Autozone Inc (AZO) — Q3 2018 Earnings Call Transcript

Certain statements contained in this presentation are forward-looking statements. Forward-looking statements typically use words such as believe, anticipate, should, intend, plan, will, expect, estimate, project, position, strategy and similar expressions. These are based on assumptions and assessments made by our management in light of experience and perception of historical trends, current conditions, expected future developments and other factors that we believe to be appropriate. These forward-looking statements are subject to a number of risks and uncertainties including, without limitation, product demand, energy prices, weather, competition, credit market conditions, access to available and feasible financing, the impact of recessionary conditions, consumer debt levels, changes in laws or regulations, war and the prospect of war, including terrorist activity, inflation, the ability to hire and retain qualified employees, construction delays, the compromising of the confidentiality, availability or integrity of information, including cyber attacks and raw material costs of our suppliers. Certain of these risks are discussed in more detail in the Risk Factors section contained in Item 1A under Part 1 of the Annual Report on Form 10-K for the year ended August 26, 2017, and these risk factors should be read carefully. Forward-looking statements are not guarantees of future performance and actual results, developments and business decisions may differ from those contemplated by such forward-looking statements. And events described above and in the Risk Factors could materially and adversely affect our business. Forward-looking statements speak only as of the date made. Except as required by applicable law, we undertake no obligation to update publicly any forward-looking statements whether as a result of new information, future events or otherwise. Actual results may materially differ from anticipated results.

Good morning. And thank you for joining us today for AutoZone's 2018 Third Quarter conference call. With me today are Bill Giles, Executive Vice President and Chief Financial Officer, and Brian Campbell, Vice President, Treasurer, Investor Relations and Tax. Regarding the third quarter, I hope you've 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.autozoneinc.com. Please click on quarterly earnings conference call to see this. To begin this morning, I want to thank all AutoZoners across the company for their efforts that allowed us to deliver solid financial results this quarter. As we entered the third quarter, we were quite optimistic about our sales prospects since we were coming off the first reasonably severe winter in the last three years. We anticipated seeing a significant acceleration in the sales of maintenance products as the harsh winter impacted these products, and as the weather improved, our customers would get outside and catch up on their maintenance work. Unfortunately, we had a very cold, wet spring through March and much of April. The anticipated acceleration in maintenance category sales for much of the quarter did not materialize. Instead, two of our top performing categories were wiper blades and antifreeze, which are not the categories we want leading the way in the spring. Additionally, the northeastern, Mid-Atlantic, and Midwestern geographies did not excel as expected after the harsher winter. However, at the end of the quarter, in the last two weeks, when most of the country entered a dry, hot weather pattern, our sales improved materially in the geographies and categories that we expected. While we were disappointed with our sales for the quarter, they performed in line with our expectations from week-to-week based on the weather patterns we were experiencing. We were encouraged when our sales responded positively as the weather turned more favorable. We continue to be optimistic about the balance of this selling season, as we know there is significant deferred maintenance outstanding. Despite the headline sales performance, we had some encouraging results to highlight. Our commercial business growth accelerated, increasing over 7% versus last year's third quarter, and our revenue per program grew nicely. As we continue to enhance many elements of our commercial program, we are encouraged to see our business improve. We have substantially enhanced our inventory availability over the past three years, and those improvements continue to strengthen our competitive positioning in the marketplace. Additionally, our commercial customers operate in garages, so the negative weather doesn't impact them as much as it does the DIYers. This fiscal year-to-date, we have opened just over 90 new commercial programs and expect to end the year with approximately 150 new programs. Internationally, we continued to perform well. We still expect to grow our international store base in both countries as we see years of opportunity ahead of us. We continue to refine and experiment with our omni-channel efforts during the quarter. We standardized our pricing across the internet and stores by discontinuing the aggressive promotional discount for ship-to-home items only. We've been concerned that offering different promotional offers to customers based on how they wanted their products fulfilled would potentially create a channel conflict. As we look to the future, we see an environment where the distinction between online and offline gets very blurred. Our omni-channel efforts are focused on interacting with the customer through their preferred means: in-store, online, over the telephone, or via their mobile device, and then fulfilling that order to meet the customer's desires and timeline in the most cost-effective manner. As some of you have noticed, we've begun to test improved delivery speeds to home customers in select markets. Across all sectors of the economy, companies are testing new ways to enhance the customer experience. We too are working on various fronts; some will work, some won't. But in this age of innovation, it is imperative that we continue to find new ways to improve the customer experience and deepen our relationships with our customers. We will share more specifics about this test and others as we learn, adjust, and ultimately implement. Today, our online ship-to-home business is quite small relative to the sales of the enterprise, but seizing the discount had a negative impact on our sales, which also negatively impacted our overall same-store sales. Our goal isn’t to get this balance right today, but to learn how best to leverage all of our assets and capabilities over time to strengthen our overall value proposition. In last quarter’s press release, we produced an adjustment to our GAAP numbers for the divestiture of two businesses. This quarter, the sale of these two businesses had a nominal impact on our operating profit, but given the nature of the business, it did benefit our gross margins by approximately 40 basis points. Initially, our tax rate came in at 27.2%, below our previous expectations at the beginning of the quarter. We expect a rate in the range of 27% to 28% in Q4, and a lower rate next year as the full-year lower federal tax rate is taken into account. Beginning at the start of our fiscal 2019, we will start recognizing the full benefit of the changes and expect our ongoing global tax rate to be around 24.5%. Overall, we expect the Tax Reform Act will benefit net income by over $200 million annually, realized over fiscal 2018 and 2019. As we considered enhancing profitability to the enterprise due to lower corporate tax rates, we discussed during our second quarter conference call, proactively investing some of these proceeds to improve our business for the long term. We highlighted investing in wages and benefits to maintain our competitiveness with other retailers and investments in technology to improve our service levels across DIY and commercial, both with an enhanced omni-channel emphasis. Some of these investments are pull-forwards of what has been contemplated in our long-term strategic plan. We’ve begun to accelerate some of our technological investments, though that will take time. For wages, we continue to monitor market conditions and plan on executing our changes in our first quarter of next year in conjunction with our normal annual evaluation process. Our enhancements will focus on our more knowledgeable and tenured hourly AutoZoners. As this investment is unique, we want to add more clarity for you. We are modeling SG&A dollar growth to be in the 4% to 5% range over last year in our fourth quarter. We are in the later stages of developing our operating plan for fiscal 2019. Based on our latest thinking, we expect SG&A to grow in the 6.5% to 7.5% range. The wage adjustments will not take effect until the second half of our first quarter 2019, so that quarter will not bear the full burden of those changes. These wage changes are designed to ensure we can attract and retain terrific, knowledgeable AutoZoners and to make sure our wages are competitive. The technology investments are designed to grow sales. Regarding our internal initiatives, and specifically continually improving inventory availability at the market level, we see a nice pickup in sales from the markets with mega hub capabilities. Mega hub stores are our stores with approximately 100,000 unique SKUs, providing delivery to surrounding stores and other hubs. This quarter, we opened three additional mega hubs, bringing the total to 21, and we are on track to have 25 locations opened by the end of the fiscal year. Additionally, I would like to recognize our supply chain team for continuing to leverage our warehouse delivery costs again this quarter while starting up a new distribution center in Ocala, Florida. This marks the third sequential quarter where we have leveraged our costs. We remain mindful of fuel cost increases and driver labor shortages across several carriers, but we remain encouraged with the direction of our business costs over the remainder of calendar 2018. As noted earlier, we saw solid performance in our commercial business during Q3. Total commercial sales increased 7.3% for the quarter. Our growth continues to outpace the overall industry by executing our game plan. With fewer year-over-year program openings, more of our sales growth comes from existing customers or new customers in older programs. We believe our inventory availability work is vital to these efforts and is enhancing our position in the market. I credit our commercial performance to our store AutoZoners, who are simply getting better at executing our model. Commercial relationships take time to cultivate, and we are encouraged by their efforts. Turning to our online efforts, specifically regarding helping our commercial customers, we are making investments to further enhance our digital capabilities. Our investments in technology are expected to help our customers get the parts they need faster. We will continue to invest in our omni-channel strategies to ensure we can conduct business with our customers based on their needs. On the cost front, I've highlighted the accelerated pressure we are experiencing on wages during the past few quarters. Those pressures continue to exist and are much greater than historical norms. The regulatory changes will continue, as evidenced by areas that have already passed legislation to increase their wages substantially over the next few years. More impactful are the current market forces in retail as we all compete for talented employees in a very low unemployment environment. We are diligently working to find new innovations to better manage our cost structure, and those efforts will continue. We believe this area will continue to pressure us for some extended period of time, which is why we are proactively leveraging a portion of the benefits derived from the recent tax law changes to invest in this crucial aspect of our business, our AutoZoners. Our management team remains committed to managing this business for the long term to provide great service for our customers and great opportunity for our AutoZoners; ultimately, delivering strong shareholder value. We operate in an industry driven by in many cases inelastic demand. If the part breaks or wears out, our customers need to fix it to get to work. Because this predictability is based on miles driven and an aging car population, we remain committed to improving our ability to aid customers in meeting their needs. Now, let me provide more detail on the quarter. For the quarter, our sales increased 1.6% and our domestic same-store sales were up 0.6%. During the quarter, we opened 26 net new stores in the U.S. and our commercial business opened 38 programs. Year-to-date, we opened 75 net new stores and 91 commercial programs in the United States, 12 new stores in Mexico and two in Brazil. We expect to open approximately 150 new domestic stores, 40 in Mexico, and about 10 in Brazil for a total of 200. We expect to open about 150 net new domestic commercial programs. Currently, 85% of our domestic stores have a commercial program. Along with improving our local parts availability and assortment, we continue to manage this organization to provide exceptional service for our customers, create a great workplace for our AutoZoners, and ensure we do it on a long-term profitable basis, providing strong returns for our shareholders. We will continue to stress the importance of going the extra mile to fulfill our customers' needs, regardless of how difficult the request. With our commitments to service intact, we have continued to gain market share over the quarter according to the available data. Now, let me review our highlights regarding execution of our ongoing operating theme from 2017 that we carried over into 2018. Yes, we’ve got it; the key priorities for the year are great people providing great service, profitably growing our commercial business, leveraging the Internet, and leveraging IT. On the retail front this past quarter, under the great people providing great service theme, we are committed to supporting our store AutoZoners. We’re focusing on enhanced training for store-level AutoZoners and increasing the share of voice regarding availability with the yes, we've got it theme. We remain aggressive with our technology investments and believe these initiatives will help differentiate us going forward. We realize as customers have become much more tech and mobile savvy, we must have a sales proposition that touches all the ways they wish to interact with us. Our current and future technology investments will foster sales growth across all of our businesses. We must also highlight another strong performance in return on invested capital, as we finished our third quarter at 30.8%. We continue to be pleased with this metric, as it is one of the best, if not the best, in all of hard lines retailing. This metric is a key component of our pay-for-performance culture at AutoZone, and we demand our AutoZoners across the organization to be accountable for our investment decisions. Great ideas look wonderful on paper, but it's our job to deliver results. We are always learning from both successes and failures in our investments. Our primary focus has been and continues to be ensuring every incremental dollar of capital that we deploy in this business provides an acceptable return well in excess of our cost of capital. It's essential to reinforce that we will always maintain diligence regarding capital stewardship, as the capital we invest is our investors' capital. Before I pass the discussion over to Bill Giles to talk about our financial results, I’d like to thank our AutoZoners for their efforts to continue meeting our customers’ vehicle needs. This is not easy. I see every day what customers expect from our AutoZoners, and they meet those needs with a smile on their faces. Their efforts make our Company what it is today. We are bullish on our fourth quarter sales potential because we have a great business operated by an exceptional team. Now, I’ll turn it over to Bill Giles.

Thanks, Bill, and good morning everyone. To start this morning, let me take a few moments to talk more specifically about our retail, commercial, and international results for the quarter. Total auto part sales, which includes our domestic and international stores, increased 3.2%. For the trailing 52 weeks ended, total sales per domestic AutoZone store were $1,785,000. Total commercial sales increased 7.3%. In the quarter, commercial represented 20% of our total sales and grew $37 million over last year's Q3. We opened 38 net new programs in the quarter, and we now have our commercial program in 4,683 stores, or 85% of our domestic stores, supported by 192 hub stores. For all of fiscal 2018, we expect to open approximately 150 new commercial programs. As Bill mentioned earlier, we remain confident we will continue to gain market share with our commercial customers. We are encouraged by the initiatives we have in place and feel we can further grow sales and market share. Our Mexico stores continue to perform well. We opened four new stores during the third quarter and year-to-date opened 12, ending the quarter with 536 stores and expecting to open approximately 40 new stores in fiscal 2018. Currency volatility remains significant and causes us to be deliberate with our pace of investment, with moves in foreign currency rates of greater than 5% from one quarter to the next being common. Regarding Brazil, we did not open any new stores and now have 16 total stores open. Our plans are to add eight more locations over the remainder of the fiscal year. While still running with an operating loss, our performance has improved and gives us optimism about the long-term future of this market. As we further scale the business, we will improve operating performance. Long-term, we believe this market has the potential to be much larger than Mexico. Gross margin for the quarter was 53.5% of sales, up 86 basis points from last year's third quarter. The gross margin rate benefited from higher merchandise margins and the sale of the two business units. While we continue to be optimistic on gross margin rate for the remainder of fiscal 2018, our primary focus remains growing absolute gross profit dollars in our business. SG&A for the quarter was 33% of sales, deleveraging 56 basis points. Operating expenses, as a percentage of sales, were higher than last year, primarily due to deleverage on occupancy cost and increased store payroll. Earnings differentials and taxes for the quarter were $546 million in the third quarter. Interest expense for the quarter was $42 million compared to $36 million in Q3 a year ago. Debt outstanding at the end of the quarter was $4,955 million. Our adjusted debt level metric finished the quarter at 2.5 times EBITDAR. While in any given quarter, we may increase or decrease our leverage metric based on management's views regarding debt and equity market conditions, we remain committed to our investment-grade rating and our capital allocation strategy, with share repurchases being a key element of that strategy. For the quarter, our tax rate was 27.2% and 27.3% excluding the slight benefit received from exercising stock options. We expect our global tax rate to approximate 27% to 28% for Q4 and around 24.5% for fiscal 2019. I should mention that the accounting for stock options this quarter benefitted our overall effective rate by a small degree, 8 basis points or $0.01 per share, but this is very hard to model and can lead to unusual comparisons year-over-year. Net income for the quarter was $367 million, up 10.6% compared to Q3 last year. Our diluted share count of 27.3 million was down 5.8% from last year's third quarter. The combination of these factors drove earnings per share for the quarter to $13.42, up 17.3% over the prior year's third quarter. Looking at the cash flow statement for the third quarter, we generated $503 million of operating cash flow. Net fixed assets were up 5.6% versus last year. Capital expenditures for the quarter totaled $112 million and reflected the additional expenditures required to open stores this quarter. Capital expenditures on existing stores, southern mega hub store remodels or openings, work on development of new stores for upcoming quarters, investments in our new and expanded domestic distribution centers, and information technology investments. With the new stores open, we finished this past quarter with 5,540 stores in 50 states, the District of Columbia, and Puerto Rico; 536 stores in Mexico, and 16 in Brazil, for a total AutoZone store count of 6,092. Depreciation totaled $79.8 million for the quarter versus last year's third quarter expense of $75.3 million. This is generally in line with recent quarter growth rates. We repurchased $400 million of AutoZone stock in the third quarter. At quarter end, we had $897 million remaining under our share buyback authorization and our leverage metric was 2.5 times. I want to stress we manage to appropriate credit ratings and not any one metric. The metric we report is a guide only, as each rating firm has its own criteria. We continue to view our share repurchase program as an attractive capital deployment strategy. As evidence of this commitment, we recently surpassed $1 billion in annual share repurchases for the 10th consecutive year, bringing our life-to-date share repurchases to $19 billion. Next, I'd like to update you on our inventory levels in total and on a per store basis. The Company's inventory increased 3.7% over the same period last year. Inventory per location was $650,000 versus $653,000 last year and $671,000 just this past quarter. Net inventory, defined as merchandise inventory plus accounts payable on a per location basis, was negative $48,000 versus negative $47,000 last year and negative $46,000 this past quarter. Accounts payable as a percent of gross inventory finished the quarter at 107.3%. I also want to update you that we recently decided to terminate our pension plan, which was frozen at the end of calendar 2002. We anticipate taking a one-time non-cash charge in the range of $130 million to $140 million in our fourth quarter in connection with the termination of the plan, including the transfer of plan assets and related liabilities to a third party. Again, this is entirely a non-cash accounting charge and we are excited to eliminate the risks and volatility that it could produce. Finally, as Bill previously mentioned, our continued disciplined capital management approach resulted in a return on invested capital for the trailing four quarters of 30.8%. We have and will continue to make investments we believe will generate returns that significantly exceed our cost of capital. Now, I'll turn it back to Bill Rhodes.

Thanks, Bill. As we head into the fourth quarter, we are encouraged by the traction we are gaining with internal sales initiatives, the investments we are making to improve customer service and product availability, the strength of our industry, and the favorable macro trends. We are optimistic looking forward for the remainder of the selling season. We are excited to intensify our focus on our core businesses because we view these core businesses as tremendously attractive and in strong markets. We will continue our domestic and international expansion efforts, growing roughly 200 locations annually. We will continue to focus on growing our commercial business at an accelerated rate relative to the market growth. We will intensify our omni-channel efforts and leverage ALLDATA as the premier tool shops use in the automotive aftermarket. To execute at a high level, we must consistently adhere to living the pledge. We cannot and will not take our eye off of execution. We must stay committed to executing day in and day out on our game plan. Success will be achieved with attention to detail and exceptional execution. Our customers have choices, and we must exceed their expectations in whatever way they choose to engage with us. We are fortunate to operate in one of the strongest retail segments, and we continue to be excited about our industry's growth prospects for 2018 and beyond. As consumers look to save money while taking care of their vehicles, we are committed to providing the trustworthy advice they expect. It truly is the value-add that differentiates us from any other faceless transaction. Customers have come to expect that advice from us. It is with this focus we will implement enhancements to both our DIY and commercial websites and in-store experience to provide even more knowledgeable service. We don't ever expect an online experience to replace the advice our customers desire, but today's customers want more information from a variety of sources on repairing their vehicles. This aspect of service has always been our most important cultural cornerstone, and it will remain so long into the future. Our charge remains to optimize our performance regardless of market conditions and continue to ensure we are investing in the key initiatives that will drive our long-term performance. In the end, delivering strong EPS growth and ROIC each and every quarter is how we measure ourselves. This formula has been extremely successful over the last nearly 39 years, and we continue to be excited about our future. Now, we’d like to open up the call for questions.

Bill, so you mentioned that the quarter turned out a little faster than you expected. So if we assume that you anticipated 2% to 3% comp coming into the quarter, and it finished maybe 150 basis points or so below that. In your experience would you expect that you’ll recoup half of that or more from the weather being delayed from last quarter into this quarter?

Yes, your general expectations of what we’re anticipating coming into this quarter are about right. I’d go back to what we discussed in September. This industry, our sales over the last five years have traded in a very tight band. This summer we were a little bit disappointed by them. As we move into the fourth quarter, I don't know whether we’ll recoup half of them or most of them. But as we look forward, we know that there is extensive deferred maintenance, particularly on the maintenance-related parts. That maintenance work is going to need to be done at some point in time. You could see some of it was done on the commercial side with how they were working in garages, but we just didn't see the rebound in those undercar categories that we would’ve anticipated.

And my quick follow-up question is on the SG&A growth outlook for 6% to 7% for next year. That on a 52 to 52 week basis. Is that going to be just a one-time increase next year or should we think about that as the new run rate for the business?

No, I think of it as more of a clarification. When you consider fiscal year 2019 in relation to that increase in selling, general, and administrative expenses, it's based on a 52-week year comparison, excluding one-time items like the impairment charge from the pension plan termination. I see that as more of a one-time investment for us. We will continue making investments here and there, but those investments in wage rates and benefits are really aimed at ensuring we have the right personnel in place and can maintain a competitive edge in the marketplace. Therefore, we view this as a one-time investment, and afterwards we expect to return to a more normalized run rate. I believe our investments in technology will continue to boost sales, with those enhancements being rolled out throughout the year.

Michael, I’d like to add on that front too. If you recall back in 2006, we had a similar investment cycle. We were running about 17.5% operating margin at the time, and we felt like there were some things that needed to be done to improve our execution for the long term. We invested about 50 basis points of margin at that time, and our margin went down to about 17%. Of course, over the next 10 years, that improved up to about 19.4%. We envision this the same way. These are opportunities to enhance our performance over the long term, and we feel comfortable doing them, but they’re one-time in nature.

A little more clarity on the investing. Obviously, you had the divestiture of the two businesses that took place I think at the beginning of the quarter, and then for IMC towards the middle of the quarter. And those would presumably take some SG&A out of next year. So are we talking about the specific guidance that you provided net of the reduction of SG&A for the sales of those businesses?

No, just to be perfectly clear, those SG&As are going to be reallocated as those business units really did not contribute a lot of EBIT. We’ll redeploy the assets we have there both from an inventory perspective as well as from an SG&A perspective.

So in other words, as you sell those businesses and presumably they generated some SG&A, the SG&A does not go down to reflect the disappearance of those sales?

Not in the numbers that I’m giving you, that’s correct.

And then also, if you think about the impact on operating margin overall and the operating margin outlook overall. What’s your early thinking on gross margin? If you think about this particular quarter, your gross margin was up 8 basis points to 36 basis points, 46 basis points, excluding the impact of that divestiture. So some of that momentum is sustainable for the business going forward?

Yes, we feel really good about gross margin. The merchandising organization has done a terrific job of improving the sourcing and reducing costs. The supply chain team has done well, and we feel that stabilized. They’ve done a great job opening two distribution centers over the last year. We feel pretty bullish about gross margin, both from a merchandising cost perspective and supply chain. There is no question we’re facing headwinds on transportation costs in the supply chain, but the team has done a great job managing expenses and leveraging supply chain this past quarter. So outlook wise, we feel pretty confident.

And then finally, do you have an IMC dollar sales number for this quarter just to clean that out of our models for that partial quarter contribution?

It was relatively small. I don’t have it off the top of my head. It’s not a significant number. But we can shoot that out at some point.

Also some follow-ups here on the prior questions. So in thinking about the recoup question, maybe you could give us a sense of what April looked like for you relative to the total quarter. It looks like all the impact was pretty much seen on the DIY side of the business, which is obviously the preponderance of your business. But how did April look relative to the quarter?

April looked tough in the first half of the month. The third week improved, and the fourth week was very strong. But the fourth week was the first time that we had really warm, dry weather. You can’t straight-line warm, dry weather all the way through the fourth quarter, but we were encouraged when the weather improved, as it met our expectations for what would happen in the business.

Is it fair to assume that the first half of the month would mathematically turn negative in April? So if we’re down one or two points, you would think that’s the upside potential or recapture potential as we think about the current quarter?

We’ll wait and see how this turns out. No question, April was a soft period, and the weather wasn’t in our favor. What that means for the summer, we’re bullish and hope that it means more sales generation from the deferred maintenance that has transpired in the marketplace, but we’ll have to see how this shapes up.

And then two more follow-ups. First, as you think about the benefit to gross margin from the divested business, is that staying at a 40 basis points pickup until we lap that?

That’s roughly about right.

And then a question for Bill Rhodes. Big picture, for many years you’ve driven this low double-digit earnings growth algorithm with half of that coming from share repurchases. Now with the lower tax rate, you just drove high-teens earnings on a modestly positive comp. You talked about SG&A growth next year. But you get a big chunk of the tax savings next year as well. So I'm just trying to understand how you think about the return to the shareholder in terms of the earnings growth outlook balancing the tax benefit versus the acceleration of investment?

As you think about it, we’ve said several times that we’re going to recoup over $200 million net income on an annual basis. We’re talking about investing less than half of that into the long-term aspects of our business. We’re very comfortable with where we’re putting those dollars. We're really focused on two things: wages for our hourly AutoZoners, the most tenured and knowledgeable people that truly help differentiate us in the marketplace, and then secondly, we’re making some significant investments in technology. Many of those things are things we would have done, but we’re accelerating our investments in technology somewhat because of this tax reform. So we will have an expanded investment profile next fiscal year. But once we get beyond that, we feel like we’ll be in very good shape.

Do you feel comfortable continuing to be able to drive a low double-digit type earnings growth algorithm?

I would anticipate, once we get on the other side of it, that our EBIT growth would be in the 3% to 5% range, depending somewhat on the cash flow that we’re generating. Frankly, it also depends a little on the multiples of stock regarding how much the share repurchase program grants. There were periods where we were generating $1.3 billion in share repurchases, and that would mean 5% or 6%, and sometimes it’s 4% or 5%. So it somewhat depends on other factors as well.

I want to focus on the commercial improvement. You mentioned a 7% growth, and I think Bill Rhodes you implied that it was pretty steady throughout the quarter. Can you tell us if that 7% had a big range of growth rates during the quarter, or what that was? You mentioned expanded inventory. Are you selling across newer categories, new customers? Is fulfillment making a difference, or is being in stock the most important attribute?

You packed a lot of questions in there; let me try to unpack them. Yes, the 7.3% growth in commercial for the quarter was strong; we felt good about it. It was variable and also based on week-to-week performance affected by the weather, but it was less variable than the DIY business. It too came out of the quarter pretty strong. As we think about the drivers of that business, we’ve made immense investments over the last three years in ensuring that we have the right delivery frequency for our cost model and optimizing our cost model, and also expanding our mega hubs, which are now up to 21 and looking toward 25 by the end of the year. Those mega hubs give us enhanced access to hard-to-find inventory. We see that the mega hub does very well, and the local market it serves improves, and even the other stores attached to other hubs see improvement. Also, our team has spent a lot of time over the last two years focusing our in-store teams on the commercial business, including store managers and district managers, intensifying their focus on the commercial side. I believe all those factors together are leading to significant dividends and will continue to do so.

My follow-up is just on the backdrop for the industry. If this summer will be the ultimate boost for this industry, whether demand is going to bounce back or not as good as it was in the past. While some months have been good and others bad, it seems to be par for the course, though the wet weather didn’t help. Why should things get materially better from here? We think they will but want to hear your thoughts because the weather seems to still be an issue in what was the beginning of a cold quarter. So trying to think about the summer and whether it'll be the ultimate boost for a better run rate?

I would hesitate to say one quarter is the ultimate boost for the run rate for our industry. This industry, as you very well know, has been robust for 20 or 30 years. I did a presentation last week to our vendors at the Vendor Summit and talked about the 20-year run rate of this industry. The DIY market has grown about 4% a year for 20 years, and the commercial market around 4.5% for the same period. This total growth is not on a same-store basis. I’ve said time after time, I’m disappointed with a 0.6 comp, but it’s not a minus 6 comp. We are trading within a fairly tight band. Looking back over the last five years, quarterly performance has traded from about 3% to minus 1.8%. I just don’t think it’s radically shifting in any direction.

Just thinking about the SG&A growth outlook, Bill. When you spoke to us last year you were looking for 60 to 90 basis points of margin pressure from investments. Based on that, it looks like you're expecting more pressure than that. What’s changed between then and now as you think about the outlook?

I would say not much has changed. Most of the numbers are coming in pretty close to where we initially expected them. We have always looked at wages, benefits, and technology as key drivers. I think we’re still consistent in our discussion of those items. There are some other less significant items, but our investment plans for next year are pretty consistent with what we have previously discussed. The timing is a little bit different; we probably will implement more of them, as Bill mentioned, in the middle of the first quarter, our fiscal first quarter to align with merit increases. But otherwise, it’s been relatively consistent.

As you think about the breakdown between benefits, wages, and tech, what does that look like approximately?

I would say that wages and benefits represent the lion's share.

A couple of follow-ups here. First, in terms of the DIY comp, I guess it was down roughly 70 bps on our math at least. Obviously, you had a weather impact but also cited negative impact from the online promotional changes. Can you just give us a sense of how meaningful that may have been?

It’s not terribly meaningful. It could be in the 20 to 30 basis points range overall. Our online ship-to-home business is not a very large part of our overall business. We wanted to incentivize customers to interact with us regardless of their chosen channel. So we made some changes that negatively impacted our ship-to-home business, but it’s not significant overall.

On the SG&A, specifically looking at the fourth quarter, can you help us bridge the 4% to 5% growth versus the 3% this past quarter? What are the incremental drivers in the fourth quarter?

We’ll likely continue to see a bit of wage pressure from the overall market. We also have some technology investments coming in during the fourth quarter as well. So those will be the primary pressure points.

Finally, as I contemplate next year, given your positive comments around gross margin, do you think operating margin can actually be flat or even up excluding the extra week?

I think, excluding the extra week, we’ll need to wait and see. We don't really want to give guidance on that relative to what our EBIT is going to be or even our operating margin. As I’ve mentioned before, we feel good about gross margin. Our organization has done well from a sourcing perspective and managing costs, and we think there will be momentum in the business.

Can you just talk about what you're seeing in inflation, and whether that benefit is starting to come through in the top line or in gross margins at all?

I don't think we're seeing any significant impacts from inflation at this point. Oil prices have started to move up, and we are mindful of that. So far, we haven't seen any material impacts. We’ve dealt with inflationary impacts over long periods and our industry, particularly our AutoZoners, have handled it pretty well.

So even in terms of product inflation and price inflation, you're not seeing any of that yet?

It's not very material. We see pushes and pulls. We have a significant effort going on to direct source, which helps lower our acquisition cost.

What do you see as the most important drivers going forward in 2019 and 2020 that gives you confidence the domestic sales rate can get back to mid-single-digit rates, or that average over the last 20 years? If things aren't radically changing, what do you think are the catalysts that can get things going again from the 1% range back up to mid-single digits?

I think, number one, we control our own destiny. I have a high degree of confidence in our team to continue to deliver. We've got some really exciting initiatives we’re working on. The biggest growth driver will be our performance in commercial. It is our single biggest growth opportunity; we hold about 3% market share and have a lot of initiatives to improve that business. We are already gaining traction, so I remain very bullish about our business long-term.

I'd like to focus on your comment about strengthening the overall value proposition, particularly online. You clearly don’t believe price or promotions were a part of that value proposition, and you're talking about investments to strengthen that. I'm trying to understand the disconnect. What can you now do that you couldn't do before online to strengthen that value proposition that allows you to wean off price and/or promotions? And why is this shift happening now?

The driver is thinking about how to interact with customers. In the long-term, how will transactions be defined? They might take place over the phone, mobile device, or desktop. We want to avoid creating channel conflicts. Our value proposition is strong, centered around our knowledgeable and trustworthy AutoZoners. Customer engagement is important, regardless of channels. That’s what drove our decision.

Can you talk about what you’re seeing with the competitive response when you open a mega hub? More specifically, have you observed any change in competitive response as you open more?

I don’t think we’ve observed significant competitive changes as a result of opening individual mega hubs. All of us in the industry have different tactics. If one of our competitors opens a new distribution center, we don’t change our operating model in that market; I haven't seen material changes across any of the markets where we’ve opened these mega hubs.

I am curious about wages. Do you have any more detail about where the planned increases stand compared to other retailers? And how is the stable market for those that you want to hire?

The labor market is tightening further as we get deeper into the economic cycle. We’re at historic low unemployment rates, but we’re continuing to hire great people daily. Our turnover rate is slightly down, so it's not a catastrophic situation. We're ensuring we stay ahead of this situation. If you look at regulatory changes, California and certain parts of the Northeast reveal what’s ahead regarding those changes. The bigger question is, you read all the retailer announcements on wage hikes over the last two years. It’s imperative that our AutoZoners remain a critical component of our value proposition, and we want to ensure we are compensating them appropriately.

I wanted to follow-up on your comment on oil prices. Is there a high watermark for fuel prices at which miles driven and sales start to see negative impact? At $72 oil today, where do you think we are on that demand elasticity curve?

We've seen historically around a tipping point at $4 a gallon. We are currently a long way from that level. We've experienced periods when we approached that price, and we clearly saw impacts on miles driven during those times. But we’re far from the $4 per gallon mark.

When you think about the work you’ve done on inventory availability, could you talk us through the incremental benefits you typically see when you open a new mega hub? With new distribution centers coming on as well, could you walk through general expectations for sales lift given the better anticipated availability?

The distribution centers mainly focus on driving improvements in cost rather than directly driving sales, as they service closer areas and reduce transportation miles. While there are slight improvements in service, those centers primarily are a cost efficiency play. Our mega hubs, carrying around 100,000 SKUs, significantly enhance our 'yes' percentage—that is, our ability to meet customer needs. When we open those, we see significant sales improvements in both retail and commercial in the stores served by mega hubs. These hubs may also service other stores and deliver parts three times a day, resulting in significant sales growth.

On your test of free next day delivery, did you get anything out of that? Is that something you're going to expand, and did it significantly drive online sales in those markets?

As I mentioned in the prepared remarks, we’re testing a variety of things, and I appreciate your observance. However, I don’t want to make a big deal out of it yet, as it’s early in our test. We’re monitoring different elements to ensure we service our customers effectively. Speed of delivery is crucial, and we’re working to deliver parts as quickly as possible, which is part of what we’re testing. We’ll provide clarity on the results when we have additional information.

Did you get any commercial customers out of that program? Given it’s quicker than your average online transaction, did you see any shift beyond DIY?

While some commercial customers could be taking advantage of the next day delivery program, it’s primarily designed for DIY customers. For commercial customers, we're generally delivering within 30 minutes, so the next day option would be a significant deterioration in service.

Can you clarify for the quarter, was transaction count positive or negative?

Transaction count was down for the quarter a little bit, but we continue to have good performance in our average transaction value.

Regarding the reinvestment from the tax savings, we were initially thinking around 35% to 50% reinvestment, indicating majority retention. Given the numbers I'm seeing now, they seem to be the inverse. Can you explain if there has been a change regarding retention versus reinvestment, or is this just a mix?

That's really consistent. The dollar amounts are pretty similar. We’ve recouped about $200 million from the tax reform act, and probably a little less than half of that will be reinvested back in the business, with a little more than half going back to shareholders.

Thank you. Before we conclude the call, I would like to wish everyone a nice Memorial Day weekend and thank everyone that has served in our Armed Forces. We’re excited about our growth prospects for this year. We will not take anything for granted. We understand our customers have alternatives with a solid plan for future success. But I want to stress that this is a marathon and not a sprint. As we continue to focus on the basics and optimizing long-term shareholder value, we are confident AutoZone will continue to be successful. Thank you for participating in today's call. Have a great day.