Autozone Inc (AZO) — Q1 2023 Earnings Call Transcript

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

Good morning and thank you for joining us today for AutoZone’s 2023 first quarter conference call. With me today are Jamere Jackson, Executive Vice President, Chief Financial Officer, and Brian Campbell, Vice President, Treasurer, Investor Relations and Text. Regarding the first quarter, I hope you have had an opportunity to read our press release and learn about the quarter’s results. If not, the press release along with slides complementing our comments today is available on our website www.autozone.com under the Investor Relations link. Please click on quarterly earnings conference calls to see them. As we begin, we’d like to thank and congratulate our AutoZoners across the enterprise for their commitment to taking care of our customers, which led to the strong results they continue to deliver. It has been a busy first quarter of our new fiscal year, as every day we strive to get back to normal and exit ‘pandemic mode’. This quarter, we opened our new direct import distribution center on the West Coast, continued to improve our in-stock position, and we had our first full national sales meeting since the pandemic began. In fact, we returned to having national sales meetings in every country where we operate and at ALLDATA. These meetings are critical to our success, where we celebrate our past accomplishments and lay the groundwork for our future success. Most importantly, they allow us to inspire each other and grow and nurture our unique and powerful culture. For the quarter, as our teams delivered exceptional service, their efforts led to our overall sales growing 8.6% on top of 16.3% last year. Our two-year growth rate marks some of the highest ever. We could not have achieved this success without phenomenal contributions from across the organization. Our AutoZoners’ efforts generated a positive and accelerating retail same-store sales comp along with another strong commercial comp for the quarter. Thank you, AutoZoners, for always putting customers first, which led to this success. This morning, we will review our Q1 same-store sales, DIY versus the DIFM trends, our sales cadence over the 12-week quarter, merchandise categories that drove our performance and any regional discrepancies. We’ll also share how inflation is affecting our costs and our retails and how we think inflation will impact our business for the remainder of FY ‘23. Our domestic same-store sales comp was a solid 5.6% this quarter, on top of last year’s 13.6%. On a two-year basis, we delivered a 19.2% comp, and on a three-year basis, a 31.5% stacked comp. Our team once again delivered amazing results, despite these difficult comparisons. Let me spend a few moments on growth dynamics in the quarter. Our growth rates for retail and commercial were both strong with domestic commercial growth of 15%. We set a first quarter commercial sales record and over $1 billion in sales, another impressive quarter as we generated $138 million more in sales than in Q1 last year. On a trailing four quarter basis, we delivered just under $4.4 billion in annual commercial sales, up an amazing $820 million over last year. We also set a Q1 record for average weekly sales per store at $16,000 versus 14,400 just last year. Domestic commercial sales represented 29% of our domestic auto parts sales versus 27% last year. Our sales growth in the quarter was driven by transaction growth from new and existing customers along with higher tickets as we price for inflation. Our commercial growth of 15%, while still very impressive, and well ahead of industry growth did slow. And unfortunately, we broke our streak of six straight quarters of 20% plus sales growth. While we could easily explain this resulted from a difficult comparison to last year’s Q1 amazing growth of 29.4%, we also saw our transaction counts decline nearly 4 points from the pace we were growing in Q4 of fiscal ‘22. That said, we continue to be pleased with the results from the key initiatives we have been working on for the last several years. Improved satellite store availability, hub and mega hub openings and improvements in coverage, the strength of the Duralast brand, better technology to make us easier to do business with, reduced delivery times, enhancing our sales force effectiveness, and living consistent with our pledge by being priced right for the value proposition we deliver. We believe our offering to our customers is better than ever, and we continue to hear great things from our customers and prospective customers about the strength of our value proposition as we continue to execute our commercial acceleration strategy. Our goal remains, over time, to become the industry leader in both, DIY and commercial in every geography where we operate. Our strategy, execution, and market momentum give us tremendous confidence as we move forward. We’re also very proud of our organization’s performance in domestic DIY. Our growth in retail since the beginning of the pandemic has been remarkable, representing the highest three-year growth we have experienced in my 28-year tenure with the Company. We delivered a positive 2.6% comp this quarter on top of last year’s 9%. And versus last year’s quarter’s growth, DIY grew on a two-year basis and on a three-year basis. While our ticket growth was similar to last quarter, of just over 7%, we are encouraged that our transaction count trends improved, decreasing by 4%. These results are very strong considering the difficult comparison, driven by the lingering effects of stimulus last year. From the data we have available, we continue to retain the vast majority of the enormous dollar share gains we built during the initial stages of the pandemic. And more importantly, we continue to grow unit share, a critical measurement of success for us. Our recent performance gives us continued conviction about the sustainability for our fiscal year. In terms of sales cadence, our total same-store sales trends were very consistent, increasing in the mid-single-digit range for each of the four-week periods. In addition, for Q1, our two-year comp was 19.2% and our three-year comp was 31.5% and relatively consistent over the four-week periods. We are incredibly pleased with the sustainability of the very large sales and share gains we generated since the beginning of the pandemic. Weather did not have a material impact on our sales this quarter. On a national basis, weather trends were very similar to last year. Regionally, we saw less rainfall in the West and Southeast than last year. But overall, we didn’t feel this drove our results materially. This winter’s weather forecast calls for a slightly colder winter with, as we’ve recently experienced, cooler weather beginning sooner. As a reminder, historically, extreme weather, cold or hot drives parts failures and accelerated maintenance. During the quarter, there were geographic regions that did better than others as there always are. This quarter, we saw comp sales in the Northeastern and Midwestern markets underperform the balance of the country by about 260 basis points. We believe that our underperformance in these markets was driven by milder and wetter weather this year. For our second quarter, winter weather is likely to meaningfully influence our results. As a reminder, our Q2 is historically by far and away the most volatile sales quarter as weather patterns can greatly vary week-to-week. We have key holidays that fall on different days of the week. At the moment, our forecasting team is telling us winter will likely be colder than last year’s Q2. If that happens, it would be a positive for our outlook. Now, let’s move into more specifics on our performance. Same-store sales were up 5.6%, our net income was $539 million, and our EPS was $27.45 a share, increasing $0.45 a share, which is a 6.9% increase. Regarding our merchandise categories in the retail business, our hard parts outperformed sales floor categories, with approximately 1% difference between them. With elevated gas prices, our discretionary categories remain soft. The discretionary categories represented approximately 18% of our DIY sales and were down 2.5% versus up 8% last year. In general, the categories that are driven by failures performed well, and we were encouraged to see our battery category successfully lap very strong performance last year, and again exceed our expectations. We believe our hard parts business will continue to do well this winter as we expect miles driven to improve, while our growth initiatives are delivering solid results. Let me also address inflation and pricing. In Q1, we experienced 11% pricing inflation, in line with cost of goods, which was also up 11%. We believe both numbers will decrease slightly in the current quarter, as we begin to lap the onset of high inflation last year. But, to be clear, we do not believe inflation is going away, especially wage inflation, but expect it to slow a bit as the economy slows. I want to highlight that our industry has been disciplined about pricing for decades and we expect that to continue. Most of the parts and products we sell in this industry have low price elasticity, because purchases are driven by failure or routine maintenance. Historically, as costs have increased, the industry has increased pricing commensurately to maintain margin rates, thereby increasing margin dollars. It’s also notable that following periods of higher inflation, our industry has historically not meaningfully reduced pricing to reflect lower costs. While we continue to be encouraged by the current sales environment, it still remains challenging for us to forecast near to mid-term sales as the economy impacts our customers. What I previously said on the past six quarterly calls is sales have been consistent on both a two-year and three-year stack comp basis. While it’s difficult to predict sales going forward, we are excited about our growth initiatives, our team’s execution, and the tremendous share gains we have achieved in both sectors. Over the past year and a half, the overall macro environment has been favorable for our industry despite inflationary pressures for our customers. Even if these near-term trends fade, we believe that we are in an industry that is positioned for solid growth over the long term. For our second quarter of 2023, we expect our sales performance to be led by the continued strength in our commercial business, as we execute on our differentiating initiatives combined with the resilient DIY business. As always, we will be transparent about what we are seeing and provide color on our markets and performance as trends emerge. Before handing the call over to Jamere, I’d like to give a brief update on a few of our key business priorities for the new fiscal year. First, we continue focusing on our supply chain with two initiatives that are in flight to drive improved availability. One is our expanded hub and mega hub rollouts. We know intelligently placing more inventory in local markets will lead to our ability to continue to say yes to our customers more frequently and in turn drive sales. Secondly, we are expanding our distribution center footprint. We announced the development of two new domestic DCs and one additional DC in Mexico. These DCs will allow us to not only reduce drive times to stores but also increase our capacity. Note that we didn’t expect to grow our business 30%-plus in three years as we have, and the additional capacity will enable us to carry more slower turning inventory that is not yet in high demand. I’m also excited to announce that we opened a facility on the West Coast to handle direct import product on a timelier basis. This facility will flow products ordered abroad and distribute them to our other DCs to reduce safety stock and drive productivity. Our supply chain strategy is focused on carrying more products closer to the customer. We believe it has been a significant contributor to our recent success, especially in commercial. We have initiatives in place to continue our growth trajectories in both our domestic retail and commercial businesses. Additionally, we plan on continuing to grow our Mexico and Brazilian businesses. At almost 800 stores combined, these businesses have had impressive performance again this quarter and should continue to be key contributors to sales and profit growth for decades to come. We are leveraging many of the learnings we have in the U.S. to refine our offerings in Mexico and Brazil. In Brazil, in particular, we are targeting to significantly and aggressively expand our store footprint over the next five years. We are very excited about our growth prospects internationally. Now, I’ll turn the call over to Jamere Jackson.

Thanks Bill. Good morning, everyone. As Bill mentioned, from a sales perspective, we had a strong first quarter stacked on top of an exceptionally strong first quarter last year with 5.6% domestic comp growth. We also had a 4.2% decrease in EBIT and a 6.9% increase in EPS. To start this morning, let me take a few minutes to elaborate on the specifics in our P&L for Q1. For the quarter, total sales were just under $4 billion, up 8.6%, reflecting continued strength in our industry and solid execution of our growth initiatives. Let me give a little more color on some of our growth initiatives, starting with our commercial business. For the first quarter, our domestic DIFM sales increased nearly 15% to $1 billion and were up 44.3% on a two-year stack basis. Sales to our domestic DIFM customers represented 29% of our domestic auto parts sales. Our weekly sales per program were $16,000, up 11.1%. Our growth was broad-based as both national and local accounts performed well for the quarter. Our results for the quarter set a record for the highest first quarter weekly sales volume in the history of the chain. I want to reiterate that our execution on our commercial acceleration initiatives continues to deliver exceptionally strong results as we grow share by winning new business and increasing our share of wallet with existing customers. We have a commercial program in approximately 88% of our domestic stores, which leverages our DIY infrastructure. We’re building our business with national, regional and local accounts. This quarter, we opened 117 net new programs finishing with 5,459 total programs. As I have said previously, commercial growth will lead the way in FY23. We continue to deliver on our goal of becoming a faster-growing business. Our strategy and execution continue to drive share gains and position us well in the marketplace. Delivering quality parts, particularly with our Duralast brand, improved assortments and local market availability, competitive pricing and providing exceptional service has enabled us to drive double-digit sales growth for the past nine quarters. In addition, we are increasing the penetration of our market leading ALLDATA shop management, diagnostic and repair software suite to new and existing commercial customers, which gives us yet another key competitive advantage. As I’ve noted on past calls, our mega hub strategy is driving strong performance and position us for an even brighter future in our commercial and retail businesses. Let me add a little more color on our progress. As we’ve discussed over the last several quarters, our mega hub strategy has given us tremendous momentum. We now have 80 mega hub locations with two new ones open in Q1. While I mentioned a moment ago, the commercial weekly sales per program average was $16,000, the 80 mega hubs averaged significantly higher sales and are growing much faster than the balance of the commercial footprint. As a reminder, our mega hubs typically carry 80,000 to 110,000 SKUs and drive tremendous sales lift inside the store box as well as surge as an expanded assortment source for other stores. The expansion of coverage and parts availability continues to deliver a meaningful sales lift to both our commercial and DIY business. What we’re learning is that not only are these assets performing well individually, but the fulfillment capability for the surrounding AutoZone stores gives our customers access to thousands of additional parts and list the entire network. This strategy is working. We remain committed to our objective to reach 200 mega hubs supplemented by 300 regular hubs. We’re targeting at least 25 new mega hubs in FY23. We continue to leverage sophisticated data analytics to expand our market reach, placing more parts closer to our customers and improving our delivery times. We’re determined to build on our strong momentum. Our domestic retail business count was 2.6% in Q1. The business has been remarkably resilient as growth rates accelerated from Q4 and we have managed to continue to deliver positive comp growth despite underlying market headwinds. As Bill mentioned, we saw traffic down 4% from last year’s levels. However, they improved sequentially from Q4, where traffic was down 7%. We also saw 7% ticket growth as we continue to raise prices in an inflationary environment. Our DIY businesses continue to strengthen competitively behind our growth initiatives. In addition, on a macro basis, the market is experiencing a growing and aging car part and is still challenging, new and used car sales market for our customers. These dynamics, pricing, growth initiatives and macro car part tailwinds have driven a positive comp despite tough comparisons from last year’s stimulus injection and consumer discretionary spending pressure from overall inflation in the economy. Our sales were steady through the quarter, and we’re forecasting a resilient DIY business in FY23. Now, I’ll say a few words regarding our international businesses. We continue to be pleased with the progress we’re making in Mexico and Brazil. During the quarter, we opened three new stores in Mexico to finish with 706 stores and 4 new stores in Brazil ending with 76. On a constant currency basis, we saw accelerated sales growth in both countries, in fact at higher growth rates than we saw overall. We remain committed to our store opening schedules in both markets and expect both countries to be significant contributors to sales and earnings growth in the future. With 11% of our total store base currently outside the U.S. and a commitment to continue expansion in a disciplined way, international growth will be an attractive and meaningful contributor to AutoZone’s future growth. As Bill mentioned earlier, we expect significant growth in store count internationally over the next five years. We are excited about the future. In the spirit of our growth in store count outside of the U.S. we will celebrate our chain’s 7,000th store opening this week in Leon, Mexico. I know Bill looks forward to being there to celebrate this historic event with our AutoZoners. We couldn’t be more proud to celebrate this occasion with our Mexico team. Now, let me spend a few minutes on the rest of the P&L and gross margins. For the quarter, our gross margin was down 242 basis points, driven primarily by a 203 basis-point headwind, stemming from a noncash $81 million LIFO charge. The difference for the quarter, a decline of 39 basis points in gross margin was primarily driven by our faster-growing lower gross margin commercial business. With this quarter’s LIFO charge, we have taken our LIFO credit balance to $96 million. As I mentioned last quarter, hyperinflation and freight costs are the primary driver for the charges. We are still modeling for higher freight costs through the end of the calendar year, and we anticipate approximately $40 million in LIFO charges during the second quarter. Both the first quarter actuals and our second quarter outlook are below the outlook we gave last quarter, as freight costs have continued to abate over the past few months. As spot rates have come down, we have also renegotiated some of our long-term contracts, and the lower costs are reflected in our outlook. We expect freight costs to continue to abate, and I want to remind everyone that at some point we expect to see these quarterly charges reverse, and we will begin to rebuild our LIFO reserve balance. We plan to take P&L gains only to the extent of the charges we have taken thus far, and after we have taken P&L gains that fully reverse the charges we have incurred, we expect to rebuild our LIFO reserve balances we have done historically. Moving on to operating expenses. Our expenses were up 8.6% versus last year’s Q1 as SG&A as a percentage of sales were flat with last year. Our operating expense growth has been purposeful as we continue to invest at an accelerated pace in IT and payroll to underpin our growth initiatives. These investments are expected to pay dividends in customer experience, speed and productivity. We are committed to being disciplined on SG&A growth as we move forward, and we will manage expenses in line with sales growth over time. Moving to the rest of the P&L, EBIT for the quarter was $723 million, down 4.2% versus the prior year’s quarter. Excluding the $81 million LIFO charge, EBIT would have been up 6.6% over last year’s quarter. Interest expense for the quarter was $57.7 million, up 33.4% from Q1 a year ago, as our debt outstanding at the end of the quarter was $6.3 billion versus $5.3 billion at Q1 in last year, and our variable rates have increased significantly. We are planning interest in the $60 million range for the second quarter of fiscal 2023 versus $42.5 million in last year’s second quarter. Higher debt levels and expected higher borrowing costs across the curve are driving this increase. For the quarter, our tax rate was 18.9%, below last year’s first quarter rate of 21.9%. This quarter’s rate benefited 446 basis points from stock options exercised, while last year benefited 159 basis points. For the second quarter of FY 2023, we suggest investors model us at approximately 23.4% before any assumption on credits due to stock option exercises. Moving to net income and EPS. Net income for the quarter was $539 million, down 2.9% versus last year’s first quarter. Our diluted share count of 19.6 million was 9.1% lower than last year’s first quarter. The combination of lower net income, offset by lower share count drove earnings per share for the quarter to $27.45, up 6.9% over the prior year’s first quarter. Excluding the LIFO charge, our net income would have increased 8.3% and our EPS growth would have been 19.2%. Now, let me talk about our free cash flow for Q1. For the fourth quarter, we generated $794 million of operating cash flow and spent $114 million in CapEx, allowing us to generate $680 million in free cash flow versus $676 million a year ago. We expect to continue being an incredibly strong cash flow generator going forward, and we remain committed to returning meaningful amounts of cash to our shareholders. Regarding our balance sheet, our liquidity position remains very strong and our leverage ratios remain below our historic norms. Our inventory per store was up 14.4% versus Q1 last year, and total inventory increased 17.6% over the same period last year, driven primarily by inflation, our growth initiatives, and in-stock recoveries. Net inventory defined as merchandise inventories less accounts payable on a per-store basis was a negative $249,000 versus negative $207,000 last year, and negative $240,000 last quarter. As a result, accounts payable as a percent of gross inventory finished the quarter at 131% versus last year’s Q1 of 129.4%. Lastly, I’ll spend a moment on capital allocation and our share repurchase program. We repurchased $900 million of AutoZone stock in the quarter and at quarter end, we had just under $2.7 billion remaining under our share buyback authorization. The strong earnings, balance sheet and powerful free cash we generated this year has allowed us to buy back almost 2% of the shares outstanding at the start of the fiscal year. We have bought back well over 90% of the shares outstanding of our stock since our buyback inception in 1998 while investing in our existing assets and growing our business. We remain committed to this disciplined capital allocation approach that will enable us to invest in the business and return meaningful amounts of cash to shareholders. We finished Q1 at 2.2 times EBITDAR, which is below our historical objective of 2.5 times. However, we remain committed to this objective, and we expect to return to the 2.5 times target during FY ‘23. To wrap up, we remain committed to driving long-term shareholder value by investing in our growth initiatives, driving robust earnings and cash, and returning excess cash to our shareholders. Our strategy continues to work. We’re growing our market share and improving our competitive positioning in a disciplined way. As we look forward to FY ‘23, we’re bullish on our growth prospects behind a resilient DIY business and fast-growing commercial and international businesses that are growing considerable share. I continue to have tremendous confidence in our industry, our business, and the opportunity to drive long-term shareholder value. Before I turn it back to Bill, on December 5th, we celebrated Bill’s 28th year anniversary with the Company. And I want to say congratulations to you, Bill. It’s been a remarkable ride.

Thanks, Jamere. Fiscal 2023 is off to a solid start. But we must continue to be focused on superior customer service and flawless execution. Execution and our culture, a culture of always putting the customer first, is what defines us. As Jamere said a moment ago, we continue to be bullish on our industry and in particular on our own opportunities for the New Year. Our team continues to work collaboratively with our suppliers. Together, we’ve done a good job improving our in-stock position. But we still are a couple of hundred basis points below our historical norms. We’re also being smart about adding new inventory coverage. We’re meeting the ever-growing needs of our customers, especially our commercial customers, by being able to say yes, we’ve got it. It’s a requirement. For the remainder of fiscal '23, we are launching some very exciting initiatives. Not only will we be opening roughly 200 stores across the U.S., Mexico and Brazil, but we’ll be opening more mega hubs and hub stores. We are focused on initiatives in place to continue driving strong performance in both, our retail and commercial businesses. For the remainder of fiscal 2023, we are keenly focused on relentless execution. We will not accept shortcuts. Our vendors must return to providing us the right amount of merchandise at the right time. Every store has to be staffed right, every hour of every day, and our processes need to function correctly, always. We have to meet our store opening goals and timelines. Simply put, we have to focus on exceptional execution. It has made a difference for us for decades. We know that investors will ultimately measure us by what our future cash flows look like three to five years from now, and we very much welcome that challenge. I continue to be bullish on our industry and in particular on AutoZone. Now, we’d like to open up the call for questions.

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

Yes. Thanks, Brian. International freight rates are back at pre-pandemic levels. One of the things that we discussed on last quarter’s call was this notion that during the height of the pandemic to secure capacity, we entered into some longer-term contracts. We’re now in a position where, as the spot rates have come down, we’ve renegotiated some of those contracts. We have a pretty bullish outlook on where international freight rates are going to be for the balance of the year. Domestically, rates are still a little bit high. As we work our way through the year, we expect those to start to abate a little bit. But domestically, the rates are still a little bit higher than what we would have anticipated. As it relates to LIFO, as you saw in the second quarter, we have lowered our outlook to be about a $40 million charge. You could see in the back half of the year that abating completely. I won’t be date certain about when we’ll see this flip to gains rolling back through the P&L. But as we said last quarter, it could take the equivalent of three or four quarters before it all rolls through, and we see the gains come back through the P&L that offset the charges that we’ve taken. So, our outlook is positive, and we’re managing the business accordingly.

Can I add a bit more on another aspect, not related to LIFO, but concerning our regular product costs? Many of the freight expenses are being included in the inventory cost. Therefore, we will experience higher product costs outside of LIFO in a business that turns over 1.5 times a year for about nine months to a year, once those freight expenses decrease. So, we will continue to feel pressure on product costs for an extended period.

That's very helpful. I appreciate the insight. As a quick follow-up regarding traffic, you mentioned that while the store traffic was still down in Q1, it had shown improvement compared to Q4. Can you share any comments on the expected trajectory through the quarter? Additionally, how are you anticipating traffic trends as we continue to move through 2023?

Yes, Brian. When we discuss traffic, we are mainly referring to our DIY business. I can say that our DIY performance in Q1 was significantly better than we anticipated. Although our traffic counts are down 4%, this was an improvement compared to 8% in Q4. It's important to remember, and you've been involved in this industry for some time, that there has been a long-term decline in DIY traffic counts over the past 25 years. As technology has advanced, the products we sell have become more durable and last longer. Additionally, there is a natural inflation in product costs as new technologies are incorporated. Therefore, a 4% drop in DIY traffic is not unusual during typical times. To see it decline by only 4% after the growth we've experienced over the last three years is quite encouraging for us.

Good morning, everyone, and Bill, congratulations on the anniversary. My question is a follow-up to what you just mentioned, Bill. The traffic, or what we might refer to as units, appeared to improve sequentially on a year-over-year basis. We’re not clear on how the traffic or unit stacks look, and I'm curious if the underlying stacks are also improving. Is this a sign of rebasing, indicating that we are in the clear regarding units, and that the negative numbers are normalizing back to the negative 4% you referred to?

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

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

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

Yes. I look at the macro in a pretty broad way. You’ve got a couple of dynamics going. One, you have an aging and growing car part. Used car prices, while they’ve started to abate, they’re still up almost 30% over the last two years. New car prices are up closer to 20%. You’re in an environment where you have rising interest rates that have made financing more challenging. We do believe that it is still a little bit of a tailwind for our business. More importantly, we’ve been managing our business to take advantage of all of the robust market opportunities that we have, and this is just one portion of that. I think as we’ve talked about our business and the growth that we’re seeing, it’s not just that macro strength, but inflation has been our friend to some extent, driving higher prices, volumes held up under those dynamics. Our growth initiatives have helped us create a faster-growing business in both DIY and DIFM. So, when you take the combination of what you’re seeing from inflation, our growth initiatives, from the work that we’ve done with hubs and mega-hubs and this macro strength, those are all the things that are in the soup, if you will, in terms of how our business is growing.

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

Sure, Kate. Yes. Our in-stock position today is significantly better than it was at this time last year, around 18 months ago. It’s improved slightly compared to last year and to Q4, but we’re still about 200 basis points below our historical expectations and experiences. When will it be resolved? Honestly, I would have expected it to be resolved by now. However, there are still certain product categories that present challenges, and we’re actively seeking new sources and geographies in those categories to help us move past it. We feel optimistic about our current situation and very confident about our competitive stance.

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

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

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

Yes. I mean, we expect LIFO charges in the second quarter to be somewhere in the $40 million range, if you will. That will be significantly less pressure from a gross margin standpoint.

Got it. As a follow-up, regarding SG&A, aside from the mix challenges with Do-It-For-Me affecting gross margin, is there anything else we should be aware of? Also, SG&A dollar growth year-over-year has been in the 8% to 10% range over the last four quarters. How much of that growth is attributed to wage and benefit cost inflation versus investments made during prosperous times? Looking ahead, how do you plan to approach inflation, wages, and SG&A in relation to your overall leverage strategy?

Yes. From an SG&A standpoint, we’re going to continue to grow SG&A in a disciplined way as we create a faster-growing business. As I said, we were flat as a percentage of sales this past quarter. But we’ve been investing, and we’ve been investing to maintain high levels of customer service. We’ve been investing because many of our growth initiatives, both on the retail and commercial side of our business are underpinned by investments in IT. So IT investments, in particular, are an enabler to what we’re doing from a growth standpoint. Wage pressure is a macro labor market issue, and we certainly haven’t been immune to those dynamics. Historically, our wages have run in the 2% ZIP code. It’s been running closer to 5%. That’s put some pressure on us. But I’ll say about SG&A over time is that we will continue to manage it in line with the top line. We’ve been opportunistic as our business has grown to invest at an accelerated pace in some areas to support the growth in our business and to maintain great levels of customer service, and we’ll continue to be very disciplined about it going forward.

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

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

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

That’s an excellent question, Michael, and I'm not certain I can provide a definitive answer. I can begin by highlighting our 15% growth in the commercial sector, which has generated a lot of excitement, especially after our impressive growth over the last couple of years. We are satisfied with the performance in our commercial business, which is quite broad. The slight slowdown we have observed is widespread. It isn't limited to national accounts or specific locations, nor is it particular to our ProVantage customers. We are noticing a general decrease in momentum across various customer types and regions. I believe this isn't due to any actions taken by AutoZone. We've experienced rapid growth, achieving 15% growth on top of that, and we are pleased with the results.

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

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

I wanted to start on the commercial side. Bill, in your prepared remarks, you mentioned some technology investments aimed at making it easier to do business with you. Could you provide more details on those initiatives? Also, what stage are we at in the rollout of these various tech programs on the commercial side?

Sure, Daniel. Thank you. One of the things we've implemented over the past few years is handheld devices for everyone in the store who picks products and for those delivering to commercial customers. This ensures we have the correct product and helps us manage delivery times, which we have reduced by about 20% since introducing that technology. Another significant aspect involves how we interact digitally with our commercial clients. We're providing them access to invoices and working to create a more seamless experience, aiming to remove pressure points and make transactions with us frictionless. The handheld devices have been deployed, and we are continuously refining the technology, which might take another year. The digital integration is not as advanced; we have more innovative ideas that we plan to pursue regarding digital integration with our customers, which will likely take two to three more years.

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

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

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

We are closely analyzing both our retail and commercial customers because this is an unusual environment. I've not experienced inflation rates in the upper single digits and lower double digits before. We are particularly focused on understanding customer behaviors. It's worth noting that we have more experience in the DIY sector compared to the commercial sector. In response to the last four economic shocks in the U.S., our business has significantly outperformed during typical periods. We are keeping a close watch on the low-end consumer to ensure we comprehend the current situation. I suspect there may be a trend where some commercial customers are opting for DIY solutions for tasks they would typically have done through DIFM. We are observing these trends but have not identified anything alarming so far. We continue to track the situation and remain pleased with the 15% growth in our commercial business.

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

Certainly, we increased our openings in the first quarter. Currently, around 88% of our stores have the commercial program. We do not anticipate reaching 100% or anything close to that. Over the past few years, the economics for our commercial business on a per store and per program basis have changed significantly. There are programs we now believe are viable that we wouldn’t have considered two years ago. While we may open around 100 more, I do not expect significant growth rates in commercial openings. Typically, it takes four to five years for these programs to mature. As we improve, they launch at higher levels than in the past. We will see if this maturity sustains as it once did. A notable exception is our mega hubs, which come out strong right from the start. The volumes we achieve almost immediately from a mega hub are impressive.

Thank you, Bill. Enjoy the trip to Mexico.

All right. Thanks. I look forward to it.

I have a couple of questions. The gap between ticket growth and inflation has increased slightly. It's now 4 percentage points in retail compared to 3 last quarter. Can you remind us if this is due to fewer units per transaction or a shift to less expensive items? Any insight into what’s causing this would be appreciated.

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

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

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

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

Considering the consumer from a broader perspective, it's evident that inflation is impacting them in various ways. Inflation is likely to reduce overall consumer spending. However, in our business, we're experiencing primary pressures in our discretionary categories and our core failure and maintenance categories, yet demand remains strong. The pricing actions we've implemented haven't significantly affected volume. It's also important to note that we are operating in a two-speed economy. Consumers at the middle and upper end have healthier financial situations and are continuing to spend significantly, while those at the lower end are feeling the squeeze. We are observing some consumers opting for lower-tier options, but there haven't been any substantial shifts so far. We are monitoring this closely due to the unusual factors influencing the situation.

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