汽車地帶 (AZO) 2005 Q1 法說會逐字稿

Welcome, and thank you for standing by.

This is the conference call to discuss AutoZone's first quarter fiscal 2005 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 that you listen to the following statement regarding forward-looking statements.

Certain statements contained in this presentation are forward-looking statements.

Forward-looking statements typically use words such as believe, anticipate, should, intend, plan, will, expect, estimate, project, positioned, strategy, and similar expressions.

These are based on assumptions and assessments made by our management in light of experience and perception of historical trends, current conditions, expected future developments, and other factors that we've believed to be appropriate.

These forward-looking statements are subject to a number of risks and uncertainties, including, without limitation, competition, product demand, the economy, the ability to hire and retain qualified employees, consumer debt levels, inflation, raw material costs of our suppliers, gasoline prices, war and the prospect of war, including terrorist activity, availability of consumer transportation, construction delays, access to available and feasible financing, and our ability to continue to negotiate, Pay On Scan, and other arrangements with our vendors.

Forward-looking statements are not guarantees of future performance and actual results.

Developments and business decisions may differ from those contemplated by such forward-looking statements and such events could materially and adversely affect our business.

Forward-looking statements speak only as of the date made.

Except as required by applicable law we undertake no obligation to update publicly any forward-looking statements whether as a result of new information, future event or otherwise.

Actual results may materially differ from anticipated results.

Please refer to the risk factors section of the form 10-K for the fiscal year ended August 28, 2004 for more information related to these risks.

In addition to the financial statements presented in accordance with generally accepted accounting principles AutoZone has provided metrics in this presentation that are not calculated in accordance with GAAP.

For a reconciliation of these metrics, please see AutoZone's press release at the Investor Relations section at www.autozoneinc.com.

Mr. Odland, you may now begin.

Thank you and good morning.

Thanks for joining us today for AutoZone's fiscal 2005 first quarter conference call.

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

I hope you've had an opportunity to read our press release and learn about this quarter's results.

If you haven't the press release along with the slides complimenting our comments today are available on our website, www.autozoneinc.com.

Just click on the quarterly earnings releases to see them.

Our first quarter 2005 continued last quarter's difficult sales environment.

But despite this challenge we are pleased to announce the first quarter continued our trends of record earnings and earnings per share.

We continue to maintain metrics at their highest levels since AutoZone became a public company.

While this quarter we reported a minus 3 comparable sales result we were able to reduce our expenses appropriately, manage our cash flow, repurchase stock, and report a 13% increase in earnings per share on top of 30% increase in last year's quarter.

For the 12 week quarter we reported sales of $1.286 billion, which was an increase of 0.3% from the first quarter ended in November of 2003.

Gross profit as a percentage of sales improved by 44 basis points while operating expenses increased by 40 basis points.

This resulted in an operating margin of 16.8% which is up 4 basis points from last year.

Operating profit increased 1% over the prior year.

Net income for the quarter increased to $122.5 million and diluted earnings per share increased 12.7% to $1.5 2 a share from $1.35 a share in the year ago quarter.

Now, excluding last year's one-time gains from warrant, operating profit as a percentage of sales was actually up 130 basis points and earnings per share were up 22.8%.

Our disciplined capital management resulted in a return on invested of capital for the trailing 4 quarters of 24.9%.

So for every incremental dollar invested in the business AutoZone continues to significantly exceed its cost of capital thereby creating a continued wonderful competitive advantage.

We have not deviated from our efforts towards optimizing shareholder value.

We continue to be fiscally prudent with our capital investments while attempting to optimize our earnings per share.

So that's the summary.

Now, let's turn to the specifics.

First of all, sales.

For the quarter total retail sales were flat versus year ago.

As I stated last quarter, back on September 22, the sales environment for the first 2.5 weeks of this quarter looked very similar to the previous quarter overall and this pattern did not change fundamentally over the remainder of the quarter.

While our average ticket remains up slightly over last year, the number of transactions did not improve.

Last quarter, I talked about how the higher gas prices showed a high correlation to reduced same store sales.

While gasoline prices did stabilize somewhat during the quarter we saw no material decrease in the prices at the pump.

On a national basis regular unleaded gasoline hovered at almost $2 a gallon versus last year, a number of about $1.50 a gallon.

We also continued to track closely the miles driven across the country which is reported by the federal highway administration.

Their website shows monthly miles driven.

Now, we've long known and spoken about miles driven as being one of the key macro drivers for this industry along with the number of registered vehicles on the road.

While July miles driven reported as a slight improvement over the previous months, August, September and October continued to show difficult comparisons to last year.

In fact, total miles driven showed a decline in August and in again in October.

October's decline of 1.2% was the largest monthly decline shown over the past year.

The federal highway administration has not released the November results yet.

Although our analysis indicates that gasoline prices are the primary cause for our ongoing slow downs in transactions, opportunities continue for us to -- for the remainder of fiscal 2005 to increase our sales through advertising, improved stock levels, store level execution, visual merchandising, and additional merchandise availability.

So net net our category management initiatives still have a very long way to go.

Finally, as I mentioned last quarter, our inventory levels were too low.

We have needed to put more late model coverage into the stores.

We did increase our store level inventories a little bit to just over $500,000 a store last quarter on a total inventory level.

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

So what were some of the successes in the past quarter?

Well, advertising and merchandising programs continue to be primary drivers to our volume.

Along with our ongoing radio campaign, we continue to utilize television and introduce print media into the mix to reach a wider customer base.

In this challenging environment, it is important to convey a message of superior quality, assortment, and selection in order to win customers and overcome debt deferred maintenance.

We continue to focus on marketing opportunities towards our drive time customers during the first quarter.

Radio continued to be a focus.

Our television spots, which were on the theme of anything you want, generated broad customer interest and traffic in our stores.

We also tested new spots and we're encouraged by the traction that those spots received.

Lastly, we continued with our newspaper inserts during the quarter and we found the ads continue to be moderately successful even in the face of rising gas prices.

Over the last couple of quarters, I've mentioned how the company has been managing over 100 projects to create quick head opportunities for us to grow sales as well as manage expenses effectively.

These projects continue to contribute millions of dollars to our EBIT for the quarter.

Just to give you a few examples of the sales initiatives, we continue the Value Craft brand extensions across multiple merchandise categories including belts, water pumps, battery cables, thermostats.

We continue to add Duralast premium products to our stores including brakes and water pumps.

We introduced a new multi-use retail fixture display which gives us great flexibility to display multiple kinds of products around the store.

We also continued our strategy of fill-in acquisitions.

We completed the acquisitions of a small chain called Car Parts, which is located in the state of New Jersey.

We expanded late model parts coverage a little and we also expanded our import parts coverage a little.

On the customer service front, we continued with our ongoing initiative to increase the number of ASE certified employees throughout our organization.

And as of the end of the quarter, we have approximately 4500 ASE certified parts professionals, which represents a 25% increase year-over-year for us.

The title sponsorship of the NASCAR elite racing series has created a strong crossselling merchandising opportunity.

This series covers 51 races and includes over 250 driving teams today.

This is a great opportunity to reach a dedicated audience of DIYers and those fans who follow the sport.

As the country's second most watched sport, NASCAR offers a wonderful opportunity for us to attract new customers to our stores and we'll continue to work with NASCAR to maximize our exposure to this core customer of AutoZone.

AutoZone's also pleased to become the sponsor of the AutoZone Liberty Bowl, the annual college football bowl game this year.

This year promises to be a good game and gives us another great way to reach our customers.

Back inside the stores, the truck zones in the area of the store that features our light truck and SUV accessories and we had truck zones in approximately 950 stores by the end of the past quarter.

And ultimately we think that the majority of our stores can benefit from this new merchandising effort as the SUV fleet continues to age.

We continued our strategy of establishing the good, better and best delineation for many of our product categories.

For example we now rolled the strategy which gives us 3 levels of product quality and warranty and price across roughly 100 merchandise categories and we've got more to go.

Besides the opportunity proprietary brands offer for margin enhancement, they represent a distinct point of differentiation for AutoZone.

Value Craft, Duralast and Duralast Gold brand names are some of the most trusted brands in America and they're available exclusively at AutoZone.

This past quarter we continued to roll out our new line of proprietary Gold -- Duralast Gold friction products to fill in that best category line.

The impact will be felt throughout 2005.

This line is entirely new to AutoZone and we're optimistic about its potential for both our DIY and commercial customers.

We are going to continue to take advantage of nascent trends by introducing certain products as quick head opportunities to optimize sales and profit.

So by continuing to keep the product assortment fresh and exciting, especially around the entrances to the stores, we feel that we're helping to create the most exciting zone for our customers.

For the trailing 4 quarter sales per square foot were $257.

This statistic continues to set the pace for the rest of the industry.

Our new stores continue on track to achieve a 15% internal rate of return and we continue to see an opportunity to open thousands of additional stores in the United States.

We opened 28 new stores this quarter for a total of 3,448 domestic stores.

Also told you last quarter that we reopened 7 of the ABC Auto Parts stores that we had purchased in the third quarter of fiscal 2004, opening those under the AutoZone banner.

We reopened the remaining 5 stores during this past quarter and these 5 are included in the domestic store count of 3,448.

We can continue to take advantage of opportunities like the ABC type acquisitions as we go forward.

During this quarter we purchased another small chain of 4 stores located in New Jersey, as I mentioned before, during the quarter.

We look forward to converting those stores to the AutoZone format by the end of the second quarter.

We continue to track around 200 new stores to be opened by the end of 2005, representing a continued 6% growth in square footage for the company.

And we feel that's well in line with both our capabilities and the demands of the marketplace.

Now turning to commercial sales.

For the quarter total commercial sales were down 2% from last year's quarter.

We now have the commercial program in 2,132 stores supported by 119 hub stores.

You may notice that we've reduced the number of stores with commercial from last quarter by 77 in order to optimize our operations.

This results -- this move alone resulted in a 2% sales reduction.

This quarter's slow down in sales also was driven by the impact of higher gasoline prices and that impact on miles driven, thereby driving lower preventative maintenance and lower traffic -- store traffic at many of our commercial customers.

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

We continue to focus on our commercial program and we continue to have successes developing customers around our existing stores and adding new local and chain accounts as well as implementing new hub stores.

With only about a 1.5% share of the commercial sectors total business, AutoZone still has a significant opportunity to gain market share.

We have grown significantly faster than the market over time and we think that we can continue to grow and add shareholder value in the future.

In Mexico our stores continue to perform very well in the quarter, even with the continued peso fluctuations and that country's economic volatility.

We opened one store during the quarter which now gives us 64 stores in Mexico compared with the 3448 in the United States.

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

Now turning to gross profit.

Our gross profit margin for the quarter was 48.3% of sales, up 44 basis points from last year.

But if you adjust that for last year's one-time warranty gain of $16 million, gross margin was actually up 169 basis points versus last year.

So we continue to be successful in partnering with our vendors to offer the right products at the right prices to our customers.

This effort includes supply chain initiatives, tailoring the merchandising mix, continued implementation as I discussed earlier of the good, better, best product lines, and all that allows pricing to be differentiated to customer needs, as well as the ability -- it gives us the ability to grow to manage our gross margin.

We have maintained our pricing strategies now for many quarters and pricing alone has had little impact on the margin improvements over the past several quarters.

I want to remind everybody until recently, AutoZone was only -- was one of the only companies in our sector to report a warranty liability, although we were likely not the only one with the exposure.

We continued our multi-year effort to move this warranty liability up the supply chain to our vendors, where their costs are significantly lower than our costs of covering that warranty.

This is much more efficient for ourselves as well as for the industry.

It puts the responsibility with the vendors who are in a better position to manage it.

This quarter the company experienced no gain from the changes in the warranty negotiations.

For the third quarter of last year, you may recall, the company experienced a gain of $10.6 million or 8 cents a share.

In the fourth quarter of last year it resulted in a pretax gain of $15.5 million or 12 cents a share, as we relieved AutoZone of that future liability and lowered the risk level for the company.

So at the end of the first quarter of this fiscal year we still have roughly $6 million of remaining liability which means that we have substantially completed our initiative to remove this risk.

We believe there continues to be some margin expansion opportunity albeit at a slower pace than the previous couple of years.

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

SG&A for the quarter was 31.4% of sales which is up 40 basis points versus last year.

The majority of this increase was due to the late quarter openings of the 28 new stores along with higher utility and fuel expenses.

We continue to focus on initiatives to reduce operating expenses on a percentage of sales over future quarters.

Store payroll and full-time part-time ratios have been continually managed appropriately to reflect the seasonal demands of the business.

We believe our payroll spending and part-time/full-time balance are at appropriate levels.

Full-time AutoZoners continue to be the core of providing our customer service.

We utilize part-time AutoZoners to flex our staffing up at peak times.

Over the past year approximately 60% of the headcount has been full time consistent with the past several years.

So there has been no change here.

More importantly, the percentage of full-time hours deployed in our stores has remained consistent.

These full-time hours are critical to delivering trustworthy advice.

Advertising costs were up versus last year as our advertising reach and frequency continues to increase and we continue to roll out our television campaign in the quarter.

Our advertising expense may continue to increase throughout 2005 in order to drive sales but we expect vendor support to neutralize any negative impact to our operating profit.

We also continue to manage our costs.

Scores of projects have allowed us to lower our costs over time and pass that savings on to our shareholders.

Just to give you some examples of some of these cost saving programs.

First of all, we continue to convert our credit card paying customers to debit cards and we've experienced several million dollars in savings since its inception.

This marks 3 consecutive years of improvement there.

We've identified opportunities to reduce our utilities cost and we have begun to act on those.

We've been successful in lowering our phone rates.

We've been successful in replacing simple things like light bulbs in our stores which have significantly lowered our energy costs.

Instore temperature controlled systems have done the same.

We have increased direct deposit rates, thereby reducing our costs of handling paper checks.

We've got less register waste.

Switching to remanufactured toner cartridges, renegotiating property taxes, and then selling closed circuit TV in the stores has helped control shrink.

So, you know, you get the idea here but we've got lots and lots of ideas to continue to lower costs and those cost savings can be passed on to our shareholders.

EBIT for the quarter was up $216 million which was about 1% from last year.

And interest expense for the quarter was 21.8 million compared with 20.3 million a year ago.

Debt outstanding at the end of the quarter was 1.825 billion versus 1.453 billion last year.

Over the quarter our debt levels were maintained in line with our guidance of 2.1 times our trailing 12 month EBITDAR.

We are pleased with our ability to lock in rates at historically low levels.

Mike will talk about that more in a moment.

We generated more cash flow than capital expenditure needs and discriminately issued debt to appropriately manage our capital structure, which balances the more expensive equity component with historically inexpensive debt.

We've purposely managed this capital structure relative to our cash flow in order to maintain our credit ratings at an investment grade while reducing our cost of capital.

For the quarter our tax rate was 37% down from 37.5% last year, which resulted all in a net income of $122.5 million which is up 1%.

Earnings per share for the quarter were $1.52, up 12.7% on 80.7 million diluted shares.

But, again, excluding last year's onetime warranty gains the earnings per shares were up 22.8%.

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

Mike?

Thanks, Steve.

Good morning, everyone.

This quarter we generated $113 million of operating cash flow and bought 400,000 shares for a purchase amount of $30 million.

For the first quarter of this year we reported yet another ROIC improvement to 24.9%, up from last year's 24.0%.

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

Looking at the balance sheet highlights, our inventory per store reflected on the balance sheet which excludes the Pay On Scan inventory was $464,000 per store versus last year's $459,000 per store.

What was impressive was our inventory per store net of payables was actually reduced from 44,000 last year to 40,000 per store this year.

Net inventory per store actually decreased in total by 10% this quarter versus the same time last year.

Additionally, we improved our net inventory turns in the quarter, which is based on an ending gross inventory number, to 20.7 times from 20.2 times last year.

Our accounts payable as a percentage of the gross inventory increased to 91% from 90% last year.

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

This quarter we reached a total of $150 million of inventory on Pay On Scan which is not reflected on our balance sheet which is in accordance with GAAP.

Most importantly, for AutoZone, these same vendors represent several hundred million dollars of inventory which we expect to convert to Pay On Scan all the time.

While this quarter was not a big quarter for growth in inventory on Pay On Scan and total, several vendors goods sold through our system on Pay On Scan and were then offset by new vendors and their goods.

We expect this initiative to continue to gain traction throughout F '05.

This effort will continue to grow as more and more of our vendors transition to the program.

We continue to partner with our vendors to sell more merchandise as a team.

As with last quarter, we will continue to keep referring to this, using a couple of new terms, as we described our inventory levels.

Gross inventory is used to define the inventory which excludes Pay On Scan inventory which is the number that is reflected on our balance sheet.

Net inventory is used to define the gross inventory less the accounts payable.

As we continue to increase the dollars of inventory on Pay On Scan, we continue to expect to report reduced inventory per store statistics into the future.

This will continue to be a benefit to our working capital numbers as well.

However, I want to point out that we expect to continue to add SKUs where appropriate but to have the incremental costs offset by accounts payable and Pay On Scan.

As stated earlier, we will continue to only invest in inventory that exceeds our 15% IRR hurdle rate.

We continue to believe that car model proliferation in this sector requires us to continue to add inventory.

Please recall that two thirds of all the SKUs in our store have an on hand of only one.

That's why our accounts payable to inventory and our Pay On Scan initiatives are so important to us and provides us with a strategic competitive advantage.

Total working capital was higher by $48 million from year-ago levels.

But still at a negative working capital number of $29 million.

This slight increase was attributable to our increase in accounts receivable, primarily driven by funds due from our vendors.

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

Looking at our fixed assets, net fixed assets were actually up 6% versus last year.

CapEx for the quarter totaled $59 million.

Depreciation and amortization totaled $26 million for this quarter and reflects the additional expenditures required to open 28 new stores in the quarter and work on site development for the upcoming quarter.

Our debt levels at the end of the quarter was 1.825 billion, a decrease of $4 million from last quarter.

But as Steve mentioned earlier, we continue to manage our adjusted debt, which includes the leases, to the guide of 2.1 times EBITDAR.

With these same trends, the EBITDA coverage, or EBITDA to interest coverage, is now at 11.8 times for the trailing 12 months.

So we've got -- continue to have great coverage.

We are very pleased with our success at refinancing $1 billion of debt over the past 2 years at a weighted average effective annual interest rate of 5.3%.

Further, we filed a shelf registration, placed a $300 million 5 year note back in August.

During the first quarter, we decided to actually pursue a bank term loan instead.

The rates quoted appear very attractive for the 5 year loan and it is expected to contain covenants similar to our other bank agreements.

As of the end of the quarter, as of November 20, 2004, AutoZone continues to be one of the few players in our industry to have an investment grade debt rating.

The senior unsecured rating from S&P is BBB+, with a CP rating of A 2.

Moody's has assigned us a senior unsecured debt rating of BAA-2 and a CP rating of P-2.

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

Shareholders equity, turning down the balance sheet, declined reflecting the repurchase of our common stock over the trailing 4 quarters.

Our return on equity for the trailing 4 quarters was 151% versus 87% in the quarter last year.

I do want to take a moment here and talk on the subject of book equity.

Our return on shareholders equity is an amazing 151%, as I stated, but that number doesn't mean much to our performance these days because we continue to buyback our shares of outstanding stock.

I want to reiterate that we manage our capital structure not to book equity but to cash flows.

Specifically, we continue to keep managing our leverage to the 2.1 times adjusted debt to EBITDAR that we mentioned earlier.

We do this because we believe it to be a more accurate reflection of the leverage and the interest coverage appropriate for an investment grade credit.

Now I would like to turn it back to Steve.

Thank you, Mike.

Our business was challenged again in this quarter as our customers continued to manage their expenditures closely and hold off on doing some preventative maintenance.

We understand the challenge of what gas prices can represent to our customers who are low-end consumers and fix their cars themselves as they cannot afford to have it done for them.

When their transportation costs increase 30% it is very easy to see why they respond by cutting back deferrable maintenance, especially in an environment where the consumer has been trading up to larger vehicles in the past few years, gas price jumps can have a material impact on miles driven and spending habits.

But, our financial model is very strong and we have continued to increase earnings and operating cash flow while simultaneously improving our business model while -- by removing the risks associated with interest rate fluctuations and warranty liability over the long periods of time.

This consistency in cash flows will continue to be our focus.

We have accomplished this during both strong and weak economies.

We have called our business a cyclical and we still believe it is.

Higher gas prices are not economic cycles but they can have an impact on miles driven which in turn can lead to deferred maintenance.

Now, looking forward to gas prices, there is lots of different scenarios you can envision, but let's talk about 3.

First, gas prices could continue to rise.

And if they do that and continue to put pressure on consumer spending habits it would be the worse case as that would prevent -- defer preventative maintenance further.

But, you know, over time cars are still going to break and need to be fixed.

But consumers will delay that maintenance as much as possible.

Second possibility is that gas prices can maintain at these levels.

Over time the consumer may become acclimated to paying for gas at these prices.

We have seen this sort of thing in Canada and Europe where consumers have learned to adapt to the higher prices.

We expect this could happen in the U.S.

However, there has to be a consumer buying behavioral transition.

Eventually, car owners, again, will still need to repair and maintain their cars.

The third possibility is that gas prices come down to where they were earlier this year.

Hopefully then the customers would begin to do all that deferred maintenance and add discretionary accessories to their vehicles.

We believe we've got lots of initiatives that can help us grow same store sales over time.

But we do budget conservatively to ensure that we maintain both our expense and capital structure disciplines to ensure we deliver solid returns and this was clearly evident in our ability to drive nearly 13% increase in earnings per share despite soft comps.

Repurchasing stock has been a tool in managing our capital structure and we may continue to repurchase stock as long as it is 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're pleased to continue to demonstrate industry leading financial metrics.

Being an extremely disciplined financial planning company, we have proven our abilities to manage costs appropriately, invest in incremental projects that exceed our stated 15% after-tax IRR hurdle rate.

So we are focused on operating this company to profitably grow sales, efficiently to build capital, optimize shareholder value, while maintaining the highest levels of ethics.

Now I would like to open up the call for questions.

Thank you.

At this time if you would like to ask a question please press star, one.

You will be prompted to record your name.

Again, to ask a question, please press star, one.

Our first question comes from Bill Sims with Smith Barney.

Sir, your line is open.

Thank you and good morning.

Good morning, Bill.

Good morning.

I have a few questions.

First, I see that you spent significantly more on CapEx this quarter versus year but opened at least 12 fewer stores.

Can you just walk us through the major highlights of what drove the increase in CapEx?

Yeah, it -- part of it is timing.

There is -- and it has to do with when we're actually spending the dollars to open up the stores and, as Steve mentioned, we expect to open up over 200 stores in this fiscal year so some of it is timing and then there is a significant portion of it that has to do with our new distribution center that we are going to be opening in Carol, Texas shortly.

So we've got some incremental spending associated with the DC as well as the timing.

All right, thank you.

My second question is this, in my calculation gross inventory was up roughly 7%.

Can you just point me to where the inventory increase was coming to?

Was it hard parts or accessories?

And how much of the gross margin improvement was driven by that mix or increased inventory?

It has been increased across the board in both hard parts as well as in accessories so it has been across the store.

The biggest piece of it has been in the late model coverage, which of course does mean the hard parts, but it has been an increase throughout the store.

And that's what has really enabled us to manage our category management and manage good, better, best so as part of optimizing that is all part of improving our gross margin.

So the pieces don't necessarily split out but if you look at it as just retail and mix, that's really the primary drive.

Third question is one of your major initiatives was to increase the percentage of Value Craft and Duralast product into the stores.

How are those products gaining traction with commercial customers?

Are the commercial customers receptive to this product versus the retail customer?

We have been very successful with the further introduction of our own label products and the receptiveness from the commercial customers has been outstanding.

You've got different mix of needs in the commercial market, just like in the DIY market.

Some of them want a value product with a shorter warranty and for them the Value Craft product has been an outstanding success.

Some of them want the highest quality products available, and now, as I mentioned, with our introduction of the Duralast Gold friction products, we believe we have that for them in the marketplace.

So that actually was a need that we weren't filling before.

And finally, can you comment on the progression of comps through the quarter?

Is this any color you can provide us?

There really isn't.

I think as we mentioned before, we are -- our comps have been, unfortunately, you know, really driven by the change in gas prices and, you know, we -- this isn't just, you know, shoot from the hip explanation.

We do sophisticated and multivariate time series analysis which look at dozens and dozens and dozens of variables that, you know, could impact our business.

And gas prices just simply never showed up as a driver of our business until these past couple of quarters.

And when we saw, of course, gas prices jump nearly 30, 40%.

And so what we're seeing is that this impact, you know, has been pretty consistent with the gas prices, as it has taken the cash out of our low end consumer.

Presumably, new merchandising, though, and increased inventory should have a positive benefit to comp and yet the comp levels remaining roughly flat year-over-year, quarter-over-quarter I should say, so do you think that traffic is getting worse,yet inventories offsetting that slightly?

Or how should we look at our comp outlook going forward?

Well, we don't give guidance, as you know.

I think, you know, unless some of the scenarios change, as I tried to describe on the gas front, you know, I wouldn't expect -- I would expect that the comps to follow that.

You know, remember, also, that unlike most retailers we're in our lowest season right now, where as most are experiencing their high season.

Our new season starts in the spring and our greatest hope is that gas prices moderate and come down and we can launch a great spring season and get this thing going again.

But if there is not cash, and consumers, you know, the low end consumer pocket and we've seen this across, I think, other retail categories and other retailers, in general, if not the cash there, then, you know, it is going to be difficult.

All right.

Thank you.

I think our next question comes from John Lawrence with Morgan Keegan.

Your line is open.

Good morning, guys.

Good morning, John.

Hi, John.

Steve, would you comment just to take one step further on the spring sales season, what would you say are the initiatives for advertising for the spring?

Can you go into that yet?

Well I think -- thank you, John.

As I mentioned in the script, we are constantly working on new ideas and, you know, the -- if you look at some of the merchandise that we've been able to put in our stores, we've differentiated more on the Value Craft, Duralast, Duralast Gold, so let's start in hard parts which is the primary driver of our business and, you know, accounts for, you know, most of our inventory and most of our cash flow.

That differentiation, which we continue to do, has had great impact on our margins, great impact on our sales and our penetration in the commercial market and so forth.

So as we continue to prepare for the launch of our season in the spring, you know, we're hopeful that that will continue to impact our business.

Also, you know, we are preparing, obviously, advertising which talks to that.

I think, you know, we have to remember in this business we've got -- we've got to deal with the 5 to 700 new models of cars that are introduced every year and you don't get that -- you don't get those old cars dropping off the back end in terms of models, you constantly got to be adding just new inventory for the coverage aspects of that.

One thing I want to point out is that, you know, this is a model which if you just let it go to infinity here, we'd chew up all of our working capital, you know, in just covering inventory.

That's why our Pay On Scan initiatives and our vendor initiatives to, you know, to get our payables ratios up and so forth have been so important and so strategic for us, because essentially, it allows us to put that breadth of merchandise in our stores and that breadth of coverage in our stores year after year without burdening our company with the cash flow risks of that.

And just to followup on that point, on the working capital side, is that -- does that have something to do with the reduction of the 77 stores from the commercial and that balance of inventory management?

You know, what we were trying to do there is -- and I mentioned this the past couple of quarters, you know, as we continue to open programs, you know, we're trying to optimize, you know, one program which is near another and another and so forth, in order to be as close as possible to our commercial customers, to service them in the right way, but then not overlap with our programs.

So, you know, as we go forward we're going to continue to optimize this and we're going to close some, we'll open some to try to get the best balance of coverage so we can service our customers the best.

Great.

Thanks a lot.

I think our next question comes from Kevin Flaherty with Credit Suisse First Boston.

Good morning.

Thank you.

Just 2 quick questions.

I guess, you know, first of all, it looks like, you know, the gross margins were, you know, very strong in light of the comparison versus the warranty reversals.

As we -- some of the initiatives that help drive that up in terms of the private label mix, as we scroll through the rest of this year, you know, do the comparisons get significantly more difficult?

Is this something that just started to hit this quarter?

Or, you know, how should we look at that?

Since you still are comparing versus some tough warranty reversals and then also, just in terms of the low end consumer and lay of the weakness and that hurting the traffic, have you seen much of a shift specifically between what percentage of your customers are opting for good versus better, you know, versus best when you do offer that?

Thanks.

Yeah, the mix of parts, you know -- we've got a mix of consumers, we've got a mix of commercial customers.

Some of them want the low end products with the shorter warranties, lower price and so forth.

Some of them want the very high end products because they're buying a used car and they want to put parts on it that are going to last a long time and have the best warranty, so what we see as the needs of the low end consumer change, regarding what they want, in other words if they're trying to keep a car a long time, we see them trading up, if they don't want to keep a car a long time, or if they're, you know, just trying to get by, they trade down.

The beauty of our category in management initiatives is that the margins are relatively constant across those products, because we scale the pricing consistent with the quality and the warranty and the costs of those products.

And on the second -- the first part of your question, then Kevin, in terms of the gross margin improvement, yeah, you're right, even despite the fact that we were bumping up against one-time warranty gains that were included in the gross margin in last year, we still managed to beat that gross margin, so on an apples-to-apples basis, we actually improved our gross margin by 169 basis points over the prior year.

While we don't -- we're not predicting that we will continue to get that kind of level of improvement year-over-year, apples-to-apples, we are saying that we continue to expect to continue to improve our gross margin on an apples-to-apples basis.

So as we continue to execute category management, as we continue to introduce new lines, brand extensions, et cetera, we have opportunities to continue to keep improving our gross, just not at the kind of levels that we have seen historically.

So this is a notable improvement.

We expect to see continued improvement but not necessarily at these levels.

Thanks.

Okay, thanks, Kevin.

I think our next question comes from Brian Postol with A.G. Edwards.

Thank you.

Good morning, guys.

Hi, Brian.

You know, recent industry trends during your quarter suggests that comps should have been where you were or down year-over-year.

However, some of your competitors of lately have commented that late September, early October their trends started to improve for the better.

Did you see anything of that nature during a shortened period of time not to get too micro managed here but -- or is there something else baked into your customer that you are -- specific to your customer versus theirs?

I think what we're seeing is an industrywide phenomenon in our industry and I think if you age adjust the comps for the stores, in otherwards a lot of people have bought stores or opened stores and so the store base are younger and as those stores mature you get that impact into the comp of those younger stores.

You know, when you acquire a store, even if the store is 20 years old, so you may say it is a 20 year old store in your store age but in your comp you count it after the first year.

And so it is important that as you're evaluating comps across all of our competitors, that we age adjust.

If you do that you don't see, you know, a dramatically different kind of trend across the industry.

I think we're all being -- I think we're all being hit by the gas prices primarily.

And I think you see that showing up in some of the other retailers who cater to our kind of customer as well.

So, you know, we don't have great industry numbers which talk about market share and talk about, you know, give you the data for it, so we get a peek at it through AAIA about once a year, but I suspect that you're going to see that, you know, over the past couple of quarters that it has been an industrywide phenomenon and, therefore, I don't expect to see material shifts in market share.

I think our next question comes from Gerry Marks with Raymond James.

Just to kind of followup -- good morning, by the way.

Good morning,.

Hi, Jerry.

Just got to followup on that industry thought.

You know, at a time where maybe it is gas prices, it seems to be something happening externally, I think your competitors all agree with you with regards to that.

We're seeing square footage growth increase right at a time when the demand for gas prices for whatever reasons are declining.

Aren't you worried that this could set up, you know, some competitive issues over the next 12 months?

No, you know, I do think it is an industry issue, as we've said, and I do think market share is not an issue, I think some people have been concerned about, you know, market share shifts which I don't think will be the case, given the dynamics across the industry.

But I see all of -- I see this industry as being very rationale in its expansion of square footage.

You know, I think that, you know, the top 5 chains only account for about 35% of the market share, especially in the DIY side.

And if you took, you know, sort of a mid single digit percentage growth in square footage on that 35% and, you know, virtually no growth to a decline, which is what -- you know, we've seen a 5% decline in the number of stores, you know, over the past several years, but if you see a decline in the 65%, well, you really have a very -- you know, a very productive growth rate.

So, no, I'm not concerned about that and you know, people don't plan a new store opening pipeline based on one quarter's gas prices, which is, you know, what we're experiencing.

I think we got to remind ourselves here that what -- what we've experienced is a very stable long-term growth rate in this industry.

We've got a couple of quarters here which have been rocked by the gas prices.

But we can't lose sight of the great growth potential over the long run, the great stability in the cash flow, the noncyclicality from an economic cycle standpoint, and clearly there is macro factors here but from an economic cycle standpoint.

So I just -- I just don't -- you know, I know that we're focused on this quarter and that's the purpose of this call but I want to put it in the context of the broader picture which is very, very positive.

That's fair. 2 quick follow-ups.

Mike, why did the tax rate decline 50 basis points?

Actually, we continued to keep looking at our tax structure and being sure that we optimize it.

It is another thing that -- another way that we continue to keep challenging our structure and our costs and tax like anything else is another cost.

So what we've been doing is looking at our legal entity structure, looking at our tax structure and making sure that we've got it so that it parallels where our costs are actually incurred in the supply chain pipeline and then by doing that we've actually been able to reduce our effective tax rate.

So this is not a one-time unexpected kind of drop in the rate.

We expect to be able to achieve this kind of a level going forward.

And if I calculated it right your other line item of revenues was up roughly like 30%, that is Mexico and ALLDATA in it, can you comment whether more of that seemed to be coming from Mexico or ALLDATA?

It's really -- it's been driven by both, because as Steve mentioned, we've increased the number of stores within Mexico, our Mexico stores continue to perform very well.

As well, we are very, very happy with the performance of our ALLDATA business, which as we said before, a great tie-in with the entire commercial business and gives us a great opportunity to make sure that we can sell parts through the commercial customer stores, potentially online with them, so it is a large growing piece of our business.

Now, that's basically software type margin, so did that also contribute to some of the higher margins this quarter?

It is such a small piece of the sales that it doesn't, you know, it doesn't really move the total needle but you're right it is a higher margin business.

Thanks.

Thank you.

Your next question comes from Gregory Melich with Morgan Stanley.

Hi, A couple followup questions.

One was on the CapEx.

Was there any change in the percentage of lease stores back to your normal where it is a minority that may have driven that number.

The answer is no, the mix looks similar.

You know, if you look at the stores that we expect to open this year, we expect it to look similar to our percentage of loan versus lease.

Again, to your point, Greg, last year, we did have a more significant portion of our stores that wound up being leased.

That's not our preference, because we actually preferred to own them because it gives us better control over our destiny in the future.

But where it is necessary to get into markets we will be open to the possibility of leases.

We look at it is as a deployment of capital either way, which is reflected in our leverage number.

But it is all pretty consistent with prior years.

Okay.

So the 200 stores this year, all else equal, you think you would be back at that sort of own 60% or more level?

Well, more or less.

I mean last year, it skewed more towards the leasing side, so, you know, given where we're expanding particularly in the northeast, particularly in the Pacific Northwest, you know, those are some areas where it is harder to come up with the dirt, so therefore, we have to be open to leasing at times.

And how much is the DC going to cost us?

We haven't said a specific number associated with that, but, you know, what we said is it is a significant portion of why the CapEx was an increase in this quarter.

Okay.

And so for the full year should we still expect that sort of the run rate we had last year?

Yes, sir.

Okay.

Second is on the SG&A front, you continue to do quite well there and I guess the question is if I look -- if you look at it on a per foot basis you're back to around 18.5 SG&A cost per foot which is almost to where were you 2 years ago.

But if I'm wrong here, 2 years ago you would have had the benefit of netting the vendor funding of advertising against SG&A.

I'm just curious, if you look at it on a per foot basis how much more do you think you can get out from these different activities that you mentioned?

The answer is we have been very successful at driving it in the past and thank you for noticing that.

And you're exactly right in how you're looking at that, which is 2 years ago those numbers did reflect the vendor funding credit down in SG&A, so in fact, the improvement is even better than what that looks like.

And that's due to the real continued cross functional effort that we have as an organization to drive costs.

I think, you know, Steve mentioned, while we're probably close to a dozen of those projects that we've worked on and every year we continue to find more ways to be able to reduce costs.

So we expect to be able to continue to find ways to reduce costs.

Obviously, the lowest hanging fruit is what we go after first.

You know, I just want to followup on that, Greg, because, you know, so many people assume that we must be cutting labor in order to get our SG&A down, and it's just simply not true.

And we've said that repeatedly, that the labor that we have in our stores is so important to the service levels and the creation of our brand, that's why we called out a lot of these kinds of projects we're working on and any one of them may sound trivial, but they do add up and it has been what has been driving our cost savings, not a change in strategy or in labor or short -- you know, part-time/full-time ratios or any of the other things that people assumed must have been the case.

These are -- this is true cost savings.

And I think this is, you know, the hallmark of a great focus and a great organization.

And then we can pass that along to to our shareholders.

Great.

If you can also, on the ALLDATA front, if you have any updates in terms of how many people you have using it and any objectives there?

You mentioned that it is going to help -- you want to use it to help drive the commercial but just even excluding that, how is it going in terms of number of subscribers and how you're going to market with that?

Well, we're very pleased with the performance of our ALLDATA group.

We view ALLDATA as an integral part of our commercial strategy which provides customers with parts but also the information that they need in order to repair cars.

That -- our subscriber base continues to go up and you know, we're well over 50,000 installations at this point.

And, you know, it is, I think, somebody referred to it as a software product, I guess in some ways it is and to that extent we continue to add value to that and try to make it easier for our commercial customers to use that product and manage their shops and market to their customers and so forth.

So, you know, what we're trying to do is we're trying to make sure that we add value to our commercial customers to make it easier for them to buy parts from us.

So if you're using it to drive more commercial business, does that mean that the monthly subscriber fee could come down?

Or --

Well, we really can't talk about, you know, what we plan to do with pricing going forward.

But I think the point is that there is lots of opportunities here to integrate data and parts sales and that's our effort, our strategic effort going forward and it is going to be a long-term effort.

Okay.

But people aren't getting this for free?

Again, we don't discuss the cost of our products, but you know, you don't make money on things giving it away.

Right.

Okay.

Thanks a lot.

Thank you.

Your next question comes from Frank Brown, with SunTrust Robinson Humphrey.

Hi, Frank.

Good morning.

Just touching base again on gross margin.

I guess somebody asked earlier but it looks like we could be thinking about gross margin improvement of 100 basis points or better over the next several quarters, I'm just trying to get a little bit better feel for, you know, the category management initiatives and where that would come in.

You know, is it a private label, increase in mix, or, you know, in terms of category management wouldn't we see positive impacts on comps in some of that as well, you know, when we have the right products in the right stores and the more tailored mix?

Well, we didn't say we that were going to increase our gross margin by 100 basis points going forward.

We don't give specific guidance.

But we have been very successful with our category management initiatives, Frank, and I think that -- I think you point that out and it is true.

The whole notion of creating this good, better and best range is critically important.

It is not -- you know, we're not increasing pricing to drive our growth but we're introducing value products and high-end products that we've been missing.

We've, you know, traditionally have products in the middle of the range but we were missing products which met the needs of all of our customers.

And, you know, I've talked about this in the past several years and this initiative continues to bear fruit going forward.

Not -- you know, we've had to increase inventory in order to do some of that and we've been willing to do so.

And we will need to continue to put more products and more coverage in the stores year after year because of the parts that are out there.

As we continue to do that better and make sure we've got the right part at the right place, well, of course, then we hope that that will, you know, that will improve our sales.

So when we lap this gas price situation or get through it in some way that we will return to normalcy.

So that's our focus and that's our strategy and it's got to be -- you know, in this industry we've got to have the parts there for the customers when they come in the stores.

Did I understand you to say earlier that it is margin neutral between good, better and best for the most part?

Well, I think I was describing it, you know, in pretty general terms but the point is that we attempt to construct the products coupled it with the warranty and the price such that there is -- there are, you know, there is relatively comparable margins.

And, you know, that's going across a lot of products, Frank, so I'm really trying to generalize with that.

Okay.

Just shifting gears into the share repurchase and the cash available for repurchase, I guess we've seen that number on a year-to-year basis come in a little bit the last couple of quarters.

And I was curious about timing in terms of, you know, getting the payables to inventory ratio up and other sources of cash at the working capital line.

How should we think about change in working capital over the course of fiscal '05?

The way to think of it is that obviously we actually already have negative working capital.

We're already at 91% accounts payable to inventory.

We expect to continue to make progress on that AP'd inventory.

That is basically the essence of what is our working capital number.

So we expect progress toward the 100%.

Not to the 100% in this fiscal year.

So as we continue to gain that cash flow out of our working capital that adds to the cash flow from our operations and we will continue to manage to the 2.1 times leverage ratio.

So, you know, given that that affords us the opportunity to be able to redeploy the capital and buyback our shares.

Okay.

Thank you, gentlemen.

Thanks.

Thank you, Frank.

I think we have time for about one more.

Our last question comes from Scott Fraut(ph) with HSBC.

Thank you.

Could you give us a little fill in the blanks -- fill in the blanks here on cash outstanding and operating cash flow?

Sure.

Well, cash outstanding, that's on our balance sheet, I don't think it is in our press release, but it is an inconsequential number.

It is really cash in transit and it doesn't represent any hoarding of cash or, you know, cash that is short-term investment or anything like that.

I understand.

So we don't look it that way.

In terms of --

Do you have the number or no?

Hold on a second.

Our balance sheet cash is about $64 million --

Okay.

end of the quarter, which is down slightly from what it was as of our year-end but again that is cash in transit and is not, you know, any kind of short-term investments.

In terms of the operating cash flow, I'd actually mentioned that in the press release.

I came late, I'm sorry if I missed it.

Okay, going back to my quick notes here.

Our operating cash flow for the period was $113 million.

That's the operating cash flow that's defined in the statement of cash flows.

Okay, so I've got 113 million operating cash flow, CapEx of 59 million as a use, roughly, and net repaid 44 million of debt and share buybacks of 30 million.

Are those numbers right?

Yes, they are.

Okay, great.

And on the refinancing, the outstanding loan, is the bank term loan expected still to be in the $300 million range?

That's correct.

We still expect about $300 million and we just found that market to be attractive in terms of this pricing right now.

And following up on that, can you give us any indicative price talk of where that would -- I mean not exact levels but just sort of price talk right now on a libor basis.

Obviously, favorable -- I will tell you it's favorable to what we see in the public market right now and significant enough that it makes the bank debt market a lot more attractive to us but -- .

Right but you've also got -- you are also going to have covenants in that deal versus uncovenanted public debt.

I was trying to get a feel for what that kind of option is -- where the banks are kind of pricing that option.

Right.

It is pricing significantly south of the public markets or we wouldn't be willing to accept the covenants that come with the bank financing.

Okay.

All right?

Thank you very much.

One, just one more point I want to make.

You know, people -- some people have characterized earnings as being flattish in the quarter but I think what is really important here is that people focus on earnings per share.

Our earnings per share grew 12. almost 13% in the quarter and if you look at it versus last year excluding the one-time, it was nearly 23%.

I think it is really important that people understand the benefit of share repurchases and the benefit of our change in our capital structure because it is not earnings per se, it's earnings per share of stock held.

And so our shareholders have really received true shareholder value creation with those -- with fewer shares outstanding.

So you spread -- even if you spread the same number of earnings over fewer shares that is shareholder value creation.

So earnings per share really is the focus and the metrics that we use here.

With that, I would like to thank everybody for joining us today and we look forward to talking to you next quarter.