AutoZone Q2 2024 Earnings Call Transcript

Quartr
Provided by Quartr
February 27, 2024

There are 13 speakers on the call.

Operator

Greetings. Welcome to the AutoZone's 2024 Q2 Earnings Release Conference Call. At this time, all participants are in a listen only mode. A question and answer session will follow the formal presentation. Please note this conference is being recorded.

Operator

Before we begin, the company would like to announce the following forward looking statement.

Speaker 1

Before we begin, please note that today's call includes forward looking statements that are subject to the Safe Harbor provisions of the Private Securities Litigation Reform Act of 1995. Forward looking statements are not guarantees of future performance. Please refer to this morning's press release and the company's most recent annual report on Form 10 ks and other filings with the Securities and Exchange Commission for a discussion of important risks and uncertainties that could cause actual results to differ materially from expectations. Forward looking statements speak only as of the date made and the company undertakes no obligation to update such statements. Today's call will also include certain non GAAP measures.

Speaker 1

A reconciliation of GAAP to non GAAP financial measures can be found in our press release.

Speaker 2

Good morning and thank

Speaker 3

you for joining us today for AutoZone's 2024 Q2 conference call. With me today are Jamere Jackson, Chief Financial Officer and Brian Campbell, Vice President, Treasurer, Investor Relations and Tax. Regarding the 2nd quarter, I hope you had an opportunity to read our press release and learn about the quarter's results. If not, the press release along with the slides complementing our comments today are available on our website at www.autozone.com under the Investor Relations link. Please click on the quarterly earnings conference call to see them.

Speaker 3

As we begin this morning, I'd like to say how honored I am to talk with you on behalf of our more than 120,000 AutoZoners, as today marks my first conference call as AutoZone's President and Chief Executive Officer. At AutoZone, our first priority is to provide what we call Wow! Customer service. This quarter, the efforts of our AutoZoners increased our total sales by 4.6% and total company same store sales by 1.5% on a constant currency basis. Both our operating profit and earnings per share grew by very impressive double digit rates.

Speaker 3

We continue to build on the phenomenal performance we had over the last several years. Congratulations to our AutoZoners everywhere who helped us achieve this amazing growth. Before I begin my comments regarding our 2nd quarter sales, as a reminder, this is always our most volatile quarter to predict as the timing and severity of winter weather is both meaningful and variable. It is also our lowest sales volume quarter. This year, the Christmas and New Year's Day holidays fell on a Monday compared to Sunday last year.

Speaker 3

For commercial sales, this really mattered. Sunday is a very low sales day, while Monday is one of the best. While weather across the U. S. Was very mild for the 1st 8 weeks of the quarter, we experienced a polar vortex and snow in the last 4 weeks.

Speaker 3

This extreme weather helped to propel us to stronger results in DIY, but muted our sales in commercial as snow in much of the Eastern United States stayed on the ground for an extended period of time. Again, weather extremes, either hot or cold, drive hard part failures and accelerate maintenance over time. For the Q2, our total company same store sales were 1.5% on a constant currency basis. As international has become a more important part of our growth story and an area where we are increasingly deploying capital, we will continue reporting on our international performance. We encourage you to focus on the same store sales constant currency number where international again had a strong quarter, up 10.6%.

Speaker 3

We are very excited about the short and long term growth prospects internationally and we plan to accelerate new store openings over the next several years. Our domestic same store sales were up 0.3% this quarter compared to 1.2% last quarter and 5.3% in Q2 of last year. Breaking our 12 weeks of sales into the 1st 8 weeks and then the last 4 weeks, you can see the impact of the holiday shift and the weather volatility. Domestically, we ran a negative 1.8 comp across the 1st 8 weeks and a positive 4.4% comp in the last 4 weeks. This was even more pronounced when splitting these time frames up between commercial and DIY.

Speaker 3

Our commercial business grew 2.7% against very strong sales last year of 13.1%. Although our commercial business finished stronger than we started, our results were below our expectations. Across the 12 week quarter, we were up 4.1% for the 1st 4 weeks, then down 0.7% over the 2nd 4 weeks segment and up 4.4% over the last 4 weeks. Although better in the last 4 weeks segment of the quarter, our sales were depressed due to the winter storm shutting down many commercial customers, particularly in the Mid South. The holiday shift combined with weather negatively impacted our sales by roughly 2% for the quarter.

Speaker 3

Despite all this volatility in commercial sales, we are encouraged that we finished the quarter stronger. Commercial sales growth continues to be driven by the key initiatives we have been working on over time: improved satellite and store inventory availability, material improvements in hub and mega hub coverage, the strength of the Duralast brand with an intense on high quality products and technology enhancements to make us easier to do business with. We recently launched initiatives focused on improving customer service with faster delivery times in commercial. While very early, we are encouraged by the initial results. In commercial, we continue to see higher growth rates for traffic relative to ticket.

Speaker 3

In Q2, we opened 20 net new commercial programs. We now have commercial programs in 92% of our domestic stores. Domestic commercial sales represented 30% of our domestic auto parts sales for Q2. We believe our commercial business will get stronger and growth rates will improve as we move through the year. Sales growth comparisons get easier in the back half of the year and our execution, customer delivery times, in stock levels and parts availability continue to improve.

Speaker 3

Regarding domestic DIY, we had a negative 0.3% comp this quarter versus last year's comp of positive 2.7 DIY ran 0.7% across the 1st 4 weeks of the quarter, a negative 6.2% across the 2nd 4 weeks segment and a positive 4.8% comp over the last 4 weeks. The last 4 week time segment was accelerated due to the winter weather. As a reminder, last year, the polar vortex hit in the 2nd 4 week segment. I'd like to add some color on our regional performance as well. The Northeast and the Midwest markets underperformed the remainder of the country by 500 basis points in the middle 4 weeks segment, only to swing to a positive 12 50 basis points over performance for the last 4 weeks segment.

Speaker 3

For the quarter, we saw a 270 basis point favorable performance in the Northeast and the Midwest versus the remainder of the country. Although the Midwest had some extreme cold, we frankly would like to see more winter weather along the East Coast markets where the winter has been persistently mild for more than 2 years now. Overall, for the quarter, the West performed least favorably. Headed into the Q3, we are planning for a more normal weather pattern, meaning we feel weather will not play a big story one way or the other. Our Q3 performance is always contingent on a normalized tax refund season, and we expect this year to be similar to last year.

Speaker 3

Regarding our merchandise categories and DIY business, our sales floor categories underperformed hard parts as we saw more discretionary pullback, particularly from the low end consumer. Regarding this quarter's traffic versus ticket growth, our DIY traffic was down 2.2%, while our ticket average was up 1.7%. We expect our ticket growth will return to more normalized levels in the 2% to 4% range as we get further removed from higher inflation last year. We attribute our share gains to improved customer service levels in our store and our in stock nearing pre pandemic levels driven by improved productivity in our distribution centers. While we were up against exceptionally strong same store sales from a year ago, particularly in commercial, we believe we are making progress.

Speaker 3

We've made many changes across the organization. From doubling down on many of our long term execution processes, ensuring that we are hiring the best AutoZoners and reducing turnover, our execution is improving and we're making steady progress. Before handing the call to Jamere, I'd like to highlight and give some color on our international business. At 859 stores opened internationally or 12% of our total store base, the business had impressive performance last quarter and should continue to grow at a robust pace for the remainder of fiscal 2024. We are leveraging many of the learnings we have in the U.

Speaker 3

S. To refine our offerings in our international markets. And finally, before Jamere discusses our financial results, I'd like to remind you of our overarching objectives for fiscal 2024. We are focused on growing our domestic commercial business and believe our improved service levels will lead to continued sales growth. We also continue to focus on our supply chain with 2 initiatives that are in flight and drive improved availability.

Speaker 3

1st is our expanded hub and mega hub rollouts. And secondly, we're making good progress on transforming our distribution network. We have 2 domestic distribution centers currently under construction in the U. S, Chowchilla, California and New Kent, Virginia. We are also nearing the completion of our expanded Tepej Mexico distribution center.

Speaker 3

Additionally, we have broken ground on a larger facility that will house our relocated Monterrey distribution center. Our strategy is focusing on leveraging the entire network to carry more inventory closer to the customer, driving sales growth with improved speed, expanded parts, availability and improved efficiency. Now, I'd like to turn the call over to Jamere Jackson.

Speaker 4

Thanks, Phil, and good morning, everyone. As Phil has previously discussed, we had a solid second quarter, marking our 5th sequential quarter of double digit EPS growth. This quarter, we delivered 4.6 percent total company sales growth with a 0.3% domestic comp, a 10.6 percent international comp on a constant currency basis, a 10.9% increase in EBIT and a 17.2% increase in EPS. We continue to deliver solid results and the efforts of our AutoZoners in our stores and distribution centers continue to enable us to drive growth in a meaningful way. To start this morning, let me take a few moments to elaborate on the specifics in our P and L for Q2.

Speaker 4

For the quarter, total sales were up were $3,900,000,000 up 4.6%. Let me give a little color on our sales and our growth initiatives, starting with our domestic commercial business. Our domestic DIFM sales increased 2.7 percent to $980,000,000 and were up 15.8% on a 2 year stack basis. Sales to our domestic DIFM customers represented 25% of our total company sales and 30% of our domestic auto parts sales. Our average weekly sales per program were $14,051 down 2.8% versus last year.

Speaker 4

Once again, the weekly sales averages were impacted by the addition of a significant number of immature programs over the last couple of quarters. I'll also remind you that Q1 and Q2 are our toughest comparisons this fiscal year and we expect our year over year comparisons to be somewhat easier in the back half of our fiscal year. We now have our commercial program in approximately 92% of our domestic stores, which leverages our DIY infrastructure, and we're building our business with national, regional and local accounts. This quarter, we opened 20 net new programs finishing with 5,823 total programs. Our commercial acceleration initiatives continue to make progress as we seek to grow share by winning new business and increasing our share of wallet with existing customers.

Speaker 4

Importantly, we have a lot of runway in front of us and we will continue to aggressively pursue growth opportunity. To support our commercial growth, we now have 101 mega hub locations. Our mega hubs continue to average significantly higher sales than the balance of commercial programs and grew more than 3 times the rate of our overall commercial business in Q2. Our mega hubs typically carry roughly 100,000 SKUs, drive tremendous sales lift and size the store box and serve as an expanded fulfillment source for other stores. These assets are performing well individually and fulfillment capability for the surrounding AutoZone stores is giving our customers access to tens of thousands of additional parts and lifting the entire network.

Speaker 4

We will continue to aggressively open mega hubs for the foreseeable future and we expect to have north of 200 mega hubs at full build out. On the domestic retail side of our business, our comp was negative 0.3% for the quarter. As Phil mentioned, we saw traffic down 2.2% offset by 1.7% ticket growth. As we move forward, we would expect to see slightly declining transaction counts offset by low to mid single digit ticket growth, in line with the long term historical trends for the business, driven by changes in technology and the durability of new parts. While DIY discretionary purchases were challenging Q2, we continue to see a growing and aging car park, a challenging new and used car sales market and a consumer that is likely to continue to invest in their existing vehicles.

Speaker 4

In addition, miles driven are back to pre pandemic levels. As such, we believe our DIY business will remain resilient for the remainder of FY 'twenty four. And now I'll say a few words regarding our international business. We continue to be pleased with the progress we're making internationally. Our same store sales grew an impressive 23.9 percent on an actual basis and 10.6 percent on a constant currency basis.

Speaker 4

During the quarter, we opened 6 stores in Mexico to finish with 7 51 stores and 4 stores in Brazil ending with 108. We remain committed to international and given our success, we're bullish being an attractive and meaningful contributor to AutoZone's future growth. Now let me spend a few minutes on the rest of the P and L and gross margins. For the quarter, our gross margin was 53.9%, up 160 basis points, driven primarily by a significant improvement in our core business gross margins and 63 basis points from a non cash $10,000,000 LIFO charge in last year's quarter versus a $14,000,000 LIFO credit this year. Excluding LIFO from both years, we had a very strong 97 basis points improvement in gross margin, which increased from last quarter's 70 basis point improvement.

Speaker 4

We've had exceptional gross margin improvement and in fact Q2's gross margin was at the highest gross margin rate we've had since Q2 of FY 2021. I'll point out that we now have $43,000,000 in cumulative LIFO charges yet to be reversed through our P and L, and we expect this credit balance to reverse over time. We're currently modeling $15,000,000 in LIFO credits for Q3 based on the deflation experience in Q1 and Q2. This compares to $17,000,000 LIFO credit we had in Q3 last year, which means we'll have a $2,000,000 net LIFO headwind in gross profit in Q3. As I've said previously, once we credit back the $43,000,000 through the P and L, we will not take any more credits and we will begin to rebuild an unrecorded LIFO reserve.

Speaker 4

Moving to operating expenses. Our expenses were up 6.1% versus last year's Q2 as SG and A as percentage of sales deleveraged 49 basis points. The accelerated growth in SG and A has been purposeful as we continue to invest in store payroll and IT to underpin our growth initiatives. These investments are paying dividends and customer experience, speed and productivity. We're committed to being disciplined on SG and A growth as we move forward, and we will manage expenses in line with sales growth over time.

Speaker 4

Moving to the rest of the P and L. EBIT for the quarter was $743,000,000 up 10.9% versus prior year, driven by our positive same store sales growth and gross margin improvements. Interest expense for the quarter was $102,600,000 up 56% from Q2 a year ago as our debt outstanding at the end of the quarter was $8,600,000,000 versus $7,000,000,000 at Q2 end last year. We're planning interest in the $105,000,000 range for the Q3 of FY 'twenty four versus $74,300,000 last year. Higher debt levels and borrowing rates across the curve are driving this increase.

Speaker 4

For the quarter, our tax rate was 19.6 percent and down from last year's Q2 of 21.2%. This quarter's rate benefited 3 60 basis points from stock options exercised, while last year it benefited 222 basis points. For the Q2 of FY 'twenty four, we suggest investors model us at approximately 23.4% before any assumption on credits due to stock option exercises. Moving to net income and EPS. Net income for the quarter was $515,000,000 up 8.1 percent versus last year.

Speaker 4

Our diluted share count of 17,800,000 was 7.8% lower than last year's Q2. The combination of higher net income and lower share count drove earnings per share for the quarter to $28.89 up 17.2 percent for the quarter. Now let me talk about our free cash flow for Q2. For the Q2, we generated $179,000,000 in free cash flow. We had higher CapEx spending this quarter versus a year ago, and we expect to spend close to $1,100,000,000 in CapEx this fiscal year as we complete the addition of our distribution center capacity expansion ahead of schedule.

Speaker 4

I'll also remind you that we generate a majority of our free cash flow in the back half of our fiscal year. We expect to continue to be an incredibly strong cash flow generator going forward and we remain committed to returning meaningful amounts of cash to our shareholders. Regarding our balance sheet, our liquidity position remains very strong and our leverage ratio finished Q2 at 2.4 times EBITDAR. Our inventory per store was up 1.6% versus last year, while total inventory increased 4.2% driven by new store growth. Net inventory defined as merchandise inventories less accounts payable on a per store basis was a negative $164,000 versus negative $227,000 last year and negative $197,000 last quarter.

Speaker 4

As a result, accounts payable as a percentage of inventory finished the quarter at 119.8 percent versus last year's 127.7%. Lastly, I'll spend a moment on capital allocation and our share repurchase program. We repurchased $224,000,000 of AutoZone stock in the quarter and at quarter end we had just over $2,100,000,000 remaining under our share buyback authorization. We've bought back over 100% of the then outstanding shares of stock since our buyback inception in 1998, while investing in our existing assets and growing our business. We remain committed to a leverage target in the 2.5 times area and a disciplined capital allocation approach that will enable us to invest in the business and return meaningful amounts of cash to shareholders.

Speaker 4

So to wrap up, we remain committed to driving long term shareholder value by investing in our growth initiatives, driving robust earnings and cash and returning excess cash to our shareholders. We're growing our market share, expanding our margins and improving our competitive positioning in a disciplined way. And as we look forward to the remainder of FY 'twenty four, we remain bullish on our initiatives to grow sales behind a resilient DIY business, a fast growing international business and a domestic commercial business that remains underpenetrated and should accelerate in the back half of the fiscal year. I continue to have tremendous confidence in our strategy and our ability to drive significant and ongoing value for our shareholders. And now I'll turn it back to Phil.

Speaker 3

Thank you, Jamere. I want to stress how proud I am to represent the company as only the 5th CEO over the almost 45 years we have been in business. As you've heard, we have a lot of initiatives in flight and we have a great team of AutoZoners in place to take us to the next level. We truly believe we will continue to improve from here. We are well positioned to grow sales across our domestic and international store bases with both our retail and commercial customers.

Speaker 3

Our gross margins are solid and our operating expense structure is appropriate for future growth. We are putting our capital expenditures where it matters most our stores, our distribution centers and leveraging technology to build a superior customer experience where we are able to say yes to our customers' needs. Fiscal 2024's top priority is enhanced execution. Additionally, we have many strategic projects in various stages of completion. We will continue opening new mega hubs and hubs, completing construction on the new distribution centers and optimizing our new direct import facility.

Speaker 3

We are also in the early stages of ramping up our domestic and international store growth. As you noticed, our international teams posted same store sales comps on a constant currency basis of 10.6%, much higher than our domestic comps. International has been strong for several years now. While I mentioned all these investments in FY 2024, AutoZone's biggest opportunity remains growing share in our domestic commercial business. While Q2 was below our expectations, we believe we have a solid plan in place for growth over the remainder of the year.

Speaker 3

We know our focus on parts availability and Wow customer service will lead to additional sales growth. We are excited about what we can accomplish and our AutoZoners are committed to delivering results. Now, I'd like to open up the call for questions.

Operator

Certainly. At this time, we will be conducting a question and answer Your first question for today is from Chris Horvers with JPMorgan.

Speaker 3

Good morning, Chris.

Speaker 5

Thanks. Good morning. Thanks for all the information. My first question for you is on the domestic pro business, what's your sense of what the market is actually growing, especially in light of your mix? Obviously, your largest and most relevant competitor has a much smaller mix of national accounts.

Speaker 5

So don't think that's obvious to us from the outside. So how are you seeing the performance of national accounts? Are you seeing that start to get better? Do we have to wait to lap that starting in June July? And how do you think that you're growing relative

Speaker 2

to the market on the pro side?

Speaker 3

Yes. So if you kind of segmented the business, I think an area of customer growth on the commercial side that's been more challenged has been the folks that are more focused on under car. So think brakes, suspension, those types of areas related to the tire, one of the four corners of the car, those are probably been the areas that have been more challenged. So for us, that's categories like brakes and suspension, which we've talked quite extensively about that over the last year. And that's probably been where we've been most challenged.

Speaker 3

But I'll go back to the growth opportunities we have in the commercial. At the end of the day, we still have pretty low share and there's a big opportunity for us to continue to grow share in both terms of share of wallet for the customer as well as new customers.

Speaker 5

So does that mean that, I mean, I guess if you were going to isolate more of the up and down the Street account, Are you seeing better relative performance? And I know you're a little often to give too much detail in breaking out more detail, but like any commentary of like what the performance gap between like a national account business versus an up and down the street account would be really helpful? Thank you.

Speaker 3

Yes. I would say that the national accounts depending on who they are, they can be wildly positive or negative depending on as you pick up business or your mature business etcetera. I probably should have mentioned another area that's been challenged for us really for the last 18 months has been the buy here, pay here segment and the used car segment. Those have been pretty challenged as well as they've struggled with inventory. They had incredible sales coming out of the pandemic and that's probably been a pretty challenged segment as well.

Speaker 5

Got it. And then on that you mentioned tax refunds expected to be normal this year. I mean based on the data that we track, it does seem to be lagging year over year. So can you talk about what you mean in terms of the expectation on tax refunds? It would seem like it actually plays out a little more inverted where you get benefit later in this quarter versus some headwinds at the start of the quarter?

Speaker 5

Thank you.

Speaker 3

We're effectively 2 weeks into our quarter, a couple of weeks into our quarter. And the taxes may be pushed back a week or 2, but I think over the 12 week quarter, we expect them to be pretty similar to last year and the vast majority of the taxes should land with well within our 12 week timeframe. So maybe slightly moved back a little bit, but not meaningful to the quarter. We expect it to be normal.

Speaker 5

Got it. Thanks very much.

Operator

Your next question is from Bret Jordan with Jefferies.

Speaker 6

Hey, good morning guys. Hey, Bret. Good

Speaker 3

morning, Bret.

Speaker 6

I guess a question on the competitive landscape as it relates to WDs, they seem to get better after maybe 2022 into 2023. Could you talk about the up and down the street business? Is that a pretty stable competitive environment? Do they still improve or are they sort of plateauing?

Speaker 3

Well, on the sorry, just to make sure I'm clear on your question. Your question is relative to the WDs or to the actual

Speaker 6

Yes, WD competitors. It seemed like they were raising their game for a bit after the pandemic and whether they're kind of stable where they are or are they still be are they becoming more competitive still?

Speaker 3

Yes, I think, it's hard to tell exactly what's going on in their business, but from my sense and we see it in our business as well, the vast majority of the supply chain constraints that you had in the latter half of the pandemic have resolved themselves for the most part. We'll still continue to improve. Instocks are not quite back to where they were previous to the pandemic. I suspect they will continue to improve slightly. And I would also think that the vast majority of the WDs that had the inventory issues, in the latter half of the pandemic have probably recovered for the most part.

Speaker 3

So I think they're better, but I don't think they're going to have they're not going to materially get better over the next short period of time. I would say everybody's pretty much back to slightly lower than pre pandemic levels.

Speaker 6

Great. And then I guess a question on international. O'Reilly has gone and acquired BaaS, and it seems like there's some Carquest assets for sale up there. Is Canada a market that you'd think about is or are really focused in Mexico and sort of secondarily Brazil?

Speaker 3

Yes, I would say we have I mean, we've got 2 markets that we're trying to expand in today, which are obviously Mexico and Brazil. And we like where we are in our international footprint. Canada is interesting. I would never say we would not look at Canada, but it does have a pretty solid competitive base up there. And we just think there's better opportunities for us at the moment in the current markets that we have.

Speaker 3

We've got plenty of expansion opportunities in both markets and we like our performance internationally. Doesn't mean we never go to Canada, but it's not a focus for us at the moment. Not in 24? No. We've got 6 months left in 24.

Speaker 3

Yes. In our 24 anyway. Thank you.

Speaker 7

Thanks, Brett.

Speaker 3

Thanks, Brett.

Operator

Your next question for today is from Michael Lasser with UBS.

Speaker 2

Good morning. Thank you so much for taking my question. Do you still see an opportunity return the commercial business back to a double digit growth rate over time? Why or why not?

Speaker 3

Michael, great question and thanks for the question.

Speaker 2

At the

Speaker 3

end of the day, we have let me go back to our comment on share. We have very low share in this marketplace. I think we will improve from here. Can I tell you exactly when we're going to get back to double digit growth? No.

Speaker 3

I would expect that we would grow faster. We have initiatives in place that we'll think we will accelerate our sales growth, particularly in the back half of this year, and it will continue. To nail a date when I think we get back to a positive double digit number is frankly tough to do. There's a lot of variables in there. I think we'll see consistent share growth and consistent same store sales and total growth in the commercial market for a long time to come, probably because we have we're better than we were as we continue to expand our hubs and mega hubs, improve our assortments, and take share, we see a long term growth trajectory for the commercial side of the business.

Speaker 2

Got you. That's helpful, Phil. Thank you so much. My follow-up question is that AutoZoom's gross margin has really been growing nicely for some time now. But at what point does the gross margin get too high

Speaker 3

such that

Speaker 2

it invites more competition within the sector, especially on the commercial side?

Speaker 4

Yes, I don't think we're over earning from a gross margin standpoint. We've been very disciplined about gross margin expansion. We've been very disciplined about pricing. And what we're actually seeing in our gross margins today is we come out of a period where we had very high freight costs. We had a supply base that was very challenged from a cost standpoint when you looked at what was happening with transportation costs, wages and just overall inflation in general.

Speaker 4

As we've moved past those periods, it gives us an opportunity now to start to negotiate deflation with our supply base. And at the same time, as we took pricing during those higher inflationary periods, we're not giving back retails. So what you're actually seeing is sort of a natural evolution of gross margins, if you will. The other thing I'll remind you is that our supply chain was particularly challenged during this timeframe. And as our supply chain has improved its cost performance and its efficiencies, we're seeing some gross margin improvement in the from our supply chain.

Speaker 4

So this industry has been very, very disciplined for decades. We'll continue to be disciplined for decades. We don't believe that we're over earning, and it's been a very disciplined approach to gross margin expansion and growing market share over time.

Speaker 2

Thank you so much, Phil, Jamere and Brian. Good luck.

Speaker 3

Thank you. Appreciate it.

Operator

Your next question is from Scot Ciccarelli with Truist.

Speaker 2

Good morning, guys. Jamere, can I follow-up on something you just said? So you're trying to negotiate deflation. So is the idea to drive down procurement costs, but fully hold retails?

Speaker 4

Yes. I mean, if you look at what's happened in this industry literally for decades is during periods where we have high inflation or even hyperinflation, we've raised retails to basically cover those additions and costs. And then as those cost pressures abate, this industry typically does not lower retails. So what you're seeing is sort of the natural progression that we've seen from a gross margin standpoint as we're now in a period where things are becoming a little bit more deflationary, it gives us an opportunity to expand our margins, if you will. And we've been very disciplined about doing that as has the entire industry over this time period.

Speaker 3

Let me add another can I add another just another comment on that? I think if you go back and look at some of the gross margin pressures we had in the specifically in the latter half of the pandemic where the supply chain was most stressed, some of those costs that we had in logistics, either overseas or internal in the U. S, not all of those costs got pushed on to the consumer because we didn't want to kill unit demand. So we've hurdled some of that. To Jamere's point, we took those prices up and as the underlying logistics cost basis comes down, that margin is what you're seeing today.

Speaker 3

We don't think we'll give the pricing back because this industry has been very price rational over, to Jamere's point, decades. We just don't see that retail pricing having to come back down.

Speaker 2

So just to clarify, so unless we see a spike in logistics or freight costs, the assumption should be where your current run rate of gross margin is, should be kind of the forward number we should be thinking about?

Speaker 4

Yes. And the only thing that I would add to that is that we do expect our commercial business to grow faster as we move forward. And so that naturally will put some drag on the gross margin percentage, if you will. We'll take that trade off because it'll give us an opportunity to have more gross margin dollars. So, there'll likely be a mix pressure as we move forward with a faster growing commercial business.

Speaker 4

But the underlying fundamentals of what we're seeing in gross margin in terms of deflation, in terms of improving supply chain profile is something that is sustainable as we move forward.

Speaker 8

Super helpful. Thanks guys.

Operator

Your next question is from Simeon Gutman with Morgan Stanley.

Speaker 9

Hey, good morning, everyone. Hey, Phil, I know it's tricky to prescribe when the commercial comps get back to double digit. Can you give us a sense, I don't know if innings is the right way to think about it, where your efforts are in totality? You mentioned faster delivery times, labor normalizing, there's some supply chain investments. So the collective of those, where you are on that journey to where you want to get to?

Speaker 6

Yes.

Speaker 3

The part of your question there is, what are we doing that have helped stabilize our business and get it back on a more stable footing. Our in stocks have come back to very close to pre pandemic levels. We've expanded our hubs and our mega hubs. We have a long way to go to get to our ultimate goals of north of 200 mega hubs and significantly more hubs as well. Those put hard to find parts in the market where we can get those parts to our commercial customers in particular faster.

Speaker 3

It also helps DIY. It will take us quite a few innings, if you will, to get to more than 200 of those hubs. They just take longer to set up and get in place. But that is improving our efforts on delivery times. We've invested in technology.

Speaker 3

We've been talking about this for quite some time. We continue to leverage the technology we've put in the hands of our commercial AutoZoners And we've got some tests in place in some early innings where we're able to show better delivery times by enabling better technology and leveraging that technology. So that will take time to roll out and it will take time for AutoZoners to digest the change management. So in the quarter of it in the number of innings, if we're going to play baseball, which starts pretty soon this year, we'll maybe we're in the 3rd or the 4th inning, but hopefully we'll have a rally in the 9th inning.

Speaker 9

Good. And I wanted to ask you, I think we asked Jamere when he joined, but since you've taken over, I wanted to ask about the EBITDA growth question versus margin. And part of it is timely because one of your competitors has been leaning into SG and A and it seems to be working and you're having a bifurcation in performance now in the sector. So your thought process on that balance and then leaning into SG and A over a longer period of time to take advantage of some displacement?

Speaker 3

Yes. On the SG and A front, I would we have investments that are some in CapEx, some obviously in SG and A. To the degree we can invest and grow sales and EBIT dollars, we'll make those investments all day, every day. I think over time you should see us get our EBIT our SG and A growth should start to bend down slightly. I wouldn't expect a radical change, but we've had a lot of investments as we continue to improve our operational efficiencies in our distribution centers, in our stores, as our auto centers get longer tenured and we hold on and reduce turnover things of that nature, they will obviously start bringing down some of the SG and A on the margins.

Speaker 3

But we would invest in a kind of I think maybe in part of your question is, would we take lower margin rates in commercial as a mix of sales like Jamere mentioned to get higher gross profit dollars? Absolutely. Increase EBIT dollars, we'll do that all day long. Those are good exchanges for us.

Speaker 9

Thanks. Good luck.

Speaker 4

Thanks, Amy.

Operator

Your next question for today is from Seth Sigman with Barclays.

Speaker 10

Hey, good morning, everyone. I wanted to follow-up on a couple of those points around the commercial. A lot of noise this quarter, if you step back, there was a lot of momentum in this business pre-twenty 20 and then you clearly outperformed very significantly for multiple years, right? And then the business has slowed reverting back to maybe more like industry growth, I'm not sure. But I guess the real question is what gives you confidence that this is the right go forward strategy, particularly from a supply chain perspective as you think about the next leg of growth?

Speaker 10

Mega hubs has been the central part of that strategy. Is that right? Are there other options that you've thought about? I'd love to get some perspective on that. Thank you.

Speaker 3

Yes. We're extremely excited about both our hub and our mega hub strategy. And I'll use the previous comments around innings. We think we'll have well north of 200 mega hubs and significantly larger growth of hubs. We're roughly in the 3rd inning or so in hub growth mega hub growth, if you kind of said that.

Speaker 3

That strategy works for us. We see significantly higher growth in those stores, those types of stores and they help feed harder to find inventory to what we call our satellite stores, the markets that are close to those hubs. So yes, we believe that is the right strategy. We will continue to modify and enhance our assortment strategies in both our satellite stores and our mega hubs and hubs to get more relevant inventory closer to the customer. The faster we can get those hard to find parts into the shop, the better we will grow market share.

Speaker 3

And by the way, all of that inventory we add for the commercial customer also finds its way to sales on the DIY customer.

Speaker 10

Okay. Thank you for that. I guess just thinking about the programs that you've added over the last year or so, you've talked about the drag from some of these newer programs. Just any perspective on how the new programs are ramping and if that's any different than what you've seen in the past? Thanks.

Speaker 4

Yes. I mean, the math on that is we've added over the last couple of years or so almost 600 new programs. So we went back and retrofitted several stores that didn't have commercial programs. If you remember historically, we ran sort of 80% to 85% of our stores had a commercial program. That number is now up over 92%.

Speaker 4

We really accelerated that over the last several quarters. So right now, we've got probably 300 to 400 immature commercial programs that are ramping up in terms of sales and efficiency and performance. And as those programs mature, it will certainly provide a tailwind to our business. So when Phil talks about this notion of our commercial business improving from an execution standpoint, we not only have that working in our favor, but we also have these maturing programs that have only been in operation for the last couple of quarters. And so, if we think about the commercial business very broadly, I just keep grounding us back to this notion that we're under penetrated.

Speaker 4

We have a 4 or 5 share in what's approaching $100,000,000,000 market. We've put a number of things in place that are delivering and have delivered exceedingly well for us. And as we move forward, we like the competitive hand that we have with growing mega hub footprints, with improving execution, with adding more commercial programs. It's our number one growth priority inside the company and we're all hands on deck there. The last thing I'll just say is, as you think about commercial is just you think about the back half of this year, the front half of this year, we had we're up against a 15 comp and then a 13 comp, the back half of the year, the comps get a little bit easier.

Speaker 4

So the comments that we made earlier in our prepared comments are just along the notion that the comparisons get a little bit easier. And as we have all of these things from an initiative standpoint, working in our favor, it gives us a lot of confidence about our back half execution.

Speaker 3

Let me add a little bit on that too, specifically around new stores and I'll maybe take a little bit of the history lesson here. If you go back to FY 2017 or those types of number years, our productivity per store, we have been on a pretty heavy diet of opening up new programs. And then we decided from a strategy perspective, we would slow down our new store openings for commercial and really start trying to drive per store productivity. Back then, our per store productivity was in the $7,000 to $8,000 range. Today, as Jamere quoted earlier in the prepared comments, we're significantly higher than that.

Speaker 3

The other thing that's happened is as we open up new programs in today's environment versus years ago, they are maturing at a faster rate and get to a higher, more plateaued rate. So we like that math. We're probably not going to open up 600 stores in the next 2 years or so like we have over the recent history. That will probably slow a little bit. But we like the way the new stores come out of the box and the maturity curves that we get versus frankly 2017 or 2018.

Speaker 10

Thank you both. Appreciate it.

Speaker 4

Thanks.

Operator

The next question is from Stephen Forbes with Guggenheim Securities.

Speaker 11

Good morning. Maybe just a follow-up on Seth's question. And just a way to sort of maybe contextualize the mega hub strategy for us. Is there any way to think through or maybe discuss the contribution to growth or how ROI is trending behind these investments versus what the potential should be as we look out sort of a couple of few years? Like any sort of numeric contextualization of where we are in the maturity curve of the initiatives?

Speaker 4

Yes, I think a couple of things stand out to us. The first is that the mega hubs are growing from a commercial perspective and from an overall perspective, significantly faster than our satellite stores. And it's over 3x what we see on a total domestic business basis. So we've been very pleased with the tremendous sales lift that we're getting inside of the box, both on the DIY and the commercial side. I think the second thing that gives us a lot of confidence is we talked about this notion of testing multiple mega hubs in major metro markets and we've done that over the last few years or so.

Speaker 4

And the idea there was to jam more mega hubs in a market and jam more parts closer to the customer to see really how high is high. And what we experienced in that timeframe was the fact that we didn't see the kind of cannibalization that we would have anticipated, which suggested that the number of mega hubs that we could actually operate was significantly higher. And if you recall, we had mega hub targets that went from 100 to north of 200 over a very short period of time. So we like what we see from a sales standpoint. We like what we see from an earnings standpoint.

Speaker 4

And we and it's not only what we're seeing inside the four walls, but it's also the fact that these mega hubs are an important fulfillment source for the surrounding satellite stores. So when you put all that together in the mix, I mean, it's a pretty attractive story for us, both in terms of sales and earnings and return on investments and we're going to go as fast as we possibly can to accelerate.

Speaker 11

Thank you for that. Maybe as a quick follow-up on the outlook for expense growth. I think you mentioned how it should curve downward, but obviously we also have this store growth acceleration plan looking out to 'twenty six and beyond. And so maybe just help provide additional clarity on why there's sort of no disconnect in maybe sort of leaning into the investment cycle ahead of a ramp in store growth? I mean, is there any risk that EBIT margin could or should take a step back as you sort of ramp the business for a more accelerated growth period?

Speaker 4

Yes. I mean, we've invested in SG and A in a very disciplined fashion over the last several years or so. And what we've always said is that over time, SG and A growth should be in line with what we see in terms of the top line. Now in the near term, to your point, we've invested at an accelerated pace behind technology, behind store payroll, all of those things to drive near term growth for us. And we won't hesitate to go do that.

Speaker 4

To the extent that there are opportunities for us to invest in SG and A to drive our growth initiatives, We will do that as we've done historically. As we move out and look to accelerate our store growth, there will be some drag on SG and A, but we should be able to manage that within that framework that I talked about.

Speaker 11

Thank you.

Speaker 2

Thank you.

Operator

Your next question is from Gregg Malek with Evercore ISI.

Speaker 8

Hi, thanks. Congrats guys. It was a nice quarter.

Speaker 7

Thanks, Greg.

Speaker 2

I'd like to follow-up

Speaker 8

on inflation. So if ticket was up 1.7%, was it fair to say that same SKU inflation was sort of near that number? And that how did items in basket mix etcetera out in the quarter?

Speaker 4

Yes. So, what we've seen on ticket growth was something in the low single digits right now, and we're seeing same SKU inflation somewhere in that same zip code, Greg. I think the important thing to recognize from an inflation standpoint is we came off a period of significantly higher inflation, that's tempered some, most of that inflation was driven by freight. So as freight costs have come down, we've seen some of that inflation start to come down as well. And I think the overarching point is that, we're continuing to be very disciplined about pricing where there are opportunity for us to take retails, we will do so.

Speaker 4

And where there's an opportunity for us to get deflation in our cost to drive gross margin, we'll do that as well. We're not expecting sort of the same levels of inflation to drive ticket growth that we have in the last year or so. And so you should expect ticket at some point to normalize back in that low to mid single digit range to offset the decline that we naturally see on the DIY side from transactions.

Speaker 8

Got it. But presumably that a little bit of acceleration in ticket comes from mix and items in basket rather than inflation ticking up? Same SKU.

Speaker 4

I think that's right. And as we move forward, I mean, it's a pretty dynamic environment out there, even from an inflation standpoint. We'll stay very close to and be disciplined about how we manage our business.

Speaker 3

Kevin, go back over long periods of time, decades, I mean this industry has had a slight decline in transactions and units and an increase in ticket average and average unit retails and that somewhere between 2% to 4% range on average, predominantly because of changes in technology, better parts and some it's great to think about belts on a car. The average car used to have 4 belts on it. Today, they have 1. And the belt used to be $4 or $5 today, a belt may be $60 or $70 So that technology change is probably going to continue. And it's been a pretty understandable decline in units and a change in average unit retail and we generally have pretty good line of sight to this because the product development takes years and an item may stay in our stores for 20 years.

Speaker 3

It's the beauty of having a frankly a lower term business that's very predictable.

Speaker 8

I'd love to follow-up on SG and A and investment there. Shramir, maybe could you level set us on just what wage inflation is running now and what you're looking at into the next few quarters? And if you think about these pilots that you're doing on the faster delivery, it sounds like it's a lot of tech investment, but is there are there delivery people as well? Just help us understand that a little bit more, the reacceleration of commercial there.

Speaker 4

Yes. So from an average wage standpoint, we're thrilled that we're starting to see average wages now with a 2 handle versus a 3 or 4 that we've seen over the last few years or so. So as things have cooled down, we've seen some of the hyperinflation go away in the labor markets. We're now back to more normalized sort of wage inflation, if you will. In terms of the investments that we're making, nearly every investment that we have from a growth initiative standpoint is underpinned by some changes in technology, whether that's on the commercial side with what we're looking to do with some of our commercial acceleration initiatives or on the retail side.

Speaker 4

Nearly all of those growth initiatives are underpinned by some changes that we're making in technology. Our technology teams have done tremendous job doing that in a very cost efficient way. And as we move forward, we'll continue to invest in a very disciplined way as we move forward. In terms of the commercial business and how we improve delivery, I mean, we've been very efficient in terms of how we've deployed our physical assets in terms of vehicles and our people assets in terms of labor to manage that commercial business over time and there hasn't been a meaningful change in what we're doing there.

Speaker 8

Well, great. Thanks and good luck.

Speaker 3

Thank you.

Operator

Your next question is from Max Rygielko with TD Cowen.

Speaker 12

Great. Thanks a lot guys. So in the stores where you're piloting the initiative to improve DIFM service and speed levels, just how is that going versus your own internal expectations? And then how are you thinking about scaling these initiatives over the coming quarters? Just curious how early those are and when you think that they could be ready to go wider?

Speaker 3

Yes. It's thank you for the question. It's early innings in that. We've been testing some stuff, how to use the data. We've had our if you think about our handhelds and a lot of technology enhancements that we made over the last couple of years.

Speaker 3

And now we've got a pretty robust set of data where we can look and figure out what are the best and most efficient ways to use our assets, both human assets, our auto our great AutoZoners and our trucks and where the inventory is, how do we get the part to the customer the fastest to improve customer service. It is early innings, but we like what we see, and we're in the process of rolling that out. There's some change management that we have

Speaker 7

to work

Speaker 3

through. There's some changes in technology that auto owners need to be comfortable with and some changes in operations in the stores. But we like what we see and we have had some pauses and evaluate and then move a little further, pause and evaluate and move a little further, but we're happy with what we see and we think it will improve customer service to the shop and we'll get the parts faster to the customer without having to drive the car any faster because we want to be safe.

Speaker 12

Got it. That's very helpful. And then can you just speak to your in store staff retention rates? How are those trending? And if that's translating into improvements in pro satisfaction and then ultimately better demand trends in those stores?

Speaker 3

Yes. I'll say 2 things have happened. One is, and we've mentioned it a couple of different times. If you think about staffing in whole, it's not back to pre pandemic levels, but it's better than it was during the pandemic. We still have work to do to get retention and turnover back down to pre pandemic levels, both in our stores and in our distribution centers, but improving and we like the trends that we're seeing, although we'd love it to be faster.

Speaker 3

The other thing we did on commercial and Jamere has mentioned it a couple of times, we've opened up roughly 600 stores in slightly over 2 years. As we did that, obviously that takes your the commercial specialists and the TSMs and things of that nature, those really high caliber of people that were concentrated in some stores, we expanded pretty quickly. So you got new promotions and people got to learn their job and learn those new shops and get really ingrained with those long term relationships and that will continue to get better as we move forward. So it's kind of 2 elements.

Speaker 12

Great. Thanks a lot. Best regards.

Speaker 3

Thanks. Thank you. Appreciate the question. Okay. I think we have time for one last call.

Operator

The next question is from Brian Nagel with Oppenheimer.

Speaker 7

Hi, good morning. Thanks for slipping me in. Good morning, Brian. So my first question, I know there's been a lot of questions on commercial, And we recognize this has been an ongoing conversation. There's a lot of moving parts here as we look at the kind of near term trends.

Speaker 7

But I guess not at the risk of being too simplistic. I know we for a long time have talked about key measure of success in commercial, so to say climbing that list, each individual store climbing that list of your mechanic customers. So the question I have is, as you pull and talk to your stores, are you seeing any indications that you're falling further down those lists or maybe the climb up some of these lists has stalled?

Speaker 3

Yes. I mean to say we're falling down the list, I don't think that would be a good characterization. Is there always opportunities to improve? The answer is yes. Go back to our share comments that we've made several times, we still have under 5% share, we believe.

Speaker 3

And as we get better and mature in relationships, open up new stores, get better in new stores and drive parts availability and what we call internally time to shop, the quicker we can get those parts to the shop, the better we'll be. And I think there's a bit of a misnomer that a customer has a first call. They all nobody has every part that's needed in a particular shop. So a customer will have multiple people they call. We think we will continually move up the call list and gain a larger share of wallet for each customer.

Speaker 3

But to say that you're always first call with any particular customer that's pretty rare for a customer to put all of their eggs in one basket, because nobody's got all the parts. It's virtually impossible. There's too many SKUs. So I think we will continue to get better. I think we've gotten better from where we were and we've got a long road in front of us to continue to take market share and gain new customers.

Speaker 7

That's very helpful. And then a quick follow-up, just on weather. And in your prepared comments, you talked about some of the sales volatility we saw through the fiscal Q2. And obviously, weather was a key component of that. But I guess the question I have is, as you look at the weather, maybe we're not even through winter yet.

Speaker 7

But as you look at the weather, has it been enough winter weather, so to say, give you that normal driver business as we head into spring and even the summer? Yes.

Speaker 3

Great question. And time will tell. We're not completely through winter weather, as you said. I think if I could lay out the weather calendar that I'd love to have, like I said, I would love to have more really cold winter in the big cities on the eastern seaboard. I mean, if you're in New York, you got a little bit of snow this year and it was gone within 24 hours.

Speaker 3

It's a heck of a lot more than you got last year. But New York, Philadelphia, D. C, those areas really haven't had a lot of really extreme cold weather. The Midwest did, and the eastern half of the Northeast or the western half, I'm sorry, got some pretty cold weather. But the big metro cities along the East Coast just really haven't, for more than 2 years now.

Speaker 3

So I would love to have had more there, but that's something that we can't control. We're going to do our best to go grow market share in those areas of the country no matter what. So thanks for the follow-up question. All right, guys. Thank you.

Speaker 3

Thank you. All right. So before we conclude the call, I'd like to take a moment and reiterate, we believe that our industry is in a strong position and our business model is solid. We are excited about our growth prospects for the year. But we'll take nothing for granted as we understand our customers do have alternatives.

Speaker 3

We have exciting plans that should help us succeed in the future, but I want to express that this is a marathon and not a sprint. As we continue to focus on the basics and drive to optimize shareholder value for the future, we are confident AutoZone will be successful. Thank you for participating in today's call.

Operator

Thank you. This concludes today's conference and you may disconnect your lines at this time. Thank you for your participation.

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AutoZone Q2 2024
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