the customer decision journey for each job, including the role of price. Obviously, the importance of price varies by both channel and job based on a variety of factors. As we execute our strategy, we can remain competitively priced, remove unprofitable discounts and drive further gross margin expansion. Separately, we're streamlining and simplifying our supply chain to improve service and reduce cost.

Speaker 1

We continue to roll out a single across the Advance and Carquest DC network and are on track to complete the implementation by the end of 2023. We've also begun activating elements of our labor management suite of tools across our DC network and are beginning to see productivity benefits. Finally, in terms of SG and A, we're leveraging our labor management tool to do a better job of matching hours to transactions in our stores. This helps improve scheduling to ensure we're there when the customer needs us and offsets rising cost per hour inflation when transactions soften. In summary, during the Q2, we're pleased that we were able to expand adjusted operating margins and deliver a record quarter of adjusted diluted EPS.

Speaker 1

We also returned nearly $700,000,000 in cash to shareholders in the front half of the year. Over the long term, we remain focused on building a stronger customer value proposition for both Pro and DIY customers. While we expect that both the consumer and retail environments will be challenging in the back half of twenty twenty two, We also believe that the continued disciplined execution of our initiatives will enable sustainable long term growth and margin expansion going forward. I'll now turn the call over to Jeff to review our Q2 financials and updated outlook for the balance of the year. Jeff?

Speaker 2

Thanks, Tom, and good morning. I would also like to thank all our team members for their ability to quickly adapt in this unique environment. In Q2, our net sales of $2,700,000,000 increased 0.6% compared to Q2 2021, driven by continued growth in our professional business and new store openings. Our comparable store sales declined 6 10ths of a percent. As Tom mentioned, both net and comp sales were reduced by approximately 100 basis points due to increased own brand penetration.

Speaker 2

Adjusted gross profit margin expanded 166 basis points to 48% Through the combination of our strategic pricing actions and the benefit of higher margins associated with own brands. These improvements were partially offset by continued product cost inflation, which was an 8.8% increase on a same SKU basis in the quarter, along with headwinds associated with product and channel mix. While we realized planned cost savings and supply chain, These were more than offset by wage and transportation inflation. Our Q2 adjusted SG and A was $967,000,000 or 36.3 percent of net sales. This compares to $926,000,000 or 35% of net sales in Q2 2021.

Speaker 2

Our largest headwind to SG and A in the quarter was higher inflation in wages and fuel. Additionally, we incurred anticipated start up costs related to our California expansion. However, with over 50% of our locations open, they are now contributing incremental revenue and operating income. Finally, costs related to our anticipated channel mix shift to professional were higher than a year ago. These SG and A costs were partially offset by favorability and incentive compensation as we lap higher bonuses Resulting from our strong performance last year.

Speaker 2

We also saw improvements from last year's productivity efforts related to our corporate restructuring and reducing our office and store footprint along with lower COVID-nineteen related expenses. As we look at SG and A going forward, we're experiencing higher inflation than we estimated when we provided our original 2022 guidance. We now anticipate higher inflation in wages and fuel will continue and this combined with a softer than expected top line will result in SG and A deleverage in Q3. However, we remain focused on leveraging SG and A in the back half of twenty twenty two. Our Q2 adjusted operating income was $312,800,000 an increase of 3.6% compared with Q2 2021.

Speaker 2

Our Q2 adjusted OI margin rate of 11.7% was an increase of 34 basis points compared with Q2 of the prior year. Our adjusted diluted earnings per share of $3.74 increased 10% compared with Q2 twenty twenty one. For the first half of the year, free cash flow was $97,300,000 compared with $647,000,000 in the first half of twenty twenty one. This was largely driven by working capital, particularly inventory and receivables. We expect significant improvement in working capital metrics in the back half As reflected in our updated full year guidance for free cash flow.

Speaker 2

In addition, we continue to invest in the business and our Q2 capital expenditures were in line with expectations at $96,400,000 bringing our year to date capital expenditures The $211,000,000 In addition to the strategic initiatives Tom reviewed, we continue to return excess cash to shareholders through a combination of share repurchases and our quarterly cash dividend. In Q2, we returned $200,000,000 to shareholders Through the repurchase of approximately 1,000,000 shares for an average price of $199.02 and approximately $90,000,000 for a quarterly cash dividend. Our Board also recently approved our quarterly cash dividend of $1.50 Importantly, despite macroeconomic pressures, we have returned $694,000,000 to shareholders in the first half of twenty twenty two, which is more than triple what we returned in the same timeframe of 2019. Shifting to the back half of the year. Our original guidance in February included the estimated impact of several factors, Such as lapping stimulus and elevated inflation.

Speaker 2

However, we did not anticipate total inflation to be at a 40 year high. In addition, the increases in fuel prices during the Q2 far exceeded our expectations. As we described earlier, we're seeing evidence these two factors are putting a strain on DIY customers. Combined with our front half results, will provide updated ranges for our 2022 guidance of net sales of $11,000,000,000 to $11,200,000,000 Comparable store sales of negative 1% to flat, adjusted operating income margin rate of 9.8% to 10%, Adjusted diluted earnings per share of $12.75 to $13.25 A minimum free cash flow of $700,000,000 and share repurchases between $500,000,000 $600,000,000 We're maintaining our previously provided ranges for income tax rate of 24% to 26%, CapEx range of $300,000,000 to $350,000,000 and new store and branch openings of 125 to 150. To close out our prepared remarks, our goal is to deliver top quartile total shareholder return as outlined in our 2021 investor presentation.

Speaker 2

The midpoint of our updated 2022 guide for adjusted diluted earnings per share is up 8% when compared with 2021 and represents a 60% increase to the comparable 2020 base period for our 3 year plan. We remain focused on the disciplined execution of our strategic plan, and I want to once again thank our team for their dedication in serving our customers every day. With that, let's open the phone lines to questions. Operator?

Operator

Your first question comes from the line of Christopher Horvers with JPMorgan.

Speaker 3

Thanks and good morning. So My first question is, can you talk a bit more about the cadence of the quarter? You've given some provided some granular detail in the past. And As gas prices have receded, did you see a return to positive comps? And then can you give some color on what you've seen quarter to date?

Speaker 1

Hey, good morning, Chris. As we talked about in our remarks, DIY was really the driver of the performance in the Q2. We've been looking at our sales on a multiyear stack basis for quite a while. And early in the quarter, Our 3 year stack and 1 year comp sales were the strongest in the quarter. As we went further into it, our top line slowed and it was really DIY That was the majority of the shortfall versus expectations in that timeframe.

Speaker 1

We expected the 3 year stock for DIY to be Similar to what it was in the Q1 and it just wasn't. And we attribute that primarily to the broader consumer dynamics that you've heard from many others, Significant inflation, rising fuel prices, which really pressured lower income consumers and caused them to make some choices on Purchases and we saw that. We saw discretionary categories like appearance chemicals and accessories were very soft for us in the quarter. So really it was DIY that was the driver and that's what changed as the quarter went on. We're not going to talk about specific Numbers quarter to date, but what we have done is embedded our quarter to date performance into our full year guidance, which you saw in the back half is minus 2 to 0 for the back half of the year.

Speaker 3

Got it. You mentioned DIY, it was down low single digit. Presumably, that's a comp. On a 3 year basis, it looks like DIY actually improved, whereas Do It For Me decelerated and that would do it for me at low single digits. And that's well below what Others are posting in the industry and the structural growth rate of the industry.

Speaker 3

So I'm just curious, can you expand more on what You were referencing earlier around the pricing efforts and it sounds like basically you're eliminating unprofitable Smurs and that's what's driving the relative performance in Do It For Me?

Speaker 1

Yes. I think you have that right, Chris. I mean, we I think the short answer is we're executing a very different strategy right now. And our strategy is to essentially to grow above the market and expand margins at the same time. We've talked about the fragmentation in the industry many times.

Speaker 1

We believe there's lots Room for us to grow above the market in the coming years. But right now, the biggest opportunity we have at Advance is to complete the integration of the company And improve our margins, which is unique to us, I think. In the back half of the year, that means we're going Our category management plan, which includes a deliberate intentional move to increase own brand penetration. And we talked about This opportunity we have with strategic pricing, we built a terrific team there. We stood the pricing software package up about a year ago.

Speaker 1

We knew we could get to localized pricing in DIY and ultimately into DIFM. We're now leveraging the full capabilities of that tool And we are removing unprofitable discounts really in all trade channels. But inside of Pro, this particular action may mean we're going to lease some unprofitable sales on the table in the back half. So we firmly believe this is the right strategy for us. We recognize that we didn't grow above the market in But we did grow margins to a quarterly record and we grew earnings per share by 72% on a 3 year basis.

Speaker 1

So our long term goal Is to grow above the market and expand margins and that's what we're executing right now.

Speaker 3

My final question is just as you think about your the 3 year plan that you laid out and your thoughts on getting to that 10.5% to 12.5% and delivering the total shareholder returns that you've laid out, how are you thinking about your ability to get into that range next year?

Speaker 1

Yes. Well, right now, obviously, we're focused on finishing 2022 and beginning 2023 as strong as possible. But let me react to the specific The short answer is based on what we know today, yes, we believe we can get inside the ranges that we laid out. We laid out goals for 2021 through 2023 as you remember for net sales, for earnings per share, for margin rate and a number of other Financial metrics. We believe we can get inside the range on all of those key metrics.

Speaker 1

We do see the margin rate at this point is going to be the most challenging Given the inflationary environment that we're dealing with, but we still believe we can get inside of that range. And we're excited about continuing to execute our plan to do that. So I will reinforce this is obviously a point in time assessment. We've got a lot of volatility in the current environment. There's several macroeconomic factors out there that are difficult We plan to provide annual guidance as we usually do next February In 2023, and we'll have a lot more insight into just exactly where we're going to finish within the framework we decided.

Speaker 1

The one thing I would add, Chris, is We also believe that beyond 2023, there's continued opportunity for growth and margin expansion for us beyond that.

Speaker 3

Got it. Thanks very much.

Operator

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

Speaker 4

Good morning. Thanks a lot for taking my question. So your adjusted operating margin and gross margin were up, But your GAAP gross margin was down. Can you explain why that was the case? And your free cash flow was under a significant amount of pressure, suggesting that the GAAP gross margin is more a reflection of What's happening with the cash flow?

Speaker 4

So can you explain that as well?

Speaker 2

Yes, sure, Michael. Let me start with The GAAP margin, if we were to include the LIFO expense into our adjusted results, we would have deleveraged 30 basis points versus last year, which I think is what you're focused on. And just in terms of context, from a dollar standpoint, The LIFO benefit from an adjusted standpoint was $92,000,000 this quarter versus last year when it was $39,000,000 So you have that increase of $53,000,000 But let me give you some context around this. It's really That we frame LIFO into our broader gross margin plan. And what I mean by that is we've got a very comprehensive strategy to improve our gross margin rate over Hi.

Speaker 2

So the execution of our strategic pricing initiatives, we talked about a lot of that in our prepared remarks, The expansion of our own brand portfolio, optimizing supply chain and these were all the contributors that drove our 166 basis points of Adjusted Gross Profit. Now looking forward, as it relates to LIFO, We know the products. We know the categories. We know the SKUs that are driving these inflationary costs that are sitting on our balance sheet. And we're able to model how and when these costs come off the balance sheet, whether it's a FIFO basis or whether it's a LIFO basis.

Speaker 2

So we've incorporated these inflationary costs and the related headwinds into our guide. And that includes these higher product cuts coming off the balance sheet. And it's important to note, Michael, that we're already seeing that today. This is not something that's looming. This is not something that's late 2023, 2024.

Speaker 2

We're experiencing it in Q2. We're going to experience it in Q3, So forth and so on. So that's all very much contemplated in what we've done in the back half And then once we guide in February for 2023. Now as it relates to free cash flow, Specific to the guide, it's really attributable to the top line guidance that we provided yesterday. It's important to keep in mind in the Q1, we had free cash outflow of $170,000,000 And we outlined all of the factors that went into that largely anticipated.

Speaker 2

If you look at our free cash flow discretely in the 2nd quarter, significant improvement. We had free cash inflow of $267,000,000 and we do anticipate that the back half to be more in line with the second quarter, We're going to be collecting on those. We believe our inventory is going to be coming down in the back half. And those factors along with the revised guidance is why we have a Minimum of $700,000,000 of free cash flow.

Speaker 4

So my follow-up question is, Jeff, would you expect the LIFO gross margin to Turn positive this quarter or in the next few?

Speaker 2

Over the back half, it's very difficult to say. We are we continue to believe we're going to be in an inflationary environment in the back half. Sequentially, we think it's going to moderate, but year over year in the back half, we think inflation, Including product cost is going to be higher. So if we think about just LIFO, for example, we've had 170 About $175,000,000 in LIFO expense in the first half of the year. We're thinking it could be $250,000,000 $275,000,000 So it could be another $7,500,000,000 more in the back half.

Speaker 2

Okay.

Speaker 4

Thank you very much.

Operator

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

Speaker 5

Good morning, everyone. Hey, Tom, I wanted to ask about strategic pricing. I wanted to ask if You, I guess, accelerated the strategy in the last, call it, quarter. And in the past, it feels it felt like you've done it in a way To minimize the elasticity, it sounds like the stuff that's happening now and maybe into the back half is having a greater impact than

Speaker 1

Yesterday, about a year and a half ago was the plan for strategic pricing over time. We talked about lifecycle pricing. We talked about how we were going We talked about the ability to localize and essentially priced literally by channel, by store, by Customer, etcetera, etcetera. And it took us a while to stand up those capabilities. We were able to get to that on the DIY To your point, when we looked at it, obviously, the environment has changed versus what we anticipated heading into the year.

Speaker 1

But for us, the right strategy is to make sure that we are spending money very wisely as it pertains to discounting in the Our biggest opportunity is to get those margins up. And we've obviously looked at the competitive landscape and what's going on By product type and where there are where there is pressure, for us, this is the right strategy for us to execute. And it's definitely the long term play. Separately, we're continuing to build out our value proposition in Pro in those areas that we think matter most to Which I'm happy to speak to, but that's really the approach.

Speaker 5

Thanks. That's helpful. And then just a follow-up, the private Brand penetration, if we heard it right, was 200 basis point year over year growth in the quarter. And is the spread between the private brand gross margin and national. Is it about the same?

Speaker 5

Can you quantify it? And then maybe can you just quantify the contribution It had to overall gross margin in the quarter.

Speaker 1

Yes. We're not going to break it out specifically. But what I can tell you is within category management, We outlined 3 broad territories, strategic pricing, own brand penetration and sourcing in that order. So home brand penetration is a significant contributor. We basically laid out 180 to 200 basis points of margin expansion On our Investor Day presentation, so it's the 2nd largest.

Speaker 1

And we clearly see further runway there. I mean, we're definitely getting meaningful contribution to margin expansion today with our own brand expansion. We expect that to continue in the back half. It's going We'll continue into 2023 and candidly will continue into 2024. It's going to take a while, and we're continuing to improve The overall impression of those brands, Die Hard is doing well.

Speaker 1

Carquest is doing well on the professional side. So we're very excited about it and we're going to continue to execute against it.

Speaker 5

Okay. Thanks, Tom. Good luck, everyone.

Speaker 1

Thank you.

Operator

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

Speaker 1

Hey, good morning, guys. Good morning. Good morning. On the second quarter and then I guess the outlook for the second half, What does that comp I guess, explain inflation versus units? What was the price contribution?

Speaker 1

Because I guess, obviously, owned brand is lower price So maybe adjusting for mix, how did that shake out? Yes. Well, units for everyone in the industry are down, Primarily driven by DIY, Brett, as I think we called out at the beginning of the year, DIY It's about 60% of our units, right? So and those lower price per unit items in DIY tend to Drive that number. But Jeff called out our cost inflation in the quarter, which was 8.8%.

Speaker 1

So you should assume our pricing was slightly above that because we are essentially pricing to At least keep rate neutral or better. So that's kind of where it is. Okay. And I guess on the second half outlook, the minus 2 to 0. Yes, I think you're lapping harder inflation compares in the second half of last year.

Speaker 1

Yes, that's factored in. Yes, we recognize that. We looked at the broader industry, the retail landscape in total, which as you know is we're not Seeing consumption growth in the broader industry, I mean everyone is seeing units down and all of the growth in retail is coming from pricing at this point. We looked at the industry performance. We can only see DIY and when our peers report, but we expect Transactions and units will continue to be below a year ago in the back half.

Speaker 1

And then obviously, our own initiatives. And in our case, we've got A particular initiative on strategic pricing that's going to impact our top line a little bit, but it's going to drive our margin performance. So that's Those are the factors that went into it. Okay. And then I guess the outlook on payables ratio in the second half, as a contributor to cash flow, Where do you see that?

Speaker 1

I mean, I think you were running in the 80s, but not significant expansion on the Q2. But how do you see payables growing? And is that is going to be impacted by the private label owned brand strategy. Is that more or less likely to get extended payables?

Speaker 2

Yes. Just from an overall payable ratio, in Q1, we did some forward deployment related to inventory. So it was Less impacted by payables is more impacted by the increase in the inventory as we did the forward buys To avoid disruption primarily related to China lockdown, we talked about the Olympics, we talked about Chinese New Year. So that's really what's kind of pressured our AP ratio. We did improve from Q1.

Speaker 2

We Expect that to continue to improve. It's going to be a combination of both payables and inventory because we expect inventory to come down in the back half. And that coupled with our ongoing efforts in AP, we expect to see improvement over the back half in our AP ratio.

Speaker 1

Okay, great. Thank you.

Operator

Your next question comes from the line of Scot Ciccarelli with Truist.

Speaker 6

Good morning, guys. Gotcha, Corelli. So you guys talked about significant softness in your discretionary DIY sales. Can you guys help provide some color on how big that segment is as a percent of mix?

Speaker 1

Well, first of all, just to make the point, I think you know, Scott, the non discretionary categories are much larger, right? So when we're talking about Our business, that's what we love about the auto parts industry, batteries, brakes, Failure related parts are much larger. But at the margin on the DIY side, things like accessories and appearance chemicals are pretty sizable and certainly at certain points of the year, they're bigger than others, in fact, in Q2. We definitely saw softness in those discretionary categories. I think what's happening is The low to middle income customer, you've heard about all these quintiles and things like that from others.

Speaker 1

These Customers are obviously paying significantly more for food. They're paying significantly more for gas and they're making choices about where they spend their discretionary money. What's a little bit difficult to tease out in DIY is part of the benefit we saw in appearance chemicals and accessories over the Over the last couple of years was related to people being at home and having time on their hands, we believe. But that will moderate as we get into the back half. Obviously, very important categories for us.

Speaker 1

We're going to continue to stay focused on them. They've been soft for the entire industry, but over time, that's going to normalize.

Speaker 6

Tom, just to clarify for everyone. So the overall DIY, including the failure related parts, Everything was negative with particular softness on the discretionary side. Is that the message we should be walking away with?

Speaker 1

Yes. I mean, the non discretionary were up, but the discretionary categories Hold the number down because they're down pretty significantly.

Speaker 7

My discretion was up. Okay, that's what I was looking for. All right, thanks guys.

Operator

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

Speaker 8

Yes. Hi. This is Nathan Friedman on for Seth. My question is following up on the 2023 operating margin And target question, you initially provided some building blocks in category management, supply chain, SG and A and the negative impact from inflation relative to 2020. Can you possibly quantify what you realized to date relative to these targets?

Speaker 8

How much higher inflation is relative to this plan? And what, if anything, is or could run ahead or behind schedule at this point in time.

Speaker 1

Well, I'll let Jeff speak to how much ahead of plan inflation is. But I mean, the biggest variable is inflation. I think in terms of us executing our targets, Nathan, we are The category management initiatives are very much on track. We still see further upside with category management. As we said earlier, we're starting to Execute that more versioned strategic pricing platform.

Speaker 1

We're going to continue to drive own brands. In terms of supply chain, We're making a lot of progress. I mean, we are in a position where we're now opening brand new distribution centers that are much more modern. The team is doing a terrific job transitioning very old, I would say antiquated facilities, as an example, Riverside, California. We've moved into a brand new building in San Bernardino, California, up near Toronto.

Speaker 1

We've moved from a very antiquated building in Rexdale So a new building in Bolton, both of those are going to be operational in the Q4. So that's going to really help us improve our service to customers and reduce our cost Over time, so we are executing against the supply chain initiatives also. And then within SG and A, we're executing against those initiatives. So We're going to continue to execute the initiatives. What has been the wildcard is the inflationary costs in things like fuel and wages, which I don't know if we can quantify it, Jeff, but it's a very big number versus William Rizzo.

Speaker 2

Yes, I can give you some color. When we did the Investor Day in April, we The 280 to 290 basis points, which was largely covering non product inflation. We said that was embedded in our category management. And just some data points, fuel is up 50%. So we certainly didn't contemplate that wage Mid single digits.

Speaker 2

So 2, 3x what we had anticipated. We did not anticipate 5%, 6%, 7% wage inflation. We did not anticipate 50% inflation in fuel. And so if we were to redraw that chart, That last red bar that we had there in April would certainly be bigger and so with the green bars to the left To overcome that, so we can still hit our 10.5% to 12.5%.

Speaker 8

Got it. Thank you for that. And then my follow-up is just on the SG and A near term guide. You mentioned expectations for 3Q deleverage, but I believe second half overall leverage, if I heard this correctly. Just curious if you could provide a little bit more color on these expectations and some of the drivers just beyond

Speaker 2

Yes. What we said originally was first half was going to be heavily driven by gross margin That certainly was the case. 2nd half, we're going to continue to see benefits from gross margin. As it relates to SG and A, our goal is to leverage SG and A in the back half, but there's some puts and takes there. And so let me just give you a little bit of perspective.

Speaker 2

It looks a little different relative to what we expected in our full year guide in February. And what we just talked about first, while inflationary costs in Store payroll and fuel, they're moderating sequentially, but these costs are much higher than what we originally expected. And look, we've got to pay. It's important that we stay competitive in wages, in our stores, for example, make sure we're fully staffed, Serving our customers now what we can do is to continue to leverage our demand driven labor tool that we call it MyDay will help offset this cost per hour inflation. And then we still have the tailwinds.

Speaker 2

We're going to get the benefit from last year's corporate restructuring. We had the rent reduction initiatives and we're lapping in the second half, we're lapping last year's investments in our California expansion And we're opening more of these stores. So the sales from the stores are beginning to help offset the cost that we're incurring. And then we do The benefit from last year's higher incentive compensation. So we've taken all of these factors along with the moderation of our top line and incorporated into our updated guidance.

Speaker 8

Just a quick follow-up on that. When will you be opening all of the California Stars?

Speaker 1

We're pretty excited about I'm seeing some of the new store openings we have around the country with the store openings in California. We're going to get as many of them open this year as we can. Some of them may move to the Q1, but overall, very pleased with the performance out there. We were out there recently. We've got a partnership with the Dodgers that Has really resonated with the Hispanic community.

Speaker 1

We can see our market share gains out there. We're making a lot of progress out there. I feel really good about our performance, And we're going to stay focused on that market. It's a very important market, as you know. It's one where we have very little penetration.

Speaker 1

We've got nice Overall professional business with Worldpac, so that's where we're going to leverage our enterprise assets to bring that whole package together. So the DIY business that we're getting from the converted But also a very, very large professional opportunity in Southern California. So on track to get these stores open Soon. And as I mentioned earlier, the San Bernardino DC, once it's fully operational, is going to help us immensely out there.

Speaker 8

Great. Thanks for the call guys and good luck going forward.

Speaker 2

Thanks.

Operator

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

Speaker 9

Hey, thanks for taking the question. So on the impact to sales and comps from the owned brand shift, how long can that pressure linger? And should this be the peak of the impact in terms of Magnitude at about 100 basis points and if you could share with us anything that's embedded in the back half guidance.

Speaker 1

Hey, good morning, David. I think it's we don't see it as a linger. We see it as a good thing. I mean, the performance of these brands drives our margins And it has a lower cost per unit than the alternatives that are out there. So in this environment Where our customers are looking for value, in particular, the professional garages are looking for value.

Speaker 1

This is something that they want. So Now it pulls the comp sales number down for sure, because you have a lower price per unit. You sell 100 units. The alternatives that we have are priced at a higher price per unit than the owned brands. But we see that honestly potentially accelerating In the back half and then into 2023 and then it will moderate over time.

Speaker 1

But we've said before that the own brand penetration that we have is below What we're targeting over time and we believe below what our peers have already done for many years. So we're going to continue to focus on that and continue to forge Stronger relationship with our national brand suppliers because they're very important to us too. We have a very wide selection Of National Brands and OE Parts that are extremely important to our overall value proposition. So it's a balanced approach, but The success of Die Hard and Carquest is something that will really help us deliver on our goal of profitable growth.

Speaker 9

Got it. And my second question, you mentioned a couple of times that the better matching labor with in store traffic and demand. So what's the timeframe for getting that system fully in place and how do you size the potential labor savings attached to that?

Speaker 1

Well, I'm really pleased with how our field team is managing this, David. I mean, we stood up the tool, Jeff mentioned it, we call it my day. We were a little bit, I would say, we had a pretty good sized opportunity in terms of how we staffed. And once again, we're rebuilding a lot of things in the company with really great leaders, with improved technology and improved processes around it. We've got a great field leader.

Speaker 1

The person that runs this The next slide of the business just came out of a region Vice President job. He's got extensive experience in this area. And we're using the technology tool the way it's been designed, Which is to really look forward at the transaction outlook. And obviously, the lower the transactions, the less Hours you need. When you need more, when you see more transactions coming, you have to increase hours.

Speaker 1

So we're matching that up against The hours that we're issuing and then we measure obviously our performance of issued hours to scheduled hours and the like. So Much more rigor around it, much more success around it. Our field team is doing a really good job executing it. Obviously, When we get past the back half, we want transactions to go back up. But it's just a temporary situation where the DIY business in particular, We expect to be soft on transaction in the back half and that enables us to offset cost per hour inflation as we said.

Speaker 9

Appreciate it. Thanks, Tom.

Operator

Your next question comes from the line of Michael Baker with D. A. Davidson.

Speaker 10

Okay. Thanks. Two questions. 1 short term, Longer term, just to confirm and if you said it, I apologize, but the DIFM business, it seems like I think it was positive you said, but where was it relative to plan? How did that perform versus your expectations?

Speaker 1

Good morning, Mike. DIFM was relatively close to plan in the Q2. DIY was The driver of our shortfall versus expectations and part of that was we knew what we were going to be doing in DIFM. We are executing a different strategy as I outlined earlier. And as we look at the back half, That's when we really fully implement what we're talking about here in terms of version, more localized pricing and elimination of, We would say unprofitable discounts in the professional channel.

Speaker 10

Okay. Makes sense. And then I guess it's a long term question to follow-up on that. Doing away with those unprofitable discounts in DIFM. So presumably, you're giving up share to someone.

Speaker 10

As you've done this, any idea who Coming in and taking that business that you're giving up?

Speaker 1

That's a very difficult thing to say. We're obviously very aware of the competitive landscape and we obviously look at it by category. We look at it by product. We look at it by geography. So those are the big things and by channel.

Speaker 1

So we No, from an internal perspective, we balance, right, the share of wallet opportunity we have with each customer on the professional side With the return on investment we get. In some cases, our large strategic accounts, our large TechNet accounts, We lean in heavily with those accounts and we're very, very mindful of what's going on there. And our goal obviously is to continue to better Serve those customers and drive share of wallet with those customers. What we're talking about here is at the margin, Discounts that we're offering to very low share of wallet customers where we don't have a large presence. And by Strengthening our value proposition and focusing what we're doing in Pro on those things that matter to those customers in those areas, we believe we'll be able to grow faster long term.

Speaker 10

Okay. That makes sense. But if I could follow-up and maybe you can answer this, but if you're giving up that business, why would someone else come in and take that business? Is it in your view, is it that they're willing to take a lower margin or does someone else have a lower cost to serve for some reason? Do you have any view on that?

Speaker 1

Yes, that's obviously a difficult thing to say. I mean, we don't look at it in isolation, though. I want to reinforce I mean, it's not just about, well, this particular discount or deal that we're offering doesn't provide the adequate return. We look at it with our longer term objective. We have to set priorities.

Speaker 1

These are difficult decisions. They're tough decisions. But we all looked at this Again, multiple times this year as we went through the year. And we believe this is the right strategy for us.

Speaker 10

Perfect. Thank you. Appreciate the color.

Speaker 4

Thank you.

Operator

Your next question comes from the line of Emily Hyde with Evercore ISI.

Speaker 7

Hi, it's Greg Malek from Evercore ISI. My question is really twofold. One is on Pro and then the Pep Boys stores. So first on the Pro units, were those up in 2Q, Given inflation was probably less than pro?

Speaker 1

Units units were down in Q2, Greg, I think that's been a bit of a multiyear trend. The units were down. Part of that is just the price per unit. The average selling price per unit is up significantly as you know. So units were down.

Speaker 7

And in your second half guide, would pro units also be down?

Speaker 1

Yes.

Speaker 7

Got it. And then the second question was on the converted stores. I think It was like 100 some leases that you got from Pep Boys. How many of those are actually converted now? And do we is that all in the $125,000,000 to $150,000,000 this year?

Speaker 1

Yes. We incorporate what we're going to open

Speaker 10

in the $125,000,000 to $150,000,000 I think

Speaker 1

we gave the number year to date. Over half. 25 to 150. I think we gave the number year to date.

Speaker 2

Over half.

Speaker 1

Over half. And in total, we're at 78, I think.

Speaker 6

Year to date. Yes.

Speaker 1

So I mean, our year to date new store openings are on track to get to the 125, 150. So Yes.

Speaker 7

Got it. And remind me, when you open those, are those those aren't in the comp. Those are do they stay out of the comp for 13 months When you confirm that?

Speaker 2

Yes, 13 periods, roughly a year, but our 13 periods. And then once it hits that 14 period, it then goes into comp.

Speaker 7

So I guess maybe a follow-up on those. I mean, how are those going when you get them opened? It sounds like What sort of lift are you seeing? What's the mix of business showing you?

Speaker 1

Yes. We still have a big opportunity on Pro, Greg. I think you know The stores themselves were primarily DIY, which is great. So the DIY business is somewhat established by Pep Boys previously. So the DIY business is still the majority of the sales, which is different for us.

Speaker 1

Typically in advanced or more fifty-fifty, but these are much higher as a percent of sales on DIY. And that's the biggest opportunity for us. We've got our large National Accounts that are out there that are really excited that we're opening the stores. So now we're able to service them In Southern California, which we have not been able to do in the past. So that's going to be the big opportunity for us as we get the stores open.

Speaker 1

And part of it is just getting density in Metro LA and some of the other urban markets, San Diego, etcetera, that we have out there. Once we get the larger number of

Speaker 7

And then I think it's hopefully a quick follow-up. You talked about how inflation was more than the product cost inflation in the Q2. We know you are cycling more inflation back half last year. Should we expect year over year inflation to sort of decelerate to mid single digits in the back half? Is that what's in your guide?

Speaker 2

Yes. That's a good way to think about it. That's how we're looking at it. It's, as we said, sequentially coming down, but year over year still up.

Speaker 7

Got it. All right. Good luck, guys.

Speaker 2

Thanks, Greg.

Operator

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

Speaker 6

Hey, good morning. Can you refresh us on your take for industry growth rates in 2022 for DIY versus pro and how that evolved since your initial expectations. And then as we look ahead, do you think DIY and Pro units can both grow in 2023?

Speaker 1

Hey, good morning, Zach. I mean originally when we did our Investor Day, which again was a year and a half ago, we had DIY low single. Obviously, as the year went on, it was a stronger year in 2021, pardon me for DIY than we'd originally anticipated. So that's when in February, we said, boy, we don't know on DIY in 2022. It could be more challenging.

Speaker 1

So I think relative to our Investor Day, 'twenty one better, 'twenty two probably slightly below. Obviously, we look at the reported numbers of peers and we look at the syndicated data, which don't exactly match up, I can tell you. So that's the short answer there. But I think DIY in the back half of this year, knowing all of the things we know today, The inflationary pressures we think that there's going to continue to be pressure on the discretionary income and that's going to put pressure on DIY in the back half. Sorry, remind me your second question again.

Speaker 6

Do you think units can grow in 2023?

Speaker 1

Units is a tricky question. I mean transactions, we do think transactions can grow. Units is a function of the complexity of a vehicle and how difficult the repair is and how parts change over time. Sometimes You need fewer parts to do the same job, but it's higher revenue for the job, right? So but we are focused on transactions there and driving transactions We do think they can grow in 2023.

Speaker 6

Got it. Thanks for that, Tom. And then Jeff, you had called out About a $20,000,000 SG and A drag from the Pep Boys start up costs in Q1. Can you talk through how that trended in Q2 and the deleverage impact, and how you expect the drag to trend as we move through the second half

Speaker 2

Yes. So in the second quarter, it was not as high as what we saw in Q1. Obviously, as we open those stores, they're not start up costs anymore. We're getting revenue associated with those stores. That trend is going to continue into Q3 and into Q4.

Speaker 2

And while we expect to have start up costs, they're going to be significantly lower and what we saw in the back half of twenty twenty one. So net net, it will be a tailwind because it won't we won't have as much Startup costs in the back half of this year as we saw last year, because we really didn't have that many stores open in California last year. So that's sort of how we're thinking about that.

Speaker 6

Got it. Thanks for the time, guys.

Speaker 2

Thanks.

Operator

At this time, there are no further questions. I'll turn the call over to Tom Greco for any closing remarks.

Speaker 1

Well, thanks to all of you for joining us this morning. As we move into the back half of the year, we remain committed to the disciplined execution of our long term strategic plan, including profitable top line growth and Sustainable Margin Expansion. In turn, we're confident that we'll be able to return meaningful value for our shareholders. Importantly, while we're focused on transforming Advance and completing the integration, we also recognize the importance of giving back to ensure we're leaving the communities we live and serve is better for generations to come. This includes the kickoff of our American Heart Association fundraising campaign in stores tomorrow.

Speaker 1

Our 2021 campaign was a record fundraising year for us, raising nearly $1,700,000 to support the critical mission dedicated to fighting heart disease and stroke. We're incredibly grateful for the generosity of our team members, our partners and our customers who are giving back. And I'm really excited to get back out into the stores next week and kick off this year's campaign. I'd like to wish everyone a safe and healthy end of summer and look forward to sharing more in November. Thanks for your support of Advanced Auto Parts as we navigate the current environment, while continuing to deliver on our long term strategic priorities.

Operator

Thank you for participating. You may disconnect at this time.

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Dyne Therapeutics Q2 2022
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