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. If you have any objections, please disconnect at this time. This conference call will be discussed AutoZone's 2nd Quarter Financial Results.
Bill Rhodes, the company's Chairman, President and CEO, will be making a short presentation on the highlights of the quarter. Conference call will end promptly at 10 am Central Time or 11 am Eastern Standard Time. Before Mr. Rhodes begins, the company has requested that you listen to the following statement regarding forward looking statements.
Certain statements contained in this presentation are forward looking statements. Forward looking statements typically use words such as believe, anticipate, should, intend, plan, will, expect, estimate, project, position, strategy and similar expressions. These are based on assumptions and assessments made by management, have had to experience a 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, credit market conditions, the impact of recessionary conditions, competition, product demand, the ability to hire and retain qualified employees, consumer debt levels, inflation, weather, raw material costs to our suppliers, energy prices, war and the prospect of war, including tariffs activity, construction delays, access to available and feasible financing, the compromising of the confidentiality, availability or integrity of the information, including cybersecurity attacks and changes in laws or regulations. Certain of these risks are discussed in more detail in the Risk Factors section contained in Item 1A under Part 1 of the Annual Report on Form 10 ks for the year ended August 27, 2016, 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 the risk factors may materially and adversely affect our business. Forward looking statements speak only as of the date made. Except as required by applicable law, we undertake no obligation to obtain publicly any forward looking statements, whether as a result of information, future events or otherwise.
Actual results may materially differ from anticipated results.
Now I'll hand the call over to Mr. Bill Boats. You may begin.
Good morning. Thank you for joining us today for AutoZone's 2017 Q2 conference call. With me today are Bill Giles, Executive Vice President, Chief Financial Officer and IT and Brian Campbell, Vice President, Treasurer, Investor Relations and Tax. Regarding the Q2, I hope you've had an opportunity to read our press release and learn about the quarter's results. If not, the press release, along with slides complementing our comments today are available on our website, www.autozoneinc.com.
Please click on quarterly earnings conference calls to see them. To begin this morning, I want to thank all AutoZoners across the company for their tremendous efforts during what ultimately resulted in a challenging quarter. Our results this quarter were below our expectations due largely to delay in tax refunds this year compared to last. Unfortunately, our performance this quarter ended our remarkable string of 41 consecutive quarters of double digit growth in earnings per share. While this is clearly disappointing, I want to recognize and acknowledge the incredible performance of our teams across the company for delivering this virtually unheard of level of consistent performance for over a decade.
Our sales increased 1.4% for the quarter, but domestic same store sales were flat. It's worth highlighting the 1st 9 weeks comp sales were up 2.2%, while the last 3 weeks comp sales declined 6.3%. And unfortunately, the last week was materially weaker than the other 2 weeks. As a result of these weaker than expected sales in the last few weeks, we ended the quarter with flat same store sales. In an effort to provide a little more color, our sales through the Christmas holiday season were quite strong.
Remember, prior to Christmas, we had some significant winter conditions, but our sales as expected were strong. After Christmas, the weather was much more mild with minimal snow and ice in the Midwest, Northeast and Mid Atlantic. During this period, our sales growth moderated. Then as noted above in the last 3 weeks, when we began lapping the beginning of last year's tax refund season, our same store sales declined fairly significantly. Late last year, the IRS announced that in an effort to combat fraudulent tax refund filings, they would be delaying the issuance of refunds associated with returns claiming the earned income tax credit.
Unfortunately, the timing of refunds typically begins in the last 2 or 3 weeks of our 2nd quarter. And this year most of the refunds were delayed until after our quarter concluded. As context, as of the end of our quarter this year, the IRS had issued $24,000,000,000 in tax refunds compared to last year when they had issued $70,000,000,000 This delay clearly created a material headwind this past quarter, but all indications are that total tax refunds for the year will be generally consistent with last year. Our expectation is we have shifted some sales from Q2 into Q3. Regarding regional discrepancies, our Northeast, Mid Atlantic and Midwestern stores performed slightly better for the quarter than the remainder of the country.
As a reminder, our Northeast, Mid Atlantic and Midwestern stores represent approximately 25% of our overall sales. Clearly, this year we experienced more winter conditions early in the quarter than we did last year. But we expected the winter conditions to be more pronounced and last longer. We are exiting this winter with 2 consecutive fairly mild winners. In regards to our 3 primary merchandise categories failure maintenance and discretionary merchandise, we experienced similar slowing trends across all three categories during the last 3 weeks of our quarter.
The majority of our sales are in the failure category and close behind is maintenance. The deterioration in the last 3 weeks also drove our retail traffic count down for the quarter, while our average ticket trends were consistent with Q1. During the quarter, we opened another 33 new stores in the United States. We expect to open approximately 160 new domestic stores in fiscal 2017. Our commercial business continued to expand with 7.2% sales growth over last year's Q2, while opening 12 net new programs.
We expect to open approximately 200 net new commercial programs for the fiscal year or approximately 150 additional programs for the last two quarters of the year. At the end of the quarter, 83% of our domestic stores had a commercial program and we continue to expand in Mexico, opening 3 new stores. We didn't open any additional IMC branches this quarter, but we did open 1 new store in Brazil. While the domestic business dominates our sales mix, it continues to be our primary focus. We believe we have great growth opportunities outside of the U.
S. Regarding the Internet, we experienced improving trends versus our Q1 as our results improved sequentially as the quarter moved along. When I discuss online, I'm referencing business shipped directly to the customer and not buy online and pick up in store. Our pick up in store business sales are recorded in store sales and are not in our all other category. Our pickup in store business continues to grow rapidly, up over 20% for the quarter.
Under the yes we've got it thing, we are focused on improving our store closure rates. While our winter quarter is our is a lower volume quarter, we still see plenty of examples of not being able to say yes to product requests because we didn't have or couldn't find what the customers needed within our network. In the spirit of satisfying our customers, we are making ongoing significant system investments and enhancements. We capture data about our customer shopping patterns across all of our platforms. We understand we have to be able to share information and process seamlessly between our stores, commercial shops, phone and online experiences in order to meet all of our customers' needs.
As our primary objective remains growing our domestic retail and commercial businesses, we continued with our inventory availability initiatives in order to respond to the ever increasing challenge of parts demand in the industry. This past quarter we rolled out 2 additional mega hub locations and now have 13 in operation. We are working diligently on the development of future sites and we expect to open approximately 5 more over the remainder of fiscal 2017. Our mega hubs continue to exceed our expectations. Additionally, we are continuing development on our 2 new distribution centers based in Washington State and Florida and we're expanding our distribution center in Illinois.
Our current expectations are for the Washington State facility to come online in late fiscal 2017 or early 2018, while the Florida facility will open 6 to 12 months later. For your modeling purposes, each new distribution center is expected to cost approximately $60,000,000
Now I'd like to take
a moment to go into detail on our inventory availability initiatives. These are 2 very discrete and different strategies addressing different opportunities. Multiple frequency delivery is solely focused on improving the in stock levels for the SKUs that are stocked in our stores. And the mega hubs are focused on adding additional coverage to the local markets, meaning adding SKUs that would not have been available locally in our network before. Regarding multiple frequency of deliveries, we had roughly 2,200 stores receiving 3 or more deliveries per week at the end of Q2.
This quarter we added just over 100 additional sites as we tempered our rollout to focus on standardizing our operations and refining some of our methodologies.
This has
been a considerable change and we haven't yet been able to fully achieve our desired results on a variety of fronts. As you remember, up until recently, we've serviced the vast majority of our stores once a week. All of our systems, processes and practices were focused on the cadence of these activities being once a week. This past quarter's deleverage was generally as expected, but still a bit higher than we thought at the beginning of the quarter due to the softness in sales at the end of the quarter. Once we open our new distribution centers, it will allow us to alleviate some of the cost pressures.
We continue to model 15 to 20 basis points of gross margin headwind from this initiative in 2017. The second ongoing initiative is a mega hub store concept. We're currently operating 13 mega hubs. We are very excited about what the mega hubs allow us to offer customers. As a reminder, these supersized AutoZone stores carry 80,000 to 100,000 unit SKUs, approximately twice what a hub store carries today.
They provide coverage to both surrounding stores and other hub stores multiple times a day or on an overnight basis. Our sales results thus far in our open mega hubs continue to exceed our expectations. Currently, we have just over 3,009 100 domestic stores with access to MegaHub inventory. A majority or about 2 thirds of those 3,900 stores receive their service on an overnight basis today. But as we expand our M Mega hubs, more of them will receive this service same day and many will receive it multiple times per day.
We expect to ultimately operate 25 to 40 mega hubs once the implementation is complete. The constraint on the speed with which we can open these is availability and location of real estate. While an average AutoZone location is just under 7,000 square feet, a mega hub is 20000 to 30000 square feet or even more. Identifying and developing these locations in prime retail areas is challenging and it takes time. While there are incremental cost of these rollouts, we continue to feel these investments will provide a better customer experience and increased market share.
Our current assumption on this rollout is that we won't experience meaningful deleverage from this initiative in fiscal 2017. Along with improving global parts availability and assortment, we continue to manage this organization to provide exceptional service for our customers, provide our AutoZoners with a great place to work with opportunities for advancement and ensure we do it on a profitable basis to provide strong returns for our shareholders. We will continue to stress the importance of going the extra mile to fulfill our customers' needs regardless of how difficult the request. Regarding Mexico, we opened 3 stores this quarter and now have 491 total stores. In local currency, Mexico experienced another solid quarter.
However, Mexico sales in U. S. Dollars declined given the decrease in the value of the peso to the U. S. Dollar.
As our peso financial results are converted to U. S. Dollars on an average rate over the quarter, we continue to experience headwinds to our net earnings as a result. Based on exchange rate differences this year to last, we experienced an $0.18 headwind to EPS this past quarter alone. Sales in our other business for the quarter were down 3% over last year's Q2.
As a reminder, all data and e commerce businesses, which includes autozone.com and AutoAnything make up this segment of sales. This compares to being down 4.2% last quarter and reflects stronger performance in autozone. Com's business for Q2. As I previously mentioned, we continue to see 20% plus growth in our buy online pickup in store sales. This strength in pickup in store encourages us to continue investing
in our in store
experience. Pickup in store while smaller than home delivery is quickly catching up in sales volume. We recognize that the majority of our site traffic is providing information to our customers prior to purchase. And our e commerce platform represents an important part of our omni channel experience. We see customers doing lots of research to learn about the products and on how to do repairs.
While these businesses are small for us at less than 5% of our total sales, the omni channel experience is important and we will continue to invest in our e commerce platform. With the continued aging of the car population, we continue to be optimistic regarding trends for our industry in both DIY and DIFM. As new vehicle unit sales are reaching all time highs and gas prices on average remain subdued, miles driven continued to increase. The lowering consumer benefits the most from lower gas prices relative to income. This trend remains encouraging.
Regarding our expectations for the remainder of 2017, we expect performance to improve in Q3 if for no other reason than the shift in timing of income tax refunds. As we exit a disappointing performance in Q2, we are reinforcing to ourselves that we must continue to focus on both short term and long term performance and we will be keenly focused on delivering continuing to deliver consistently strong performance. Now let me review our highlights regarding execution of our operating theme for 2017. Yes, we've got it. The key priorities for the year are great people providing great service, profitably growing our commercial business, leveraging the Internet, Yes We've Got It and leveraging information technology.
On the retail front this past quarter under the great people providing great service thing, we continued with our intense focus on improving execution. While we've been adding store payroll this year, we're now enhancing our training to store level AutoZoners and increasing the share of voice regarding availability and the Yes We Got It thing. We've been aggressive on our technology investments and believe these initiatives will help differentiate us on a go forward basis. We realize as customers have become much more tech and mobile savvy, we have to have a sales proposition that touches all the ways they desire to interact with us. Our current and future technology investments will lead to sales growth across all of our businesses.
The focus is on making sure AutoZoners can see inventory availability across the entire organization, not just their store swiftly and accurately. In regards to commercial, we opened 12 net new programs during the quarter. Our expectation is we will continue to open new programs in the range of 200 programs in 2017. As we continue to improve our product assortment and availability and as we make other refinements to our commercial offerings, we expect that the estimated sales potential from the market will continue to grow. Our results continue to provide us confidence to be aggressive in adding resources and new programs to this very important growth initiative.
We should also highlight another strong performance in return on invested capital as we were able to finish our 2nd quarter at 31.0%. We continue to be pleased with this metric as it is one of the best, if not 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 thank and reinforce how appreciative we are to our entire team's efforts to continue to meet and exceed our customers' wants, needs and desires.
We remain bullish on our future performance because we have a great business operated by exceptional AutoZoners.
Now I'll turn the call over to Bill Giles. Bill? Thanks, Bill, and good morning, everyone. To start this morning, let me take a few moments to talk more specifically about our retail, commercial and international results. For the quarter, total auto parts sales, which includes our domestic retail and commercial businesses, our Mexico and Brazil stores and our 26 IMC branches increased 1.6%.
Switching over to macro trends during the quarter, nationally unleavened gas prices started out at $2.16 a gallon and ended the quarter at $2.31 a gallon, a slight decrease. Last year, gas prices decreased per gallon during the Q2, starting out at $2.09 and ending at 1 $0.72 dollars While prices at the pump are higher today than they were last year at this time, we continue to feel the absolute price of $2.31 a gallon is not high enough amount to change the driving behavior of Americans as we continue to see miles driven increasing. We also recognize that the impact of miles driven on cars over 7 years old, the current average is much different than on newer cars in terms of wear and tear. Miles driven increased 1.6% in October, 4.2% in November and 0.5% in December. And for all of 2016, miles driven were up 2.8%.
Another statistic we highlight is the number of 7 year old and older vehicles on the road, which continues to trend in our industry's favor. For the trailing 52 week ended, total sales per Autozone store was $1,775,000 For the quarter, total commercial sales increased 7.2%. In the 2nd quarter, commercial represented 19% of our total sales and grew $29,000,000 over last year's Q2. This past quarter, we opened 12 net new programs versus 32 programs opened in our Q2 of last fiscal year. We now have our commercial program in 4,437 stores or 83 percent of our domestic stores, supported by 183 hub stores.
Approximately 900 of our programs are 3 years old or younger. In 2017, we expect to open approximately 200 new programs. As we have begun our fiscal 2017, our trends have accelerated, which is encouraging to us. We are focused on having a great sales team and having much stronger engagement of our store management teams, particularly the store managers and district managers. We remain confident that we will continue to gain market share with our commercial customers.
We are encouraged by the initiatives that we have in place. We feel 2017 should be a better sales growth year than 2016. Our Mexico stores continue to perform well. We opened 3 new stores during the Q2. We currently have 4 91 stores in Mexico.
This upcoming year, we expect to open approximately 40 new stores. As Bill said earlier, we were challenged by a difficult foreign exchange rate in regard to the peso. While sales and base currency were above plan this quarter, the devaluation in the peso was much greater than we assumed at the start of the year. The peso devalued over the course of the quarter. This has created a headwind and our EPS was negatively impacted by $0.18 a share.
We do believe the Mexico leadership team has done an exceptional job managing the peso denominated business. During Brazil, we opened 1 new store and currently are operating 9 stores. Our plans are to grow between 20 25 total stores over the next few years. And while sales growth has been very encouraging, we continue to refine our business model to make sure that it works for us financially. Gross margin for the quarter was 52.7 percent of sales, down 9 basis points.
The decrease in gross margin was attributable to higher shrink expense and higher supply chain costs associated with current inventory initiatives, partially offset by lower acquisition costs. In regards to product cost inflation, it was relatively insignificant. Currently, we feel costs will be predictable and manageable, and we remain cognizant of future developments regarding inflation and we'll make the appropriate adjustments should they arise. Compared to the prior year, we have incurred more costs related to our supply chain in support of our inventory availability initiatives along with rising shrink expense after several years of declining expenses. The merchandising organization has and will continue to work diligently to offset these headwinds with a focus on lowering acquisition costs.
Our primary focus remains growing absolute gross profit dollars in our total Auto Parts segment. SG and A for the quarter was 35.9 percent of sales, higher by 9 basis points from last year's 2nd quarter. Operating expenses as a percentage of sales were higher than last year due to higher domestic store payroll, offset in part by lower incentive compensation. We are beginning to see an acceleration in average wage rates as certain states and municipalities have increased minimum wages and as some national retailers have also increased entry level wages. EBIT for the quarter was $384,000,000 up 0.3% over last year's Q2.
Our EBIT margin was 16.8%. Interest expense for the quarter was 34 $1,000,000 compared with $32,800,000 in Q2 a year ago. Debt outstanding at the end of the quarter was $5,152,000,000 or $307,000,000 more than last year's balance of $4,845,000,000 Our adjusted debt level metric finished the quarter at 2.6x EBITDAR. While in any given quarter, we may increase or decrease our leverage metric based on management's opinion regarding debt and equity market conditions, we remain committed to both our investment trade rating and our capital allocation strategy, and share repurchases are an important element of that strategy. For the quarter, our tax rate was 32.2 versus last year's Q2 of 34.7%.
Now I want to take a moment to remind listeners of AutoZone's 1st quarter adoption of new accounting standard. The new standard requires us to recognize the tax benefit received from the gains employees have on stock options as it credits income tax expenses on the P and L. This past quarter, it lowered our tax rate 3 58 basis points. The accounting change also increases the diluted share count calculation. Net income for the quarter was $237,100,000 up 3.7% over last year.
Our diluted share count of 29,300,000 was down 4.7% from last year's Q2. A combination of these factors drove earnings per share for the quarter to $8.08 up 8.8 percent over the prior year Q2. Excluding the impact of the previously mentioned change in accounting for stock option exercises, our EPS would have increased by 3.8% for the quarter. Related to cash flow statement, for the 2nd fiscal quarter, we generated $157,000,000 of operating cash flow. Net fixed assets were up 7.3% versus last year.
Capital expenditures for the quarter totaled $118,000,000 and reflected the additional expenditures required to open 37 new locations this quarter, capital expenditures on existing stores, hub and mega hub store remodels or openings, work on development of new stores for upcoming quarters, initial investments in our new domestic DCs and information technology investments. With the new stores opened, we finished this past quarter with 5,346 stores in 50 states, the District of Columbia and Puerto Rico, 491 stores in Mexico and 9 in Brazil for a total AutoZone store count of 5,846. We also had 26 IMC branches open at fiscal year end, taking our total locations to $5872. Depreciation totaled $72,800,000 for the quarter versus last year's 2nd quarter expense of $68,700,000 This is generally in line with the recent quarter growth rates. We repurchased $198,000,000 of AutoZone stock in the second quarter.
And at quarter end, we had $585,000,000 remaining under our share buyback authorization, and our leverage metric was 2.6x mid quarter end. 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 8.7% over the same period last year, driven primarily by our ongoing inventory initiatives during the fiscal year and to a lesser extent by the deterioration of sales trends at the end of the quarter. Inventory furloughation was $665,000 versus $633,000 last year and $647,000 just this past quarter. Net inventory, defined as merchandise inventories less accounts payable on a per location basis, was a negative $36,000 versus a negative $57,000 last year and a negative $67,000 last quarter. As a result, accounts payable as a percent of gross inventory finished the quarter at 105.5%. Finally, as Bill previously mentioned, our continued disciplined capital management approach resulted in return on invested capital for the trailing 4th quarters of 31%.
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 Gil Rhodes.
Thank you, Bill. This quarter, our sales and profitability performance were not up to our standard. Much of the challenge was macro in terms of delayed IRS refunds, but we've also incurred rising operating costs, which include our initiatives. At the end of the day, we have had a remarkable track record of success and we will continue to focus on optimizing both short and long term performance. We have an exceptional team that executes extremely well.
Our focus remains on being successful over the long run. That success will be attributable to our approach to leveraging our unique and powerful culture and focusing on the needs of our customers.
To execute at a high level, we have
to consistently adhere to living the pledge. We cannot and will not take our eye off of execution. We must stay committed to executing day in and day out on our game plan. Success will be achieved with an attention to detail and exceptional execution. Over the course of the last quarter, 2 topics have garnered a significant amount of attention.
And before we move to Q and A, I would like to address those directly. 1st, following the election, the border adjustable tax has become a hot topic. As I'm sure many of you know, I was part of a contingent of Retail Industry Leaders Association CEOs who went to Washington DC and met with President Trump, members of his administration and various members of Congress to share our perspective on the potential harmful effects of this proposal. While we are concerned about the impact on retail business models, we are more concerned about the ramifications for hardworking American families due to likely significant inflation that would ensue. Our key message is that we certainly support a pro growth agenda, including corporate and individual tax reform, but we stress the importance of a thoughtful approach to tax reform to avoid any unintended consequences.
Secondly, there have been articles written with increased dialogue around online retailers encroaching on our space. Much of the information highlighted is not new news. There hasn't been any significant changes in the competitive landscape including suppliers' relationships with online retailers. We are very aware of online threats and we are very focused on leveraging our long standing strengths to effectively compete with all competitive sets. While clearly the online channel has grown their share in the automotive aftermarket and virtually every other retail sector, to date our portion of the sector of the industry has continued to grow generally in line with the overall market.
While we can never take any competition lightly, we believe we have some clear strengths that allow us to more than effectively compete, Specifically, the trustworthy advice provided by our AutoZoners each and every day helps customers in many ways and many cases where they don't know what parts or services that they need. And we provide basic services to get them on their way. We also have the ability to test parts on cars to determine exactly what the problem is. With 80% of the U. S.
Population within 8 miles of an auto zone, the immediacy to resolve a customer's needs with trustworthy advice and having the right high quality parts remains a competitive advantage for us. Our customers have choices and we must exceed their expectations in whatever way they choose to shop with us. We are fortunate to operate in one of the stronger retail segments and we continue to be excited about our industry's growth prospects for 2017. As consumers continually look to save money while taking care of their cars, we are committed to providing the trustworthy advice they have grown to expect. It truly is the value add that differentiates us from any other faceless transactions.
Customers have come to expect that advice from us. It is with this focus we will implement more enhancements on both our website and in store to provide even more knowledgeable service. We don't ever expect an online experience to replace the advice our customers want, but we do expect more information on repairing their vehicles. This aspect of service has always been our most important cultural cornerstone, and it will be long into the future. Our long term model is to grow new store square footage at a low single digit growth rate and we expect to continue growing our commercial business at an accelerated rate.
Therefore, we've looked to routinely grow EBITDA dollars in the mid single digit range or better in times of strength. And we leverage our very strong and predictable cash flow to repurchase shares, enhancing our earnings per share growth in the double digits. We feel the track we are on will allow us to continue winning for the long run. We believe our steady consistent strategy is correct, but it's the attention to details and consistent execution that will matter. Our belief is strong consistent strategy combined with superior execution is a formula for success.
Our charge remains to optimize our performance regardless of market conditions and continue to ensure we are investing in the key initiatives that will drive our long term performance. In the end, delivering strong EPS growth and ROIC each and every quarter is how we measure ourselves. Now, I would like to open up the call for questions.
Thank you. We will now begin the question and answer. Our first question comes from Alan Ryskin from BTIG. Your line is open.
Thank you very much. Bill Rhodes, based on your past experience with the delays in income tax refunds, is there any reason why we should not believe that the revenues lost in Q2 will be replaced dollar for dollar in
the fiscal Q3? That's a great question, Alan. How are you? I would say, 1st of all, all indications that we see are that the total tax refund dollars will be the same as they have during the last few years. So that is a good thing.
The piece that we don't know and which is uncharted waters for us is the timing is going to be delayed significantly more than it has been in the past. We've had times where it's been a week or week and a half. This time there was a full 3 week or more delay for the most significant of those refunds. And so one thing that we question, we don't have any facts to know whether it's good, bad or indifferent for us is with the timing being in a different time of year, do more of those dollars come into our sector or more of those dollars go into another sector? We don't know the answer to that.
So we're somewhat going to have to wait and see what happens.
Okay. And a follow-up, if I may. So with respect to your 3 initiatives, increased delivery, the hubs and the mega hubs, all of which are at various stages of maturity. Can you just go through and assess your belief in terms of the potential progress of each of those three and what the ultimate revenue gains and profitability gains and most importantly ROIC gains can be. If you had to rank the 3 initiatives, Bill, in terms of ultimately what would be the biggest bang for the buck, how would you rank them?
Yes.
Great. First of all, I would start with hubs. We've got 183 or so hubs that are out there today. They are tried and true. We first started them around 2000, 2001.
We somewhat deemphasized them in the middle 2000s and realized in 2008 or 2009 how vitally important they were. So we rejuvenated them in 2008 or so and they have been humming right along 100 since. That gave us the insight that expanded parts coverage is a material differentiator in the marketplace. So then we came up with the concept of mega hubs, which basically doubles the number of SKUs that we carry in the local marketplace. That takes it to 80,000 to 100,000 SKUs.
Ever since we began talking about the mega hubs, every time we've talked about, we've said they continue to exceed our performance. I don't know that we could be more bullish or more open about how good that has worked for us so far. So we're really excited about that. Everybody keeps asking us why don't we go faster? I promise you we're going as fast as we can.
So I think part of this is finding really high quality retail space that's 30,000 square feet. That is not easy to do. I think our teams have done a great job in the 13 that we have opened. We have about 5 or so more to open in the second half of the year. We hope to be able to open 25 to 40.
We're still trying to figure out what that right number is. As we continue to perform, I think that makes the likelihood of the number being higher rather than lower. And then the third one is
I'm sorry? I'm sorry. No, please go ahead.
The third one is multiple frequency of delivery, MSD for us. And I know it's been a little bit of a mixed bag. So far, we absolutely believe it's the right thing to do. But we've gone and we've changed a significant amount forever. In our 37 year history, the vast majority of our stores we've delivered once a week.
And so our replenishment algorithms are based on once a week deliveries. Our DCs and the way they're structured are set for once a week deliveries. Our stores and the way they put up trucks are set for once a week deliveries and on and on and on. And as we've gone further, if you know, we kind of slowed this from down about 6 months ago. We slowed it down because we started to uncover some unintended consequences that were happening as a result of those changes.
We still believe this is this in some form is going to be the right thing to do for our customer and for our business. We still got quite a bit of work to do to make sure that we optimize it. So that one is still a little bit influx. The other 2 are tried and true. They're in full implementation mode.
We just got some work to do to refine MSC. Sorry, Alan.
No, thank you very much. Does the potential exist to any of the hubs to be converted to mega hubs?
Yes. That's what happened with some of them. Some of them are on a piece of property where we can add another 15,000 square feet and so we've done that. Others of them are landlocked and it may be a great hub store that's in the right place, but we have to move it because we've got to get a bigger facility. It's strictly about the size of the facility.
Thank you very much. Yes. Thank you.
The next question comes from Seth Sigman, Credit Suisse. Your line is now open.
Thanks. Good morning, guys. Good morning.
Couple of
questions on gross margin. First on the shrink issue, it seemed to be one of the biggest differences versus prior quarters. Have you seen a change in the actual losses? Or does that just reflect inventory growth over the last few quarters? And how do we think about that drag on margin rate going forward into the back half of the year?
That's a good question. I mean, we've had really a number of years of unprecedented shrink results. They've been really historic below and now we're seeing that turn the other way. And we recognize, as you highlighted, we've made a lot of changes. Phil just kind of walked through a little bit on some of the inventory availability initiatives, particularly on more frequent delivery.
So we've introduced a lot more activity in the supply chain and store operations and suspect that that probably has contributed a little bit. So I would expect that headwind to continue for a little bit of time. It takes time for shrink to be able to turn around. It's not something that's going to turn around in a particular quarter. But I suspect it will continue to improve, and the teams are working really hard to be able to bring it down.
Okay. And then I guess more broadly, there has been
some gross margin pressure across the space. As you think about pricing, have you seen any change in pricing behavior? I mean, it seems like most of the gross margin issues are company specific or isolated, but just wondering if you've seen any sort of promotions or pricing changes across the group.
Yes, that's a good question because when you look at our gross margin, we've rifle shot at 2 particular individual items, both supply chain, which is inventory availability initiatives that we're very conscious about, shrink, which has been at historic lows and now a little bit higher. Past that, our gross margin rate is very healthy. We have not seen any kind of pricing activities in the marketplace that I would consider to be disruptive. Our merchandising organization continues to work very hard at lowering acquisition costs and have been very successful at it. So overall, I would categorize our gross margin as very healthy.
It continues to be a very healthy and rational industry. We've got a couple of items that are in our control, and we're working hard at reducing
them. Okay.
Thanks very much.
The next question comes from Simeon Gutman from Morgan Stanley. Your line is open.
Hi, guys. This is Tan Zerman on for Simeon. Thanks for taking my questions. I wanted to piggyback a little bit on the inventory initiatives and then ask another question related to miles driven trends. Related to inventory initiatives, it looked like you actually slowed the multi frequency delivery rollouts a little bit this quarter, yet the shrink expense popped up.
Can you give us any color on what to expect in terms of gross margins for the back half of the year? Should we expect them to expand if shrinking inventory headwinds persist? Or can you give us some color on that? And then I have one more question.
I think, first of all, we did intentionally slow down the multiple frequency of delivery rollout. We actually tipped that on the last call that we were going to move from 300 to 350 stores a quarter to 100 stores in a quarter. And that's what we did. And we did that because it's causing quite a bit of change. And with change comes some disruption in our supply chain.
And we wanted to slow it down so that we could work through some of those elements of change management. And honestly, it had the desired result. I think things are settling down a bit in our distribution center. We added a tremendous amount of workload to them over the last couple of years. So we're pleased with that change.
Clearly, that has resulted in some increased cost in our supply chain. You saw that called out in our press release. Part of that was due to MSP. Part of that was also due to the significant decline in sales that we had the last 3 weeks. So I think as we think about it going forward, we've been seeing a 15 or 20 basis points of headwind going forward.
Regarding the shrink question, I wouldn't necessarily draw a direct correlation in slowing down MFP and an increase in shrink. As Bill previously stated, I do think we've been moving a lot of inventory throughout our network over the last couple of years. And when you move inventory, the more times you handle it, the more susceptible you are to shrink. I again want to say what he said. We've had unprecedented improvements in our shrink expense over the last 6 years.
It's going the other way now, but I am highly confident that our team will get back out in front of it and control it effectively. The only problem is when shrink starts going one way or the other, it has a bit of a tail to it and takes some time to turn around. I think we would expect that to be a bit of a headwind for the balance of the year.
Got it. Thank you. And then just one more question around miles driven. I know miles driven on at least a 1 year to year basis decelerated a little bit in December. I don't know if you've seen this data, but if you were to slice the miles driven data by average vehicle age and look at each individual vehicle bucket, are you seeing any difference in trends between miles driven within your sweet spot of say 7 to 13 year old vehicles versus newer vehicles that tend to be with more at the dealer while they're under warranty?
No. And I'm not so sure that we have access to slice it that way. I mean, from our perspective, the 2.8% increase for 2016 was a great number. I mean, for us to be able to be anything above 1% on miles driven is a really solid number. And so it's going to reflect more wear and tear.
And we feel really good about where the age of the vehicles are and the increased wear and tear that they are incurring given the higher miles driven. So I think, again, it points to a really healthy industry.
The next question comes from Michael Lasser from UBS. Your line is open.
Good morning. It's Michael Goldsmith on for Michael Lasser this morning.
Thanks a
lot for taking my questions. My first question is on the tax refund. And the delay in those tax refunds, does that have an outsized impact on particular parts categories or the DIY or commercial side of the business? And does the amount that you can recapture differ between these segments?
Yes. I think the second part of your question is yet to be determined. Historically, we think we've recaptured them this time. As I said earlier, the timeframe is significantly better. So we're significantly different.
So we'll have to wait and see a little bit. I think the parts categories, yes, there's some differences. I don't think there's really any material differences in which categories respond differently. There's some of them deferred maintenance categories like brakes, where you'll see a more pronounced difference. Know your categories are a little bit less pronounced because you have to get the car up and running that day.
You asked specifically about differences between retail and commercial. And I would say it's definitely more pronounced in retail. But as it lingered, we saw it increase in commercial. So, but we're all this is going to play itself out over the next 3 or 4 weeks. We think it is transitory in nature.
There's nothing we could have done about it. As we now look back on it, I don't think there's anything we would do differently as a result. We're just somewhat have to deal with the consequences of them trying to deal with fraud, which I think is the right thing to do.
That's helpful. And then as a follow-up, even though we had a little bit of a colder December than last year, but generally a milder winter overall, how does that impact the setup for the rest of the year for Zone and the industry overall?
Yes, to me that's the most germane question that we're talking about. We loved what happened in December. Last year we didn't have that kind of winter weather and it was very encouraging to us. All the long term forecast said that it was going to last longer and be more pronounced. But basically, as soon as we got through the Christmas holidays, the weather got much more mild.
We would have preferred that December would have repeated itself in January. In the past, we've had a very mild winter followed by a more normalized winter, and we've seen those sales rebound in the spring and particularly in the summer. We're a little bit uncertain as we go into this year. We think clearly some of the deferred maintenance items that were pulled into December January last year, that did not happen. We would anticipate getting those deferred maintenance items in the Q3 and in the beginning of Q4.
But as far as failure items, because of the difficult winter, I think winter, I think it's still yet to be seen. So chassis parts and brakes and the like. So we're going to have to wait and see. It's a little bit of a different cycle for us.
Thanks again.
Thank you. The next question comes from Ryan Nagel from Oppenheimer. Your line is open.
Hi, good morning. Good morning. So I hope not to beat a dead horse here, but first question quickly on the tax refunds.
I think it's basically a follow-up to
the prior question. If you look at the results we saw today, it seems as though this delay may likely have a larger impact on the DIY side. So the question I have is that I understand this delays prior delays, but as you look back over time, is that usually what happens? Did you usually see a more pronounced impact on the DIY side?
Yes. I would say number 1, we're much more mature in our retail business than we are in our commercial business. So any macro headwinds or tailwinds, we see more pronounced in the retail business. But clearly, every time we've seen it, there's been a bigger impact on retail than it has commercial. This time, we saw we clearly saw it in commercial, although it lagged a week and a half or so.
Okay. And the second question I had, and I appreciate your comments, Bill, in your prepared remarks regarding e commerce because that hasn't been a topic lately. So the question I have is, have you has AutoZone taken any proactive or any more proactive actions lately, such as pricing, more aggressively pricing against some of the online competitors or even in advertising to protect the business more from this type of competition?
I would say no. I would say we are continuing to execute our strategy. And I also want to say our head is not in the sand. We're very much cognizant of what's going on in and around us. I would say, our pricing philosophies, our advertising philosophies to date have not changed as a result of any competitive threat.
I would say we're constantly looking for ways to optimize our pricing and we're constantly looking for ways to improve our advertising. And clearly, digital advertising is becoming more and more important, whether that's going up against an online only competitor or going up against traditional brick and mortar competitors. That is becoming a more and more important element. But I don't see that as a shift because of online competition. Got it.
Thank you.
Thank you.
Next question comes from Matt Faster from Goldman Sachs. Your line is open.
Thanks. Thank you for taking my question. This is Shamli Lutra on behalf of Matt Saster. Most of my questions have been answered, but just quickly wanted to touch base on one of the topics. In terms of tax refunds, last week seemed to have seen a little bit of a pickup in the refund activity.
Bill, could you talk if your comps also saw a bit of refunds in the last week or this week? Just curious there.
Yes, sure. Last week, Wednesday, Thursday Friday, I think there was something like $70,000,000,000 of tax refunds that were released, not that we're paying attention. We clearly saw our sales increase as a result of that. I want to be really careful about getting to the 2 finite issues on what's going on day to day or even over a weekend. We're in this business for the long term.
But clearly, as those large amount of refunds hit the market, we saw a pickup in our business. I'll leave it at that.
Great. Thank you. And then a follow-up on the lines of a question that Brian just asked in terms of the online business, via the other category of all the dog or anything that declined 3% and was in Q2 running. How are you thinking about improving trends in this business?
Yes. I think both of them are very different businesses, by the way, And they have made some improvements since the previous quarter. So I think they will continue to grow. I think AutoAnything has had some challenges over the last six or so months and there's some real opportunities for us to expand SKU assortments and also to increase our search engine optimization activities, etcetera, in order to drive traffic. So I think that we'll continue to be competitive there.
And All Data continues to be a very strong business and a very important business in the commercial segment as well. So both businesses are flattish at the moment, down a little bit, but they're making some improvements and we expect to see them continue to make improvements over the next few quarters.
Perfect. Thank you.
Thank you. The next question comes from the line of Mike Baker from Deutsche Bank. Your line is open.
Thanks. I guess you had said you haven't really changed your pricing strategy. So I'll ask the question, why not? How do you look at Amazon's pricing versus yours? I think a lot of us have done pricing studies and
it does look like they are
a little bit below you. So why wouldn't that necessitate a change to your strategy?
Yes. I don't think there's any question that they're priced below us in many different cases. But I think the value proposition is extraordinarily different. Number 1, the convenience factor you can walk into our store is a sense of immediacy, particularly if you have a failure part is right at your hand. You can get back on the road immediately versus having to wait overnight or a couple of days in most cases.
I don't think many consumers today are willing to wait when their car is down for that. So that's one element. There are many elements. Another element is we've got tremendous trustworthy advice in our AutoZoners in store. That comes with a cost and therefore it's part of the value proposition.
But for an AutoZoner to help a customer figure out not only figure out what is going on with their vehicle and what the solution is, there's value to the customer in that. We do core returns of significant amount of our sales come with a core return. We're there to take that core back and on and on and on. So I think we feel like there's a significant value proposition differential between us and any online competitor. And what happens to that over time, we'll see.
We've dealt with price competition for years. And some of that price competition, for instance, is in mass merchandising. And we've effectively managed through that over the years because there's a different value proposition. So we don't see it necessarily any different.
So I guess to follow-up on that, those are good points. Are there any way to quantify those points, whether it be the need for immediacy, you gave us the year over year growth in buy online, in store pickup. But what percent of your total sales is that? Or maybe what percent of your sales come with some consultation rather than just someone grabbing an item and going percent of returns, anything like that? And really, can you help us?
What is a what
do you mean by core return? Sound familiar?
So a core return is an alternator from us. We will sell you the alternator for, let's say, dollars 100 and has a $25 core because the old alternator is it's a remanufactured alternator and the old alternator is the raw material to make the next one. So there's a deposit, if you will, is what a core charge is. But the point is, there's a tremendous reverse supply chain in this business that doesn't exist in many other businesses. A lot of other businesses talk about return, but this one has a significant reverse supply chain.
On buy online pickup and store, it's not a significant part of our business today. So I don't want to overstate that. And then you asked, how are we going to determine what this right price differential is over time? I think we're going to do it just the same way we've done it the last 37 years. It's trial and error.
We've had different competitive channels over the years. And we have very effectively been able to optimize our pricing in light of the different competitive sets. And I think we'll continue to do that.
Okay, good. I think I'll turn it over to someone else now.
Thanks. Thanks, Mike.
The next question we have is coming from Don Weaver, Raymond James.
Bill, one of the territories that did not achieve above average same store sales growth was the Southeast. We've seen a large number of daily stores opening in the state of Florida. Can you talk about how the growing competitive overlap in that state could be impacting the
sales growth? Dan, I wouldn't overstate their role into South Florida. We have different competitors that are going into different parts of the country all the time. Clearly, Florida is a strong market for us, but we're not the most dominant player as far as store count in Florida. There are others that have significantly more stores than us.
I don't think we're seeing anything different in Florida than we've seen as we've had competitive encroachments in other parts of the country.
Okay. And then a second question and talking about Mexico, it sounds like that could be a longer term challenge given some of the political decisions being made in Washington. Is there anything that you can do to whether it's hedging or pricing, anything to improve the profitability of your stores in Mexico?
Yes. I would start with, 1st of all, we're very pleased with the performance of our Mexico business. I think our team down there has done a superb job of managing in light of this significant devaluation of the peso. Frankly, this all started a couple of years ago. And if you recall, we were talking last year that we thought it would kind of be a one time deal and then we'll have muted impact going forward.
That clearly has not happened post the election. The peso significantly deteriorated yet again. We can't manage the peso. We can go up and hedge, but we've elected not to do that. We've elected to try to do most of our hedging by buying in local currency and therefore we hedge the product costs versus hedging the profitabilities.
But at
the end of the day, if there's a deterioration in the peso, it hurts our U. S. Dollar profits. But at the end of the day, we would be doing the same thing in Mexico that we've been doing all along. And it's been a good business for us, and we anticipate it being a good business for a long time.
And the last question I have is on the better momentum in commercial. Do you think that's primarily the sales training that you alluded to earlier focusing on yes, we've got it. Are you extending that message to a larger number of commercial customers? Or is it just going to your existing sites for those accounts and hitting them more aggressively?
I think it's multifaceted. Number 1, yes, we're out communicating to our customers. Yes, we've got it in a way that we never have before. We believe we can do that because we're in a better position than we ever have been before. I would add a lot of the emphasis to just strictly the improvements that we have in inventory availability.
And then as we talked over the last year, another big part of what we're trying to do is significantly increase the engagement of our store managers and our district managers in this business. Many of us, myself included, grew up with the retail business. And so for lack of a better term, it's kind of our comfort zone or our asphalt. We've got to force ourselves to get deeper and deeper into the commercial business, and I think we're doing that over time. And I think that will pay long term significant dividends.
Okay, great. Thank you. Thank you, Dan.
Thank you. The next question we have is coming from Stephen Fords from Jin Han Securities. Your line is open.
Good morning, guys. Good morning.
Good morning. I wanted to focus
on growth in the Commercial segment given the acceleration this quarter. Maybe just some high level commentary on how this business is progressing relative to your expectations in both segments, right, building existing customers and then also gaining new customers?
I think on both sides of it, we're very pleased overall even with the recent performance this quarter. I mean, we had an acceleration in our commercial programs overall. We're clearly gaining share, growing significantly faster than the industry. The team has put in several new programs in order to help drive both existing customers as well as prospecting and attaining new customers as well. So that business does seem to be healthier and it seems on a track to continue to grow.
So I think on both sides, it's been healthy. But it's really more the existing customers have been really strong, and that's the one area that we're really focused on.
And then maybe staying on that topic as a follow-up. I mean, is there anything to call out regionally? I mean, we talked about for the region so far, this call from a performance standpoint within the Commercial segment, anyone outstripping others? And then do you know where you're gaining share from when you think about growing your existing customer base? Or is it really broad?
It's very broad. And in fairness, we have a low market share. So we believe that there's enormous greenfield opportunities for us across the country. All the regions performed reasonably well. Clearly, the weather affected regions in prior years had been more challenged, but they weren't this year.
They continue to perform well. So we see it pretty balanced across the country. So we feel pretty good about the commercial team as a whole and how they're performing.
Thank you.
Thank you. And that concludes our question and answer session. I'll hand the call over back to Mr. Bill Rhodes. Thank you.
Okay. Thank you. Before we conclude the call, I would like to take a moment to reiterate that our business model continues to be very solid. We're excited about our growth prospects for the balance of the year. We will not take anything for granted as we understand our customers have alternatives.
We have a solid plan to succeed this fiscal year, 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 very successful. Thank you all for participating in today's call. Have a great day.
That concludes today's call. Thank you for your participation. You may now disconnect.