ADVANCE AUTO PARTS INC Q4 2025 earnings call

Good morning, and thank you for participating in today's call. I'm joined by Shane O'Kelly, President and Chief Executive Officer, and Ryan Grimsland, Executive Vice President and Chief Financial Officer. During today's call, we will be referencing slides which have been posted to the investor relations website. Before we begin, please be advised that management's 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 initiatives, plans, projections, goals, guidance, and expectations for the future. Actual results could differ materially from those projected or implied by the forward-looking statements. Additional information can be found under Forward-Looking Statements in our earnings release and Risk Factors in our most recent Form 10-K and subsequent filings made with the SEC. Shane will begin today's call with an update on the business and our strategic priorities.

Later, Ryan will discuss results for the fourth quarter and full year 2025 and provide guidance for 2026. Following management's prepared remarks, we will open the line for questions. Now, let me turn the call over to our CEO, Shane O'Kelly.

Thank you, Lavesh, and good morning, everyone. I want to begin today's call by thanking our frontline team for all of their hard work in 2025. During the year, we laid the foundation to build a better future for the company and create long-term value for our shareholders. We are undergoing a significant transformation focused on the fundamentals of selling auto parts through initiatives guided by the voice of our customer. These efforts are beginning to improve our competitive position and are translating to stronger financial performance. In 2025, we returned to positive comparable sales growth after three consecutive years of negative results. We also expanded adjusted operating income margin by over 200 basis points from near-breakeven levels, while also navigating a volatile external environment. Our journey has just begun, and the early progress is being recognized by vendor partners, customers, and team members.

During 2026, we will continue to execute actions aimed at enhancing parts availability and customer service by building on the foundation established in 2025. We expect these efforts to deliver stronger financial performance in 2026, including an acceleration in comparable sales growth to the 1%-2% range, an expansion in adjusted operating income margin to the 3.8%-4.5% range, and a return to positive free cash flow. We expect to generate approximately $100 million in free cash flow in 2026, while allocating more capital to strategic projects and store investments. The progress made by our team in 2025 has created positive momentum that we are carrying into this year, and I am confident in our ability to succeed in 2026.

Before I provide an overview of our strategic priorities for this year, let's recap 2025. We entered the year with a renewed emphasis on the Blended Box and establishing Advance as a consistent, reliable auto parts provider for both pro and DIY customers. Our team is already driving results through comprehensive actions taken last year. For example, number one, we rationalized our asset footprint by exiting underperforming locations, including over 500 corporate stores and 200 independents. We achieved this with minimal disruption to our day-to-day operations and saved approximately $70 million in operating costs. Number two, we expanded our assortment by 100,000 new SKUs. We improved store availability to the high-90% range from the low-90% range at the start of 2025, and we also reduced product costs by more than 70 basis points.

Number three, we increased our average speed of delivery to pro customers by cutting more than 10 minutes in delivery time from an average of over 50 minutes at the start of 2025. Number four, we moved with speed to substantially complete the consolidation of our distribution center network. We now operate 16 distribution centers in the U.S., compared to nearly 40 DCs at the end of 2023. And number five, we opened 14 new market hubs and now operate 33 market hub locations. We also opened 35 new stores to further enhance density in our strongest markets, and we invested nearly $90 million in store infrastructure upgrades at more than 1,600 stores. Throughout the year, we also navigated a series of external challenges, including a volatile tariff and consumer spending environment. We maintained focus on executing actions to improve availability and service.

This enabled us to deliver positive performance in the pro channel, which strengthened throughout the year. We are progressing on our strategic plan with a stronger balance sheet, having proactively accessed the capital markets during 2025. As we move forward, we will continue to prioritize actions within our control to improve operational performance. In recent months, we have also strengthened key leadership positions through internal promotions and the addition of talented external expertise. These include Anthony Sarlanis, former Regional Vice President of our Northeast Operations. He was promoted to Senior Vice President of the pro business. He has been with Advance for over 15 years and brings more than two decades of automotive experience to the role. Kunal Das, our former Chief Data Officer, now promoted to Chief Technology Officer. His team has led the development of proprietary AI tools to improve our day-to-day execution. Ron Gilbert.

Ron joined Advance in December as Senior Vice President of Supply Chain. He brings more than 20 years of experience in supply chain logistics, with a track record of delivering operational efficiencies in complex supply chain systems. Tony Hurst. Tony joined Advance in January as Senior Vice President of U.S. Stores. He brings more than 25 years of field leadership and store transformation experience across pro and DIY, with a proven record of simplifying work for the front line. The caliber of our leadership team reinforces my confidence in our ability to grow transaction volumes through strong customer service, and to deliver greater productivity in our store and distribution center operations. Since late 2023, we have acted decisively to stabilize the business, conduct a comprehensive review of operational productivity, sell non-core assets, and develop a strategic plan.

To date, this team has delivered approximately 500 basis points of adjusted operating margin expansion. We continue to believe that our goal of 7% adjusted operating income margin with a mid-40% gross margin, are appropriate medium-term targets for the company. As a reminder, about half of our identified margin opportunity is tied to merchandising excellence, with the balance being driven by supply chain and store operations. I am pleased with the progress being made in unlocking this margin opportunity. We concluded 2025 with an adjusted operating income margin of 2.5%, and for 2026, we are targeting an additional 130-200 basis points of expansion to the 3.8%-4.5% range.

This guidance includes an approximate 45% gross margin rate, which showcases success against our initiatives on the path to a 7% operating margin target. Our goal is to deliver consistent progress on our plan to narrow our margin gap to the industry. We currently believe that we can deliver at least another 100 basis points of margin expansion in 2027, which would mark the third straight year of 100 basis points or more of expansion. Although this pace would imply an outcome below our previous target of achieving 7% in 2027, it is important to note that this is not the result of any change to the execution of our strategic plan. Rather, we are being prudent about two factors as we consider the expected timeframe for achieving our goals. First, initiatives across our three strategic pillars are progressing at varying rates.

We have made strong progress in merchandising and completed the consolidation of distribution centers. We are now in the early stages of implementing supply chain and store labor productivity initiatives. I am excited to welcome new leaders overseeing the implementation of these activities. We expect our investments in 2026 to enable further margin expansion in 2027 and beyond. And second, top-line momentum has lagged original expectations. Our pace of same-store sales growth has been impacted in part by external economic factors that have resulted in a softer consumer spending environment. While we are pleased with the strong positive comps in our pro business, including traction with Main Street Pros, we still have a lot of opportunity ahead as we continue to improve availability and service metrics. I want to reiterate, I am pleased with the progress being made on our strategic plan.

I remain confident in the ability of our team to deliver against our operational and financial goals. Our quality of execution is improving, and we expect 2026 to be a pivotal year on the path of long-term value creation. Next, let's turn to an update on our strategic plan. As I've indicated previously, our strategy is unchanged and built on three pillars that are supported by targeted initiatives to deliver long-term profitable growth. Turning to our key priorities for 2026, which build on the foundational improvements achieved in 2025. Merchandising excellence is expected to be the largest contributor of margin expansion during the year, and our four merchandising initiatives for the year include: First, in 2025, we began repositioning Advance as a trusted long-term growth partner.

Our focus on operational excellence and streamlining legacy processes has signaled to the vendors that Advance is here for the long term. In 2026, we expect to further deepen our vendor partnerships to jointly grow our businesses. We are doing this through strategic business planning, exploring supply consolidation, eliminating non-value-add supply chain costs, engaging in training opportunities for the field, and collaborating on joint marketing efforts. We expect this to translate to better cost opportunities and stronger part margins in the year. Second, in 2025, our pricing decisions were made largely in reaction to new tariff programs. However, we still focused on offering compelling value to our customers through fewer, bigger, and bolder promotions. During 2026, we expect to deploy a new pricing matrix, which provides our team better intelligence of market-based pricing by channel and by SKU.

Our goal is to offer competitive pricing while continuing to operate rationally in the marketplace. We expect a combination of smarter pricing, supplemented with seasonally relevant promotions, to drive stronger customer engagement and support repeat purchases. Third, 2025 was an important year for our assortment. We addressed product gaps and also improved brand coverage and application job bundles for parts in our stores. We did this by using a specialized data-driven approach, as well as improving internal processes and incorporating feedback from customers to develop a new assortment framework that was fully rolled out to all stores last year. This work has expanded parts coverage for brands we carried previously and also enabled us to introduce new brands. Our success with the brake category is a great example of this.

Thank you, Shane, and good morning, everyone. I want to begin by thanking our frontline associates for their commitment to serving our customers and delivering a strong finish to 2025. For the fourth quarter, net sales from continuing operations were approximately $2 billion, which declined 1% compared to last year. This is mainly attributable to the store optimization activity completed in Q1 of 2025. Comparable sales grew 1.1% in the fourth quarter. Following a softer start to the quarter, transactions improved during the last eight weeks, resulting in positive comparable sales growth over that timeframe. In fact, outside of weather-related comparisons, our business has been averaging low single-digit positive comps over the last six months, reflecting operational stability as we execute our strategic plan. Brakes, undercar components, and engine management led performance, indicating progress in improving coverage and availability of hard parts.

Ticket was positive for the quarter and driven by a combination of better unit productivity and higher average prices. Our frontline team has been focused on providing complete job solutions to our customers, and I want to thank them, as their efforts have translated to an acceleration in units per transaction on a one- and two-year basis. Overall, average ticket was still below expectations due to some discrete factors. First, same-SKU inflation came in just under 3%. This was about 100 basis points lighter than expected due to successful tariff-related negotiations, which were still underway at the start of the quarter. Second, during Q4, we accelerated the transition of some front-room assortment to introduce new brands following recent supplier changes and to support the planned launch of our new owned brand, ARGOS.

These transitions led to a higher-than-expected markdown headwind of about 50 basis points, which impacted comps. This activity has been completed. It is not expected to impact Q1 results. Looking at channel performance, our pro business grew by nearly 4% during the quarter, with sales strengthening throughout the quarter on both a one- and two-year basis. Trends in DIY remain volatile, leading to a low single-digit-percent decline in comps. We believe this is largely a continuation of the market trends we have experienced all year. Our core consumer group has been adjusting purchasing habits in response to rising prices. Moving to margins. Adjusted gross profit from continuing operations was $873 million or 44.2% of net sales, resulting in nearly 530 basis points of gross margin expansion compared to the same period last year.

During the quarter, we cycled through approximately 280 basis points of atypical margin headwinds related to our restructuring activity last year. The balance of margin expansion was driven by savings associated with our footprint optimization activity and benefits from our strategic sourcing initiatives. Additionally, LIFO expense came in at $56 million for the quarter, which was lower than previously expected. Adjusted SG&A from continuing operations was $800 million or 40.5% of net sales, resulting in nearly 340 basis points leverage. This was consistent with expectations for a high single-digit-percent expense decline and driven by a reduction in stores compared to last year. As a result, adjusted operating income from continuing operations was $73 million or 3.7% of net sales, resulting in nearly 870 basis points of year-over-year operating margin expansion.

Our Q4 results also include an extra operating week, which contributed $132 million in net sales and $9 million in adjusted operating income. Adjusted diluted earnings per share from continuing operations for the quarter was $0.86, compared to a loss of $1.18 last year. The extra week added $0.08 to fourth quarter EPS. Moving to an update on full-year 2025 results. Net sales from continuing operations declined 5% to $8.6 billion, primarily due to store optimization activity that was completed during Q1 2025. Comparable sales grew just under 1% for the year, marking our return to positive comparable sales growth. Both channels improved compared to last year. Our pro business grew in the low single-digit range, while DIY declined in the low single-digit range.

Same-SKU inflation contributed about 140 basis points to ticket growth for the year. Adjusted gross profit from continuing operations was $3.8 billion or 43.9% of net sales. Resulting in about 165 basis points of gross margin expansion compared to last year. During the year, we cycled through approximately 90 basis points of atypical margin headwinds related to our restructuring activity from last year. Adjusted SG&A from continuing operations was $3.6 billion, or 41.4% of net sales, resulting in about 50 basis points of leverage, driven by operating fewer stores compared to last year. As a result, adjusted operating income from continuing operations was $216 million, or 2.5% of net sales, resulting in 210 basis points of year-over-year operating margin expansion.

Adjusted diluted earnings per share from continuing operations was $2.26 for the full year 2025, compare with a loss of $0.29 for full year 2024. We ended the year with free cash flow of -$298 million, which included approximately $140 million in cash expenses associated with our store optimization activity. The remaining outflow of approximately $160 million impacted our ability to generate positive free cash flow. About half of the variance compared to our expectations was related to combination of Q4 business performance, timing of certain cash obligations, and a delay in receipt of tax refunds. The other half was associated with variances relative to our expectations for timing of certain inventory payables that drove approximately $80 million of cash outflow and reduced our payables balance at the end of the year.

Separately, we also lowered the usage of our supplier financing program to $2.5 billion from $2.7 billion last quarter. We enter 2026 with a solid balance sheet, including more than $3 billion in cash and $1 billion undrawn revolving facility, which is more than sufficient to support approximately $2.5 billion in supplier financing payables over the long term. Our net debt leverage improved to 2.4 times at the end of the year, compared to 2.6 times last quarter, and is in line with our targeted range of 2-2.5 times. Turning to 2026 guidance. We expect net sales to decline slightly year-over-year, mainly driven by two non-recurring items from 2025. First, we generated $51 million in liquidation sales in Q1 last year.

Second, Q4 included an extra week, which generated $132 million in net sales. In aggregate, both items drive over 200 basis points of headwind to sales growth. Excluding these non-recurrent items, we expect underlying net sales to grow in the range of approximately 1%-2%. This includes comparable sales growth of 1%-2% and about 10-20 basis points of pressure related to sales normalization at independent locations, following a reduction in locations last year. We expect positive comp growth in each quarter with a stronger first half, owing to easier comparisons. Same SKU inflation is currently planned in the 2%-3% range for the full year and assumes no change in the current tariff environment. In terms of channel performance, we expect pro to outperform DIY, with both channels contributing positively to comp growth.

This is expected to be driven by gradual improvement in transactions, with initiatives focused on enhancing availability and service levels. We are excited to get back on the path of consistently delivering positive comparable sales growth and expect our strategic plan to ultimately position us to gain market share in the future. Moving to margins, we expect adjusted operating income margin between 3.8% and 4.5% for 2026, resulting in 130-200 basis points of year-over-year margin expansion. We are forecasting gross margin expansion in the range of 110-150 basis points to approximately 45%. This margin expansion includes about 20 basis points of year-over-year favorability from cycling non-recurrent items from 2025.

The balance of the expansion is expected to be driven by merchandising initiatives related to strategic vendor sourcing and optimization of pricing and promotions. The benefits from merchandising initiatives will be partially offset by investments to improve productivity in our supply chain operations following completion of the consolidation phase of our DC network. Based on the progress of our initiatives, we expect gross margin rate to build throughout the year, starting with Q1 gross margin in the 44%-45% range. Regarding SG&A, we expect reported full year expenses to be down year-over-year, contributing 20-50 basis points of leverage. Specifically regarding Q1, SG&A expense is planned to be down in a 3%-4% range as we cycle through the store closure activity from last year.

Full year 2025 SG&A expense included about $90 million of non-recurring items to support liquidation sales and the extra week, which is expected to drive about 20 basis points of favorability in 2026. Adjusting for the non-recurring expense, SG&A is planned to be higher year-over-year, with modest leverage driven by positive comp sales growth. We expect to deploy savings generated from better in-store task management, better resource allocation, and a reduction in indirect spending to fund general wage inflation, store opening expenses, and strategic labor investments in priority markets. As Shane indicated, we have completed the rollout of our new store operating model, which has enabled us to position labor and truck resources based on volume.

Thank you, Ryan. During 2026, we are building on the foundation established last year with a clear focus on executing our strategy to deliver improved operational performance. I'd like to close by thanking the Advance Auto Parts team for all of their hard work and commitment to serving our customers.

Thank you. Operator, we can now open the line for questions.