汽車地帶 (AZO) 2004 Q1 法說會逐字稿

This is a conference call to discuss AutoZone's first quarter fiscal year 2004 financial results.

Steve Odland, the company's Chairman and Chief Executive Officer, will be making a short presentation on the highlights of the quarter, the conference call will end promptly at 10:00 a.m. central time, 11:00 a.m. eastern time.

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

Contained in this presentation 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, 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 factors section of the Form 10-K for year ended 2003 for more information.

Actual results may materially differ from anticipated results.

AutoZone undertakes no obligation to publicly release any revisions to any forward-looking statements contained in this presentation to reflect events or circumstances after the date of this presentation or to reflect ok curbs of unanticipated event.

In addition to information present in accordance with generally accepted accounting principles AutoZone has provided metrics non calculated with GAAP.

Please see AutoZone's press release at web web.AutoZone.com.

Mr. Odland, you may begin.

Thank you, and thanks to everybody for joining us today for AutoZone's first quarter fiscal 2004 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'm sure you've had an opportunity to read our press release and learn more about this quarter's results but if not, the press release along with slide complimenting our comments today are available on our website at www.AutoZoneInc.com, just click on the Investor Relations button and you can see all of the slides.

We are pleased this morning to report another record quarter.

This first quarter continued our trend of record EBIT, record EBIT margins, and record earnings per share even against a record quarter last year.

And these records go back to the start of our company -- remember, we became a public company back in 1991.

In this quarter, we reported a 2% comparable sales increase on top of a 4.5% increase last year, and a 30% increase in earnings per share on top of a 37% increase last year.

For the 12-week quarter, we reported sales of 1.282 billion dollars, which is an increase of 5.2% from the first quarter ended November 23rd, 2002.

Same-store sales, or sales for domestic stores open at least one year, increased 2% during the quarter, including 1% for retail and 17% for commercial same-store sales.

Gross profit as a percentage of sales for the quarter improved by 2.7 percentage points, while operating expenses as a percentage of sales increased by 1.4 percentage points.

This resulted in a reported operating margin of 16.8%, up 1.3 percentage points from last year.

Operating profit increased 14% over the prior year.

Net income for the quarter increased by 16% to 121.7 million, and diluted earnings per share increased 30%, to $1.35, from the $1.04 level reported in the year ago quarter.

Our strong earnings growth and disciplined capital management resulted in a record return on investment capital for the trailing four quarters of 24%.

Now let's turn to some of the details of our business.

First starting with the retail, or what we call the do it yourself, or DIY business.

For the quarter total retail sales were up 3.3% with same-store sales up 1%.

This improvement is on top of last year's 2% retail comp.

Towards the end of last quarter our company began to implement new initiatives it had begun to improve sales rules and I'm pleased to report that we began to see the results through stronger sales performance for the last period of the quarter.

This is our core business, and we will continue to drive improvements in this area.

We have many growth opportunities as we continue to focus on relentless innovation.

Once again I'll remind you of the $60 billion of unperformed maintenance that we continue to have as an opportunity every single year.

First of all our advertising and merchandising programs continue to be the primary drivers of our volume along with our ongoing radio campaign, we have spent money this quarter on developing our brand through the use of television.

We have implemented more and varied messaging around regular car maintenance than ever before.

As well, we have started a campaign primarily print-driven focusing on our AZ commercial customers.

We've begun to experiment with our more commercially driven marketing to drive foot traffic.

Our continued focusing on marketing towards our younger customers, especially with regard to making our stores cool and the cool place for them to shop has shown continued results.

In this regard we announced this past quarter that we have signed Jesse James of the discovery channel's Monster Garage television show, to be a company spokesperson.

We're very excited about the younger customer base that we will be able to reach through utilizing Jesse James.

We intend to also develop a Jesse James brand of products to be available in our stores to supplement his sponsorship.

Our ongoing focus on targeted marketing represents proven growth opportunities as well.

For example.

Along with sponsoring Tom Joiner's Morning Show, we have renewed our arrangement with Sabido Eguante(ps) television show reaching spanish speaking customers.

We also just announced an agreement with NASCAR to be the primary sponsor of their Elite racing series as the country's second most watched sport, NASCAR offers a wonderful opportunity for us to attract new customers to our stores.

We also have renewed our focus on the Super Chevy show, which is important to mention, as a primary sponsor of these events it's a wonderful opportunity to reach our customer base.

More recent initiatives also include the new Truck Zone.

We now have the Truck Zone in roughly 100 stores and ultimately anticipate auto the majority of our stores can benefit from this new merchandising effort which trades on the heavy growth in the SUV and light-truck trend and groups all of the accessories and appropriate parts together in one area of the store.

We continue our strategy of establishing a good, better, best delineation for most hard parts categories and we are extending our ValueCraft and DuraLast proprietary brands.

AutoZone's brands now represent a little over half of our sales, making AutoZone the exclusive place to get some of the most recognized brands in all the business.

Just a few weeks ago we announced that we were introducing our new DuraLast tools in our stores.

These are professional grade hand tools that are currently being marketed to the DIYer.

These tools we believe represent an exciting opportunity to us.

After extensive surveys we identified a real opportunity with a category of customer that was being underserved by our current product assortment.

We also continued to expand sales in many of the new products this quarter including Optima batteries, ValueCraft rotors and drums, Goodyear Gator back belts, and a whole variety of other new products both in our brands as well as our suppliers' brands.

We've expanded the number of vendors doing business with us on Pay-on-Scan, and we now have scores of vendors signed up and millions of dollars in inventory already on POS.

Mike Archbold will take you through more on our efforts later in our discussion this morning.

We experimented with weekend promotions to remind people to do some of that $60 billion in undone maintenance at a point in time on the weekend when they had more time to do it.

Also our store refresh program along with our ongoing hub store opportunities continue to make us excited about the future.

So you can see we have a considerable number of efforts going on right now in order to help build our sales with the DIY customer.

For the trailing four quarters our sales per square foot up were 1% to $265 per square foot and continue to set the pace for the rest of the industry.

New store productivity continues to improve, and we opened 40 new stores in the quarter and replaced one for a total now of 3,259 stores in the lower 48 states.

Year to date we plan on opening 195 stores, new stores, in the fiscal year.

We've begun to see the results from our initiatives in the DIY area and we are excited about the remaining quarters of the year.

Now turning to commercial sales.

Our A Z commercial sales continued its rapid pace of growth with same-store sales increasing at 17% this quarter, as we continued to execute our game plan.

We now have the commercial program in 1,986 stores supported by 115 hub stores.

This actually is a lower count with the A Z commercial program than last year as we consolidated some of the programs while continuing to build our customer reach.

The hub stores continue to provide us with fast replenishment of critical merchandise to support both our commercial and DIY businesses.

We continue to commit much focus, as you know, through the AZ commercial program and we continue to have success developing our sales force, developing customers around existing stores, adding new and local chains, and implementing new hub stores.

This quarter's results were impacted by our efforts to execute our business model regarding our previously announced relationship with Midas.

When we teamed to begin this joint effort we committed to have all Midas stores serviced by AutoZone D.C. by calendar year end.

I'm proud to announce by November 29th we are now servicing Midas locations nationally with their weekly replenishment orders.

This obviously was ahead of schedule.

We made sure this past quarter that we not only did we begin to service their locations but we did it right.

We initiate team meetings with both made das and AutoZone represent testifies and monitored all levels each week of the past quarter.

We've spent a tremendous amount of time and human capital making sure that this customer was well served and that everything happened on schedule this quarter.

I'm absolutely confident that this will lead AutoZone to being better able to service all of our customers in the future.

Now we'll turn the focus on growing our daily hotshot business with Midas, as well as all of our commercial customers.

With only 1.4% of the commercial sector's business AutoZone has a significant opportunity to gain market share.

This sector is highly fragmented, as we all know, yet we're already the third largest player.

In an industry that the automotive aftermarket industry association, or AAIA, states is a $48 billion industry growing at 4.8% a year we are confident our model can continue to grow and add shareholder value over time.

Now turning to Mexico.

Our Mexico stores continue to do very well in the quarter even with the continued peso fluctuations and their economic uncertainties.

We opened one store in Mexico during the quarter which now gives us 50 stores in Mexico which compares to 3259 stores in the U.S.

Our ongoing commitment remains to prudently and profitably grow the Mexico business.

Gross profit for the quarter was 47.8% of sales for the total company, up 2.7 percentage points from the prior year.

Now, 1.7 percentage points of the improvement were driven by the reclassification of vendor funding from SG&A to gross profit due to the adoption of EITF issue 02-16.

Comparable gross margin was 41.6% versus 45.1% last year.

The remaining 1.1 percentage points of our improvement in gross was directly attributable to our continued category management efforts.

We have been successful in partnering with our vendors to offer the right product, at the right prices to our customers.

These efforts include supply chain initiatives, tailoring merchandising mix, the continued implementation of our good, better, best initiative, price negotiation with vendors, shifting responsibility for warranty, and adjusting prices where appropriate.

We continue to work harder today than ever before in creating the most exciting Zone for vehicle solutions.

At this point I'd like to address some of our opportunities for margin expansion going forward.

Beyond the fact that we believe that there's continued expansion opportunities, albeit at a slower pace than previous couple of years, we have not given a specific target percentage.

Primarily our improvements have been driven through our category management initiatives.

Our efforts have been at the forefront in our industry, and we feel that we continue to have opportunities working with our vendors to provide the best selection of merchandise to our customers at the right prices.

Filling out the good, better, best assortment allows us to drive appropriate cost of goods at the end price points across categories there by improving margins overall.

As part of our category management process that we started, last year, we began to challenge our vendor community to incur more of the warranty burden for returned goods.

AutoZone continues to be the only auto parts retailer with a reserve for this liability.

In return for vendors who gave us full rights of return on defective products, we were able to reduce our warranty liability exposure going forward so.

Reduction with warranty exposure may, however, be coupled with other cost changes.

The continuing effort resulted in a net benefit in fiscal 2003 of 6 cents a share, and in fiscal 2004 first quarter of 10 cents a share.

We anticipate that the benefits of this initiative will continue to flow over the next several years.

Remember, it doesn't represent any change in our accounting, rather it reflects our continuing multiyear process of working with our vendors through category management in order to shift the expense of warranty to the manufacturers.

For those of you keeping models, this has been one more example of our effort to identify cost savings opportunities and it will be ongoing.

Now turning to our expenses.

Our focus on expense control has shown great results.

SG&A for the quarter was 31.0% of sales, up 1.4 percentage points from last year.

The adjustment for credits previously recognized in SG&A and now reported under cost of goods represented an increase to the SG&A line of 1.7 percentage points.

So without that shift, SG&A would have improved to 29.4% from 29.6% year ago.

So we're pleased with our ongoing progress towards controlling our expenses, and we continue to see room for improvement.

We continue to show leverage of store level expenses, at the store support center we gained leverage from controlling staffing, salaries, and IT spending.

We also have been effective at managing our retirement, medical, and insurance costs on an ongoing basis.

This includes the company pension plan which was frozen last January and partially offset by introducing an enhanced 401(k) plan.

But like all of our cost initiatives we believe that all of our expense savings initiatives will have ongoing benefits to earnings in the future.

Store payroll has been continually managed appropriately to reflect the seasonal demands of our business and we believe that our payroll spending is at optimal levels right now.

Advertising costs, net of co-op, were once again down versus last year though our advertising reach and frequency continues to increase and we continued to roll out our television campaign during this quarter.

So our earnings before interest and taxes for the quarter was $215 million, up 14% versus last year.

EBIT margin was up 1.3 percentage points to 16.8%.

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

With the ability to grow profitably we continue to see opportunities to improve our gross margin and SG&A as a percent to sales in the future.

Interest was 20.3 million, compared to 19.1 million a year ago.

Debt outstanding for the quarter increased 10.7% to 1.453 billion dollars versus last year while the weighted average interest increased from 4.8 to 5.4%.

The increase in the interest rates reflect our issuance of $700 million of long-term debt over the last 12 months.

Over the last year we have increased our average debt duration to 7.4 years from 4.1 years.

So we've been really very pleased with our ability to lock in rates over the past year at historically low levels.

Further, we were pleased to lock in very strong rates on a $500 million debt placement during this first quarter.

We have the wonderful privilege of being a company that generates more cash flow than our capital expenditure needs.

We've not been a company that indiscriminately issues debt simply to buy back stock but we have purposefully maintained and managed our capital structure relative to our cash flow in a disciplined fashion in order to maintain our credit rating at an investment grade.

We're not interested in de-leveraging by paying down debt with excess cash flow.

Our coverage ratios continue to be within our goal of 2.1 times adjusted debt to EBITDA.

For the quarter our tax rate was 37.5%, down slightly from 38% last year, and we expect to be able to run this percentage for the remaining quarters of the fiscal year.

Net income for the quarter was $122 million, up 16% over prior year.

In earnings per share for the quarter, were $1.35, up 30% on 90.4 million diluted shares.

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

Mike.

Thanks, Steve.

In this past quarter we generated $154 million of cash flow reflecting $77 million generated from working capital before we repurchased 644,000 shares of our stock for $60 million.

We continued to drive this decrease in working capital primarily through our accounts payable growing as a percentage of inventory to 89% as of the end of this past quarter.

Since the inception of our share repurchase program, we have bought back 72.7 million shares at an average price of $39.73, driving tremendous value for our shareholders.

We will continue to opportunistically repurchase shares as long as it's accretive to earnings.

We also continue to focus on improving return on invested capital, or ROIC.

For the first quarter of this year we reported yet another improvement to 24.0%, up from last year's 23.4%.

Our relentless focus on ROIC underscores our belief that it and EPS growth are the best indicators of the creation of shareholder value over the long run.

Turning to some of the balance sheet highlights, gross inventories are up 2.3% versus the prior year and well below our overall sales growth of 5.2%.

Additionally we continue to maintain our inventory per store levels at levels lower than the first quarter of last year.

Our gross inventory per store is now down to 459,000 per store versus last year's 473,000 per store.

Our net inventory per store, which is net of accounts payable, was reduced even more, from 116,000 per store to only 52,000 per store.

Net inventory actually decreased in total by almost 53% this quarter versus the same time last year.

Additionally, we improved our net inventory turns in the quarter based on an ending inventory to 20.4 times from 8.5 times last year.

Accounts payable as a percent of inventory increased to 89% from 75% last year.

And lastly I want to reiterate our goal which is to achieve 100% accounts payable to inventory over time.

I want to take a minute to discuss this morning's -- to discuss our policy regarding LIFO versus FIFO.

We've gotten a number of questions recently regarding what policy we follow.

And to be clear, AutoZone is on the LIFO method of accounting for inventory.

However, starting several years ago, we started to experience actual cost deflation when it came to merchandise purchases.

Working with our external accountants, Ernst & Young, we decided that the lower of cost or marketing account principal actually overrides LIFO and therefore we continue to charge cost of sales at the higher inventory cost.

The difference between this higher book cost and the actual lower cost which now aggregates $102 million, is, in effect, deferred on the balance sheet to be used against possible future cost increases.

This means we could have taken $102 million into operating profit over the last eight years had we not adopted this rule.

We've been conservative, however, and not recognized this difference in income.

Back on the balance sheet, looking at the working capital number, total working capital was again down $158.5 million from year-ago levels to a negative $78 million, negative working capital, and was again this year a source of cash.

The continued focus on working capital reflect our relentless focus on cash flow management.

Additionally, we continue to work with our vendors on both the vendor A/R factoring program to reduce their cost of borrowing as well as our new Pay-on-Scan opportunity.

The Pay-on-Scan program was introduced to vendors earlier this year, essentially the 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 focus on growing customer sales - end customers, real customers.

We have sound up many vendors thus far in pursuit of our goal which is to have all of our vendors on the program in the future.

We have continued to reflect the inventory on our balance sheet and we are in the process of proactively seeking review of the accounting with the SEC to ensure that we reflect the appear I can't tell accounting for this ground-breaking initiative.

Net fixed assets on the balance sheet were up 3.3% versus last year.

Capital expenditures for the quarter totaled $29 million.

Depreciation and amortization totalled 24 million for the quarter, down slightly driven by the continuation of assets become fully depreciated, primarily those assets that were purchased during acquisitions of Chief Auto Parts, Auto Palace, and Pep Boys Express location back in our fiscal 1998 and 1999 years.

In fiscal 1998 we purchased Chief Auto Parts with over 500 retail location much of the fixed assets within the stores were depreciated on average over five years.

Therefore, starting in our fiscal 2003 last year these assets became fully depreciated this by reducing depreciation expense.

To be clear, we have not extended the useful lives of any asset classes.

Depreciation has been trending downward for several quarters due to this roll-off of assets from the acquisitions.

However, we expect that that trend will slow as the years continue.

Our debt at the end of the quarter was 1.453 billion, increase of 140 million, or 11% from the prior year level of 1.313 billion.

Due to our increased cash flow which provides the additional debt capacity.

We will continue to manage our adjusted debt which includes leases, to roughly 2.1 times EBITDA.

Although that ratio the past two quarters were 1.8 times and 1.9 times respectively we still hold 2.1 times as our potential target.

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

It significantly lowers our blended after-tax cost of capital as the cost of equity is significantly higher than the cost of debt.

With these trends, EBITDA to interest coverage is now at 12.2 times for the trailing 12 months compared with 11.6 times last year.

As of November 22nd, 2003, our quarter end, AutoZone continues to be one of the few players in our industry to have an investment grade debt rating.

Our senior unsecured debt rating from Standard & Poor's is triple B plus and we have a commercial paper rating of A-2.

Moody's investor service has assigned us a senior unsecured debt rating of B.A.

A 2 and a commercial paper rating of P-2.

We continue to be comfortable with our long-term debt ratings, leverage ratios and targets.

Shareholders' equity declined reflecting the repurchase of common stock over the past four quarters.

Our return on equity, or ROE, for trailing father quarters was 87.1% versus 54.0% last year.

Our financial model is strong is, and we have continued to increase earnings and cash flow.

Lastly, as required, last year we adopted the new accounting standards Steve referenced earlier, the emerging issues task force issues EITF 02-16.

This ruling says all vendor funds must be offset to cost of goods as the new agreements are entered into or modified and should not be reflected in income until the merchandise is actually sold.

This has the impact of temporarily lowering EPS versus the previous treatment as is the delay in recognizing some of those vendor funds.

To repeat this, pronouncement in no way impacts the way that we are running our business or our negotiation with vendors.

It simply reflect noncash effect to the new accounting pronouncement.

The ruling stipulates timing as to when previously received vendor funds can be recognized into income.

You may recall as the total income deferral expected from EITF 02-16 was estimated last year to be $25 million pretax.

With $10 million recognized all of last fiscal year and the remainder to be recognized roughly evenly in F '04, and we continue to be on track with that guidance.

For all of 2004 it is estimated this would result in roughly a 270-basis point shift from SG&A to gross margin.

As you may recall, we had previously indicated a target of our SG&A getting as low as 28% of sales over the next couple of years.

The reclassification of 270 basis points would actually increase that target to an adjusted 30.7%, but as we've continued to see opportunities to leverage our SG&A we've established a revised target for SG&A of 30.0%.

Lastly regarding the EITF 02-16 I want to reiterate that AutoZone would have absolutely preferred to do the one-time cumulative adjustment.

We were precluded from doing this by the pronouncement itself and we will follow EITF 02-16 to the letter of the pronouncement.

Therefore, all vendor fund willing now but included in cost of goods sold going forward as we've now amended all of our vendor agreements and completed that by end of last fiscal year.

Now I'll turn it back to Steve.

We continue to believe that our business model performs well in both strong and weak economies.

We're very proud of the results for the first quarter of F'04 as we have done well even against our peak comparisons from last year.

We've begun to see our reinvigorated effects, our efforts show improved sales towards results at the end of the quarter.

Having said that we're never satisfied with our performance, and we always seek to improve it.

We believe that we've got many initiatives that will help us continue to grow same-store sales over time, but we do budget conservatively to ensure that we maintain our expense discipline and are able to deliver solid returns as we have this quarter.

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

It leverages our infrastructure, it drives our incremental EBIT dollars with little investment and will be accretive to our historic high ROIC of 24%.

We continue to have opportunities to expand gross margin in coming quarters driven by supply chain efficiencies, mix of business, and improved pricing.

Additionally, new programs like Pay-on-Scan will help us create an even stronger vendor focus on the top line.

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.

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

Our industry leading results continue to show that AutoZone is a tremendous cash generator which has enabled us to add shareholder value over time.

We don't give specific sales or earnings guidance because we're not managing the business to a specific target, as we believe that that could actually inhibit performance, so, therefore, we will work to deliver our best results every day, every quarter, as we have over this past quarter.

In summary, we continue to be excited by the progress we've made, we're clearly confident in our ability to grow AutoZone well into the future.

AutoZone is the clear leader in this very exciting industry, and this upcoming quarter's plan is very strong and we're excited to get going.

We're focused on operating this company to profitably grow sales, efficiently deploy capital, and maximize long term shareholder value while maintaining the highest level of ethics.

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

Thank you.

At this time if you would like to ask a question please press star 1 on your touch-tone phone.

You will be announced prior to asking your question to.

To withdraw your question, you may press star 2, once again to ask a question press star 1 on your touch-tone phone.

One moment.

Frank Brown, you may ask your question.

Please state your company.

Good morning, SunTrust Robinson Humphrey.

Two questions.

One, you know, in looking at the warranty expenses, you know, it looks like that's about 110 basis points in the first quarter.

And we talked about apples to apples, removing EITF of about 100 basis points in the gross margin.

I'm curious, when will the lower claims on warranties, when will we cycle that and how will the gross margin look looking past that?

Well, the warranty, as we mentioned, is going to be part of our category management process.

And as of our last fiscal year end we had some $77 million in warranty liability on our books, which we've recognized for the return of defective product that's going to happen.

So we have an opportunity as part of category management to continue to get our manufacturers, our vendors, to absorb that risk.

So in this quarter we were able to get about 10 cents per share of a benefit of that which is about $14 million, and we still have a long way to go.

So we think this is just another one of the initiatives.

You know this better than most, Frank, that part of our category management process, we focus on reducing our costs, extending our terms, taking costs out of supply chain everywhere we can.

This is just another way for us to innovate and drive down costs out of the entire industry, and at the same time we can do this in conjunction with Pay-on-Scan and focus more importantly on driving top line.

So all of those things can happen.

We don't view it as something that we're worried about cycling on because it's just another tool for to us drive costs out of the industry.

Okay.

The second question I had is on the private label.

If I heard you right, you're saying that the merchandise assortment is a little over 50% private label, or proprietary to AutoZone?

I know hearing other retail there's a magic number in terms of having enough brand to drive traffic in the stores.

Is that something that concerns you that, the private label might have gotten high enough that it's impacting store traffic?

No, Frank, I think that private label is a real important thing, and it works different in different sectors of retail.

Perhaps in other sectors there is a magic number.

We don't have a magic number in mind here.

We believe that our private brands, like DuraLast and ValueCraft and AutoZone are important to driving loyalty among our customers and we actually think that done to the right extent it actually drives traffic.

So let's take an example here.

We've been advertising DuraLast batteries, and we believe that the batteries are at the top in performance in the industry.

This is a brand that we've been advertising over time.

Now, to leverage that quality, the durable nature of it, the long-lasting nature of it, hence DuraLast, we can extend that to tools, and it extends very fluidly, as it is extending to our other hard parts.

So we're going to end up with a brand that could be a billion dollar brand.

I think if you look around consumer products in total, our industry and any other consumer products in general, there aren't a lot of brands of this power.

So we see a lot of potential here to begin -- and I think we've just scratched the surface, Frank, quite honestly, to begin to drive loyalty and build store traffic going forward.

Now, on the commercial side there are some brands that are really important to our commercial customers, and obviously we want to work with our vendors to carry their brands and we want them to build their brands, and to have representation in our stores, so I think it is a balance, but I think we can continue to grow our proprietary brands and have that be a strategic advantage to us more in the future.

Okay.

Great.

Thank you.

Thank you, Frank.

Bill Sims, you may ask your question.

Please state company name.

Bill Sims from Smith Barney.

Two questions.

First, can you discuss your store refresh efforts and, you know, give us an idea of what the average age of your stores are, an idea of how your oldest stores are comping?

And then second question is in regards to the initiatives that you're in the middle of putting through.

Can you give us an idea of what impact these initiatives will have on margins going forward and how long, in your mind, it's going to take before we do see a material gain in traction?

And then finally if you would, you talked about an acceleration in comps in the last period of the quarter.

Can you define what you mean by period, please?

Thank you.

Sure, Bill.

Great question.

I think much has been made in, you know, clearly I think there's some concern about this 1% retail comp out there and I think most people were targeting a 2% retail comp, and I guess I would point out that a couple of things.

First of all, you know, we're never satisfied with those results, and, you know, we always want to do better.

We want to do better regardless of how well we do in the quarter.

We're not satisfied with the comps the way they are.

However, I would point out that, you know, 1%, 2%, I think we're cutting a little close here, number one.

Number two, I think it's important to recognize that we're one of the few retailers that does break out our comps by area of business.

Most people talk about a total comp.

Our total comp was 2.5%, and that's -- you know, most retailers would be extremely happy with that kind of performance out there, and I think if you look throughout all of retail today that's a really good comp.

I would also point out that as we have put a lot of focus on growing our AZ commercial business, that business cannot have not impacted the DIY business.

We don't have exact numbers on this but look at the AZ commercial strategy that we've got.

We're focusing on up and down the street customers in a three-mile radius.

Take an example.

We open an AZ commercial program and we -- whereas before perhaps the garages in that area would have walked in and bought their merchandise over the counter, and that would have been counted in the DIY comp, now we've set them up as a commercial customer, we're delivering it for them.

It's a good thing because we're getting more of their purchases, we're deepening our relationships with them, setting up an infrastructure that allows us to go after even more commercial customers but it has to have taken away from the DIY comps.

So I just want to point out a couple of those things.

And as it relates to the store age that's another great question that I don't think we've focused on.

Clearly with 3200-some-odd stores out there our average store age is going to be older than those people who are out there buying a lot of companies and building a lot of stores and investing a lot of capital in that.

So just on average age alone, remember the stores mature over a four to five-year period, so actually you come off that first year, if you have a lot of very young stores, that will go and drive your same-store sales, whereas in our case, our stores are far more mature, and, therefore, what you're seeing more is a base kind of mature store sales level.

You know, as it relates to the initiatives, Bill, we have -- we started a lot of things in this quarter, and I've talked about many of them, and you've seen many of them in the marketplace.

We had a tough start to this quarter, you know, just to be frank, be we came back, and when we talk about a period, remember we're on a period basis.

A period is four weeks.

They're four-week periods.

We have 13 four-week periods.

So in the last four weeks we've seen a pickup in the comp.

So we're pleased with the early results on that, in some of the initiatives traction.

We're going into the lowest seasonal period of our year here through the holidays, then business will begin to pick up after the first of the year.

That's just indigenous to the industry.

So we believe that our initiatives that we've just begun are going to begin to see more traction as we build through the fiscal year.

We are managing this business very closely, such that we manage costs very carefully, such that we don't have the impacts on our gross margin.

So, listen, I think that, you know, we want to do better, you know, we're never satisfied, but, you know, this is a pretty good comp, and it must be viewed on a total basis.

I appreciate your comment that a 2.5% comp in a normal retail environment would be perceived as satisfactory, but when you're losing market share in this environment for a couple of quarters in a row I don't see how you could look at a 2.5% comp as a satisfactory comp.

In your mind how long it will take before these initiatives that you're implementing can again produce market share type gains?

I want to point out we've not lost market share.

In fact, we've built market share.

Remember, the market is growing, we think, at around 4%.

Now, those are old data because we don't have fresh data in the industry, but the AAIA says that over the past several years it's been growing around 4%.

So our sales have grown over 5% in this quarter, which suggests that we're picking up market share.

Isn't that 4% comp number -- or 4% growth, that's retail growth, and if I understand correctly, you grew retail at 3.3% retail sales.

4% total growth, you're right on your number on retail but it's 4% total growth.

So we don't believe we're losing market share.

Remember, the top five chains put together have a 35% market share, so 65% of the market share is spread out in lots of little mom-and-pop's and so forth that continue to exit the business, over time.

So we are building market share here.

Thank you.

Thanks, Bill.

You may ask your question and please state your company name.

Thanks a lot.

Good morning.

I have three questions.

First, Steve, I believe that you spoke to promotional efforts to reinvigorate sales in your initial comments.

Were you referring to the NASCAR and related promotions or was there something else that you might have been alluding to there?

Good morning, Matt.

Yeah, we have tried -- I think, as we've spoken over the past several years, we have lots and lots of tests going on at any one given time.

I think we counted them up at one point and probably upwards to 100 different things that we're trying, we try them number of stores here, versus control stores, and so forth.

So I want to put it against the back drop that we continue to have that level of testing going on.

Then when we see result from that we spin it out and roll it either into a regional area or sometimes nationally.

So then in the quarter, we've had lots of new efforts.

First of all, our television campaign is new.

We've been off-air on television for many years, and we've extended the Get-in the-Zone campaign.

We've also targeted towards a younger demographic.

We noticed a few years ago that our customers were getting a little older and we weren't attracting the younger demographics so we added parts and accessories to our stores that are more consistent with the things the younger kids were looking for, and now we've expanded our marketing to that.

We just announced, for instance, the Jesse James spokespersonship and we've not done anything with that yet, that's to come.

Also we've got these other segmented things that we've begun.

The NASCAR thing is brand-new.

We just announced that last week that, we were going to be a sponsor of their elite racing series.

The whole truck and SUV thing is new for us.

We only have it in 100 stores right now.

Clearly the opportunity is vast, as I think everyone knows over half of the new light vehicles sold in America last year were trucks and SUV's.

Clearly this is a group of vehicles that we have not done a great job of marketing towards, and now we're putting that effort into place.

The tools are another thing which have just been on the shelf here for a couple of weeks.

I'm giving you examples of things that have come out of tests now and are going forward but the clear benefit from these new initiatives will come later in the year.

Remember this is entering our lowest seasonal point in the year, and as we gear up and roll these initiatives out going into our higher season they'll have more benefit.

Gotcha.

Second question relates to Pay-on-Scan.

Mike, when you discussed it you talked about essentially running this by the SEC just from an accounting perspective.

You hadn't previously expressed any doubt or uncertainty about this catching on, and, you know, to follow up on that, with a billion five in inventory, you know, millions of dollars of inventory on Pay-on-Scan could mean a very small percentage, could it mean a significant percentage, so if you could talk about what, if anything, has changed in your perception in the traction that this effort is capturing and a little more magnitude on vendor buying it would be helpful.

Nothing has changed in our perception on where they can go.

This will be the way we do business in the future.

We already have scores of vendors that literally represent half of our inventory on board and we're working through the processes to what it's going to mean, how we're going to interact and how the data is going to interchange, et cetera.

But more importantly this is the way that we will be doing business in the future.

And vendors wishing to continue and grow their business with us have recognized these benefits and have signed up to make this happen.

And in terms of kind of getting, you know, the sign-off on the accounting and such is that a new thought process by you, is it to further validate it with the vendor base, did anything change on that front?

No, again, it's all the same.

We're doing it for all the right reasons, which is to focus on the top line sales, to take the expenses out of the supply chain wherever they exist from the point of manufacture to the point that we put it in the customer's hands and it stays in the customer's hands.

So looking at from that perspective that's why we're doing Pay-on-Scan.

The accounting is by no means the driver here.

Think about it.

Even if we go to Pay-on-Scan what that does is gets us to 100% AP to inventory.

So we're already at 89%.

So that does get us that extra percentage but we're doing it to drive top line and to drive cost out of the inventory.

I think Mike answered that really well, but I think that we also are trying to respect, and I hope that you all understand, we have not talked a lot in -- and shared a lot of numbers on Pay-on-Scan, mostly to respect the privacy of our vendors, you know, and their pressures from, you know, from the other members that they deal with.

But make no mistake, this has been a very successful initiative, it has gone exactly as we have planned.

We are on track, and this is a multiyear effort because we're trying to be very careful not to, you know, economically hurt our vendors as we go through this thing, so we're taking a cautious approach and customizing the transition for everybody involved.

But, you know, I think everybody is cautious about talking about this, and you can expect that, and so we're not talking about the details.

But it is significant.

It is happening.

We are well on our way, and the accounting treatment is just, because it's so new, you know, we're being overly cautious by just, before we make any change to our accounting we're getting the SEC input into that, but this wasn't for accounting reasons, this was for a focus on sales, which is what we've been talking about.

If a vendor makes a shipment to our distribution center right now they count it as sales.

Well, that's not a sale.

A sale is getting through the register and driving a comp store sale.

So getting everybody, all of us, vendors as well as AutoZone, focused on moving products through, market their brands, through to the customer, is going to benefit all of us in top line sales.

Gotcha.

My final question is kind of philosophical discussion.

Your operating margins are far and away the highest in the business, the highest -- among the highest in retail.

Same store sales growth is tracking the lower to middle end of your direct competitive brand, the do it yourself auto parts stores.

As you contemplate the initiatives, to reenergize the top line, which clearly you're focused on doing, you know, do you see now?

And I I know you don't have operating margin targets, I'm not expecting them, but what's your view on investing some of that operating margin back into the business?

Do you think that's necessary?

Do you think that's likely, as you pursue sales here?

You know, Matt, I think it's a really good question, and, you know, as I stand back and look at this industry and look at AutoZone, I see an evolution of an industry that was highly fragmented to one that is becoming a little more organized.

I see an evolution, you know, with AutoZone now the clear leader, the only national player, and so forth, and it looks to me like economic patterns that have happened in other industries where a clear leader emerges with superior margins that are sustainable over time.

I think about this as a consumer product.

If you look at the consumer products industry what you see is a more normalized growth rate.

It's harder to put up tremendous comp numbers off of 3259 store base than do when it you're at a couple hundred stores, which is where we were at a few years ago.

But when you look at consumer oriented companies that have the kind of scale that we have, you see a more normalized single digit kind of rate, but you see tremendous efficiency and use of capital, strong margins structures is, high ROICs, and if you look around the industry, and you see them every day.

You see those kinds of consumer products companies driving tremendous amounts of cash flow, tremendous amounts of shareholder value, and consequently very high multiples.

AutoZone is, I think, evolving into one of those companies.

I'm saying that modestly because I think we are one of those kinds of companies now, and I think we have matured into that kind of a company.

I think that in some sectors of retail, you can go out and be highly promotional and slash prices and drive a top-line comp.

It destroys margin but in some sectors you can do that.

In our sector I think we've proven over and over again that throwing money away and throwing shareholder value away to try to drive sales for the sake of driving sales is not -- is a destructive process.

It's not a very productive process.

So as a result, what we do is we focus on testing lots and lot of things, and when they work, and drive shareholder value, we do that over time.

So we're not interested in driving sales for the sake of driving sales.

We're interested in driving long-term shareholder value.

Okay.

Thanks a lot.

Thanks, Matt.

Greg Melich, you may ask your question.

Please state your company name.

Yeah, it's Greg Melich from Morgan Stanley.

Two questions.

One is on the commercial side.

How much of the commercial growth was related to the Midas and the roll-up of the Midas program and rolling it out and was there any sort of SG&A impact to getting that implemented?

The second question, Steve, if AutoZone is really going to be -- if that's where your competitive strength is over the longer term, if you look at those consumer product companies that you're talking about that can generate lots of cash consistently, whether it's Procter & Gamble or McDonald's, or Gillette or the ones I just punched on my screen, they do have one thing in common, they all pay a dividend with a yield of 1.5 to 2%.

Is that something you are willing to consider now that it looks like the share bay back has decelerated?

Greg, excellent question.

On the first part of your question, Midas has consumed a lot of our attention, and I talked about total comp, the commercial, us moving some of the DIY comp to commercial.

I think Midas, we wanted to do it right, they're a terrific customer, hat generated some significant portion of the commercial growth, and now we need to focus on getting back to growing the hotshot business and so forth.

It actually is an efficient business to add, however, because it -- you simply throw -- you know, some extra merchandise on a truck that was driving past those stores anyway, so the incrementality of that business is good.

As it relates to the dividend, there's two ways you can pay a dividend.

One, take the excess cash flow and you distribute it in cash.

We've talked about that, and our Board is not opposed to that, but we say, you know, we look at it in terms of how can we sustain our shareholder value when we give back?

And when you give cash back that, cash goes out, and there is no sustaining shareholder value to that.

So right now our Board feels that the best way to drive the shareholder value is to use that dividend, if you will allow me to use that term, by buying shares back.

Once you do that, you permanently lower the denominator, and, you know, look, over the past year, we've been able to drive, you know, 9 to 10% earnings per share growth simply by our share buy-back program.

And while we're not committing to any numbers for the future, you know, if you view the kind of capability with the cash flow we have to set a floor of that kind of earnings per share growth simply on our way of doing the dividend, which is the share buy-back, that is a very, very strong and compelling way to build shareholder value over time.

If I could follow up on the Midas side of that, do you actually after number as to how much of the commercial growth was related to Midas?

I don't, Greg.

We're not breaking it out that finely.

Okay.

Thanks.

Gerry Marks, you may ask your question.

Please state your company name.

Hi, Raymond James.

Just two questions.

Most of my questions have been answered.

The first was, Mike, with the depreciation that you mentioned, or the example you gave with the 500 stores rolling up, when does that cycle?

Is that cycling now, where you have the lower depreciation?

Yes, we're actually cycling the five-year property now on most of those acquisitions, because they were done in fiscal 1998 and 1999.

You said you expected, you know, the depreciation moderation to not continue into the year.

I mean, is it still going to continue to go lower, or do we just kind of hold it flat?

What do you think?

I would say that it should moderate very slightly from the levels that we're at now, because once you've cycled, it kind of stays the same at that level, and then at the same time we're adding new stores that were depreciating the fixtures and equipment over those shorter lives as well.

So I think you can expect a more steady state kind of depreciation from here on out.

Then the other question, I noticed that your -- your square footage growth was like 4% but your number of stores that you are increasing were a little bit over 5%.

Are you guys going in the smaller markets?

That really has to do with the mat tougher ration, Gerry, which is, you know, when we open up a new store it opens up at about 60% as productive as a mature store, then it matures over about a four-year period so.

If you think of it from a 60% productivity with a 6% square footage growth that gets you to 3.6% kind of top-line growth associated with the new stores.

And that really ties into, you know, Steve's earlier point which is most of our stores are really mature, which is a part of what drives the comp number itself.

And to the extent that we wind up with more stores or others might have more stores in the newer category in the 1's and 2's, and 3 year category, that would serve to inflate the comp at this point.

But we have taken up our number of new stores to 195 for this fiscal year and those will be cycling into the comp pool in next year.

Okay.

Thanks

Thank you.

We have time for one more question.

Bret Jordan, you may ask your question.

Please state your company name.

Advest.

Good morning.

Couple of quick questions, and most of my sales questions were answered.

A question on the inventory at the store level.

We've been running around 470, and you brought it down this quarter.

I thought strategically there was an issue holding it around 470 to adequately serve the commercial customer.

Is there a level we should be thinking about?

Are you going to bring store level inventory down more?

That's for asking that, Bret.

What we've been trying to explain over the last several years is our strategy on inventory.

First of all, on a gross inventory level, we have worked to try to make our inventory as productive as possible, customizing it by store and working that down, and I think we've been successful at driving gross inventory down over time per store.

Then last year we took a one step up in order to catch up with some of the late model parts that we added for our AZ commercial expansion program, and that inventory add did go directly towards building those sales.

And what we said is that it was a one-time increase, which it was, of course it took four quarters to cycle that, then we said we were going to flatten out thereafter.

So I think over time you're going to see a flattish kind of inventory per store.

It could go down from here as we become more productive and more customized and more and more efficient as to how we put it in, but it's the strategy of having the right level of parts in our stores is important.

That's just the growth side.

And I know that everybody understands also that, you know, on a fundamentally two turn business, two or less, when you have parts being introduced every single year, manufacturers build more and more cars, and the parts don't disappear from the earlier cars, you're adding more and more and more inventory every single year.

That's the nature of this business.

It becomes important that that inventory is not carried as a burden to our shareholders.

Hence, the focus on the AP to inventory ratio, the credit terms, and ultimately Pay-on-Scan, which transfers the ownership of that inventory back to its rightful owners, whereby they're focusing, they, meaning the vendors, are focusing on the end sale.

So that is a really important thing, and we're down now to very little net inventory, and that is a real competitive advantage, it is a real economic advantage that AutoZone has, not only in our industry, but I think, you know, in all of retail today.

I guess one last question on the Pay-on-Scan.

Mike had referenced half of the vendors being on Pay-on-Scan.

Are you talking about half of the absolute number or half of the dollar value?

And I guess to, an earlier question, could you give us a feeling for the percentage of the inventory you hold on the books that is represented in Pay-on-Scan?

Once again, I think we've characterized it as scores of vendors and number and hundreds of millions of dollars of inventory that is under Pay-on-Scan, and the accounting for which will, you know, be determined as we get more clarity going forward.

So, listen, we're real pleased.

Every one of our vendors doesn't want to talk about it, and they have their privacy, and so forth, and we really respect that.

But make no doubt this, is a very successful thing, and now we're -- this is why we've created some of these new initiatives.

We want to drive our comp store sales.

We understand the importance of that.

We're not satisfied with where we're at, and Pay-on-Scan is one of those initiatives that we have to bring all of these creative minds from all of our vendors to help us focus on -- and help them devote their resources to help drive sales through our registers and, therefore, with our comp.

Okay.

Because I think one of the trade publications yesterday, I think it was Aftermarket Business, referenced the study saying there was reasonably low adoption in a consultants' polling of the vendors, and is that -- did they have misinformation and you are getting better adoption, or is it just a slower adoption than you might have expected?

It is faster than we expected, it is a very strong adoption, but I think when you go ask a vendor, are you on Pay-on-Scan, I think they're reticent to say yes.

Even the ones we know are on it are not out there affirmatively talk about it.

There's a very noisy segment of vendors out there who are not on Pay-on-Scan who aren't our vendors, so we get all that noise going on in the system.

But we're very pleased with the progress on Pay-on-Scan and I think we've characterized the magnitude as hundreds of millions of dollars, which is, you know, a far different than what is being reported in the press.

Okay.

Thank you.

Thanks, Brett.

Well, that concludes our time this morning.

We'd like to thank everybody for tuning in and for all your questions.

So I will wrap up.

We appreciate everybody participating in the call and we look forward to talking with you in the future.