汽車地帶 (AZO) 2003 Q2 法說會逐字稿

Good morning, this is the conference call to discuss AutoZone's second quarter fiscal year 2003 financial results.

Steve Odland the companies Chairman and CEO will be making a short presentation on the highlights of the quarter.

The conference call will end promptly at 10 a.m. central time, 11 a.m. eastern time.

All parties will be on listen only mode until we open up for questions and answers.

Also today's call is being recorded.

If you do have objections you may disconnect.

Before Mr. Odland begins the company has requested you listen to the following statement regarding forward looking information. .

These statements are forward looking statements.

These statements discuss among other things business strategies and future performance.

These forward looking statements are subject to risks, uncertainties and assumptions including without limitation competition, product demand, the economy, and inflation, gasoline prices, consumer debt levels, war and the prospect of war including terrorist activity and availability of commercial transportation.

Please refer to the risk factor section of the form 10-K for the fiscal year ended Aug. 31, 2002, for more information related to these risks.

Actual results may materially differ from anticipated results.

AutoZone undertakes no obligation to publicly release any revisions to reflects events or circumstances occurring after the date of this presentation or to reflect the occurrence of unanticipated events.

Mr. Odland, you may now begin.

Thank you.

Thank you for joining us today for AutoZone's 2003 second fiscal quarter conference call.

With me today are Mike Archbold AutoZone's Senior Vice President and Chief Financial Officer and Brian Campbell our Director of Investor Relations.

I hope you had an opportunity to read our press release very strong results in the quarter.

If not the press release along with the slides complementing today's comments are available on our website at www.AutoZonene.com.

Click on Investor Relations to see them.

Turning to the quarter results, we are very pleased to report another great quarter for AutoZone.

The second quarter continued our trend of record of record sales, record EBIT, record EBIT margin, record cash flow and record earnings per share even against our very strong quarter -- in fact our strongest performing quarter in the prior year.

This quarter we reported a 2.4% comparable store sales increase on top of last year's very strong and peak period where we had 12% increase.

And we had a 36% increase in our earnings per share this quarter on top of the 107% increase in the same quarter a year ago.

For the quarter, total sales increased 3.6% from year ago to $1.121b.

When you exclude the sales of TruckPro, which was a subsidiary that we sold in December of the prior year, total sales increased by 4.8%.

Same store sales were up 2.47% in the quarter.

And for this quarter a little more was driven in the comparable store sales by average tickets and traffic.

Gross margin for the quarter as a percent of sales increased .34 percentage points to 44.3%.

Net operating expenses were 31.1% of sales which is down 1.62 percentage points or 162 basis points versus a year ago results in a quarterly operating margin of 13.2% versus last year's 11.2%.

Net income was $79.3m or 7.1% of sales generating an earnings per share of 79 cents.

Our strong earnings growth and our discipline capital management resulted in return on invested capital for the trailing year of 21.4%.

I'd like to take a moment here and just talk a little bit about corporate governor answer.

AutoZone was one of the first companies to adopt corporate governorance principles back in 2001.

Additionally we created a nominating committee.

All committees are comprised of independent directors and we restructured our board of directors and instituted a code of conduct.

I am very proud to stay these efforts have been honored recently by institution of shareholder services.

Out of 5,000 public companies assessed, ISS ranked AutoZone in the top handful of companies in its overall corporate governorance quotient central research tool.

This award confirms for that us we are focused on the right things for instilling honest, clear, decision making procedures in all of our day to day activities.

Now let's turn to our sales.

First let's look at the retail or the Do-It-Yourself DIY business.

For the quart, total retail sales were up 1.3% for the business.

Same store sales were down .6%.

But it's very important to note here that this marks very strong performance considering that last year in this quarter we reached our peak and enjoyed 11% retail same store sales with a balance between customer transactions and average ticket.

This quarter we were going up against those comps and we were able to keep those customers and keep those sales.

We were very successful at basically maintaining our tremendous growth from last year into this quarter.

This is not an easy accomplishment and its extremely encouraging to see that the initiatives being executed are paying great dividends in this year's financial results.

Our sales performance has been amazing considering we have only opened 100 stores roughly in the last two years each and we've had no acquisitions in the past several years.

Which, of course, as you know would have increased our comps as they all matured.

We continue to successfully build sales in this core business and we have tremendous growth opportunities as we continue to focus on innovation.

Advertising merchandising programs continue to be the primary drivers of our volume.

We have followed up on our extremely successful "Get in the Zone" radio campaign with complementary successfully testing television messaging.

This is the first time since July of 2001 we will be using television as a medium.

We also just completed our ultimate garage promotion which showed great results.

Our introduction of high gondolas on every other aisles in the store enable us to keep our merchandising fresh and compelling.

In our front end sales growth has continued to be strong with the innovative red zone and continued new merchandise introductions.

We've made a commitment to establishing good, better and best delineation for most of our categories and we continue to expend our very strong value craft and [DURAlast] brands.

For the trailing 12 months sales per square foot were up 5% to $261 per square foot and continued to set the pace for the rest of the industry.

New store productivity continues to improve.

We opened 30 stores, new stores, in the quarter, closed six, and replaced three for a total of 3,122 stores.

So year to date, we've opened 61 stores.

We plan on opening at least 150 new stores for fiscal 2003.

Now turning to commercial, AZ Commercial sales in same stores increased 29.2% this quarter while total commercial sales increased 31.1% as we continued to execute our strong game plan.

We now have the commercial program in roughly 2,000 stores supported by about 90 hub stores.

A hub store continues to provide us with fast replenishment of critical merchandise, that supports both our commercial and DIY businesses.

We have committed much focus on the AZ Commercial program as you know over the past year and we have continued to have success developing our sales force, developing customers around existing stores, and adding new local and chain accounts.

As well as implementing the whole hub store system.

We have focused our efforts on local customer as well as chain accounts with vigor and we have been successful in cultivating relationships by utilizing our national reach and our message.

Being the only chain to have national store coverage of company owned and operated sites we are able to have the right parts in stock to supply any chain customer and exceed their customer service expectations with only 1% of the commercial sectors business AutoZone has tremendous opportunity to gain market share.

In an industry that the automotive aftermarket industry association states is a $47b industry, it has groan at 5% compounded per year, we are confident our model will continue to attract new customers.

In Mexico, our Mexico stores continue to do well in the quarter even with the continued Peso fluctuation and economic uncertainties there.

We opened one new stores which now gives us 41 stores in Mexico compared with the 3,122 in the U.S.

Our commitment remains to prudently and profitably grow the Mexican business.

Grot profit for the quarter was 44.3% of sales which is up .34 percentage points from the prior year.

Now, the absence of TruckPro from this quarter's numbers improved gross margin by .2 percentage points.

The remainder of the improvement in domestic gross profit continues to come from cost savings, not pricing, and as AutoZone holds the position of price leadership within the industry.

Our previously mentioned focus on expense control has shown really great results.

SG&A for the quarter was 31.1% of sales which is down as I said 1.62 percentage points from last year.

We are very, very pleased with our continuing progress in controlling expenses even though we continue to see room for further improvement.

We continue to show leverage at the store level.

At our store support center we gain leverage from controlling from staffing, salary and IT spending.

We have also been effectively managing our medical and insurance costs on an ongoing basis.

Advertising costs net of vendor funding were down versus last year.

Though our advertising frequently continues to increase as mentioned previously and we returned to television for the first time since 2001.

Our business showed some seasonality therefore it's really important to note that sequential quarter performance will vary with the majority of our sales coming in quarters three and four the next two quarters, we expect to further enjoy leverage on expenses.

Expenses as a percent of sales need to be looked at on a year-over-year-basis and there we show very strong results.

EBIT for the quarter was $147m up 22% from last year.

Our EBIT margin was up 1.96 percentage points to 13.2%.

This is the best second quarter EBIT margin performance in the history of our company.

In fact, with quarter one being our best EBIT margin performance in any previous first quarter this marks the best year to date performance in our public company's history.

Interest expense for the quarter was $19.6m compared with $18.3m a year ago.

This increase is a result of our issuance of long-term debt during the first quarter along with an increase of total debt outstanding by $88m.

Total debt balance were increased in proportion to our cash flow.

So with these trends EBITDA to interest coverage is now 11.7 times for the trailing 12 months compared to 8.5 times last year.

And adjusted debt to EBITAR is at 1.9 times which is down from 2.27 times last year excluding the restructuring impairment charges.

At Feb. 15, 2003, AutoZone continues to be one of the only players in the industry to have an investment grade debt ranking.

Our senior unsecured debt rating from Standard & Poor's is a triple B plus and we have a commercial paper rating of A2.

Moody's investor service has assigned us a senior unsecured debt rating of BWA2 and a commercial rating of P2.

Additionally during the first quarter both S&P and moody's improved their outlook for AutoZone.

For the quarter our tax rate was 38% flat with last year and finally net income for the quarter was $79m up 24% versus the prior year and earnings per share for the quarter was 79 cents up 36% on $100.4m shares diluted.

Now I'll turn it over to Mike Archbold to take us through the cash flow, share repurchases and the balance sheet.

Thanks, Steve.

In the quarter AutoZone generated $54.5m of cash flow reflecting seasonal working capital needs before we repurchased $3.8m shares of our stock for $259m.

Of the $259m, $81m was actually purchased on the balance sheet during the quarter.

The remaining $178m was purchased under forward agreements that will be settled at a later date.

For the trailing 12 months, we've generated $601.7m of cash flow from $943m of EBITDA which we used to purchase $689.3m of our common stock.

Since the inception of our share repurchase program we have bought back 66.3m shares at an average price of $36.08 per share.

We continue to focus on improving our return on investment capital and in fiscal '02 we achieved a 19.8% ROIC.

For the trailing four quarters, we report yet another improvement to 21.4%.

Our relentless focus on ROIC underscores our belief that it is truly the best indicator for the creation of shareholder value.

Turning to the balance sheet highlights.

Gross Inventories are up 17% versus the prior years.

However, as previously discussed we maintained our inventory per store at levels lower than the first quarter while also reducing net inventory per store versus the prior year.

Remember, we purposefully increased inventory through the first fiscal quarter to do a number of things, reduce out of stocks, add commercial brand coverage, add late model parts for AZ Commercial and to expand our good better best product ranges.

We intend to continue to hold our inventory per store roughly at these levels for the balance of the year.

Again, just as a reminder, inventory in this business is not fashion oriented or perishable and the increase has been entirely financed through accounts payable.

Owned inventory net of payables changed by only $7m last year for a slight 1.6% change.

And we improved our net inventory turns in the quarter based upon ending inventory to 6.9 times from 6.6 times last year.

Accounts payable is a percentage of inventory again increased to 70% from 66% last year.

It's important to note here accounts payable does have some seasonality on a per quarter basis but we have announced our internal goal as stated previously of achieving 100% AP to inventory over time.

As previously mentioned, we improved our in stock position while holding inventory dollars per store flat versus Q1.

We've done this buy utilizing our inventory management system which identifies the right parts to have customized to each of our 3,122 stores.

While our supply chain assures we get them there as quickly and as efficiently as possible.

Through this one-time purposeful effort at increasing gross inventory during Q1 to have the right parts at the right location, we believe that we are servicing our customers at industry leading levels.

Additionally, we now have commercial brands in place and greater late model coverage to service our commercial business.

And we're committed to our mandate of achieving a 15% after tax IRR threshold on all projects, therefore, all the inventory supporting our stores, no matter how quickly or slowly they sell, will not be added unless they achieve that hurdle.

Continuing with some of the highlights, looking at working capital, working capital is down $35m from a year ago to $108m.

And represented 2.0% of trailing year sales.

Down from 2.8% in the prior year.

The continued improvement in working capital reflects our focus on cash flow management.

Additionally we've introduced our vendors to both a vendor accounts receivable factoring program to reduce their costs of borrowing as well as our new pay on scan opportunity.

The pay on scan program was introduced to our vendor community back in January.

Essentially, this program is designed around having ownership and inventory management of merchandise reside with the vendors until it is purchased by the ultimate consumer.

This initiative encourages AutoZone and its vendors to focus on taking costs out of the entire supply chain and ultimately growing customer sales.

Net fixed assets were down 1.2% versus last year, capital expenditures for the quarter totaled $31.4m and year to date are at $61.8m.

Depreciation and amortization totaled $25.2m for the quarter.

We opened up 30 new domestic stores in the second quarter after having opened 31 stores in the first quarter.

The second quarter of last year stores opened 38 new stores.

Year to date we've opened 61 total domestic stores on our way toward our target of opening at least 150 stores in fiscal 2003.

Our debt at the quarter end was $1.34b an increase of $88m or 7% from the prior year level of $1.252b.

Which is mainly explained by the repurchase of $81m of our stock in the second quarter.

Debt continues to be an important and strategic part of our capital structure.

It significantly lowers our blended cost of capital.

Equity costs remain in the mid teens while debt is in the mid single digits.

Our shareholders equity declined slightly reflecting that repurchase of $689m of our common stock over the past 12 months.

And our return on equity on a trailing four quarters basis is 57% versus 27% last year.

Additionally during the quarter, we announced that our board of directors granted a $500m share repurchase authorization and we will continue to our r our shares as long as it is accretive to earnings.

In sum we've reduced our invested capital by $56m or 3% compared to a year ago.

Our financial model is stronger than ever as we continued to increase both earnings and cash flow.

Lastly, just want to spend a minute on vendor funding here.

AutoZone has strict procedures in place to manage this activity.

With much discussion outside this industry on vendor funding I thought it important to define this as AutoZone manages it.

These vendor funds can be described as either moneys earned strictly from volume purchase quantities or from all other advertising support, new product promotion, et cetera.

We at AutoZone have established procedures that are audited and by acting as our internal audit as well as Ernst and Young acting as our external auditors to recommend this income as the appropriate merchandise is sold to the customers or the expenses are incurred to prepare the merchandise for selling.

This procedure is tightly monitored and moneys not recognized as income are placed in inventory until appropriate.

Now I'd like to turn it back over to Steve to discuss the outlook.

Thank you, Mike.

What we generally decline to give specific guidance on future sales and earnings by pre-releasing our last quarter results it Allowed us to continue to buy back our shares at prices that were very accretive to earnings in the quarter.

We were able to do so at a time that would typically be a black out period for share repurchases.

As we said before we continue to believe that our business model has strengths in both strong and weak economies.

We're pleased with the results thus far for fiscal 2003 and have done well even against our peak comparisons a year ago.

The sales we have experienced to date continue to be driven primarily by our advertising and merchandising effort as well as our expansion in the AZ Commercial business.

We believe that we have many initiatives that will help us continue to grow same store sales.

But we budget very conservatively to ensure that we maintain our expense discipline and deliver solid returns.

Our opportunity to continue to expand our commercial business is vast.

It leverages much of our infrastructure in drives incremental EBIT dollars with very low incremental investment and it will be accretive to our very high ROIC that we just achieved in the trailing four quarters of 21.4%.

We continue to have opportunities to expand our gross margin in the coming year driven by lower product cost, supply chain leverage, mix of our business, and some improved pricing.

Additionally, new programs like pay on scan will help to create stronger partnerships with our vendors.

At the same time we are dedicated to reducing our expense ratios in the future, even as we continue to increase advertising and marketing spending.

Our objective over time is to get back to the more favorable SG&A level experienced in past years.

Repurchasing stock is a key tool in managing our capital structure and we will continue to repurchase stock as Mike said as long as we believe it's accretive.

We're not giving specific earnings guidance again because we are not managing the business to a specific target as that could actually inhibit our performance so instead we work our hardest every day to deliver our best results for our shareholders.

We continue to be excited by the progress we've made over the past quarter.

And the year to date.

We are confident in our ability to profitablely grow AutoZone well into the future.

AutoZone is the leader in this very exciting business of ours and we have a great plan, wonderful team to execute it.

We are clearly focused on operating this company to profitably grow sale.

Efficiently deploy capital and maximize long-term shareholder value.

Now I'd like to open up the call for questions.

Thank you.

At this time we are ready to begin the question and answer session.

If you would like to ask a question, please press star one on your touch-tone phone.

You will be announced prior to asking your question.

To withdraw your question you may press star two, once again if you would like to ask a question, please press star one on your touch-tone phone.

John Lawrence your line is open and please state the company name.

Good morning guys.

Good morning.

From Morgan Keegan.

Steve, would you comment a little bit on the commercial program and give us a little more insight as to that 29% growth, I know it's difficult to break it down, can you give us a feel for what is growing faster?

The chain accounts or the small mom and pops?

Great question.

You know, the majority of our business is with the up and down the street business as we call it which is serviced from all of our stores and so think about it as a three-mile radius around all of our commercial programs.

And that business is where we started a few years ago.

In the past year, we've begun to focus on the chain customers and we've done that because we think that AutoZone has a strategic advantage with the chain customers in that we're the only commercial supplier in the United States that owns our stores that has complete national footprint that overlays any chains footprint of stores and we can be of one stop shop for them where we can meet at the headquarters level, determine the appropriate pricing and the program and go forward from there saving them money so that their store managers don't have to go through and negotiate parts deals with all the smaller players.

So we really do have a very strong strategic advantage and we're starting to see some good growth there, but, you know, John, the sales in the chain side doesn't ramp up in a stair step kind of fashion.

The way it works is you probably know, is we work with the accounts for some time, we build the relationships, eventually as we're successful it allows us then to begin and go out and begin to sale their franchises and their corporate stores.

So once we quote unquote ran a chain customer that gives us a chance to build chains in that chain for many years to come.

We've had good balance in our growth in the quarter between both but we're really excited about our point of differentiation among the chain accounts in the future.

Thanks.

Thank you.

Our next question comes from Brett Jordan, please state your company name.

Addvest.

A couple quick questions on the commercial, also.

One I think first quarter ended with about 2,000 stores I think you reduced that commercial distribution in about 45 stores in the end of the second quarter.

Is there a target number that you've got for the year in commercial distributions?

Then a quick follow-up on the commercial side?

What was the receivables?

Clearly this has groan as piece of the business.

Are their credit sales associated with commercial?

Good question, on the commercial side we open programs or stores as you know over time we open several hundred stores to commercial in the fourth quarter of last fiscal year.

But we're constantly monitoring and contouring our, which stores have commercial and consolidating here and fine tuning there.

And so those programs sometimes move around a little bit.

We are -- we're very pleased with where we're at right now and the stores that have open commercial in the past six months are maturing nicely.

We haven't set exactly a target for our self the balance of the fiscal year but clearly adding the commercial programs in the stores that we have are tremendously incremental.

You know, we analyze every store for the addition of commercial based on the number of customers and service bays that are in the three-mile perimeter surrounding those stores and you know as those stores -- and those opportunities continue to develop we'll add the stores as we go.

Your second question was related to the receivables.

Can you just state that again, Brett?

Clearly as your commercial has groan some of these are credit sales to the commercial accounts.

Do you have a receivable line that you're beginning to report so we can sort of monitor the credit quality of the commercial receivables to you?

Brett, it's Mike Archbold.

The receivables as part of this business is actually very small, the up and down the street customer, the local accounts tend to be on very, very short terms that could be anywhere from cash on delivery to paid at the end of each week so the extension of credit is very low so those accounts.

There is some extension of credit for the larger chain accounts.

And we disclosed that balance is somewhere south of $30m and we're currently factor those receivables and maximizing our cash flow currently.

So I wouldn't expect that to be a very big number to be driving into the future.

Okay.

As you pick up chain accounts in the commercial side and clearly you guys have done a good job and Firestone is certainly some share gain.

Do you see any margin pressure as they become a bulk buyer from you?

Are they asking for better terms from you?

We don't get into discussions about any individual --

Just in general forget the name of the account.

But I think we, you know, clearly the commercial gross margin as we said before is lower than the retail gross margin but since it leverages all the assets that we have in place from stores and distribution systems and supply chain, our merchandising line, et cetera, it is highly accretive.

Over time we've been pleased at how our business has developed there and developed profitably there.

As you know this isn't a business that is highly price driven.

It is a business where it's service is the most important thing.

The way it works is a mechanic gets a car on a lift, he or she diagnoses it, finds out what is wrong with it and they need a part then they make the call.

At that point you're tying up high priced labor and high priced real estate their bay, waiting for the part.

So the most important thing is servicing the customer as quickly as possible so they can fix the car, turn the bay, satisfy the customer.

That's what our commercial customers are focused on, therefore that's what we're focused on, that's why the three-mile perimeter around our store is important as well as the proximity of our company owned stores to the chain account stores.

Then really quick I'll get out of the way here.

Do you have an ALLDATA revenue number for the quarter.

I know downtown comment on Intra quarter sales if at all possible given the fact that the real storms of February came into the current quarter do you have a number of stores that were closed that were related to that storm?

I think around President's day weekend.

We don't give specific numbers on ALLDATA but as you know ALLDATA is a software business that we have that we sell to over 40,000 commercial technicians out there and we've done a great job of leveraging the ALLDATA sales force with the AZ Commercial sales force doing joint calls and making sure that we're going to market as an integrated parts and data business so that penetration continues to help both the ALLDATA business as well as the AZ Commercial business.

As it relates to the storms.

You know, you're right, it's hard to fix a car when you can't find it under a couple feet of snow and clearly in any given week weather can impact the business but we're unique and lucky in the sense that we're the only national chain and so therefore we've got good weather and bad weather all over the country at any given time and so this kind of thing really levels out over time and over the course of a quarter.

So you know the sun will shine again.

It always does.

All right.

Thank you.

Thank you, Alan Rifkin please state your company's name.

It's actually Scott Nesson on Alan’s behalf, Lehmann Brothers.

Two quick question, with respect to the I think you said stronger driver versus traffic was traffic also positive?

Also clarified the inventory build-up, just curious if you would characterize last year's in stocks as possible below plan?

If so, what would be sort of the adjusted year over year increase in inventory if that's the case?

Both contributed to the comp store sales although more a contributor in this quarter versus almost perfect 50/50 balance in other quartz.

Second piece of your question related to in stock last year and I think you got to look at the, again, the inventory on this business is different than all other sectors of retail and when you look at the way the customers interact with the inventory, the vast majority of our Inventories in what we call hard parts area so somebody's car breaks down and they need a starter, and so they can't -- it's a need and if they go to a store and we don't have the part well they are going to keep going until they find the part to fix their car so having the right inventory, the right parts the right coverage in every single store is absolutely critical to the future as well as the present health of a company in the auto parts retail sector and hence we have somewhat lower gross inventory turns than other sectors and hence the inventory gross inventory needed to come up as we introduced good, better, best programs as we introduced the AZ Commercial business and we put more late model coverage.

Remember in the retail side we came to the OKV, which are 7-year-old and older vehicles.

With AZ Commercial you see breaks being replaced six months after they come off the assembly line.

We need to do a one-time adjustment in making sure that we had the right inventory for both sides of the business.

So we did it deliberately.

We told everybody we were going to do it last quarter and we've held that inventory constant on a per store basis.

It's not perishable.

It's an entirely different thing.

I think people need to think about this business model in that context and think about it differently.

I just wanted to add, as Steve said, Scott, this was a one time thing.

We've talked about that and modeling and going forward we'll keep the inventory levels per store flat.

What you'll see is by our fourth quarter there should be very little year over year changes in our inventory levels and at that point you'll see the sales outpace the inventory.

So this was a one-time event for us to make sure we had the right parts, the right coverage in those stores.

Thank you both.

Thank you.

Our next question comes from Wayne Cooperman , please state the company name.

Yes, you guys talk about inventory a lot, but given that it's all returnable and you can finance more of it with payable.

Why wouldn't you just have more inventory in the store?

I don't see what is so negative about increasing inventory if it's leading to more profits.

That's a great point because we have financed our inventory so even though we deliberately -- the reason we spent a little time on it here is because there seems to be some misunderstanding about it.

That's what I'm trying to figure out.

Clearly we have more than compensated for the gross inventory because our vendors pay for it and it is returnable.

So why not even increase the Inventories more?

Well, we want to have the right appropriate level of inventory which is what we believe we have now.

So that's the whole point here.

Your point is extremely well taken.

Our net inventory has actually gone down.

Our net inventory turns have therefore increased and, you know, the risk in inventory just simply -- it isn't there but we believe now we've got -- we've got the right level to support both the DIY side as well as the commercial.

How much of that inventory is just on the commercial side?

Nothing is exclusive.

It's interesting as we have put some of the later model parts in we're seeing that we're selling those same parts to the DIY.

So we don't segregate the inventory.

It's all in the store for sale into both channels but we thought about ourselves as a DIY business before and then didn't add the later model stuff late are and now it has helped our penetration.

As the commercial side grows faster than the DIY side, you don't think that you need more inventory per sales on a go forward basis?

What we've added is SKUs, it's not quantity.

The vast majority of the SKUs in our stores have one item there so this isn't like we're stocking up quantities of it.

Having one of them in the stores.

And so, therefore, it's been parts coverage that we've added or the number of SKUs particularly in the late model example.

Now, we have also put the hub store business in place where we replenish from the hub stores to the satellite stores daily and so we've got -- we don't need to add more items per SKU in the stores, it's a matter of having the coverage across the variety of the SKUs.

If we looked at the business on a -- forget obviously we know the gross margins are lower and operating expenses are lower in commercial, if we look at the operating margin are they similar or different on a go forward basis how should we model out your margins as the mix shifts a little bit?

As we said, the gross margins are a little lower on the commercial business and we have increased our investment in the commercial business over the past year by adding the sales force and so on.

Now as we grow our business particularly at the rates we're growing we ought to see a strong leverage against those costs.

So I think the important thing though to remember is that the EBIT is 100% incremental because it's an entirely different customer base.

It's added to the DIY business and leverages the assets therefore the instrumentality is quiet high which is how we are thinking about it.

Right.

Just for simplicity, though, when you expect your operating margins to continue to improve or will they get draped down by the mixer?

I think what you have seen to date is that we've been able to show improvement in the operating margin as well as increase our commercial sales over and above the retail business.

You guys break out -- if I looked at just the retail business what the margins are doing kind of on a retail only basis?

We don't, you know, we don't break down all the details of each business.

We try to just characterize it in terms of how the business models work.

Great.

Thanks for your question.

Next question, please.

Thank you, again, as a reminder if you like to ask a question you may press star followed by one.

As a reminder please limit your question to two.

Our next question comes from David Berman .

Hi, it's Bowman Capital.

I just wonder if you could elaborate on the balance sheet.

I'm not that familiar with your practices what your capital structure intention is and I'm just looking at it and see that the debt level has gone up a little.

You did have a lot of share buy back program.

But what sort of struck me a little -- is the amount of accounts payable.

It's about five months worth if I am doing my calculations correctly?

That was about the highest I have ever seen it and I was wondering if you could elaborate that as well.

Let me start with accounts payable.

Yes we have had tremendous success in terms of getting our accounts payable as a percentage of inventory up.

Your calculation is correct that we have approximately five months worth of accounts payable.

And that is largely because of the successes we've had in category management in testimonies of negotiating with our vendors as well as the fact that we're one of the only investment great credits in this space so, therefore, the extension of credit to us can be actually advantageous versus the extension of credit to others.

It is an amazing number.

Just out of curiosity last year it was I think four months, right?

It was -- you.

Have improved it dramatically.

It's up from about 66% of inventory to about 70% of inventory.

And then -- are they okay with it?

The vendors have been working very closely with us and making sure that we've got the right parts and have their products in our stores.

And we negotiate on the accounts payable.

How many different vendors is there?

Is it a lot of them or is it -- are there any that account for more than 20-30% of the business, the accounts payable?

No, no.

We've discussed this, you know, over time here.

You know, at length on the payables.

If they don't have their parts in our stores they don't have any sales so --

I understand that, that's why I'm --

For a lot of them this is a tremendous way for them to get the exposure of their parts in our stores.

So we work very, very closely with them on making sure that we've got the appropriate stock conditions t appropriate sales, the appropriate innovation going on, and it's part of our management process which we introduced 18 months ago we enter into discussions about what are the appropriate levels, credit terms and the appropriate levels of payables and so these are all very carefully negotiated and so forth we work with them to make sure that we've done factor and so forth to help them lower their borrowing costs so it's a very partnership oriented --

As the debt goes up, doesn't that give you a lot more leverage with them, that they have to give you bigger discounts because in a way you know you've kind of got them where you want them, so to speak?

No, are you talking about -- if you're talking about our debt has actually --

No, no, no, no, in the sense that -- you owe them a lot of money.

So, you know, could you get more discount from them is what I'm saying because you've got to pay them?

Could you take advantage of them?

It's an incredible number.

Discounts and vendor funding and so forth are not anything to do with the credit terms.

Our vender funding relates to performance, you know, on advertising and those kinds of things.

It's a different discussion as it relates to payables.

The payables discussion is, hey, we're in a low -- naturally a low gross inventory turn business.

You've got to have the parts in there.

And you know we've got to make sure that the appropriate parties are participating.

Relatedly are there -- is there much obsolescence from some of the inventory related to some of the payables?

I've got to make sure the right parties are engaged in taking responsibility for the financing of those.

And as we've said both on this call as well as previous calls, this is not fashion oriented stuff.

This is not perishable and so there's very, very little, if any, risk of obsolescence markdowns or any of that kind of thing and it's fully returnable to the vendors.

So that's why you have to think --

Fully returnable to vendor I understand that.

That's why in the previous question that's why it's important that you think about inventory differently in this channel.

I understand.

So when you look at the total debt and the capital structure you want, obviously accounts payable could be construed as the way you look at it but it's obviously not -- you've got -- I mean how comfortable are you with -- how would you look at that?

What we said is that we will continue to buy back our shares with our excess cash flow as long as we believe it's accretive.

Okay.

Thank you.

Thank you very much, guys.

Thank you, David.

Our next question comes from Brian Riley please state your company name.

A.G. Edwards.

Gentlemen, congratulations on the quarter and congratulations on your continued repurchasing of your stock.

I think most of your shareholders are totally onboard with that idea.

My question has to do with the pay on scan opportunity.

I have talked to a number of your suppliers and in the conversation the word opportunity never came up.

I was wondering it is viewed sort of as a very disruptive method of doing business from their perspective, I was wondering in the process of doing this consignment of inventory who will be paying for the inventory that has to be done on their behalf?

And are your computer systems up to snuff to handle that and process returns and so forth?

Well, I'm not sure who you've talked to, we did as we announced in January at a vendor summit where we had all of our key suppliers there.

The opportunity and our intent to move from our current method of payables to a pay on scan direction and you know we're not flipping a switch on this thing.

What we are doing is we're meeting one on one with each vendor, discussing their business in talks with them and figuring out with them how do we build our business together?

What's the appropriate way to go about implementing this and so forth.

Are your computer systems up to date to handle this kind of thing?

And have you looked at the cost of doing inventory --

Our computer systems are very advanced and fully capable of taking everything on that we've talked about, of course,.

Then who will be paying for the inventory that has to be done on behalf of the suppliers who some of them have banking relationships whereby they borrow based on their inventory and if you're a banker lending to somebody with inventory as collateral and that collateral is now in 3,000 of your stores or in your warehouses, if I was a banker I don't think I'd be real comfortable with that type of lending.

Well, you know, frankly we're not hearing that from our suppliers.

We're working, as I said, individually with each one of our vendors and we're working to make sure that we do the right thing for their business and our business and we continue to grow this business.

The important thing is here we want our suppliers focused on the end customer.

We want them to be able to plan their manufacturing instead of getting hit with a purchase order which gyrates their manufacturing system.

We want them to be able to manage the inventory through our system and have better accessibility and visibility to the entire supply chain.

We think this is going to have benefits for them through that vendor managed process and it will help smooth out their manufacturing.

There's a lot of things.

But, look, this is something we're doing individually and carefully with each of our suppliers.

I think we have time for just one more question, if we could.

Thank you.

Our next question comes from Matt Fassler and please state your company name.

Hi, this is Deron Kennedy on Matt Fassler's behalf.

How are you?

Hi Daron.

I have a question first on a--.

I know you're not giving earning guidance though the sales outlook for the next two quarters if I'm not mistaken – would stay at tough or tougher on a two-year basis.

Would you expect sales attracting in a similar range as they are now?

Clearly you're correct.

Last year we had our peak same store sales in the second quarter with 12% same store sales growth which is what had made this quarter's comparisons that much more difficult.

They do -- comparisons do get easier in the coming quarters and so we're looking forward to those comparisons as we go forward.

You know, I'm not sure how to think about the two-year comparable store sales number.

On the one hand it is interesting that we've been able to hold -- our two-year numbers at a very high level but I'm not sure how predictive it is, quite frankly, so we don't focus on that.

We focus on growing our business and innovating day in and day out.

I think that's the important thing.

We've introduced lots of new initiatives.

We're doing interesting consumer promotions, interesting services in the stores, new television advertising, new categories that we're introducing, so our level of innovation is very, very high.

We try not to get ahead and talk about it in advance of doing it but what you see in the stores as we come into our busy season now, in the next few weeks is when we start to see our seasonal national lift.

But we're very excited about what we have planned.

All the growth opportunities from a marketing and merchandising standpoint, our AutoZoners are ready and certainly the inventory is in place to take advantage of a great spring and summer season.

So you would expect that with the comparison getting -- all the things you are doing sales trend could improve?

I think that the comparisons definitely do get easier and we have a tremendous amount of innovation in place.

Okay.

My second question is, the commercial business and as it's growing, how can we look at that in terms of the trafficking ticket mix numbers that you give us?

How does the commercial flow into that?

How does it affect that?

Yeah, that's a good question.

Remember, that commercial still is a very small portion of our total business at roughly 10%.

So even if there were big swings in the come position on commercial it doesn't impact our overall numbers very significantly on the ticket and the customer account.

But we're seeing good growth in both on the commercial side.

Okay.

Thank you very much.

Thanks very much.

Thanks very much, Deron.

And I think we're running out of time.

I'd like to wrap things up.

As am of you know we're actually planning on presenting during the quarter at the upcoming Merrill Lynch conference and appreciate your participation in today's call.

Thank you very much.