領先汽車配件 (AAP) 2021 Q2 法說會逐字稿

Welcome to the Advance Auto Parts Second Quarter 2021 Conference Call. Before we begin, Ms. Elisabeth Eisleben, Senior Vice President, Communications and Investor Relations, will make a brief statement concerning forward-looking statements that will be discussed on this call.

I will now turn the call over to Ms. Elisabeth Eisleben. Please go ahead.

Good morning, and thank you for joining us to discuss our Q2 2021 results that we highlighted in our earnings release this morning. I'm joined by Tom Greco, our President and Chief Executive Officer; and Jeff Shepherd, our Executive Vice President and Chief Financial Officer. Following their prepared remarks, we'll turn our attention to answering your questions.

Before we begin, please be advised that our remarks today may contain forward-looking statements. All statements other than those of historical facts are forward-looking statements including, but not limited to, statements regarding our initiatives, plans, projections, guidance and future performance. Actual results could differ materially from those projected or implied by the forward-looking statements. Additional information about factors that could cause actual results to differ can be found under the caption Forward-looking Statements and Risk Factors in our most recent annual report on Form 10-K and subsequent filings made with the Securities and Exchange Commission.

Now let me turn the call over to Tom Greco.

Thanks, Elisabeth, and good morning. We hope you're all healthy and safe amid the ongoing pandemic and recent surge of the Delta variant. I'd like to start by thanking the entire Advance and Carquest independent family for your hard work to serve our customers throughout the quarter. It's because of you that we're reporting the positive growth in sales, profit and earnings per share we're reviewing today.

In Q2, we continued to deliver strong financial performance on both the 1- and 2-year stack as we began lapping more difficult comparisons. In the quarter, we delivered comparable store sales growth of 5.8%, and adjusted operating income margin of 11.4%, an increase of 11 basis points versus 2020. As a reminder, we lapped a highly unusual quarter from 2020, where we significantly reduced hours of operation and professional delivery expenses reflective of the channel shift from pro to DIY.

As we anticipated, the professional business accelerated in Q2 2021, and between our ongoing strategic initiatives and additional actions, we expanded margins. Our actions offset known headwinds within SG&A and an extremely competitive environment for talent.

On a 2-year stack, our comp sales improved 13.3%, and margins expanded 227 basis points compared to Q2 2019. Adjusted diluted EPS of $3.40 increased 15.3% compared to Q2 2020 and 56.7% compared to 2019. Year-to-date, free cash flow more than doubled, which led to a higher-than-anticipated return of cash to shareholders in the first half of the year, returning $661.4 million through a combination of share repurchases and quarterly cash dividends.

Our sales growth and margin expansion were driven by a combination of industry-related factors as well as internal operational improvements. On the industry side, the macroeconomic backdrop remained positive in the quarter as consumers benefited from the impact of government stimulus.

Meanwhile, long-term industry drivers of demand continued to improve. This includes a gradual recovery in miles driven, along with an increase in used car sales, which contributes to an aging fleet. While we delivered positive comp sales in all 3 periods of Q2, our year-over-year growth slowed late in the quarter as we lapped some of our highest growth weeks of 2020. Our category growth was led by strength in brakes, motor oil and filters with continued momentum in key hard part professional categories.

Regionally, the West led our growth, benefiting from an unusually hot summer, followed by the Southwest, Northeast and Florida. To summarize channel performance, we saw double-digit growth in our professional business and a slight decline in our DIY omnichannel business.

To understand the shift in our channel mix, it's important to look back at 2020 to provide context. Beginning in Q2, we saw abrupt shifts in consumer behavior across our industry due to the pandemic, resulting from the implementation of stay-at-home orders. This led to more consumers repairing their own vehicles, which drove DIY growth.

In addition, our DIY online business surged as many consumers chose to shop from home and leverage digital services. Finally, as we discussed last year, our research indicated that large box retailers temporarily deprioritize long-tail items, such as auto parts, in response to the pandemic. These and other factors resulted in robust sales growth and market share gains for our DIY business in 2020. Contrary to historical trends, the confluence of these factors also led to a slight decline in our professional business in Q2 2020.

As we begin to lap this highly unusual time, we leveraged our extensive research on customer decision journeys. This enabled us to move quickly as customers shifted how they repaired and maintained their vehicles. Our sales growth and margin expansion in Q2 demonstrates the flexibility of our diversified asset base as we adapted to a very different environment in 2021.

Specific to our professional business, we began to see improving demand late in Q1 2021, which continued into Q2, resulting in double-digit comp sales growth. This is directly related to the factors just discussed, along with improved mobility trends as more people return to work and miles driven increased versus the previous year.

Strategic investments are strengthening our professional customer value proposition. It starts with improved availability and getting parts closer to the customer as we leverage our dynamic assortment machine learning platform.

Within our Advance Pro catalog, we saw improved key performance indicators across the board, including more online traffic, increased assortment and conversion rates, and ultimately, growth in transaction count and average ticket. We also continued to invest in our technical training programs to help installers better serve their customers. Our TechNet program is also performing well as we continue to expand our North American TechNet members, providing them with a broad range of services. Each of these pro-focused initiatives has been a differentiator for Advance, enabling us to increase first-call status with both national strategic accounts and local independent shops.

Finally, we're pleased that through the first half of the year, we added 28 net new independent Carquest stores. We also announced the planned conversion of an additional 29 locations in the West as Baxter Auto Parts joins the Carquest family. We're excited to combine our differentiated pro customer value proposition with an extremely strong family business, highlighted by Baxter's excellent relationships with their customers in this growing market. In summary, all of our professional banners performed at or above our expectations in Q2, including our Canadian business despite stringent lockdowns.

Moving to DIY omnichannel. Our business performed in line with expectations considering our strong double-digit increases in 2020. While Q2 DIY comp sales were down slightly, DIY omnichannel was still the larger contributor to our 2-year growth. DIY growth versus a year ago gradually moderated throughout the quarter as some consumers return to professional garages.

Within DIY omnichannel, we saw a shift in consumer behavior back to in-store purchases, consistent with broader retail. We've also been working to optimize and reduce inefficient online discounts. These factors, along with highly effective advertising, contributed to an increase in our DIY in-store mix and a significant increase in gross margins versus prior year. We remain focused on improving the DIY experience to increase share of wallet through our Speed Perks loyalty platform. We made several upgrades to our mobile app to make it easier for Speed Perks members to see their status and access rewards.

We continue to see positive graduation rates among our existing Speed Perk members. In Q2, our VIP membership grew by 8%, and our Elite members, representing the highest tier of customer spend, increased 21%.

Shifting to operating income. We expanded margin in the quarter on top of significant margin expansion in Q2 2020. This was led by our category management initiatives, which drove strong gross margin expansion in the quarter. First, our work on strategic sourcing remains a key focus as consistent sales growth over several quarters resulted in an increase in supplier incentives.

Secondly, we've talked about growing owned brands as a percent of our total sales. This has been a thoughtful and gradual conversion, and we began to see the benefits of several quarters of hard work in Q2. This was highlighted by our first major category conversion with steering and suspension, where we saw extremely strong unit growth for our high-margin Carquest premium products.

In addition, the CQ product is highly regarded by our professional installers with consistent high level of quality standards that are now delivering lower defect rates and improved customer satisfaction.

We also recently celebrated the 1-year anniversary of the DieHard battery launch. Following strong year 1 share gains in DIY omnichannel, we've now extended DieHard distribution into the professional sales channel, where we're off to a terrific start. Further expansion of the DieHard and Carquest brands is planned for other relevant categories.

In terms of strategic pricing, we significantly improved our capabilities, leveraging our new enterprise pricing platform. This platform enabled us to respond quickly as inflation escalated beyond our initial expectations for the year.

Moving to supply chain. While we're continuing to execute our initiatives, we faced several unplanned offsetting headwinds in Q2. Like most retailers, we experienced disruption within the global supply chain, wage inflation in our distribution centers, and an overall shortage of workers to process a continued high level of demand. In addition, our suppliers experienced labor challenges and raw material shortages.

Despite a challenging external environment, we continue to execute our internal supply chain initiatives. This includes the implementation of our new warehouse management system, or WMS, which we're on track to complete in 2022. In the DCs that we've converted, we're delivering improvements in fill rate, on-hand accuracy and productivity. The implementation of WMS is a critical component of our new labor management system, or LMS. Once completed, LMS will standardize operating procedures and enable performance-based compensation.

We also continue to execute our cross-banner replenishment, or CBR initiative, transitioning stores to the most freight-logical service in DC. In Q2, we converted nearly 150 additional stores and remain on track with the completion of the originally planned stores by the end of Q3 2021.

In addition to CBR, we're on track with the integration of Worldpac and Autopart International, which is expected to be completed early next year.

Shifting to SG&A. We lapped several cost reduction actions in Q2 2020, which we knew we would not replicate in 2021. We discussed these actions on our Q2 call last year. Primarily a reduction in delivery costs as a result of a substantial channel mix shift, along with the reduction in store labor costs at the beginning of the pandemic. Jeff will discuss these in more detail in a few minutes.

In terms of our initiatives, we continue to make progress on sales and profit per store. Our team delivered sales per store improvement, and we remain on track to reach our goal of $1.8 million average sales per store within our time line.

Our profit per store is also growing faster than sales per store, enabling 4-wall margin expansion. In addition to the positive impacts of operational improvements we've implemented to drive sales and profit per store, we've also done a lot of work pruning underperforming stores, and we're back to store growth. In the first half of the year, we opened 6 Worldpac branches, 12 Advance and Carquest stores, and added 28 net new Carquest independents as discussed earlier. We also announced the planned conversion of 109 Pep Boys locations in California. We're very excited about our California expansion with the opening of our first group of stores scheduled this fall.

The resurgence of the Delta variant has resulted in some construction-related delays in our store opening schedule. We expect to complete the successful conversion of all stores to the Advance banner by the end of the first quarter 2022.

Finally, we are focused on reducing our corporate and other SG&A costs, including a continued focus on safety. Our total recordable injury rate decreased 19% compared to Q2 2020 and 36% compared to Q2 2019. We're also finishing up our finance ERP consolidation, which is expected to be completed by the end of the year. Separately, we're in the early stages of integrating our merchandising systems to a single platform. Both these large-scale technology platforms are expected to drive SG&A savings over time.

The last component of our SG&A cost reduction was a review of our corporate structure. In terms of the restructuring of our corporate functions announced earlier this year, savings were limited in Q2 due to the timing of the actions. We expect SG&A savings associated with the restructure beginning in Q3.

In summary, we're very pleased with our team's dedication to caring for our customers and delivering strong financial performance in Q2. We're optimistic as the industry-related drivers of demand continue to indicate a favorable long-term outlook for the automotive aftermarket. We remain focused on executing our long-term strategy to grow above the market, expand margins, and return significant excess cash back to shareholders.

Now let me pass it to Jeff to discuss more details on our financial results.

Thanks, Tom, and good morning. I want to echo Tom's thanks to our team members, who continue to prioritize the health and safety of our customers and their fellow team members while helping to deliver solid results for the quarter.

In Q2, our net sales increased 5.9% to $2.6 billion. Adjusted gross profit margin expanded 239 basis points to 46.4%, primarily as a result of the ongoing execution of our category management initiatives, including strategic sourcing, strategic pricing and owned brand expansion. We also experienced favorable inventory-related costs versus the prior year. These benefits were partially offset by inflationary cost in supply chain and unfavorable channel mix.

In the quarter, same-SKU inflation was approximately 2%, and we expect this will increase through the balance of the year. We're working with our supplier partners to mitigate costs where possible.

Year-to-date, gross margin improved 156 basis points compared to the first half of 2020. As anticipated, Q2 adjusted SG&A expenses increased year-over-year and were up $109 million versus 2020. This deleveraged 228 basis points and was a result of 3 primary factors: First, our incentive compensation was much higher than the prior year, primarily in our professional business as we lapped a very challenging quarter in 2020 when pro sales were negative. Second, we experienced wage inflation beyond our expectations in stores. We remain focused on attracting, retaining and developing the very best parts people in the business and will continue to be competitive. We expect both headwinds to continue in the back half of the year.

Third, and as expected, we incurred incremental costs associated with professional delivery and normalized hours of operation when compared to Q2 2020. These increases in Q2 were partially offset by a decrease in COVID-19-related expenses to approximately $4 million compared to $15 million in the prior year.

As a result of these factors, our SG&A expenses increased 13.3% to $926.4 million. As a percent of net sales, our SG&A was 35% compared to 32.7% in the prior year quarter. Year-to-date SG&A as a percent of net sales improved 88 basis points compared to the first half of 2020.

While we've seen a decrease in COVID-19-related costs year-to-date, the health and safety of our team members and customers will continue to be our top priority. As the current environment remains volatile, and the Delta variant remains a concern, we may see increased COVID-19 expenses in the back half of the year.

Our adjusted operating income increased to $302 million compared to $282 million 1 year ago. On a rate basis, our adjusted OI margin expanded by 11 basis points to 11.4%. Finally, our adjusted diluted earnings per share increased 15.3% to $3.40 compared to $2.95 in Q2 of 2020. Our free cash flow for the first half of the year was $646.6 million, an increase of $338.4 million compared to last year. This increase was driven in part by our operating income growth, along with continued momentum in our working capital initiatives.

Our capital spending was $58.7 million for the quarter and $129.6 million year-to-date. We expect our investments to ramp up in the back half of the year, and in line with our guidance, we estimate we will spend between $300 million and $350 million in 2021. Due to favorable market conditions, along with our improved free cash flow in Q2, we returned nearly $458 million to our shareholders through the repurchase of 2 million shares at an average price of $197.52 and our recently increased quarterly cash dividend of $1 per share.

We're pleased with our performance during the first half of the year and moving into the first 4 weeks of Q3, on a 2-year stack, our comparable store sales are in line with Q2. We're continuing to monitor the COVID-19 situation as well as other macro factors, which may put pressure on our results, including inflationary costs in commodities, wages and transportation. Based on all these factors, we're increasing our full year 2021 guidance ranges, including net sales in the range of $10.6 billion to $10.8 billion, comparable store sales of 6% to 8%, and adjusted operating income margin of 9.2% to 9.4%.

As you heard from Tom on our new store openings, we've encountered some delays in the construction process of converting Pep Boys stores, primarily permitting and obtaining building materials related to the ongoing pandemic. As a result, we're lowering our guidance range and now expect to open 80 to 120 new stores this year. Additionally, given the improvement of our free cash flow and our accelerated share repurchases in the first half of the year, we're also increasing our guidance for free cash flow to a minimum of $700 million and an expected range for share repurchases of $700 million to $900 million.

We remain committed to delivering against our long-term strategy as we execute against our plans to deliver strong and sustainable total shareholder return. Now let's open the call for your questions. Operator?

(Operator Instructions) Our first question comes from the line of Michael Lasser of UBS.

Tom, your sales performance in 2Q trailed behind some in the industry as well as some indicators of how the industry performed. What would you attribute that to? And is this a sign that it's just going to be harder to realize the top line expectation that you have outlined as part of your long-term plan?

On the contrary, we're very pleased with our sales performance in the quarter. This is one of those unusual quarters where the timing of the quarter makes a very big difference. If you think about our quarter that started on April 25, we didn't have the first 24 days of April. That 3-week period, we can see our growth. It was over 50% in those weeks, and they get replaced by a couple of weeks in July. Our quarter ended on July 17. So it's really around the timing piece.

As far as we're concerned, it's -- we've normalized the calendar for the months of April through June. We're performing very well in relative terms.

So in general, this is a very fragmented industry as well. There's lots of room for everyone to grow. We have just 7% of the total market. We're also pleased that we were able to grow margins -- gross margins in the quarter on top of the sales growth. So again, when we normalize our quarter relative to our peers, we feel very good about our sales performance.

Understood. My follow-up question is on your operating expenses. SG&A versus 2019 in the quarter was up around 14% following an 11% increase in the first quarter. How much of this has been due to wages inflating more than you expected? And what's a reasonable expectation for us to assume wages are going to continue to increase in the next couple of quarters? And then how much is this going to be offset by other potential sources of savings or even the gross margin expansion that seems sustainable that you generated in the second quarter?

Yes. Well, specific to SG&A, when you compare it to 2019, you got to remember, we do have the COVID-related costs in '21 that we didn't experience in 2019. And I think that just about evens it out. In fact, we might actually be a little bit better on a relative basis when you take out those $4 million.

In terms of inflation, we certainly experienced inflation throughout the P&L. And the wage inflation was higher than our expectations. Certainly, the product costs are well within our expectations. They are a little over 2%. But just kind of stepping back, if we continue to execute our margin expansion initiatives, especially in gross margin, many of which you saw this quarter, we think that's going to continue into the back half of the year.

And keep in mind, a lot of our SG&A initiatives that we laid out in April either don't start in '21 at all or just begin in the back half of '21. So for example, that $30 million of restructuring, we're not going to start seeing that until the back half. So that will help us somewhat. But SG&A is going to be challenged throughout the balance of the year, but we're confident we can continue with our gross margin and, hopefully, continue to show positive operating margins.

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

My first question is on gross margin. This quarter, looked like it was a pretty strong inflection on that line item. Can you talk about if it's reflective of the collective of initiatives that you're working on? And then is there any part of it that may not be repeatable?

Yes. Thanks, Simeon. The short answer is yes. It's directly attributable to our category management initiatives. It's the combination of our strategic sourcing, our strategic pricing, and as Tom mentioned, we rolled out our own brands. And so if you take those and put them together, that not only offset the inflation, which, as I just mentioned, was a little over 2% that we saw in product costs, it drove all of our gross margin improvement in the quarter. And we absolutely believe that these are sustainable in the back half of the year.

Now we did see favorability with some of those inventory-related items, namely capitalized supply chain costs, but those were essentially offset by the supply chain headwinds and channel mix. So overall, we're very pleased with how our initiatives drove gross margin improvement in Q2, and we expect that to continue.

Okay. That's helpful. And then maybe, Jeff, I'm going to stick with supply chain cost, because I know -- you just mentioned it now, and I think it was in the press release. Because these costs are getting capitalized, and we know what container rates and freight rates are moving up, have we seen the peak level of these costs reflected? Or we have to wait as your inventory turns means we're going to see a little bit incremental pressure from these items down the road?

Over time, down the road, you would see these come back through. Remember, we've got $4 billion of inventory sitting on our balance sheet. So I wouldn't expect a way to come back in the next few quarters, and it really varies by the velocity of the various SKUs. So if it does get onto your balance sheet. It does come back off over time. But overall, we're not anticipating anything, at least not in the back half of the year.

And just related to this thing, related to my first and the second question. This inflection in terms of magnitude of gross margin combined with maybe some higher supply chain costs, is there any rule of thumb where the business should be doing 30, 50, 70 basis points of margin? Or is it you're not going to draw a line in the sand that specifically?

Yes, we're not going to draw lines in the sand that specifically. We're really pleased with the -- of the initiatives that we have in place. They're absolutely going to continue, and we're going to try our best to manage the inflation as we go through the balance of the year.

Your next question comes from the line of Christopher Horvers of JPMorgan.

So my first question is on the commentary around quarter to date, the DIY compares really start to ease off going forward. If our math is right, you were running sort of low double digit through the end of August last year, and then it eased down to sort of mid-single digit plus in the latter part of the quarter. Is that fair? And does that imply that you're running sort of like a low single-digit 1 year positive at this point?

Chris, you're in the ballpark. What we said was we're in line with the 2-year stack in the second quarter, which as we reported this morning, was a little over 13%. So our third quarter was 10%. So you're in that ballpark, and I think your cadence is right as well. I mean July and August were very strong last year and started to gradually moderate through the fall.

Understood. Makes sense. And then as a follow-up, just helicoptering up, you did it in the first quarter, you had a 9% operating margin. In the second quarter, you had an 11.4% operating margin. What's the new sustainable level? Or maybe asked differently, what's not sustainable in the 11.4%? I understand in some quarters seasonally light, so less sort of leverage on the fixed cost side. But what's sort of the build point that we're going from as we think about the second quarter and forward?

Yes. A couple of things, Chris. We're pleased with the -- not only the 1 year, but the 2-year improvement in the second quarter on margin expansions over 200 bps. The big thing that's starting to kick in for us and is sustainable is the category management initiatives. I mean we've been working on those for a couple of years. We've said all along it's going to take time.

We've had several quarters, 5 quarters in a row of growth now. The last couple of years, we only have the one difficult quarter in early 2020. And that's helped us on the sourcing side and vendor incentives piece. The rollout of our owned brands, which as you know, given the turns in our category, has taken time. But that is really starting to benefit our P&L.

There's a significant difference in the margin rate between the Carquest premium owned brand products and some of the alternatives that we have there. And as you know, we implemented that pricing tool in the middle of last year, and that also has enabled us to be a lot smarter in how we price, whether that's regionally or by channel or by account, all of those things. So clearly, the category management initiatives are going to be sustainable for us. The supply chain initiatives, we're going to continue to execute against. They're very much on track.

What we're dealing with on the unknown side is just the ongoing inflationary environment. And in the second quarter, we saw that coming. We dealt with it. We feel confident. This is an industry that's been able to deal with unplanned inflation very successfully over many years. So that's the approach that we're going to take. But the gross margin initiatives, we feel very strong -- very good about and we believe are sustainable, and we're going to continue to execute that.

So I guess, said another way, ex sort of seasonality and overall sales levels, there was nothing unusual in the 11.4%?

Yes. We called out the inventory-related costs that were basically fully offset, as Jeff just said, by the channel mix and the supply chain headwinds. But other than that, it was equal. Jeff?

The only thing I would add to that, Chris, is in the back half, we're going to continue to invest in marketing as long as it makes sense. We're seeing a really good return on our advertising spend. It was relatively flat in Q2, just so you know. But in the back half, we've got some plans to invest further into marketing. So we're going to see some of that in the back half.

Your next question comes from the line of Elizabeth Suzuki of Bank of America.

This is Jason Haas on for Liz Suzuki. So I wanted to focus in on the DIY business. I'm curious what you could say about the health of that customer. We know they've been flush with cash with stimulus and high saving rates for a while. So it sounds like you're starting to see a moderation in that business. I'm curious to what extent do you think that folks shifting over to the do-it-for-me channel? Or do you think maybe there's just some slowdown in their spending after the stimulus dollars start to run out?

Well, we've actually been pretty pleased with the performance in DIY. We fully anticipated the shift back to DIFM at some point this year, given what happened last year again. Again, in the second quarter of 2020, people were locked in their homes. They had time on their hands. They were doing things that they wouldn't normally do, including DIY automotive. So as we get back into more of a normalized environment here where people are commuting, they're going out to baseball games and traveling on airplanes and all the things that they do, they lose that time. And then they're going to obviously get their car repaired and maintained by a professional. It's more likely that they would do that.

And also in the second quarter last year, many of the professional garages were closed for a period of time, so they couldn't even get them repaired at a garage. So it's really held up more than we would have expected. And we're very pleased with our DIY performance in the quarter. We can see that we held on to customers that joined us last year, that came on to our -- to the Advance team, if you will, last year, and we've maintained those customers. And the DIY business has held up. So it hasn't -- we haven't given back a whole lot of the gains from last year.

That's great to hear. And then on your inventory position, I know you mentioned and it's been widely reported, some supply chain challenges. So I'm just curious how that looks from here on out. If you are getting a sense of things just starting to improve from here? And then just the state of your inventory and how you feel for the remaining quarters of the year.

And then if it's related at all, I did want to follow up on the free cash flow guidance. Just curious what the driver is. If that's inventory related? I don't know if the delayed store openings has an impact. Just any color on that would be helpful as well.

Okay. Well, I'll take the supply chain question, and I'll put the free cash flow over to Jeff. I think in general, we would say our store in-stocks are not where we'd like them to be. At the same time, we're very well positioned competitively. I've been out in the market a lot. I can see what's going on in the DIFM network, in DIY. I feel very good about our competitive position. I think everyone is experiencing some level of difficulties there.

I'm very proud of our merchant inventory and supply chain teams. They've leveraged long-term relationships that we have with our partners to keep the product moving. So we're going to continue to work with them to build our inventory back and make sure that we're at the level of service that we want to be for our stores. But I feel very good competitively. Jeff?

Yes, sure. On the free cash flow, really, there's 3 things that are going to impact us in the back half that we didn't see as much in the first half. So first of all, we do think we're going to still generate meaningful operating cash in the back half. But that's going to be largely offset by 3 things.

First is our capital expenditures. We still have a very robust plan in the back half to invest back in the business, investing in our margin expansion objectives. And so the CapEx spend will be elevated as compared to the second half. As you saw, we held our guidance there at $300 million to $350 million for the year.

Second, and related to the first question, we are going to be making investments in inventory that will likely increase our inventory in the back half to support what Tom just said, both the in-stocks as well as our new store openings. So that will put some pressure on our working capital.

And then the last thing is we have a couple of expenditures that we didn't see in the first half. We have to repay half of the CARES Act. So if you recall, we didn't have to make the cash payment on the employer payroll tax last year. We have to pay back half of that this year in the fourth quarter. And then we do have an additional rent payment due to the timing of our fiscal year-end. So those are really the drivers for the lower free cash flows compared to the first half.

Got it. That's helpful.

Your next question comes from the line of Steven Zaccone of Citigroup.

I guess I wanted to start on the outlook for parts inflation. If you could elaborate a little bit more on how you're thinking about the full year. I think the prior expectation was for 2% to 4% benefit to the full year comp. So just talk about that. And then I guess more broadly on the pricing environment, have you really seen any issues with passing cost onto the pro customer or the DIY consumer?

Yes. So I'll take the first part. I think you mentioned the parts inflation. As I said, in the quarter, we saw product costs at a little over 2%. When we started the year, we were estimating inflation at 1% to 2%. We now think it's going to be 2% to 4%. We do know there is more inflation coming. We're planning for that. So that 2% to 4% range, we feel like it's going to be still in that range.

Yes. And on the pricing piece, we've been able to leverage our tools much better this year. We're being a lot more strategic in how we pass on pricing. We leverage all the work we do on the customer decision journey, whether that's in DIY or in DIFM. And with that in mind, we've been able to pass it on very successfully. And it's kind of a tradition within our industry. We feel confident we'll be able to continue to do that.

Great. And just a second question on the broader like macro backdrop and some of the industry drivers. How do you see demand playing out over the balance of the year? I guess, in particular, we've seen the strength in used car sales. Do you think that's a tailwind that can continue here in the back half of the year?

We definitely do. I mean that's a very important number to see that used car growth. And we do believe that's going to continue to contribute to an aging fleet, which in turn means more parts sales. So that's a strength. And the traditional drivers of demand, all of them are relatively positive. We're seeing a recovery in miles driven. The car parc's growing. The fleet is aging. So all of those contribute to incremental part sales. So we do believe the industry continues to grow. And as you saw from our April investor presentation, as you get into '22, '23, we think that continues in the 4% range.

Your next question comes from the line of Kate McShane of Goldman Sachs.

I just wanted to go back to the wage inflation piece. Just curious why maybe it was higher than expected in Q2. And I wondered if you could talk a little bit about turnover currently at the DCs versus stores. And where your average hourly wage is currently?

Well, first of all, we definitely have planned some level of wage inflation for the year, Kate. It is a little bit -- I mean, you're very familiar with the labor situation [en masse], which was very challenged in the second quarter. So we were surgical with how we invested in wages. We look at them market-by-market. And we look at it on an ongoing basis. We want to make sure we've got the very best people that we can get into our stores to work with our customers.

And that's been a multiyear effort. We've been investing in our frontline team members for several years. We've got a very unique program called Fuel the Frontline, which provides stock to our frontline team members. No one else in the industry has that. We've invested over $60 million there. And as we look at our store team, we want to keep that turnover number down as low as possible. So there are markets where we made investments in the quarter in the stores.

Supply chain is a very challenging situation. We are seeing inflation there, as we called out, more than we expected. The turnover, I think has peaked and started to come down is what I would tell you there. Obviously, as some of the benefits, the unemployment benefits, et cetera, start to come off, we are seeing more applicants and able to source the people that we need. So I think the difficult environment is going to continue, but it's going to be less challenging, I think, than it was in the second quarter.

Your next question comes from the line of Bret Jordan of Jefferies.

On the category initiatives, I guess, do you think that they are having any impact on your in-stocks as you put more of the supply chain on your own plate as opposed to third-party distributors, suppliers?

No. I think in general, we're transitioning certain categories, but it's -- in general, it's a challenging environment for our suppliers, getting people to work, getting containers. Obviously, we've got to source products from China. There's a lot of variables in there, Bret. So I think it's really a broader issue.

Okay. And then I guess on the Pep Boys topic, you talked about some of the store conversions. Could you give us any color as how -- any early feedback on how those stores are performing if you've converted? And I guess on those that you're having a problem with, may they never convert? Is it something that you're just not getting approval on the zoning for and they may get left out? Or it's just going to be slower?

First of all, no, we'll get them all converted. What we said was by the end of the first quarter of '22. We obviously want to get this right as quickly as we can. We've run into some challenges with permitting and construction and things like that in California, quite unique to that market.

But I got to tell you, we're so excited about this opportunity, Bret. I've been out there a couple of times. I've been through the stores, meeting the team members. These are experienced team members. They know the L.A. market. They know the California market. We're going to bring them all of our initiatives. We're going to bring the DieHard batteries, Carquest premium products, all of our professional customer base. We're very excited about this opportunity. And you're going to hear more about it this fall. I mean we're going to be starting opening soon.

Okay. Great. Then one quick housekeeping question. I guess on the accounts payable to inventory, now in the 80s. Years ago, we talked about this maybe being a target. Do you think that number goes higher? Or are there just structural headwinds like Worldpac that would prevent your accounts payable north of 100%?

Yes. We've said in the past that we think we can get our AP ratio into the low 90s. For the balance of the year, we think it will moderate to some extent versus what you're seeing in Q2, and that's largely driven by the inventory investments that I had mentioned earlier.

Your next question comes from the line of Daniel Imbro of Stephens.

I want to start on the expense side. I think in recent quarters, Jeff and Tom, you've mentioned taking up your advertising dollars. I think you've noted that it had probably skewed toward more driving DIY sales and DIY mix. But DIY sales slowing and becoming a smaller percentage going forward, can you maybe talk about how you're planning those advertising dollars? And frankly, how you're measuring ROI just given the channel shifts going on in the business?

Yes. Daniel. We measure it based on the ability to drive the P&L and margin expansion. Incremental sales dollars are in the equation, obviously. But we've been very, very successful at refining our marketing spend.

DieHard has been a home run. We launched DieHard last year. We gradually reduced our discounts online on batteries. Our gross margin improvement in batteries is significant. We -- part of our gross margin benefit in the quarter was related to batteries, where on a year-to-date basis, we're still gaining unit share and growing gross margin. So when those marketing dollars, which show up in SG&A are spent against an initiative, such as DieHard, we look at the total picture, not just the SG&A investment, obviously. To the extent we can drive the entire P&L, we'd do that, and that's how we look at it.

Got it. So it's not slowing. That's helpful. And then two, just on the DIY customer. First, you talked about moving customers up your loyalty tiers. What are the reward redemptions looking like at each level? And is there a different gross margin impact? Is there a positive benefit from moving up tier with customers?

And then the last DIY question, just with gas prices much higher maybe year-over-year and, frankly, staying here at levels we haven't seen in a while, have you seen any impact on that lower-end DIY customer? Any pullback in discretionary spending you attribute to that factor?

Well, first of all, in Speed Perks, we're pleased we're starting to grow share of transactions again. We saw a nice increase on that. We're seeing what we call graduation, so the increases in our Elite members, increases in our VIP members. So the short answer is we want that, right? We want to capture a higher share of wallet with our DIY customers. And when we do that, we make more gross profit dollars. The discounts are not, obviously, factored into that. But you're getting a higher share of wallet, in total, you're very happy with that outcome.

We haven't seen anything yet in terms of DIY customers trading down. We're very cognizant of that, though, Daniel, to your question. In some cases, as we roll out Carquest premium owned brand, we're seeing that naturally. And that's actually a good thing for us because it drives gross margin. However, in general, I don't think we can say we've seen a broad trend to trade down yet, but we're cognizant of it given the environment and given the stimulants coming off and all of those things.

Your next question comes from the line of Michael Montani of Evercore ISI.

I just wanted to ask for some incremental color, if I could, Tom, in terms of transaction counts. Can you just give us a sense for how that played out on DIY, DIFM? And then that 5.8% comp, how much was traffic versus ticket there?

Sure. Pro was strong across the board. Strong ticket growth, strong average ticket. DIY was down in terms of transactions, lapping huge growth last year. So in terms of our overall performance, we're pleased with both in terms of our expectations and what we -- how we thought the quarter was going to play out. Average ticket was strong in DIY as well, by the way. So a bit of a tale of 2 cities and -- but not different than we expected.

And just a follow-up was, if we look at the back half of last year, it's kind of 100, 150 bps higher EBIT margin in aggregate versus the back half of '19. And just thinking about this year's back half, we're talking about kind of double-digit trends in terms of 2-year sales productivity lift. So just wondering if there's any structural impediment that would kind of prevent the retention of much or all of that kind of benefit that you all had last year.

Well, I mean, our back-half guide represents a combination of factors. I mean we've looked at the environment. It's obviously a pretty dynamic environment right now. There's a lot of unknowns in the back half. So we have reflected that in the guide. But based on the tailwinds we had in the second quarter and all of those headwinds that we see, we did increase the guide for the third time on all the key financial metrics. And we're pleased that through the first 4 weeks on a 2-year stack, our sales performance is in line with Q2, roughly 13%. So all of that's positive, Michael.

So we're going to continue to execute our plan. We want to grow faster than the market. We want to expand our margins. We're going to return the excess cash back to our investors and continue to do what we believe we're capable of doing over the next couple of years. And we're cognizant of the dynamic nature of the environment.

And I'm showing no further questions in the queue at this time. I'll hand the call back to Mr. Tom Greco for closing remarks.

Well, thanks again for joining us today. As you heard this morning, we're very proud of our performance in the first half of the year. And we're extremely grateful for nearly 70,000 team members who are dedicated to serving the customer while working to keep our Advance family safe and healthy amid a very challenging environment. We're committed to continue to execute our long-term strategy to deliver strong and sustainable total shareholder return, and we're confident in our ability to deliver against our strategic initiatives.

I'd also like to announce that starting September 1, we're launching our annual American Heart Association fundraising campaign at our stores as well as our independently owned Carquest stores in the U.S. and Puerto Rico. The funds we raise will go towards American Heart Association's fight against heart disease and stroke. We believe that by increasing the awareness of heart health and raising critical funds for research, we can help improve the lives of our team members, customers and members of our communities. We hope you'll join us in supporting this important mission. Thank you.

And ladies and gentlemen, this concludes today's conference call. Thank you for participating. You may now disconnect.