汽車地帶 (AZO) 2005 Q2 法說會逐字稿

Welcome to AutoZone's second quarter fiscal earnings financial results conference call. 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 AM Central, 11 AM Eastern time. Before Mr. Odland begins the Company has requested that you listen to the following forward-looking statements.

Certain statements contained in this presentation are forward-looking statements. Forward-looking statements typically use words such as believe, anticipate, should, intend, plan, will, expect, estimate, project, position, strategy and similar expressions. These are based on assumptions and assessments made by our management in light of experience and perception of historical trends, current conditions, expected future developments and other factors that we believe to be appropriate. These forward-looking statements are subject to a number of risks and uncertainties, including without limitation, 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 or/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 (technical difficulty) 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 events 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.AutoZone.com.

Thank you, and now Mr. Odland, you may begin.

Thank you and thank you for joining us today for AutoZone's fiscal 2005 second-quarter conference call. With the today are Mike Archbold, AutoZone's Executive Vice President and Chief Financial Officer and Brian Campbell, our VP of Investor Relations. I hope you have had an opportunity to read our press release and learn about this quarter's results, but if not, the press release along with slides complementing our comments today are available on our website at www.AutoZoneInc.com. Just click on the quarterly earnings releases to see them.

Before I talk about the quarter I want to remind everyone about our vision and our strategic priorities. Our vision is relentlessly creating the most exciting zone for vehicle solutions and our strategic priorities are first, U.S. retail, second, U.S. commercial and third, Mexico. We remain consistently committed to these priorities.

Now turning to the quarter, we're very pleased to announce that the second-quarter showed improving sales trends. Additionally, we were pleased to announce the second quarter continued our trend of record sales, record earnings and record earnings per share. We continue to maintain metrics at their highest level since AutoZone became a public company. For the twelve week quarter we reported sales of $1.204 billion which is an increase of 3.9% from the second-quarter ended February 14, 2004. While total same-store sales were flat, retail same-store sales were positive. Gross profit as a percentage of sales for the quarter was down slightly while operating expenses as a percentage of sales declined by 147 basis points. This resulted in an operating margin of 15.7%, up 116 basis points from last year's quarter.

Operating profit increased 12% over the prior year. Net income for the quarter increased to $119.5 million and diluted earnings per share increased 42% to $1.48 from $1.04 in the year ago quarter. Now excluding a onetime tax benefit from the deduction on the repatriation of certain foreign earnings in this quarter's results, net income was up 14%, and earnings per share were up 24%. Our disciplined capital management resulted in a record return on invested capital number for the trailing four quarters, and that was 25.4%. For every incremental dollar invested in the business AutoZone continues to significantly exceed its cost to capital thereby creating a continued powerful competitive advantage. We have not deviated from our efforts towards optimizing shareholder value, and we continue to be fiscally prudent with our capital investments while attempting to optimize our earnings per share.

Now let's turn to more specifics on retail sales. For the quarter total retail sales were up 4% versus last year. Just to take a moment here and address the point about gas prices that we had mentioned on last quarters call, as you recall gas prices in the previous couple of quarters had been high while in this quarter gas prices came down, and we continue to see that correlation of gas prices to our same-store sales. We noticed this as prices begin to settle down and even drift downward slightly the foot traffic began to pick right up in our stores. The slowdown in miles driven from those gas prices last summer continued all the way into October. However, in November, December and January began to show improvements. In fact, total miles driven increased organically in both November and December at about 1.4% overall rate. Preliminary January data appear to be positive, as well.

Although these correlated factors continue to be monitored, we still have opportunities for the remainder of fiscal '05 for AutoZone to increase the levels of advertising, to improve our in stock levels, our store level execution, our visual merchandising and additional merchandise availability. So we're going to continue to work all of our category management initiatives.

I mentioned last quarter that our inventories were too low and we needed to put more late-model part coverage into our stores. Well, this quarter our store level inventories ended the quarter at approximately $484,000, including Pay On Scan merchandise as compared with roughly $443,000 per store last quarter on a total inventory level. We are determined to invest in this single most important driver to both attracting and maintaining our customer, and that is parts coverage. And we will continue to focus on having the right merchandise available by individual store location to satisfy our customers. We know that by improving our merchandising mix that we will drive sales. We have many growth opportunities as we continue to focus on relentless innovation.

So what were some of our successes this quarter? Well, as has been the case in the past several years, advertising merchandising programs continue to be the primary divers of volume. We also pursued some new tactics. We continued our focus on opportunities to drive customer traffic. We launched our U.S.O. fund-raising campaign to support our troops in late November. This required customers to come to our stores to donate funds, and then we were supported by a significant public relations effort. Once completed we were very proud to contribute over $200,000 directly to our troops through the U.S.O. I would like to thank all of our AutoZoners and our customers for your wonderful support for such a great cause.

The company would also like to recognize and thank our 243 AutoZoners who are deployed in overseas military efforts today. Over the last couple of quarters I have mentioned how the company has been managing scores of projects to create quick hit opportunities for us to grow sales and also to manage expenses effectively. Well, these projects continue to contribute millions of dollars to our EBIT for the quarter. Just to list a few examples of the sales initiatives, we rolled out new, multiuse retail display fixtures to all of our stores that support our off-the-shelf promotions. We continued to add to the Duralast premium productline to our stores including the extension of our very successful Duralast professional tool line. Third, we introduced exciting new merchandise in the quarter. Things like state-of-the-art car care merchandise, microfiber polishing materials, exclusive NASCAR apparel and more.

Next, we expanded late-model parts coverage. We expanded original equipment parts coverage, which was a new addition for us by approximately 60,000 new SKUs. We also expanded salvage parts, which we offer on special order, by 430,000 SKUs. And then finally, we expanded crash parts coverage by over 10,000 SKUs. And we also expanded our imports parts coverage so in virtually every one of these areas and especially in the special order area we increased our coverage dramatically. This came under the banner of a brand-new project which we are announcing today, which is called project "got it." We have just begun to advertise this expanded coverage with a national ad campaign that just kicked off. Under this initiative the parts coverage in our catalog has more than doubled to roughly 750,000 items available either on a same or next day basis. We are very excited about this effort.

This expanded coverage will better support both our DIY and our commercial customers. But the good thing is these are special orders with very, very quick vendor turnaround, so we don't have to carry the inventory in our stores or our system. So we continue to pursue our vision of vehicle solutions by placing more parts in the hands of more customers on a timely basis. Stay tuned for updates on this initiative in next quarter's call.

On the customer service front we continued with our ongoing initiative to increase the number of ASE certified employees throughout the organization. We continue to challenge all of our AutoZoners to become certified in order to better support our customers.

AutoZone was pleased to sponsor the AutoZone Liberty Bowl annual college football game this year on New Year's Eve. This game drew the highest rating of any ESPN televised ballgame in the network's history. Louisville beat Boise State, but both played a great game, and we are excited by the advertising coverage the event provided, and we thank everyone who helped make the event such a success.

The truck zone is an area of our stores that features our light truck and SUV accessories. We had truck zones in roughly 1200 stores at the end of the quarter, and ultimately we anticipate the majority of our stores can benefit from this merchandising effort as the SUV fleet continues to age.

We continued our strategy of establishing good, better, best delineation across many product categories. For example, we have now rolled this strategy or the strategy across about 110 merchandising subcategories with more to go. Our proprietary brand represented distinctive point of difference for AutoZone and helped to build our gross margin. Customers can only get our brands, which are some of the most trusted brands in all of America at our stores. Those brands include Value Craft, Duralast and Duralast Gold (ph). This drive's loyalty in incremental customer store traffic.

We also continue to take advantage of nascent trends by introducing certain products as quick hit opportunities to optimize sales and profits. By continuing to keep the product assortment fresh and exciting especially around the entrances to our stores, we think that we are helping to create the most exciting zone for our customers. An example of this strategy was the introduction of motorized scooters into our stores over the past year, and while they were successful selling items they were clearly a fad and we knew that going in. So the desire to address our customers' demands for these items but to also remove the associated risk from these kinds of fashion or faddish items, we introduced these goods to our stores through our Pay On Scan program so that when the fad wore off the vendor took back their inventory and AutoZone had no risk. Expect us to continue to introduce these kind of in and out items in our stores using the Pay On Scan program going forward.

For the trailing 4 quarter sales per square foot were $256. This statistic continues to set the pace for the entire industry. New stores are on track to achieve at least a 15% IRR if not higher, and we continue to see an opportunity to open thousands of additional stores in the United States alone. We opened 27 new stores in the quarter for a total of 3,474 domestic stores, and we continue to track to open about 200 stores during fiscal 2005, which would represent the continued 6% growth in square footage for the Company. And we feel that that is well in line with both our capabilities, as well as the demands of the marketplace.

We may continue to take advantage of small acquisition opportunities as we go forward in order to achieve our store opening target. We also relocated two stores year-to-date, and we continue to see opportunities to expand the relocation initiative into the future. And finally, related to new store growth opportunities, I would like to take a moment to talk about our planned store openings in Puerto Rico. As part of our plan to open more than 200 stores or about 200 stores this year, the Company will enter the Puerto Rico marketplace for the very first time. We expect to open 10 stores by the Fall of 2005. We are very excited by this opportunity as we believe the Puerto Rico customers will be excited by our store concept and its unique offering. We hope to add additional sites next year, and we look forward to keeping you updated on our progress.

Now turning to commercial, for the quarter total commercial sales were flat versus last year. We now have the commercial program in 2,131 stores supported by 122 hub stores. Now the last couple of quarter sales performance for commercial has clearly not been up to our expectations. We have been very focused in the past couple of quarters on running a profitable, commercial program. It is very easy in that business to drive unprofitable sales with those customers. But our focus remains first to take care of the current customers with great products and quick delivery, but second to make sure that this business remains profitable.

We see others chasing growth for growth sake without getting any expense leverage or profitability, and we just don't believe that that adds shareholder value and we don't want to do it. Our model is differentiated by our unique, high-quality brands, our proximity to up and down the street customers, and finally our national footprint which overlays any chain customer in America. The hub stores continue to provide us with fast replenishment of critical merchandise to support both our commercial and our DIY businesses. But with only 1.5% of the commercial sectors business AutoZone still has a significant opportunity to gain market share over time.

We have grown significantly faster than the marketplace over the past several years, and we think we can continue to grow and add shareholder value on this business over time. Regarding Mexico, our Mexico stores continue to perform very well in the quarter even with the continued peso fluctuations and the economic volatility. We opened three more stores during the quarter which now give us 67 stores in Mexico compared of course with 3,474 in the U.S. Our ongoing commitment there remains to prudently and profitably grow that business.

Gross profit, gross margins for the quarter was 48.4% of sales, which was down 31 basis points from the previous year's quarter. But this was mostly due to one time costs associated with the opening of our new distribution center in Dallas, Texas and the closing of our oldest distribution facility in San Antonio, Texas. We continue to be successful in partnering with our vendors to offer the right products, the right prices to our customers and this includes supply chain initiatives, tailoring the merchandise mix, continued implementation of good, better, best productlines and that allows us to price to different customer needs, as well as to manage gross margin.

On pure pricing alone we have maintained our price strategies now over the past several years. Additionally I want to remind everyone of our multiyear effort to move warranty liability up the supply chain to our vendors where their costs are lower than ours. The Company experienced no material gain from warranty this quarter. And none in the quarter last year. But for the third quarter last year the Company experienced a warranty gain of $10.6 million or $0.08 a share, and in the fourth quarter last year it resulted in a pre-tax gain of $15.5 million or $0.12 a share as we relieved AutoZone of future liability and lowered that risk level for the Company.

So at the end of this quarter, quarter 2, we have roughly $6 million in remaining liability which means that we have substantially completed our initiative to remove this risk. We believe there continues to be some margin expansion opportunities albeit at a slower pace than the previous couple years. 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 price. It is important to note that we have driven our gross margin improvements over the last several years without recording any LIFO benefits. So as of February 12, 2005 the end of this quarter AutoZone had an unrecorded LIFO credit of $171 million, which is up $10 million from the quarter. SG&A for the quarter was 32.7% of sales, down 147 basis points, so great leverage in this quarter. The majority of the basis point decrease was due to our ongoing initiatives to reduce expenses.

Now store payroll and the full-time, part-time ratios have been continually managed to appropriately reflect seasonal demands of the business. We believe our payroll spending and our part-time full-time balance are at appropriate levels. Full-time AutoZoners continue to be the core of our customer service, and we utilize part-time AutoZoners to flex up at peak times. Over the past year approximately 50% of our headcount has been full-time consistent with the past several years. These full-time hours are critical to delivering trustworthy advice. We look to ramp up our marketing campaigns now as we head into our peak selling season from here on in through the balance of our fiscal year.

Our advertising expense may continue to increase through 2005 in order to drive sales, but we do expect vendor support to neutralize any negative impact to operating profit. We also will continue to manage our costs. Scores of projects have allowed us to lower costs over time, and to pass that savings on to our shareholders. And while last quarter I gave you a few of those examples I just want to reiterate today that we continue to focus on lots of those and other projects to hopefully reduce costs into the future. And I would like to thank our entire organization for the continued efforts towards focusing on managing these expenditures. Cost control will be a continued focus for us going forward.

Finally, EBIT for the quarter was 189 million, which was up 12% as I said, from last year. Interest expense for the quarter was 23.6 million compared to 21.9 million last year, and debt outstanding was 1.902 billion versus 1.787 billion last year. Over the quarter our debt levels were maintained in line with our guidance of 2.1 times our trailing 12 months EBITDAR. And we have purposely managed our capital structure relative to our cash in order to maintain our credit ratings at investment-grade while optimizing our cost of capital.

For the quarter our tax rate was 28%, which was down from the 37.5% last year, but I would like to point out that this past quarter contained a onetime tax adjustment primarily related to the repatriation of earnings from our Mexico business. If you exclude these items our tax rate continues to run at approximately 37%, which is still down from the 37.5% last year. Net income for the quarter was $119.5 million, up 30% over the prior year. Earnings per share were $1.48, up 42% on 80.9 million diluted shares. But again, excluding this year's onetime tax credit EPS were up 24%.

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

Thanks Steve. Year-to-date we have generated $101 million of operating cash flow. On a trailing 4-quarter basis operating cash flow has been $582 million, and EBITDA has been $1.132 billion or an amazing 20% of sales. For the second quarter of this year we reported yet another ROIC improvement to 25.4%, up from last year's 24.5% as we continue to focus on the true driver for the creation of shareholder value over the long-term.

Looking at the balance sheet, inventory per store on the balance sheet which excludes Pay On Scan inventory was 450,000 versus last year's 443,000. This increase has been sequential over several quarters now. And we feel that having these additional goods is necessary for us to maintain a strategic advantage over our competition. Inventory per store net of our payables was up from 74,000 in the quarter, in quarter two last year to 86,000 per store this year. Again, this increase is a direct reflection of AutoZone making sure it has the appropriate levels of merchandise to meet customer demands.

Accounts Payable as a percentage of gross inventories declined just slightly to 81% from 83% last year as we are in our seasonal low quarter. Our goal is still to achieve 100% accounts payable inventory over time. This quarter we reached a total of $121 million of inventory on Pay On Scan. Which in accordance with GAAP, is not reflected on our balance sheet. Importantly for AutoZone, these same vendors represent several hundred million dollars of inventory, which we expect to convert to POS inventory over time. While this quarter was a slight reduction in inventory on Pay On Scan in total, I want to point out that this was a deliberate, positive development as that inventory went back to the vendors. Over the past year AutoZone along with many other retailers enjoyed the benefits of selling seasonal and fad items. But unlike others, AutoZone carried these items on Pay On Scan. Now that these trends are waning, the vendor has taken back their inventory and AutoZone has eliminated the need to take markdowns on such fashion oriented merchandise.

It is important to note we have increased the number of active vendors actually on Pay On Scan, and we expect this initiative to continue to gain traction throughout F '05. We use the following terms to describe our inventory levels, gross inventory we use to define the inventory excluding Pay On Scan inventory, which is what is reflected on our balance sheet. Net inventory is used to define that gross inventory less the Accounts Payable.

As we continue to increase our dollars of inventory on Pay On Scan, we may report reduced inventory per store stats into the future. This would continue to be a benefit to our working capital numbers. 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 previously, we will continue to only invest in inventory that exceeds our 15% IRR hurdle rate. We continue to believe the car model proliferation in this sector requires us to continue to add inventory. Recall that two-thirds of all of our SKUs have an on hand of only one. Cars continues to stay on the road longer, and we continue to need to carry all those additional SKUs to satisfy the demand.

An interesting statistic that validates this point is 29% of the cars that were produced in 1970 were still on the road in 1985. Compared with today, 60% of the cars produced in 1990 are still on the road today. That is why our accounts payable to inventory and our Pay On Scan initiatives are so important and continue to give us strategic advantage.

Total working capital was $209 million. The continued success of working capital reflects our focus on cash flow management. Net fixed assets turning down the balance sheet were up 7% versus last year. Capital expenditures for the quarter totaled $60 million. Depreciation and amortization totaled $27 million for the quarter and reflects the additional expenditures required to open 27 new stores this quarter and work on the development of new stores for upcoming quarters.

I want to reiterate our preference of owning real estate versus leasing. Today we own approximately 60% of all of our stores, which reduces our operating expenses, derisks our business model and again creates competitive advantage. Our debt at the end of the quarter was 1.902 billion, an increase of $77 million from last quarter. We continued to manage the adjusted debt including our leases to roughly a guide up 2.1 times EBITDAR.

At this point I would like to talk a little bit about our ongoing share repurchase program. We stated we focused on our 2.1 times EBITDAR guide as the metric to determine the amount of stock we are able to purchase in any one quarter. This past quarter we elected not to purchase any shares. This has a lot to do with the seasonality of our business, and we expect to do the majority of our annual share repurchase program in the upcoming two quarters when the seasonal cash flow is historically at higher levels. With these trends, EBITDA to interest coverage is now at 11.8 times on a trailing 12-month basis.

We are very pleased with our success in having refinanced $1.3 billion of debt over the past 27 months at a weighted average effective annual rate of 5.1%. This past quarter we accessed the bank market for a five-year term loan and effectively converted it to a fixed rate of 4.6%. This strategy saved AutoZone approximately 70 basis points compared with a more expensive public market alternative. At the end of the quarter 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 S&P is triple B+ with a CP rating of A2. Moody's has assigned us a senior unsecured debt credit rating of B AA 2, and a CP rating of P2, and we continue to be comfortable with our long-term debt ratings as well as our leverage ratios.

Based upon some recent SEC clarifications, the Company is reviewing its accounting for leases and related leasehold improvements. While the impact on fiscal 2005 is estimated to be less than $1 million net of tax, the Company expects to record a onetime charge for the cumulative non-cash adjustment in the second quarter. The charge, which is not reflected in the reported results, is currently estimated to be in the range of 15 million to $25 million net of tax.

Regarding AutoZone's planned strategy toward expensing stock options, as many of you know during December of 2004 the financial accounting standards board issued statement 123-R, share based payments, which requires companies to measure and recognize compensation expense for all stock based payments at fair value. Stock based payments include stock option grants and certain transactions under other company stock plans. The Company plans to adopt this pronouncement on August 28, 2005, which is the beginning of its next fiscal year.

I would like to take a final moment here and talk on the subject of book equity. Stockholders equity increased to $410 million. Our return on equity for the trailing four quarters was 185% versus 111% in the quarter last year. But the number doesn't mean much to our performance these days as we continued 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, the 2.1 times EBITDAR that we mentioned earlier. We do this because we believe it to be a more accurate reflection of our leverage.

With that I would like to turn it back to Steve.

Thank you, Mike. Our business gained momentum this past quarter even while our customers continued to manage their expenditures closely and hold off doing some of their preventive maintenance. We understand the challenges of what gas prices can represents our customers who fix their cars themselves because they cannot afford to have it done for them. And we remain very excited heading into our selling season here as we have seen miles driven rebound versus the previous year. And more and more of our kind of vehicles are on the road every single day. So the industry remains healthy, and appears to be reaccelerating its growth rate.

Now while others in our industry may report stronger quarterly same-store sales, due to their average store age, we do not think that we are losing market share. Our 3.9% overall sales increase was at roughly the pace of the projected industry growth. While our DIY business made good progress in the quarter, we continue to post a little less than expected commercial sales. While profitability improved this area of business was a slight drag on the overall comps, but we are happy with the nearly 400 basis point improvement in the retail same-store sales this past quarter. We look forward to talking with you next quarter about our ongoing programs and initiatives to hopefully continue our momentum into this important summer selling season.

Now our financial model remains strong, and as we have continued to increase earnings and operating cash flow, while we have simultaneously improved our business by removing the risks associated with interest rate fluctuations and warranty liability over the long term. This consistency in cash flows will be our ongoing focus. And we've accomplished this during both strong and weak economies, which is why we call our business acyclical, and we still believe it is. We believe we have many initiatives that can help us to grow our same-store sales over time, but we budget conservatively to ensure that we maintain both our expense and capital structure disciplines and to ensure that we deliver solid returns. This was clearly evident in our ability to drive an industry-leading 24% increase in comparable earnings per share as our comps began to improve.

I would just like to reiterate while sales are very important profitable sales are even more important. And we continue to be able to boast earnings per share growth rates that set the benchmark for our industry. While we certainly cannot guarantee this rate into the future, we know that we have the best model and the best team. Repurchasing stock has been a tool in managing our capital structure, and we will continue to repurchase stock as long as we believe it is accretive. We believe we have an outstanding business and as long as we feel our shares are selling below their intrinsic value in the marketplace we will use our excess cash flow after capital expenditure needs to repurchase our shares.

Our industry-leading results continue to show that AutoZone is a tremendous cash generator, with $1.1 billion in EBITDA over the past year and that has enabled us to add shareholder value over time. We are pleased we continue to demonstrate industry-leading financial metrics being an extremely disciplined financial planning company, we have proven our abilities to manage costs appropriately and invest in the commercial projects that exceed our stated goals. We are focused on operating this company to profitably grow sales, to efficiently deploy capital and optimize our long-term shareholder value while maintaining the highest level of ethics. And this is exemplified in this past quarter with AutoZone being honored with the Armstrong Award for corporate ethics. This award is given annually to only one company, and that company is the one who has demonstrated leadership and vision in the practice of ethics in all of its business dealings. And I'm very proud that AutoZone has received that award this year. What that, I would like to open up the call for questions.

(OPERATOR INSTRUCTIONS) David Schick of Legg Mason.

I guess three questions. Two of them are related -- could you talk about pricing and what you are seeing both -- what you're deciding to do and what you are seeing on the competitive front between retail and commercial? Related to that the ticket and the traffic for the improvement in the DIY comp would be helpful just at least directionally what you saw. And the second question, can you give us a little more detail, Steve, you mentioned the cost control and that you are comfortable with your balance of full-time, part-time. Can you maybe explain in more detail how you find that comfort and what metrics you use to talk about that? Thanks.

Regarding our pricing, I think what I mentioned is our pricing strategies have not changed over the past couple of years. We get a lot of questions about what is driving our gross margin, and people assume that it must be that we are taking prices up in order to drive our gross margin increases over time, and that simply hasn't been the case. We have got a little bit of pricing in there, but the vast majority of our gross margin changes over time have been built by supply chain savings and efficiencies and lower cost of goods, and our category management initiatives by introducing our good, better and best programs. So we have not seen a change, and we don't plan to deviate from that.

Traffic did pick up in the quarter, but ticket was even better, and so that was a positive thing for us. Related to cost control, and this is another question we get all the time they assume that because we are saving cost it must be in labor, and that is something that we have said absolutely we would not do -- labor is our product. It is what creates our brand in the stores, and allows us to deliver trustworthy advice, which we think is our point of difference. And so because our customers largely are novices; they are not experts at this, they don't do it every day. They fix their cars because they can't afford to have somebody fix it for them. Well, we need to have the experts in our stores. The vast majority of our people are full-time people who are highly trained and thousands of whom are AST certified which gives them a third party certification in as a parts pro.

So our customers come to our stores for that kind of advice, so it's very critical. So what we do is we use part-time headcount during peak times of the day, and then more importantly during peak times of the year, so you will see our, as we go into our summer selling season here you'll see us ramp up our part-time headcount in order to take that surge in sales. So that is our philosophy; we have not deviated from it. Some people say that we must have, but it's not true. We have not deviated from it in the past several years, and we remain committed to it.

Thanks. Very helpful.

Matthew Fassler of Goldman Sachs.

Thanks a lot. Good morning. I've got a couple questions. First of all, as you focus on the increased inventory commitment that you are making to the business, does that show up more in back stop for hard parts or in the front end of the store?

It is parts coverage, I think as we said before, there are hundreds of new models of cars introduced by the manufacturers every single year. But unlike most retailers who can take a mix of X number of SKUs and simply drop off the bottom end of the SKUs and add new ones every single year, they manage to a fixed number. In our case you don't see whole decades of cars going off the road. And so there are cars who are being introduced at a faster rate, as I said, hundreds of models. You need to carry all the parts from the past as well as add new parts every single year. So what we have said, and that's why we've explained our inventory very carefully; our inventory will go up on a gross basis because we got to carry the parts for the new cars. Now, what we have done I think uniquely in our industry as well as in retail, is we have been very aggressive with our AP to inventory ratios, which we said we will target 100% over time. But more importantly introduce the Pay On Scan initiative, and now we have what, a little less than 10% of our inventory on Pay On Scan, which is owned by others. And we intend to expand this over time to derisk this and allow us to carry the complete parts coverage and have them on hand without having that need for increasing our inventory over time.

Would you say you spoke today about Pay On Scan as relating largely to some of the trendier front end goods, scooters etc. Would you say that Pay On Scan is more associated with those products or in fact with back end hard parts coverage?

It's both, but we took a slight decline in our Pay On Scan numbers, and that decline was due to the seasonal and the faddish kind of items. So we are looking for a balance here. We're looking for Pay On Scan for the back room, but we are also looking for Pay On Scan on any of these in and out types of things. Because you can introduce all this faddish stuff, but the risk to any retailer by introducing this kind of stuff is that they get stuck with the inventory. In our case, if we introduce it and have the vendors continue to own it under Pay On Scan, there is absolutely no risk and so you will see us doing these kinds of things which gives us the advantage of leveraging the traffic in our stores and increasing our ticket without the risk. And I think it is the risk, the derisking of this business through that technique, the Pay On Scan initiative, as well as the warranty liabilities that you have seen. And so this is a far more predictable and less risky business today than it was just a few years ago.

A couple other questions on the inventory. I know that decline in payables as a percent of inventories was just a couple hundred basis points, and it is not that meaningful. Still it is a bit of a departure from trend. Any particular reason why this quarter you saw that step back a bit?

No, it is very close to where we were. And this is a particularly low point. This is the lowest point this quarter, and it's really hard to get leverage. What you see every year is you see that payables percentage leveling out here in this quarter, and then you see it ramping up so that by the end of our fiscal year we are into the '90s and our goal is to get it to 100 over time. So this is really very normal.

And on the inventory front, I know you talked about the LIFO and the implied LIFO reserve. What are you seeing in terms of not in terms of competitive pricing but just kind of product depletion in general in the industry compared to recent quarters?

We've really seen a continuation of trends that have been out there historically, and absent commodities and things like that that move. I think you can look at both the CTI and the PTI that have a subsector specifically related to automotive parts (indiscernible). You see a slight inflation on the CPI side and a slight deflation on the PTI side, and we expect that trend to continue.

And the final question related to -- actually that's it. Thank you.

Greg Melich of Morgan Stanley.

Hi, thanks. It is Greg Melich from Morgan Stanley. Two questions. One, could you give a little more color on the comp trends for the quarter also by month and by region? Then I have a follow-up.

We typically don't talk about regional trends, but I think what we did say is that we were pleased that our trends improved as the gas prices came down. So you could almost see it as gas retail gas prices came down traffic picked right up in our stores through the quarter. So we were very pleased with that. We are not giving guidance for the future, and we are not saying that's what is going to happen, we're not saying anything about the third quarter, and we won't because we don't do that. But we did factually see that during the second quarter.

And so when gasoline prices start to creep back up, so we should assume that correlation continues?

What we have seen over the past 6 to 9 months is a strong correlation between miles driven and our store traffic and retail gas prices.

And regionally, even if you don't give us numbers, where there any reasons that were particularly strong?

Well, again we hate to characterize that. We have stores in 48 states, and at any one given point in time they are stronger than another. Our business is sensitive to weather in any one given day, and if it snows on the East Coast which I think it is today or was yesterday with the Noreaster, people aren't lying in the snow fixing their cars and if it's raining in California, which it has, you don't see that. So at any one given point in time you have good weather/bad weather and that drives regional trends. But over the long-term we see pretty stable trends around the country.

Do you think the weather helped you in the quarter? I mean Advance (ph) said it probably helped them. Do you think it helped? I mean, it hurts short term but it helps on a sort of a month or two basis?

All of our competitors are regional in nature, and so weather is more important to them in a given quarter. Our's tends to balance out across the country.

And just to go on the number side, Mike, could you take us through a little more granularity on the CapEx? You didn't buy back stock for the first time I think in close to five years in the quarter, and it just seems from the limited cash flow stuff we have here that it's because the CapEx is ramped up. I just want to get a sense of how long the CapEx should stay north of 200 million on a run rate annually. Is that the right sort of number given the 200 stores a year? Is there something special going on with the DC buildout that has impacted that?

I think you are right on target which is we expect to build about 200 stores this year. Your CapEx number is about right. It costs us $1.1 million per store for us to build it ground up. As you know, there is very little maintenance CapEx. So we have invested more in our stores. We've also invested more in our inventory that we talked about this quarter. And at the same time, our AP to inventory ratio has been roughly flat so that the years when we were taking huge amounts out of the working capital are not what they were. Now we still see an opportunity to drive that, but it is not going to be at the same kind of level. So given that this is our seasonal low, we're investing in the stores, we invested in the inventory; I think what you can expect is continued levels of CapEx similar to this, and our buying back our stock basically more leaning towards the second half which is when our cash flows are strongest.

Okay, great. Thanks a lot.

Bill Sims of Citigroup Smith Barney.

Thank you, and good morning. Just a couple quick questions. Steve, you mentioned that gross margin declined for mostly from the DC changeover costs. The remaining declines that you are seeing in gross margins such as the results of pumping more inventory into the system and ultimately (indiscernible) can get a benefit in the long run or what was driving the declines in gross margins outside the DCs?

Virtually all of it was the onetime closure of the oldest DC and replacing that with the newest DC. So there really was not anything else material.

Second question as regards to SG&A your competitors had some comments on workmen's comps and insurance, clearly you do a significant amount of leverage during the quarter. What type of impacts are workmen's comp and insurance costs have in relative to what we've seen in the past couple of quarters? And presumably you are seeing something relative to your competition, therefore SG&A improvement is probably been better than expected. Outside of headcount, what is the major driver of the improvement?

I will take all three of those. First of all on worker's comp, we are not impervious to the trends that go on in the marketplace. Nonetheless, we don't sit and become victims of them. So like any other costs, we aggressively manage our worker's comp. And we have attacked that in the past several years with a number of projects. We know factually that as we focus on closing claims faster and on reporting claims faster, that we can actually drive down our workers comp and we've created metrics and held ourselves accountable to doing exactly those kinds of things.

So we've seen actually good success in terms of managing our workers comp to make sure that we don't just get hit with those kinds of increases. Secondly, focusing on the broader SG&A, you're right, we have not gotten it on payroll because we continue to manage to those same kind of levels that Steve mentioned before, 60% kind of full-time numbers. So wherever we've gotten the expense leverage then and we've gotten them in a number of places. We've gotten them from pushing our pin based debit program to record highs, which reduced our cost of process and credit cards. We've gotten them through focusing on revamping our stores and putting in P 5 (ph) lighting which has a tremendous payback, and we get a tremendous return reducing our utility consumption at the same time that rates have gone up. So it has helped to manage our utility exposure.

We've also put in place set back thermostats to make sure we control the temperature in the stores appropriately. We've challenged all of our property taxes. We've reduced our cost of handling paper checks. We've increased our direct deposit rates. So there has been a whole list of projects. I would love to tell you there is one silver bullet, but there is not. This is about managing all of the costs and making sure we have our hands on all the small dollars, and that's what we've really been focused on.

And it's important that we say really clearly if our SG&A leverage was not due to changes in headcount it was due to all those other things, and so we're very pleased with the expense leverage that we got on this -- a very big business here.

A quick follow up to that question, why can't we assume that SG&A improvement will be sustainable at that similar rate given a lot of these programs are fairly new within the last quarter or two?

We don't give guidance as you know, Bill.

So what we said is we still see opportunities to improve our SG&A, but we said we don't predict that we will get it at the kind of levels that we have historically seen. Because as we work our way through these initiatives you get the lowest hanging fruit first and then it just gets tougher and tougher.

Final question is on the commercial comp weakness. You have had a fair amount of management turnover in the past year in that particular area in terms of leadership. You said you don't want to fight for nonprofitable accounts. What is your strategy going forward? I guess the first question is where in the commercial business where is the weakness? Is it national account driven or up-and-down the street type of account? And two, how much of it is just the turnover you've experienced amongst management impact in the business versus the overall industry decline, etc.?

But we have not had significant turnover in management, so.

I am referring to like Steve Handshoe (ph) coming in for a couple of quarters, running the business and then being pulled back out.

We had one person that turned over in the business, everybody else is the same. And Steve's working on a different initiative, an industry initiative now. But the point of the matter is we've expanded this business very rapidly in the past, and we have said that we are not going to chase pricing on this business. I think it is more -- what we've experienced in this past quarter is more about what has happened in the marketplace as others began to chase unprofitable sales and you can see it with lack of expense leverage and so forth. We just simply are not going to run this business without running it profitably. Sales without profits really don't add shareholder value, and that is our focus.

All right. Thank you.

(inaudible)

Could you comment a little bit about some of the new products you're bringing into the box strategically crash parts, salvage, what have you learned? Is that more targeted to the commercial business, or just talk a little bit about that, please.

This has been a significant effort which we are just launching, and it has really been in the last couple of weeks in preparation for our third and our fourth quarter. And that is a virtual doubling of the number of SKUs that we offer to our customers. And we are offering this for the first time offering original equipment parts, as well as crash parts as well as salvage parts through a -- which are parts that are very, very hard to get and aren't remanufactured but you can go get them through salvage yards. So this has been an enormous effort for us, and we have just begun it. But there are -- this gives us an opportunity to say yes to our customers going forward here. So this is what we think is a major initiative for us, not just for a quarter but for many years to come. And we are very pleased with the kickoff of this initiative.

Secondly, would you talk about technology on the commercial side, ordering from that garage or shop, what initiatives are continuing there?

We have invested a lot in technology, both in our core delivery business, as well as through all (technical difficulty) We now have commercial drivers with PDAs, handheld PDAs which they can do signature capture and tax ID, recordkeeping, and it's a much cleaner system and much more efficient for us. But also through ALLDATA we are, we have developed and expanded that product to include electronic ordering, and we are in the process of expanding that through our shop installations. So lots of efforts here on the technology side in the commercial sector.

Pat Niemer (ph) of Thomas Weisel Partners.

First question is just to dig a little deeper on the salvage parts that you are adding, can you explain how that will work from a logistical standpoint and where you are getting those parts?

There is a series of salvage yards around the country and there is a new business model out there where third parties aggregate and provide a clearinghouse for all those parts. And so what we do is we special order -- it's in our computers, and so there is a brand-new system for it in our stores. We've upgraded our catalog and our point-of-sales equipment dramatically in order to handle this initiative. And so customers can come in and order a salvage part which could be an engine, or it could be a fender, or it could be a carburetor, something that is very hard to find. And our orders go through a third party so we don't own any of the inventory, we don't take any of the risk, and they source the part for us and guarantee the part. And we ship it directly and have it for the customer. So it is a great system, which gives us access to all sorts of parts that previously people would have to on their own go crawl through salvage yards to find. So great customer service initiative, too.

And just to clarify, is it one third party or are you working with multiple vendors?

It is -- we're not saying exactly how we're doing that because we are working with other people.

And then on the ad spending, you mentioned that you were planning to ramp that up a little bit. I am just wondering if you could give us any more detail on the percentage increase in advertising that we might expect for the next few quarters.

First of all I need to mention that we test all of our ads, and right now our advertising is working and scoring at the highest levels of recall and persuasion ever in the history of our Company. So our advertising continues to get better and better which means for every dollar we spend it is more efficient and it works harder for us. But going into our seasonal period of the year, and we believe we can ramp up the amount of spending in television and radio predominantly, which is a great, continues to be a great vehicle for us, both in English and Spanish language, both in urban and general markets, and so we've really gotten very customer targeted and specific with our advertising. So that is our plan for the coming couple of quarters.

And then lastly, regarding the promotional product, should we assume that you have basically pulled scooters completely or are you going to maintain a couple of SKUs in that category?

Well, I think if you go to our stores you will probably see some of the newer things out there. We will continue to take advantage of these kinds of trends and using Pay On Scan going forward to make sure that we always have new and novel things in the stores. So that will be an ongoing strategy for us.

It looks like we're out of time, and so I would like to thank everybody for joining us today on the call and wrap things up. We'll look forward to talking to you next quarter.

This concludes today's conference. Thank you for participating.