AutoZone, Inc.

Good morning and welcome to the AutoZone conference call. Your lines have been placed on listen only until the question and answer session of the conference. Please be advised, today's call is being recorded, and if you have any objections, please disconnect at this time. The conference call will discuss AutoZone's third quarter earnings release. Bill Rhodes, the company's chairman, president, and CEO, will be making a short presentation on the highlights of the quarter. The conference call will end promptly at 10 a.m. Central Time or 11 a.m. Eastern Time. Before Mr. Rhodes begins, the company has requested that you listen to the following statements regarding the forward-looking statements.

Certain statements contained in this presentation constitute forward-looking statements that are subject to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. Forward-looking statements typically use words such as believe, anticipate, should, intend, plan, will, expect, estimate, project, position, strategy, seek, may, could and similar expressions. These are based on assumptions and assessments made by our management in light of experience and perception of historical trends. current conditions, expected future developments, and other factors that we believe to be appropriate. These forward-looking statements are subject to a number of risks and uncertainties, including without limitation product demand, energy prices, weather, competition, credit market conditions, access to available and feasible financing, the impact of recessionary conditions, consumer debt levels, changes in laws or regulations, war and the prospect of war, including terrorist activity, inflation, the ability to hire and retain qualified employees, construction delays, the compromising of confidentiality, availability or integrity of information, including cyber attacks, and raw material costs to suppliers. Certain of these risks are discussed in more detail in the risk factors section contained in Item 1A under Part 1 of this annual report on Form 10-K for the year ended August 25, 2018. And these risk factors should be read carefully. Forward-looking statements are not guarantees of future performance and actual results. Developments and business decisions may differ from those contemplated by such forward-looking statements, and events described above and in the risk factors could materially and inversely affect our business. Forward-looking statements speak only as of the date made. Except as required by applicable law, we undertake no obligation to update publicly any forward-looking statements, whether as a result of new information, future events, or otherwise. Actual results may materially differ from anticipated results.

Thank you. I would now like to turn the call over to Mr. Bill Rhodes.

Good morning, and thank you for joining us today for AutoZone's 2019 Third Quarter Conference Call. With me today are Bill Giles, Executive Vice President, Chief Financial Officer, and Brian Campbell, Vice President, Treasurer, Investor Relations and Tax. Regarding the third quarter, I hope you've had an opportunity to read our press release and learn about the quarter's results. If not, the press release, along with slides complementing our comments today, is available on our website, www.autozoneinc.com. Please click on quarterly earnings conference calls to see them. To begin this morning, I want to thank all AutoZoners across the organization for their commitment to our company's pledge, especially putting our customers first in everything that they do. Their passion for living our culture and surprising and delighting customers is our greatest strength. Overall, we were pleased with our performance for the third quarter. Our commercial sales again accelerated from the previous quarter, and we posted the highest sales increase in DIFM since the fourth quarter of 2012. Our DIY business also remained solid. The quarter began very soft as tax refunds were delayed and as late February saw milder weather with significant precipitation. Once tax refunds began in earnest in early March, our sales rebounded nicely and remained pretty consistent for the remainder of the quarter. Yes, heavy precipitation in certain weeks slowed trends in both DIY and commercial, But that's normal in the spring. Ultimately, we were pleased with our sales performance in both retail and commercial for Q3, ending the quarter with same-store sales growth of 3.9%. Now let's focus on the two different customer bases we serve, DIY and DIFM. We previously mentioned that our DIY market share gains were strong in the first half of last fiscal year, and that growth materially subsided in the second half. This year, based upon the data available to us, our share gains are accelerating. While our retail business is far more mature than our commercial business, we were pleased with our performance in Q3 and remain optimistic about the fourth quarter and beyond. Our optimism comes from the inventory availability and staffing initiatives that we have in place. Our constant focus on enhancing the customer service experience is making a difference. As a reminder, last fall we made meaningful wage adjustments to our most tenured hourly auto owners to ensure they were being compensated appropriately and consistent with market trends. We believe these adjustments have and will continue to help us attract and retain high-quality talent that is providing WOW customer service. It's imperative to remember the high-touch nature of this business and the vital role our highly knowledgeable auto owners play to help our customers maintain and enhance their vehicles. Regarding commercial, our sales growth eclipsed last quarter's double-digit gains, increasing 14.9%, marking another great quarter of growth. We are encouraged by this acceleration and it has been focused on a focused effort for us for quite some time. We have been steadily building a stronger foundation and our customers are continuing to notice, recognize, and reward those improvements. Over the last several years, we have improved our product coverage and we've worked diligently to enhance the quality of the parts and products we sell, many under the DuraLast name. Our buying team has done an excellent job in identifying opportunities where our coverage could be improved. where we could improve on the already high-quality parts we have and do it all at a good cost so we can provide our customers a good value. And our sales force continues to do an ever-improving job at communicating our offerings. As I said on our last conference call, we have been increasing the engagement of the store teams, particularly the store managers and district managers with our customers. Yes, they are making sales calls, but they are really making customer service calls. where they can find where we are excelling and do more of it, and also hear our areas for improvement. Rest assured, these women and men know how to drive customer service, and now they have improved visibility on our opportunities. We estimate our market share at roughly 3% of the industry, and we're excited about the significant opportunity to further capture market share. Overall, we are encouraged with our ongoing initiatives. While we have invested more in our auto zoners, inventory, and systems, we have done so with the objective of improving customer-facing activities. While we are never perfect, we believe our execution is improving as we intensify our focus on the customer. I'd also like to remind everyone that last year we highlighted that in Q3 and Q4, we had an abnormal level of category changeovers. a few of which that had not gone as planned and were undergoing substantial changes to our supply chain. While we always have some level of disruption occurring as we make changes to our offerings, this year's level of activity is more normal and substantially below last year. As I mentioned on last quarter's earnings call, our annual operating theme for 2019 is focused on drive for excellence. a relentless focus on what matters to our customers, exceptional service, fast deliveries, high-quality parts and products, flawless execution of changes and product assortments, in-store merchandising, and on and on. As part of this initiative, we have challenged our store leadership teams to reduce the time committed to redundant or non-customer-facing activities. Although early, we have identified opportunities to improve the effectiveness of our auto zoners in performing store tasks ultimately allowing them to increase customer-facing time. Over the course of the last year or so, there's been significant focus on tariffs and inflation. After months of being in a steady state, the United States increased tariffs with China recently. When the first tariffs were enacted in September, we said we were able to negotiate many of the increases away due to the change in the Chinese currency. As the additional tariffs were just added, it is too early for us to know the implications. That said, if we do in fact experience higher costs, it will be our intention to pass those higher costs on to our customers, as has been our practice and our industry's practice for some time. As a result of the tariffs, there has been an elevated discussion of what is happening in our sector regarding inflation. Over many, many years, Our average unit retails have grown at a mid single digit level as the parts and products we are selling have more technology or higher cost materials in them and that makes them last longer. But average unit retail is different than inflation because the former includes new products while inflation is a same skew comparison. Historically, as evidenced by our substantial unrecorded negative LIFO reserve, we generally have experienced deflation in same SKU product costs. This often occurs because as new products are introduced, they are being made in small quantities. As volumes increase, so do efficiencies and costs come down. This year, we have experienced a small amount of inflation while our average unit retails have increased slightly faster than normal. Turning to our omnichannel efforts, we continue to invest in our strategy to enhance the customer shopping experience by meeting them when, where, and how they want to shop. We have initiatives in place to improve our in-store systems and websites, AutoZone.com, AutoZonePro.com, mobile, and all data. We are investing heavily in systems to support these shopping patterns. We continue to see rapid growth in website traffic as well as ship-to-home and buy-online pickup in-store sales. While representing a very small percentage of our business, substantially below 5%, we are pleased with how the customer is embracing all our offerings. Last quarter, we discussed our next day delivery program that allows customers in over 85% of the US markets to order as late as 10 PM and receive their products at their home the very next day. We're even testing midnight cutoffs in a couple of markets. we continue to expand to more markets. And I would be remiss if I didn't say we are working diligently to further enhance our digital capabilities with our commercial customers. The improvements with the online commercial offering will be ongoing, as we know we have ample opportunities for improvement, which, once addressed, will allow us to make inroads with certain customers that have not bought from us in the past, and will allow us to further grow our business with existing customers, many of which are the more sophisticated shops. While ship to home, ship to home next day, buy online, pick up in store, and commercial customer ordering are all showing growth and traffic to our online sites is continuing to increase at rapid rates in our retail business, we continue to see customers primarily doing lots of research online and then coming into the store in order to receive trustworthy advice, fix finder, loan a tool, and a host of other services that simply cannot be duplicated online prior to making the sale. Our efforts in 2019 are to make sure our auto zoners are freed up in stores to provide wow customer service to every one of those customers. In summary, we are pleased with our performance and remain encouraged with our industry strength in both DIY and DIFM, and our prospects for the remainder of 2019. Macro factors have largely been in our favor, and we remain committed to growing our market share in both our DIY and commercial businesses. Now let me provide more detail on the quarter. For the quarter, total sales increased 4.6%, and our domestic same-store sales were up 3.9%. Regionally, our northeastern, midwestern, and mid-Atlantic markets, representing roughly 28% of our store base, performed better than the remaining markets. For our fiscal year, we expect to open approximately 200 new stores, including international, and 150 net new domestic commercial programs. During the quarter, we opened 35 new stores in the United States, and our commercial business opened 43 net new programs. Currently, 85% of our domestic stores have a commercial program, and the vast majority of our international stores have a commercial program. During the quarter, we continued to expand in Mexico, opening eight new stores. We also opened three new stores in Brazil, this quarter finishing with 25. Regarding our inventory initiatives, in the spirit of our Yes, We've Got It initiative, we continued expanding our hub store network. We opened four additional hubs this quarter and now have 174 hub stores and an additional 28 mega hubs, totaling 202 stores with significantly expanded parts assortments. As we have seen both our DIY and commercial sales expand in markets where hub mega hubs are added, we will continue to grow this number of hubs we have this year. Having opened eight hubs already this fiscal year, we expect to open as many as 11 in total for the full year, with most being mega hubs. As a reminder, both our hubs and mega hubs are focused on making available additional coverage to the local markets, meaning adding SKUs that would not have been available locally in the network before. Both the inventory and hub store initiatives are designed to enhance our ability to meet our customers' needs for coverage and immediacy. When we originally launched our mega hub initiative, we said we felt we could open 25 to 40 mega hubs domestically. And as we said, every time we have discussed their performance, they have outperformed our expectations. Today, as a result, we are expanding our expectations for long-term mega hubs to 70 to 90 in the United States. Along with improving our local parts availability and assortment, we continue to manage this organization to provide exceptional service for our customers, provide our auto zoners with a great place to work with opportunities for advancement, and ensure we do it on a long-term profitable basis to provide strong returns for our shareholders. We remain focused on the importance of going the extra mile to fulfill our customers' needs regardless of how difficult the request. Along with our operating theme for 2019, Drive for Excellence, we create key priorities each year. For 2019, these priorities are customers first, commercial acceleration, omni-channel, leveraging technology, and finally, yes, we've got it, inventory initiatives. Adding a little more color to our customers first initiative, we're also making further technology investments to improve our electronic catalog and point of sale systems to ensure we are putting the customer first. We believe our current and future technology investments will improve our competitive position, will make our auto zoners more knowledgeable and efficient, and lead to sales growth across all of our businesses. While these investments are adding to both operating expense and capital expenditures, we feel this will meaningfully improve the customer shopping experience. Our expectation is our business will experience ongoing acceleration in technology investments for the mid to long term. Regarding commercial acceleration, we have been investing in systems to help auto's owners sell more efficiently and customers conduct business with us easier. While most of these initiatives won't be rolled out until late in calendar 2019 or even later, Our focus on increasing the engagement of the broader store team and focusing on existing customers is paying off today. We are quite pleased with our momentum heading into the fourth quarter. We should once again highlight another strong performance in return on invested capital as we were able to finish our third quarter at 34.5%. We continue to be pleased with this metric as it is one of the best in all of Hardline's retailing. However, our primary focus has been and continues to be that we ensure every incremental dollar of capital that we deploy in this business provides an acceptable return well in excess of our cost of capital. It is important to reinforce that we will always maintain our diligence regarding capital stewardship as the capital we invest is our investors' capital. Before I pass the discussion over to Bill Giles to talk about our financial results, I'd like to again thank and reinforce how appreciative we are of our AutoZoners' efforts each and every day. We are excited about all the initiatives we are working on throughout 2019, but everything must start with the effort of our AutoZoners, and especially our field AutoZoners. We only have one shot to make that first impression with our customers, and our team is taking advantage of that opportunity. Now I'll turn it over to Bill.

Thanks, Bill, and good morning, everyone. To start this morning, let me take a few moments to talk more specifically about our domestic retail, commercial, and international results. For the quarter, total auto parts sales, which includes our domestic retail and commercial businesses, our Mexico and Brazil stores, increased 4.7%. For the trailing 52 weeks ended, total sales per AutoZone store increased or $1,814,000. This is up from an average of $1,785,000 at Q3 ending last year. Total commercial sales increased 14.9%. In the quarter, commercial represented 22% of our total sales and grew approximately $80 million over last year's Q3. We are excited to highlight our domestic commercial sales surpassed $10,000 in average weekly sales per program for the first time in history. On a trailing four quarters, we are now selling over $2.4 billion commercially. One metric worth highlighting is the growth rate for commercial sales since 2010. We sold $880 million of goods to professional installers back then, and today we are over $2.4 billion. Our compound annual growth rate has been 30% over this time period, a great accomplishment for our autozoners. We now have our commercial program in 4,831 stores, or 85% of our domestic stores. As Bill mentioned earlier, we remain committed to gaining market share with our commercial customers. We are encouraged by the initiatives we have in place and feel we can further grow sales and market share. Our Mexico stores continue to perform well. We opened eight new stores during the third quarter, ending the quarter with 576 stores. We expect to open approximately 40 new stores for the full fiscal 2019. Regarding Brazil, we now operate 25 stores. We have aggressive plans to open approximately 13 additional stores by the end of the fiscal 2019. Our performance continues to improve. and we remain optimistic about the long-term future of this market. If we can prove success, this market has the potential to be much larger than Mexico, so while challenging, the potential size of the market is significant. Gross margin for the quarter was 53.6% of sales, up 12 basis points from last year's third quarter. The increase in gross margin was primarily attributable to the impact of the sale of the two businesses completed last fiscal year, partially offset by lower margin of goods sold primarily from the shift in mix during the quarter. Although gross margin, excluding the impact from the two business units, was slightly below our expectations for the quarter, we continue to see opportunities to lower our costs through direct sourcing, albeit mix of goods sold can affect margin in any one quarter. And we do want to point out that promising an ever-increasing gross margin is just not possible. For example, As we have ongoing pressures from the acceleration and the growth of our commercial business, which is a good problem to have, we must continually look for ways to show margin improvements. But this is not a new phenomenon. We are committed to taking costs out of our business where appropriate. While we are asked about gross margin assumptions and the direction they will be headed, our primary focus has always been growing absolute gross profit dollars in our total auto parts segment. SG&A for the quarter was 33.9% of sales, higher by approximately 96 basis points from last year's third quarter. On the cost front, we highlighted on the last few quarter's conference calls the investments we would be making, specifically wage rates and technology for this fiscal year. The deleverage for this quarter was primarily driven by our planned domestic store payroll, which negatively impacted operating expenses by 69 basis points. For the fourth quarter, we feel the consensus numbers for SG&A generally reflect those investments. For those folks that haven't begun to model the upcoming quarter, we have an additional week of results. We encourage everyone to look to the last time we had a 53rd week, which was Q4 of 2013, as a litmus test for modeling. EBIT for the quarter was $547.5 million. Our EBIT margin was 19.7%. Interest expense for the quarter was $43 million, up slightly from Q3 a year ago. With the new bonds we sold this past quarter, we are planning interest in the $62 million to $64 million range in the fourth quarter of fiscal 2019 versus $54.3 million last Q4. Our higher forecast than last year includes our assumptions for the extra week of interest. Debt outstanding at the end of the quarter was $5,152,000,000 or approximately $200,000,000 above last year's Q3 ending balance of $4,955,000,000. Our adjusted debt level metric finished the quarter at 2.5 times EBITDAR. While in any given quarter we may increase or decrease leverage metric based on management's opinion regarding debt and equity market conditions, We remain committed to both our investment-grade rating and our capital allocation strategy, and share repurchases are an important element of that strategy. For the quarter, our tax rate was 19.5%. Now, along with tax reform, we benefited approximately 260 basis points in our rate from stock options exercised during the quarter. Excluding this benefit, our rate was 22.1%. For the fourth quarter, we are modeling 23.5% before any assumptions on credits due to stock option exercises. Because we cannot effectively predict this activity, we remain committed to reporting the benefit of any stock options mean to the cumulative tax rate. Net income for the quarter was $405 million, $900,000, up 10.7% over last year. Our diluted share count of $25.4 million was down 7.1% from last year's third quarter. The combination of these factors drove earnings per share for the quarter to $15.99, up 19.2% over the prior year's third quarter. Relating to the cash flow statement, for the third quarter, we generated $470 million of operating cash flow. Net fixed assets were up 5% versus last year, Capital expenditures for the quarter totaled $118 million and reflected the additional expenditures required to open 46 net new stores this quarter, capital expenditures on existing stores, hub and mega hub remodels or openings, work on the development of new stores for upcoming quarters, and information technology investments. With the new stores open, we finished this past quarter with 5,686 stores in 50 states, the District of Columbia and Puerto Rico, 576 stores in Mexico and 25 in Brazil for a total auto zone count of 6,287. Depreciation totaled $86.7 million for the quarter versus last year's third quarter expense of $79.8 million. This is generally in line with recent quarter growth rates. We repurchased $466 million of AutoZone stock in the third quarter. At quarter end, we had $1,169,000,000 remaining under our share buyback authorization, and our leverage metric was 2.5 times. Again, I want to stress we managed to appropriate credit ratings and not any one metric. The metric we report is meant as a guide only as each rating firm has its own criteria. We continue to view our share repurchase program as an attractive capital deployment strategy. Next, I'd like to update you on our inventory levels in total and on a per store basis. The company's inventory increased 8% over the same period last year, driven by new stores and increased product placement. Inventory per location was $688,000 versus $658,000 last year and $690,000 last quarter. Net inventory, defined as merchandise inventories less accounts payable on a per location basis, was a negative $58,000 versus a negative $48,000 last year and a negative $58,000 last quarter. As a result, accounts payable as a percent of gross inventory finished the quarter at 108.5%. Finally, as Bill previously mentioned, Our continued disciplined capital management approach resulted in return on invested capital for the trailing four quarters of 34.5%. We have and will continue to make investments that we believe will generate returns that significantly exceed our cost of capital. Now, I'll turn it back to Bill Rhodes.

Thank you, Bill. While we had a strong sales quarter, we know we have much work to do to finish this year strong. The summer months generate a large percentage of our annual sales, and we'll be opening up a substantial portion of our new stores, commercial programs, and mega hubs during the fourth quarter. We also have a lot of deliverables from our IT initiatives this upcoming quarter. We remain focused on simplifying our store autos owners' workloads to reduce clutter and unnecessary tasks that get in the way of making the customer experience better for both the do-it-yourself customer and the professional customer. We believe our industry's fundamentals will remain strong as miles driven are expected to increase over the remainder of the year. This upcoming quarter, we are laser focused on executing our game plans. We're excited about our balanced model for growth around domestic retail and commercial, international, online, and pickup in-store. We believe our hubs and mega hubs, Mexico, Alldata, and digital, can all grow their top lines for the remainder of 2019. To execute at a high level, we must adhere to living the pledge. We cannot and will not take our eye off of execution. Success will be achieved with an attention to detail and thoughtful execution. Service has always been our most important cultural cornerstone, and it will be long into the future. Our charge remains to optimize our performance regardless of market conditions and to continue to ensure we are investing in the key initiatives that will drive our long-term performance. In the end, delivering strong EPS growth and ROIC each and every quarter is how we measure ourselves. This formula has been extremely successful over the last 40 years, and we continue to be excited about our future. Now we'd like to open up the call for questions.

Thank you. And we have our first question. It's from Christopher Horvath of JP Morgan. Chris, your line's open.

Thanks. Good morning, everybody.

Good morning.

Can you talk about the Megahub expansion? You're roughly doubling the target. So a couple questions there. Is the list that you're seeing... better than what you saw prior in any quantification? And then, you know, just structurally, is this a market expansion, i.e., you were targeting 40 markets, now you're going to 80, or are you actually building in density that cuts drive time to replenishment, you know, satellite stores and directly fulfill more customer orders?

Yes, terrific question, Chris. It's both, frankly. We will be adding mega hubs in smaller markets than we envisioned originally, and we'll also be adding to density in some of the largest markets. As we've said all along since we've introduced these mega hubs, they continually have outperformed our expectations. So, frankly, the analysis that we did four or five years ago when we started them said we could only do 25 to 40. As they've their performance has improved, they've allowed us to go to these other markets.

Understood. And then in terms of the commercial business, Bill, you mentioned that you were quite pleased with the momentum heading into the fourth quarter. Sorry to parse this out, but is that a comment on April and the strong finish to 3Q, or is that a comment on May? Because arguably, you know, April is, I think, one of the easiest comparisons of the year, and May flips up to be one of the hardest.

Yeah, and I don't really want to get into too much on week-to-week comparisons. As you know in this business, Weather matters, especially on a weekly or geographic area, certain geographies. I don't want to spend too much time on it. We feel confident that we're continuing to build momentum in the commercial business. Now, when you talk about comps, we are up against tougher commercial growth in the fourth quarter of last year. That's not lost on us. But this isn't about a quarter or two. This is about a long-term growth model.

Understood. And one quick last one. On the gross margin, was there a benefit from lower product acquisition costs that offset some of the mixed headwinds the past two quarters? I think it was about 40 basis points of lower product acquisition costs.

A little bit, but, I mean, we still had some inflation, as Bill mentioned, overall. I think probably the one thing that impacted gross margin, as we highlighted, was just the increased penetration of the commercial business overall. But, you know, we continue to believe there are opportunities within gross margin markets to lower acquisition costs as we continue to increase our direct importing activity. Understood. Best of luck, guys. Thank you, Chris.

Thank you. Our next question is from Simeon Gutman of Morgan Stanley. Simeon, your line's open.

Thank you. Good morning. One follow-up to the prior question on the expansion of the 70 to 90 mega hubs. Because you have momentum in the business, in the commercial business, and you're densing up these markets, Can you talk about the cost, and I guess the presumption is it feels like the incremental cost here could be a little bit less because these are more fold-out as you dense up markets. Is that a fair assumption, and can you just talk about the cost in general?

First of all, I'd say as we rolled out the ones that we have today, we haven't called out the mega hub cost as a significant contributor to our cost structure. Clearly, it's more expensive. The first ones that we did, we were able to go into, in many cases, existing excess space that we already had. As we go to the next ones, we'll be having to take down a little bit more real estate or additional lease space next to a store that we already have. So there will be costs, but I don't think it will be meaningful costs that we're calling out as a key contributor to our performance.

Okay. And then my follow-up is on gross margin. Bill, you just mentioned that you should still benefit somewhat from lower acquisition costs. But does the mix of commercial offset that, such that gross margin should now decline? And then, in general, is there a relationship between some rate of commercial sales growth to GM that's sort of proportional as we think about, you know, as the commercial business continues to grow rapidly?

Yeah, that's a good question. I think that it will be a function of how fast commercial continues to grow. So that will continue to put a little bit of pressure on us. You know, look, the way we think about it is our margin overall is relatively healthy across our businesses. We continue to have opportunities to improve it, but we recognize that one of our lower margin businesses is growing significantly faster, and we're thrilled with that. That's exactly our objective, and that's exactly what we're trying to accomplish.

Okay, thanks, and nice result. Thank you.

Thank you. Our next question is from Seth Sigmund of Credit Suisse. Seth, your line is open.

Hey guys, good morning and congrats on the quarter. Two follow-up questions, one on the hub strategy. Just remind us what held back the rollout previously and what's changed? I mean, you talked about strong results, but we just love some more color on whether there were some real estate constraints or just how you were thinking about that. And what percent of the store base today is being affected by the hub strategy and what will that look like when you hit the 90?

Yeah, as we expand further, from 25 to 40 to 70 to 90, it's not going to add a substantial amount of additional stores to have access to that inventory. Over 90% of our stores today have access to the MegaHub inventory. What it will do is it will shorten the lead time. Many of those stores today will get it on three-time-a-day basis. Some of them will get it once-a-day basis, and others will get it overnight. As we expand this, we will go to more stores that have access three times a day and fewer stores that have access overnight. But there will always be stores that have access overnight because they're simply too far from the mega hub. I think what held us back, frankly, we would love to be farther along the mega hubs today. The big challenge with this is these are big boxes and they take time to find the right real estate and to develop that real estate. We will have the same experience as we go from our 28 today up to 70 to 90. It will take us some time. I would say what changed was the economics changed. We are getting more productivity out of the existing box of the mega hub itself, and we're getting more productivity out of the stores that are adjacent and feeding off of that box, particularly the stores that have access three times a day or in the local markets. So just the economics changed and made it more beneficial for us to do it.

That's great. Thank you. My follow-up question is on the SG&A front. You talked about this year being an investment year. It seems to have played out largely as you expected and talked about earlier in the year, and it's nice to see how that's translating into top-line gains. Do you think that this year is the peak for investments and that we should be thinking about SG&A growth next year being less than this past year?

Yeah, I think that this year is a peak. I think we'll have some overlay next year. Keep in mind that many of the investments that we put in place last year really kicked in at the very end of Q1 of this year. So we will wrap that around a little bit in Q1. But yes, I think that the investments will peak out a little bit this year and will continue to moderate as we move forward.

I do think, and I commented earlier, we're going to have increased technology spending for the foreseeable future. And today I think we're also continuing to see that the wage market is probably different than it was five to seven years ago because you have the regulated markets that are continuing to march towards $15 an hour. And then you have other markets that there are market pressures from other retailers that are moving those wages up. So I think we will continue to have, not at the level that we experienced this year, but I believe we will continue to have wage pressures and information technology accelerated spending.

Okay, understood. Thank you.

Thank you. Our next question is from Michael Lasser of UBS. Michael, your line is open.

Good morning. Thanks a lot for taking my question. As you make these investments in your stores to better position the company for commercial growth, are you equipping the stores with any tools to allow them to engage with the commercial customers, such as allowing them to do things like introductory pricing so that the commercial customers can try AutoZone and help you supplant some of the existing relationships?

Yeah, I would say that probably one of the primary things that we're focused on is making sure that we are easy to do business with. And so whether that be returning product, paying bills, looking at account information, making sure they have all the product information that they need, their history, et cetera, that's probably the first place we're starting. We always have opportunities to be able to introduce new customers to pricing depending on their spending level. And so a new customer may be able to get better pricing if they have a commitment on certain spending level. not unlike existing customers as well. So there's opportunities for those, but the bigger play is really our ability to connect with a customer, have a more personal relationship with them, both electronically as well as having our field people out talking to the commercial customers every day and being able to be an easier place to do business with.

Bill Jobs, if you look five, ten years from now and your commercial business represents 30% of your mix rather than 20%, what would the operating margin of the business look like?

Well, depending on what happens in a lot of other factors, then you would have to assume it would be slightly lower than it is today just from a math perspective. The commercial business does operate at a lower margin. But if we can grow that at that rate, that would be outstanding because we would really be driving operating profit dollars.

Okay. Thank you so much.

Thank you. Our next question is from Brian Nagel of Oppenheimer. Brian, your line's open.

Good morning. Good morning. Congrats on the next quarter. Thank you. So I had a couple questions here. I know we've already discussed quite a bit the commercial sales growth, but maybe to drill down a little bit further, here in this quarter we had year-on-year growth nearly mid-teens, and that's represented an acceleration from high single digits not that long ago. Is there a way to, with all the initiatives you have in place, that you can look at that and say what factors in particular have helped to drive that further acceleration in sales growth from an already decent level? And how should we think about the sustainability of that growth rate in the coming quarters?

Terrific question, Brian. You know, I would tell you that it's the culmination of about four years worth of very focused work. If you recall, we re-upped our strategy in 2008 and had a nice run with it. And then about four years ago, we knew we had to come up with the next leg of what our strategy looks like. We did a tremendous amount of work, most focused on improving our product assortment, leaning into the commercial business. We did things like multiple frequency of delivery. We expanded and improved the assortment that we have in our satellite stores and in our hub stores. We added mega hubs, which we didn't have four or five years ago, and on and on. We've really improved the product assortments, focused very much on commercial. Then over the last year, and we're beginning to annualize that right now, we really ramped up the engagement of our store operating teams. I will put our operating teams up against anybody out there. They can execute like nobody's business. And we really took that execution focus and dialed it into commercial. where before, for the most part, the commercial sales manager and the TSM were the direct contact with the customers. Now we've enhanced that by adding the store manager and the district managers. And our store managers are phenomenal customer service people. And when they're going out making these sales calls, they're finding out what are we doing right and where do we have opportunities for improvement. And they're coming back and leading the store team in that direction. So that's, to us, what has enhanced our performance.

That's very helpful. The second question I have, the follow-up question, a different topic, with regard to tariffs. You mentioned in your prepared comments that, basically, with the pricing power you have, and given your history and given the nature of the business, that makes a lot of sense. But the question I have is, I mean, I guess twofold. One, this reminds us how much exposure from a sourcing perspective AutoZone does have to China or to tariff affected categories. And then second, having been with the business for a while now, have there been instances where, for one reason or another, AutoZone was not able to effectively pass along costs to consumers?

I'll start with the latter question, not that I can think of off the top of my head. And we have dealt with, over many, many years, significant increases because so many of the products we sell are significant commodity-based products. So we've dealt with oil shocks. We've dealt with lead price increases. We've dealt with steel price increases. Many times those have come pretty quick, and we have been able to pass those costs along to our consumers. Let me be the first to say, we are not pleased about the tariffs. We are concerned about what that will do, not so much to AutoZone or our business, but more to what it would mean to the U.S. economy. But we have a strong history of being able to say, okay, we can pass those on to our customers. It's one of the beauties of being in a relatively inelastic demand business.

as far as the exposure to China-sourced products?

Yeah, you know, that's a very difficult question to say. We have a significant amount of products that come out of China. We don't direct import a ton, less than 10%, but we have a lot of importers that bring it in from China, and then you also have a lot of our products where the components are being manufactured in China and the products are being assembled here. So we have, you know, significant exposure to to products that are sourced from China, whether we do it or somebody else does it.

Thank you very much. Congrats again.

All right, thank you. Have a great day.

Thank you. Next question is from Brett Jordan of Jefferies. Brett, your line is open.

Hey, good morning, guys. Good morning, Brett. Just a question on the regional performance. You talked about the Northeast, Midwest, Mid-Atlantic being the strongest. Could you give us sort of a feeling for what the spread was to the weaker regions?

You know, it wasn't as significant as it has been in quarters where we've had a lot of divergence, but it was probably in the 100 to 150 basis point range. Okay. And what might have been the softest region in the country? I would say probably, you know, to be honest with you, it was really pretty even across the country. I told you it was 100 to 150 basis points between those ones that we highlighted and the ones that we didn't. But otherwise, I would say for the most part, you know, take the big geographic areas of the country. It was pretty healthy across most of the country, so it was pretty encouraging.

The one places where it wasn't healthy were the markets that were impacted by hurricanes the previous year and were lapping those significant growths. So that's Puerto Rico, Houston, South Florida, all those areas. That was where we were the weakest.

Okay, great. And then a follow-up. On the commercial business, I guess $2.4 billion, how would you categorize that mix, sort of national versus one-off commercial customers?

We really haven't gotten into specifics on the mix of what it is, but the growth of both of them were very encouraging. Our up and down the street business is growing very well, and our national account business is growing well also. Okay, great. Thank you. Thank you.

Thank you. Our next question is from Gregory Malik of Evercore ISI. Greg, your line is open.

Hi, thanks, guys. Great quarter. I guess what I'd love to know is a little bit more detail on traffic versus ticket in total. And if you give us a breakdown on do it for me versus DIY, that would be great.

Yeah, we really focus the most on traffic and ticket in the DIY business. Obviously, we're growing both in the commercial side of the business. Our DIY traffic and ticket trends were not significantly different than they have been. We have a longstanding challenge with transaction count. and that's being made up with a longstanding growth in average ticket. Those trends were not meaningfully different this quarter than they have been.

And maybe if I missed it before, last year you'd turned off some of the promotions in online, and then you brought them back. Remind me when you cycle when you turn that off and sort of any incremental color on the online pickup trend. especially with the FedEx Next Day delivery?

Yeah, we turned them off, I think, around February 1st, and we turned them back on in the latter part of August. And they still stay on today. The FedEx Next Day delivery program has really been a great addition to us. It's not the biggest program. I said in our prepared remarks that our total digital business is less than 5%, substantially less, But it's been a nice addition, and it's been a great way for us to surprise and delight customers. So we've been very pleased with that.

That's great. Good luck, guys.

All right, thank you. Thank you. Our next question is from Daniel Imbrow of Stevens, Inc. Dan, your line's open.

Thanks for taking my question. I wanted to start on the market share comment, both in the press release and in your remarks. Obviously, your growth is accelerating and outpacing the industry. Bill, it sounded like in your prepared remarks it was more on the DIY side, but wondering if you could provide some more color on where you think you're winning that share from, both on the DIY and the commercial side. Is it still the smaller independents, and is that a trend you see continuing over the next 12 months?

Terrific question. Yeah, first, on the commercial side, it's pretty clear that we're taking substantial market share. If the market's growing 4%, 4.5%, and we're growing close to 15%, then that's a pretty significant change. You know, and a lot of focus on the commercial side comes what's happening with us and our close-in competitors. I would change the dialogue. If you added the big three together, we only have about 10% market share. There's 90% other market share out there. And to me, that's where our focus needs to be is how do we enhance our position so that we can grab more and more of that market share over time. And I think the mega hubs play perfectly into that as we're substantially changing performance Our product assortment in the local market, that's taking away an advantage that was typically held by the warehouse distributors. On the retail side, we are continuing to see that our share gains are accelerating. They're not massive, but they are accelerating. Clearly, the entire industry has taken share away from the mom and pops over a long period of time. If you look at the number of outlets that sell parts in the United States, it's been around 35,000. outlets since I got in this business almost 25 years ago. That doesn't change. What doesn't change, even though us and our competitors are opening more and more programs, there's a natural consolidation that happens on the independent side. Will it continue for the future? We certainly hope so.

That's helpful. And then as a quick follow-up to an earlier answer, you guys sound confident in the ability to pass along procurement cost pressures, but if wage pressures continue to accelerate in the coming years like it sounds like you expect them to, and every one of the industries facing that headwind, how is the industry's ability changing to maybe pass along those cost pressures to the consumer and offset some of that margin pressure with retail?

Yeah, I think it all goes into the same bucket. I mean, it's an input cost to overall cost, and it'll probably contribute to general inflation. If we see a lot of wage pressure, it won't be just about AutoZone. It'll probably be general inflation across the U.S. industries. So, again, history would imply that we have some successful – both individually as in the industry, and passing along increased costs to the consumers. So that's what we'll continue to focus on. But, yeah, there will continue to be cost pressures, whether it be wage rates, interest rates, utility costs, or whatever.

Great. Thanks so much, guys. Best of luck.

Thank you. Thank you. Our next question is from Mike Baker of Deutsche Bank. Mike, your line is open.

Hi, thanks. I wanted to ask about the gross margin. So you said it was below plan. So was that on the mix? And is that mixed the commercial business or are there other products within the DIY or commercial that are causing that negative mix? And I guess to add to that, we get that commercial would hurt the margins, but your commercial business has been up double digits each of the last two quarters. Yet your gross margins were up, you know, I think 90 and 115 base points or something like that. So what was different this quarter?

Yeah, keep in mind when it was 90 and 115 basis points, you had probably about a 70 basis point plus impact from auto anything and IMC. So, you know, but I hear the question. So I would say that, yeah, some of it was product mix as well. And some of it is customer mix as well within commercial. But I would say overall that our margin was probably a little below what we expected, but not significantly. So, you know, we'd expect there to be a little bit of pressure as the commercial business continues to grow, and we expect to find opportunities to try to offset that with improvements through our merchandising organization.

Okay, that makes sense. And if I could ask one more follow-up, and maybe this isn't something that you're willing to answer, but for the past three quarters, your two-year stack comps have been in a really tight range of about 4.5% to 5%, which is a lot better than it had been in 2017 and 2018. So do we think about that as sort of the new normal? Is that how we should think about your business going forward? In other words, comping in the mid to high two range, depending on the comparison?

Well, I would say, first of all, that in the 2017 and 2018 time period, there was a lot of focus on the fact that our sales trajectory had changed radically. and I've spent a lot of time talking about how tight the band of our sales performance has been since 2013. It's really within a couple hundred basis points. We're going to have really good quarters, and we're going to have more challenging quarters, but they're still going to be within a pretty tight band. The one difference that we have today, and we'll see if it's sustainable or not, is we are growing our commercial business at a much accelerated rate. If you talk about 2017 and 18, we went down into single-digit growth there. Now that we've had it in double-digit, and this time close to 15%, that's making a meaningful difference. We will have to see if we can sustain that level or even continue to grow it from here. That will be the question. Okay. Thanks for the call. I appreciate it. All right. Thank you. Have a great day.

Thank you. And I would like to hand the call over back to Mr. Bill Rose.

Thank you. Before we conclude the call, I'd like to take a moment and call out that we will celebrate AutoZone's 40th anniversary on July 4th. The old adage rings true that we've come a long way since back then, but in the spirit of our founder's vision, we remain focused on providing exceptional service and going the extra mile. Our business model continues to be solid, and we are excited about the rest of the year. We do not take anything for granted as we understand our customers have alternatives. We will continue to execute on our game plan, but I want to stress that this is a marathon and not a sprint. As we continue to focus on the basics and focus on optimizing long-term shareholder value, we are confident AutoZone will continue to be successful. We thank you for your interest in our company and for participating on today's call. And in recognition of the upcoming Memorial Day holiday, we want to recognize and say thank you to those who have served our country past and present. We are grateful for the freedoms your service has ensured. Have a great day.

Thank you, and that concludes today's conference. Thank you for participating. You may now disconnect.