ADVANCE AUTO PARTS INC (AAP) Q1 2026 Earnings Call Transcript

Welcome to the Advance Auto Parts First Quarter 2026 Earnings Conference Call. I would now like to turn it over to Lavesh Hemnani, Vice President, Investor Relations.

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 our 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 progress on our strategic priorities for 2026. Later, Ryan will discuss results for the first quarter and guidance for the year. 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 by thanking our frontline team for their hard work, which delivered a solid start to 2026. Comparable sales grew by 3.5% in the first quarter, marking our strongest quarter of growth in 5 years. Based on market indicators, we believe our results were closely aligned to broader market trends, reflecting meaningful progress over the last 2 years. The Pro channel was the primary driver of sales with consistent monthly growth in the mid-single-digit range. Performance in the Pro channel was driven by our strategic focus on the Main Street Pro, where the sales growth remains stronger. The DIY channel also delivered positive low single-digit growth, reversing the softness experienced last quarter. Our Q1 performance reflects continued improvement in parts availability and customer service, which is helping us respond to favorable industry dynamics. We continue to execute initiatives firmly rooted in the fundamentals of selling auto parts as we aim to stabilize market share in the near term while positioning ourselves for share gain in the future. The team also delivered healthy profitability in the first quarter. Adjusted operating margin expanded by over 400 basis points to 3.8%. This progress was partly fueled by effective merchandising execution and product margin expansion. We expect Merchandising to remain the primary catalyst for margin improvement throughout the year, and I'm encouraged by the progress our team has made. We also continue to drive accountability across the organization to improve productivity, which contributed to healthy expense leverage in Q1. We are pleased with the strong start to the year, and we continue to make progress on our strategic initiatives, which gives us confidence to reaffirm our full year guidance. We are closely monitoring consumer spending patterns as we transition beyond the recent tax refund tailwinds that have shaped trends in recent months, while higher gas prices may introduce temporary fluctuations in demand we remain confident in our long-term growth prospects, supported by robust underlying fundamentals, including an aging vehicle population, growing car park and increasing miles driven. Next, let's turn to an update on our strategic priorities for 2026. Our strategy remains unchanged and is built on three pillars, supported by targeted initiatives to drive sustainable, profitable growth over the long term. We remain committed to executing actions under our 2026 strategic priorities as we make progress on our journey towards a medium-term 7% adjusted operating margin target. Let's begin with Merchandising. Over the past year, our strategic business planning efforts have helped strengthen our vendor relationships. We are doing this through better internal processes, streamlining of non-value-added vendor costs and closer collaboration through field training and marketing initiatives. In addition, last year, we implemented a new assortment framework to optimize product placement across our network. This framework continues to evolve and is helping us expand parts availability while improving market access for our vendors. Our customers are seeing more reliable product availability, which is supporting improved transaction volumes. With a broader SKU assortment, we are better positioned to meet demand and to capture growth opportunities. This is especially evident in our Pro business where the expanded assortment in brakes and undercar is driving above-average comps and helping us capture more Main Street business. At the front of the store, we are elevating the shopping experience to better meet the needs of our customers. For example, if you visit an Advance store in your neighborhood today, you'll notice a refreshed wash and wax section. We have refined the product selection based on customer feedback to better align with how customers shop by job with related product attachments. We plan to implement a similar approach across other front room categories to enhance the experience for our DIY customers. Our newly launched owned oil brand, ARGOS, is now a standout feature in the front room. Since introduction, ARGOS has met our expectations and is one of our top brands in the category. This brand delivers engine protection and performance comparable to leading national brands while offering significant cost savings, a value proposition that we believe will resonate strongly with both Pro and DIY customers. In addition to motor oil, we have also expanded the ARGOS brand to other products such as hydraulic oils, antifreeze, performance chemicals and washer fluid. We are prioritizing customer insights to deliver quality solutions to drive higher customer satisfaction. During Q1, we also launched our modernized DIY Loyalty Program, Advance Rewards, which replaced the prior Speed Perks program. Advance Rewards gives members greater flexibility in redeeming coupons along with access to exclusive vendor offers, bonus point promotions and other exciting features. The transition to Advance Rewards has been seamless, and we are already observing strong early engagement from our customers. New member sign-ups, program penetration and total transactions from loyalty members have increased since launch. These early trends suggest customers are responding well to the modernized program, which we believe has the potential to deepen loyalty and engagement across our DIY customer base. Following the introduction of our ARGOS brand and the Advance Rewards Loyalty Program, we are amplifying our connection with the DIY community through the launch of an impactful new brand campaign, Good Parts. This campaign reinforces our commitment to empower customers to get back on the road quickly and with confidence by providing trusted products and exceptional service across our expansive network of over 4,300 stores. Turning to supply chain. With the consolidation of our distribution centers nearing completion, our team has transitioned their focus to streamline and standardize DC operations to deliver greater efficiency. Following a comprehensive review of DC workflows, we have identified key process improvements, which will be systematically implemented throughout the year. We expect the productivity savings from these process improvements to drive gross margin expansion in 2027 and beyond. These enhancements are designed to improve how product flows into our DCs through the facilities and out to hubs in stores. We expect these actions to raise operational efficiency and support our productivity goals for both our supply chain and our stores. For example, one critical objective is to achieve near-perfect shipment accuracy to stores. Achieving this will eliminate the need for store teams to manually scan each product upon receipt, which can save labor hours allocated for those tasks. We have also launched tools that improve visibility into parts movement between hubs and stores helping free up more time for customer service. Additionally, we are working to optimize vendor ordering practices which will address the current fragmentation in order volumes that drives higher handling costs for us and our vendors. By refining these processes, we aim to minimize redundant touches on product lines, streamline transportation costs, and alleviate congestion in our store back rooms. We expect these operational changes to lower the cost-per-unit shipped from our distribution centers while improving consistency for store teams and service levels for customers. Our existing distribution center network is well equipped to support strong parts availability as we expand our multi-echelon network. We are on track to open 10 to 15 market hubs this year. To date, we have opened 2 additional market hubs, bringing our total to 35 hubs as we progress towards our target of 60 locations in 2027. The strategic expansion of Market Hubs locations is enabling us to enhance same-day hard parts coverage across the store network, which creates incremental opportunities to capture market share. Next, I will conclude with an update on our third strategic pillar, store operations. Our store leadership team is prioritizing better task execution, stronger sales productivity and higher labor utilization. Our field leaders are simplifying task workflows and improving scheduling to help teams operate more efficiently. Concurrently, we are upgrading training content to strengthen team capabilities while also providing transparent performance measurements to drive accountability. The new store operating model was fully implemented in Q4 and is yielding opportunities for strategic investments in key markets to support transaction growth. We will continue to allocate payroll and store resources strategically while monitoring the new operating model to increase productivity. Early indicators of our service enhancements are encouraging, including an improvement in customer Net Promoter Scores, which reinforces our confidence in the actions we are taking, delivering strong customer service remains a long-term priority, and we are pleased with our consistent Pro delivery times of under 40 minutes as well as the continued focus on improving in-store NPS. Technology is also playing a pivotal role in unlocking better store productivity. We have equipped our store teams with tools like Zebra Devices to improve daily task efficiency like inventory management. We are also modernizing servers and other systems infrastructure to drive store efficiency. These technological investments are integrated into our financial plan and are in addition to physical store upgrades being executed at more than 1,000 locations this year as part of our multiyear asset management plan. In closing, I want to once again thank the team for their hard work this quarter. This past April marked Advance Auto Parts' 95th year in business. As we reflect on how far we've come, we believe we have a bright future, thanks to the passion of our team members who continue to drive us forward. I will now hand the call over to Ryan to provide details on our Q1 financial performance. Ryan?

Thank you, Shane, and good morning, everyone. I want to begin by thanking our frontline associates for continuing to serve our customers and delivering a strong Q1. For the first quarter, we reported net sales of $2.6 billion, which grew 1% compared to last year. This included comparable sales growth of 3.5%, which was offset by 2 points of headwind created from cycling $51 million in liquidation sales related to the store optimization activity that was completed in Q1 last year. Next, let's dive into the cadence of our comparable sales performance. Our Q1 fiscal period stretches across 16 weeks from January through April. The early part of the quarter witnessed multiple winter storms, which helped drive sales of failure-related items, although we also experienced some disruption with temporary store closures and delayed spending on maintenance categories. Starting in mid-February, sales trends began to improve. This was driven by a combination of consumers deploying tax refunds and resuming spending on vehicle maintenance in the backdrop of better weather during March. As we transition into April, the contribution from weather was relatively muted as some of our markets witnessed unusually dry conditions, while others experienced a prolonged transition into spring. On balance, we estimate that weather was not a material driver of results in fiscal Q1. Outside of these factors, Q1 performance primarily benefited from our focus on Main Street Pro, along with improvements in parts availability and customer service. The benefits from our initiatives were evident in the acceleration in our 2-year comparable sales trend throughout the quarter despite the more onerous comparisons during the second half of Q1. Looking at performance by channel, the Pro channel grew in the mid-single-digit range with monthly growth tracking consistently within that range. As we have indicated previously, we are strategically optimizing our large national account Pro business and focusing our selling efforts on the Main Street Pros. Our outside sales team has been doing a tremendous job in engaging with these customers, which is yielding more than 200 basis points of outperformance in comparable sales relative to our overall Pro comp, while the optimization of national accounts has created a natural headwind in the Pro channel this year, our underlying comparable sales trajectory is healthier, and we expect our actions this year to position us more favorably over the long term. The Main Street Pro represents a larger portion of the addressable market, and we see a meaningful opportunity to grow within this segment. In the DIY channel, comparable sales grew in the low single-digit range. Performance within the channel remains tempered due to the broader inflationary backdrop and stretched household budgets. In this environment, our teams remain focused on serving customers well and delivering a strong in-store experience. Ticket was positive for the quarter and included same SKU inflation of approximately 3%, which was in line with expectations. Transaction volumes improved in both channels, and we continue to be encouraged by the growth in units per transaction. Both metrics accelerated on a 1- and 2-year basis highlighting our progress with enhancing parts availability and customer service. Moving to margins. Adjusted gross profit was approximately $1.2 billion, or 45.1% of net sales, resulting in over 210 basis points of gross margin expansion compared to the same period last year. The improvement in gross margin was mainly driven by product margin expansion, reflecting the strength in our underlying Merchandising initiatives and commitment to operational progress. During the quarter, we also cycled through approximately 90 basis points of atypical margin headwinds related to our store optimization activity last year. This benefit was more than offset by a year-over-year margin headwind created by $17 million in LIFO expense during the quarter. Adjusted SG&A was approximately $1.1 billion or 41.3% of net sales resulting in approximately 200 basis points of leverage. SG&A declined 3% compared to last year as we cycled through an estimated $37 million in expenses associated with our store optimization project. Adjusting for this comparison, SG&A was relatively flat to last year, reflecting strong productivity in the business. As a result, adjusted operating income was $99 million or 3.8% of net sales, resulting in 410 basis points of year-over-year margin expansion. Adjusted diluted earnings per share for the quarter was $0.77 compared to a loss of $0.22 last year. We ended the quarter with free cash outflow of $75 million compared to an outflow of $198 million in the same period last year. The improvement in free cash flow year-over-year was primarily driven by stronger operating performance, improved working capital management and a reduction in cash expenses for restructuring costs associated with the store optimization activity. Inventory at the end of Q1 grew by approximately 5% compared to year-end 2025 and reflecting our focus on expanding product depth and breadth across the network while aligning availability with market demand. We expect to continue allocating inventory investments on a market-by-market basis to provide broader access to parts for our customers. Our balance sheet is in a solid position with approximately $3 billion in cash at the end of the quarter. Net debt leverage was stable at 2.4x compared to last quarter and in line with our targeted range of 2x to 2.5x. Turning to full year guidance. Let's start with net sales. For the full year, net sales is projected at approximately $8.5 billion. This includes comparable sales growth in the 1% to 2% range. Each quarter is expected to deliver positive same-store sales growth. Although the first half is expected to be stronger, owing to easier comparisons and the strong Q1 performance. Same SKU inflation is planned in the 2% to 3% range for the year. The recent tariff regulations have not altered our inflation expectations. 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 a gradual improvement in transactions with initiatives focused on enhancing availability and service levels. While we are encouraged by the strong start to the year, our outlook considers the potential for some near-term demand variability related to continued pressure on the consumer, which is now being intensified by elevated gas prices. Moving to margins. We expect adjusted operating income margin between 3.8% and 4.5% for 2026, resulting in 130 to 200 basis points of year-over-year margin expansion. We expect gross margin expansion in the range of 110 to 150 basis points to approximately 45%. Most of this margin expansion is expected to be driven by Merchandising initiatives related to strategic vendor sourcing and optimization of pricing and promotions. We expect that the benefits from Merchandising initiatives will be partially offset by investments to improve supply chain productivity following completion of the consolidation phase of our DC network. We plan to continue to work closely with our vendor partners to navigate the current volatility due to the evolving geopolitical landscape and the goal of mitigating any potential supply or cost pressures. Regarding SG&A, we expect reported full year expenses to be down year-over-year, contributing 20 to 50 basis points of leverage. This is largely due to cycling of approximately $90 million in nonrecurring expenses from 2025. Adjusting for these expenses, we expect SG&A to grow at a low single-digit rate compared to last year. We expect to deploy savings generated from better in-store task management, effective resource allocation and a reduction in indirect spending to fund general wage inflation, store opening expenses and strategic labor investments in priority markets. As we move forward, we will continue to look for opportunities to streamline tasking operations in stores to create more time for customer service. The slide presentation accompanying today's call provides a detailed view of our full year 2026 sales and operating margin guidance. Moving to other items in guidance. We expect adjusted diluted EPS in the range of $2.40 to $3.10. This includes full year pretax interest expense of approximately $210 million, partially offset by pretax interest income of approximately $80 million. During Q1, we experienced favorability in interest income based on rates in the quarter. We are not updating full year EPS expectations on account of higher interest income given that it's still relatively early in the year. We expect to increase capital expenditures in 2026 to approximately $300 million, with spending allocated to new stores and greenfield market hub growth, store infrastructure upgrades and strategic investments. We plan to open 40 to 45 new stores and 10 to 15 market hubs during the year. Full year 2026 free cash flow is expected at approximately $100 million supported by stronger sales and profitability. Q1 typically represents a seasonal trough for free cash flow, and we expect stronger cash generation for the balance of the year. To conclude, I want to thank our frontline team for delivering a strong Q1 and their commitment to serving our customers and enhancing operational execution. I will now hand the call back to Shane.

Thank you, Ryan. I'd like to close by thanking the Advance team for building momentum against our strategic priorities. We are strengthening the business by enhancing the customers' experience and our operational productivity which we believe will position us well to drive long-term growth. Thank you Operator, we can now open the line for questions.

Your first question comes from the line of Steven Zaccone from Citi. We are serving our customers and enhancing operational execution. I will now hand the call back to Shane. Shane O'Kelly, President and Chief Executive Officer: Thank you, Ryan. I'd like to close by thanking the Advance team for building momentum against our strategic priorities. We are strengthening the business by enhancing the customers' experience and our operational productivity, which we believe will position us well to drive long-term growth. Thank you, Operator. We can now open the line for questions.

Congrats on the strong results. I wanted to just start with the same-store sales outlook for the year. Obviously, you maintained it given you had such a strong print here in the first quarter. Just help us think about the cadence of the year. Is there really any change? You mentioned some near-term demand variability, I think. So what are you seeing in the near term? Anything to think about for the second quarter would be helpful as well.

Yes. Thanks, Stephen. This is Ryan. So in Q2, we expect comps to moderate a little bit from Q1, and that's consistent with how we planned earlier in the year. We expect comps in line with our guidance range, so still in that ballpark. We also don't expect any major tax refund tailwinds going into it. We begin lapping inflation in the second half of Q2, thinking of last year's inflationary events. We are monitoring potential increased volatility in consumer spend as we go through the quarter. For Q3 and Q4, there's really no change to expectations; comps are in line with the low end of our full year guidance, which is what we expected. A couple of things to think about from a quarter perspective and where we see things going right now: there is this difference, we call it a shoulder period between tax refunds and peak driving. As we get past Memorial Day, that's peak driving season, and knowing consumer household budgets are pressured right now will be a good indicator for us to see how that plays out. Getting past Memorial Day is really when peak driving season takes off. For now, we're keeping guidance where we had it, with Q2 consistent with where we planned in the back half of the year. One thing to remember about the back half from an inflationary standpoint is that we're cycling over inflation. We called out 2% to 3% inflation on the year, with the first half being more toward the high end of that and the back half being more toward the lower end of that from an inflationary impact.

Okay. Great. Then the follow-up I had is just on the DIFM side, how do we think about some of the moving pieces now with Main Street accounts? And then winding down some of the national account business as we think about tailwinds and headwinds through the balance of the year?

So yes, it's a good one on that one. From a national account standpoint, probably Q1 is going to be the largest headwind from some of the actions we've taken, that will start to kind of reduce over time. It will still be pressure in the back half of the year because there were actions we took in the back half of the year. But Q1 is probably the largest headwind. You start to see the Main Street's performance and the overall Pro get more in line and then especially going into next year, but we'll still have pressure throughout the year, but Q1 probably being the largest pressure, and we'll start to see that moderate throughout the year, but there will still be some. We're really excited about the work the team is doing on the Main Street side. It's a larger addressable market. A higher margin profile. The team has done a phenomenal job getting out there and providing the right service level, getting the right assortment of parts in our stores to meet the needs of the Main Street Pro. So we're excited about the momentum there and what we're doing.

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

So you're growing above inflation, and that's the first time in a while, which is good progress. Can you talk about that? I know, and I think it sounds like it's happening in both DIY and do-it-for-me. Is it specific to certain categories or certain geographies? Can you share spreads, if you're willing, across different geographies and categories so we can get a sense of how broad it is?

Yes. From an inflationary standpoint, that’s pretty much across the board. From a transactional perspective there are some nuanced geographic differences, partly driven by varying levels of consumer pressure. We are seeing better performance in the Northeast and Mid-Atlantic, which are some of our key markets, but overall the improvement has been broad based and not a significant deviation. Weather during the quarter also affected different geographies. For the most part, in terms of assortment, availability and in-stock levels, we feel really good across all of our regions. We’re encouraged by service level improvements everywhere. The initiatives we’re implementing are having broad-based impact across geographies and we like the momentum we’re building. While factors like weather can create some localized differences, overall inflation’s impact has been fairly universal across our areas.

Simeon, it's Shane. A couple of additions to Ryan's point. First, on the Pro side, our time to serve and Main Street focus are working well. We like what we're doing there and how we're using technology to help our sales team be effective with the Small Pro customer. On DIY, brakes has been a great category for us and we're very pleased with the ARGOS launch. As a reminder, ARGOS began with motor oil, has had great receptivity and is now expanding into hydraulics, performance chemicals, antifreeze and washer fluid. Combined with the assortment moves Ryan mentioned and refreshed POGs, we see this reflected in our NPS improvement. We like what we're doing across both Pro and DIY, and I want to thank the team. As you noted, a 3.5% comp is our best in five years and is the result of hard work in the field every day.

And so just as a follow-up, so this is looking out a bit far. But as you think about the curve of '26 and then even into '27, right now, you are lapping really good SG&A efficiency. There was some easy compare on gross margin. But as you lap into next year, does the cost structure start to go back up and more meaningfully? And then the ability to continue on gross margin, meaning if we continue in comps of this 3% to 4% range. And I don't know if that's the right number or not, is that enough to drive the continued margin expansion that you expect over, call it, the medium term?

A couple of items about our build going into next year. This year, most of the margin expansion has come from merchandising initiatives that have been underway. We are also building supply chain productivity initiatives and establishing the timeline for those in our stores. Those efforts are more likely to deliver a productivity lift next year; we are already seeing early signs and feel confident about our ability to continue driving productivity in those areas in future years. This year has been focused on the merchant initiatives first, and with Ron looking at our supply chain network after the recent consolidation, we are now in the buildings driving productivity and developing those initiatives and plans. Over the course of this year we’ll be able to better assess timing, but we feel good about driving productivity in the out years, particularly in the two areas where we are now building plans. We feel positive about the trajectory going into next year. On SG&A, similar inflationary growth is expected, but we’ve done a lot of work on indirect spend and are repositioning SG&A dollars to be more effective at driving productivity. We will remain strategic about those investments, and we believe we have a good runway for productivity.

Your next question comes from the line of Steve Forbes from Guggenheim Securities.

Maybe just a follow-up to start on the new assortment framework, Merchandising initiatives. Curious if you could just update on the percentage of sales covered and the associated comp lift. It almost feels like you're articulating an improvement in the lift that you're capturing from the Merchandising initiatives versus the original 50 basis point framework. So I would love to just hear you talk about what you're seeing in the stores inclusive of ARGOS and the broader merchandising strategy?

Yes. Sure, Steve. I'll start and let Shane add some additional color. From an assortment perspective, the majority of the work is related to background hard parts. When we rolled that out this past year, we saw a benefit in those markets, particularly a lift in hard parts. We also see a build over time because when you focus on hard parts and the Pro channel, it takes time for customers to recognize availability and inventory and start moving up their call lists. We saw incremental improvement in performance over that period and expect that to continue. We like what we're seeing. Service levels are also improving. The team has done a great job improving service in the field, reducing time to serve, and raising NPS, which will help drive incremental sales. For assortment, we're focused on background parts. Shane mentioned some resets like wash and wax to improve front-room assortments, and we continue to work on that area. The updates are more focused on the backroom and our Pro channel, and it's showing up in Main Street Pro performance, where sales teams are driving sales and customers are beginning to recognize our availability.

Steve, I'll just add that it's interesting when you triangulate different data points on how things are going. Obviously you have the sales numbers, but I recently attended a major vendor conference with hundreds of companies and their leaders, and the feedback on the assortment changes we're making — adding parts, the speed at which we do that, how we order parts, and where we place them across the network — was overwhelmingly positive. They endorsed the actual parts we're ordering, the processes we're implementing, and the talent we have in place. That gives me a lot of confidence in our merchandising strategy, because suppliers are pretty candid when we're not getting it right. We're on the right path with the assortment framework and will continue to execute it going forward.

And then just a quick follow-up, maybe on the back of Simeon's question. Third quarter in a row here, mid-40s gross margin profile and even stronger, right, if you sort of adjust for LIFO, Shane, I believe you talked about sort of the identification of key process improvement opportunities within the supply chain that should build into 2027 and beyond. So are you sort of giving us early indications here on a potential change in the margin contributions behind the 7% adjusted EBITDA target? Or should we view those sort of supply chain opportunities as a funding mechanism for reinvestment to the value proposition?

So I'm going to make a couple big-picture points. We're focusing on what we can control. We have a strategy we like with three pillars, and we want to get better each day, each month, each quarter, each year. That's what we're aiming to do as a company. In supply chain, Ryan touched on this. When I came to the company, we had 50 distribution centers of all shapes and sizes. If we sell Worldpac, we go from 58 to 38, then from 38 to 28, and 28 to 16. We're at 16, maybe 15. We're still doing some work. But when you're doing those consolidations and asking distribution centers to take on huge swaths of new stores — take these 100 stores, 200 stores — it's very hard to tune what goes on inside the four walls. We have a great supply chain leader in Ron. I just spent time with him in a distribution center, and he's already hard at work. He's brought in great team members to work on receiving, and he's identified that we have different receiving methodologies across our DCs. Beyond some accommodations for where conveyors might be, we're structurally different. The first thing he's doing is bringing rigor to that process to make it more consistent across the DCs and, correspondingly, more productive on inbound. Think about inbound and putaway, picking, outbound — step by step through a DC — and we think there's value there that will flow to margins. As to our broader timeline, Ryan?

Yes. So Steve, you mentioned we changed anything. We're not pivoting from what we originally said. I'll just lay that out here. We talked about 500 basis points really being stuff we control that we can go get about half of that would come from merchandising initiatives and is that pillar that we talked about. And that's been underway, and we're seeing the benefit of that. You're seeing our gross margin rate around 45%, and we expect to finish the year around 45%. And we talked about this year being a build year for stores and supply chain, in particular, and getting a better understanding of the timing and sequencing of the productivity we can get out of that. So half of the 500 basis points was Merch, that's coming. It's in place. We're continuing to work that. Supply chain, not yet there. And Shane talked about the consolidation piece. Now that we've got all our stores running out of these DCs getting productive and processes within those buildings now so we can drive that productivity within the building is what we're doing. And so building out those plants to, this is a build year investing some into supply chain to get the productivity, laying out those time lines, get into better assessment of when we'll start to see those benefits. That's what this year has always been about, and that will help us provide a better outlook as we get through the year on what that gross margin profile looks like benefiting from supply chain productivity in the out-year.

I'm going to add one more point because it's a good question. We're very pleased with the market hubs. That node didn't exist before, and we identified the need for better hard parts availability, including same-day availability, so we began building market hubs. We finished the year with 33 hubs and plan to add 10 to 15 this year. As we add hubs, the radius we can support increases and the frequency of store visits rises. Customers become accustomed to that availability, and we continue to refine how product moves from a distribution center to a market hub and then out to stores. This is a strong initiative for the company; we will keep building hubs, and they will further improve efficiency and parts availability.

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

Seeing there's an argument out there that says at this point in the transformation, AAP is essentially a beta to the fundamental performance of the overall aftermarket: when trends are good, AAP will see outsized gains, and when trends are not as good, it may take an even bigger step back. How would you respond to that? And at what point do you think you will see less dependence on the overall state of the aftermarket and have more control over AAP's destiny?

Michael, thanks for the question. I think we have a lot of control over our destiny. As you look at our strategy, we've picked things we can work on to be better that ultimately relate to your beta comment. Think about the assortment. We control what we buy and where we put it, and we're making great progress. Think about service. We benchmark and realized we need to be at 40 minutes in terms of when we go see a Pro customer. We know that when a DIY customer comes in, if you come out from behind the counter and greet them, they have a better experience, attach goes up, and ticket size is higher. So that's a good piece. We know we need to be measuring things like NPS and providing that feedback. We're doing all of the things that good aftermarket auto parts companies should be doing. We're also cognizant of the commitments we make, and we know it's important for everyone who contributes data to have confidence that we will do what we say. I was recently in stores and starting to see the combination of these initiatives come to light. For example, I was up in New York. They're seeing benefits: they've optimized labor with their delivery vehicles, so they're making deliveries on time; they have more hard parts in the back room, so they can say yes to a Pro customer; they have a refreshed front room that's inviting for a DIY customer; they have new servers in the store for uptime reliability; and they have Zebra devices with our AIM advanced inventory management software so they can do cycle counts more quickly. We've got our balance sheet in great stead with $3 billion of cash to go forward. We have the right leaders in place, and our relationship with independents and our footprint there are on solid ground. At every turn, we're making strides to be better and do what we say we're going to do, and I think that's ultimately what contributes to a normalized beta.

Understood. And I was less talking about the stock price and more so just the fundamental performance of the business, but your answer really addressed that. My follow-up question is there has been some focus on Ryan's point around the shoulder periods being a little softer. The market is incurring that as a signal or a message that maybe quarter-to-date has started off a little slow. So a, is that a fair interpretation of the comment and b, how much did that play into your vision just to reiterate the full year guide even with what was a very strong first quarter performance.

Yes. Thanks, Michael. Appreciate it. I think right now the trends are in line with how we planned, essentially at the low end of the guide. The period between tax refunds and Memorial Day up to peak driving is always a different volume period, so we're watching consumer behavior to see whether people will drive fewer miles because budgets are under pressure. We'll learn more this summer during peak driving. We don't yet know if miles driven will decline or if budgets are constraining consumers. Remember, less than 10% of our business is discretionary; this is a needs-based business. Cars need to start and stop and families need to get where they're going, so overall the industry tends to fare well. How consumers might adjust their miles driven is still to be seen. There's uncertainty around the consumer, and we want to see how that plays out during peak season, which is when this industry benefits. The shoulder period between tax refunds and Memorial Day is hard to gauge, and we're in line with what we had planned.

Yes. I'll just say we feel good about where we are. And we're back to that data. We're cognizant of the say-do, coming off a great quarter. We'll obviously be working hard and staying on strategy, and always appreciative of what our team members are doing.

Your next question comes from the line of Max Rakhlenko from TD Cowen.

Great. So first, just on gross margin, can you speak to the shape of the year and the key puts and takes that we should consider as we keep in mind the strong 1Q outperformance and you guys reiterated the full year?

Sure, Max. I appreciate it. So from a margin standpoint, Q1, the performance gives us confidence in our guidance range. Q2 and Q3 seasonally higher margin periods for us. So expect that to tick up a little bit. Expect EBIT margin around the high end of our full year guidance for Q2 and Q3. So operating income, expect that margin to be towards the high end of our guidance. The full year guidance, roughly 45% on gross profit. I expect gross margin around 45%, Q2 and Q3. In Q4, there's a mix of business where you'll see that come down a little bit. It's really mix driven. So Q2, Q3, more towards the higher end and Q4 comes down a little bit just because of mix. But that's how we'd expect the rest of the year to go.

Got it. That's helpful. And then can you just discuss how the mix of your DIFM accounts has evolved from a year ago, as we think about up down the street, regional and national. And then how do you think it evolves further over the medium term? And then, Ryan, can you discuss the gross margin benefit that you are seeing from the improved mix of DIFM accounts. You sort of highlighted it a little bit earlier, but just any more color there.

Yes. I won't give a specific business mix, but the mix is shifting more toward Main Street than before. National accounts are still not the majority of our business. Main Street has always been a larger portion and is now significantly outperforming national accounts because of our rationalization and optimization of that business. Both are good Pro accounts to have in our portfolio. We probably over-indexed a bit on the national side. Main Street has a better margin profile and a larger addressable market, so we want to allocate resources where the market is larger. On the margin side, there's a little benefit from mix, but Pro is growing faster than DIY, which changes the mix because DIY has a higher margin profile. Net-net, it's slightly favorable from a margin mix standpoint, although that's partly offset by adding more DIY in the portfolio.

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

So with 35 market hubs, I think about half of them are a year in now. Maybe you could share the performance of the regions with a market hub versus the regions without a market hub and how the lift from a market hub tends to build from initial opening to 1 to 2 years in terms of maturity?

Yes. Thanks, Zack. Actually, so they're still performing and we've said about 100 basis points better than markets without that ecosystem. Greenfield still a little early for us, but we like what we're seeing out of our greenfield. And just as a reminder, when we did the consolidation, we converted a lot of the old smaller DCs into those market hubs. So only 4 of the 35 are actually greenfields, where we're actually selecting the site and opening those. And we like what we're seeing there. It's still early in that. The parts availability does build over time from a benefit to the market, and we're seeing that. So right now, on average, 100 basis point lift, if you've got this versus markets that don't have it. But we like what we're seeing and that impact in the Pro business and having those parts closer to the customer that time and that speed, we really like the market hub network, and we want to continue to push forward.

So I have consistently heard from Pro customers about the positive impact of the market hubs. I've also heard it from our independents, and if you think about how we would manage this situation in the past, you would have been dependent on the DC. That's an expensive tick and a much more time-consuming route to get it to a customer, and often you don't end up within a time window they consider acceptable. I'm particularly excited by the next chapter of what we do with our market hubs. They increase time to serve. As we think about greenfields, we are really happy with our real estate team in how and where they're selecting sites. By being thoughtful about locations and considering a radius of about 50, 50-plus stores now getting supported from that market hub, it really changes the game in terms of what they can do. We're ending this next phase; 10 to 15 is what we're going to do this year. We've committed to 60 in 2027. We'll revisit and then re-announce what we think our goal will be from there.

Got it. And then two-part question on inflation. You're at 3%. This compares to some of your peers running at about 5% to 6%. Considering those differences, could you talk about your like-for-like pricing versus peers and whether you're running at a discount or if you were previously at a premium and now in line? And then second on just inflation as a whole. We've seen some changes in the environment, oil prices, freight rates that has an impact on vendor financing metals. When you look to the second half of the year and you see the impact of these items, do you think there could be another round of inflationary pricing in the back half?

Yes, thanks Zach. Two-part answer. Based on CDI, our pricing strategy hasn't changed: we aim to be competitively priced every day. We are not trying to be the lowest-price operator in the market, nor are we trying to be the highest-priced; it’s a very rational industry and we are maintaining that posture. That approach directly affects our inflation and like-for-like SKUs — the prices we set are meant to be competitive each day. On inflation and fuel/freight cost changes, we have seen a small increase in transportation costs and related SG&A, but nothing material. In our guidance we assumed some increase in SG&A and transportation expenses and some upward pressure on COGS from supply-chain costs. It’s still a bit early to know the full impact on product costs, but the industry’s rational behavior and the inelastic nature of our category help. We will continue to work with vendors to mitigate any cost increases, and our inflation guidance for the rest of the year does not assume significant product-cost increases.

And your last question comes from the line of Brian Nagel from Oppenheimer.

So I want a little bit repetitive, but I just want to understand, if you look at the comps from Q4 to Q1, there was a nice step-up in growth. As you look back on that, look, some of that, I guess, the tailwinds, better tailwinds to this sector are pretty well documented now. But how much of that step up in Q4 to Q1, do you contribute to the underlying repositioning efforts at Advance? And maybe some of those efforts really start to take hold better versus where would likely improve to industry tailwinds.

Yes. Great question. Thanks for asking it. I think there's a lot going on here. First, we're putting a ton of effort into parts availability and customer service, and I think that's enabling us to participate in the positive macro environment that was helped by higher tax refunds. In the past, we might not have been able to participate because of service and parts, so this is definitely making a difference. This is the first quarter since we embarked on the transformation that we delivered growth roughly in line with the market, and that's what we want to continue to do. While consumers received higher tax refund checks, there is a correlation between tax refunds and seasonality in auto parts. It's less clear in the sector or other consumer categories which saw a disproportionate benefit, but surveys from several sources show that consumers put money into auto parts and other areas, and also into savings and debt reduction. Big picture, there are positive signs that our initiatives are working: our NPS score has improved, our time to serve continues to track under 40 minutes, and we're getting traction with Main Street Pro — they're outperforming and growing units per transaction, which highlights the benefit of parts availability. ARGOS is doing well, and Advance Rewards is also in progress. There's a lot of work ahead, but we would not have been in a position to capture the demand tailwind in Q1 without the foundation that was laid between Q4 and Q1.

And Brian, I'll add to that in Q4 last year, we talked about the comp maybe even a little lower than we expected. And that's because we still make decisive actions here to get things right. We made some product moves within our store. It created some disruption in Q4, but it set us up as Shane mentioned, to have the right assortment going into the year. And so doing that in Q4 and a lower volume time period, we wanted to accelerate some of that. So a lot of what Shane talked about what decisions we made to accelerate some of that in Q4, so we could set up to capitalize on it in Q1.

That's very helpful. I appreciate all that color. Second question, different topic. I don't think you've mentioned yet, like others have started talking more about potential tariff refunds. So I guess the question is, do you have any commentary there? Your efforts to apply to these refunds and the insights to when and if these refunds may come?

Yes. I mean we've looked at it. We do work on it, and we've done work on it, but nothing as of now to report on it. I mean it's something that I think everyone that's impacted, we're following the process. And as soon as we have more information, we'll share that out. But we are following the process and like everyone else interested in how that plays out.

And that ends our question-and-answer session. I will now turn the call back over to Shane O'Kelly for some closing remarks.

Ladies and gentlemen, thank you very much for joining us on our call. We're proud to have put forth our best comp in 5 years. We look forward to staying on strategy most importantly, thanking the men and women from Advance Auto Parts for their hard work, and we look forward to chatting with you for our next quarterly call in August. Thank you. Have a great day. Bye-bye.

This concludes today's conference call. Thank you for your participation. You may now disconnect.