Prepared remarks
Welcome to the Advance Auto Parts Second 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 second quarter and provide an update on the guidance for full year 2026. Following management's prepared remarks, we will open the line for questions. Now let me turn over the call to our CEO, Shane O'Kelly. Shane?
Thank you, Lavesh, and good morning, everyone. I would like to start by expressing my appreciation for our frontline team for their hard work and dedication to serving our customers. During the second quarter, the team navigated a volatile demand environment, which contributed to a slight decline in comparable sales. This included low single-digit sales growth in the Pro channel, which performed in line with our expectations. Within Pro, the Main Street business continued to outpace overall growth, supporting share gains in that segment. In the DIY channel, sales declined more than we anticipated, particularly during the last 4 weeks as tighter household budgets weighed on consumer spending during the quarter. Against this backdrop, the Advance team continued to prioritize actions across our strategic initiatives, which contributed to solid profitability in Q2 with an adjusted operating margin of 5.6%. Excluding the benefit of IEEPA refunds received in the quarter, adjusted operating income margin expanded by nearly 130 basis points to 4.3%. We maintain focus on executing actions within our control, which has translated to sequential improvement in core operational KPIs, including NPS, time to serve, and attachment rates. The second quarter marked an inflection point for Advance with the return to positive free cash flow as we generated $120 million year-to-date compared to an outflow of cash during the last 2 years. During the quarter, we also repurchased approximately $30 million of outstanding debt, which, along with improved profitability, supported further deleveraging of the balance sheet while we continue to allocate more capital to investments to grow the business. Based on our first half performance and updated projections for the remainder of the year, we are reaffirming our full year sales, operating margin, and free cash flow guidance. This includes comparable sales growth in the 1% to 2% range, which considers continued spending pressure in the DIY channel, offset by ongoing strength in the Pro channel, along with higher same-SKU inflation due to increased commodity costs. We are also implementing a focused action plan aimed at strengthening execution across our operational KPIs and driving higher customer engagement to deliver better transaction performance in the second half compared to trends during Q2. Our margin outlook balances the tailwind from recent tariff refunds with incremental headwinds stemming from shifts in channel mix and increased commodity costs. We will continue to prioritize efforts to make progress on our strategic objectives as we work to create long-term value for our shareholders. Let's turn to an update on our strategic priorities for 2026. Our strategy remains unchanged and is built on 3 pillars: merchandising, supply chain, and store operations, 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. We are focused on ensuring reliable product availability, which supports the efforts of our store team to enhance customer service and drive growth in unit sales per transaction. Our new assortment framework launched last year is helping us increase the breadth of parts we carry in each store and broadening availability across our network of DCs, hubs, and stores. Halfway through this year, we have added approximately 80,000 new SKUs to our assortment catalog, building upon the 100,000 new SKUs we introduced last year. Through comprehensive category reviews, we are strengthening relationships with existing vendors and identifying opportunities to improve margins while also partnering with new vendors to further expand our selection of parts. In the near term, our merchandising team is refining communication within the DIY channel to enhance brand awareness and deliver value-driven offerings aimed at increasing customer engagement. We are collaborating with vendors on targeted media campaigns, leveraging Advance Rewards, providing store incentives, and optimizing online paid search to stimulate transaction growth and improve conversion in stores. Moving to an update regarding our pricing and promotions management initiatives. We are on schedule to complete the full deployment of a new pricing framework for both DIY and Pro segments by year-end. Our pricing philosophy remains unchanged. We aim to offer everyday competitive prices and operate rationally in the market. The new framework is expected to enhance visibility of competitive pricing actions and enables the execution of precise market-based pricing strategies. The early results from the Pro channel have shown an increase in team member and customer confidence, which we expect to support efforts to grow share among Main Street Pros. Alongside the implementation of more sophisticated pricing models, we are also improving discipline around the management of store-based promotional activities. We expect to offer everyday competitive prices along with seasonally relevant promotions and plan to deploy marketing dollars on offers that yield an improvement in sales or profitability. On a year-to-date basis, our merchandising initiatives have contributed approximately 100 basis points to product margin expansion. We anticipate building upon this growth in the second half of the year to support our margin improvement goals for the year. Turning to supply chain. In the second quarter, we completed our distribution center consolidation. This initiative commenced more than 2 years ago when we operated nearly 40 DCs across the United States, utilizing multiple warehouse management systems. As of today, we operate 15 DCs supported by a unified warehouse system, marking a key milestone in our efforts to enhance asset productivity throughout our supply chain. Along with consolidating our DC network, we also launched market hubs that improve same-day parts availability for our customers. Areas equipped with market hub locations consistently outperformed those without market hubs, which reaffirms the strategic value of these locations. Year-to-date, we have opened 5 market hubs, bringing the total to 38 locations. Our real estate team has done a great job in expanding our capabilities, and I am pleased to share that we are accelerating the pace of market hub openings for this year. We now plan to open 15 to 20 market hub locations this year and remain on track to achieve our goal of operating 60 locations by mid-2027. Regarding DC productivity, our team is concentrating on key process improvements aimed at streamlining and standardizing operations within our distribution centers. We anticipate that these actions will yield greater operational efficiency and facilitate improved product flow into and out of the DCs. During the second quarter, we completed 25% of the identified process improvements and remain on track to systematically implement the remaining process changes by mid-2027. These actions are aimed at increasing labor productivity within our DCs and provide visibility into cost reductions per unit shipped, which is expected to contribute to margin expansion starting next year. Our strategy is focused on minimizing redundant product handling, improving shipment accuracy, reducing inventory lead times and transitioning to a more variable cost structure. For example, we have now standardized the DC receiving process across our facilities, eliminating a significant number of variations, which is expected to deliver better productivity through higher processing volumes per labor hour. Another critical component of supply chain productivity is transportation optimization. We are currently rebidding all of our carrier contracts, and we expect to consolidate our volume with 70% fewer carriers. This initiative is expected to generate tens of millions of dollars in cost savings, which will support margin expansion in 2027. Collectively, the DC process changes and transportation initiatives are expected to enhance our ability to operate a more efficient and scalable supply chain. Next, I will conclude with an update on our third strategic pillar, store operations. In our stores, we are holding teams accountable for service execution and measuring the effectiveness of our initiatives through clearly identified KPIs as we strive to increase labor utilization. The second quarter provided further evidence of progress on our store-based initiatives. NPS or Net Promoter Scores have improved to nearly 80 points from the high 60-point range in the same period last year, which suggests that our service enhancements are resonating with customers. In-store attachment rates have improved to nearly 30% from the mid-high 20% range in the same period last year, which contributes to unit share gains. And average time to deliver Pro orders consistently track below 40 minutes during each week in Q2, which is improving reliability for our Pro customers. In addition to measuring progress through these KPIs, we are also identifying opportunities to better prioritize store tasks, investing in technology to drive operational efficiencies and enhancing training content to further elevate customer service. These actions will help us strengthen execution across our primary KPIs in the near term, while our store and merchandising teams partner to drive higher customer engagement and improve conversion in the second half of the year. During the second quarter, we also completed an independent evaluation of store task execution with the objective of updating our store labor standards that were previously unchanged for over a decade. This activity follows the rollout of our store operating model last year, which determined the allocation of resources such as trucks and drivers based on market demand factors. The study examined time allocated to routine store responsibilities, including picking or stocking products, receiving shipments from distribution centers and assisting customers with product installations such as batteries and wipers. We expect to use the findings to identify tasks that deliver the highest value to our customers and simultaneously highlight non-value-added activities that can be reduced to enhance productivity. The next phase of this initiative involves updating our labor allocation systems to align with the newly developed labor standards. We anticipate beginning this implementation later this year, which will enable us to further improve NPS and drive productivity in the years to come. To conclude, I want to reiterate that our strategic plan is unchanged. Our KPIs are improving, and we have returned to positive free cash flow. We are cognizant of the external macro pressures impacting consumer spending in the near term. We are implementing a focused action plan to support the business in the second half while we actively manage the execution of our strategic initiatives throughout the year. I will now hand the call over to Ryan to discuss our Q2 financial performance. Ryan?
Thank you, Shane, and good morning, everyone. I want to begin by thanking our frontline associates for their commitment to serving our customers. For the second quarter, we reported net sales of $2 billion with a slight decline in comparable sales. The Pro channel delivered low single-digit growth, which was in line with our expectations. The strength in Pro was more than offset by a decline in DIY sales in the low single-digit range as constrained household budgets impacted spending during the quarter. We also experienced milder summer weather in several of our markets, which drove an underperformance in weather-sensitive categories, such as cooling and climate control and fluids and chemicals. In our view, the combination of a larger-than-anticipated deceleration in DIY spending with deferral in large ticket projects, a reduction in discretionary spending compared to last year and weather-related drivers during Q2 accounted for approximately 100 to 150 basis points of comp headwind in the quarter. Turning to the cadence of sales. During the first 8 weeks of Q2, comparable sales grew by approximately 1%, including a low single-digit growth in Pro and flattish DIY sales. In the final 4 weeks, comp growth moderated in both channels as we cycled through difficult comparisons from last year. Also, this time frame coincided with price changes to reflect movements in commodity costs, which further stretched consumer budgets. In this period, the Pro channel delivered positive comparable sales growth, but DIY volumes slowed further, driving most of the shortfall in sales for the quarter. For the quarter, average ticket was positive and included same SKU inflation of approximately 4%. The sequential step-up in inflation from approximately 3% last quarter was driven by market-related price adjustments and increases in commodity costs, which impacted motor oil and other petroleum products. Our team remains committed to enhancing customer service, and these efforts continue to support growth in units per transaction, which grew on both a 1- and 2-year basis, helping partially offset lower transaction volumes. Diving deeper into category performance, within DIY, sales were stronger in maintenance and failure categories such as filters, motor oil and batteries, while hard parts categories lagged, likely indicating selective spending behavior and deferral of larger projects. On the other hand, in the Pro channel, our hard parts business, including brakes and undercar, continue to outperform, supported by an improvement in parts availability and consistency in delivery times. We maintained our strategic focus on growing share across Main Street Pros, which represents the largest portion of our addressable market. The Pro team carried the momentum from Q1 with transaction performance for this segment outpacing the overall enterprise. The Main Street Pro comp exceeded our total Pro comp by more than 200 basis points, helping offset the headwind created by the optimization of national accounts. Moving to margins. Adjusted gross profit was $924 million or 46.2% of net sales, resulting in approximately 240 basis points of gross margin expansion in Q2 compared to the same period last year. Tariff refunds contributed $26 million in gross margin, accounting for 130 basis points of year-over-year change. The balance 110 basis points of margin expansion was primarily driven by an improvement in product margin and included 2 incremental cost drivers in the quarter. First, a channel mix shift due to the slowdown in DIY sales resulted in a headwind of approximately 20 basis points. Second, supply chain expenses, including higher freight and fuel costs drove approximately 20 basis points of deleverage due to the lower-than-expected sales volume. These headwinds were offset by approximately 40 basis points of tailwind from immaterial LIFO and warehousing expenses in the quarter compared to a headwind in the same period last year. Excluding the benefit of IEEPA refunds, we generated a gross margin of approximately 45% for the first half of 2026, highlighting the progress across our merchandising strategies. Shifting to expenses. Adjusted SG&A was $812 million or 40.6% of net sales, driving 15 basis points of leverage compared to last year. Expenses were down approximately 1% year-over-year, reflecting our focus on labor productivity through simplification of store tasks and management of resource allocation, along with reinvestment of savings from indirect spend optimization. Adjusted operating income came in at $112 million or 5.6% of net sales, resulting in approximately 260 basis points of year-over-year margin expansion. Adjusted diluted earnings per share was $1.03 compared to $0.69 during the second quarter last year. We generated $120 million of free cash flow year-to-date, marking a significant improvement from an outflow of $201 million last year. The improvement in free cash flow was driven by improved profitability and working capital management, a reduction in cash expenses related to our store optimization activity last year and the receipt of tariff refunds. Our balance sheet continues to be in a solid position as we ended the quarter with a cash balance of approximately $3.1 billion. During the quarter, we utilized approximately $30 million of cash to repurchase a portion of our 2028 senior notes, and we ended the quarter with a net debt leverage of 2.1x compared to 2.4x last quarter, which is in line with our targeted range of 2.0 to 2.5x. We remain committed to repaying debt at or before maturity. Turning to full year guidance. Let's start with net sales. For the full year, net sales are projected at approximately $8.5 billion, including comparable sales growth in the 1% to 2% range. Based on product cost inflation experienced during Q2, we now expect full year same SKU inflation of approximately 3%, implying second half inflation of approximately 3%, consistent with the first half of 2026. The step down in inflation compared to the second quarter reflects the comparison against last year's tariff-driven price adjustments. Based on revised inflation expectations, along with our focused action plan to increase customer engagement, our range of comparable sales growth guidance assumes a recovery in transaction volumes compared to the second quarter. Regarding Q3, trends during the first 4 weeks of the quarter are tracking slightly ahead of trends in the final weeks of Q2 and have accelerated on a 2-year basis. As a reminder, these first 4 weeks of Q3 represent our most difficult comparisons to last year, and our comparisons begin to ease significantly over the next 8 weeks. Moving to margins. We have reaffirmed full year adjusted operating income margin guidance between 3.8% to 4.5%, resulting in 130 to 200 basis points of year-over-year margin expansion. We expect full year gross margin to expand in the range of 110 to 150 basis points to approximately 45%. Most of this margin expansion is expected to be driven by the merchandising initiatives related to strategic vendor sourcing and optimization of pricing and promotions. We expect that the benefits from these merchandising initiatives to be partially offset by investments in supply chain productivity. As I discussed earlier, we had some moving items within gross margin in Q2. These items have also been factored into our full year guidance. During the second quarter, we received substantially all the IEEPA refund claims by us. These refunds equate to approximately 30 basis points of gross margin contribution for the full year. However, this benefit is being fully offset by the headwind from changes in sales mix compared to our prior forecast and the incremental impact of higher shipping, freight and fuel costs in the supply chain. We will continue to work closely with our vendor partners to navigate the evolving geopolitical landscape and mitigate potential supply or cost pressure. Regarding SG&A, we expect reported full year expenses to be down year-over-year, contributing between 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, new store and market hub 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 dedicate more time to serving customers. Moving to other items and guidance. We have raised adjusted diluted EPS guidance to a range of $2.60 to $3.30. The revised EPS outlook includes approximately $100 million of interest income, which is an increase of $20 million compared to our previous expectations based on trends through Q2. We continue to plan for pretax interest expense of approximately $210 million for the full year. The recent debt repurchase does not have a material impact on guidance. The benefit of higher interest income is being partially offset by a slight increase in tax expectations for the year. Shifting to cash flow. We continue to expect 2026 capital expenditures of approximately $300 million, with spending allocated to new stores and greenfield market hub growth, store infrastructure upgrades and strategic investments. We have revised our store opening schedule for this year. Our revised guidance includes 30 to 35 new store openings this year with 6 stores opened in the first half of 2026. For Market Hubs, our guidance now assumes 15 to 20 new market hubs this year, which exceeds our prior expectations. We opened 5 Market hubs in the first half of 2026 and currently plan to open 9 market hubs during Q3. We are reaffirming our full year free cash flow guidance of approximately $100 million. Our guidance includes the flow-through of tariff refunds received during the second quarter and timing for certain general operating expenses planned for the balance of the year. The change in free cash flow trend compared to our year-to-date trend of $120 million does not reflect any change in underlying operational progress of the business. To conclude, I want to thank our frontline associates for the continued improvement in the quality of service provided to our customers. Their efforts are supporting improved conversion, NPS and attachment rates, while our Pro team continues to drive share gains across the Main Street Pro. I will now hand the call back to Shane.
Thank you, Ryan. I'd like to close by thanking the Advance team for staying focused on elevating our customer experience and driving operational productivity, which we believe will position us well to create long-term value for our shareholders. Thank you. Operator, we can now open the line for questions.
Questions and answers
Operator provided instructions for participants on how to ask questions. Your first question comes from the line of Steve Forbes from Guggenheim Securities.
Shane, I wanted to maybe dig into customer segmentation and whether you're seeing transaction growth among your largest up and down the street customers and maybe any comments you can provide that help build conviction around sort of sustainable transaction comp growth into the out year here as you reap the benefits of the strategic priorities.
Yes, Steve, thank you for the question. Let me begin by thanking our team; it's important to recognize what they do every day. Great question. Let's unpack Pro. Think about it in terms of Main Street and national accounts. We are excited by what we're seeing with Main Street. Growth there is 200 basis points above total Pro, and that's inclusive of transactions. We're getting real traction with Main Street. Think of this as being in the trenches, seeing a local shop, someone with two or three bays, where our connectivity, reputation, and the quality of both our outside and inside sales team members make a difference. Within our Pro numbers, we have national account headwinds. Ryan can unpack the numbers a little bit, but we're starting to lap that. Remember, we're asking where we want to be in the Pro segment, where we have a right to win, and where profitability is more attractive. All of that points to Main Street. So national accounts are waning, and we're starting to see that diminish over time. Given our success with Main Street and our position to compete there, we feel good about what you've seen and what we can do in the future.
Yes, Steve, I'll add a couple of things. Think about the main point: I'll hit on Main Street and the national accounts. The national account pressure in the second half will be about half of what it was in the first half, so we are starting to lap it. There will still be some pressure, but it should be about half of what we saw earlier in the year, which will help the trends a bit. On Main Street Pro, we’re not just seeing longer‑term accounts continue to shop with us and buy more transactions; we’re also seeing Main Street accounts that hadn’t shopped much with us before start to give us some of their business. That’s a good sign that our assortment is improving and service levels are getting better. A couple of reasons we believe we’re making the right moves: by the end of the year, 70% of our stores will have a Market Hub, bringing more parts closer to the customer and allowing us to reach additional Main Street Pros with a better level of service. We’re excited about accelerating Market Hub deployment. We still expect all stores to have a Market Hub by the middle of next year, but we’re able to accelerate a few more this year; we’ll open nine in Q3, which will be impactful in bringing parts closer to customers. We’re also working on assortment improvement for the Pro customer and still have opportunities to enhance coverage. The work we’ve done is starting to resonate, and we’ll continue to improve coverage to be more relevant for our Pro customers.
A couple of just last additions and then look forward to your follow-up. If you look at how we've played in the Pro space over the years, we have a TechNet program, which has been very successful and included in that is a warranty program. So you say, Steve, you own a small shop somewhere and you fix their car and the customer drives 3 states away and needs to get that original work repaired. They could do that through an unrelated shop through our warranty program and get that paid for. We have programs like MotoVisuals, MotoLogic that help break down what's going on in vehicles, our credit programs, our tools and equipment programs, our ability to work with your account as you grow. And so there's a number of things that we do with Main Street that I'm going to use the word that's specialized or even bespoke relative to what else is out there that helps our level of attractiveness and builds that partnership. Most recently, and this is just sort of coming out now with Anthony Sarlanis and our Pro team is owning the mile, where he's using both our CRM software, the partnership between the outside sales team member, which is called a CAM, and our inside sales team member, which is CPP, to really focus on customers who are geographically proximate to our stores. Now on the plus side, our aggregate total time to serve is under 40 minutes, and we think that's a key threshold. But now when you think about focusing on customers that are very close to the store, and I'm thinking 1, 2, 3 miles, we'll be well under 40 minutes there, and that's a further point of differentiation. So look for us to continue to do that. But net-net, we feel good about what we can do with Main Street Pro.
Maybe just a quick follow-up, given the commentary around hub growth. I know the transition here with the greenfield growth, I believe, this year over repurposed footage right of the distribution footprint. So can you talk about how those greenfield hubs are performing relative to the original cohort of hubs that were more repurposed footage? And if that sort of performance is what sort of supports the acceleration that you're referencing here into the back half?
Yes. I'll jump in here, and Shane can add color. The greenfield market hubs, the actual store because there's a store within the market hub, are performing a little bit better than the others. I'll give you some background on the rest. The non-greenfield hubs were actually conversions of old blue Carquest distribution centers, smaller DCs that we converted. They weren't necessarily in prime retail locations, but they did service the market and provide parts, so the hub runs help the market. The greenfield hubs tend to be in better retail locations where we can get more retail sales out of that hub as well. From a volume standpoint, they tend to do a little bit better on the greenfield side than the conversions because of the retail business we generate from them. The conversions still supplied some parts to the market through what we call PDQ, so there was still some service level, but it wasn't as strong or as efficient as the market hubs. When we put a greenfield in place, a lot of parts go to that market that weren't there before, so they tend to perform a little bit better than the conversions.
I'll just add that the market hub paradigm for us is a key part of how we're going to grow, not just with Pro, but with DIY. And so we're accelerating what we're doing there. And as Ryan touched on, we'll open 9 in Q3. We're sitting at 38 currently. We want to be at 50 by the end of the year. As a reminder, think about these as having 70,000, 80,000 SKUs, sometimes a little bit more, being able to get parts same day to a radius of stores, I think 50-plus stores. So that really changes our ability to compete for parts that people want that day. And so we're going to continue it. We're going to refine it, and we'll talk more about what we'll do as we get to the 50 going forward.
Your next question comes from the line of Simeon Gutman from Morgan Stanley.
This may be a slight repeat from the prior question. I missed some of the prepared remarks. But thinking about the core driver of do-it-for-me, if there's temporal pressure in the economy, like gas prices, I would expect DIY to be more sensitive, not DIFM. So can you talk about the trajectory you're on with core DIFM improvements and how much of this quarter was more macro or could be like strategy just taking some time to take hold?
Yes, I'll talk about Q2 and then the Q3 trend. In Q2, the deceleration we saw in our P7, the last period of the month, showed us running roughly flat on DIY and low single-digit positive in Pro for the first eight weeks. DIY really decelerated toward the end of the quarter, which accounted for most of the shortfall versus our expectations. DIFM also slowed slightly but remained positive during that period; I think that reflected some macro pressure. Pro stayed positive for the quarter and in the final four weeks. That momentum in Pro has continued into Q3, and we like what we're seeing. On the DIY side we've seen a bit of an acceleration compared with the Q2 trend, and on a two-year basis we've seen good acceleration. More importantly, in Q3 we're seeing transaction growth improve, so transactions have improved versus the trend where we exited Q2. Those positives give us confidence in our guide for the rest of the year.
Okay. And then a quick follow-up. And again, I apologize if you said this already, but merchandising success or excellence, I forget the terminology for some of the gross margin initiatives. I guess, ex tariff, if I got this right, the margin may have come in a little bit, I guess, worse than we expected. I don't know if that's right or wrong. Some of that, I assume, was deleverage of distribution expense? Or was there any slowdown in just the merchandising success strategy during the quarter?
Actually, good question, Simeon. The rate was impacted a little bit by mix here. So you got about 20 basis points of mix impact from DIY the lower volumes that we anticipated. And then you had about 20 basis points. It's fuel surcharge, just things that were flowing through. So those are really the 2 that impacted us that drove it down. It still was like a 44.9%, so close to the 45%, still able to manage close to 45%. The merchandising initiatives still cost out really strong and provided great value for us. I mean, 110 basis points year-over-year if you back out the tariff impact on margins. So the real slight decrease versus our expectation in the quarter was driven by fuel supply chain expenses and the channel mix.
Your next question comes from the line of Steven Zaccone from Citi.
I want to follow up on the second half here. So clearly, the decision to reiterate the same-store sales guidance, it does look like the second quarter still missed expectations. So maybe just help us understand some of the phenomenon that can help in the back half. The lost sales due to weather, do you expect them to come back? And then any help on the third quarter versus the fourth quarter because it seems like you've got some work to do and the compares get a bit tougher in the second half of the year.
Steven, it's Shane. I'll start and then Ryan can unpack it further. So big picture, we cater to the lower and mid-tier consumers. And you see this not just in our numbers, but I think you see it broadly in our market and others. That's been a very stressed consumer. And so from a macro perspective, they've struggled. They've struggled as fuel prices have risen, and those budgets have continued to get tighter as they've gone through. And you saw that, by the way, in our Q2. And if you look at the last 4 weeks of our Q2, we were probably a little slower pivoting to value given that the consumer said, 'Hey, this is what's really important to me.' So as we look at Q3 and Q4, we're taking a series of actions to be more attractive and to maintain and improve conversion for those consumers as they come and visit us. So here's what's going on with that. So we've got our Advance Rewards program. That's been recently launched. We'll continue to reach out to that cohort of customers. We're doing work with paid search optimization to make sure both in terms of what keywords we're using, what geography of customers we're talking to and how we get them in there. We're going to continue to promote our Good Parts campaign. We're simplifying tasks inside of stores and communications so that when a customer does come in, that experience is as positive as it can be. And by the way, I've seen an uptick in feedback that I personally get from customers about what they're seeing in our stores. We know that value plays are important. We've got ARGOS, which is our private brand of oil, and we're now expanding across a broader line of products that we think will be attractive. We also know that, and this is a good part of what we do from an assortment perspective, it's good, better and best. And so in the past, when the consumer is healthier, they'll say, 'Hey, tell me more about the better and the best.' Now they want to learn a little bit more about, tell me about the better or tell me about the good. We've got those products in. So that speaks to what we're doing on conversion. That speaks on what we're doing with units per transaction. So we have a series of activities geared towards rekindling what's going on with the DIY customer to do as well as we can. On the Pro side, you heard some of that with how we respond to Steve's earlier comments, but we really like what we're doing with Main Street Pro. We're going to continue to push in there.
Yes. Steven, I'll be specific about what's driving our back-half comparable performance expectations. Everything Shane mentioned should help DIY, and on a two-year basis we've seen that accelerate. You noted difficult compares in the back half; the toughest compare is P8, and it tends to ease as the back half progresses. Also, last year in Q4 we had about a 50 basis point impact from product transitions related to First Brands Group and other front-room changes; we will not be cycling that this Q4, so that is a tailwind. We are focused on Pro, which will continue to outperform — we are seeing those trends continue and it will be a key driver. We still expect more DIY channel pressure than we originally thought, even though trends improved over the last four weeks of the quarter into Q3. To Shane’s point, we believe we have a compelling value offering across our product set and categories with good-better-best, and ARGOS expansion into other categories could not come at a better time for consumers. Our efforts to increase customer engagement should help. Finally, for the back half we expect about 3% inflation, mainly from commodity and oil prices, which is roughly 100 basis points higher than we had originally planned.
My follow-up is the prior commentary, 7% operating target on a medium-term basis. I think next year, '27 was expected to see at least 100 basis points of expansion. Do you still think that's a reasonable target in light of some of these weaker DIY trends and maybe cost inflation across the business?
Yes. I mean we're still focused on 7% as a medium-term target. The 100 basis points next year, that's where we're at today. It's a little too premature to give specific guidance for next year. But I'll tell you what Ron is doing in supply chain because the bulk of this year is supply chain planning, driving improvements, understanding the timing of benefits we'll get from supply chain and also our store optimization work and what we're doing there. And both Ron and Tony have been digging in. What Ron is doing, he's about 25% of the way through really looking at the productivity in different areas, think of our receiving capabilities, our inbound, our outbound. And that team has been hard at work. It's giving us more confidence in the value unlock in supply chain. We're not ready to necessarily give what that guidance will be for next year. We're still working through the planning, but the work he's uncovered year-to-date, it's just continuing to confirm for us that there's opportunity there. So we're still 100 basis points for next year still makes sense for us, but we're not ready to give more specific guidance.
Yes. Let me expand: I think 7% is the right target. We're in a very complicated geopolitical situation that's impacting the consumer, so consumers are stressed. But over the longer term I don't think this situation will be permanent. The industry backdrop remains very attractive: consider the number of vehicles on the road, their age, the penetration of electric vehicles and the continued prevalence of hybrids with engines, miles driven, and the cost of a new car. New cars are pushing $50,000, so people are keeping their cars longer and want to fix them. The total addressable market is about $160 billion and it's fragmented. Those long-term fundamentals, beyond the immediate pressures on consumers, are positive for us as we compete in the market. That's why keeping the target the same is appropriate.
Your next question comes from the line of Bret Jordan from Jefferies.
How should we think about working capital, I guess, accounts payable to inventory and what your factoring costs are looking like now that your leverage ratio has come down a little bit?
Yes. Our coverage has improved slightly, and we expect it to continue improving over the medium to long term. We are investing in working capital related to our assortment work, but we are also finding productivity gains. Overall, working capital and coverage should improve. We have productive conversations with vendors to work through this, though it will take place over the medium term. We have seen improvement in our coverage ratio. Banks set rates for our vendors and we don't get involved, but those rates have stabilized. The external rate SOFR was under pressure but has stabilized since we completed the transaction last year. Anecdotally, the spread is starting to converge and has been fairly stable despite a volatile rate environment, which is beneficial for our vendors who want stability. One key development in Q2 was that Moody's and S&P stabilized our outlook, reflecting the improved balance sheet. Free cash flow has returned to positive for the first time in two years, so the balance sheet is improving. Supply chain finance is very stable, the banks support the program, and the transaction helps bridge us to investment grade.
And then on the commercial business, ex the national account cutbacks, are you gaining share, if you think or retaining share with the up and down the street business? I mean, sort of adjusting for same SKU inflation and looking at that 200 basis point comp ahead of Pro. Do you think that's a share gain indicator or just holding share?
I think it's a hold and, in some markets, potentially a gain. There's a lot of noise as we shift mix from national accounts to Main Street. But personally, when I visit accounts, the consensus around improving time to serve, improving assortment, and initiatives like TechNet and other promotions gives us confidence about our path forward.
Yes. The Main Street, Bret, larger addressable TAM. I mean you know this, but we're really excited about larger transactions there for us. So the transactions are stronger for us in the Main Street. So I think maybe it's hold and gain in certain areas. We're excited about what we're doing on the Main Street Pro.
Your next question comes from the line of Maksim Rakhlenko from TD Cowen.
So first, can you just help bridge gross margin for both 3Q and 4Q, the key puts and takes that we should be considering? And then just any help triangulating to final outcomes compared to 2Q?
Yes, absolutely. A couple of things. Thinking about the back half of the year, we expect it to include headwinds from higher freight and fuel costs and some channel mix pressures. DIY is coming down, so you'll see some mix pressure there. We still expect elevated freight and fuel costs to be in our margins. Using Q2 as our guidepost for operating income, these cost items drove approximately 30 to 40 basis points of headwind. We are also cycling a 53rd week, which is roughly a 20 basis point headwind to Q4 operating margins. Our EBIT margin guide for the second half is 3% to 4%, with the high end consistent with last year excluding the 53rd week. For gross margin specifically, we assume a range of 44% to 45%, with Q3 higher than Q4 due to seasonality and mix. We do not expect any material tariff refund inflows in the back half of the year. On SG&A, thinking about operating income flow-through, we expect those dollars to be relatively flat to last year in Q3, including more store openings. The year-over-year decline in Q4 is really due to that extra week of SG&A, so excluding that it would be a low single-digit increase.
And then so you guys repurchased a little bit of debt this quarter for the first time in a while. If you remain on track to hit your guide for this year, should we see further repurchases ahead? And then will it be a similar magnitude or potentially do those step up? And then just bigger picture, can you update us on conversations with the rating agencies? And any sort of goalposts that we should consider as you look to get back to investment grade?
A couple of points on that. We will be opportunistic with excess cash that we cannot or do not think we can deploy into the business. Our capital priorities are to deploy cash into the business to continue driving the comeback and improving operations. When we have excess cash beyond those needs, and if there are economic benefits to retiring debt before maturity, we will use it to retire debt. We have no immediate plans, but we are always monitoring the market and our plan is to retire debt at or before maturity if it makes sense and we are comfortable with the cash position. I’m encouraged that for the first time in a long while we can use excess cash and that our cash balance is a positive on the balance sheet. We have $3.1 billion of cash and are in an excess cash position relative to our obligations. If we can deploy that to the business, we will; if not, we will continue to delever the balance sheet. With the rating agencies, we have had very constructive dialogue and we are pleased with the stable outlook. As a reminder, moving to investment grade requires about three notches with Moody’s and two with S&P, so it is a journey. The conversations have been positive, and returning to positive free cash flow and beginning to delever the balance sheet are all indicators we hope they view favorably. We speak with them regularly and are working toward getting back to investment grade, but it will take time.
Your next question comes from the line of Kate McShane from Goldman Sachs.
This is Mark Jordan on for Kate McShane. As we think about your focus on Main Street customers, is there a way to quantify how much of that DIFM comp is coming right now from existing customers? How much is coming from new customers? And I guess if we think about the time it takes to win a new account, is there a lag or what is the lag between opening a new market hub and maybe signing up a new Pro account?
Yes. Good question. On the Pro side, most customers know who we are, and we will commonly get some sort of business from them. Within the Pro world, there's a hierarchy where you want to be first call. You want to be the guy that the customer says, 'Hey, I'm ordering a lot of parts today and Advance is going to be the first call.' And by the way, the questions that go around how you earn that is, do you have the part? Yes or no? When can I get it? Time to serve. And then sometimes, 'Hey, what's my cost going to be?' And so as we improve in each of those areas, our ability to get first call customers or earn our way in the first call improves. And we haven't sort of unpacked that number specifically other than to say that we're very focused on it and opening market hub certainly helps. In my experience, when you go into somebody where you're not first call, it's not a question of, hey, I make one visit and then the customer says, great, you're here, and so now I'm going to switch. So it usually takes a series of visits over a period of weeks where you have to both demonstrate the value proposition and earn that right. And usually, it comes in the form of, okay, I'm going to give you guys this category, I'm going to give you this set of orders and then how do you perform and you earn your way in. It's a trust-based business. It's a relationship-based business. And if I go back to some of the things that we talked about before, whether it's our TechNet program or the quality of our CAMs, our outside sales team member, we've got the right constituent parts to go make that happen. And now the Market Hub has become a further enabler of that. But it's not an immediate process, but we feel good in terms of where Main Street Pro sits today. We feel good in terms of how we're migrating through some of our national account business, and we feel good about where we're going forward with our Own The Mile program, our use of CRM, our value plays for our Pro customers, the quality of our inside sales team in our stores, our CPPs, our reputation, Advance has long been known for being in the Pro universe.
And just to add, the mix between new and existing, it's a mix of both. We're seeing growth in both.
And one follow-up, if I could. You mentioned the same SKU inflation you're seeing on motor oil and other lubricants. Can you just talk about how your ARGOS line is positioned relative to the competitors there?
Yes. So we like the name. We like the people that we source the product from. We like the performance within the category. ARGOS is actually our highest unit selling motor oil. And by the way, we represent very high-quality prominent brands. And by the way we're proud to sell those as well. But as the consumer says, value is really important to me, they know the quality we put into the product, but the idea that it comes with affordability, reliability, sustainability, it really resonates with them and resonates with our team. And so it's an easy product for our store team members to sell.
Your final question comes from the line of Michael Lasser from UBS.
It seems like your guidance is basically saying, hey, at the low end, we could do a flat comp. And part of that is you're going to see more like-for-like inflation in the back half of the year. The comparisons get a little easier. But on the other hand, it does seem like the business is becoming more volatile. You had spoken about some volatility coming into the second quarter and some volatility coming out of the second quarter. So how does that influence your perspective on the back half? Said another way, was there any thought to lowering the comp outlook for the back half just to be a little bit more conservative?
Yes, I appreciate it, Michael. To discuss the trends: entering Q2 we had noted a DIY slowdown and some softness, but the first eight weeks were largely in line with expectations. We were tracking about a 1% comp; DIY was roughly flat while Pro was up low single digits. The weakness came in the last four weeks. During that period we experienced a unique weather impact across our store footprint — average temperatures were down year over year. Also, DIY shifted toward value and we were slower to adjust our messaging to reflect that. We do have a strong value offering and have since pivoted to ensure customers see it. The last four weeks were not indicative of the underlying health of the business. When we look at Q3, trends have accelerated, especially transactions. On a two-year basis we are consistent with our guidance, roughly a 3% two-year stack, and we expect to continue on that trend. We do not expect a deviation from that two-year trend and remain within our guidance range.
Sorry. My follow-up question is on the path moving forward. You have articulated a lot of confidence that over time, there are idiosyncratic drivers to improve Advance Auto Parts profitability, especially from all the actions that have already been made. So are you still of the view that next year, there could be more margin expansion as the fruits of those initiatives take place? And if the overall environment for the aftermarket remains more challenging next year, to what degree does that potentially offset the idiosyncratic gains in profitability that you are expecting in 2027?
Yes, I appreciate it, Michael. I'll just talk about that. We talked about at least 100 basis points next year, and we still have confidence in that. A lot of the work Ron has been doing this year has been around supply chain, store planning, and getting under the hood. As he works through supply chain, it gives us more confidence in the unlock that supply chain improvements will provide going forward. We’re not ready to give specifics yet, but we’ll update later in the year. Frankly, we’re gaining confidence as Ron continues his work. On the store side, Tony is driving a shift to ensure our labor hours are as productive as possible serving customers, with less tasking and more customer focus to drive productivity. We’re seeing that and gaining confidence in the actions we will be able to take there. So we remain confident and still view at least 100 basis points as a target for next year. You asked about current pressures. They’re primarily around DIY and possibly some freight pressures. If the DIY weakness persists, there may be some pressure; we saw about 20 basis points of mix pressure in Q2. Even so, we delivered underlying margin growth of over 110 basis points excluding tariffs, so the business is still driving operating income and gross margin growth despite those headwinds. If those pressures continue, we expect to be able to mitigate them next year.
Michael, it's Shane. Thanks for the questions. If I come back to the big picture, it's a good industry. By the way, if you look at how we're running the business, we're willing to make the tough calls. We're using KPIs to track how we're doing. We're being transparent about it. We're being disciplined in the execution. We're not happy with how Q2 came out. We're putting in a series of initiatives to help us as we think about what we can do with DIY and what we can sustain with Pro. But even in the tough moments, you can point to and find evidence of improvements in areas that are critical for our continued advancement and for our turnaround and comeback. You can think about that in terms of NPS. We rolled that out and our initial numbers were rough, and we've talked about the journey from the 60s to the 80s. That's meaningful. That's a customer saying, "Hey, I had a better experience than what I had last time." You can think about attachment rate, our market hub openings, what we're doing with the assortment, and the DC consolidation. We literally just finished the DC consolidation. I don't want to say we're nascent in the journey because we've been at it for a minute, but we are making improvements and getting better every day on the things that we can control, and we're staying at it, being rational actors and putting in plans to make that improvement continue in the future.
And that concludes our question-and-answer session. I will now turn the call back over to Shane O'Kelly for some closing remarks.
Thanks, everybody, for joining the call. I want to thank the team members at Advance. It's their hard work that's making the progress on some of the KPIs that I mentioned, and it's their hard work that's helping us as we go through Q3. We look forward to talking to everybody at the end of the quarter, and we appreciate you following the company. Take care. Thank you.
This concludes today's conference call. Thank you for your participation. You may now disconnect.