AutoZone, Inc. (NYSE:AZO) Q1 2023 Earnings Call Transcript

AutoZone, Inc. (NYSE:AZO) Q1 2023 Earnings Call Transcript December 6, 2022

Operator: Good morning, ladies and gentlemen, and welcome to AutoZone’s 2023 First Quarter Earnings Release Conference Call. At this time, all participants have been placed on a listen-only mode and the floor will be opened for questions and comments after the presentation. Before we begin, the Company would like to read forward-looking statements.

Brian Campbell: 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-K 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. A reconciliation of non-GAAP to GAAP financial measures can be found in our press release.

Operator: It is now my pleasure to turn the floor over to Mr. Bill Rhodes, Chairman, President and CEO of AutoZone. Bill, the floor is yours.

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Bill Rhodes: Good morning and thank you for joining us today for AutoZone’s 2023 first quarter conference call. With me today are Jamere Jackson, Executive Vice President, Chief Financial Officer; and Brian Campbell, Vice President, Treasurer, Investor Relations and Text. Regarding the first quarter, I hope you have had an opportunity to read our press release and learn about the quarter’s results. If not, the press release along with slides complementing our comments today is available on our website www.autozone.com under the Investor Relations link. Please click on quarterly earnings conference calls to see them. As we begin, we’d like to thank and congratulate our AutoZoners across the enterprise for their commitment to taking care of our customers, which led to the strong results they continue to deliver.

It has been a busy first quarter of our new fiscal year, as every day we strive to get back to normal and exit €˜€˜pandemic mode”. This quarter, we opened our new direct import distribution center on the West Coast, continued to improve our in-stock position, and we had our first full national sales meeting since the pandemic began. In fact, we returned to having national sales meetings in every country where we operate and at ALLDATA. These meetings, they are critical to our success, where we celebrate our past accomplishments and lay the groundwork for our future success. Most importantly, they allow us to inspire each other and grow and nurture our unique and powerful culture. For the quarter, as our teams delivered exceptional service, their efforts led to our overall sales growing 8.6% on top of 16.3% last year.

Our two-year growth rate marks some of the highest ever. We could not have achieved this success without phenomenal contributions from across the organization. Our AutoZoners’ efforts generated a positive and accelerating retail same-store sales comp along with another strong commercial comp for the quarter. Thank you, AutoZoners, for always putting customers first which led to this success. This morning, we will review our Q1 same-store sales, DIY versus the DIFM trends, our sales cadence over the 12-week quarter, merchandise categories that drove our performance and any regional discrepancies. We’ll also share how inflation is affecting our costs and our retails and how we think inflation will impact our business for the remainder of FY23.

Our domestic same-store sales comp was a solid 5.6% this quarter, on top of last year’s 13.6%. On a two-year basis, we delivered a 19.2% comp, and on a three-year basis, a 31.5% stacked comp. Our team once again delivered amazing results, despite these difficult comparisons. Let me spend a few moments on growth dynamics in the quarter. Our growth rates for retail and commercial were both strong with domestic commercial growth of 15%. We set a first quarter commercial sales record and over $1 billion in sales, another impressive quarter as we generated $138 million more in sales than in Q1 last year. On a trailing four quarter basis, we delivered just under $4.4 billion in annual commercial sales, up an amazing $820 million over last year. We also set a Q1 record for average weekly sales per store at $16,000 versus 14,400 just last year.

Domestic commercial sales represented 29% of our domestic auto parts sales versus 27% last year. Our sales growth in the quarter was driven by transaction growth from new and existing customers along with higher tickets as we price for inflation. Our commercial growth of 15%, while still very impressive, and well ahead of industry growth did slow. And unfortunately, we broke our streak of six straight quarters of 20% plus sales growth. While we could easily explain this resulted from a difficult comparison to last year’s Q1 amazing growth of 29.4%, we also saw our transaction counts decline nearly 4 points from the pace we were growing in Q4 of fiscal €˜22. That said, we continue to be pleased with the results from the key initiatives we have been working on for the last several years.

Improved satellite store availability, hub and mega hub openings and improvements in coverage, the strength of the Duralast brand, better technology to make us easier to do business with reduced delivery times, enhancing our sales force effectiveness and living consistent with our pledge by being priced right for the value proposition we deliver. We believe our offering to our customers is better than ever, and we continue to hear great things from our customers and prospective customers about the strength of our value proposition as we continue to execute our commercial acceleration strategy. Our goal remains, over time, to become the industry leader in both, DIY and commercial in every geography where we operate. Our strategy, execution and market momentum give us tremendous confidence as we move forward.

We’re also very proud of our organization’s performance in domestic DIY. Our growth in retail since the beginning of the pandemic has been remarkable, representing the highest three-year growth we have experienced in my 28-year tenure with the Company. We delivered a positive 2.6% comp this quarter on top of last year’s 9%. And versus last year’s — quarter’s growth, DIY grew on a two-year basis and on a three-year basis. While our ticket growth was similar to last quarter, of just over 7%, we are encouraged that our transaction count trends improved, decreasing by 4%. These results are very strong considering the difficult comparison, driven by the lingering effects of stimulus last year. From the data we have available, we continue to retain the vast majority of the enormous dollar share gains we built during the initial stages of the pandemic.

And more importantly, we continue to grow unit share, a critical measurement of success for us. And our recent performance gives us continued conviction about the sustainability for our fiscal year. In terms of sales cadence, our total same-store sales trends were very consistent, increasing in the mid-single-digit range for each of the four-week periods. In addition, for Q1, our two-year comp was 19.2% and our three-year comp was 31.5% and relatively consistent over the four-week periods. We are incredibly pleased with the sustainability of the very large sales and share gains we generated since the beginning of the pandemic. Weather did not have a material impact on our sales this quarter. On a national basis, weather trends were very similar to last year.

Regionally, we saw less rainfall in the West and Southeast than last year. But overall, we didn’t feel this drove our results materially. This winter’s weather forecast calls for a slightly colder winter with, as we’ve recently experienced, cooler weather beginning sooner. As a reminder, historically, extreme weather, cold or hot drives parts failures and accelerated maintenance. During the quarter, there was geographic regions that did better than others as there always are. This quarter, we saw comp sales in the Northeastern and Midwestern markets underperform the balance of the country by about 260 basis points. We believe that our underperformance in these markets was driven by milder and wetter weather this year. Four our second quarter, winter weather is likely to meaningfully influence our results.

As a reminder, our Q2 is historically by far and away the most volatile sales quarter as weather patterns can greatly vary week-to-week. And we have key holidays that fall on different days of the week. At the moment, our forecasting team is telling us winter will likely be colder than last year’s Q2. And if that happens, that would be a positive for our outlook. Now, let’s move into more specifics on our performance. Same-store sales were up 5.6%, our net income was $539 million, and our EPS was $27.45 a share increase$0.45 a share, increasing 6.9%. Regarding our merchandise categories in the retail business, our hard parts outperformed sales floor categories, with approximately 1% difference between them. With elevated gas prices, our discretionary categories remain soft.

The discretionary categories represented approximately 18% of our DIY sales and were down 2.5% versus up 8% last year. In general, the categories that are driven by failures performed well and we were encouraged to see our battery category successfully lap very strong performance last year and again exceed our expectations. We believe our hard parts business will continue to do well this winter as we expect miles driven to improve, while our growth initiatives are delivering solid results. Let me also address inflation and pricing. In Q1, we experienced 11% pricing inflation, in line with cost of goods, which was also up 11%. We believe both numbers will decrease slightly in the current quarter, as we begin to lap the onset of high inflation last year.

But, to be clear, we do not believe inflation is going away, especially wage inflation, but expect it to slow a bit as the economy slows. I want to highlight that our industry has been disciplined about pricing for decades and we expect that to continue. Most of the parts and products we sell in this industry have low price elasticity, because purchases are driven by failure or routine maintenance. Historically, as costs have increased, the industry has increased pricing commensurately to maintain margin rates, thereby increasing margin dollars. It’s also notable that following period’s higher inflation, our industry has historically not meaningfully reduced pricing to reflect lower costs. While we continue to be encouraged with the current sales environment, it still remains challenging for us to forecast near to mid-term sales as the economy impacts our customers.

What I previously said on the past six quarterly calls is sales have been consistent on both a two-year and three-year stack comp basis. While it’s difficult to predict sales going forward, we are excited about our growth initiatives, our team’s execution and the tremendous share gains we have achieved in both sectors. Over the past year and a half, the overall macro environment has been a favorable for our industry despite inflationary pressures for our customers. And even if these near-term trends fade, we believe that we are in an industry that is positioned for solid growth over the long term. For our second quarter of 2023, we expect our sales performance to be led by the continued strength in our commercial business, as we execute on our differentiating initiatives combined with the resilient DIY business.

We will as always be transparent about what we are seeing and provide color on our markets and performance as trends emerge. Before handing the call over to Jamere, I’d like to give a brief update on a few of our key business priorities for the new fiscal year. First, we continue focusing on our supply chain with two initiatives that are in flight to drive improved availability. One is our expanded hub and mega hub rollouts. We know intelligently placing more inventory in local markets will lead to our ability to continue to say yes to our customers more frequently and in turn drive sales. Secondly, we are expanding our distribution center footprint. We announced the development of two new domestic DCs and one additional DC in Mexico. These DCs will allow us to not only reduce drive times to stores, but also increase our capacity.

Note that we didn’t expect to grow our business 30-plus-percent in three years as we have, and the additional capacity will enable us to carry more slower turning inventory that is not yet in high demand. I’m also excited to announce that we opened a facility on the West Coast to handle direct import product on a timelier basis. This facility will flow products ordered abroad and distribute them to our other DCs to reduce safety stock and drive productivity. Our supply chain strategy is focused on carrying more products closer to the customer. And we believe it has been a significant contributor to our recent success, especially in commercial. And we have initiatives in place to continue our growth trajectories in both, our domestic retail and commercial businesses.

Additionally, we plan on continuing to grow our Mexico and Brazilian businesses. At almost 800 stores combined, these businesses have had impressive performance again this quarter and should continue to be key contributors to sales and profit growth for decades to come. We are leveraging many of the learnings we have in the U.S. to refine our offerings in Mexico and Brazil. In Brazil in particular, we are targeting to significantly and aggressively expand our store footprint over the next five years. We are very excited about our growth prospects internationally. Now, I’ll turn the call over to Jamere Jackson. Jamere?

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Jamere Jackson: Thanks Bill. Good morning, everyone. As Bill mentioned, from a sales perspective, we had a strong first quarter stacked on top of an exceptionally strong first quarter last year with 5.6% domestic comp growth. We also had a 4.2% decrease in EBIT and a 6.9% increase in EPS. To start this morning, let me take a few minutes to elaborate on the specifics in our P&L for Q1. For the quarter, total sales were just under $4 billion, up 8.6%, reflecting continued strength in our industry and solid execution of our growth initiatives. Let me give a little more color on some of our growth initiatives, starting with our commercial business. For the first quarter, our domestic DIFM sales increased nearly 15% to $1 billion and were up 44.3% on a two-year stack basis.

Sales to our domestic DIFM customers represented 29% of our domestic auto parts sales. Our weekly sales per program were $16,000, up 11.1%. And our growth was broad based as both national and local accounts performed well for the quarter. Our results for the quarter set a record for the highest first quarter weekly sales volume in the history of the chain. I want to reiterate that our execution on our commercial acceleration initiatives continues to deliver exceptionally strong results as we grow share by winning new business and increasing our share of wallet with existing customers. We have a commercial program and approximately 88% 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 117 net new programs finishing with 5,459 total programs. As I have said previously, commercial growth will lead the way in FY23. And we continue to deliver on our goal of becoming a faster growing business. Our strategy and execution continue to drive share gains and position us well in the marketplace. Delivering quality parts, particularly with our Duralast brand, improved assortments and local market availability, competitive pricing and providing exceptional service has enabled us to drive double-digit sales growth for the past nine quarters. In addition, we are increasing the penetration of our market leading ALLDATA shop management, diagnostic and repair software suite to new and existing commercial customers, which gives us yet another key competitive advantage.

And as I’ve noted on past calls, our mega hub strategy is driving strong performance and position us for an even brighter future in our commercial and retail businesses. Let me add a little more color on our progress. As we’ve discussed over the last several quarters, our mega hub strategy has given us tremendous momentum. We now have 80 mega hub locations with two new ones open in Q1. While I mentioned a moment ago, the commercial weekly sales per program average was $16,000, the 80 mega hubs averaged significantly higher sales and are growing much faster than the balance of the commercial footprint. As a reminder, our mega hubs typically carry 80,000 to 110,000 SKUs and drive tremendous sales lift inside the store box as well as surge as an expanded assortment source for other stores.

The expansion of coverage and parts availability continues to deliver a meaningful sales lift to both, our commercial and DIY business. What we’re learning is that not only are these assets performing well individually, but the fulfillment capability for the surrounding AutoZone stores gives our customers access to thousands of additional parts and list the entire network. This strategy is working. And we remain committed to our objective to reach 200 mega hubs supplemented by 300 regular hubs. We’re targeting at least 25 new mega hubs in FY23. We continue to leverage sophisticated data analytics to expand our market reach, placing more parts closer to our customers, and improving our delivery times. We’re determined to build on our strong momentum.

Our domestic retail business count was 2.6% in Q1. The business has been remarkably resilient as growth rates accelerated from Q4 and we have managed to continue to deliver positive comp growth despite underlying market headwinds. As Bill mentioned, we saw traffic down 4% from last year’s levels. However, they improved sequentially from Q4, where traffic was down 7%. We also saw 7% ticket growth as we continue to raise prices in an inflationary environment. Our DIY businesses continue to strengthen competitively behind our growth initiatives. In addition, on a macro basis, the market is experiencing a growing and ageing car part and is still challenging, new and used car sales market for our customers. These dynamics, pricing, growth initiatives and macro car part tailwinds have driven a positive comp despite tough comparisons from last year’s stimulus injection, and consumer discretionary spending pressure from overall inflation in the economy.

Our sales were steady through the quarter, and we’re forecasting a resilient DIY business in FY23. Now, I’ll say a few words regarding our international businesses. We continue to be pleased with the progress we’re making in Mexico and Brazil. During the quarter, we opened three new stores in Mexico to finish with 706 stores and 4 new stores in Brazil ending with 76. On a constant currency basis, we saw accelerated sales growth in both countries, in fact at higher growth rates than we saw overall. We remain committed to our store opening schedules in both markets and expect both countries to be significant contributors to sales and earnings growth in the future. With 11% of our total store base currently outside the U.S. and a commitment to continue expansion in a disciplined way, international growth will be an attractive and meaningful contributor to AutoZone’s future growth.

As Bill mentioned earlier, we expect significant growth in store count internationally over the next five years. And we’re excited about the future. In the spirit of our growth in store count outside of the U.S. we will celebrate our chain’s 7,000th store opening this week in Leon, Mexico. I know Bill looks forward to being there to celebrate this historic event with our AutoZoners. We couldn’t be more proud to celebrate this occasion with our Mexico team. Now, let me spend a few minutes on the rest of the P&L and gross margins. For the quarter, our gross margin was down 242 basis points, driven primarily by a 203 basis-point headwind, stemming from a noncash $81 million LIFO charge. The difference for the quarter, a decline of 39 basis points in gross margin was primarily driven by our faster-growing lower gross margin commercial business.

With this quarter’s LIFO charge, we have taken our LIFO credit balance to $96 million. As I mentioned last quarter, hyperinflation and freight costs are the primary driver for the charges. We are still modeling for higher freight costs through the end of the calendar year, and we anticipate approximately $40 million in LIFO charges during the second quarter. Both the first quarter actuals and our second quarter outlook are below the outlook we gave last quarter, as freight costs have continued to abate over the past few months. As spot rates have come down, we have also renegotiated some of our long-term contracts and the lower costs are reflected in our outlook. We expect freight costs to continue to abate, and I want to remind everyone that at some point we expect to see these quarterly charges reverse, and we will begin to rebuild our LIFO reserve balance.

We plan to take P&L gains only to the extent of the charges we have taken thus far, and after we have taken P&L gains that fully reverse the charges we have incurred, we expect to rebuild our LIFO reserve balances we have done historically. Moving on to operating expenses. Our expenses were up 8.6% versus last year’s Q1 as SG&A as a percentage of sales were flat with last year. Our operating expense growth has been purposeful, as we continue to invest at an accelerated pace in IT and payroll to underpin our growth initiatives. These investments are expected to pay dividends in customer experience, speed and productivity. We are committed to being disciplined on SG&A growth as we move forward, and we will manage expenses in line with sales growth over time.

Moving to the rest of the P&L, EBIT for the quarter was $723 million, down 4.2% versus the prior year’s quarter. Excluding the $81 million LIFO charge, EBIT would have been up 6.6% over last year’s quarter. Interest expense for the quarter was $57.7 million, up 33.4% from Q1 a year ago as our debt outstanding at the end of the quarter was $6.3 billion versus $5.3 billion at Q1 in last year, and our variable rates have increased significantly. We are planning interest in the $60 million range for the second quarter of fiscal 2023 versus $42.5 million in last year’s second quarter. Higher debt levels and expected higher borrowing costs across the curve are driving this increase. For the quarter, our tax rate was 18.9% and below last year’s first quarter rate of 21.9%.

This quarter’s rate benefited 446 basis points from stock options exercised, while last year benefited 159 basis points. For the second quarter of FY 2023, 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 $539 million, down 2.9% versus last year’s first quarter. Our diluted share count of 19.6 million was 9.1% lower than last year’s first quarter. The combination of lower net income, offset by lower share count drove earnings per share for the quarter to $27.45, up 6.9% over the prior year’s first quarter. Excluding the LIFO charge, our net income would have increased 8.3% and our EPS growth would have been 19.2%.

Now, let me talk about our free cash flow for Q1. For the fourth quarter, we generated $794 million of operating cash flow, and spent $114 million in CapEx, allowing us to generate $680 million in free cash flow versus $676 million a year ago. We expect to continue being 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 ratios remain below our historic norms. Our inventory per store was up 14.4% versus Q1 last year, and total inventory increased 17.6% over the same period last year, driven primarily by inflation, our growth initiatives and in-stock recoveries. Net inventory defined as merchandise inventories less accounts payable on a per store basis was a negative $249,000 versus negative $207,000 last year, and negative $240,000 last quarter.

As a result, accounts payable as a percent of gross inventory finished the quarter at 131% versus last year’s Q1 of 129.4%. Lastly, I’ll spend a moment on capital allocation and our share repurchase program. We repurchased $900 million of AutoZone stock in the quarter and at quarter end, we had just under $2.7 billion remaining under our share buyback authorization. The strong earnings, balance sheet and powerful free cash we generated this year has allowed us to buyback almost 2% of the shares outstanding at the start of the fiscal year. We have bought back well over 90% of the shares outstanding of our stock since our buyback inception in 1998, while investing in our existing assets and growing our business. We remain committed to this disciplined capital allocation approach that will enable us to invest in the business and return meaningful amounts of cash to shareholders.

We finished Q1 at 2.2 times EBITDAR, which is below our historical objective of 2.5 times. However, we remain committed to this objective, and we expect to return to the 2.5 times target during FY23. 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. Our strategy continues to work. We’re growing our market share and improving our competitive positioning in a disciplined way. And as we look forward to FY23, we’re bullish on our growth prospects behind a resilient DIY business and fast growing commercial and international businesses that are growing considerable share. I continue to have tremendous confidence in our industry, our business, and the opportunity to drive long-term shareholder value.

Before I turn it back to Bill, on December 5th, we celebrated Bill’s 28th year anniversary with the Company. And I want to say congratulations to you, Bill. And it’s been a remarkable ride.

Bill Rhodes : Thanks, Jamere. Fiscal 2023 is off to a solid start. But we must continue to be focused on superior customer service and flawless execution. Execution and our culture, a culture of always putting the customer first is what defines us. As Jamere said a moment ago, we continue to be bullish on our industry and in particular on our own opportunities for the New Year. Our team continues to work collaboratively with our suppliers. And together, we’ve done a good job improving our in-stock position. But we still are a couple of hundred basis points below our historical norms. We’re also being smart about adding new inventory coverage. We’re meeting the ever-growing needs of our customers, especially our commercial customers, by being able to say, yes, we’ve got it.

It’s a requirement. For the remainder of fiscal €˜23, we are launching some very exciting initiatives. Not only will we be opening roughly 200 stores across the U.S., Mexico and Brazil, but we’ll be opening more mega hubs and hub stores. And we’re focused on initiatives in place to continue driving strong performance in both, our retail and commercial businesses. For the remainder of fiscal 2023, we are keenly focused on relentless execution. We will not accept shortcuts. Our vendors must return to providing us the right amount of merchandise at the right time. Every store has to be staffed right, every hour of every day, and our processes need to function correctly, always. We have to meet our store opening goals and timelines. Simply put, we have to focus on exceptional execution.

It has made a difference for us for decades. We know that investors will ultimately measure us by what our future cash flows look like three to five years from now, and we very much welcome that challenge. I continue to be bullish on our industry and in particular on AutoZone. Now, we’d like to open up the call for questions.

Q&A Session

Operator: And the first question this morning is coming from Brian Nagel from Oppenheimer. Brian, your line is live. Please go ahead.

Brian Nagel: Hi. Good morning. Nice quarter. So, the first question I have, just with respect to freight costs, and Jamere you talked about this in your comments, and you mentioned the LIFO issues. But I guess the question I have is as we think about your freight costs now and what you’re seeing, where are you now tracking say, versus pre-pandemic? And then, even maybe putting some of the accounting noise aside, at what point could this become a tailwind to gross margins, as it really starts to work through the P&L?

Jamere Jackson: Yes. Thanks, Brian. International freight rates are back at pre-pandemic levels. And one of the things that we discussed on last quarter’s call was this notion that during the height of the pandemic to secure capacity, we entered into some longer-term contracts. We’re now in a position where as the spot rates have come down, we’ve renegotiated some of those contracts. We have a pretty bullish outlook on where international freight rates are going to be for the balance of the year. Domestically, rates are still a little bit high. And as we work our way through the year, we expect those to start to abate a little bit. But domestically, the rates are still a little bit higher than what we would have anticipated.

As it relates to LIFO, as you saw in the second quarter, we have lowered our outlook to be about a $40 million charge. And you could see in the back half of the year that abating completely. I won’t be date certain about when we’ll see this flip to gains rolling back through the P&L. But as we said last quarter, it could take the equivalent of three or four quarters before it all rolls through. And we see the gains come back through the P&L that offset the charges that we’ve taken. So, our outlook is positive, and we’re managing the business accordingly.

Bill Rhodes: Can I jump in and add a little color on one other element, not on LIFO, but on our normal product cost? Many of those freight costs are being capitalized as part of the inventory cost. So, we’re going to have elevated product cost outside of LIFO for — in a business that’s turning 1.5 times a year for 9 months or a year, whatever the case may be, once those freight costs abate. So, we’ll continue to have pressure on product cost for foreseeable — for an extended period of time.

Brian Nagel: That’s very helpful. I appreciate the color there. And then as a quick follow-up, with respect to traffic, and also going back to the comments you made, so it’s — I think what you said was that the traffic in the stores, while still down in Q1, had improved from Q4, any comments on maybe the trajectory through the quarter? And then how are you thinking about traffic as we move into — continue to progress through €˜23 here?

Bill Rhodes: Yes, Brian. So, when we’re talking about traffic, we’re predominantly talking about — we are talking about our DIY business. I will be first to tell you that our DIY strength in Q1 was stronger than we expected, considerably stronger than we expected. And yes, our traffic counts are down 4%, but that was meaningfully better than — I believe it was 8% in Q4. Remember — and you’ve been following this industry for a long time, there is a natural drag on DIY traffic counts that have been happening for 25 years. As you know, technology has gotten better and better on the products that we sell, and so they last longer. But there’s also inherent inflation in those product costs as technologies are added to the products. So, a 4% traffic decline in the DIY business is not abnormal in normal times. And to see it down 4% after the growth that we’ve seen over the last three years was very encouraging to us.

Operator: Your next question is coming from Simeon Gutman from Morgan Stanley.

Simeon Gutman: Good morning, everyone, and Bill, congratulations on the anniversary. My question is actually a follow-up to what you just mentioned, Bill. The traffic or I guess we will look at — we try to call it units, I don’t know if you would say that they’re synonymous. It did look like it improved sequentially on a single-year basis. We don’t see what the stacks have looked like, I think, on traffic or units. And curious if underlying stacks are also improving such that this is the rebasing and we are in the all clear in terms of units probably done reverting and the negative numbers are normalizing back to that negative 4% that you mentioned.

Bill Rhodes: Well, that’s a strong statement, Simeon, in the all clear. I think we still have a level of anxiety on what the next year or so is going to look like coming off of unprecedented growth over the last three years. If we were on this call last year, we had expectations that our sales — our same-store sales would decline, and they didn’t. They were up considerably, and they were positive in DIY. Here we are again, comping off a positive DIY number with another positive DIY number. So, I think the farther we get away from the pandemic and the more resiliency we see in the DIY business, the more confidence we have that the gains that we picked up during the pandemic are sustainable. That said, I wouldn’t characterize it as €œall clear€.

Jamere Jackson: Yes. The only thing I’d add to that is when we look at our business in our bread and butter failure and maintenance categories, our volume trends have been strong, as Bill mentioned in his prepared comments. The relative inelasticity of demand there gives us a lot of confidence about that business. But in our discretionary categories, we were down 2.5%. And if you think about where consumers are feeling the most pressure today and where that pressure actually manifests itself, it manifests itself in discretionary purchases. And so, the fact that our discretionary business trends actually improved quarter-over-quarter, give us a lot of confidence about the future. That being said, there’s still a lot of volatility and uncertainty, as Bill mentioned. We’ll continue to manage our business accordingly.

Simeon Gutman: And then my follow-up is on used car prices. The empirical evidence tied to the industry’s growth isn’t great, statistically speaking. But it certainly has been a benefit. And it still feels like the industry is benefiting from the surge that we’ve seen. Are you finding there’s sensitivity now on the way down? Do you feel like we’re still benefiting from the surge? And then, if so, when does that tail off? And I don’t know if it becomes a headwind or not in your minds?

Jamere Jackson: Yes. I look at the macro in a pretty broad way. You’ve got a couple of dynamics going. One, you have an ageing and growing car part. And used car prices, while they’ve started to abate, they’re still up almost 30% over the last two years. New car prices are up closer to 20%. And you’re in an environment where you have rising interest rates that have made financing more challenging. So we do believe that it is still a little bit of a tailwind for our business. And more importantly, we’ve been managing our business to take advantage of all of the robust market opportunities that we have, and this is just one portion of that. I think as we’ve talked about our business and the growth that we’re seeing, it’s not just that macro strength, but inflation has been our friend to some extent, driving higher prices, volumes held up under those dynamics.

And our growth initiatives have helped us create a faster-growing business in both DIY and DIFM. So, when you take the combination of what you’re seeing from inflation, from our growth initiatives, from the work that we’ve done with hubs and mega-hubs and this macro strength, those are all the things that are in the soup, if you will, in terms of how our business is growing.

Operator: Your next question is coming from Kate McShane from Goldman Sachs.

Kate McShane: You had mentioned at the beginning of the call about your improving in-stock position. I wondered if you could talk a little bit more about that and where you see yourself by the end of €˜23 from an in-stock position? And then, I’ll follow up with my second question. Thank you.

Bill Rhodes: Sure, Kate. Yes. Our in-stock position today is meaningfully better than it was at this time last year — well, 18 months ago. It’s up a little bit from this time last year. It’s up a little bit from Q4, but we’re still about 200 basis points below our historical expectations and experiences. When will it resolve? It still — frankly, Kate, I would have thought it had been resolved by now. But there are certain product categories that are still a challenge, and we’re looking to continue to find new sources in some of those categories and new geographies in some of those categories to help us get past it. But we feel pretty good about where we are. We feel very good about where we are competitively.

Kate McShane: And is there an expectation that you’ll want to do better than the 200 basis points where you are below those expectations? And in terms of how much your sourcing has changed, has it been meaningful since where you used to source pre-pandemic?

Bill Rhodes: Yes. Our sourcing has not changed a significant amount at this point in time. We do have some objectives to diversify the geographies with which we source in basically every category. As far as having higher expectations for in-stock, right before the pandemic, we’d reached an all-time high, which was 100 basis points ahead of where we were historically. So, our supply chain team — need to remind them that we need to break our old high, which was 100 basis points higher. So, that would be about 300 basis points ahead of where we are right now. And I think they’ll get there. It may take a little more time.

Operator: Your next question is coming from Chris Horvers from JP Morgan.

Chris Horvers: So, my first question is just to check the math, on the LIFO the headwinds being halved in the second quarter. So I guess, directionally, should we think about your gross margin headwind in the second quarter being roughly half of what you experienced in the first quarter?

Jamere Jackson: Yes. I mean, we expect LIFO charge in the second quarter to be somewhere in the $40 millionish range, if you will. And so that will be significantly less pressure from a gross margin standpoint.

Chris Horvers: Got it. And then, is — as a follow-up to that and then a question on the SG&A side, I mean, is there — other than the mix headwinds of Do-It-For-Me in gross margin, is there anything else to consider? And then on the SG&A side, SG&A dollar growth year-over-year has been running in this 8% to 10% range over the past four quarters. How much of that is wage and benefit cost inflation versus investing during the good times? And then going forward, how are you thinking about inflation and wages and SG&A in the context of your overall leverage point?

Jamere Jackson: Yes. So, from an SG&A standpoint, I mean, we’re going to continue to grow SG&A in a disciplined way as we create a faster-growing business. As I said, we were flat as a percentage of sales this past quarter. But we’ve been investing, and we’ve been investing to maintain high levels of customer service. And we’ve been investing because many of our growth initiatives, both on the retail and the commercial side of our business, are underpinned by investments in IT. So IT investments, in particular, are an enabler to what we’re doing from a growth standpoint. As you know, wage pressure is a macro labor market issue, and we certainly haven’t been immune to those dynamics. Historically, our wages have run in the, call it, the 2% ZIP code.

It’s been running closer to 5%. And so that’s put some pressure on us. But what I’ll say about SG&A over time is that we will continue to manage it in line with the top line. We’ve been opportunistic as our business has grown to invest at an accelerated pace in some areas to support the growth in our business and to maintain great levels of customer service, and we’ll continue to be very-disciplined about it going forward. And I’m sorry, what was the first part of your question again?

Chris Horvers: Other than the mix of commercial versus DIY, is there any other variables that are different here in the second quarter in the context of that LIFO headwind being halved?

Jamere Jackson: No. We’ve said that our faster-growing commercial business is likely going to put 35 to 45 basis points of pressure on our gross margins. You saw that in this quarter. And we continue to expect our commercial business to grow significantly faster than our DIY business. And those are the kinds of headwinds that you’ll see from a margin standpoint as we move forward.

Operator: Your next question is coming from Michael Lasser from UBS.

Michael Lasser: Bill, your tax in the commercial business remains quite consistent, but it did slow on a one-year basis. Do you think that’s more related to something happening out of AutoZone where the log diminishing returns are taking over such that you’re still generating similar amount of incremental sales, but it’s just on a larger base, or is there something happening in the underlying trend of the commercial segment itself?

Bill Rhodes: It’s a great question, Michael and one that, frankly, I’m not sure that I can factually answer. I will start with 15% growth in our commercial business, we are all excited about that, especially coming off of the growth that we’ve had in the last couple of years. So, we are pleased with the performance in our commercial business. It’s widespread. The slowdown, the slight slowdown that we’ve experienced is across the board. It’s not national accounts. It’s not up and down the street. It’s not our ProVantage customers. We’ve seen a general slowdown across different customer bases and across geographies. So, I don’t think that it’s anything that we’ve done at AutoZone. I think it’s — we’ve grown very fast, and we grew 15% on top of it, and we’re pleased with that.

Michael Lasser: And is this now a more realistic run rate? It will still grow double digits? Is it hard to maintain that 20% that you have been achieving? And my follow-up is one of your competitors recently announced that they’re going to make some price investments. This comes on the heels of another competitor emulating what you had done and make price investments. At what point should we call this a trend, and increased price transparency is just leading to a little bit more price competition within the commercial segment of the auto part retail sector?

Bill Rhodes: Yes, I’ll leave it to you guys to define the trends that you want to do. What I can tell you is our pricing investments that we made about 18 months ago we had nothing to do with our close in competitors. They were focused on looking at our value proposition versus the 80% of the market that’s outside of our close in competitors, and trying to make sure that we were priced right for the value proposition that we were delivering. We’ve been very pleased with that and pleased with we’re believing that our outside growth over the last couple of years has been driven not by taking share from our close in competitors by taking share from the broader market. And so I’m not seeing anything by any indications based upon either of our close in competitors pricing that we see anything very different.

Operator: Your next question is coming from Daniel Imbro from Stephens.

Daniel Imbro: I wanted to start on the commercial side. Bill, in your prepared remarks, you talked more about some tech investments you’re making to make it easier — I think you said easier to do business with you guys. Could you provide more detail on what those initiatives are? And then where are we — what inning are we in, in terms of the rollout of these different tech programs on the commercial side?

Bill Rhodes: Sure, Daniel. Thank you. One of the things that we’ve rolled out over the last couple of years is handheld devices for everybody that’s in the store picking the products and everybody that’s delivering to a commercial customer. And that helps us ensure that we have the exact right product, and it helps us manage delivery times, which we have brought our delivery times down about 20% since we deployed that technology. The other big part of it — and there’s a lot of different technology things that we’re doing along the way. But the other big one that we’ve done is really how we interact digitally with our commercial customers and — from providing them access to invoices to making us more seamless to operate together, just trying to take the pressure points out and make a frictionless transaction with us.

The handheld pieces have been deployed. We’re continuing to refine the technology. And I suspect that those refinements will probably take up to another year or so. I think the digital integration is less far along. We have more newer ideas that we have yet to embark on, on the digital integration with our customers. And so, that’s got to probably have 2 or 3 years of legs to it.

Daniel Imbro: And then I want to follow up on Chris’ question earlier on LIFO. So, Jamere, you provided a helpful color on 2Q. But I think in your prepared remarks, you said you expected to recognize some LIFO benefits in the back half of this year that would offset it. So if we just think about the $40 million you’re now guiding for 2Q and a LIFO headwind, should we assume there’s about $120 million of a LIFO benefit that’s going to flow through the gross margin line in the back half of the year? And then, what would the cadence be that you’d expect to recognize that $120 million benefit?

Jamere Jackson: Yes. Well, there are lots of things that will impact when we actually see the reversal of the charges that we take. The biggest one, as we mentioned, is the pace with which freight comes down and we get out of some of the contracts that we’re in. And as I said before, we won’t be date certain about when that actually happens, but we do anticipate that happens. So, it’s moving in the right direction for us. And given that our inventory turns at, call it, 1.5 times, you should expect it to take two or three quarters potentially for us to have all of those costs worked their way through and us to see it turn the other way. So, we’ll give a more fulsome update on our next quarter call. And as I said before, we’ll be very transparent about what we’re seeing.

Operator: Your next question is coming from David Bellinger from MKM Partners.

David Bellinger: The first one on commercial. It seems like the transaction counts maybe have been a bit slower this quarter. So, is there anything to read into that? And what type of consumer or customer activity are you seeing? Is there some type of deferral coming into play? Just any other details around the commercial counts would be helpful?

Bill Rhodes: Yes. We’re doing a lot of studying on both our retail and commercial customers because if you think about it, this is a pretty unprecedented environment. I know I’ve never seen inflation rates in the upper single digits and lower double digits. So, we’re paying particular attention to what customer behaviors are happening. As a reminder — and we certainly have more experience in the DIY business than we do in the commercial business, in the last economic shocks, the last four economic shocks in the U.S., our business has significantly outperformed normal periods of time. So, we’re monitoring that to make sure we understand, particularly what’s going on with the low-end consumer. And then, I think the expectation — and we don’t have near the evidence here at this point in time, but I believe that there’s an expectation that some commercial customers or some jobs that a commercial customer would normally be done DIFM, can trade down into the DIY sector.

And so, we’re watching those kind of trends, but we don’t see anything yet that is alarming to us. We continue to monitor it. And again, we’re pretty darn pleased with the 15% growth in our commercial business.

David Bellinger: Got it. And then, just on the commercial program growth, that seemed to step up a little in Q1. It was about 5% year-over-year. Can you give us an update on how those programs are maturing? Is it still something like three to five years for those units to gain some material traction, or are you now seeing an accelerated pace in ramp-up, just given all the progress in the commercial business and the mega hub strategy?

Bill Rhodes: Sure. Well, we certainly stepped up openings in the first quarter. But remember, we’re at about 88% of our stores have the commercial program today. There’s no vision that we’re going to be 100% or anywhere close to that. As you would imagine, the per store and per program economics of our commercial business over the last couple of years have changed pretty meaningfully. So, there are programs that now make sense to be open that two years ago, we might want to service them from another program. So, that’s what you’re seeing. We may open another 100 or so, but I wouldn’t expect for massive growth rates in commercial openings. And you’re exactly right. It typically takes four or five years for those programs to mature.

I think as we’ve gotten stronger, they come out of the box higher than they did before. And we’ll see what — if the maturity lasts as long as it used to. The one place that is very different, they mature — we don’t know how long it takes for them to mature, but they come out of the gates much higher our mega hubs. It’s amazing to see the volumes that we do almost day one coming out of a mega hub.

David Bellinger: Thank, Bill. Enjoy the trip to Mexico.

Bill Rhodes: All right. Thanks. I look forward to it.

Operator: The next question is coming from Mike Baker at D.A. Davidson.

Mike Baker: Okay. Thanks, guys. A couple of questions. The spread between the ticket growth and inflation widened a little bit. It’s now — I think it was 4 percentage points in retail versus 3 last quarter. Remind us, is that — are you seeing — is it fewer units per transaction? Is it a trade down to less expensive items? Just any color on what’s going on there?

Jamere Jackson: Yes. It’s primarily basket mix that’s impacting that. One of the things we’ve been very disciplined about is moving retails, as we see cost and we’ve been very transparent about what we’re seeing there and been very disciplined about what we’re doing. This is the entire industry.

Mike Baker: So, when you say basket mix, does that mean people trading down to lower more entry-level price points or private label? Just what exactly do you mean by basket mix?

Jamere Jackson: It could actually mean the types of products that are being purchased relative to what we saw in the previous period.

Mike Baker: Okay. And do you see that as any kind of sign of the consumer being strapped, or is it just sort of a random situation? What would cause that, I guess?

Jamere Jackson: Again, as we talked about the consumer, if you think about it from a macro standpoint, I mean, clearly, the consumer is feeling the pinch of inflation on multiple fronts. And quite frankly, inflation is going to erode consumer spending overall. But in our business, where we see the primary pressures in our discretionary categories and our bread and butter failure and maintenance categories, the demand has been there. And the actions that we’ve taken from a pricing standpoint have not impacted volume in a meaningful way, so. The other thing I’ll say about just the consumer in general is it’s clearly a two-speed world. The middle and upper end consumers have stronger balance sheets, and they’re continuing to spend in a meaningful way and the lower end consumer is pitched.

So, what we’re seeing from our business standpoint is quite frankly consumers, when they have an opportunity, as Bill mentioned, to potentially trade into DIY from DIFM for certain things, they will do that. And these are the kinds of things that we’d expect consumers to do over time. But I wouldn’t read anything into the fact that tickets are 1 point or 2 below what we’ve seen historically, most of that again is mix related.

Mike Baker: Well, if I could ask one more, how about the opposite now? Gas prices, believe it or not, are now lower than they were prior to the Russia-Ukraine situation and essentially flat year-over-year. Historically, can you remind us how much relief does that provide to your customers? And can that help offset some of those pressures that you just talked about?

Bill Rhodes: For sure, Mike. No question about it. If you recall — you followed us for a year. So, one thing that we said that really does matter to our customer is gas prices, and particularly when they get over $4 a gallon. We’ve said that for the last 15 years, there just seems to be something special about that $4 a gallon. Obviously, we’re below that level now. But there’s a lot of puts and takes that are going on with the customer today. We’ve never seen this kind of combination. You got near double-digit inflation. You’ve got low-end wage inflation that’s up 5%, 6% across the marketplace. You’ve got gas prices that went up exponentially and then quickly came back down. So, we’re spending a lot of time looking at different stratus of our customer bases, particularly on the DIY side.

And while we see some people trading down into — on the good, better, best spectrum, we’re not seeing any significant moves at this point in time. But we’re obviously paying a lot of attention to it because these are kind of unprecedented underlying factors that are going into it.

Operator: And that is all the time we have for questions today. I would now like to turn the floor back to Mr. Bill Rhodes for closing remarks.

Bill Rhodes: Great. Thank you. Before we conclude the call, I want to take a moment to reiterate, we believe our industry is strong, and our business model in particular is solid. We will take nothing for granted as we understand our customers have alternatives to shopping with us. We have exciting plans that should help us succeed for the future. But I want to stress again that this is a marathon and not a sprint. As we continue to focus on the basics and strive to optimize shareholder value for the future, we are confident AutoZone will continue to be very successful. I want to wish everyone a happy and healthy holiday season. And thank you for participating in today’s call and for your interest in our company. Have a great day.

Operator: Thank you, ladies and gentlemen. This does conclude today’s conference call. You may disconnect your phone lines at this time, and have a wonderful day. Thank you for your participation.