All right. What an opportunity this is. For the first time in the 18 years that I've been running this conference, we're very fortunate to have Advance Auto Parts here. When you think about some of the companies that are undergoing change, maybe Advance provides one of the greatest opportunities, at least from our perspective. Company is based in Roanoke, Virginia, is about 58 million shares, about a $3 billion equity cap, effectively no net debt, about $200 million in net debt.
We're really fortunate to have Shane O'Kelly here, who joined Advance from HD Supply in 2023 as the company CEO, and then Ryan Grimsland, the company's CFO. We will get into Q&A, but thank you, gentlemen, for making the trip here. 18 years. We're going to put our hooks in you and make sure you're here for our 50th. Thank you very much.
Good. Thank you for having us.
Thanks for joining us today. Maybe just start off, can you give us a quick overview of your third quarter earnings from last week and just give your thoughts on the market reaction following the results?
Yeah, certainly.
I'll just drive for the Zoom . Keep your microphone as close as you can. Thanks, Shane.
Great. Thank you. Great to be here, ladies and gentlemen. If I could sort of suggest one thing that's different this time, it is the fact that we're here. You're going to see that theme throughout our comments and our actions. We are turning around Advance Auto Parts. Being here is a small step towards that. Specifically, as it relates to Q3, we're in a great quarter, our strongest in over two years, as evidenced by a 3% comp, 4.4% OI, positive growth in DIY and Pro, an acceleration of our DMA strategy, where we're improving the assortment in our markets and stores, an acceleration of our market hubs, a new facility for us to where we'll have 33 by the end of the year, a validation that our strategic sourcing plans are working.
We hear from vendors leaning in to partner with us on our journey forward. Continuity in our DC consolidation, where we will end the year at 16 DCs. Normally, we do not comment on the market. I do feel that last week's movement was an overreaction. I say that because if you look at three kind of key points, first is our strategy remains unchanged in terms of what we are doing in the company. Secondly, we are making progress on those strategic pillars, on those key actions, demonstrable progress moving forward. Third, in terms of the backdrop where we are doing it, auto parts, aftermarket, the aftermarket auto parts industry is a great industry to be a participant in. Ryan?
Yeah. I'll just add, one thing that should be clear is our strategy hasn't changed. Shane talked about it. Our goals haven't changed. What we're doing is we're making incremental progress in all of those initiatives. Just going back to the building blocks we laid out last year, last year was a very different time for us. Right here, we were a week away from announcing shutting 500 stores, exiting 300 independents, restructuring the business. To be here today and the progress we've seen this past year, we're pretty excited about what we've been able to accomplish within a year. It's only two quarters since we shut our last store. That means a lot that the teams have really pushed forward on those building blocks. To go back to those building blocks, there were three pieces to it. It was merchandise and excellence.
It was our supply chain, productivity, and then our stores. That merchandise and excellence, if you are familiar with the story and the plan we laid out last year, was the biggest block of that success in achieving our goal. We have seen tremendous success there this past year and will continue. Our goals were built on improving operating margins every single year. We still plan to continue to improve operating margins. We like the progress we are making so far. We like seeing what the merchant team has done and been able to partner and our vendors leaning in to support this transformation. A lot of good work this past year. We are excited about what we are doing going forward. We obviously wanted to give some insight into more recent challenges we see in the DIY consumer.
Overall, we're super excited about a quarter that was really pivotal for the company and also the progress we're making on our initiatives.
If we're, Shane, if we've been sitting here, obviously, for a while from an annual perspective, and we've seen subsequent, we've seen each subsequent CEO come into Advance with a strategy, a vision to fix. Maybe talk about what was done prior to your arrival and what's so different about how you and your team are attacking the challenges that are ahead.
Yeah. So, well, we're here. So first time in 18 years. By the way, should not be lost on anybody. I view this as the professional opportunity of a lifetime. So much so that you have a Home Depot guy and a Lowe's guy working together that in our past lives, never the twain shall meet. Right? So.
We'll see if you hire anybody from Annapolis.
Yeah. I did a stint there as well. I am a service academy graduate. I went to West Point. Importantly, there are a couple of tenets from my time in the service that are applicable here and why it is different. First, I believe in the inverted pyramid. That is a way of leading where customers are first and everybody supports the front line. There is no ruling by fiat. Leadership only gives you the mandate to do right by the people in your charge. That is a different approach than perhaps what our company epitomized previously. By the way, I also believe from my time in the service, you have to act decisively. You have to be willing to make tough decisions, in particular when those decisions are critical for the company's long-term well-being. By the way, often commonly known by certainly folks internally, if not externally.
The first thing we did as it relates to how we're fixing this company is look at the big picture and say, what and who do we want to be? We espouse the idea of being a blended box, which means we serve pro and DIY out of the same facility. By the way, I've seen that in a past life. Ryan's seen that in a past life. We will focus on the fundamentals of selling auto parts, not shiny objects, not the latest initiative from Management Today magazine. We're going to focus on having parts in stores that meet the needs of our customers, pro and DIY. By the way, part of that means getting the right leaders in the seats and being willing to look at the experience base of who's playing.
I use this example a lot, but Lamar Jackson got injured with the Ravens. Why did they not put Michael Phelps in there? Michael Phelps is a great athlete. Michael Phelps is from Baltimore. Michael Phelps is 6'5". We, unfortunately, as a company, did not look at the requisite functional competence or industry experience in terms of who we put in the seats. That has changed. By the way, back to the military experience on tough decisions, here is a list of them. We sold Worldpac. By the way, when we sold Worldpac, people saw the residual business for what it was and what it was not in terms of profitability. We reduced headcount significantly inside of headquarters. We made the decision to close hundreds of stores and cancel hundreds of independents. That is brutal to do. We exited entire states. We had to move the product.
We had to deal with the team members. We had to deal with customers, all of the complexities that come with that. We invested in the front line where wages simply were not where they needed to be. We made the decision to consolidate the DC infrastructure of things that are tough to do. Think about the hundreds of thousands of parts moving every day across the network. When I came to the company, Ryan came to the company, we had 50 DCs. As we sold Worldpac, there was 38. Last year, we went 38 - 28. This year, we will go 28 - 16. Every time you do that, there are hundreds of stores that get pointed to a different DC. There are assortments, items that have to be added. We introduced the Market Hub, a brand new node.
By the way, as we do our approach, if we see success in terms of an activity or an initiative that's being well executed somewhere else, we will mimic that. We will mimic that. We will bring metrics and rigor to the process. By the way, under Ryan, make sure we have the balance sheet for the journey.
Yeah. I'll add a couple of things to that. I think it's really important. We invested in pricing in that first year. Remember that? We invested $100 million in pricing, and that got us into a competitive place, but we took it on the chin for that. We do accelerate things. We were rolling out our new assortment work, which was getting the right parts in our stores to service that market based on vehicles, etc., in the marketplace. When we were rolling that out, we planned to do that over 18 months. We saw good success. We accelerated that, just completed that Q3. We started that in Q1. We finished it in Q3. That was an 18-month plan. Where we can see opportunities accelerate, we will. Where there are opportunities for us to pause and learn more, we do that as well.
Our store operating model, which is aligning the right trucks and assets to the demand of the market, also aligning our hours in our stores correctly, that we started testing early part of the year. We wanted to learn more. We knew that if we rolled that out and we rolled that out incorrectly, that could have a really big impact on our customers, our store employees, etc. We took longer testing versions of that. We're starting to roll that out in Q4. We originally wanted to roll that out the second half of the year. We're actually delayed a little bit in that. That is because we know we wanted to learn more. Some things we're going to accelerate where we see opportunity to accelerate. We're going to slow things where we feel like it's prudent for us to learn more before we accelerate.
You've touched on different parts of this, but can you just back up a little bit and just give us a quick overview on the kind of different pillars that you guys are looking at when it comes to kind of optimizing the business?
Yeah. Fundamentals of auto parts, blended box. What falls out from that are the right parts in the right place with the right service. As you guys know from studying the industry, there are two fundamental questions that govern your success. Customer calls up, says, "Do you have the part? Yes or no? When can I get it?" At times, "How much does it cost?" We modeled what we needed to do to be successful in answering those questions. The first strategic pillar is merchandising excellence. That includes how we source our products. That includes how we assort product in the stores. That includes how we manage pricing and promotions. Ryan can unpack a bit about the magnitude. I'm particularly excited by the opportunity.
Of particular note, when I came to this show two years ago and met with vendors, the support of the vendor community for Advance's long-term success can't be understated. They say, "We want you. We want you as an outlet to sell our product. And importantly, we need you in the industry." It's helpful to their dynamic. To have that vendor support and to have the backdrop of this industry being as favorable as it is is really important for the turnaround. Secondly, as we think about getting parts in the right place, what we're doing with our supply chain, again, back to really tough decisions, consolidating down the DC network is a huge undertaking. Simultaneously opening Market Hubs, simultaneously figuring transportation routes. That's really important. Lastly, in terms of the right service, that's what goes on in our stores.
That goes on as it relates to how we manage our operating model in terms of where we put hours and trucks. That goes on in terms of how long it takes us to deliver. In this industry, my sense is you got to be 30-40 minutes from the time you get an order to get it to a customer to be in the mix each and every day. Lastly, we needed to rejuvenate, really restart a new store opening capability and, by the way, a store improvement capability to where the atmosphere for our team members and our customers was conducive to winning business. Perhaps a bit about the size of the prize.
When we rolled out this strategy, we quantified what these three pillars really meant from an operating margin expansion. It's over 500 basis points for us from OI. The biggest chunk, if you go back to our nice little fancy waterfalls, the biggest piece of the merchandising excellence from an operating income expansion, and that's where we're going to see the largest portion of that margin expansion is going to be in gross margin. The second piece is supply chain. We talked about consolidating supply chain down to the 16 DCs. You go from 38- 16 DCs in two years. That's a lot of movement of product, change and replenishment for your stores. It's really impressive the team's been able to do that and continue to replenish our stores and improve the replenishment levels for our stores.
The next unlock in supply chain is now that you've consolidated down to these bigger DCs, it's getting productive within those boxes. Now your order quantities change and the flow of the product changes and the speed at which you can flow it and then your transportation around those DCs and your stores. That's the next unlock that we're working towards into next year. On the store operating model, one thing to note, while SG&A is a part of that growth, it's not the largest piece of that. SG&A, there is some opportunity for us to continue to get some improvement there. Really, that's because I don't think it was efficiently spent in the past. This is getting our SG&A dollars spent in an efficient manner. Not just cutting just to cut. We want to invest for growth. We're investing in areas.
We're investing in hours in the right areas. We're investing in trucks in the right areas to support demand. Where there are other areas where there was inefficient, that's where we're pulling back SG&A. Getting smarter on that. As far as some of the things we've done to support those pillars, I think one of the biggest things we did this past year was we supported our supply chain finance program. When we think about merchandising excellence and those conversations with your vendors, supply chain finance is a critical piece of that vendor ecosystem and the whole ecosystem within our industry. The work we did this past summer, we raised $2 billion. We now have over $3 billion of cash on our balance sheet along with current assets that support that program. It's very unique. It's different. We know this program was important.
We went out and worked with our banks as this is an investment-grade type product. We're not investment-grade. We want to keep it in place. We want to bridge ourselves back. Let's think creatively around how we can support it where you will feel comfortable supporting this program. It stays in place for our vendors. The merchants and the vendors can have good, fruitful conversations and this not be an impact. We've created a unique product where it's supported one for one. Actually, more. We've got $3.2 billion of cash on our balance sheet, and we have less than $3 billion in commitments on supply chain finance. When you look at what's going on today and the questions around supply chain finance, it's a much more stable program within Advance Auto Parts given what we've done on the balance sheet. We're pretty excited about that work.
That helps. That's an enabler. That's a foundation enabler that helps the merchants go have conversations with vendors from a position of strength and being on our front foot versus being on our back foot.
If I could, where Ryan's bringing up a good point is to do this turnaround effectively, we want to do the things that we can control. If you think about those three pillars and you think about those different activities, those are things we control. We can control how we get a good merchant in a seat who learns best practices around doing a product line review and has those conversations to sign an agreement that has more normalized terms than perhaps we had in the past. As we've gone across that, we control how we consolidate the supply chain. We control how we assign hours in the store. We know that if we do these things, it goes back to being able to answer those customers' questions. Do you have the part? Yes or no?
When can I get it that we can be successful? What Ryan's done with the balance sheet is made sure that that's not a vehicle that's going to interrupt us, that we've got the balance sheet for the journey to include the importance of supply chain financing.
Hey, guys. It's Michael Lasser.
Hey, Mike. Good to see you.
Michael!
Good to see you guys. As you mentioned at the outset, your stock's been volatile over the last few days. Probably two factors that have weighed on the stock price have been one, the comments that you have made consistently that this transformation is going to be non-linear. Those fears were exacerbated by your indications that the fourth quarter has started off slow, which may have suggested the business is going to take a little bit of a step back. Second, that you've indicated that there should be some modest or moderate margin expansion in 2026, but may have been interpreted by the market that you're placing a lot of weight on 2027 to get to your 7% operating margin. In light of the confusion around these factors, can you shed a little bit more insight on those two considerations?
Yeah. Great question. I'll start and let Shane jump in too. I would say that our plan, strategy hasn't changed. Plan hasn't changed. Improving operating margins year over year is absolutely part of the plan and will continue into next year. We are currently in our planning process for 2026, which needs to contemplate those investments and timing of those investments we're making or the timing of a line review and the product coming in and when that will hit next year to give everybody a good idea of what next year's expansion would be and the magnitude of it. It needs to be a positive growth. I think thinking of it as a small, modest, moderate is probably not appropriate. We want to be able to give a more informed view of exactly what we believe next year to be.
We will show gross margin improvement. We'll show operating income improvement next year. We like the work we're doing. Some of that work is continuing into next year. As you think about supply chain investments, we've consolidated DCs down. We're going to invest in productivity next year. The timing of that and when you get the productivity is important for us to lay out. When we said non-linear, I think everybody in here is smart enough to know in a turnaround, you're going to have some quarters where you accelerate some investments. You have some quarters where I don't think we need to educate anyone any longer on what a turnaround looks like and the non-linear nature of it. I think we all know that we will make plans and we'll adjust accordingly. Like the fact that we accelerated our assortment work in our DMAs, that's non-linear.
The fact that we paused the store operating model to test and learn more about it. That's not linear, right? There's things that happen. I don't think we need to dive deep into that. I think to answer the question on operating margin next year, yes, we're going to have operating margin expansion next year. That's part of the plan. The strategy plan hasn't changed. The magnitude of that, we want to come back in the February call to share that as we finalize the plan so we have a good idea of what that looks like.
I think people construed non-linear to mean instead of Y equal X, Y equals - X. As we go forward, we're on a positively sloped curve in terms of where we're taking the company. Ryan touched on operating margins. We'll share when we get our 2026 numbers out there. Think about that in terms of CapEx. Think about that in terms of cash flow. Think about that in terms of things that we're doing with pro accounts. We are making progress and demonstrable progress across the three pillars. We have a series of subset initiatives every period. We go over them as a team and we review them. I think as a function of the slope, still positive changes and/or the sentiment that everybody sees on the broader consumer in the market, I think that ended up being taken pretty negatively.
Gentlemen, can you just refresh for the audience post Worldpac the DIY, DIFM split from a customer base? And what's the easier customer to bring back into the organization?
50:50, I think, is what we put out. Both customer cohorts have their needs and wants. I think in the earlier days, as we go forward, the pro customer is where we've had greater earlier traction as a company. If you think about both from a heritage perspective and in terms of what we have in terms of innate capabilities, we're well suited to drive pro growth. By that, I'm referring to the men and women in our outside salesforce, our delivery capabilities, trade credit, and our independent network, our relationships with larger accounts. We have a whole series of things around conditions for success there. On the DIY side, we're certainly interested in that market segment. You'll see us engaging in activities to make our traction there firmer. Those include our new store opening capability. Those include fixing our existing stores.
Those include building capabilities on our website to do things like bundled products. Those include how we use paid search. Those include how we use regular search. Those include training for team members to engage with DIY customers coming through the door. We have a whole host of activities just within the DIY cohort. Other things you want to?
Yeah. I think both of them shop very differently too. A DIY consumer a couple of times a year, whereas a pro, you get an opportunity every single day to show up. However, they have a business that they're running. I think in the past, we have not supported the pro, Main Street pro customer well enough. I think it's going to take a little bit of time to move up that call list. How long that takes, I'm not sure. We need to show up every single day consistently delivering the service level, having the parts in place. Then we'll win that business. I think our team members will be a differentiator.
I mean, the service level that we're seeing, the improvement in that service level, the relationships that they build, we're leaning in there because that's going to be a differentiator for us. The DIY, we're making the right investments, but they don't shop as frequently. Their experience might take time for them to understand, "Oh, it's different in this place than it was three years ago when I shopped here.
If you think about a couple of the components from our strategic pillars that have pro-centricity, one is the delivery timeline. It is atypical for DIY customers to take delivery, but almost always the norm with the pros. The second is the assortment work that we have done as this first unlock has been hard parts, backroom oriented. That is the domain of the pro customer predominantly.
Your cash flow guidance this year of - $80 million to $90 million, that includes the $130 million of cash restructuring charges?
Actually, $150 million. $130 million was through Q3. We'll do 150 by the end of the year. It does include that. If you back out the $150 million, we're cash flow positive.
Yep. That would, based on the operating margin improvement then for 2026, that would imply that you should be meaningfully cash flow positive then.
Yeah. We expect to continue to be cash flow positive and improve on that. Going forward, that's part of the plan is that we maintain a positive cash flow as a company. You might see a little bit of uptick in CapEx from the normal one just because we had some timing this year where we're moving some CapEx into next year, but we'd still remain in a positive trajectory and free cash flow.
Yep. Thank you.
Absolutely.
Hey, guys. Thanks a lot, Max Rakhlenko, TD Cowe n. So, two-parter. First, just any more color on what you're seeing on the DIY side and what has occurred more recently given concerns around elasticity and deferrals. Then separately, at what rate do you think inflation could peak? Is that more of a 1 Q or potentially 2 Q 2026 event?
Yes. A couple of things. On the DIY trends, we saw a little bit in the beginning of the quarter, some deceleration in that, some moderation in the DIY performance. We saw a little bit on the pro. We talked about this on our call. Some of that can be weather related. The first week or so of our quarter, we had some real cold weather come through. We saw some good performance last year, so we are cycling over that. The trends on the DIY, we are just cautious and watching because we have seen inflation in this industry. Is that having an impact on consumer behavior or not? That is what we are looking at. The one interesting part about our industry is that even when there is consumer pressure or recessions in the past, 90% of our business is repair maintenance.
Only about 10% is discretionary. You have to start and stop your car. You have to get from point A to point B. You can put off for a little bit some of that work you have to do, but you cannot put it off that long. Our industry, and those that have followed this industry for a while, are fairly familiar with this, is that it is somewhat resilient in those times. I would expect that resiliency would continue. Consumers have to get from point A to point B. By the way, if you put off a brake job too long, it becomes a much bigger brake job. Now you are replacing rotors and calipers, etc. That bodes well for the industry. We are watching it. We are monitoring it.
It doesn't change what we control, which is the continued execution of our strategy, the continued execution of merchandising excellence. We're going to open up four more market hubs this year. We have over 2,000 stores in a market hub ecosystem by the end of the year, which is really positive for us going forward. We're going to continue to execute, roll out our store operating model. The things we can control, we'll control. We'll stay vigilant to see how the consumer is being impacted. I think broadly across retail, you're seeing some impact on the DIY side of the consumer.
We're bumping. Go ahead.
Yeah. Just a quick one. How much per hub? And at the end of 2026, you'll have how many hubs left to build?
Yes. We'll have 33 by the end of this year. We've committed to having 60 by mid-2027. We haven't put out the number for 2026. All in CapEx is about $2 million that we do that. Yeah.
All right. Shane, Ryan, thank you very much for being here. It's been great. I look forward to seeing how Advance, advances.
Yeah. We'll be back. Thanks.