Autozone Inc (AZO) — Q3 2024 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 GAAP to non-GAAP financial measures can be found in our press release.

Good morning. And thank you for joining us today for AutoZone's 2024 third quarter conference call. With me today are Jamere Jackson, Chief Financial Officer; and Brian Campbell, Vice President, Treasurer, Investor Relations and Tax. Regarding the third quarter, I hope you had an opportunity to read our press release and learn about the quarter's results. If not, the press release, along with the slides complementing our comments today, are available on our website www.autozone.com under the Investor Relations link. Please click on the quarterly earnings conference calls to see them. As we begin the call, I want to say thank you to our more than 120,000 AutoZoners across all of our businesses for delivering solid earnings results in the face of a difficult macro environment. With our continued focus on providing what we call WOW! Customer Service, our AutoZoners delivered a total sales increase of 3.5%, and total company same-store sales were up 1.9%. On a constant currency basis, total company same-store sales were at 0.9%. Our operating profit grew 4.9% while our earnings per share grew 7.5%. In spite of our lower than planned sales, we managed our business well and were able to deliver bottom-line results that continued to build on the phenomenal results we've had over the last several years. Congratulations to our AutoZoners everywhere who helped us achieve this quarter's growth. Your dedication to delivering on our commitment of WOW! Customer Service is always inspiring. Before I begin my comments on our third quarter sales, as a reminder, the backdrop to this quarter and every third quarter of our fiscal year includes tax refund season. It is roughly a $300 billion influx of cash to our customers. It begins around Valentine's Day and generally lasts four to six weeks. These dollars matter to our customers and meaningfully impact their shopping patterns in our stores. This year, refund dollars ended up slightly versus the previous year. However, February refund flows were lower than expected and negatively impacted the first three weeks of the quarter's domestic same-store sales. While the refund flows did catch up later in the later weeks, we felt the delayed refunds were a drag on our sales results through February and early March, similar to what you may have heard from other retailers. Secondly, the weather was unfortunately cooler and wetter than we had expected and planned, especially in the Northeast and the Midwest markets. As a result, sales in these markets were noticeably below the remaining markets with this pattern more pronounced over the last eight weeks of our 12-week quarter. Again, extreme weather, either hot or cold, drives hard part failures and accelerates maintenance over time, thereby driving higher sales. On balance, we believe this quarter's sales were impacted negatively by the late start of the tax refund season, while the last eight weeks were impacted by the cooler than expected weather. Despite these headwinds, we also had many successes. We gained share in our retail business, and we believe we continue to gain share in commercial. We are encouraged by our supply chain initiatives. The construction of our two new domestic distribution centers is on track for Q2 FY25 opening, as well as our continued forward deployment of inventory across both our hubs and our mega hubs. We continue to see progress on our initiatives within our domestic commercial business that give us confidence about accelerated growth. While it is prudent for us to remain cautious on our outlook for the remainder of the year, we believe sales will accelerate over time. We are excited about our commercial initiatives that are providing deeper parts coverage closer to the customer with faster delivery times, improving customer service and thereby driving sales. For the third quarter, our total company same-store sales were 0.9% on a constant currency basis. International has become a more important part of our growth story in this quarter. We delivered another strong quarter, up over 9.3% on a constant currency basis. We continue to be very encouraged with both our short-term and long-term growth prospects internationally, and we plan to accelerate new store openings and drive operational improvements in these markets over the next several years. Our domestic same-store sales were flat this quarter compared to up 0.3% last quarter and up 1.9% in Q3 of last year. As I mentioned previously, we believe our sales were impacted in the first four weeks of the quarter by the delayed tax refund season and the last eight weeks by the mild wet weather pattern across much of the US. Domestically, we ran a negative 0.7% same-store sales across the first four weeks and collectively across the last eight weeks, we saw a plus 0.3% same-store sales. Our commercial business grew 3.3% against last year's Q3 growth of 6.3%. Our commercial results were higher in the first eight weeks and relatively consistent, but slightly lower in the last four weeks. The last four weeks' comparisons were the most difficult of the quarter. Weather impacts were more pronounced in the last eight weeks of the quarter, and it was during this time that the regional performance disparities became more apparent. The Northeast and the Midwest underperformed the remainder of the country by close to 200 basis points over the last eight weeks of the quarter. Commercial transaction counts were up and were partially offset by slightly negative ticket growth, which was attributable to similarly negative inflation on a same SKU basis. We opened 20 net new commercial programs and now have commercial in 92% of our domestic stores. Domestic commercial sales represented 31% of our domestic auto parts sales for Q3. Despite the choppiness in our commercial sales results this quarter, we are planning for a stronger growth rate in Q4 behind continued execution of our growth initiatives and somewhat easier comparisons. Commercial sales growth continues to be driven by the key initiatives we've been working on over time, improved satellite store inventory availability, material improvements in hub and mega hub coverage, the strength of the Duralast brand with an intense focus on high-quality parts and products and technology enhancements that make us easier to do business with. We are encouraged by our recently launched initiatives focused on improving customer service with faster delivery times. As we roll these initiatives out to the majority of the chain, we anticipate faster growth and accelerated share gains. Regarding domestic DIY, we had a negative 1% same-store sales this quarter versus last year's comp of 0.6%. DIY ran negative 2% across the first four weeks of the quarter, positive 0.1% the second four weeks, and negative 0.1% same-store sales over the last four weeks. Regionally, the Northeast and the Midwestern markets underperformed the remainder of the country by approximately 100 basis points over the last eight weeks of the quarter, similar to our commercial business. Heading into the fourth quarter, we feel weather should be less volatile and we are planning accordingly. Regarding our merchandise categories in the DIY business, our sales floor categories, and particularly discretionary categories, underperformed hard parts. We also saw several seasonal merchandise categories and weather-sensitive hard part categories being below our planned results due to the cooler than expected weather. Regarding this quarter's traffic versus ticket growth, our DIY traffic was down approximately 2% while our ticket average was up only 1%. We expect our average ticket growth will return to more normalized levels in the 2% to 4% range as we get further removed from the higher inflation of the last couple of years. We attribute our previously mentioned DIY share gains to improved customer service levels in our stores and our in-stock nearing pre-pandemic levels, driven by most of our vendor partners returning to more normalized operations, meaning recovering from the pandemic sales surge and supply chain disruptions. As we look forward, we are continuing to focus on flawless execution and delivering WOW! Customer Service will drive our accelerated sales growth in our domestic business. Before handing the call to Jamere, I'd like to highlight and give some color on our international business. At 872 stores opened internationally or 12% of our store base, this business had yet again impressive performance last quarter and should continue to grow at a robust pace for the remainder of fiscal year 2024 and beyond. We are leveraging many of the learnings we have in the US to refine our offerings in our international markets. And before Jamere discusses our financial results, I'd like to remind you of our key objectives for fiscal year 2024. We are focused on growing our domestic commercial business and we believe our improved customer service levels will lead to continued sales growth. We are also focused on our supply chain with two initiatives that are in flight to drive improved availability versus our expanded hub and mega hub rollouts. And secondly, we are making good progress on adding capacity to our distribution network. We have two distribution centers that are nearing completion in the US, one in Chao Chilla, California, and the other in New Kent, Virginia. We are also very close to completing the expansion of our Tapeje Mexico distribution center. Last quarter, we broke ground on a larger facility that will house our relocated Monterrey, Mexico distribution center. Our strategy is focused on leveraging the entire network to carry more inventory closer to the customer, driving sales growth with improved speed, expanded parts availability, and enhanced efficiencies. These capacity expansions will underpin our future growth. Now I'd like to turn the call over to Jamere Jackson.

Thanks, Phil. And good morning, everyone. As Phil has previously discussed, we had a solid third quarter with 3.5% total company sales growth, flat domestic comp growth, a 9.3% international comp on a constant currency basis, a 4.9% increase in EBIT and a 7.5% increase in EPS. We continue to deliver solid results, and the efforts of our AutoZoners in our stores and distribution centers continue to enable us to drive earnings growth in a meaningful way. To start this morning, let me take a few moments to elaborate on the specifics in our P&L for Q3. For the quarter, total sales were $4.2 billion, up 3.5%. Let me give a little more color on sales and our growth initiatives. Starting with our domestic commercial business, our domestic DIFM sales increased 3.3% to just under $1.2 billion and were up 9.6% on a two-year stack basis. Sales to our domestic DIFM customers represented 31% of our domestic auto part sales. Our average weekly sales per program were $16,400, down 2.4% versus last year's $16,800. As a reminder, we have added over 300 new programs over the last 12 months, and these new programs are diluting the overall sales per program. We are, however, extremely pleased that these programs are maturing significantly faster than our historical performance and position us well for the future. We now have our commercial program in approximately 92% of our domestic stores, which leverages our DIY infrastructure, and we’re building our business with national, regional, and local accounts. This quarter we opened 20 net new programs, finishing with 5,843 total programs. Our commercial acceleration initiatives continue to make progress as we grow share by winning new business and look to gain share of wallet with existing customers. Importantly, we have a lot of opportunity in front of us, and we will continue to aggressively pursue growth in the highly fragmented commercial market, which we believe is our single largest growth opportunity. To support our commercial growth, we now have 103 mega hub locations, with two net new mega hubs opened in Q3. Our mega hubs continue to average significantly higher sales than the balance of the commercial programs and grew more than three times the rate of our overall commercial business in Q3. Our mega hubs typically carry roughly 100,000 SKUs, drive tremendous sales lift inside the store box, and serve as an expanded fulfillment source for other stores. These assets are performing well individually, and the fulfillment capability for the surrounding AutoZone store is giving our customers access to tens of thousands of additional parts and lifting the entire network. We will continue to aggressively open mega hubs for the foreseeable future, and we expect to open well north of 200 mega hubs at full build-out. These assets are key to our growth plans. On the domestic retail side of our business, our comp was down 1% for the quarter. As Phil mentioned, we saw traffic down approximately 2%, offset by approximately 1% ticket growth. Over time, we would expect to see slightly declining transaction counts offset by low to mid-single digit ticket growth, in line with the long-term historical trends for the business, driven by changes in technology and the durability of new parts. While DIY discretionary purchases were challenged in Q3, we continue to see a growing and aging car park, miles driven back to prepandemic levels, a challenging new and used car sales market, and a consumer that is likely to continue to invest in their existing vehicles. As such, we believe our DIY business will remain resilient. Now I'll say a few words regarding our international business. We continue to be pleased with the progress we're making internationally. Our same-store sales grew an impressive 18.1% on an actual basis and 9.3% on a constant currency basis. During the quarter, we opened 12 stores in Mexico to finish with 763 stores, and one store in Brazil ending with 109. We remain committed to international, and given our success, we're bullish on international being an attractive and meaningful contributor to AutoZone's future growth. Now let me spend a few moments on the rest of the P&L and gross margins. For the quarter, our gross margin was 53.5%, up 102 basis points, driven by a significant improvement in our core business gross margins and 15 basis points from a non-cash $24 million LIFO credit in this quarter versus a $17 million LIFO credit in Q3 of last year. Excluding LIFO from both years, we had a very strong 87 basis point improvement in gross margin. Our merchandising and supply chain teams have done an exceptional job of driving gross margin improvement this year. I will point out that we now have $19 million in cumulative LIFO charges yet to be reversed through our P&L, and we expect this credit balance to reverse over the next couple of quarters. We're currently modeling approximately $10 million in LIFO credits for Q4 based on the deflation experienced this past year. This compares to a $30 million LIFO credit we had in Q4 last year, which means we would have a $20 million net headwind from LIFO in gross profit. As I've said previously, once we credit back the $19 million through the P&L, we will not take any more credits, and we will begin to rebuild an unrecorded LIFO reserve. Moving to operating expenses, our expenses were up 6% versus last year’s Q3, as SG&A as a percentage of sales deleveraged 76 basis points. On a same-store basis, SG&A grew 3.3% as we continue to invest in initiatives that drive speed, productivity, and improve customer service. 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 $900 million, up 4.9% versus the prior year, driven by our positive same-store sales growth and gross margin improvements. Interest expense for the quarter was $104 million, up 41% from Q3 a year ago, as our debt outstanding at the end of the quarter was $9 billion versus $7.3 billion in Q3 last year. We are planning interest in the $148 million range for the fourth quarter versus $109 million last year. Higher debt levels and borrowing rates across the curve are driving this increase, along with the extra week that we will have in this year's fourth quarter. For the quarter, our tax rate was 18.1%, up from last year's third quarter of 17.4%. This quarter's rate benefited 479 basis points from stock options exercised, while last year it benefited 595 basis points. For the fourth quarter, we suggest investors model us at approximately 23.2% before any assumptions on credits due to stock option exercises. Moving to net income and EPS, net income for the quarter was $652 million, up 0.6% versus last year. Our diluted share count of $17.8 million was 6.4% lower than last year's third quarter. The combination of slightly higher net income and lower share count drove earnings per share for the quarter to $36.69, up 7.5% for the quarter. Now let me talk about our free cash flow. For the third quarter, we generated $434 million in free cash flow. We had higher CapEx spending this quarter versus a year ago, and we expect to spend close to $1.1 billion in CapEx this fiscal year as we complete the addition of our distribution center capacity expansion ahead of schedule. I will also remind you that we generate a majority of our free cash flow in the back half of each of our fiscal years. 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 ratio finished Q3 at 2.5 times EBITDAR. Our inventory was up 7.9%, driven by a combination of inventory per store growth to support our growth initiatives, improvements in in-stock levels, along with new store growth. Net inventory, defined as merchandise inventories less accounts payable on a per store basis, was $168,000 negative versus $215,000 negative last year and negative $164,000 negative last quarter. As a result, accounts payable as a percent of inventory finished the quarter at 119.7% versus last year's 126.5%. Lastly, I'll spend a moment on capital allocation and our share repurchase program. We repurchased $735 million of AutoZone stock in the quarter. And at quarter end, we had $1.4 billion remaining under our share buyback authorization. We have bought back over 100% of the then outstanding shares of stock since our buyback inception in 1998, while investing in our existing assets and growing our business. We remain committed to a leverage target of 2.5 times and a disciplined capital allocation approach that will enable us to invest in the business and return meaningful amounts of cash to shareholders. To wrap up, we remain committed to driving long-term shareholder value by investing in our growth initiatives, driving robust earnings and free cash flow, and returning excess cash to our shareholders. We're growing our market share, expanding our margins, and improving our competitive positioning in a disciplined way. And as we look forward to Q4, we remain bullish on our initiatives to grow sales behind a steady DIY business, a fast-growing international business, and a domestic commercial business that remains underpenetrated. I continue to have tremendous confidence in our strategy and our ability to drive significant and ongoing value for our shareholders. And with that, I'll turn it back to Phil.

Thank you, Jamere. We are proud of the results our team delivered this last quarter. We remain on track to deliver a solid 2024, but we must continue to focus on superior customer service and flawless execution. Execution and our culture of always putting customer first is what defines us. We are well positioned to grow sales across our domestic and international store bases with both our retail and commercial customers. Our gross margins are solid, and our operating expense structure is appropriate for future growth. We are putting our capital investments where they matter most, our stores, distribution centers, and leveraging technology to build a superior customer service experience where we are able to say yes to our customers' needs. Fiscal 2024's top priority has been enhanced execution. We are making good progress. Additionally, we have many strategic projects in varying stages of completion. We will continue opening new mega hubs and hubs, completing construction on our new distribution centers, and optimizing our new direct import facility. We are also in the early stages of ramping up our domestic and international store growth. As discussed, our international teams posted same store sales comps on a constant currency basis of plus 9.3%, continuing several years of strong growth. While I mentioned all these investments in FY24, AutoZone's biggest opportunity remains growing share in our domestic commercial business. We continue to believe we have a solid plan in place for growth for the foreseeable future. We know our focus on parts availability and WOW! Customer Service will lead to additional sales growth. We are excited about what we can accomplish, and our AutoZoners are committed to delivering the results. Now I'd like to open up the call for questions.

Could you talk a little bit about the cadence? You commented at the end of the quarter that the commercial business ended a bit softer and obviously very early in Q4, but could you give us any color sort of as we've trended sequentially into the fourth?

The commercial business, like we said, has been choppy. The last four weeks were the more difficult comparisons for the quarter. And as we said several times, I hate being the weatherman, but this particular spring has been challenging for us from a wet and cooler season. Typically, in the latter half of the quarter, we start seeing some improved performance around the hot weather categories like AC chemicals and AC hard parts and battery sales, etc., and we just didn't get that through the last several weeks of the quarter.

And then I guess on a calendar year basis, could you just maybe give us some color where you see inflation in pricing for your mix as the compares?

On the inflation front, that has definitely been challenging as we've come off several years of hyperinflation, if you will, at our average unit retail on both the DIY side and the commercial side. I suspect the average unit retail same-SKU inflation would get back to more normal growth levels as we move further and further away from the inflation that we had over the previous years. Now those inflation numbers start to come back as we get into the later quarters of the calendar year, and I suspect they'll return to more normalized levels over time.

It's Christian Carlino on for Chris. First question on gross margin. Supply chain crisis aside, you've grown the commercial business pretty considerably over the past couple of years. So could you speak to, I guess, the degree of vendor rebates you've yet to receive and how long you should benefit from this catch-up period for all the growth that you've had since prior to the pandemic?

Certainly, our gross margins as it relates to our relationship with vendors have an opportunity to improve. As Phil mentioned previously, we are coming off a period of significant hyperinflation, particularly in the areas like freight. Quite frankly, we saw snarls across the majority of the supply chain. It impacted them from the standpoint of having higher labor costs, higher input costs in total. So we're starting to see that abate, and it's given us an opportunity to go and negotiate for some deflation as we move forward. We're still in early innings there, and I wouldn't say that all of the inflationary pressures have abated, but we're certainly in a much better position today than we were a year ago.

Now that you're beginning to see the effects of earlier maintenance deferral at some tire centers, are there any improvements in trends with that group of customers? Additionally, could you provide insights on the performance of national accounts, tire centers, and buy here, pay here dealers?

I would say if you kind of broke apart those segments that you just talked about, probably the most challenged group of customers are those that drive their repair revenue from tires. Tires have definitely been a pressure point. I think that downward trend on tires has probably flattened out a little bit. But I still think the tire segment, in particular, is under some pressure and has been for quite a while. On your other segment of customers, the buy here, pay here lot and used car centers, those have been more challenged as well. You think about there were tons of used cars that were sold over the last two years or so, and I think that's just been slower. Also, as the consumers are under a little bit more economic pressure due to inflation, not just in our category but across all of retail and across life at the moment, I think there's more pressure on some of those bigger ticket items like tires. New tires are a pretty big purchase for a customer.

My first question is about mega hubs. Can you provide some calculations on them? You mentioned 200 over time; can you tell us how many we should expect to see per year year-over-year? Also, could you explain the one-year impact from them?

So certainly, from a mega hub standpoint, we're pretty excited about our future there. As we've announced, we'll likely have over 200 mega hubs at full build-out. Last year, we opened 20; we're likely going to open less than that this year. But our pipeline is very strong, and our pipeline is robust as we look into FY25. So we're going to go as fast as we possibly can. These are big boxes and difficult to find places. But we've done a really good job and worked really hard to fill up that pipeline, and you'll start to see that accelerate as we move into FY25 and beyond.

Hubs have been excellent stores for us. Initially, we anticipated having 30 to 40 of these in various markets. However, we now expect to exceed 200 mega hubs. The hubs remain a crucial part of our strategy, featuring about 30,000 to 40,000 fewer SKUs than a mega hub, but both store types serve us well. They significantly bolster the commercial aspect of our business and enhance the DIY market. These are valuable assets for us and are performing better than our standard stores.

Can I ask about your outlook for fiscal '25, considering the first and second halves? Is it reasonable to expect that the performance will be more weighted towards the second half? It seems the top-line could improve slightly, possibly due to weather factors, but you'll also be dealing with significant gross margin gains in core, non-LIFO areas while needing top-line growth to manage expenses. It appears there might be a second-half emphasis next year. I'd like to hear your thoughts on the timing and progression for next year.

We don’t provide guidance, but I want to share a few things I’m excited about. The weather has been challenging, but as we move into summer, we expect an improvement in our merchandise categories, which should help our sales. Our commercial initiatives are progressing, albeit slower than we would prefer, and we anticipate they will continue to develop over time. Given that we currently hold under 5% market share in the commercial business, we see significant opportunities for growth through enhanced service, better hard parts availability, and improved delivery. Our investments in parts, mega hubs, and technology will help boost our sales, but this will take time rather than happening quickly.

I wanted to follow up on inflation, because it sounds like it was still across the box slightly positive in the quarter. But I think I heard in commercial that it was same SKU, slightly negative. So could you just give us a little more detail on that?

I think two things from an inflation standpoint. Number one, the backdrop is we're coming off a period of significantly more inflation last year. So as we look at this year and its impact on our ticket growth, our ticket growth is lower than it's been historically. Quite frankly, that's had an impact on the top-line growth. You've heard me say a number of times that while hyperinflation is difficult from a cost standpoint, from a top-line standpoint, inflation has been our fronted, and we just don't have that tailwind right now. We do expect inflation to normalize over time, but the high freight cost that we had and the significant inflation that we had in the industry, it's just not there right now. This industry has been very disciplined about passing that inflation through; but also, in times where the inflation is not there, we've also been disciplined about the pace with which retails are raised. We feel pretty good with where we are in total. We think inflation is going to return, but right now, it's running significantly lower than it was a year ago and lower than what we've seen historically.

And just to be clear, in the quarter, it was zero?

Yes, we saw ticket growth across the business being very muted in the quarter, and we're seeing some inflation in certain categories, while in other categories, we're seeing hardly any inflation. As we manage our way through that, we've just got to make sure that we're pricing dynamically to price for inflation where we see it, and in places where you don't see it. Obviously, we're being disciplined, as this industry has been for a really long time.

So still discipline and you expect it to normalize, but right now, it's not; it's on the…

Yes, it's pretty muted right now.

And then my follow-up was just to understand a little bit more about the consumer trends. I know you've talked in the past that we really haven't seen trade-down on the DIY side at all. I'm just curious if that started to show up as a way. I think you mentioned maybe fewer items in the basket. Could you just double-click on that a little bit?

I think there are a few factors affecting the average transaction size. Some of this is related to the mix of categories, and I’ll explain it in a couple of ways. First, highly discretionary items have faced challenges for some time. Many of these have higher prices, but there are likely slightly fewer items in the cart. This trend has been influenced by the environment and weather conditions. Larger jobs, such as air conditioning work, have definitely been subdued in the spring. These significant tasks typically involve higher expenses with multiple components. When it rains, consumers might buy two wiper blades, while nicer weather encourages tune-ups that require various filters and additional parts. I believe average ticket sizes will improve, although not due to the hyperinflation we’ve experienced over the past couple of years. I am confident they will increase as we progress through the summer and see a better mix of products in response to the current challenging weather conditions.

Given the slowdown in sales that we're discussing, is there anything you think can be done to boost sales trends, or is it mainly about executing well and relying on an improved broader environment? Additionally, if sales remain low for an extended period, would that make you consider another round of price investments, even though that wasn't the original plan? I think a prolonged period of sluggish sales could create that possibility.

Let me start with the first part of your question. Are there things that we can do to improve? The answer is yes. We're currently focusing on enhancing customer service and execution. On the commercial side, we're continuing to invest in hard parts coverage, hubs, and mega hubs, which drive sales. We are also making investments to service customers better and faster, and we are confident in these initiatives. I believe these efforts will help improve our sales execution. The second part of the question...

The second part is on pricing. From a pricing standpoint, as I mentioned before, we've been very disciplined on pricing. We executed around the pricing initiatives a couple of years ago, and it helped us grow our shares and improve our units. We like where we're priced today, and we don't see the need to go move the needle on pricing as a way to go accelerate sales growth. I'll just remind you that the lion's share of the demand in this business is relatively inelastic. This industry has been disciplined about pricing for decades, and we continue to see that being the case. To Phil's point, we're committed and doubling down on our growth initiatives. It's improving the quality of our parts, expanding the assortments with mega hubs, improving delivery times, leveraging technology, and being competitive on pricing. All those are the kinds of things that are driving our business as we move forward, and we're pretty excited about the future.

Our pricing strategy on both DIY; we like where we are, and we believe we have the right strategies on both sides of the business. We made those investments several years ago to right size those strategies. The industry has been very disciplined on pricing over a long period of time, and we don't see that changing.

I just wanted to clarify. I think you mentioned in the prepared comments a mention of store growth. I wondered if that was more of a domestic comment versus an international comment? Should we see an acceleration of store openings here? And we wondered if just with the sheer amount of growth you've seen over the last few years, do you think some of the demand weakness that you're seeing is just due to the sheer volume of what your current store base is handling?

We've talked several quarters ago about our aspirations to expand and accelerate our store growth in the back half of the decade. We historically have built about 150 stores, give or take a few domestically. We think that we can significantly expand that number as we move forward. The drivers there, obviously, are the growth opportunities that we see in DIY, but also a significant growth opportunity in commercial. As we look at that, along with the expanded trade areas in the US, there's an opportunity for us to expand our business domestically. We're going to do that by accelerating our store growth as we move through the balance of the decade. Internationally, we've been extremely pleased with what we've seen in Mexico, and we like the growth prospects that we've seen in Brazil. You've seen what we've posted in terms of same-store sales comp growth now for several quarters. There is an opportunity for us to go faster there as well. So that accelerated store growth is certainly a part of our future growth strategy, and it will help us become a faster-growing business as we move forward. Your comment about the capacity of our stores means one of the things that we've done over time is we've continued to optimize the footprint of our satellite stores and augment that with what we've done with hubs and mega hubs to jam more parts in a local market closer to customers. It's an important part of the growth strategy, both on the DIY and the commercial side of the business. We'll continue to do that as we move forward, which is one of the reasons why we talked about expanding the number of mega hubs we have; our mega hub count will be north of 200 at full build-out.

We just wish the pace were quicker. Establishing new stores involves a lengthy process from signing a contract to when we can actually open and start selling parts. It simply takes longer than we prefer.

A couple of follow-ups from my side. When I look at the gap between your DIY business and the commercial business, it just seems narrower than it's been in the past, certainly pre-pandemic, and that's been happening in the last couple of quarters. If you look at DIY down 1%, it's actually not that different than the range we've seen in the past. So it's really commercial at this lower run rate. I know there's a lot of moving pieces here, but it's more of a macro question, right? Do you think that the commercial end customer is just slowing more? And maybe that's deferral, maybe that's trading down; I'm not sure, but I guess that's really what we're trying to figure out. Is that commercial end customer that may be more middle-income consumer trading down a little bit more?

Yes, that's tough to figure out exactly what's going on in commercial when you start talking about how is the customer migrating up or down the cost curve, if you will. We don't get near the segmentation on the commercial side that we do on the DIY side and the retail side of the business. If you think about whether customers are trading down, I think if you look at some of the segments that we have that are more challenged, thinking of tires, right? Tire purchases could be well north of $1,000 for a customer. That segment has been challenged for sure. Some of the new car and used car dealer segments have been a little more challenged, partly because I think they're not selling as many units. So those two segments have been pressured. If you think are customers migrating down because of bigger jobs or down the good, better, best column, I think that's probably true; they may have normally taken a car to an OE dealer, but do they then migrate to a Firestone or something of that nature, and do they migrate to the UDS customer, or do the job themselves? I think you could see that, but it's very hard to understand how customers move on the commercial side of the business.

I think part of that, as we think of the commercial market in general, that's why we've been focused on this notion that we're roughly a five share in what's approaching a $100 billion market. Despite the fact that big ticket is pressured across all of retail and certainly, a big-ticket purchase in auto parts is not immune to those dynamics. We still have an opportunity to grow significantly in commercial and an opportunity to grow significantly faster. All the things that Phil talked about in terms of our initiatives are the things that we're focused on. If we do those things and execute on them, then that gives us an opportunity to really accelerate our commercial growth as we move forward.

And just on that last point around accelerating commercial, you mentioned a number of initiatives around service and delivery. Can you just help us better understand operationally what is actually changing? Are we adding people, are we adding routes, and just how to think about that? It sounds like you've had some success early on in some of the markets where you have deployed some of these changes. Any sense on the lift they're seeing there that gives you that confidence?

I think we are seeing success. Again, still relatively small in our rollout, and that rollout is not very mature at the moment. But we’re leveraging some technology, leveraging the technology to handhelds and other technology in our stores to be smarter about how we deliver and where we deliver a part from. We're ultimately able to get the part to the shop faster than we were previously and we're leveraging all of the assets we have in the local market to get those parts to a customer faster, and we like the results that we're seeing. We believe that as we roll these out, our sales will improve in those markets. Ultimately, we'll provide better customer service and gain new customers as well as share of wallet with existing customers.

So the first question I have, I know that we've already had a number of questions on commercial, so I apologize for also asking about commercial. But just in the near term, if I heard the prepared comments correctly, it sounded like you expected a bit of strength in here into the end of fiscal '24, the fourth period. So the question I have is, as you look at the business, I think comparisons do get easier. Are there specific sort of building blocks which could help to strengthen the business here in the very near term?

I think you got two dynamics. One, as you mentioned before, is that the comparisons do get a little bit easier in the fourth quarter if you look at our growth-over numbers. The second one is just the initiatives that Phil talked about. I mean we've been really focused on jamming more parts in the local markets, and we've done a great job of doing that, and that's paying dividends for us. We've been focused on service and delivery speeds. If we can win the game in terms of parts availability by jamming those parts in the local market and we can get them to the customer faster, those are things that are going to drive our business as we move forward. Again, we're excited about where we are and excited about the opportunity to accelerate our growth as we move forward. There are always macro challenges that you have to fight your way through, and big-ticket is pressured. But you combine the fact that we're under-penetrated with our full slate of growth initiatives in place; those are the things that get us excited about the future.

My follow-up, again, is a follow-up. But just with respect to the consumer, I mean, you operate in a unique part of retail. A lot of the spend that happens at your stores is not necessarily discretionary, but there's a lot of chatter out there across the consumer about maybe some incremental pressures on the lower-income consumer. The question is, are you seeing that? As you look at your business and the data that’s available to you, are you seeing clearly or somewhat clearly signs of incremental pressure on this core consumer that's affected their shopping patterns?

Big-ticket items have been a challenge for consumers across all of retail, not just for us. As mentioned, significant portions of our business involve essential items like starters, alternators, and batteries. When a car breaks down, those repairs need to be made. While these costs are significant, they are not exorbitant; for example, a starter and an alternator can cost a few hundred dollars. This puts financial pressure on lower-income consumers who must pay out-of-pocket during these tough times. Discretionary spending has been under strain for quite a while. It surged during the pandemic when consumers had extra cash, but the situation has been more difficult for the last 18 to 24 months, and that trend continues. As customers tighten their belts, they tend to prioritize maintenance, knowing that taking care of their vehicles can lead to better performance and long-term savings. Maintenance items gradually gain importance over time. If a car needs repairs to get back on the road, those purchases must be made. We don't offer many options for good, better, or best in our categories; we have a few in brakes and some other areas, but most of our sales come from application parts where there is generally one option, and customers choose that to repair their vehicles. We believe this trend will persist.

Phil, how would you compare and contrast this year for the aftermarket to 2017, which was the last year of challenged trends within the industry? In your mind, is it really just a function of more cooperative weather that will drive an acceleration for the industry from here, or do you think something else needs to happen in order for the backdrop to be more favorable?

It's a great question. I was wondering when the tough weather questions from a winter perspective would come up, and that was kind of that 16% to 17% range you're talking about. It's frankly one we talk about internally all the time. We've had a pretty soft winter weather pattern for the last two years. When I look across the country, this winter pattern, we got some pretty good weather from a precipitation, snow and temperatures in the Midwest. We got very soft weather patterns relative to driving break-fix part failures on the Eastern seaboard. There wasn't a lot of snow in New York, Boston, Philadelphia, D.C., and we didn't have a lot of cold temperatures in those markets. Typically, those have meant undercar and brake categories performed very well when you have those types of seasonal patterns. We didn't get that this year and frankly, didn't get it last year. It’s a little undetermined what happens in a long period of time where you haven't had those weather patterns in that half of the country. I think that is yet to be seen. We don't have the inflation that we had probably back in '17 or '18 and, frankly, over the last two years to be a benefit. I do think we'll get a better mix of categories going into the summer selling season than we've had in Q3. So I don't know if I'm really answering your question. I think that's yet to be seen and I think it will prove out over the next four months or so.

My follow-up question is on the underlying gross margin trend outside of the LIFO benefit. It sounds like the LIFO could be about a $20 million drag in Q4. How much more room do you have to improve the underlying gross margin to offset that type of headwind that you're going to experience, especially as you move into next year where comps could remain uncertain and the market is still expecting double-digit EPS growth?

What I'll say is we've run the gross margin play with intensity, and our merchandising teams and our supply chain teams have done a fantastic job. You saw last quarter; we had this past quarter, we had almost 90 basis points of margin improvement strictly from what we're doing on the merchandising side and what we're doing with the supply chain. I wouldn't suggest those numbers are going to be as high as we move forward. We are coming out of a period where we had some pretty significant inflation that we got some deflation. As we mentioned a little bit earlier, we're not getting the ticket necessarily to help us from a gross margin standpoint. So that will be muted some. But we believe that we'll have the potential to offset most, if not all, of the pressure that you see from a LIFO standpoint.