AutoZone, Inc. (NYSE:AZO) Q2 2023 Earnings Call Transcript

AutoZone, Inc. (NYSE:AZO) Q2 2023 Earnings Call Transcript February 28, 2023

Operator: Greetings. Welcome to AutoZone’s 2023 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. Before we begin, the company would like to read some 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 obligations 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: I will now turn the conference call over to your host, Bill Rhodes, Chairman, President and Chief Executive Officer. Sir, you may begin.

Bill Rhodes: Good morning. And thank you for joining us today for AutoZone’s 2023 second quarter conference call. With me today are Jamere Jackson, Executive Vice President and Chief Financial Officer; and Brian Campbell, Vice President, Treasurer, Investor Relations and Tax. 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, are 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 would like to thank and congratulate our AutoZoners across the company for their commitment to delivering exceptional customer service.

For the second quarter, our team delivered total sales growth of 9.5% versus 8.6% in the first quarter, in line with our expectations. We were pleased with this performance as we were up against 15.8% total sales growth in last year’s second quarter. We could not have achieved these results without phenomenal contributions from across the organization. Once again, our AutoZoners’ efforts generated double-digit domestic commercial growth and single-digit domestic retail same-store sales growth. As we move further and further away from the societal impacts experienced as a result of the pandemic, we are very pleased with our team’s ability to not only retain the tremendous growth we experienced over the last three years, but continue to grow on top of those phenomenal levels.

Our team is relentlessly focused on getting back to normal or, as I call it, quote-unquote, exiting pandemic mode. We must get back to our well-known and highly regarded flawless execution. In all candor, we still aren’t there yet. But we also have to reignite our innovation engine. We have some very good initiatives in development in both retail and commercial, and we have some significant improvements underway in our supply chain, as we modernize and expand it for the next decade of growth and beyond. We are halfway through our fiscal year and we are pleased with our performance so far. More encouraging, we feel good about the balance of the year and know our AutoZoners are keenly focused on delivering great service and terrific performance.

This morning, we will review our second quarter same-store sales, DIY versus DIFM trends, our sales cadence over the 12-week quarter, merchandise categories that drove our performance and some regional call-outs. We will also share how inflation is affecting our cost and retails, and how we think inflation will impact our business for the remainder of our fiscal year. Let’s now move into more specifics on our performance. Domestic same-store sales were up 5.3%, our net income was $477 million and our EPS was $24.64 a share, increasing 10.5%. Our domestic same-store sales comp was on top of last year’s 13.8% and in line with last quarter’s 5.6% comp. On a two-year basis, we delivered a 19.1% comp, and get this, on a three-year basis, a 34.3% stacked comp.

Our team once again delivered amazing results despite the comparison to the last couple of years being the hardest quarterly compare for the entire fiscal year. Now let me spend a few moments on growth, our growth dynamics in the quarter. Our growth rates for retail and commercial were both strong, with domestic retail sales up nearly 5% and domestic commercial growth north of 13%. We continue to set commercial quarterly records with $955 million in sales, another impressive quarter as we generated $111 million more in sales than in Q2 last year. On a trailing four-quarter basis, we delivered just under $4.5 billion in annual commercial sales, up an amazing 19% over last year. We also set another Q2 record for average weekly sales per store at $14,500 versus $13,500 last year.

Domestic commercial sales represented 30% of our domestic auto parts sales versus 28% this time last year. It was encouraging to see our transaction trends improving from last quarter. Our retail transactions meaningfully improved and were down just 2.2% for the quarter, while our commercial transactions were up mid-single digits and improving. Our average ticket in both retail and commercial experienced solid mid single-digit growth. Ticket growth decelerated from Q1 as we began to lap the acceleration in inflation we experienced this time last year. We are beginning to see signs of product cost and freight inflation slowing, and we expect to see these begin to return to historical norms over time. We are continuing to see — to experience substantially higher wage inflation than historically in the mid single-digit range, more than double our historical experience.

While the staffing environment is substantially improved versus this time last year, we don’t envision wage inflation abating soon as there continues to be regulatory and market pressures. While we have to manage through these external forces, our focus continues to be on driving profitable market share growth, particularly in units and transactions. Our growth initiatives are doing just that and include, new store unit growth, improved satellite store availability, hub and mega-hub openings, improvements in coverage, leveraging the strength of the Duralast brand, enhanced technology to make us easier to do business with and more efficient, reducing delivery times, enhancing our sales force effectiveness and living consistent with our pledge by being priced right for the value proposition we deliver.

Our goal remains over time to become the industry leader in both DIY and commercial. Our strategy, execution and market momentum give us confidence as we move forward. Digging deeper into our domestic DIY business this past quarter, we delivered a positive 2.7% comp on top of last year’s 8.4%. Our DIY results were similar to last quarter’s results on a one-year and two-year basis and accelerated on a three-year basis. As previously said, our ticket growth was up 5% versus last year. We are pleased with our transaction count trends improving as we reported transactions down just 2%. These results are very strong, considering the difficult comparison to last year. From the data we have available, we continued to retain the majority of the dollar share gains we have built during the pandemic and we continue to grow unit share, a critical measurement of our success.

Our performance gives us continued conviction about the sustainability of our sales growth for the remainder of the year. As we have shared forever, our second quarter is always the most volatile sales quarter due to the holidays, their timing shifts, and more importantly, weather, specifically extreme temperatures, which all can have a tremendous impact on our weekly sales. This quarter was no different, with softer sales at the beginning of the quarter when the weather was mild and wet, followed by a large spike around Christmas with the very cold temperatures the country experienced. We exited the quarter with normalized growth rates. We do believe we had enough harsh winter weather that we won’t be talking about the lingering effects of a mild winter weather or mild winter for the next several months.

Our attention has now turned to tax rebate season, which historically drives enormous demand in our category. Regarding our retail merchandise categories, our sales floor outperformed hard parts with approximately a 1.5% difference between them. Our relative outperformance in sales for categories is attributable to the discretionary categories improvement. As gas prices naturally have come down and consumer has shown surprising resiliency, our discretionary categories performed better. The discretionary categories represented approximately 18% of our DIY sales in the quarter. We were encouraged to see our battery, oil and wiper categories performed well and successfully lapped very strong performance last year. These categories have exceeded our expectations all year.

Our friction category for both DIY and commercial performed below our expectations for much of the quarter. However, it bounced back late and we are encouraged by our recent trends. We believe both our sales floor and hard parts businesses will continue to do well this spring, as we expect miles driven to continue improving, while our growth initiatives continued delivering solid results. Let me also address pricing. In Q2, we experienced high single-digit pricing inflation in line with cost of goods. We believe both numbers will decrease in the current quarter as we begin to lap the onset of high inflation last year. 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, increasing margin dollars. It is also notable that following periods of higher inflation, our industry has historically not meaningfully reduced pricing to reflect lower cost. Over the last three years, we have encouraged investors to keep a keen focus on our two-year and three-year comparisons. As we return to normal, we believe our year-over-year comparisons will be more and more relevant.

While it’s difficult to predict sales, we are excited about our growth initiatives. Our team is improving execution and the tremendous share gains we have achieved in both sectors. For our third quarter 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 to Jamere, I’d like to give a brief update on our supply chain initiatives. I will start with our in-stock position. I spent several quarters talking about how we were not back to where we were pre-pandemic.

I am pleased to report, we are continuing to improve and are very close to our targets. Our merchandising and supply chain teams have worked diligently and creatively to get our levels back up, and we have made enormous progress. There are still a few categories where we are not where we want to be, but we will — we have line of sight to putting this behind us. This has taken a lot of effort by our vendor community, and I’d like to publicly thank them for their tremendous efforts as well. We know this will pay future dividends. Second, our supply chain initiatives that are in flight to drive improved availability are on track. One we have often highlighted is our expanded hub and mega-hub rollouts. We know intelligently placing more inventory in local markets closer to the customer will lead to our ability to continue to say, yes, to our customers more frequently and in turn drive sales.

Additionally, we have previously announced the development of two new domestic distribution centers and additional capacity in Mexico. All three efforts are under construction and are expected to be completed by early fiscal 2025. These distribution centers will allow us to not only reduce drive times to stores but also increase our capacity. With the tremendous sales growth we have experienced since 2020, the additional capacity will enable us to carry more slower turning inventory that is not yet in high demand. I am excited that — I am also excited we opened a facility on the West Coast recently to handle direct import product on a timelier and more effective and efficient basis. This new West Coast facility is already paying dividends by allowing products ordered abroad to be distributed 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 sales success, especially in commercial. Simply put, every time we intelligently add inventory to our network our sales grow. Lastly, we plan on continuing to grow our business in Mexico and Brazil at almost 800 stores combined across the two markets. These businesses had impressive performance again this quarter and they 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 expand our store footprint significantly and aggressively over the next five years.

Photo by Julian Hochgesang on Unsplash

We are very excited about our growth prospects internationally. We are dedicated to growing our business in a disciplined and profitable manner well into the future, and we know, with our AutoZoners leading the charge, we will continue to be very successful. Now I will turn the call over to Jamere Jackson. Jamere?

Jamere Jackson: Thanks, Bill, and good morning, everyone. As Bill mentioned, we had a strong second quarter stacked on top of exceptionally strong comps from last year. This quarter we delivered 5.3% domestic comp growth, a 6.9% increase in EBIT and a 10.5% increase in EPS. To start this morning, let me take a few moments to elaborate on the specifics in our P&L for Q2. For the quarter, total sales were just under $3.7 billion, up 9.5%, reflecting continued strength in our industry and solid execution of our growth initiatives and let me give a little more color on those growth initiatives. Starting with our commercial business for the second quarter. Our domestic DIFM sales increased just over 13% to $955 million and were up just over 45% on a two-year stack basis.

Sales to our domestic DIFM customers represented 30% of our domestic auto part sales. Our weekly sales per program were $14,500, up 7.4% and our growth was broad-based as both national and local accounts performed well for the quarter. Our results for the quarter set another record for the highest second 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 in approximately 88% of our domestic stores, which leverages our DIY infrastructure and we are building our business with national, regional and local accounts.

This quarter we opened 41 net new programs, finishing with 5,500 total programs. As expected, commercial growth is leading the way in FY 2023 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. We have delivered double-digit sales growth for the past 10 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 have noted on past calls, our mega-hub strategy is driving strong performance and positioning us for an even brighter future in our commercial and retail businesses.

Once again, I will add some color on our progress. As we have discussed over the last several quarters, our mega-hub strategy has given us tremendous momentum. We now have 81 mega-hub locations with one new one opened in Q2. While I mentioned a moment ago, the commercial weekly sales per program average was $14,500, the 81 mega-hubs averaged significantly higher sales than the balance of the commercial footprint and grew significantly faster than our overall commercial business in Q2. As a reminder, our mega-hubs typically carry 80,000 to 100,000 SKUs and more in certain cases and drive tremendous sales lift inside the store box, as well as serve 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.

These assets are not only performing well individually, but the fulfillment capability for the surrounding AutoZone stores is giving our customers access to thousands of additional parks and lifting the entire network. This strategy is working. We are targeting 25 new mega-hubs for FY 2023 and we remain committed to our objective to reach 200 mega-hubs, supplemented by 300 regular hubs. 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 will build on our strong momentum over the remainder of the fiscal year. Our domestic retail comp was up 2.7% in Q2. This business has been remarkably resilient as growth rates remain solid and we have managed to continue to deliver positive comp growth despite underlying market headwinds.

As Bill mentioned, we saw our traffic down 2.2% from last year’s levels. However, they improved sequentially from Q1 where traffic was down 4%. We also saw 5% ticket growth as we continue to raise prices in an inflationary environment. Our DIY business has continued to strengthen competitively behind our growth initiatives. In addition, on a macro basis, the market is still experiencing a growing and aging car park, and a still challenging new and used car sales market for our customers. These dynamics, pricing growth initiatives and macro car park 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. We are forecasting a resilient DIY business for the remainder of FY 2023.

Now I will say a few words regarding our international businesses. We continue to be pleased with the progress we are making in Mexico and Brazil. During the quarter, we opened one new store in Mexico to finish with 707 stores and five new stores in Brazil ending with 81. On a constant currency basis, we meaningfully accelerated our sales growth in both countries at higher growth rates than we saw in the overall business. 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 continued expansion in a disciplined way, international growth will be an attractive and meaningful contributor to AutoZone’s future growth.

We are bullish on international growth, and as Bill mentioned earlier, we are adding distribution center capacity in Mexico to improve our competitive positioning in the market. 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 69 basis points and included a 27-basis-point headwind stemming from a noncash $10 million LIFO charge. The difference for the quarter, a decline of 42 basis points in gross margin was driven by supply chain costs and our faster growing lower gross margin commercial business. With this quarter’s LIFO charge, we have taken our LIFO credit balance to $106 million. As I mentioned last quarter, hyperinflation and freight cost is the primary driver for the charges.

Both the first quarter and second quarter actuals are below the outlook we gave at the start of each quarter as freight costs have continued to abate over the past few months and we expect this trend to continue. As such, we anticipate having minimal if any LIFO charges during the third quarter. As spot rates have come down, we have renegotiated some of our long-term contracts and the lower costs are reflected in our outlook. We expect freight costs to continue to abate. We expect to see these quarterly charges start to reverse during FY 2024, and quite possibly, as early as Q4. 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 unrecorded LIFO reserve balance as we have done historically.

Now moving to operating expenses. Our expenses were up 8.8% versus last year’s Q2 as SG&A levered 24 basis points versus 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 and 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 $670 million, up 6.9% versus the prior year’s quarter. Excluding the $10 million LIFO charge, EBIT would have been up 8.5% over last year. Interest expense for the quarter was $65.6 million, up 54.5% from Q2 a year ago, as our debt outstanding at the end of the quarter was $7 billion versus $5.8 billion at Q2 end last year.

We are planning interest in the $72 million range for the third quarter of fiscal 2023 versus $42 million in last year’s third quarter. Higher debt levels and expected continuing higher borrowing costs are driving this increase. For the quarter, our tax rate was 21.2% and above last year’s second quarter rate of 19.3%. This quarter’s rate benefited 222 basis points from stock options exercised, while last year’s benefit was 401 basis points. For the third quarter of FY 2023, we suggest investors model us at approximately 23.4% before any assumption on credits due to stock option exercises. Now moving to net income and EPS. Net income for the quarter was $476.5 million, up 1% versus last year’s second quarter. Our diluted share count of 19.3 million was 8.6% lower than last year’s second quarter.

The combination of higher net income and lower share count drove earnings per share for the quarter to $24.64, up 10.5% versus a year ago. Excluding the LIFO charge, our net income would have increased 2.6% and our EPS growth would have increased 12.3%. Now let me talk about our free cash flow for Q2. For the second quarter, we generated $210 million in free cash flow versus $260 million a year ago. Year-to-date, we have generated $900 million versus $930 million a year ago. We expect 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 ratios remain below our historic norms.

Our inventory per store was up 10.7% versus Q2 last year and total inventory increased 13.9% over the same period, 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 $227,000 versus negative $198,000 last year and negative $249,000 last quarter. As a result, accounts payable as a percent of gross inventory finished the quarter at 127.7% versus last year’s Q2 of 126.8%. Lastly, I will spend a moment on capital allocation and our share repurchase program. We repurchased 906 million of AutoZone stock in the quarter, and at quarter end, we had just under $1.8 billion remaining under our share buyback authorization.

Our strong earnings, balance sheet and powerful free cash generated this year have allowed us to buy back 4% of the company’s total shares outstanding since the start of the fiscal year. We 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 our disciplined capital allocation approach that enables us to invest in the business, while returning meaningful amounts of cash to shareholders. Our leverage ratio finished Q2 at 2.3 times EBITDAR and we remain committed to return to the 2.5 times area during FY 2023. So to wrap up, we continue to drive long-term shareholder value by investing in our growth initiatives, driving robust earnings and cash, and returning excess cash to our shareholders.

We are growing our market share, and we are improving our competitive positioning in a disciplined way. Our strategy continues to work. As we look forward to the back half of FY 2023, we are 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. And now I will turn it back to Bill.

Bill Rhodes: Thank you, Jamere. We are proud of the results our team delivered in the second quarter. But we must, we must continue to be focused on superior customer service and flawless execution. Execution and our 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 remainder of the year. We will continue to invest in initiatives that drive an appropriate return on capital and we continue investing where our returns are the highest. For the remainder of fiscal 2023, we are launching some very exciting initiatives. This year not only we would be opening roughly 200 stores across the U.S., Mexico and Brazil, but we will be opening many more mega-hub and hub stores, and we are focused on initiatives to continue driving strong performance in both our retail and commercial businesses.

For the remainder of 2023, we are keenly focused on relentless execution. We will not accept shortcuts. We remain focused on achieving our store opening goals, both domestically and internationally. We are working diligently to expand and enhance our supply chain and we have to achieve this growth, all while managing our costs appropriately. Simply said, we have to focus on exceptional execution in order to drive continued share gains. We know that investors will ultimately measure us by what our future cash flows look like in three to four years from now and we welcome and accept that challenge. I continue to be bullish on our industry, and in particular, on AutoZone, which is led by AutoZoners. Now we would like to open up the call for questions.

See also 10 Best Stocks to Buy for High Returns and 12 Biggest Port Terminal Operators in the World.

Q&A Session

Operator: Certainly. Your first question for today is coming from Bret Jordan at Jefferies.

Bret Jordan: Hey. Good morning, guys.

Bill Rhodes: Good morning, Bret.

Jamere Jackson: Hi, Bret.

Bret Jordan: On the talk of lower transportation, supply chain costs but higher wage inflation, in this environment, where some of your inputs are going to come down and maybe you have got the opportunity to capture margin as customer prices stay firm, are we less likely to see this over for excess margin, because we have got either price investment from peers or wage inflation that might offset some of the cost of good benefit?

Bill Rhodes: Yeah. It’s a fantastic question, Bret. I will start, and Jamere, you are welcome to build on it if you want to. First of all, I think, it’s important for you all to understand, as we saw these enormous spikes in the freight cost, we did not pass all those costs along. I will use brake rotors, for instance. I mean the cost of shipping brake rotors from China to the U.S. were astronomical for a period of time. We couldn’t pass all that costs on to the industry. So some of this is we will recoup some gross margin percentages that we didn’t get in the midst of the freight issue. As we look forward, I think, you have to separate the gross margin piece from the labor piece. We are going to continue to see elevated wage growth.

We have seen it now for probably five years, Bret. We will continue to monitor that. Our pricing is really more focused on what our product costs are and what those freight costs are. We will be mindful of labor costs. But generally, that’s not a big driver of what we do with our pricing to the customer. What we need to do is make sure that we are finding ways to be as efficient as possible with the labor that we have, and over time, I think, wage rates will go back to more normalized growth rates.

Jamere Jackson: Yeah. And we haven’t seen the moves and actions by our nearing competitors impact our business, really at all. Most of those moves, quite frankly, were targeted in much the same manner as our moves were a couple of years ago, which was how do we all improve our competitive hand relative to the warehouse distributors. So we haven’t seen much of an impact there, and as a result of that, we don’t see a need to make pricing actions to sort of counter what’s being done in the marketplace by some of our newer competitors.

Bret Jordan: Okay. Great. And then a quick question on ALLDATA. I think you would mentioned expanding the user base. Is there a way to make that a product selling tool as they use your shop management software, is there a way to link it to your inventory or make it more transactional?

Bill Rhodes: Yeah. First of all, at ALLDATA, we are very focused on providing value via our ALLDATA offerings to our customers at ALLDATA. We also look for ways that we can enhance our commercial relationship at AutoZone with their customers. We have done a lot of that by cross-selling, leveraging our two sales teams to generate leads for each other. So far, we haven’t really integrated a lot with the, call it, up and down the street customer, but we have made some really meaningful progress with some of our national accounts and have some exciting things underway right now that helps integrate us more and more with them. Over time, that’s certainly the vision that we have, is how can we be on their desktop as both ALLDATA and AutoZone in a seamless way, but we got to make sure that we don’t drive the customer to that, that instead we have a product offering that the customer wants to adopt.

Bret Jordan: Great. Thank you.

Bill Rhodes: Yeah. Thank you.

Operator: Your next question for today is coming from Seth Sigman at Barclays.

Seth Sigman: Hey, everybody. Good morning. My first question is just around the improvement in transactions or ticket count. I guess that coincides with less average ticket growth. But, Bill, to your point, there really shouldn’t be a lot of elasticity in this business since it’s more need based, right? So is there something else that you would point to that’s driving that acceleration in transactions? Thank you.

Bill Rhodes: It’s a great question. Frankly, I don’t have a great answer for you. As you know, you have been following this industry for a long time, one of the dirty little secrets of the industry is that for decades and basically for the 28 years that I have been in this business, there has been transaction count declines and they have gone down over time, because the technology that has gone into the parts and products that we sell have increased, and therefore, the price of those products have increased. I often used the example of spark plugs. When I got in this business, we only sold copper clad spark bugs and they were $0.59 and they would last 30,000 miles. Today we sell Iridium spark plugs, it costs $11.99 and they will last 100,000 miles.

There’s many, many, many examples like that, 2.2% decline in retail transaction counts is historically very good. I just — I would caution everybody, as I have mentioned in my prepared remarks, Q2 is our most volatile quarter every year and it is really driven by weather patterns. And so I don’t want to read too much into an improvement in Q2, we were very excited to see it. Let’s see how we do in Q2 and Q3. We are also still going up against the massive surge in growth that we had since 2019 as a result of COVID. So what we are focused on is, we thought for a period of time, that some of the sales growth that we experienced during COVID, we would give back. We are sitting here and have been for the last year saying, I don’t think we are going to give it back, and now we are saying, look, we think we can grow from here and maybe have normalized growth rates and maybe even accelerated slightly growth rates to what we experienced historically, because of our growth initiatives.

That’s the way we are thinking about it. Does that make sense?

Seth Sigman: Yeah. That’s helpful. I appreciate that. Maybe just one follow-up is on the cost side. You did discuss some external cost pressures. I think you are probably referring to wages and some of your competitors have also talked about wage investments. I guess when we look at your SG&A growth up high-single digits, is it fair to assume that, that already reflects AutoZone investing in its people, investing in its infrastructure, does that already reflect some of those cost pressures that you are referring to?

Jamere Jackson: Certainly does. I mean one of the things that we have been really clear about is that we are going to grow SG&A in a disciplined way as we create a faster growing business and the two ways that we have done that. One, is investing in labor to maintain high levels of customer service. You saw us do that throughout the pandemic and it paid great dividends for us during that timeframe. The other thing we have talked about is investing in a disciplined way in IT, which is enabling growth in both our DIY and our commercial business. Every one of our growth initiatives, whether it’s on the retail side of the business or the commercial side of the business, includes some element of improving the customer experience and those things have required us to accelerate some of our investments in IT.

We like those investments. They are improving the customer experience. They are also improving the experience for our AutoZoners, and quite frankly, we think we will get benefits in terms of productivity in the future.

Seth Sigman: Okay. Great. Thanks very much.

Bill Rhodes: Thank you.

Operator: Your next question is coming from Zach Fadem at Wells Fargo.

Zach Fadem: Hey. Good morning. Could you walk us through the sequential performance for commercial in a little bit more detail as last quarter stepped down a touch on a multiyear basis, while this quarter bounced back nicely. So the question is, could you walk us through what you think could be driving the fluctuation in the do-it-for-me transactions from Q1 to Q2? And then with the three-year commercial compare looking a bit tougher, is it fair to assume that double-digit growth can sustain in the second half of the year?

Jamere Jackson: Yeah. Great question. So a couple of things I will highlight. As I have mentioned, we have had 10 straight quarters of double-digit sales growth, and quite frankly, six of the last eight have been above 20%. We like the competitive dynamics in the marketplace today. We also like the fact that we are underpenetrated. We are a four to five share in a huge market that’s approaching $100 billion. So there’s a tremendous opportunity for us to create a faster-growing business. If we look at our business on a two-year basis — on a two-year stack basis, we are over 45%. So we like where we are from a commercial standpoint and all the initiatives that we have in place, improving the quality of our Duralast brand, expanding our assortments with our mega-hubs, improving our delivery times, leveraging technology and the competitive pricing dynamics that we saw in the marketplace a couple of years ago that we addressed give us a lot of confidence about it.

So we have been comfortably double digits. You have heard us say that our goal is to continue to grow that share and growing that share means that we aspire to have a business that’s growing double digits really as far as the eye can see.

Zach Fadem: Got it. That’s helpful. And Jamere, just to clarify your gross margin commentary, you mentioned no negative LIFO impact in Q3. Does that mean your LIFO balance of $106 million remained stable in Q3 and Q4 or is it fair to expect that line to gradually or maybe more drastically shrink sequentially? And then big picture, is it fair to say that 52% gross margin is a fair run rate for the business going forward?

Jamere Jackson: Yeah. So first, on LIFO, what we said is that, we anticipate minimal if any LIFO charges in 3Q and by the fourth quarter and certainly into FY 2024, we could potentially see that $106 million balance start to burn down, which means we would actually take gains through the P&L. It will take several quarters for us to work our way through $106 million based on our current forecast today. But we will be very transparent about what we are seeing and what gives us this confidence, quite frankly, is that as I mentioned before, we are seeing freight moderate. And as such, in the back half of this fiscal year, barring any disruptions like we have seen in the past, we are not expecting to take any charges and again, possibly see us flipping back to gains.

In terms of our gross margin run rate, we have said that our commercial business is going to grow faster than our DIY business and that’s going to put, let’s call it, 35 basis points to 40 basis points of headwind on our gross margins going forward. Now that doesn’t mean that you can expect our gross margins to deteriorate in the perpetuity. We are still running the same play with intensity inside the company to drive margin improvement that will mute some of that, if not offset all of it. So we feel pretty good about those initiatives. Our merchants and our supply chain teams are doing a tremendous job, as Bill mentioned before, not only working on in-stocks, but driving margin improvement. And as some of the cost pressures ease in the marketplace and some of the cost pressures that our vendors and suppliers have been seeing, it gives us an opportunity to go work on margins in a more fulsome way going forward.

Zach Fadem: Got it. Thanks for the time.

Jamere Jackson: Yeah.

Operator: Your next question for today is coming from Scot Ciccarelli at Truist Securities.

Scot Ciccarelli: Hi, guys. I just had a quick question on your outlook for same SKU inflation for the rest of the year. I know you have said you think it’s going to moderate somewhat. Just wondering do you think that would get to like the mid-single digits or low single-digit range?

Bill Rhodes: Yeah. That’s a great question. I wish I could answer. There’s just so many pushes and pulls right now in the economy with our cost that I am not sure we can answer that. That seems like a reasonable assessment, but we are just going to manage through it just like we have. We have gone through some pretty big cycles over the last 24 months and we are going to manage our business appropriately, whether it’s 5% or 7%, we are just going to manage through it.

Scot Ciccarelli: Got you. That makes a lot of sense. And then just a follow-up on an earlier question, I know you mentioned transactions kind of accelerated in the quarter kind of and it really kind of offset some of the ticket decel. Do you think that could continue to happen or is there any data points that you think that, that might not happen again in the second half?

Bill Rhodes: I think that’s a reasonable assumption. We hope that we can continue to — we want to grow transactions. I talked about the challenges that are related to that, but our goal is to grow transactions. I also mentioned in the prepared remarks that we are very focused on unit growth. We believe that’s the lifeblood of this organization and we are focused on how do we grow units over the long term in both our retail and commercial business and we have been very pleased with the unit market share gains that we have had over the last three years and we are continuing to grow unit share even after the growth we have had over the last three years.

Scot Ciccarelli: Great. Thank you.

Bill Rhodes: Thank you.

Operator: Your next question for today is coming from Brian Nagel at Oppenheimer.

Brian Nagel: Hey, guys. Good morning.

Jamere Jackson: Hi, Brian.

Bill Rhodes: Good morning.

Brian Nagel: So my first question, it’s a bit of a follow-up to a prior question, but just with respect — with regard to the commercial growth, we have seen substantial growth there for a while. As you move past the effects of the pandemic, the growth rates moderated, but still stayed very healthy. I guess how — the question is how do you think about that longer term trajectory commercial growth and if you look at some of the markets that are maybe more mature for AutoZone, do they always give you insight into either from a market share perspective or more closer to a terminal type growth rate for that business?

Bill Rhodes: Well, terrific questions. I want to be clear about one thing. I don’t believe the vast majority of the growth that we have seen in the commercial business over the last three years was a result of the pandemic. There’s no question. The outside growth in our DIY business was mainly attributable to the pandemic. I don’t think that was the case with commercial. I am sure it had some positive effects. But I think what — the strategy that we began to deploy about four years ago have really been the driver of our commercial performance. Now as we continue to further and further mature on that strategy, we have seen some deceleration in our commercial growth. It’s still fantastic, but it’s not growing in the 20s. Our goal now is what’s next and we are working on that even as we speak.

What are the next levers that we are going to pull to continue to grow in the commercial business? Now just a reminder, we have got mid-teens market share in the retail business and we have about 25% or about 4% total market share in the commercial business. So we have got a tremendous runway in front of us. When you talk about certain markets and what do we see, we certainly have some markets that are more mature than others. I would say the most encouraging thing to me is to see how broad-based the acceleration has been in our 61 regions that we have across the United States. But I was in a market last week, arguably our most mature market, I am not going to tell you where that is. And it has significant hub coverage and it has significant mega-hub coverage and in that market we continue to grow at very rapid rates.

And so I am particularly optimistic, as we continue to deploy the strategy of mega-hubs, so we still have — we have roughly a little over 80 mega-hubs today. We are going to 200, and hopefully, in short order and then we are going to get to 300 hub stores. So that will be 500 stores in the United States with materially different product assortments than we have had historically. To me, that is the biggest part of our strategy.

Brian Nagel: Yeah. That’s very, very helpful. I appreciate it. And then as a quick follow-up, a different topic, you have mentioned in the prepared comments that you think the winter, I guess, it was harsh enough to drive that typical spring type business, you made that comment. The question I have is, as you look at the weather and it seemed to be very variable across the United States this year, are you seeing it much in the way of as kind of spread your comps between those markets which have been weather impacted versus those that have been less impacted?

Bill Rhodes: Yeah. I mean, we always see that. But what my point was, we have been through years where we just didn’t have a winter and it’s not just the spring, frankly, it’s as much in the summertime where we just don’t see the parts failures on the failure side of the business that we do historically and the maintenance side. It’s snow and ice and cold or all put stress on automobiles and we generally see that over the next six months to eight months once the winter subsides. So that’s what I was really getting at. I do have a bit of caution right now. I talked about tax rebates that are flowing right now. The one thing that I worry about a little bit is, we haven’t had great weather in the last week or so. We need to get some good weather, so DIYers can crawl underneath their cars, while these tax rebates are flowing, because we see a massive surge during this time of the year when our customers have more discretionary dollars.

Brian Nagel: Got it. Very helpful. Thank you.

Bill Rhodes: Yeah. Thank you.

Jamere Jackson: Thanks.

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

Jackie Sussman: Hi. This is Jackie Sussman on for Simeon. Congrats on a good quarter. I guess, first, just on the used car cycle that kind of seems to be this ongoing tailwind for the industry. Is there any way to assess where we are in that cycle and I guess just lapping this higher mix of used cars or an older car fleet become a challenge at some point or do you guys expect a softer landing?

Jamere Jackson: Yeah. So, clearly, used cars are still in tight supply and prices are up. We have seen prices moderate a little bit year-over-year, but they are still up 24% or so over a two-year basis. I think the second dynamic associated with that is, the fact that financing costs have gone up fairly significantly as well. So you have got interest rates that have made financing a vehicle, whether it’s new or used, significantly more expensive. I think the combination of those two dynamics puts tremendous pressure on consumers and what we have seen historically is that when the consumer is under pressure, whether it’s a recessionary cycle or it’s a cycle where new and used car prices spike, they tend to hang on to their vehicles longer, invest in repairing those vehicles and ride to the other side of tougher market conditions and we certainly think that, that’s going to be the case.

So while the prices have come down, we still see a very tight market that’s out there today, and quite frankly, a market that’s significantly more expensive than what consumers experience prior to the pandemic.

Jackie Sussman: Got it. That’s really helpful. Thanks. And just quickly, another on the wage inflation, I guess, that kind of feels like the most stubborn cost pressure, as you mentioned in your prepared remarks. Is the way to think about it that the cost of business seems structurally higher as a result or are there efficiencies within the labor and fulfillment model you have that you could focus on as an offset?

Bill Rhodes: There’s no question that the cost of doing business are structurally higher. And I just want to make sure I amplify this point, our wage rates are up double, more than double what they normally are and that is stick to your ribs inflation. It will be with us forever. But that’s going to continue. And it’s been going on for five years, not at this level, but we had acceleration before the pandemic and once the pandemic hit, it went up significantly more. But we have been able to manage it. We are looking for creative ways like always to be more and more efficient. But we can’t drive that level of efficiency in a 43-year-old business without some kind of structural change, which we will be looking for, but we haven’t identified at this point in time.

Jamere Jackson: And I just think from a macro standpoint, if you look at unemployment being at 3.4% or so and wage rates being in the — with a five handle on them, I mean we are in a dynamic where the combination, as Bill said in his remarks, the combination of market pressures and regulatory pressures, which is an increasing push to raise minimum wage rates, this is an environment that we have to plan for in the future. The good news, again, about our industry is that, as we have seen inflationary impacts, whether it’s product cost or it’s wages or it’s freight, I mean, we have typically seen this be an industry that is very disciplined about passing those costs along to consumers and given the relative inelasticity of the demand for our bread and butter products, we expect that to not cause our business to wobble at all.

Operator: Your next question for today is coming from David Bellinger at Roth MKM.

David Bellinger: Hey. Good morning. Thanks for taking the question. First one on the sequential improvement in discretionary categories. Why do you think that’s happening now, was there anything unique within the Q2 period? And are you seeing differences across demographics, meaning is the discretionary improvement also occurring with your lower or, call it, the lowest income customer base as well?

Jamere Jackson: Yeah. I mean what we have seen in total is that, our business has been remarkably resilient across both our upper income consumers, but also the lower end consumers. And again, that’s because the lion’s share of our business, our bread and butter categories, if you will or brake fix/failure, maintenance related sort of categories. The knock on effect of that is that to the extent that folks are making purchases for those bread and butter products if you will, then the discretionary categories tend to ride along with that as the basket gets built. So we have been fortunate in that regard. And the other thing that I don’t want to underestimate and I actually want to underscore, is the fact that, we have been very focused on our growth initiatives and our growth initiatives are about driving more customers and more purchase occasions for AutoZone.

And as a result of that, we are seeing the opportunity for us to continue to win some market share. So some of that sequential improvement that you are seeing in traffic is actually the impact of some of the things that we have been doing from a growth initiative to drive more customers into our store.

David Bellinger: Thanks, Jamere. And my follow-up on the 4% market share you highlighted before in commercial, do you have a sense of where the more mature markets are tracking in terms of market share and should we think about that as potentially in the double digits at this point and a path to where some of these newer programs can get to in due time?

Bill Rhodes: Yeah. We are definitely not in double digits in any markets that I am aware of. I would think maybe we are at 6% in that kind of ballpark. But look, if we have 16% or whatever share in retail, my thing is why can’t we have that in commercial and that’s the kind of thought process we need to have. I think one of our challenges is, sometimes we think about where we are and it limits what we think about the possibilities. We are trying to eliminate some of those glass ceilings, and say, why don’t we have the same amount of share in both, which would mean the commercial business would be meaningfully larger than the retail business?

Jamere Jackson: And the good news for us is it’s not just focused on new customers, but it is increasing our share of wallet with our existing customers. And to Bill’s point, that’s where we are focused as a company at getting what we believe our fair share or what our entitlement should be. We are pretty excited about those initiatives going forward.

David Bellinger: Great. Thank you.

Bill Rhodes: Thank you.

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

Atul Maheswari: Good morning. This is Atul Maheswari on for Michael Lasser. Thanks a lot for taking our questions. The first question is on the commercial business, compared to last year, when you were regularly doing 20%-plus to now growing in 13% to 15%. So what has changed, is it just fewer new customer additions or less ticket per customer?

Bill Rhodes: Well, I think, as I said before, I think, part of what’s changed is some of the massive improvements that we have made in our — from our new strategy on commercial acceleration have matured more, but they are not mature. And so we are — I would just say it this way, we are very pleased with the commercial growth that we have experienced over the last six months. And as I also said, we are looking for those next items that are in the next part of our strategy, they are going to drive accelerated growth.

Jamere Jackson: Yeah. We are continuing to win market share. I mean, I would venture to say that the commercial market is not growing as fast as we are growing, which the knock on to that is that we are growing market share and we are pleased with our progress.

Atul Maheswari: Got it. It makes sense. Thank you for that. And then as a quick follow-up, I know you talked about tax refunds, but how are you thinking about near-term trends given some of the data source that tax refunds are lower year-over-year and then there’s potentially some headwinds from Snap as well?

Bill Rhodes: Yeah. Look, we have never talked about Snap. I don’t think that that’s a big part driver for our business. The data we have available to us shows that tax refunds are remarkably similar to the way they were last year and are slightly up. We look at that data, it usually comes out on Mondays and we see where the big drops happened last week. Last week was a big drop as it was last year on tax refunds. So as far as we are concerned, we see everything on track, we are hoping that we get some great weather that’s very conducive to DIY and that those customers come to us.

Atul Maheswari: Thank you. Good luck to the rest of the year.

Bill Rhodes: Thank you very much.

Jamere Jackson: Thanks.

Bill Rhodes: Well, before we conclude

Operator: Your next question

Bill Rhodes: Sorry, I thought you were — I will go ahead. Before we conclude the call, I want to take a moment to reiterate, we believe 2023 will continue to be a solid year for our industry and our business model is working. We must 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 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 successful. Thank you for participating in today’s call. Have a great day.

Operator: This concludes today’s conference. You may disconnect your lines at this time. Thank you for your participation.