AutoZone, Inc. (NYSE:AZO) Q2 2024 Earnings Call Transcript

AutoZone, Inc. (NYSE:AZO) Q2 2024 Earnings Call Transcript February 27, 2024

AutoZone, Inc. beats earnings expectations. Reported EPS is $32.55, expectations were $26.08. AutoZone, Inc. isn’t one of the 30 most popular stocks among hedge funds at the end of the third quarter (see the details here).

Operator: Greetings. Welcome to AutoZone’s 2024 Q2 Earnings Release Conference Call. At this time, all participants are in a listen-only mode. [Operator Instructions] Please note, this conference is being recorded. Before we begin, the Company would like to announce the following forward-looking statements.

Unidentified Company Representative: 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 GAAP to non-GAAP financial measures can be found in our press release.

Phil Daniele: Good morning, and thank you for joining us today for AutoZone’s 2024 second quarter conference call. With me today are Jamere Jackson, Chief Financial Officer; and Brian Campbell, Vice President, Treasurer, Investor Relations and Tax. Regarding the second quarter, I hope you had an opportunity to read our press release and learn about the quarter’s results. If not, the press release, along with the slides complementing our comments today, are available on our website at www.autozone.com under the Investor Relations link. Please click on the quarterly earnings conference call to see them. As we begin this morning, I’d like to say how honored I am to talk with you on behalf of our more than 120,000 AutoZoners. As today marks my first conference call as AutoZone’s, President and Chief Executive Officer.

At AutoZone, our first priority is to provide what we call WOW! Customer Service. This quarter, the efforts of our AutoZoners increased our total sales by 4.6% and total company same-store sales by 1.5% on a constant currency basis. Both our operating profit and earnings per share grew by a very impressive double-digit rates We continue to build on the phenomenal performance we had over the last several years. Congratulations to our AutoZoners everywhere, who helped us achieve this amazing growth. Before I begin my comments regarding our second quarter sales, as a reminder, this is always our most volatile quarter to predict as the timing and severity of winter weather is both meaningful and variable. It is also our lowest sales volume quarter.

This year, the Christmas and New Year’s Day holidays fell on a Monday compared to Sunday last year. For commercial sales, this really mattered. Sunday is a very low sales day while Monday is one of the best. While weather across the US was very mild for the first 8 weeks of the quarter, we experienced a polar vortex and snow in the last four weeks. This extreme weather helped to propel us to stronger results in DIY, but muted our sales in commercial as snow in much of the Eastern United States, stayed on the ground for an extended period of time. Again, weather extremes either hot or cold, drive hard part failures and accelerate maintenance over time. For the second quarter, our total company same-store sales were 1.5% on a constant currency basis.

As international has become a more important part of our growth story in an area where we are increasingly deploying capital, we will continue reporting on our international performance. We encourage you to focus on the same-store sales, constant currency number where International, again, had a strong quarter, up 10.6%. We are very excited about the short and long-term growth prospects internationally, and we plan to accelerate new store openings over the next several years. Our domestic same-store sales were up 0.3% this quarter compared to 1.2% last quarter and 5.3% in Q2 of last year. Breaking our 12 weeks of sales into the first eight weeks and then the last four weeks, you can see the impact of the holiday shift and the weather volatility.

Domestically, we ran a negative 1.8% comp across the first eight weeks and a positive 4.4% comp in the last four weeks. This was even more pronounced when splitting these time frames up between commercial and DIY. Our commercial business grew 2.7% against very strong sales last year of 13.1%. Although our commercial business finished stronger than we started, our results were below our expectations. Across the 12-week quarter, we were up 4.1% for the first four weeks, then down 0.7% over the second four-week segment and up 4.4% over the last four weeks. Although better in the last four weeks segment, of the quarter, our sales were depressed due to the winter storms shutting down many commercial customers, particularly in the mid-south. The holiday shift combined with weather negatively impacted our sales by roughly 2% for the quarter.

Despite all this volatility in commercial sales, we are encouraged that we finished the quarter stronger. Commercial sales growth continues to be driven by the key initiatives we have been working on over time. Improved satellite and store inventory availability, material improvements in hub and mega hub coverage, the strength of the Duralast brand with an intense focus on high-quality products, and technology enhancements to make us easier to do business with. We recently launched initiatives focused on improving customer service with faster delivery times in commercial, while very early, we are encouraged by the initial results. In commercial, we continue to see higher growth rates for traffic relative to ticket. In Q2, we opened 20 net new commercial programs.

We now have commercial programs in 92% of our domestic stores. Domestic commercial sales represented 30% of our domestic auto part sales for Q2. We believe our commercial business will get stronger and growth rates will improve as we move through the year. Sales growth comparisons get easier in the back half of the year and our execution, customer delivery times, in-stock levels, and parts availability continue to improve. Regarding domestic DIY, we had a negative 0.3% comp this quarter versus last year’s comp of positive 2.7%. DIY ran 0.7% across the first four weeks of the quarter, a negative 6.2% across the second four-week segment and a positive 4.8% comp over the last four weeks. The last four-week time segment was accelerated due to the winter weather, as a reminder, last year, the polar vortex hit in the second four-week segment.

I’d like to add some color on our regional performance as well. The Northeast and the Midwest markets underperformed the remainder of the country by 500 basis points in the middle four-week segment, only to swing to a positive 1,250 basis points overperformance for the last four-week segment. For the quarter, we saw a 270 basis point favorable performance in the Northeast and the Midwest versus the remainder of the country. Although the Midwest had some extreme cold, we frankly would like to see more winter weather along the East Coast markets, where the winter has been persistently mild for more than two years now. Overall, for the quarter, the West performed least favorably. Headed into the third quarter, we are planning for a more normal weather pattern, meaning we feel weather will not play a big story, one way or the other.

Our Q3 performance is always contingent on a normalized tax refund season and we expect this year to be similar to last year. Regarding our merchandise categories and DIY business, our sales floor categories underperformed hard parts as we saw more discretionary pullback, particularly from the low-end consumer. Regarding this quarter’s traffic versus ticket growth, our DIY traffic was down 2.2%, while our ticket average was up 1.7%. We expect our ticket growth will return to more normalized levels in the 2% to 4% range as we get further removed from higher inflation last year. We attribute our share gains to improve customer service levels in our store, and our in-stock nearing pre-pandemic levels driven by improved productivity in our distribution centers.

While we are up against exceptionally strong same-store sales from a year ago, particularly in commercial, we believe we are making progress. We’ve made many changes across the organization. From doubling down on many of our long-term execution processes, ensuring that we are hiring the best AutoZoners and reducing turnover, our execution is improving, and we’re making steady progress. Before handing the call to Jamere, I’d like to highlight and give some color on our international business. At 859 stores opened internationally or 12% of our total store base, the business had impressive performance last quarter and should continue to grow at a robust pace for the remainder of fiscal 2024. We are leveraging many of the learnings we have in the US to refine our offerings in our international markets.

And finally, before Jamere discusses our financial results, I’d like to remind you of our overarching objectives for fiscal 2024. We are focused on growing our domestic commercial business and believe our improved service levels will lead to continued sales growth. We also continue to focus on our supply chain with two initiatives that are in flight and drive improved availability. First is our expanded hub and mega hub rollouts. And secondly, we’re making good progress on transforming our distribution network. We have two domestic distribution centers currently under construction in the US, Chowchilla, California and New Kent, Virginia. We are also nearing the completion of our expanded Tepeji, Mexico distribution center. Additionally, we have broken ground on a larger facility that will house our relocated Monterrey distribution center.

Our strategy is focusing on leveraging the entire network to carry more inventory closer to the customer, driving sales growth with improved speed and expanded parts availability and improved efficiency. Now I’d like to turn the call over to Jamere Jackson.

Jamere Jackson: Thanks, Phil, and good morning, everyone. As Phil has previously discussed, we had a solid second quarter, marking our fifth sequential quarter of double-digit EPS growth. This quarter, we delivered 4.6% total company sales growth with a 0.3% domestic comp, a 10.6% international comp on a constant currency basis, a 10.9% increase in EBIT and a 17.2% increase in EPS. We continue to deliver solid results and the efforts of our AutoZoners in our stores and distribution centers continue to enable us to drive growth in a meaningful way. To start this morning, let me take a few moments to elaborate on the specifics in our P&L for Q2. For the quarter, total sales were up — were $3.9 billion, up 4.6% and let me give a little color on our sales and our growth initiatives, starting with our domestic commercial business.

Our domestic DIFM sales increased 2.7% to $980 million and were up 15.8% on a two-year stack basis. Sales to our domestic DIFM customers represented 25% of our total company sales and 30% of our domestic auto part sales. Our average weekly sales per program were $14,051, down 2.8% versus last year. Once again, the weekly sales averages were impacted by the addition of a significant number of immature programs over the last couple of quarters. I’ll also remind you that Q1 and Q2 are our toughest comparisons this fiscal year and we expect our year-over-year comparisons to be somewhat easier in the back half of our fiscal year. We now have our commercial program in approximately 92% of our domestic stores, which leverages our DIY infrastructure and we’re building our business with national, regional and local accounts.

This quarter, we opened 20 net new programs finishing with 5,823 total programs. Our commercial acceleration initiatives continue to make progress as we seek to grow share by winning new business and increasing our share of wallet with existing customers. Importantly, we have a lot of runway in front of us and we will continue to aggressively pursue growth opportunities in commercial, which we believe is our single largest growth opportunity. To support our commercial growth, we now have 101 Mega Hub locations. Our Mega Hubs continue to average significantly higher sales than the balance of the commercial programs and grew more than three times the rate of our overall commercial business in Q2. Our Mega Hubs typically carry roughly 100,000 SKUs drive tremendous sales lift inside the store box and serve as an expanded fulfillment source for other stores.

These assets are performing well individually, and the fulfillment capability for the surrounding AutoZone stores is giving our customers access to tens of thousands of additional parts and lifting the entire network. We will continue to aggressively open Mega Hubs for the foreseeable future, and we expect to have north of 200 Mega Hubs at full buildout. On the domestic retail side of our business, our comp was negative 0.3% for the quarter, as Phil mentioned, we saw traffic down 2.2%, offset by 1.7% ticket growth. As we move forward, we would expect to see slightly declining transaction counts, offset by low to mid-single-digit ticket growth in line with the long-term historical trends for the business, driven by changes in technology and the durability of new parts.

While DIY discretionary purchases were challenged in Q2, we continue to see a growing and aging car park, a challenging new and used car sales market and a consumer that is likely to continue to invest in their existing vehicles. In addition, miles driven are back to pre-pandemic levels. As such, we believe our DIY business will remain resilient for the remainder of FY 2024. Now I’ll say a few words regarding our international business. We continue to be pleased with the progress we’re making internationally, our same-store sales grew an impressive 23.9% on an actual basis and 10.6% on a constant currency basis. During the quarter, we opened six stores in Mexico to finish with 751 stores and four stores in Brazil, ending with 108. We remain committed to international and given our success, we’re bullish on international being an attractive and meaningful contributor to AutoZone’s future growth.

Now let me spend a few minutes on the rest of the P&L and gross margins. For the quarter, our gross margin was 53.9%, up 160 basis points, driven primarily by a significant improvement in our core business gross margins and 63 basis points from a non-cash $10 million LIFO charge in last year’s quarter versus a $14 million LIFO credit this year. Excluding LIFO from both years, we had a very strong 97 basis points improvement in gross margin, which increased from last quarter’s 70 basis point improvement. We’ve had exceptional gross margin improvement. And in fact, Q2’s gross margin was at the highest gross margin rate we’ve had since Q2 of FY 2021. I’ll point out that we now have $43 million in cumulative LIFO charges yet to be reversed through our P&L, and we expect this credit balance to reverse over time.

We’re currently modeling $15 million of LIFO credits for Q3 based on the deflation experienced in Q1 and Q2. This compares to the $17 million LIFO credit we had in Q3 last year, which means we’ll have a $2 million net LIFO headwind in gross profit in Q3. As I’ve said previously, once we credit back to $43 million through the P&L, we will not take any more credits, and we will begin to rebuild an unrecorded LIFO reserve. Moving to operating expenses. Our expenses were up 6.1% versus last year’s Q2 as SG&A as a percentage of sales deleveraged 49 basis points. The accelerated growth in SG&A has been purposeful as we continue to invest in store payroll and IT to underpin our growth initiatives. These investments are paying dividends and customer experience, speed, and productivity.

We’re committed to being disciplined on SG&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 $743 million, up 10.9% versus the prior year, driven by our positive same-store sales growth and gross margin improvements. Interest expense for the quarter was $102.6 million, up 56% from Q2 a year ago as our debt outstanding at the end of the quarter was $8.6 billion versus $7 billion at Q2 end last year. We’re planning interest in the $105 million range for the third quarter of FY 2024 versus $74.3 million last year. Higher debt levels and borrowing rates across the curve are driving this increase. For the quarter, our tax rate was 19.6% and down from last year’s second quarter of 21.2%, this quarter’s rate benefited 360 basis points from stock options exercised, while last year, it benefited 222 basis points.

For the second quarter of FY 2024, we suggest investors model us at approximately 23.4% before any assumption on credits due to stock option exercises. Moving to net income and EPS. Net income for the quarter was $515 million, up 8.1% versus last year. Our diluted share count of 17.8 million was 7.8% 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 $28.89, up 17.2% for the quarter. Now, let me talk about our free cash flow for Q2. For the second quarter, we generated $179 million in free cash flow. We had higher CapEx spending this quarter versus a year ago and we expect to spend close to $1.1 billion in CapEx this fiscal year as we complete the addition of our distribution center capacity expansion ahead of schedule.

I’ll also remind you that we generate a majority of our free cash flow in the back half of our fiscal year. We expect to continue to be an incredibly strong cash flow generator going forward and we remain committed to returning meaningful amounts of cash to our shareholders. Regarding our balance sheet, our liquidity position remains very strong and our leverage ratio finished Q2 at 2.4 times EBITDA. Our inventory per store was up 1.6% versus last year, while total inventory increased 4.2% driven by new store growth. Net inventory, defined as merchandise inventories less accounts payable on a per store basis was a negative $164,000 versus negative $227,000 last year and negative $197,000 last quarter. As a result, accounts payable as a percentage of inventory finished the quarter at 119.8% versus last year’s 127.7%.

Lastly, I’ll spend a moment on capital allocation and our share repurchase program. We repurchased $224 million of AutoZone stock in the quarter. And at quarter end, we had just over $2.1 billion remaining under our share buyback authorization. We’ve bought back over 100% of the then outstanding shares of stock since our buyback inception in 1998, while investing in our existing assets and growing our business. We remain committed to a leverage target in the 2.5 times area and a disciplined capital allocation approach that will enable us to invest in the business and return meaningful amounts of cash to shareholders. So to wrap up, we remain committed to driving long-term shareholder value by investing in our growth initiatives, driving robust earnings and cash and returning excess cash to our shareholders.

We’re growing our market share, expanding our margins and improving our competitive positioning in a disciplined way. And as we look forward to the remainder of FY 2024, we remain bullish on our initiatives to grow sales behind a resilient DIY business, a fast growing international business and a domestic commercial business that remains underpenetrated and should accelerate in the back half of the fiscal year. I continue to have tremendous confidence in our strategy and our ability to drive significant and ongoing value for our shareholders. And now I’ll turn it back to Phil.

Phil Daniele: Thank you, Jamere. I want to stress how proud I am to represent the company as only the fifth CEO over the almost 45 years we have been in business. As you’ve heard, we have a lot of initiatives in flight and we have a great team of AutoZoners in place to take us to the next level. We truly believe we will continue to improve from here. We are well-positioned to grow sales across our domestic and international store bases with both our retail and commercial customers. Our gross margin margins are solid, and our operating expense structure is appropriate for future growth. We are putting our capital expenditures where it matters most. Our stores, our distribution centers and leveraging technology to build a superior customer experience where we are able to say yes to our customers’ needs.

Fiscal 2024’s top priority is enhanced execution. Additionally, we have many strategic projects in various stages of completion. We will continue opening new mega hub and hubs, completing construction on the new distribution centers and optimizing our new direct import facility. We are also in the early stages of ramping up our domestic and international store growth. As you noticed, our international teams posted same-store sales comps on a constant currency basis of 10.6%, much higher than our domestic comps. International has been strong for several years now. While I mentioned all these investments in FY 2024, AutoZone’s biggest opportunity remains growing share in our domestic commercial business. While Q2 was below our expectations, we believe we have a solid plan in place for growth over the remainder of the year.

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

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Q&A Session

Operator: Certainly. At this time, we will be conducing a question-and-answer session. [Operator Instructions] Your first question for today is from Chris Horvers with JPMorgan.

Phil Daniele: Good morning, Chris.

Chris Horvers: Good morning. Thanks for all the information. My first question for you is, on the domestic Pro business, what’s your sense of what the market is actually growing, especially in light of your mix? Obviously, your largest and most relevant competitor has a much smaller mix of national accounts. So I don’t think that’s obvious to us from the outside. So how are you seeing the performance of national accounts? Are you seeing that start to get better? Do we have to wait to lap that starting in June and July? And how do you think that you’re growing relative to the market on the Pro side?

Phil Daniele: Yes. So if you kind of segmented the business, I think an area of customer growth on the commercial side that’s been more challenged has been the folks that are more focused on under car. So think brakes, suspension, those types of areas related to the tire, one of the four corners of the car, those have probably been the areas that have been more challenged. So for us, that’s categories like brakes and suspension, which we talked quite extensively about that over the last year. And that’s probably been where we’ve been most challenged, but I’ll go back to the growth opportunities we have in the commercial. At the end of the day, we still have pretty low share and there’s a big opportunity for us to continue to grow share in both terms of share of wallet for the customer as well as new customers.

Chris Horvers: So does that mean that — I mean, I guess, if you were going to isolate more of the up and down the street account? Or are you seeing better relative performance? And I know you’re reluctant to give too much detail in breaking out more detail, but like any commentary of like what the performance gap between like a national account business versus and up and down the street account would be really helpful. Thank you.

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

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

Phil Daniele: We’re effectively two weeks into our quarter, a couple of weeks into our quarter. And the taxes may be pushed back a week or two. But I think over the 12-week quarter, we expect them to be pretty similar to last year and it’s — the vast majority of the taxes should land well within our 12-week time frame. So maybe slightly moved back a little bit, but not meaningful to the quarter. We expect it to be normal.

Chris Horvers: Got it. Thanks very much.

Operator: Your next question is from Bret Jordan with Jefferies.

Bret Jordan: Hey, good morning, guys.

Phil Daniele: Good morning, Bret.

Bret Jordan: I guess a question on the competitive landscape as it relates to WDs, they seem to get better after maybe 2022 into 2023 could you talk about the up and down The Street business? Is that a pretty stable competitive environment? Do they still improve? Or are they sort of plateauing?

Phil Daniele: Well, on the — sorry, just to make sure I’m clear on your question. Questions relative to the WDs or to the actual–

Bret Jordan: Yes, WD competitors. It seemed like they were raising their game for a bit after the pandemic and whether they’re kind of stable where they are. Are they still — are they becoming more competitive still?

Phil Daniele: Yes, I think it’s hard to tell exactly what’s going on in their business. But from my sense — and we see it in our business as well. The vast majority of the supply chain constraints that you had in the latter half of the pandemic have resolved themselves, for the most part, we’ll still continue to improve. In stocks are not quite back to where they were previous to the pandemic. I suspect they will continue to improve slightly. And I would also think that the vast majority of the WDs that had the inventory issues in the latter half of the pandemic have probably recovered for the most part. So, I think they’re better, but I don’t think they’re going to have — they’re not going to materially get better over the next short period of time. I would say everybody is pretty much back to slightly lower than pre-pandemic levels.

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

Phil Daniele: Yes, I would say we have — I mean, we’ve got two markets that we’re trying to expand in today, which are obviously Mexico and Brazil. And we like where we are in our international footprint. Canada is interesting. I would say — I would never say we would not look at Canada, but it does have a pretty solid competitive base up there. And we just think there’s better opportunities for us at the moment in the current markets that we have. We’ve got plenty of expansion opportunities in both markets, and we like our performance internationally. It doesn’t mean we never go to Canada, but it’s not a focus for us at the moment.

Bret Jordan: Not in 2024?

Phil Daniele: No. You got six months left in 2024. In our 2024 anyway.

Bret Jordan: Thank you.

Phil Daniele: Thanks Bret.

Jamere Jackson: Thanks Bret.

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

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

Phil Daniele: Hey Michael, great question, and thanks for the question. At the end of the day, we have — let me go back to our comment on share. We have very low share in this marketplace. I think we will improve from here. Can I tell you exactly when we’re going to get back to double-digit growth? No. I would expect that we would grow faster. We have initiatives in place that we’ll think we will accelerate our sales growth, particularly in the back half of this year, and it will continue. To nail the date when I think we get back to a positive double-digit number is frankly tough to do. There’s a lot of variables in there. I think we’ll see consistent share growth and consistent same-store sales and total growth in the commercial market for a long time to come, probably because we have — we’re better than we were as we continue to expand our hubs and mega hubs, improve our assortments and take share, we see a long-term growth trajectory for the commercial side of the business.

Michael Lasser: Got you. That’s helpful, Phil. Thank you so much. My follow-up question is that AutoZone’s gross margin has really been growing nicely for some time now. But at what point does the gross margin get too high such that they invite more competition within the sector, especially on the commercial side?

Jamere Jackson: Yeah, I don’t think we’re over-earning from a gross margin standpoint. We’ve been very disciplined about gross margin expansion. We’ve been very disciplined about pricing. And what we’re actually seeing in our gross margins today is we come out of the period where we had very high freight costs. We had a supply base that was very challenged from a cost standpoint when you looked at what was happening with transportation costs, wages and just overall inflation in general. As we’ve moved past those periods, it gives us an opportunity now to start to negotiate deflation with our supply base. And at the same time, as we took pricing during those higher inflationary periods, we’re not giving back retails. So what you’re actually seeing is a natural evolution of gross margins, if you will.

The other thing I’ll remind you is that our supply chain was particularly challenged during this time frame. And as our supply chain has improved its cost performance and its efficiencies, we’re seeing some gross margin improvement in the from our supply chain. So this industry has been very, very disciplined for decades. We’ll continue to be disciplined for decades. We don’t believe that we’re over earning and it’s been a very disciplined approach to gross margin expansion and growing market share over time.

Michael Lasser: Thank you so much, Phil, Jamere and Brian, and good luck.

Phil Daniele: Thank you. Appreciate it.

Operator: Your next question is from Scot Ciccarelli with Truist.

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

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

Philip Daniele: Let me — can I add just another comment on that. I think if you go back and look at some of the gross margin pressures we had in the — specifically in the latter half of the pandemic where the supply chain was most stressed. Some of those costs that we had in logistics, either overseas or internal in the US, not all of those costs got pushed on to the consumer, because we didn’t want to kill unit demand. So we’ve hurdled some of that. To Jamere’s point, we took those prices up and as the underlying logistics cost basis comes down, that margin is what you’re seeing today. We don’t think we’ll give the pricing back because this industry has been very price rational over to Jamere’s point, decades. We just don’t see that retail pricing having to come back down.

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

Jamere Jackson: Yes. And the only thing that I would add to that is that we do expect our commercial business to grow faster as we move forward. And so that naturally will put some drag on the gross margin percentage, if you will, we’ll take that trade-off because it will give us an opportunity to have more gross margin dollars. So there’ll likely be a mix pressure as we move forward with a faster growing commercial business. But the underlying fundamentals of what we’re seeing in gross margin in terms of deflation, in terms of improving supply chain profile is something that is sustainable as we move forward.

Scot Ciccarelli: Super helpful. Thanks, guys.

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

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

Phil Daniele: Yes. The part of your question there is what are we doing that have helped stabilize our business and get it back on a more stable footing. Our in-stocks have come back to very close to pre-pandemic levels. We’ve expanded our hubs and our Mega Hubs. We have a long way to go to get to our ultimate goals of North of 200 Mega Hubs. And significantly more hubs as well. Those put hard-to-find parts in the market where we can get those parts to our commercial customers, in particular, faster. It also helps DIY. It will take us quite a few innings, if you will, to get to more than 200 of those hubs. They just take longer to set up and get in place. But that is improving our efforts on delivery times. We’ve put in — we’ve invested in technology.

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

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

Phil Daniele: Yes. On the SG&A front, I would we have investments that are some in CapEx, some obviously in SG&A. To the degree we can invest and grow sales and EBIT dollars, we’ll make those investments all day every day. I think over time, you should see us get our EBIT — our SG&A growth should start to bend down slightly. I wouldn’t expect a radical change, but we’ve had a lot of investments as we continue to improve our operational efficiencies in our distribution centers, in our stores, as our AutoZoners get longer tenured and we hold on and reduce turnover things of that nature, they will obviously start bringing down some of the SG&A on the margins. But we would invest in a kind of — I think maybe part of your question is, would we take lower margin rates in commercial as a mix of sales like Jamere mentioned to get higher gross profit dollars?

Absolutely. I think we can slightly expand our margins on both DIY and commercial over time? Yes. And in an effort to increase EBIT dollars, we’ll do that all day long. Those are good exchanges for us.

Simeon Gutman: Thanks. Good luck.

Phil Daniele: Thanks Simeon.

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

Seth Sigman: Hey good morning everyone. I wanted to follow up on a couple of those points around the commercial. A lot of noise this quarter, if you step back, there was a lot of momentum in this business pre-2020 and then you clearly outperformed very significantly for multiple years, right? And then the business has slowed, reverting back to maybe more like industry growth, I’m not sure. But I guess the real question is what gives you confidence that this is the right go-forward strategy, particularly from a supply chain perspective? As you think about the next leg of growth, mega hubs has been the central part of that strategy. Is that right? Are there other options that you’ve thought about? I’d love to get some perspective on that. Thank you.

Phil Daniele: Yes. We’re extremely excited about both of our — both our hub and our mega hub strategy. And I’ll use the previous comments around innings. We think we’ll have well north of 200 mega hub and significantly larger growth of hubs. We’re roughly in the third inning or so in hub growth — mega hub growth. If you kind of said that, that strategy works for us. We see significantly higher growth in those stores — those types of stores, and they help feed harder to find inventory to what we call our satellite stores, the markets that are close to those hubs. So, yes, we believe that is the right strategy. We will continue to modify and enhance our assortment strategies in both our satellite stores and our mega hubs and hubs to get more relevant inventory closer to the customer.

The faster we can get those hard-to-find parts into the shop, the better we will grow market share. And by the way, all of that inventory we add for the commercial customer also finds its way to sales on the DIY customer.

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

Jamere Jackson: Yes, I mean the math on that is we’ve added over the last couple of years or so, almost 600 new programs. So, we went back and retrofitted several stores that didn’t have commercial programs. If you remember, historically, we ran sort of 80% to 85% of our stores have a commercial program. That number is now up over 92%. We really accelerated that over the last several quarters. So right now, we’ve got probably 300 to 400 immature commercial programs that are ramping up in terms of sales and efficiency and performance. And as those programs mature, it will certainly provide a tailwind to our business. So when Phil talks about this notion of our commercial business improving from an execution standpoint, we not only have that working in our favor, but we also have these maturing programs that have only been in operation for the last couple of quarters.