Advance Auto Parts, Inc. Q1 FY2026 earnings call

- **Overall Performance & Strategic Pillars** * Q1 2026 delivered a solid start to the year, with adjusted operating margin expanding 410 basis points year-over-year to 3.8%, driven by merchandising execution and product margin expansion. * The company's long-term strategy remains focused on three core pillars to deliver sustainable profitable growth, with a medium-term target of 7% adjusted operating margin.

- **Merchandising Initiatives** * Strengthened vendor relationships via improved internal processes, streamlining non-value-added costs, and closer collaborative field and marketing initiatives. * Implemented an evolving new product assortment framework that has expanded parts availability across the network, particularly for brakes and undercar parts in the pro segment, driving above-average comparable sales. * Refreshed front-of-store categories starting with the wash and wax section, aligned by customer job to improve the DIY shopping experience, with additional category resets planned. * Launched new owned home brand Argos, initially for motor oil, which has already met expectations and become a top brand in the category. Argos has since been expanded to hydraulic oils, antifreeze, performance chemicals, and washer fluid, offering national brand-comparable quality at lower prices for both pro and DIY customers. * Launched the modernized Advanced Rewards DIY loyalty program, replacing the legacy Speed Perks program. The transition has been seamless, with early increases in new member sign-ups, program penetration, and loyalty member transactions, indicating strong customer reception. * Launched the new "Good Parts" brand marketing campaign to deepen connections with the DIY community across the company's 4,300+ store network.

- **Supply Chain Optimization** * Distribution center (DC) consolidation is nearly complete, and focus has shifted to streamlining and standardizing DC operations to improve efficiency. Key process improvements are being rolled out systematically in 2026, with productivity savings expected to drive gross margin expansion starting in 2027. * Key improvements include targeting near-perfect store shipment accuracy (to eliminate store-level manual scanning and save labor), improving inter-hub/store parts movement visibility, and optimizing vendor ordering to reduce fragmented order volumes and excess handling costs. * The company is on track to open 10 to 15 new market hubs in 2026; 2 have been opened to date, bringing the total to 35, on track for a target of 60 hubs by 2027. Hub expansion improves same-day hard parts coverage to support market share growth, and markets with hubs have delivered ~100 basis point better comparable sales than markets without hubs.

- **Store Operations & Technology** * The new store operating model, fully rolled out in Q4 2025, prioritizes better task execution, sales productivity, and labor utilization. Field leaders are simplifying workflows and improving scheduling, while upgraded training and transparent performance metrics drive accountability. * Early indicators are positive: customer net promoter scores (NPS) have improved, and average pro delivery time remains under 40 minutes. * Technology investments include new Zebra devices for faster inventory management, and server/system infrastructure upgrades to improve store efficiency. * Over 1,000 stores will receive physical upgrades in 2026 as part of the multi-year asset management plan.

- **Financial Highlights** * Adjusted gross margin was 45.1% of net sales, a 210 basis point year-over-year expansion, driven by product margin improvements from merchandising initiatives and cycling 2025 store optimization headwinds, partially offset by $17 million in LIFO expense. * Adjusted SG&A was 41.3% of net sales, with 200 basis points of leverage; adjusted SG&A fell 3% year-over-year, driven by cycling 2025 store optimization expenses. * Adjusted operating income was $99 million, and adjusted diluted EPS was $0.77, compared to a $0.22 loss per share in Q1 2025. * Free cash outflow improved to $75 million from $198 million year-over-year, driven by stronger operating performance, better working capital management, and lower restructuring costs. Inventory grew 5% from year-end 2025 to support expanded product availability. The balance sheet is solid, with $3 billion in cash and net debt leverage of 2.4x, within the 2.0x to 2.5x target range.

Overall: Net sales for Q1 2026 were $2.6 billion, a 1% year-over-year increase, with comparable sales growing 3.5% (the strongest growth in five years). The 3.5% comparable growth was offset by a 2% headwind from cycling 2025 Q1 store optimization liquidation sales.

Pro Channel: Comparable sales grew mid-single-digit, with consistent monthly growth. Main Street Pro comparable sales outperformed the overall pro channel by more than 200 basis points, driven by strategic focus on this higher-margin, larger addressable market segment. The optimization of large national account pro business continues to create a headwind for the channel this year, with the largest headwind occurring in Q1 that will moderate through the rest of the year.

DIY Channel: Comparable sales grew low single-digit, reversing softness from the prior quarter. Performance remains tempered by broader inflationary pressure and stretched consumer household budgets. Same-skew price inflation was 3% in the quarter, in line with expectations, and average ticket was positive.

Management reaffirmed its full year 2026 guidance, with no upward or downward revision from prior projections. Key guidance details:

* Net sales: Projected at ~$8.5 billion, with comparable sales growth expected in the 1% to 2% range, with positive same-store growth in every quarter. The first half is expected to be stronger than the second half due to easier comparisons and strong Q1 performance. * Inflation: Same-skew price inflation is projected at 2% to 3% for the full year, with inflation running at the higher end of the range in the first half and the lower end in the second half. Recent tariff changes have not altered inflation expectations. * Channel outlook: The Pro channel is expected to outperform the DIY channel, with both channels contributing positive comparable growth, driven by gradual transaction improvements from better availability and service. * Margins: Adjusted operating margin is projected between 3.8% and 4.5%, representing 130 to 200 basis points of year-over-year expansion. Gross margin is expected to expand 110 to 150 basis points to ~45%, driven by merchandising initiatives including strategic vendor sourcing and pricing/promotion optimization, partially offset by investments to improve supply chain productivity post-consolidation. Adjusted full-year SG&A is expected to decline year-over-year, providing 20 to 50 basis points of leverage, driven by cycling $90 million in 2025 non-recurring expenses; adjusting for this, SG&A is expected to grow at a low single-digit rate. * Adjusted diluted EPS: Projected between $2.40 and $3.10, with full-year pre-tax interest expense of ~$210 million partially offset by ~$80 million in pre-tax interest income. * Capital expenditures: Expected to increase to ~$300 million, allocated to new stores, market hub expansion, store infrastructure upgrades, and strategic investments. The company plans to open 40 to 45 new stores and 10 to 15 new market hubs in 2026. * Full year free cash flow: Expected to be ~$100 million, with stronger cash generation in the second half of the year following the typical seasonal Q1 free cash outflow trough.

- Pressured consumer household budgets and elevated gas prices create potential near-term demand variability, particularly through the seasonal shoulder period between tax refunds and the peak summer driving season, as the impact of higher fuel costs on consumer driving behavior remains uncertain. - Ongoing geopolitical volatility creates potential supply chain and raw material cost pressures that are being monitored and mitigated via close collaboration with vendor partners. - The optimization of lower-margin large national accounts in the Pro channel continues to create a year-over-year headwind for comparable sales, although this headwind will moderate throughout 2026. - Recent increases in fuel and freight costs have created modest upward pressure on SG&A and supply chain costs, which have been incorporated into full-year guidance, but any further increases could create unplanned cost pressure.

Q: With a strong Q1 comparable sales print, what is the expected cadence of growth for the rest of the year, particularly Q2, and how does the national account wind-down impact Pro channel performance through the year? A: Management expects Q2 comparable sales to moderate slightly from Q1, in line with original planning, remaining within the full-year 1% to 2% guidance range, with no major tax refund tailwinds expected. Comps for the second half of the year are expected to land at the low end of the full-year guidance range, matching prior expectations. Q1 saw the largest headwind from national account optimization, and this pressure will gradually moderate through the back half of 2026, with Main Street Pro growth expected to align more closely with overall Pro channel performance over time. Main Street Pro is a larger, higher-margin addressable market, and the team has delivered strong momentum there to drive long-term growth.

Q: Is the better-than-previous sales growth broad-based across categories and geographies, and what is the medium-term margin expansion trajectory after 2026 as easier comparables lap? A: Sales improvements are broadly geographically based, with modestly better performance in the Northeast and Mid-Atlantic that is partially driven by Q1 weather. On the category side, brakes have been a strong performing category for the company, and the new Argos owned brand has seen strong customer reception across its expanded product line. 2026's margin expansion is primarily driven by ongoing merchandising initiatives, while supply chain and store productivity improvements are still being planned and rolled out, with their benefits expected to flow to margins starting in 2027. Management noted a long runway for productivity improvements after the DC consolidation phase, supporting continued margin expansion in future years while maintaining strategic reinvestment.

Q: How much of the Q1 comparable growth step-up is from the company's own transformation efforts versus broader industry tailwinds, and what does the commentary about a soft shoulder period mean for current Q2 trends? A: Management noted that improvements in parts availability and customer service from transformation efforts have allowed the company to fully participate in positive industry demand tailwinds from Q1 tax refunds, a result that would not have been possible prior to recent operational changes. This is the first quarter in the transformation where Advance has delivered growth roughly in line with the overall market, meeting a key near-term goal. Current Q2 trends are in line with planning at the low end of guidance. The shoulder period between tax refunds and peak driving is always a slower volume period, and uncertainty remains around how consumer budgets and higher gas prices will impact summer driving miles. The business is largely non-discretionary, but management is keeping guidance unchanged while waiting to see demand trends play out during peak driving season, and underlying strategic initiatives (especially Main Street Pro outperformance) remain on track.

Q: For the 35 existing market hubs, what performance lift do they deliver, and how does Advance's pricing posture compare to peers, with any potential additional inflation expected in the second half? A: On average, markets with an operational market hub deliver approximately 100 basis points better comparable sales than markets without a hub, with benefits building over time as parts availability increases. The company's pricing strategy remains unchanged: it aims to be competitively priced daily, not the lowest price in the market, which aligns with its current 3% same-skew inflation that is lower than some peer levels. While higher oil and freight costs have created modest pressure, it is not material, and the impact on product costs in the second half is still unclear. Full-year guidance already incorporates modest cost increases, and the rational industry structure allows for close vendor collaboration to mitigate any future cost pressures.