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Operator
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.
If you have any objections please disconnect at this time.
This conference call will discuss AutoZone's third quarter financial results.
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 AM Central time, 11 AM Eastern 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 press release 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 assumption and assessments made by our management in light of experience, 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 of our suppliers, energy prices, war and the profits of war, including terrorist activity, availability of consumer transportation, construction delays, access to available and feasible financing 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 one of our annual report on Form 10-K for the year ended August 29, 2009, and these risk factors should be read carefully.
Operator
Mr Rhodes, you may now begin.
- President, Chairman, CEO
Good morning.
And thank you for joining us today for AutoZone's fiscal 2010 third quarter conference call.
With me today are Bill Giles, Executive Vice President, Chief Financial Officer, Store Development, and IT, and Brian Campbell, Vice President, Treasurer, Investor Relations, and Tax.
Regarding the third quarter, I hope you had an opportunity to read our press release and learn about the quarter's results.
If not, the press release, along with slides complementing our comments today, is available on our website, www.autozoneinc.com.
Please click on quarterly earnings conference calls to see them.
We are very pleased to announce for the quarter an EPS increase of 31.5%, and a domestic same store sales increase of 7.1%.
Our same store sales performance accelerated from the second quarter considerably, growing from 1% to 7%, and it increased on both a two year and three year stacked comp basis as well.
While our average ticket continued to grow year-over-year, the improvement primarily was a result of improvements in customer counts.
We believe that our strong same store sales increase was attributable to both the macro economy and market share gains across both our retail and commercial businesses.
In reviewing our performance to better understand the causes of our acceleration, our analysis has led us to believe some of the acceleration can be attributed to macro factors.
Specifically, we believe, number one, customers are doing more DIY work due to continued economic pressure.
Two, a decrease in new car sales has benefited our industry and this is good for our business in the near term.
And finally, higher tax refunds this year have helped our customers and, therefore, our business.
The first point, customers continue to shop our stores in some cases out of economic necessity or simply to save money.
This represents an opportunity for our industry overall.
We believe customers have turned to AutoZone to help them save money in these difficult times and our approach is to help them with their needs and to develop ongoing long-term relationships with them.
Whether a customer wants to do it themselves or use one of our high quality commercial customers, we believe we can provide them with the trustworthy advice and high quality products at a good value so they can properly maintain their vehicles.
The second point is the slowdown in new car sales which has resulted in an older age of US vehicle population, which we believe results in an increase in demand.
As long as cars continue to get older and need ongoing maintenance our industry will be in a strong position.
The next point regarding income taxes is subtle but important.
Per the IRS statistics up through the week ending April 30, total refunds were up 4.1% over last year, and the average household refund was up 8%.
From what we can see, households that we would call our kind of customers disproportionately benefited from the refunds.
While this was not, in our opinion, the largest contributor to increased customer demand, it did provide additional monetary stimulus for our customers during the quarter.
While these three points were important and speak to our overall industry growth, let me point out during the quarter we again gained market share in both our DIY and commercial businesses.
We believe these gains have come from a continued focus on store execution, better parts assortment, increased availability with the support of our enhanced hub store concept, and the ongoing development of our commercial sales force, all of which taken together results in us delivering a superior customer experience.
We have good competitors in the marketplace and, therefore, it is imperative that we continue to improve every aspect of our business.
One particular highlight of the quarter was the acceleration of our commercial business, which grew 15.5% for the quarter.
I would like to congratulate our entire team for their performance in the commercial business this quarter.
This quarter marks the twelfth consecutive quarter of sales increases in this business.
I've been asked since back in 2005, do you think your commercial business can be a material part of your overall sales?
And to those folks, I've always said yes, but be patient.
This is a marathon and not a sprint.
Well, this quarter we picked up the pace considerably but kept to our overall strategies.
The acceleration from the 8.5% in the second quarter continues to reinforce to us that we're definitely on the right track.
During the quarter, due to the success of our conversions to the enhanced hub store model and the overall strength in our business, we accelerated the rate of conversions to the new model and ended the quarter with 108 of our 143 hubs on the new model, up from 82 at the beginning of the quarter.
We've also added some selling payroll to our stores to make sure we satisfy our customers' needs when they call on us.
Again, congratulations on a great quarter, AutoZoners, but we've got a long way to go and significant opportunity to grow our market share in commercial as it's only 1.5% today.
Additionally, our ALLDATA in Mexico businesses performed well during the quarter, growing both their top lines and operating profits.
These businesses are wonderful assets for AutoZone and we expect their performance to continue to be outstanding for years to come.
I want to take a moment to congratulate our AutoZoners on delivering our sixth straight quarter of 20% plus EPS growth, exceeding 30% this quarter for the first time since our second quarter of fiscal 2004, and our fifteenth straight quarter of double-digit EPS growth.
This long stretch of success can be attributed to a simple and clear strategy of delivering exceptional customer service and trustworthy advice, all while continuing to refine our retail, commercial, Mexico and ALLDATA offerings.
These important qualities are embedded in our culture and they are the principles we live by each day.
It is worth noting, our stretch of 15 straight quarters of double-digit EPS growth has occurred in very different macroeconomic cycles.
Through both boom and bust cycles, our organization has performed well and our financial performance has been strong.
I attribute this solid financial performance to our business model and our culture, a culture where passionate, highly committed people understand the objectives and consistently execute at an extremely high level.
Our team understands this industry very well and manages our resources very well.
We have been very deliberate in how we manage expenses and capital in order to deliver consistent, strong financial performance and position our business for long-term growth.
Additionally, I'd like to congratulate the organization for delivering another strong performance in return on invested capital as we were able to grow this metric to 26.5% on a trailing four quarter basis, which represents a new all-time high for our organization.
While we've invested over $1 billion in CapEx over the last four years to make sure our stores look great and expand our footprint, we've expanded our returns on capital.
This gives us great confidence in our planning models to confirm that where we have invested your dollars, we're getting an adequate return.
We will always maintain our diligence regarding capital stewardship.
Now I'll discuss our quarterly performance in a little more detail and try to address questions you may have.
Let me begin by discussing category sales.
In recent quarters we have provided more detail on the performance of our categories and clusters we have called failure, maintenance and discretionary.
In recent quarters, our acceleration has come from the maintenance and failure categories, offset by pressures in the discretionary categories.
This quarter we are excited to report that we experienced growth in our discretionary categories.
While discretionary purchases increased to approximately 20% of sales from the mid-teens last quarter, the 20% was generally in line with last year.
The shift is seasonal in nature.
Failure related categories sold slightly more than last year at 40% of the mix, and helped drive merchandise margin improvement.
Finally, maintenance related items were the remaining 40% and were slightly lower than last year.
From a regional perspective, we did not experience any material changes in sales trends that differed from the overall chain performance.
Based on NPD market share data, we continue to see market share gains in both retail and commercial in virtually every major geographic segment.
Our competitors, both large and small, continued to do a good job executing.
Therefore, it is incumbent on us to continue to perform at an extremely high level.
As I mentioned earlier, we have several initiatives under way at various stages, but I'd like to highlight the performance of our hub store enhancements.
Last year we implemented an enhanced model in 60 of our 143 hubs.
Through the third quarter we have completed an additional 48 implementations, taking our total to 108.
This effort includes enhancing our inventory assortment and increasing the frequency and reach of our daily deliveries to our satellite stores.
While this initiative represents a material investment both in terms of operating expenses and some capital, we are quite pleased with the sales performance we are experiencing.
The incremental parts additions that are now sold throughout the surrounding satellite stores are both exceeding plan and adding to the overall sales performance of the hub store and its market.
Our earliest hub store conversions, which began back in fiscal 2008, continued to experience sales growth as we refine the assortment as the operating model.
Obviously hub conversions is one of many initiatives that we are implementing, so specifically quantifying the benefits of the hubs in isolation is difficult.
However, we are confident this is having a positive impact.
More importantly, it allows our AutoZoners to say yes to both our DIY and commercial customers more frequently.
At the same time we have been able to reduce slow-moving inventory in the satellite stores by consolidating it into the hubs with an overall net inventory reduction.
With 35 hubs left to convert, we'll manage those roll-outs accordingly, but our current intentions are to complete the implementations no later than the end of the calendar year.
Overall, our gross margin rate remains healthy and showed improvement this quarter.
I'd like to congratulate our merchandising team on their efforts to improve merchandise margins through lower procurement cost, import initiatives and price optimization efforts.
We continue to feel margin opportunities exist for us in the near term.
We continue to believe there are opportunities to increase our gross margin rate over the long term.
From an expense standpoint, while we continued to accelerate some of the initiatives that we have been testing or rolling out to the chain, we continue to proactively manage our expenses in order to ensure that we are in a position to deliver great customer service and trustworthy advice in both the short and long term.
This organization takes great pride in our disciplined approach to managing our cost structure and leveraging our culture of thrift.
And this quarter's performance further solidifies that our team is capable of appropriately managing cost.
I believe we continue to be well positioned to manage our cost structure appropriately for the foreseeable future.
I'd also like to congratulate our Mexico team for opening their 212th store this past quarter.
While we've been methodical with this business over the years, it's exciting for our entire organization to further expand our reach in this important market.
With the pace of exchange rate volatile right now, we're managing our risk accordingly through in-country merchandise procurements based in pesos and methodical expense management.
Now I'll take a few minutes to talk more specifically about our retail, commercial and Mexico results for the quarter and then Bill Giles will review our gross margin results, operating expense results, balance sheet and cash flows.
For the quarter, total auto part sales increased 10% versus last quarter's 4.1% and last year's third quarter of 9.4%.
This segmentation includes both our domestic retail and commercial businesses, and our Mexico stores.
Regarding our domestic business during the third quarter, we continued to focus on driving sales and profits through improving the customer experience.
This quarter we updated 16 of our 40 plus major merchandise categories and we remain committed to completing at least one line review per major category on an annual basis.
We hosted our annual vendor summit this past quarter, inviting all our vendor community to Memphis to share our future business plans and growth strategies.
We reinforced our commitment to improving inventory productivity, while stressing the need to work together to make sure AutoZone has the parts coverage necessary to say yes more frequently tomorrow than today.
I believe that our relationships with our suppliers are quite strong, and they continue to improve.
I'll break my comments regarding retail sales up into a couple of major categories.
In addition to my previous comments regarding our enhanced hub store model, I would like to address two specific areas.
First we'll touch on our [wittiger] meeting completed this past quarter.
Second we'll address the macro trends we've seen.
Training continues to be a key priority to improve customer service and increase sales.
This past quarter we educated all our AutoZoners on the concept, sell it right, keep it sold.
We know that our customers want to get in, get what they need and get back on the road.
Therefore, we put together comprehensive training materials to make sure our AutoZoners are doing everything they can to help the customer do the job right the first time.
It is very important to note that this effort is not an initiative to quote, unquote, reduce returns.
It is an initiative to help the customer solve their real problem, where reduced returns are a likely outcome.
Regarding macro trends, during the second quarter unleaded gas prices started out at $2.61 a gallon and climbed throughout the quarter, finishing at $2.91 a gallon.
We believe gas prices have not been a material story to our sales results over the last quarter, although we have seen more volatility with oil prices as of late.
Last year's third quarter ended at $2.24 a gallon.
However, prices climbed to $2.61 a gallon by the end of the fourth quarter.
Regarding miles driven, we saw continued decline in February on top of the reduction in January.
March and April results are not yet available.
While recently we have seen minimal correlation in our sales performance with miles driven, historically it has been one of the key statistics which correlate to our sales results over the long term.
The other is the number of seven year old and older vehicles on the road, which continues to trend in our industry's favor.
Regarding weather, we believe it had an immaterial impact on our results this quarter.
For the trailing four quarters, total auto part sales per square foot were $244.
This statistic continues to set the pace for the rest of the industry.
Now let's turn to commercial.
For the quarter, total commercial sales increased 15.5%.
We remain encouraged by the consistent progress we have made, demonstrated by the continued acceleration in our sales performance over the past several quarters.
Our sales growth has come from both existing and new customers.
As we continue to increase market share, we continue to enhance our selling capabilities and improve our parts offering.
With improved tools in place combined with constant enhancements, we're building a platform for long-term growth.
We now have our commercial program in 2,340 stores, supported by 143 hub stores.
During the quarter, we opened 19 additional programs.
Our main focus remains on building and developing a world class sales force.
Over the last three years we've built our sales force from the ground up.
We are targeting sales growth through first increased penetration of existing customers, and second on acquisition of new customers in our existing service radius.
The majority of our business is derived from up and down the street customers who are the independently owned repair shops.
Additionally, we continue to work closely with our national account customers and have developed a strong business relationship with many of them.
We remain committed to growing this business profitably and are constantly focused on ensuring that our investments are resulting in improved sales and profitability.
While we were successful in growing both our operating margins and dollars for our commercial business, we did increase our investments in this business.
We added to both our sales managers, whose only job it is to develop and cultivate customer relationships, and to commercial labor hours to ensure high levels of service to these important customers.
We continue to believe more intense personal focus on existing account management will continue to drive improved results.
We continue to be very excited about our commercial growth opportunities for many years to come.
Lastly, we completed our first phase of testing the one team concept in a few locations.
Our goal was for our store AutoZoners to support both sides of the business.
Additionally, we've developed a version of Z-net for commercial that better leverages the wealth of content we have available and creates a common operating system platform that is considerably more intuitive to operate across both businesses.
We will begin implementing this new system during the fourth quarter.
We believe this improves the potential of utilizing our store labor hours more effectively, thereby garnering better coverage and support for both types of customers.
The results for the first phase of our one team initiative were encouraging and therefore we plan to expand the test to a larger store base during the fourth quarter.
While we continue to be encouraged by the feedback we've received from our customers and AutoZoners, it remains officially a test.
In summary, we remain excited about the growth prospects for the commercial business heading into the fourth fiscal quarter of 2010 and beyond.
Regarding Mexico, our Mexico stores continue to perform well, although the economic and security challenges in Mexico have been a headwind for our business.
We opened 10 new stores during the third quarter and currently have 212 stores in Mexico.
We believe we have an appropriate strategy to manage our Mexico business for the long run, while minimizing foreign currency risk.
Our ongoing commitment remains to prudently and profitably grow the Mexico business.
Now I'll turn it over to Bill Giles to discuss the remainder of the income statement, cash flows and the balance sheet.
Bill?
- EVP, CFO Store Development, and IT
Thanks, Bill.
Regarding the third quarter, for the 12 weeks ended May 8, we reported sales of $1.822 billion, an increase of 9.9% from last year's third quarter.
Same store sales, or sales for stores open more than one year, were up 7.1% for the quarter.
We experienced strong sales growth from both our retail and commercial customers.
Net income for the quarter was $203 million, an increase of 16.7% versus last year's third quarter and diluted earnings per share increased 31.5%, to $4.12, from $3.13 in the year-ago quarter.
Our continued disciplined capital management approach resulted in return on invested capital for the trailing four quarters of 26.5%.
We have and will continue to make investments that we believe will generate returns that significantly exceed our cost of capital.
Gross margin for the quarter was 50.7% of sales, up 43 basis points compared to last year's third quarter.
The improvement in gross margin benefited from higher merchandise margins, and leveraging distribution costs due to higher sales.
The merchandise margin improvement of 23 basis points was attributable to both a shift in mix to higher margin products, and lower product acquisition costs.
Our Duralast, Duralast Gold and Valuecraft product lines continued to show sales increases in both our retail and commercial businesses.
Our customers continue to recognize the value proposition these high quality brands offer.
We continue to spend marketing dollars to promote our brands as we feel they can create real competitive advantages for us in an ongoing basis.
Looking forward we believe there continues to be opportunity for gross margin expansion.
We have not managed to target gross profit margin percentage, however, as our key focus is on increasing absolute gross profit dollars.
SG&A for the quarter was 31.1% of sales, down 69 basis points from last year's third quarter.
The reduction in operating expenses as a percentage of sales reflected leverage due to higher sales, partially offset by 17 basis points of expense from the continued investment in our hub store initiative.
In addition, as discussed in the last two quarter's results, this quarter also included an increase in pension expense of approximately $2.8 million, or approximately 16 basis points, which reflected decline in value of the underlying assets of the plan.
It is our expectation that we will incur a similar negative basis point impact in the upcoming fourth quarter of fiscal 2010.
We will continue to appropriately manage our expenditures to enhance the customer experience while being fiscally prudent.
EBIT for the quarter was $356 million, up 16.6% over last year's third quarter.
Our EBIT margin improved to 19.53%, or 112 basis point increase versus the previous year's third quarter.
Interest expense for the quarter was $36.8 million, compared with $31.5 million in Q3, a year ago, a 17% increase.
Much of this increase was due to 12.2% more debt outstanding versus last year.
We would expect this higher interest expense run rate to continue into the fourth quarter.
Debt outstanding at the end of the quarter was $2.699 billion, or approximately $300 million more than last year's balance of $2.406 billion.
Our adjusted debt levels at 2.4 times EBITDAR are in line with past quarter's results.
As we have previously stated, our objective is to manage our debt levels to maintain our investment grade debt rating and at a range around 2.5 times adjusted debt to EBITDAR, we feel comfortable that we are well within an appropriate range to achieve that objective.
However, it is our expectation that in any given quarter this may increase or decrease.
In summary, while we finished below our 2.5 credit metric, we remain committed to our capital allocation strategy and share repurchases are an important element of that strategy.
For the quarter, our tax rate was approximately 36.5%, in line with last year's third quarter.
For the fourth quarter, we expect to run a higher rate, closer to 37%.
Net income for the quarter of $203 million was up 16.7% versus the prior year's third quarter.
Our diluted share count of 49.2 million was down approximately 11% from last year.
The combination of these factors drove earnings per share for the quarter to $4.12, up 31.5% over the prior year's third quarter.
Relating to the cash flow statement in the third quarter, we generated $392.1 million of operating cash flow.
We continue to see opportunities to increase operating cash flow going forward.
We repurchased $266 million of AutoZone stock, and at the end of the third quarter we had $251 million remaining under our share buyback authorization.
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.
We reported an inventory balance of $2.3 billion, up 2.1% versus the Q3 ending balance last year.
On a per store basis, we were down 2% at $506,000.
We feel our enhanced hub model will allow us to continue to manage our inventory levels more efficiently.
We do, however, expect to offset some of these inventory reductions with new hard parts coverage.
Accounts payable as a percent of gross inventory finished the quarter at 97.7%, versus 93.7% in last year's third quarter.
Net fixed assets were up 5.4% versus last year.
Capital expenditures for the quarter totaled $69 million, and reflected the additional expenditures required to open 32 new stores this quarter, maintenance on existing stores and work on development of new stores for upcoming quarters.
Specifically related to new store openings, our new stores remain on track and we continue to see opportunities to open domestic stores at a low to mid single digit growth rate for the foreseeable future.
We believe opening stores during these more difficult economic times can be advantageous.
We opened 20 net new domestic stores in the quarter for a total of 4,309 stores in 48 states, the District of Columbia and Puerto Rico.
Depreciation totaled $42.8 million for the quarter, in line with last year's third quarter expense of $41.3 million.
Our senior unsecured debt rating from Standard and Poor's is BBB.
And we have a commercial paper rating of A2.
Moody's investor service has assigned us a senior unsecured credit rating of BAA2 and a commercial paper rating of P2 and Fitch has assigned us a senior unsecured rating of BBB as well and a commercial paper rating of F2.
Now I'll turn it back to Bill Rhodes.
- President, Chairman, CEO
Thank you, Bill.
We managed our business very well this past quarter.
I would like to take this opportunity to again commend and congratulate our AutoZoners on a job very well done.
We executed our plan and had very few surprises.
While we do not and will not manage our business to a 7% comp, we're encouraged by our level of execution and our results, and we look forward to our busiest selling season, our fourth quarter.
Our stores look great heading into this quarter.
The morale across our organization and specifically in our stores is high, and our AutoZoners are excited about the investments we've made in our stores and in them personally.
We remain focused on our key priorities stated at the beginning of our fiscal year.
Number one, relentlessly hiring, retaining and training our AutoZoners to make sure we're delivering on our stated corporate goal of providing the best and trustworthy advice.
Second, continually refining our product assortment in order to meet all our customer needs.
Third, deploying inventory effectively across our network with specific emphasis on utilizing our hub and satellite network of stores.
Fourth, commercial sales growth, with a pay as you go mentality, albeit impatiently, improving our business with up and down the street, national account and public sector customers is our objective.
We will continue to develop our sales team in order to make this happen.
Lastly, we'll work to expand the roll-out of our blended store concept, our one team initiative.
We believe there can be real power in managing our stores as one cohesive unit.
This will only strengthen our service levels to all customers.
As we remain on track with all these initiatives, we promise to continue our focus on innovation, and improving every aspect of our business.
We remain focused on steady, profitable sales and earnings improvement.
We had a very good quarter, which is again worthy of congratulating our entire organization for their commitment to living the pledge.
However, we will not rest on our past performance.
Our approach remains consistent.
We are focused on going the extra mile in 2010 and we will remain well positioned -- and we remain very well positioned to do just that.
Now I would like to open up the call for questions.
Operator
Thank you.
We will now begin the question-and-answer session.
(Operator Instructions) One moment for our first question.
Our first question comes from Gary Balter with Credit Suisse.
You may ask your question.
- Analyst
Hi, this is Simeon Gutman for Gary.
With the sector going through this top line resurgence, we heard pent up demand, you mentioned tax refunds and some secular factors.
We're still trying to gauge how sustainable these sales gains are.
Are you seeing anything in your mix, even within your buckets, that tells you this may be more permanent.
Broadly in general, how sustainable do you think this momentum is?
- President, Chairman, CEO
Well I kind of mentioned in my closing comments, we're not going to manage our business to a 7% comp.
So it's not our expectation that it will run at that rate.
But we don't -- the beauty of this business is we don't have to be able to forecast what the sales are going to be in the upcoming quarter.
We can manage our business week to week certainly, and in a lot of cases day-to-day.
We don't spend a tremendous amount of time seeing what the future is going to be.
What we want to do is optimize the environment we are in.
We believe we have had some industry tailwinds now for 18 months or so.
We probably had some industry headwinds for a long period of time.
I'll just point you back to the 15th consecutive quarter of double-digit EPS growth.
I believe we have the right strategy regardless of what happens in the macro environment, and we don't have a crystal ball to see what's going to happen either.
- Analyst
I guess within your buckets, failure, that presumably gets replaced immediately, but I guess maintenance could be a little bit more put off.
Are you seeing anything that's changing in there to say hey, more of this maintenance now is getting fulfilled and right now we just -- we see that continuing?
- President, Chairman, CEO
I think what we've actually experienced is maintenance really accelerated last year.
And so this quarter we actually talked about it being down slightly.
But that was really as a result of the significant ramp that we experienced this time last year.
The only thing trend wise that we've really seen is a little bit of resurgence in the discretionary categories.
I think some of that had to do with coming into spring.
There's pent-up demand coming out of winter, regardless of which year it is.
People are making their cars -- cleaning their cars, enhancing and accessorizing their cars a little bit and we saw a little bit of a bump in discretionary that is pent up.
- Analyst
As we think through the expense line, obviously you've done a great job in the quarters where comps have been a little bit lower, controlling the expenses.
How do we think about what's controllable and what's an underlying growth rate?
- President, Chairman, CEO
Gary, that's a great question.
I'll get Bill Giles to add on to it a little bit.
What we're trying to do is make sure that we manage our business effectively to whatever business environment that we're in, and I'll point you back to last quarter where we had a 1% comp.
We were able, again, to manage our expenses very well.
This quarter, we did see significant sales acceleration at the beginning of the quarter and we did some things like accelerating our hub store enhancements.
- EVP, CFO Store Development, and IT
I think just to add on to that, Gary, I think we tried to be relatively clear on those initiatives where we added incremental investments and tried the to quantify those for you.
We believe those are going to continue to drive our business for the long term.
The one thing I would draw you back to is the organization's incredible ability to respond to the sales environment for which we are operating in, and being able to manage the expenses appropriately in order to continue to deliver strong earnings growth.
- Analyst
Thank you.
- President, Chairman, CEO
Thank you.
Operator
The next question is from Alan Rifkin with Bank of America.
You may ask your question.
- Analyst
Thank you very much.
Congratulations on a very strong quarter.
- President, Chairman, CEO
Thank you, Alan.
- Analyst
Couple questions for Bill Rhodes concerning the hub strategy.
Now that you're 75% the way through the program and now you said you'll complete the program by the end of the calendar year, whereas I believe in the past it was the end of next fiscal year, obviously this is yielding tremendous results on the commercial side of your business.
If we look at the hubs that were added early in the program versus the hubs that were reinforced in the latter part of the program, collectively what are the same store sales for the stores supported by the 108 hubs, how are they doing relative to the ones you haven't completed yet?
- President, Chairman, CEO
I think there's a myriad of factors.
We really haven't looked at particularly that way.
What we have looked at is how are the parts selling that we are adding to those hubs and how are the parts that we're replenishing to the satellite stores selling.
We've been, as we have mentioned previously, we've been very encouraged and the sales are exceeding our plans.
We're a little hesitant to quantify because there's so many factors that are going on at the same time.
What I will say and reiterate is the hubs that we opened in 2008 continue to grow quite nicely and we're continually refining the model and refining the inventory assortment, and so we're encouraged that yes we're getting a significant bump when we open them, but think there's still a long way to go to optimize them.
- Analyst
Okay and a follow-up if I may.
On the one team concept, you said you're going to be expanding this test in the fourth quarter.
What are the associated expenses with that, and are you at liberty to shed a little bit more color as to what exactly you're seeing on the revenue line as a result of the implementation of this concept in the early stores?
- President, Chairman, CEO
I'm hesitant to talk about the sales performance because it's literally been a few handfuls of stores.
So I'm pretty cautious about doing that.
But there's two things that I'd like to add.
Number one, the whole notion of one team, we have specific tactics we put in these test stores.
But the whole notion of one team is beginning to go across the organization and whether they have the assets required or not, they're really working much more closely together and that's been beneficial.
On the expense front, we're not sure that there will be significant expenses.
There might be some CapEx expenses providing more hardware on the parts counter for the commercial sales organization, but I don't think you'll ever hear us call that out as an expense drag or a CapEx major hit.
We did, as I mentioned in the prepared remarks, we did develop a version of Z-net for commercial, which is very exciting because it's been an old green screen platform and therefore it's been very hard to get people that don't work with it every day to fill in on vacations or when somebody has to go out and make a sales call or anything like that.
So we're very excited about the commercial Z-net and its ability to help facilitate one team as well.
- Analyst
One last question, if I may, Bill.
You mentioned as part of the driver to success on the commercial side was an increase in sales managers.
What is your prognosis for the number of incremental sales managers that will be added over let's say the next 12 months?
- President, Chairman, CEO
We really haven't laid out specifically how we're going to do that.
What we're doing is -- and I mentioned pay as you go.
That's our mentality.
Put some in, get them to the point that they're productive and providing incremental EBIT and then take that incremental EBIT and invest it in the next group.
We're now over 200 and we look to be significantly higher than that, and we really, frankly, don't even know how high is high at this point in time.
- Analyst
Thank you very much.
Operator
Our next question comes from John Lawrence with Morgan Keegan.
You may ask your question.
- Analyst
Good morning.
- President, Chairman, CEO
Good morning.
- Analyst
Bill, would you comment a little bit on the strength of commercial, when you break down that customer set between up and down the street customers and the chain accounts, can you sort of delve into that a little bit and talk about the strength on both sides?
- President, Chairman, CEO
Well, the way we're really looking at it is we want to do things that benefit all our customers.
When we focus on the things that are important to the up and down the street customers, they translate terrific to the national account customers as well.
We have seen more growth in up and down the street in recent quarters.
Some of that's been because of some of the businesses that we're not doing business with, but we're having really nice results with a tremendous amount of our national account customers as well.
- Analyst
Great.
Thanks.
Good luck.
- President, Chairman, CEO
Thank you.
Operator
Thank you.
Our next question comes from Colin McGranahan with Bernstein.
You may ask your question.
- Analyst
Good morning.
Thank you.
First question is on gross margin.
Unless something changes dramatically in the fourth quarter, looks like you're on track for at least 10 consecutive years of gross margin expansion.
You said and commented, I think you said this before that you continue to see opportunities for gross margin.
Just wondering as the commercial business does accelerate here, and obviously that provides a little bit of negative mix pressure, how much more gross margin opportunity you think there is and if you can comment at all, obviously the industry overall, your primary competitors have seen nice gross margin trends as well.
Does this just continue from here?
- EVP, CFO Store Development, and IT
I think that we certainly have a positive outlook on gross margin as we look forward.
We believe there are various attributes of gross margin that continue to have opportunity for us to expand.
I think we've done a good job this quarter.
We talked a little bit about shift of mix.
So that can be somewhat timing within a quarter.
At the same time, we've got lower acquisition costs.
I think our merchandising organization has done a very good job of continuing the work and reduce our acquisition cost.
Some of that comes from direct sourcing as well.
We always continue to have opportunities on supply chain.
We feel terrific about the improvements and the enhancements that we have made to improving gross margin.
At the same time, we have experienced acceleration in our commercial business.
Going forward we continue to see opportunities on each of those fronts.
- Analyst
Okay.
And no change or any pressure from pricing that could offset that?
- EVP, CFO Store Development, and IT
There's always things that can happen in the future, but at the moment I think we've done a very good job between price optimization, as well as lower acquisition costs, as well as expanding our ability to increase our direct sourcing to reduce acquisition cost, and then also our supply chain organization has done a terrific job of managing their infrastructure.
- Analyst
Okay.
And then just a second question coming back to the one team concept, can you provide any help in understanding how labor hours or labor productivity has changed or improved in the concepts, in the tests?
- President, Chairman, CEO
Really we haven't focused on labor hours that much.
We basically focused on -- if you take a typical store, may have two people in it at a point in time for DIY and two people working on commercial.
If you get a rush, either in DIY or commercial and you're focused on leveraging those two folks, you don't have the resources you have when you manage the whole business as four.
We haven't significantly changed the labor hours up or down, but what we've seen is we've been better able to service customers on both sides of the business and that's benefited us on the sales line.
- Analyst
It's really a sales per labor hour productivity enhancement?
- President, Chairman, CEO
It is.
Will it give us opportunities in the future to look at leveraging payroll differently?
Maybe.
It also may give us an opportunity to add payroll and be more productive with it.
We really don't know at this point.
- Analyst
Great.
Thank you very much.
- President, Chairman, CEO
Thank you.
Operator
Thank you.
Next question comes from Tony Cristello with BB&T Capital Markets.
You may ask your question.
- Analyst
Thanks.
Good morning, gentlemen.
- President, Chairman, CEO
Good morning.
- Analyst
One of the questions I wanted do to ask a little about is the hub conversions obviously are working and you're seeing the results.
Is it also related to -- sounded like, Bill, in some of your commentary, you talked about the ability then to force product back into the hub and carry fresher product or product that will turn quicker at the local store.
How much of that has been reset throughout your network today?
If you think about 76% of the hubs have been converted, maybe is it because of the maturation of that, is it maybe 50% of your stores are getting that benefit or that lift right now?
- President, Chairman, CEO
Well, you're talking about the benefit of lower inventories, removing the slow moving inventory.
- Analyst
Removing the slow moving inventory, then also having probably a better assortment of parts to sell through the store, at the store level.
- President, Chairman, CEO
First I'd say we are so focused right now on making sure that we have the right parts coverage in our stores, that we've been pretty cautious on removing that slow-moving inventory in the satellite stores, and candidly we'll remain pretty cautious on it.
We'll do it methodically over time because the last thing we want to do is start saying no to customers in the marketplace.
As you can tell from our overall inventory results, we were down 2% on a per store basis.
That's a significant contributor to that decrease and there's probably more upside to that over the long term.
But at the same time, as you mentioned, we're going back in and putting in newer late model coverage to make sure that we can fulfill the needs primarily of the commercial business, but one thing we keep learning is every time we put inventory in that's newer and fresher, the DIY business uses it as well.
- Analyst
One thing I wanted to also ask about is when you look at the expense or the spending related to the conversion of the hubs, is it fair for us to assume that with the success of commercial as a result, as well as you pointed out DIY, there will remain some embedded level of spend to help drive further commercial growth down the road, or could that level of spend even perhaps be accelerated somewhat?
- EVP, CFO Store Development, and IT
I think it's fair to say that there will be some embedded expense in there from the commercial -- continue to improve the commercial business overall, particularly as we talk about converting some of the hubs, there's going to be an element of those expenses that are ongoing in order to operate it.
But obviously, we believe as we continue to and Bill talks about all the time on a pay as you go mentality, that we continue to get the appropriate returns for the investment that we're making and on a long-term basis expect to leverage those expenses.
- Analyst
And Bill, do you think that the level of success you've seen to date is better than you would have anticipated at this point?
- President, Chairman, CEO
I would say I was quite pleased with 15.5% growth in commercial business in Q3.
Like I said, with the 7%, I wouldn't straight line that.
If we come down slightly, I'm not worried about it.
I'm very satisfied with the strategies that we put in place and really commend both the operating teams on improving the service levels of the stores and also the sales team, which remember is only three years old.
And while we will continue to add numbers to that sales team, the maturation of that sales force is still very early, and candidly I'm very pleased with how they're progressing.
- Analyst
Okay.
Thank you.
- President, Chairman, CEO
Thank you, Tony.
Operator
Thank you.
Our next question comes from Matt Fassler with Goldman Sachs.
You may ask your question.
- Analyst
Thanks a lot.
Good morning.
Couple questions.
First of all, you talked about having gained market share this quarter.
Given the acceleration in your sales and the similar acceleration that we saw across the sector, how did your share increases this quarter compare with the share increases that you saw in recent quarters?
- President, Chairman, CEO
What we stated was we continue to have share increases in the DIY and commercial.
I think they might have been slightly lower this quarter than they have been in the last few quarters.
We started annualizing some very significant gains last year.
- Analyst
Got it.
Second question, if I could.
Couple people have speculated about a prospective change in seasonality to the business to the extent that the fourth quarter has kind of been a pun quarter for the last couple years for whatever reason, perhaps consumers are focused on other things and they're buying closer to need, with the first quarter, the first calendar quarter, really the spring quarter accelerating to a greater degree than we have previously seen.
Do you think, Bill, that there's any relevance or truth to that assertion?
- President, Chairman, CEO
I do, Matt.
I don't have empirical evidence to say.
We've looked at a lot of different factors.
The one that we called out was we believe there was a benefit from tax refunds and if you think about a very challenged macro environment, and particularly some of the customers that we deal with who were hit the hardest by it, them getting a refund check is like a monetary stimulus to them and I think that helps bring it in.
Also, I think that there is some factor to coming out of winter, there is more demand that's pent up and people are doing that when the weather breaks.
- Analyst
And then finally, in our store checks and online checks we've noticed a little bit of price creep in some of the commodity driven front end items really across the sector, no one more than anyone else, items that would typically I think be considered inelastic, as most of your store really is.
Can you talk about us about what you're seeing in pricing and whether you think that price points and commodities in particular might be contributing to some of the acceleration that we're seeing across the space.
- President, Chairman, CEO
I wouldn't say that we've seen a significant change in commodity price points over the last 12 months.
Before that, there was a very significant change, just talk about oil for instance.
We used to sell it for $1.99 a quart.
It's now on shelf at $4.29.
There's also continuing good promotions certainly by us, we're selling a five plus quart jug and an oil filter at a very attractive price.
So all in, I don't think there's been a significant increase in commodity pricing that's driving any of the sales performance.
- Analyst
Thank you so much.
Operator
Next question comes from Kate McShane with Citi Investment Research.
You may ask your question.
- Analyst
Hi.
Thank you.
Good morning.
- President, Chairman, CEO
Good morning.
- Analyst
You had mentioned that you're seeing strong execution from your competition and I wondered if anything changed in the competitive environment during the quarter in terms of discounts, or promotion, or advertising from your competitors that was different from the quarter before?
- President, Chairman, CEO
No, I wouldn't really call out anything material by any stretch of the imagination.
Our competitors have always been strong.
We have a great deal of respect for them and what they're able to do.
Our objective is to do it better.
And that's what we're going to continue to be focused on.
- Analyst
Okay.
And how much of your growth do you think in DISM is a result of the dealership conversions and do you have a sense of how many more quarters you're going to possibly benefit from this?
- President, Chairman, CEO
I wouldn't attribute our performance in the commercial business to many significant external factors.
I think the external factors certainly come into play more in the DIY business because we have a more mature business, but in commercial, I think our destination is generally solely up to us.
We're so new in this business, that I really wouldn't put it to dealerships and if you look at the acceleration from just last quarter, we were at 8.5%, we went to 15.5%, clearly dealership closings didn't happen at that rate during the quarter.
- Analyst
Okay.
Thank you.
- President, Chairman, CEO
Thank you.
Operator
Thank you.
Our next question comes from Dan Wewer with Raymond James.
You may ask your question.
- Analyst
Thanks.
Bill, last year you noted that you were going to reduce the return on investment hurdle for new stores from 15% down to 14%, I presumed that was healthy unit growth in the state of Florida.
In hindsight, looking at the performance of your new stores, looking at the 200 basis point increase in overall return on capital, have you in fact seen the returns in your newer stores drop as you were speculating a year ago?
- EVP, CFO Store Development, and IT
It's still fairly early because those stores are still relatively immature, but I believe that strategy was helpful for us and it allowed us to penetrate faster into markets that we were underpenetrated in.
So overall our returns continue to perform well.
I think that some of the strategic decisions that we made on those stores individually have turned out very well.
And the returns have remained very healthy.
- Analyst
So when you look at their -- both the capital cost of opening the stores and the initial profit run during the first year, have they not changed from what you were seeing in other markets?
- EVP, CFO Store Development, and IT
They've all opened strong and so they've opened a little bit better.
Our new store productivity overall has been a little bit stronger than it has historically.
I would say we've been very pleased with that.
- Analyst
And then Bill Rhodes, a question for you.
You noted that on your commercial sales efforts, the first initiative is to increase share with your existing customers and then second, add new customers.
When you look at the 15% revenue growth in commercial, big acceleration from the previous quarter, can you give us a sense as to how those two priorities are playing out?
Are you in fact seeing the faster growth with your existing customers?
- President, Chairman, CEO
I would say it's pretty much across the board, Dan.
I wouldn't say -- I would say both of them, the penetration and the new customers, generally grew at about the same rate.
- Analyst
Grew at about the same rate.
- EVP, CFO Store Development, and IT
Proportionately to when they were growing at 8.5.
So nothing material there.
- Analyst
Okay.
Great.
Thank you.
- EVP, CFO Store Development, and IT
Thank you.
Operator
Next question comes from William Truelove with UBS.
You may ask your question.
- Analyst
Getting back to commercial a little bit, talking about how you set your own kind of results, could you talk about the inventory or out of stock issues with the hub stores that have been converted versus the hub stores that haven't been converted.
How much of the sales gain is just having the parts versus other kind of factors?
- President, Chairman, CEO
I think a big part of it is having the parts.
We've expanded the coverage significantly in those new model roll-outs and so we're able to say yes quite a bit more frequently than we were before, but I also think there's a halo effect.
When you continue to say yes to special order needs or special requests, from commercial or customers regardless of whether they're commercial or DIY, you build more confidence with them and the next time they have something, be it a special item or a regular item, they're more likely to call you.
We've seen a little bit of a rising tide lifts all boats.
- Analyst
Is there any way to compare that or some additional details between where that is now in the converted hub stores versus where it was in terms of that, or could you say a majority of the 15% is from that?
- President, Chairman, CEO
Yes, a majority of the 15% of the commercial growth, no, I wouldn't say that at all.
I would attribute more to our operating execution and our sales force development and maturation than I would to the hub stores.
Don't forget, the hub stores are benefiting significantly on the DIY side.
In fact, more of the benefit as a percentage of the total comes from the DIY, because we have 85% of our business in DIY.
- Analyst
Wonderful.
Thank you so much.
- President, Chairman, CEO
All right.
Thank you.
Operator
Next question comes from Chris Horvers with JPMorgan.
You may ask your question.
- Analyst
Thanks, good morning.
First, on the discretionary sales mix, can you talk a little bit more in detail on the category beneath that?
Curious to see if this is products like car wax that's driving that or is it some of it something where you could consider it deferred maintenance items, that eventually the consumers put it off and they have to do it, I don't know, something like car mats, any detail there would be great.
- President, Chairman, CEO
I would say it's more on the personalization and performance oriented areas and I would like to call out our merchandising team.
I think that group in particular is focused very hard on finding ways to fulfill customer needs and they changed their product mix as a result of the economic situation that exists today.
So things like car mats and radios and all towing and travel, all those kinds of items are where we've seen some of the pickup.
- Analyst
So basically the consumer ends up with more money in their pocket and that confronts better merchandising and that drove the improvement?
- President, Chairman, CEO
Yes, again, I don't want to over state that.
We said it went up to 20% of the mix, but we also said that that generally happens this time of the year and I think that there's a -- spring's coming and I want to get my car looking good again.
- Analyst
And then just overall on the monthly basis, can you talk about how the -- your sales mix peaks here in the next month or two.
Is May the biggest month of the year or June?
- President, Chairman, CEO
Our business comes out strong starting around Valentine's day.
It comes on pretty hard and it has ups and downs over the next six months, but it remains pretty strong across -- throughout the summer time.
- Analyst
And then finally, on the gross margin, for Bill Giles, it seems like there's a step up in tone there.
Previously you had talked about gross margin continuing to be -- to look good, but maybe not at the same pace as what you saw in that quarter.
What's driving that?
Is that acceptance of the private label brands on the commercial side?
Is it sourcing efforts?
What exactly is driving that step-up?
- EVP, CFO Store Development, and IT
I think we talked before about it being as much about mix in product, so I think that that's a lot of the offering in the work that the merchandise organization has done.
I think there's been a piece of that at some lower acquisition cost, which I think is merchants ability to source product at a more effective basis in order to help lower cost.
I think we've also experienced some improvements in our supply chain organization and their ability to continue to squeeze cost out of their organization and to leverage it.
And so we run a very healthy gross margin, and we've generated some slight improvements over the quarters, and we continue to remain positive.
- Analyst
Thank you very much.
Operator
Thank you.
At this time I'll turn the call back over to Bill Rhodes.
- President, Chairman, CEO
Thank you.
Before we conclude the call, I'd like to take a moment to reiterate that our business model remains very solid.
Our customers continue to tell us we're improving on our efforts to meet or exceed their needs, and market share data confirms their opinion.
We have a solid and consistent plan and a great team, but I want to stress that this is a marathon and not a sprint.
Our focus is on our critical success factors.
As we continue to focus on the basics and never, ever take our eye off of optimizing long-term shareholder value, we are confident AutoZone will continue to be incredibly successful.
With this Memorial Day extended weekend upcoming, I hope we all take time to remember those heros who died servicing our country.
Thank you very much for participating in today's call.
Operator
Thank you.
This does conclude today's conference.
We thank you for your participation.
At this time you may disconnect your lines.