汽車地帶 (AZO) 2007 Q2 法說會逐字稿

Welcome, and thank you for standing by.

This is the conference call to discuss AutoZone's second quarter financial results.

At this time all participants are on a listen-only mode until the question-and-answer session of today's conference. [OPERATOR INSTRUCTIONS].

I'd also like to remind parties this call is being recorded.

If you have any objections, please disconnect at this time.

Bill Rhodes, the Company's President and CEO, will be making a short presentation of the highlights of the quarter.

The conference call will end promptly at 10 a.m.

Central time, 11 a.m.

Eastern time.

Before Mr. Rhodes begins, the Company has requested that you listen to the following statements regarding forward-looking statements.

[Recording] 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 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, weather, raw material costs of our suppliers, energy prices, war and the prospect of war including terrorist activity, availability of consumer transportation, construction delays, access to available and feasible financing, and changes in laws or regulations.

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 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 factor section of AutoZone's Form 10-K for the fiscal year ended August 26th, 2006 for more information related to those risks.

In addition to the financial statements presented in accordance with generally accepted accounting principals, 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 in the investor relations section at www.AutoZoneInc.com.

Mr. Rhodes, you may now begin.

Thank you, and good morning for joining us today for AutoZone's fiscal 2007 second quarter conference call.

With me today is Bill Giles, Executive Vice President and Chief Financial Officer; and Brian Campbell, Vice President, Treasurer, Investor Relations, and Tax.

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

If not, the press release, along with the slides complementing our comments today are available on our website www.AutoZoneInc.com.

Please click on quarterly earnings conference calls to see them.

To begin, I'd like to thank and congratulate our entire organization for their efforts living the AutoZone pledge in 2007.

We continue to set new second quarter records for sales, earnings, and earnings per share.

Our sales performance was not up to our expectations, I could not be more pleased with the consistency of our financial model.

We generated 15.5% growth in earnings per share through a combination of solid earnings growth, a 6.2% increase, and leveraging our strong cash flow by reducing our shares outstanding.

We continue to believe there's a great deal of opportunity to improve our customer shopping experience, and the initiatives we have in place are building momentum.

Although our customers continue to be cautious in their buying behaviors, we believe our focus for 2007 on improving our hard parts assortment will help increase sales in the future.

As I said last quarter, 2007 continues to be about profitably growing both retail and commercial sales.

It will be about growing operating profit dollars, all while optimizing our ROIC.

And we will continue to be exemplary stewards of capital for our stockholders.

I'd also like to take a quick moment before we get into our financial details to congratulate Kevin Harvick and the number 21 AutoZone racing team for winning the Busch Series NASCAR race two weekends ago at Daytona.

Richard Childress Racing and AutoZone signed a new sponsorship agreement in January, so you can imagine how excited we were to see the AutoZone car cross the finish line in first place on the first race of the season.

I have received great comments from our AutoZoners and customers on this victory, and hopefully we will continue our success on the track.

It is important to note that one of our objectives with this sponsorship was to reinforce our winning culture.

So far, we are well on our way to meeting that objective.

Congratulations, Kevin and RCR.

As in past quarters, I'll start with comments on our overall financial results and then go into detail regarding our DIY sales initiatives, commercial selling initiatives, and Mexico.

Then Bill Giles will provide an update on the remainder of the income statement and both our balance sheet and cash flow statements for this past quarter.

Finally, I'll provide a few closing comments.

Regarding the second quarter, for the 12 weeks ended February 10th, we reported sales of 1.3 billion, an increase of 3.7% from last year's second quarter.

Same store sales or sales for stores open more than 1 year were down 0.3% for the quarter.

At the start of the quarter, we were cautiously optimistic regarding sales.

The price of a gallon of gas at a pump was down to around $2.25 a gallon, and we believed our customers were beginning to feel less pressure on their pocketbooks.

But a sales improvement never really materialized.

We noticed similar patterns across all regions of the country.

Our performance was similar in both highly competitive markets and in those markets where we're the only auto parts store.

While some of this could have been driven by unusual weather patterns in much of the country in the past 12 weeks, we are not satisfied with this level of performance.

We continue to work diligently on our customer service initiatives to drive to improved performance.

We absolutely believe our current store offering is strong and improving, and we're confident we are ready for our peak sales period this spring and summer.

In the second quarter, gross profit as a percentage of sales was basically flat compared with last year's quarter, while operating expenses as a percentage of sales decreased by 29 basis points.

This resulted in an operating margin of 14.5%, up 30 basis points from last year's quarter.

Operating profit increased 5.9% verses the prior year.

Net income for the quarter was 103 million and diluted earnings per share increased 15.5% to $1.45 from $1.25 in the year ago quarter.

Our continued discipline capital management approach resulted in return on invested capital for the trailing four quarters of 22.5%.

We're very proud that this is the second consecutive quarter that this ratio has improved.

We have and will continue to make investments that generate returns that significantly exceed our cost of capital.

We will not deviate from our efforts to optimize shareholder value over the long-term.

We continue to be fiscally prudent with our investments while optimizing our earnings per share.

Now I'd like to talk about DIY sales.

Total domestic retail sales were up 3.6% for the quarter.

During the second quarter, we continued to focus on driving sales and profits for the long-term.

Our customer research continues to reaffirm what we've always known.

Our customers shop with us because we provide them with trustworthy advice.

Our customers have told us to focus on the basics, which are the heart of the AutoZone pledge.

I'd like to speak to the major initiatives we've established for our organization to drive both retail and commercial sales for fiscal 2007.

It all starts with our customers and their interaction with our AutoZoners.

For that reason, we continue to challenge our AutoZoners to make sure they're living the pledge.

This past quarter, we celebrated a real milestone across our organization with the completion of our ZNet rollout.

ZNet is our new electronic parts catalog.

It was designed to improve the customer shopping experience by providing faster transaction times as well as more robust graphics with clear pictures of parts, components, and related repair information.

We substantially completed this rollout in December.

I'd like to congratulate and thank all the AutoZoners who dedicated so much of themselves and their time to implement this new software.

It was probably the single biggest technological change at the store level since we became a public company, and its implementation was virtually seamless.

And from the feedback we're getting, everyone -- AutoZoners and customers alike -- seem to be very excited about the system.

We also extensively trained our AutoZoners on the functionality of ZNet over the last quarter, including hosting what we call our WITTDJR meetings to allow hands on training and question-and-answer sessions to get everyone comfortable with its functionality.

We also continued with our store refresh efforts in the second quarter.

We completed our 700 store goal, and our AutoZoners in these stores like what they see.

This not only improves the customer experience, but it further communicates to our AutoZoners that our stores must always look great.

All with an eye on the bottom line, we think we're doing the right things for the future of our business.

For all of 2007, we will continue to focus on training our AutoZoners from systems training to WITTDJR training to inventory management training, we will not rest on our laurels.

We have an aggressive training schedule for the remainder of the year, and our team cannot wait to get going.

We understand that this training is a difference maker for AutoZone.

We continue to challenge our AutoZoners to become ASE certified.

Our latest testing results were the most successful in our history.

And we now have 7,180 total ASE certifications held by AutoZoners, something we're very proud of.

Continued focus on improving our customer satisfaction results is essential for our success.

Everything that we're doing is intended to differentiate AutoZone from our competitors in the eyes of our customers.

In a challenging sales environment, we believe it is more important than ever to exceed our customers' expectations.

So we have studied closely what our customers are telling us.

Our surveys continue to show sequential improvement in satisfaction scores.

We continue to be the destination for our customers' automotive solution needs.

We believe improved customer satisfaction will lead to increased sales in the future.

Quickly, I'd also like to point out the new advertising campaign we rolled out during the second quarter.

It highlights our great customer service culture, supporting our focus on living the pledge.

A second major focus for this year will be product assortment.

More specifically, refining our hard parts assortment to be more responsive to our customers' needs in both retail and commercial.

We have completed our major line reviews and are currently rolling these improved sets to our stores.

The majority of these new assortments began arriving in our stores in the second quarter and will be substantially complete in the third quarter.

We are always extremely mindful of our working capital levels.

So we attempted to balance the additions with inventory reductions where appropriate.

And we're proud to report an inventory per store number this quarter under $500,000.

This was down approximately $6,000 from last quarter and was achieved at the same time the additional products were being added.

Let me take a moment and explain why we did these merchandise additions.

We've always known that the right inventory selection for each individual store is critical to our success.

But with changing vehicle and customer demographics, combined with changes in vehicle technology, it is a very dynamic environment.

Over the last year, we have built a new process to leverage substantial additional attributes to improve our selection.

During the implementation of this new process, we found significant opportunities to add additional products to our stores.

But we also found products that didn't meet our productivity requirements.

In our lower turn environment, it is a very delicate balance.

We are encouraged by our initial results in the categories we implemented first, and I congratulate our merchandising organization for these improvements.

I'm often asked why with a high AP inventory ratio would you not simply add anything and everything.

The answer is nothing is free.

There are always cost to touch excess inventory, so it's essential to make these additions as prudently as possible.

With the lead times required for the new merchandise to be manufactured and shipped, most of the additional products will be added in our third quarter.

This has been a very exciting effort for AutoZone.

Our assortment is much improved compared to just a year ago, especially our late model coverage which is so critical to our commercial customers.

We will continue to modify our product offering to say yes more and more.

We believe this will lead to additional sales improvements.

Additionally, we continue to grow our brands under the Duralast, Duralast Gold, AutoZone, and Valuecraft labels.

These high-quality products provide our customers with a good value and provide us with another significant point of differentiation.

We continue to grow and leverage our direct import initiatives.

This important initiative allows us to improve our acquisition costs and continue to provide our customers with high-quality products at a compelling price.

Today, direct importing remains a very small percentage of our merchandise purchases, but we continue to see significant opportunities going forward.

Regarding macro trends, during the second quarter gas prices remained relatively flat.

The quarter began with the national average price of gas at $2.24 a gallon and finished on February the 10th at the same price.

While this is clearly -- or certainly lower than it has been at the beginning of our last fiscal year, we think the consumer is being cautious.

We also believe a point will come when pent-up demand for certain hard parts will drive consumption.

We certainly feel with more cars on the road than ever before, our ability to grow sales remains strong over the long run.

Regarding miles driven, we saw improvement in both November and December verses the previous year.

However, there was a slowing trend.

While we feel this trend was correlated to lower prices at the pump, again, we believe the consumer is still being cautious.

Let me reiterate the two statistics we've always felt have the closest correlation to our market growth, miles driven and the number of 7-year-old and older vehicles on the road.

We estimate that the weather had a slightly positive impact on our sales during the second quarter due to a generally mild winter with only a recent cold spell.

We think weather had more impact on our gross margin than on our sales due to the mix of products we sold.

As we have consistently stated before, we don't like to spend considerable time focusing on the impact of gas prices or the weather because neither is controllable by us and the weather impacts will normalize over time.

We do monitor these situations to ensure we are providing our customers with the advice and products they need to maximize their vehicles' performance.

We believe over the long-term that as we execute our initiatives, we will overcome the effects of gas prices or weather.

Regarding pricing across the industry, we have not seen any material change in the competitive landscape.

Overall consumer price inflation in Q2 remained in the low single digit range.

Finally, we continue to update you on our inventory levels per store.

We ended the quarter at $496,000 per store verses $494,000 during last year's second quarter, with the additions to our hard parts categories driving a portion of these increases.

For the trailing four quarters, sales per square foot were $242.

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

Our new stores are on track to achieve at least a 15% IRR, and we continue to see an opportunity to open thousands of additional stores in the United States.

We opened 34 new stores in the quarter for a total of the 3,847 stores in 48 states, the District of Columbia, and Puerto Rico.

Our goal again this year is to open stores more evenly throughout our fiscal year.

We also reopened one of the remaining three U.S. stores closed due to hurricane-related damage in last year's first quarter.

We also relocated 5 stores this past quarter, and we continue to see opportunities to expand this initiative in the future.

Lastly, as you know, we entered the Puerto Rico market at the end of fiscal 2005.

At the end of this quarter, we had 13 open stores, and we've been pleased with their results to date.

Now let's turn to commercial.

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

We now have the commercial program in 2,154 stores supported by 128 hub stores.

While our sales results were below our expectations, our focus in the commercial business continues to be on building a strong operating model for the long-term that delivers profitable growth.

AutoZone's commercial business will be built on steady improvement, improvement in sales results, as well as continued growth in EBIT.

For the last two quarters, I've mentioned our commercial test stores.

At the end of the second quarter, we had approximately 700 commercial test stores, and we purposefully didn't expand the test to additional stores this past quarter.

The second quarter is a seasonally low-selling quarter for both our retail and commercial businesses, and we felt nothing would be gained by rolling more programs during this time period.

In fact, we would have expected to deleverage costs by rolling out more programs during these months.

While we continue to see strong sales and margin improvements in a majority of these stores, we're still cautious.

As in our retail business, we experienced weakness in sales across all geographic areas during the second quarter.

From our large chain account partners to small up and down the street accounts, business was somewhat muted.

We do expect to add additional test programs during both the third and fourth quarters.

And we continue to be enthusiastic about our game plan.

As I mentioned earlier, our product placement enhancements have been very focused on late model coverage.

These are the products that are the most important to our commercial customers, and these are the products that they've been requesting.

As the new and improved product additions reach our stores, we have developed very compelling marketing programs to communicate these improvements to our customers.

Our organization is excited by these additions and optimistic about our commercial customers' reactions.

We continue to build this business to win for the long run.

We will not do things just to generate sales in the short run.

We are not interested in driving short-term sales results at the expense of profits.

We believe all of the items we've been discussing are building momentum.

Each of these pieces must work in a coordinated effort to develop a compelling program for our very important commercial customers.

Mexico.

Our Mexico stores continued to perform well.

We opened 8 new stores during the second quarter.

We currently have 108 stores in Mexico compared with 3,847 in the United States.

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

Finally, I want you to know that I remain confident we are on the right track to produce long-term shareholder value.

I believe the initiatives we have in place will lead to continued future success.

Now I'll turn it over to Bill Giles to take us through the remainder of the income statement, cash flows, and the balance sheet.

Bill?

Thank you, Bill.

Gross margin for the quarter was 49.2% of sales, consistent as a percentage of sales to the previous year's second quarter.

In the second quarter, margins continued to benefit from our ongoing category management initiatives and import efforts.

However, these gains were offset by a shift in sales to lower margin, more seasonal products.

As an example of a shift in product sales, we had higher sales of antifreeze which typically carries a lower margin.

This sales shift was due to generally mild weather during November and December with a cold spell in late January.

While not necessarily affecting sales, we think the weather did have a negative effect on our margins in the quarter.

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

This includes supply chain initiatives, tailoring merchandise mix, and the continued implementation of our good, better, best, product lines, all allowing us to price our products appropriately while giving our customers great value.

Going forward, we believe there continues to be opportunity for margin expansion, albeit at reduced rates.

Our direct import initiative is in its early stages, but we will continue to discuss it in future quarters, and we are extremely proud of our merchandising organization for their abilities to improve margins while pressures on procurement costs continue to exist.

SG&A for the quarter was 34.6% of sales, down 29 basis points from last year.

The decrease was due to favorable cost comparisons verses last year's second quarter when the organization completed its store reset initiative.

Remainder of the decrease can largely be attributed to our ongoing focus on reducing expenditures throughout the organization.

It is worthwhile to point out that occupancy charges continue to be a detriment verses last year, increasing by approximately 26 basis points during the quarter.

We are pleased with our progress to date toward managing our expenses, and we will continue our efforts into the future.

EBIT for the quarter was $189 million, up 5.9% over last year.

Interest expense for the quarter was $26.8 million, compared with $24.3 million a year ago.

Debt outstanding at the end of the quarter was 1.854 billion or approximately $75 million more than last year.

The increase in interest expense reflects both the ongoing effort to term out the Company's debt on a long-term basis as well as the year-over-year increase in short-term rates.

Additionally, interest was higher due to the accounting for capitalized leases established in the first quarter of this year.

We expect interest expense to remain higher than the previous year for the remainder of fiscal 2007.

Our adjusted debt levels were maintained in line with our guidance of 2.1 times, our trailing 12-month EBITDAR.

We have purposely managed our capital structure relative to our cash flow in order to maintain our credit ratings at investment grade while optimizing our cost of capital.

For the quarter, our tax rate was 36.5% below last year's rate of 37%.

Over the next several quarters, we expect to maintain an approximate 37% effective tax rate.

Net income for the quarter of $103 million was up 6.2% over the prior year.

Earnings per share for the quarter of $1.45 were up 15.5% on 71.2 million diluted shares.

Relating to the cash flow statement, in the second quarter, we generated $168.5 million of operating cash flow, and we repurchased $129 million of AutoZone stock as part of our ongoing stock repurchase program.

Additionally, we reported this morning in our press release, our Board has authorized an additional $500 million in capacity to our buy back program.

AutoZone's strong financial health has allowed us to continue to repurchase our stock while maintaining strong credit ratios.

We intend to continue to repurchase stock after we have appropriately allocated capital to our existing stores and new store openings as long as it is accretive to earnings and consistent with our 2.1 times adjusted debt to EBITDAR liquidity target, which we maintained again for the quarter.

For the second quarter of this year, we again reported an industry-leading return on invested capital of 22.5%.

We're proud to report that this metric continues to improve over last year's already-industry leading rate.

Looking at our inventory levels, inventory per store on the balance sheet, plus the excluded pay-on-scan inventory was $496,000 verses Q2 of last year of $494,000.

As Bill discussed earlier, this inventory amount is in line with last year, yet it includes the new products added in connection with our new product assortment initiatives.

Accounts payable as a percent of gross inventory finished the quarter at 87% compared to 83% last year.

We continue to be committed to our goal of achieving 100% AP to inventory and feel confident in our momentum.

This quarter we reported a total of $50 million of inventory on POS, which in accordance with GAAP is not reflected on our balance sheet.

As we have stated previously, POS is about aligning the interest of AutoZone, and it is one of the programs we use to achieve our financial goals.

Total working capital was at $100 million, verses last year's balance of $240 million.

We will continue to focus on minimizing working capital as this reflects our ongoing focus on increasing cash flow.

Net fixed assets were up 5.9% verses last year.

Capital expenditures for the quarter totalled $50 million and reflect the additional expenditures required to open 47 new stores this quarter, maintenance on existing stores, and work on development of new stores for upcoming quarters.

Depreciation totalled $36 million for the quarter, higher than last year, due primarily to new stores and the accounting for new capital leases established in the first quarter.

As of February 10th, 2007, AutoZone continues to be one of the few players in our industry to have investment grade debt ratings.

Our senior unsecured debt rating from Standard & Poor's is BBB+, and we have a commercial paper rating of A2.

Moody's investor service has assigned us a senior unsecured debt credit rating of BAA2 and a commercial paper rating of P2.

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

Now I'll turn it back to Bill.

Thank you, Bill.

In summarizing AutoZone's second quarter results, I would first highlight our EBIT growth of 5.9% over the prior year's second quarter and our 15.5% EPS growth.

In an environment where we are seeing a more cautious consumer, the AutoZone model proved capable of generating double digit EPS growth.

We definitely were not satisfied with this quarter's results, but quite frankly, we're never satisfied.

We continue to feel confident in our plan.

During the quarter, we were excited to complete the rollout of our ZNet electronic parts catalog, continue to refresh certain AutoZone stores, and continue with our new product assortment initiatives.

But the most exciting thing about what we're doing is staying the course.

Steady improvement over the long run.

Our story continues to be one of steady, profitable, sales improvement; sustainable, subtle improvements; refining inventory assortment; continual training of our AutoZoners, expanding our commercial focus; and prudent, profitable paced growth in Mexico.

We are about staying focused while making methodical improvements in the model so we will be well-positioned for the future.

We continue to be energized by our AutoZoners' renewed committment to our culture, exhibited in the first half of the year.

On the quarter, both our retail and commercial sales results were below our expectations.

However, our survey results tell us the AutoZone shopping experience is better than it's been since we began measuring it.

While we do not provide financial guidance, the entire AutoZone team and I continue to be enthusiastic about our future.

We continue to feel confident in our long range plans.

Our plan is a simple one, to provide our customers the parts they want at the prices they demand.

And to provide our AutoZoners a great place to work.

If we do these things, we believe we will continue to enjoy tremendous success.

We are very excited about the remainder of 2007.

Customer service will continue to be our key point of differentiation.

And AutoZoners across the Company are committed to providing that service to every customer.

We will continue living the pledge in 2007.

We continue to demonstrate industry-leading financial metrics.

Being a disciplined company, we have proven our ability to manage costs appropriately and invest in incremental initiatives that exceed our stated 15% after tax IRR hurdle rate.

We are focussed on operating this company to profitably grow sales, efficiently deploy capital, and optimize long-term shareholder value while maintaining the highest levels of ethics.

I thank you today for letting us share with you our company's past accomplishments and touch on our ongoing initiatives.

I look forward to keeping you abreast of our results well into the future.

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

[OPERATOR INSTRUCTIONS] Gary Balter, Credit Suisse.

HI.

Good morning.

It's actually Seth Basham for Gary.

Good morning, Seth.

I was wondering first if you care to comment on how current trends are in this second -- third quarter, I guess we're in now?

Yes, Seth.

When we announce our earnings, I mean, we are 2 weeks and 2 days into the quarter.

So we're -- this is very fresh news on last quarter.

And we don't think it's appropriate to get into 2-week trends.

Okay.

Fair enough.

Secondly, moving on to some of the inventory assortment initiatives, perhaps you can provide some more color on what you found in your tests in changing the assortment, how that affect sales trends in those stores?

And when you're expecting to roll it out to the entire chain?

Yes, Seth.

The rollout is not by individual store.

In fact, it's more category related.

So we will go in, and we will look at a specific category and assess it across all of our stores, and then we will run those product assortments through our distribution and supply chain networks.

So it's -- what we're seeing so far is individual category performance.

As we mentioned at this time I guess in the third quarter of last year, we had launched a new product assortment initiative, but our initial results we weren't seeing what we anticipated to see.

So we stopped and reevaluated those and over the course of the last 6 or 7 months have redone those category reviews and began rolling some of them out in the first part of last quarter.

So far we've been pleased with their performance, but the majority of those new product assortments will be hitting this quarter.

Okay.

Is it fair to say you expect a material pick up in sales on the commercial side as this is one of the biggest areas you're changing the assortment?

Well, the biggest area -- first of all, the products that we sell continue to go on both sides of our business.

A significant amount of this focus is on later model coverage or newer car coverage, but we would expect some higher penetration on the commercial side.

We've also developed some very compelling marketing initiatives that we're going to launch at the same time these product assortments that hit the stores to introduce the new product assortments to our commercial customers.

Okay.

Thank you.

Bill Sims, Citigroup.

Thank you, and good morning.

Good morning.

Bill, it sounds like you're a lot more optimistic for improvement in commercial sales in the third and fourth quarter.

But I was just wondering if we could step back to the second quarter.

Outside the sluggish macro environment, it looks like not -- lack of full assortment of product was one issue as well as the promotional environment by your competitors that you maybe weren't willing to meet was the other issue.

If we could look at the individual commercial sales for any lost sale that you had, was it more a function of not having the availability of parts or a function of not being willing to necessarily compete on price?

And as we look into the third quarter, give me a feel for how you think these two issues will change and how you'll mitigate both the price issue as well as the assortment issue?

I think the way to mitigate any price issues is we're building a different jaded model.

We are very focussed on how do we differentiate ourselves with sustainable differentiation for the long-term.

Obviously price is not a very sustainable point of differentiation.

We're focussed on making sure we have the right products for our customers and that we provide them with that trademark AutoZone customer service.

We're continuing to build what that customer service looks like on the commercial side.

Our trends in the second quarter weren't materially different than they've been over the last few quarters.

We are not satisfied with that.

But as I said in the prepared remarks, we're not going to chase sales for the sake of sales.

We continue to have improving profitability in that business, and we're building strong relationships with customers that are based upon things that we think are important, product assortment and customer service.

Can you give us an idea of which was the more important issue dragging comps?

Was it product assortment or was it -- was it unwillingness to compete for unprofitable sales?

I think it's a little bit of both.

Obviously, last year when we decided to slow down our product assortment, not only did we not gain the benefits from it, but every day that your product assortment sits out there, it becomes older and older.

And so we needed to refresh our product assortment, which is what's going on now.

There are certain players in the marketplace that want to compete on price and that's not our point of differentiation.

We're going to offer our customers very compelling prices and great values, but that's going to be supported with very good customer service.

And then once the product assortment is up to snuff, how do you communicate that to your commercial customers?

And what type of lag do you think there'll be before we do see a real tick up in sales?

I don't want to try to predict the lag, but we are creating really compelling marketing materials for our sales representatives, be them the regional commercial sales managers, the territory managers, or our commercial specialists to take to the street and to have individual sales sessions with our customers.

And we're very excited about that.

Thank you very much.

Good luck.

All right.

Thank you, Bill.

Matthew Fassler, Goldman Sachs.

Thanks a lot, and good morning.

I want to follow-up on the sector issue.

Clearly, it sounds like we're all scratching our heads a bit as to the -- the sales malaise across the sector with gas prices moving around, weather, et cetera.

Do you -- as you look at competitive expansion your own -- those of some of your -- those of some of the companies you face, do you feel that there's any change in capacity that might be contributing to this or perhaps anything on the competitive front outside the traditional aftermarket retail channel, just to go, once again, beyond the macro and see if there might be anything else at work here?

Matt, I'll start with -- first of all, we have said in our script that we think there are thousands of opportunities to open additional stores.

We've been very prudent with our store expansion, and as I've said, we're going to maintain it in the mid single digit range.

When a specific competitor opens in a specific marketplace, does that put pressure on it?

Absolutely.

But it's a localized pressure, it's not a macro pressure.

Certainly, there is some overall accumulation of those impacts on our sales performance.

But it's not materially different than it has been over time in my opinion.

As far as any outside competitive pressures, we are not aware of any.

Got you.

And then secondly, on the weather front, just to check in on some of the things that you've seen.

When the weather has cooled off during the winter, for example, has the business responded in tune with that?

I'm not asking about any one moment in time, but have you seen a typical sensitivity that you wouldn't ordinarily experience?

Matt, it is very difficult in our second quarter -- first of all, our second quarter is -- it starts before Thanksgiving and runs through Christmas and New Year's.

It is very difficult to monitor individual trends day-to-day and week-to-week because there's -- it's a very low sales period for us and there's a lot of other things going on.

Weather patterns make it a very tenuous situation, you can see them react one way or the other.

Certain categories do very well when it's warm, other categories do very well when it's cold.

But what we said in the call, we don't think -- we think it had a slight positive impact that's run through our quantitative model, and -- but we don't think it was a material impact one way or the other.

Got you, Bill.

Thank you very much.

Thank you, Matt.

Danielle Fox, Merrill Lynch.

Thanks.

Good afternoon.

I just had a question about -- a follow-up question on the inventory.

Just understanding that sort of the numbers -- it looks like total inventories were up 11% and sales were up about 4%.

Could you just explain the differential given the trend on per store inventory?

Is it that you're holding more hard parts centrally that's causing the total number to increase?

Not necessarily, Danielle.

I think the way to look at it is, you're right.

On the total basis, inventory's up about 11%.

If you adjust for the POS inventory, it's up about 6%.

Keep in mind square footage is up about 5.7%.

So when you look at it in that way, you get right down to an inventory per store that's relatively consistent with last year, which we actually feel pretty good about considering that we're in the process of trying to expand some of the coverage and some of the categories that Bill just talked about.

So I think overall we feel as though inventory is in good shape, our AP to inventory's actually got a little bit of strength to it.

So from a working capital perspective, we feel really great about where the balance sheet is and our ability to manage inventory.

Okay.

Great.

I did notice the payables going up in step.

The other thing was, I'm just curious, you mentioned that occupancy was, I think a 26 basis point drag on SG&A.

I'm wondering why that's going up and whether or not we should see that start to level off at some point?

Thank you.

No problem.

It's basically -- it's gone up a little bit.

Some of that is depreciation.

Some of that is a mix between leased stores that we take on verses stores that we outright purchase.

So that's put a little bit of pressure on occupancy overall.

So as that mix adjusts, we would expect it to level out as the mix does adjust.

But I think overall we feel pretty good about what the organization has been capable of delivering during this quarter from an expense management standpoint, and we were very pleased with the fact that we were able to leverage SG&A by 30 basis points during the quarter.

Thank you.

Matt Nemer, Thomas Weisel.

Good morning.

Two quick questions.

First, could you elaborate a little bit more on the new product that you've put into the stores?

You mentioned that it was late model, but I'd love to know whether the mix between domestic and import and then what categories you're adding in?

Yes, first of all, it's going to be every category.

As I mentioned, we created a new tool that takes into account a lot of new attributes.

And some of those attributes give us a better opportunity to forward predict where demand is going to be.

We have great data on historical demand whether we can fulfill that demand or not.

And we're leveraging that data now.

We are using that new tool across every individual category.

In some categories we're -- well, in all categories, we're adding products and in all categories we're deleting products.

Remember that we do our product assortment by individual store.

So this is helping us refine where the latest and greatest parts need to be in those stores.

Okay.

And then secondly, are there any plans internally to leverage your inventory investment with an increased effort to sell product online either separately or with some sort of an in-store pick up functionality?

Yes, I mean, we obviously believe that we still have opportunity from an internet ability, and we continue to invest in there.

It's not a significant portion of our business today.

And the other aspect of the internet is this great opportunity for customers to come to the site and get educated on certain products and get information.

And then eventually buy online and pick up at stores.

So yes.

We believe that there's opportunity for that, it's not significant as it is today, but there's certainly opportunity for us to continue to plug that channel of distribution.

Okay.

And then lastly, as you look at the macro factors that are out there, have you spent any time looking at vehicle quality?

The vehicle dealers are reporting warranty expense down double digits primarily because of improved quality, and I'm wondering if that's playing into the overall malaise here?

First of all, the correlation between dealers, what they experience on overall quality and what we experience is very difficult because they're dealing with manufacturing problems or they're dealing with a different life cycle of the vehicle.

Remember, we start seeing the sweet spot of the car at the age of 7 years old.

Those are not going to be any warranty items for them.

There's certainly places where technology has changed the quality of parts.

Ten years ago, going -- planning to go 100,000 miles on a tune-up was unheard of.

But 10 years ago you could buy a spark plug from us for $0.39; today they're as high as $9.99.

So there are some technological places where the frequency of repairs are down, but the cost to provide that additional quality makes the prices go up.

That's helpful.

Thank you.

Thank you.

Dan Wewer, Raymond James.

Thanks.

Good morning, Bill.

You had mentioned that one of the leading indicators of AutoZone's business is the number of vehicles that are 7 years of age and older.

And obviously the demographics there are favorable.

And yet at the same time, the additional inventory that you're adding is in late model vehicles and sounds at odds with where you see the sweet spot of the business.

I wanted to see if you could help me understand that.

Well, first of all, we are also attacking a new part of the business, which is the commercial part, which is earlier in the life cycle.

But that sweet spot changes based upon the various categories.

For instance, brake pads, you're going to see them much earlier in the life cycle because it's a non-warranty part and it wears out faster. 30-40,000 miles most vehicles are getting their first brake job.

Places like oil and air filters, if you don't have a 2007 in your store, you're going to dissatisfy your commercial customers as well as your DIY customers.

So it depends upon the product assortment, but we are skewing more towards later model coverage, and a big part of that is our opportunities to service our commercial customer needs.

And, Bill, I know that you've been automating your customer loyalty programs and as that evolves, have you been able to drill into that data to get any trends as to what might be accounting for the industry-wide softness that we're seeing?

It's a great question.

But we began automating it on a broad scale in December of 2006.

So we now have 2 months of data.

We are reviewing that data very frequently, but quite frankly, we don't know how to interpret it yet.

It's just so new to us that we're still learning how to interpret that data.

There are things that we're seeing that surprise us, and things that we are seeing that confirm what we've always known.

And then the last question I have, Bill, was you had noted that pricing remains stable in the industry and your competitors have made the same comments.

But is it reasonable to expect that rational pricing behavior to continue if the industry-wide slump continues through 2007?

Well, I can't certainly predict what's going to happen in the competitive environment, but what I can say is what we've said many times.

This is -- in so many cases, this is a failure business -- failure-driven business.

We can all mark alternators down 50% and nobody's going to go out and buy them.

So price is not nearly as important in this business as making sure you have the right product assortment and making sure that you help your customers do the jobs that they want to do.

And if they don't want to do them, that you refer them to your great commercial customers.

Great.

Thanks, and good luck.

Okay.

Thank you.

Michael Baker, Deutsche Bank.

Thank you very much.

I wanted to ask about some of the expense trends, and as you implement some more commercial test stores in third and fourth quarter as you do some more reassortments and some more training, should we expect there to be an SG&A impact from those initiatives?

I don't think so, Mike.

I think that we believe -- we continue to work hard on our overall expense management, and we certainly continue to identify areas where we'll continue to make investments.

But I don't think that you'll see any kind of an increase in SG&A related to those initiatives.

I think we'll continue to balance them out as we have in the past.

So you get a sales bump without much of an SG&A increase?

Oh, we think that we can continue to manage SG&A and continue to make the appropriate investments both in service as well as training, et cetera.

So yes, the object of this -- for us to continue to provide a better shopping experience, which we think ultimately will lead to improved sales performance.

Okay.

Well, great.

Thanks.

Good luck.

Thanks, Mike.

David Cumberland, Robert Baird.

Thanks.

Good morning.

Can you give an update on your loyalty program, including any changes to the rewards system?

And also, someone just touched on this, also your ability to capture customer information.

What type of information are you getting?

First of all, as I mentioned earlier, we just made it -- rolled it out across the nation virtually in early December.

And we are now doing an electronic card verses where before we had a manual punch card.

The offerings are generally the same.

We are testing a few different offerings in different parts of the country to see which ones are the most compelling to customers.

But as far as customer information, we're receiving quite a bit of customer information.

The most important part is we're seeing what the purchasing habits and frequency rates are for our individual customers.

Again, it's too early to really read anything into that data, but it's very nice to have it.

Thank you.

Armando Lopez, Morgan Stanley.

Yes, hi, thanks.

Good morning.

Just two quick questions.

One in terms of ZNet, you had mentioned you had rolled out ZNet it sounds like across the stores now.

Can you maybe just talk a little bit about are you -- in the stores -- as you've rolled it out, have you seen a pick up in sales at the stores as you have rolled it out throughout the last couple quarters?

Yes, we really didn't roll it out over the last couple of quarters.

It really was rolled out for the most part in December.

Just by the way, there are some stores in the Company that still do not have ZNet and the reason that they don't have it is so that we can measure them as control points against the ZNet performance.

We haven't seen any drastic change in trends verses what the control stores are at this point in time.

But it's going to take a little while to leverage all the data.

There is tremendous amounts of improved data in there.

It helps our AutoZoners see and visualize the parts to make sure that they get the right part to the customer.

And then it also gives the customer a tremendous amount of vehicle-specific repair information so it helps them do their jobs.

Okay.

And then, second, on the inventory and adjusting the hard part SKUs and stuff.

Could you maybe talk a little bit about like where you are on a store basis in terms of getting the right SKU count or the right mix on a store-by-store basis?

Yes.

First of all, I think we have always been very good at that.

We're just going to get even better at it.

So these are refinements.

This isn't -- we've been doing store-specific hard part assortments since the early to mid 90s.

Right.

And so this is another refinement that helps us.

And it's a pretty significant refinement.

It's really leveraging a lot of different data that we haven't had the opportunity to leverage in the past.

So we're excited about it, but it is a refinement.

Probably one of the biggest factors is because we had to stop last year, we're a little bit behind on updating those product assortments today.

But we're excited about getting caught up, and that'll be substantially complete this quarter.

Okay.

And then just one last one, on the commercial side or the stores which have the commercial programs, particularly the test stores, you had mentioned you've seen a pick up in the test stores or in the majority of the test stores.

Maybe could you talk a little bit about the stores where you haven't seen the pick up that you would have expected?

Is there something specific to those stores as to why you may not have seen the same type of results?

In a lot of the differences that we come down to, they are primarily based upon store level execution.

That's the biggest difference that we find in stores that do exceptionally well verses stores that don't.

There are certainly market differences.

Some stores don't have the market size that others do.

But when we have the right team in that store, we are very effective.

Okay.

Thank you.

Thank you.

Alan Rifkin, Lehman Brothers.

A couple questions, if I may.

Bill, with the focus on the later car coverage, is there any significant gross merchandise margin differential between the parts within that category and the more traditional part coverage?

Not terribly, Alan, it's not materially different one way or the other.

Okay.

And with respect to the refreshes, at this point in time, are those refreshes that you've undertaken or even the oldest ones, are those performing at a 15% hurdle rate?

First of all, these are -- these are not remodels.

I think I've said this on the last call.

These are refreshes.

We're painting the exteriors of the stores.

We're painting them on a slightly faster frequency than we did before.

We, quite frankly, got behind on making sure that the appearance of our stores looked great, like we say in our pledge.

And so we're returning to normalized maintenance cycles.

Okay.

I mean -- I guess -- I'm just trying to put my finger on what catalyst we can maybe look for over the next 6 to 12 months that will -- absent weather, which you have no control over, and absent gas prices, which you have no control over, what micro issues could we maybe take a look at to try to monitor to help you folks reverse the same store sales trend that we've seen for 2.5 to 3 years at this point?

Could you maybe try to help me better understand that?

Alan, first of all, we are sticking with the initiatives that we have.

We've added some new ones, we've just rolled ZNet.

That's 2 months old.

We just rolled an electronic loyalty card just two months ago.

We are substantially updating our product assortments.

We are incredibly focused on improving the customer shopping experience.

Our stores, I think, look as good as they've looked in a long period of time.

We can't predict what the future's going to be, but we're fairly optimistic that we're doing the things that are right for the long-term of this business.

Okay.

Bill, thank you very much.

Thank you, Alan.

Cid Wilson, Kevin Dann & Partners.

Hi.

Good morning, Bill.

Question, regarding your private label initiative, can you give us some sense in terms of what you're seeing there compared to national brands?

And also, can you touch on that as it relates to commercial as well?

I think one of the things that we see with respect to our private label product is that we continue to gain market share there, and we continue to gain acceptance from a quality perspective.

I mean, one of the things that we're very proud of is that there is sort of high level of quality on our private label products.

And we continue to work hard at communicating that to our customers, and I think that we're improving that and we can tell that through surveys -- customer surveys as well as research that we do that in fact our quality has improved in the eyes of the customer over time.

From a commercial perspective, we talk a lot about expanded parts coverage, et cetera.

And again, I would echo the same thing.

I think that our private label product continues to gain increased acceptance in the commercial markets.

But as we talk about a lot, it's all about quality, and it's about product coverage, and it's about service and we've got to have a compelling price.

And it's all of those things taken together that will continue to improve our commercial business.

Okay.

And my next question is regarding procurement costs.

Can you talk a little further about what's your strategy to -- in terms of controlling it or improving it on?

Yes, I think that there's obviously a lot of merchandising strategies relative to procurement costs, one of which as an example would be increasing our penetration from an import standpoint.

And we believe that as we continue to do that, again, we're in very early stages, but there's a real opportunity for us to continue to reduce our overall procurement costs.

At the same time, there's a lot of commodity based aspects of the materials that go into our products that have risen over time.

So we're battling those at the same time.

But I think imports is probably an example of an opportunity for us to reduce our overall procurement costs on an ongoing basis.

Okay.

And my final question is that regarding store openings, is there any way you can give us some sense in terms of what you're seeing from the stores that -- your new stores and what kind of productivity you're seeing in those stores compared to years passed or even a few years ago when you opened up new stores?

Are you seeing -- and where are you seeing the most opportunity geographically?

Is it more further in the northwest or the upper Midwest, or are you still finding them in the -- in like the Tennessee, Alabama Southeast areas?

Yes.

I'll probably give you a bit of a boring answer.

The fact is is that the productivity of the stores have been relatively consistent this year versus even the prior year.

So we're pleased with the way the new stores are opening.

I think we've done a little bit better job of the timing of openings in spreading them out throughout the year.

So from that perspective, I think the productivity of the new stores has been reasonably strong.

At the same time, from a geographic perspective, I can't really point to one particular area of the country that has more opportunity than others.

We continue to find significant opportunities for back fills, and -- but at the same time we're continuing to find new market opportunities at the same time.

So we believe that there's significant opportunity for us to expand our footprint across the United States.

Okay.

Thank you very much.

All right.

Before we conclude the call, I'd like to take a moment to reiterate that feel we still have much to accomplish in 2007.

While we have an incredible business model built on a strong foundation of disciplined processes focused on delivering great customer service, we understand we cannot take anything for granted.

We're committed to building a platform for profitable future growth, and we believe the initiatives we have in place for 2007 and beyond will help to accomplish that goal.

I thank you very much for participating in today's call.

That concludes today's conference.

Thank you for participating, you may disconnect at this time.