汽車地帶 (AZO) 2008 Q2 法說會逐字稿

Good morning and welcome to the AutoZone Conference Call.

Your lines have been placed on listen only until the Q&A session of the conference.

Please be advised today's call is being recorded.

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

This conference call will discuss AutoZone Inc.'s second quarter financial results.

Mr.

Bill Rhodes, that company's Chairman, President and CEO will be making a short presentation on the highlights of the quarter.

The conference call will end promptly at 10:00 a.m.

Central time, 11:00 a.m.

Eastern time.

Before Mr.

Rhodes begins, the company has requested that you listen to the following statement regarding forward-looking statements.

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

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

These are based on assumptions and assessments made by our management and life experience, perception of historical trends, current conditions, expected future development and other factors that we believe to be appropriate.

These forward-looking statements are a number of risks and uncertainties, including, without limitation, competition, product demand, the economy, credit markets, people that hire or retain qualified employees, consumer debt levels, inflation, weather, raw material costs of our supplies, 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 and 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 and personally affect our business.

Forward looking statements speak only as 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 on form 10 K for fiscal year ended August 25th, 2007 for more information related to those risks.

n addition to financial statements presented in accordance with generally accepted accounting principles, AutoZone has provided metrics in this presentation are not capped but in accordance with GAAP.

For reconciliation of these metrics, please see the AutoZone's press release in the investor relations section at AutoZone --- www.autozoneinc.com.

Good morning, and take you for joining us today for AutoZone's fiscal 2008 second quarter conference call.

With me today are Bill Giles, Executive Vice President and Chief Financial Officer of Store Development and IT, and Brian Campbell, Vice President, Treasurer, Investor Relations and Tax.

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

If not, the press release, along with slides complementing our comments today, is available on our web site, www.autozoneinc.com.

Please click on quarterly earnings conference calls to see them.

To begin, I would like to thank our entire organization for delivering another quarter of record sales and earnings.

I would like to take a moment to recognize everyone at AutoZone for the wonderful accomplishment of opening our 4,000th store in the United States this past quarter.

Founded on July 4th, 1979 in Forrest City,Arkansas, I don't think any of the AutoZoners to helped open that first store could ever have imagined that we would have that many stores today.

Congratulations, everyone, and I am looking forward to celebrating many more milestones for years to come.

Now to some details on the quarter.

We began the second quarter focused on the same key initiatives we launched at the beginning of our fiscal year.

We continue to reinforce through the organization the importance of putting our customers first in everything we do.

Our efforts include continuous training on product knowledge, leadership and, most importantly, our culture of customer satisfaction.

We understand and consistently reinforce to our organization that customer satisfaction is driven by our customers' experience with us in a variety of touch points, from their in-store experience, to our phone conversations with them or even through their usage of our internet site.

We focus intensely on providing superior, trustworthy advice regardless of mode and believe it is our key point of differentiation.

Secondly, I want to reiterate that the ongoing refinement of our parts assortment is one of our key operating priorities.

Over a year ago, we made significant enhancements to our merchandise assortment planning tool and integrated it with an enhanced category line review process.

Together, those process improvements have resulted in additional parts coverage significantly enhancing our ability to meet the demanding needs of our customers.

We continue to believe that these areas of focus are critical to our future success.

We are constantly reminded of the importance of these two priorities through our conversations with one of our most important constituents, our AutoZoners and specifically, our store AutoZoners who are on the front lines listening to and meeting the needs of our customers on a daily basis.

I am consistently inspired by the commitment our AutoZoners have to our customers, and by the level of enthusiasm they have for our business and our future prospects.

We constantly stress the importance of flawless execution throughout our organization.

Although our execution certainly has not been flawless, it has to improved significantly over the last couple of years and we are quite pleased with our progress.

While our retail sales showed a deceleration from our first quarter results, we feel our -- we feel our continued focus on putting customers first, insuring our AutoZoners are knowledgeable, making sure our stores look great and insuring that we have the best merchandise at the right price, will lead to continuing ongoing success.

We remain optimistic as we head into our most important and productive time of the year, the third and fourth quarters.

Secondly, we feel we are really gaining traction with our commercial business.

We are steadfast in our commitment to building sales and earnings momentum in this business for the long run.

Over the last year, we have implemented enhanced sales processes, marketing collateral and training for our commercial AutoZoners, all geared to deliver on our objective of building a world class sales organization.

These efforts, combined with the improvements in our core operating processes, have begun to build momentum in this business.

As this momentum has built, our enthusiasm for our ability to capture a much larger profitable share of this business has also increased.

We believe we have substantial opportunity to grow our sales and profits in this business for many years to come.

Before we discuss the specifics of the quarter, I know many of you would like to understand how sales unfolded during the quarter.

Typically, we don't discuss intra-quarter trends, and we don't discuss them because our sales can fluctuate significantly from week to week for a variety of reasons, most notably, weather patterns.

The second quarter is almost always our most tenuous quarter because it is our seasonally lowest sales quarter.

The weather is quite variable and it includes three major holidays which occur on different days of the week each year.

Instead of focusing on a weekly or monthly fluctuations in this call, we want to express to you that we have not seen any material change in the underlying trends in our business that changed our outlook for the balance of the year.

Finally, I would like to address what we are seeing from a customer standpoint.

The U.S.

economy has certainly been challenged in recent months and those challenges have resulted in softer trends across the broader retail sector.

Having said that, I want to remind you of the two largest factors we believe drive the overall performance of the automotive aftermarket, miles driven and the number of vehicles on the road.

Specifically, the number of seven-year-old and older vehicles on the road.

In recent years, we have highlighted the negative correlation we have seen with our sales during periods of higher gas prices.

We believe this has been a key contributor to the reduced level of increases and at times, decreases in miles driven.

The changes in miles driven trends appeared to again suggest some softness across the broader automotive aftermarket.

Although it is in the low single digit range, while the other macro economic challenges appear to be impacting the broader retail sector, we want to reiterate that historically, we have not been able to develop a statistical correlation between any of these other macro challenges and our sales performance.

We certainly remain mindful of other issues affecting the health of consumers, but we believe the most important determinant of our future success is our strategies, and more specifically, our execution of those strategies.

For the agenda this morning, I will review our overall financial results and then go into detail regarding our DIY sales initiatives, commercial initiatives in Mexico.

Bill Giles will then provide more detail on our earnings performance, as well as an overview of both our balance sheet and cash flow statements for this past quarter.

Finally I will provide a few closing comments.

Regarding the second quarter, for the 12 weeks ended February 9th, we reported sales of $1.339 billion, an increase of 3% from last year's second quarter.

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

For the quarter, our sales didn't meet our aspirations, but we continue to believe we are focusing on the right initiatives and that we are well positioned as we enter our peak sales period.

Our retail sales showed a modest deceleration versus the previous quarter.

Our customer satisfaction surveys continue to confirm we are on the right track.

Finally, we continue to be pleased with the significant progress we're making in our commercial business.

In the second quarter, gross profit as a percentage of sales was up 71 basis points versus last year's quarter, while operating expenses as a percentage of sales increased by 53 basis points.

This resulted in an operating margin of 14.7%, up 17 basis points from last year's quarter.

Operating profit increased 4.2% versus the prior year.

Net income for the quarter was $107 million, and diluted earnings per share increased 15.7% to $1.67 from $1.45 in the year-ago quarter.

Our continued disciplined capital management approach resulted in return on invested capital for the trailing four quarters of 23.2%.

This increase showed a slight improvement versus last quarter and a more material increase versus last year's second quarter.

Return on invested capital is a key measure of our success.

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

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

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

Now I would like to talk in detail about our DIY sales results.

Total domestic retail sales were up 1.9% for the quarter.

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

We believe we did well in spite of the head winds we saw during the quarter, specifically, we believe our customers continue to feel pressures at the pump and that, combined with a slight decrease in miles driven, negatively impacted this quarter's sales.

During the quarter, as is customary, we experienced regional discrepancies in our sales performance, both positive and negative, however, nothing was material enough to highlight.

Our theme for the past quarter was continue to focus on improving the customer shopping experience.

We challenged our AutoZoners to greet each and every customer the came to our stores, getting out from behind the parts counter and asking how they could help them.

We ask our AutoZoners to take advantage of the inventory additions in their stores to make sure we're selling our customers the complete solution for a job, not just one part at a time.

We know what it means for our customers to get all the way home, start on their car repair and realize they don't have what they need.

While this may sound basic, the key is getting over 4,000 stores and more than 50,000 AutoZoners executing this on a consistent basis.

We certainly cannot claim we have been perfect in our efforts.

In fact, we know we have stores need improvement, but on average, we feel we're making great strides.

To support this notion, we are excited by our customer survey results.

This past quarter our customers rated their overall shopping experience with AutoZone higher than ever before.

With over 40,000 surveys completed monthly, we feel we are getting a statistically significant sample across all demographics.

We continue to learn from our customers and our comments regarding their experience and we are constantly refining our offerings to create the shopping experience they demand and deserve.

As noted above, we continue to focus relentlessly on improving our parts assortment.

We are in the second year of using the enhanced tools we put in place to refine our assortment.

We have learned a great deal from last year's in implementation, both our successes and our mistakes.

During the second quarter, we implemented product assortment changes across 12 of our major categories.

We are encouraged by our results to date and excited by the differences our future enhancement can make.

We remain committed to refreshing our product assortment on a routine basis.

as this is critical to keeping our product assortment relevant to the ever-changing vehicle demographics in each store's trade area.

During the quarter, we implemented a few aggressive tactics designed to accelerate our sales momentum, specifically, during the holiday season, we ran some very aggressive promotions in an attempt to increase store traffic.

We supported those aggressive promotions with incremental marketing efforts.

We learned, yet again, two things.

One, it is very difficult for us to break through the tremendous promotional efforts of others during the very aggressive holiday marketing period.

And two, while we can certainly substantially increase our sales on specific promotional items, it is challenging at best to leverage that incremental activity into additional profitable sales across the store.

During the quarter, we continued to improve the capabilities of our new parts catalog, Z-net and continued to highlight this terrific customer service enhancement in our marketing campaign.

We believe Z-net continues to gain traction with our customers as we are able to provide better, more comprehensive information to our customers and assist them with their needs more quickly.

Additionally, we continued with our investments to insure our stores look great through improvements and merchandise placement and routine maintenance.

We believe the appearance of our stores, both internally and externally, are continuing to show significant improvement.

Regarding macro trends, during the second quarter, unleaded gas prices started out high at $3.10 a gallon and went down slightly, finishing the quarter at $2.96 a gallon.

This was materially higher than last year's second quarter when prices averaged $2.25 a gallon and did cause a head wind for this quarter.

Unfortunately, we can not control the prices of gas at the pump.

However, with more vehicles on the road than ever before, our ability to grow sales remain strong over the long term and we believe consumers will ultimately adjust their spending habits to the higher prices.

We will continue to develop marketing programs that support our customers's needs during these high priced times.

For the quarter, gas prices had a negative impact on our sales performance.

Regarding miles driven, we saw a decrease in miles driven in November.

We do not have the data for December and January yet.

Let me again reiterate the two statistics we felt had the closest correlation to our market growth.

Miles driven and the number of seven-year-old and older vehicles on the road.

While miles driven have been challenged recently, there are more registered vehicles on the road today than in our country's history.

For the quarter, we estimate that weather had a minor negative impact on our sales.

As our footprint is national, any regional differences in weather patterns are muted and weather differences will certainly normalize over the mid to long term.

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.

For the trailing four quarters, sales per square foot were $237.

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

Now let's turn to commercial.

For the quarter, total commercial sales posted an increase of 3.4% versus last year's quarter.

We now have the commercial program in 2,223 stores supported by 133 hub stores.

We are encouraged by the progress we're making on our commercial initiatives and by the initial response we are seeing from our customers' purchasing habits.

However, there is still much work to be done.

With such a small share, approximately 1.5% of the overall market, we believe there is significant opportunity to gain further shares.

We have spent considerable time and effort to ensure that we are expanding our hard parts coverage to support our commercial customers.

We have added a great deal of late model parts coverage to get ready for our busiest selling season, the spring and summer.

We extensively mined our transaction information for insights as to where we have additional inventory placement opportunities and as we react to those insights, we believe we are making a difference for our customers.

We believe our customers are recognizing our efforts and beginning to reward us with more of their business.

Secondly, we continue to expand the number of stores with the additional sales support we talked about over the last several quarters, reaching just under 1,000 programs at the end of this quarter.

These stores continue to outperform our other commercial programs.

In addition to adding additional sales personnel and incentive compensation, we have developed professional sales materials designed to educate our customers and our AutoZoners on the high-quality products we carry, the depth and breadth of our offering and the critical customer service attributes of our program.

We began implementing this new approach about nine months ago and we have received very positive feedback from our customers and our AutoZoners.

Additionally, our business has improved in the product categories that have received this additional focus.

However, we continue to be methodical in our approach to adding new programs to ensure our activities are improving our customers' experience and leading to sustained improvements in our business performance.

What we have been doing with this business is relatively straightforward.

As it -- as it has taken time to both maintain and gain traction, it has really been about focusing on profitable growth.

At that point we focus on key drivers.

First, we identified the customers we could most effectively and profitably serve, those within a reasonable distance of our stores.

Second, we focused our efforts on categories that were most important to our customers and their business success, hard parts.

We are still in the early stages of this initiative, but it has clearly made a difference for us.

To succeed in this business, we must leverage our strength to deliver a proposition our customers value and that will continue to be our focus.

Our customers consistently communicate to us that the most critical elements of our success for them, our availability of high-quality products, timely delivery and solid customer service.

We are pleased with the progress today, but have significant additional progress left before we reach our goal of developing a world-class commercial sales force.

Finally, we remain committed to building this business for the long run.

While we are excited about our potential in this business and believe over the long term we can expand the percentage of stores that operate a commercial program, we will remain committed to developing a sustainable, profitable business model.

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

We believe all of the items we have been discussing are building momentum, each of these pieces must work in a cohesive manner for us to not only attract new customers but improve our penetration with our existing customers.

Now let's turn to Mexico.

Our Mexico stores continue to perform well.

We opened four new stores during the second quarter.

We currently have 128 stores in Mexico.

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

Now I will turn it over to Bill Giles to discuss the remainder of the income statement, cash flows and the balance sheet.

Bill?

Thanks Bill.

Gross margin for the quarter was 49.9% of sales, up 71 basis points compared to last year's second quarter.

During the second quarter, margins continued to benefit from our ongoing category management initiatives, supply chain efficiencies and our direct import efforts.

Over the last several quarters, these efforts have been partially offset by an increase in product costs specifically related to oil based products and other commodities.

We continue to focus on ensuring we offer the right product at the right prices to our customers.

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

Our Duralast, Duralast Gold and Valuecraft product lines continued to show sales increases for the second quarter.

Our customers continue to recognize the value proposition these high-quality brands offer.

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

Our direct importing initiative is in its early stages and reflects less than 5% of our annual cost of goods, but we're pleased with the progress our merchandising organization has made to improve margins while pressures on procurement costs continue to exist.

SG&A for the quarter was 35.2% of sales, up 53 basis points from last year.

Our deleverage came primarily from continued higher occupancy costs and to a lesser extent, an increase in advertising.

Specifically, rent and depreciation were approximately 45 basis points higher than last year's second quarter, which reflected a higher percentage of lease versus owned stores.

As I mentioned before, the AutoZone culture of thrift and focus on cost management is an integral part of our ongoing business model.

We believe our efforts on improving customer service implemented in recent quarters will pay dividends well into the future, while our expenditures this past quarter were slightly higher than past quarters, which we feel very comfortable those dollars were invested wisely in order to capitalize on future sales growth.

Over the long run, we continue to believe we can leverage operating expenses on 1.5% to 2% same-store sales growth rate.

EBIT for the quarter was $195 million, up 4.2% over last year.

Interest expense for the quarter was $28.6 million, compared with $26.8 -- $28.6 million compared with $26.8 million a year ago.

Debt outstanding at the end of the quarter was $2,095,000,000 or approximately $240 million more than last year.

The increase in interest expense primarily reflects a higher level of debt.

Our adjusted debt levels at 2.2 times, were higher than our normal guidance of 2.1 times trailing 12 month EBITDA.

Our expectation is to return to 2.1 times metric by the end of our fiscal year, we opportunistically purchased additional shares during the first quarter of this year.

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

For the quarter, our tax rate was 36.6% above last year's rate of 36.5%.

We expect to run approximately a 37% tax rate for the remainder of fiscal 2008.

Filing net income for the quarter of $107 million was up 3.6% over the prior year.

Our diluted share count of 63.7 million shares was down approximately 10% from last year.

The combination of these factors drove earnings per share for the quarter to $1.67, up 15.7% over the prior year.

I would like to take a moment to remind everyone that our 2008 fiscal year has an extra week in it.

Every six years or so, our fiscal year has this 53rd week in the fourth quarter.

At the end of this fiscal year, we will be talking to you about EPS numbers that include an extra week.

So, we encourage everyone to model this extra week and take that into account.

At the time of reporting, we will break out the impact that this extra week had on our business.

Relating to the cash flow statement in the second quarter, we generated $126 million of operating cash flow.

We did not repurchase any AutoZone stock as part of our ongoing stock repurchase program.

However, year-to-date, we have repurchased approximately $350 million as part of our stock repurchase program compared to approximately $220 million during the same time period last year.

The second quarter of this year we reported an industry leading ROI capital of 23.2%.

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

Finally, I'd like to take a moment and update you on our inventory levels and totals, and on a per-store basis.

We reported in inventory balance of $2.1 billion, up approximately 8% versus the Q2 ending balance last year.

However, this 8% increase is not truly comparable to last year, since last year's numbers excluded $40 million in pay on scan inventory, which was not included in our GAAP numbers.

We slowly reduced our inventory balance held as pay on scan over the last several years.

Today we have approximately $11 million in inventory in our pay on scan program.

Our adjusted inventory, including pay on scan inventory was up approximately 6% versus the previous year's quarter.

This increase is being driven by our new stores opened over the last year where we have approximately 5% more square footage than last year.

On a per store basis, we reported $504,000 per store versus $496,000 in the last year's second quarter, an increase of approximately 2%.

Also, keep in mind that we have added additional parts coverage through our category line review.

And, if it had not been for our diligent work on rationalizing certain unproductive inventory, we could not have freed up the space we needed for our additions.

This effort on parts additions will continue for the foreseeable future and will allow us to say yes to our customers even more.

Overall, we feel good about the complexion of our inventory and believe that we are well positioned as we head into our third fiscal quarter.

Accounts payable as a percent of growth inventory finished the quarter at 89.1%, total working capital was $31 million versus last year's balance of $100 million.

We will continue to focus on minimizing working capital as this -- as this past quarter reflects.

We are committed to continuing our ongoing focus on increasing cash flow.

Metrics stats were up 4.4% versus last year.

Capital expenditures for the quarter totaled $50 million and reflect the additional expenditures required to open 34 new stores this quarter, maintenance on existing stores and work on development of new stores for upcoming quarters.

Specifically related to new store openings, our new stores are on track to achieve at least a 15% IRR and we continue to see ample opportunity to open stores in the U.S.

at mid single digit growth rate for the foreseeable future.

We opened 28 new stores in the quarter for a total of number 4,000 stores in 48 states, the District of Columbia and Puerto Rico.

Our goal remains to open stores more evenly throughout our fiscal year.

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

Appreciation totaled $39 million for the quarter, higher than last year, due primarily to new stores.

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 and Poor's is DDD plus, and we have a commercial paper rating of A2.

Moody's Investor Service has designed us a senior unsecured debt credit rated of the DAA2 and a commercial paper rating of C2.

Now I will turn it back to Bill Rhodes.

Thank you Bill.

While we are certainly pleased to report record earnings and earnings per share for the quarter, we also understand that we must stay focused on both growing both our retail and commercial sales.

We clearly understand our success is driven by our customers's daily experience with us and we must continue to enhance this experience.

We continue to see our customers being more cautious with their buying habits, however, we believe if we maintain our relentless focus on the basics of our business, we will continue to be very successful.

We remain confident in our ability to drive results in this business even with the macro challenges our customers are facing.

Our story remains a consistent one.

We focus on steady, profitable sales and earnings improvement, refining our inventory assortment, continual training of our AutoZoners, expanding our commercial business and prudent, profitable growth in Mexico.

While we are pleased with our execution in the quarter, our sales results were below our expectations.

However, our survey results tell us the AutoZone shopping experience is better than it has been since we began measuring it three years ago.

While we do not provide financial guidance, our team continues to be enthusiastic heading into the second half of 2008.

We continue to feel confident in our long-range plans.

We believe we have opportunity for growth in all three key business priorities, U.S.

retail, commercial and Mexico.

2008 is about further firing our hard parts assortment.

To increase our ability to say yes.

In fact, we continue to have a tremendous opportunity to increase our yes percentage for both our retail and commercial customers.

This year is also about testing enhancements to our sub store network, to make more late model parts coverage accessible to our stores and customers.

We believe this optimization can help us improve the productivity of our inventory while making more merchandise available where it counts, at the store.

Lastly, 2008 will be about growing our commercial business.

Customer service will continue to be our key point of differentiation and AutoZoners across North America are committed to providing that wow customer service our patrons have grown to expect.

We will focus on improving the trustworthy advice of our AutoZoners that they deliver through the enhanced training and providing then the tools they need to succeed.

As we continue to demonstrate, industry leading financial metrics, we remain cognizant of our investors capital.

We continue to remain focused on optimizing long-term shareholder value.

We will maintain our cost disciplines while investing incrementally in initiatives that exceed our stated 15% after-tax IRR hurdle rate.

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

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

Now, we would like to open up the call for questions.

[ OPERATOR INSTRUCTIONS ] First question comes from Matthew Fassler of Goldman Sachs.

Your line is open.

Thanks a lot, good morning.

Congratulations on a good quarter in a tough market.

Just a couple quick questions.

First of all, if you could just revisit your capital structure, you spoke about the 2.1 times target leverage that you seek to maintain.

Would there be any other reason, in terms of sort of assessing the business environment, of the strategic uses of cash that you would have held off on, on the buybacks during the second quarter?

Matt, the way I would look at it is that, on a year-to-date basis we've repurchased $350 million worth of shares versus $220 million versus last year.

We accelerated some of our repurchases in the first quarter and we are committed to get back to our 2.1 times.

And maintaining our investment grade credit rating is important to us.

To the extent that you can progressively make your way back to 2.1 times over the course of the next couple quarters while still buying back stock, is that something you would do?

In other words, do you need to feel the need to get back to 2.1 on the dot before you commence buybacks, or can you move directionally toward that.

Obviously, these are more lucrative quarters for us and the cash flow should pick up substantially.

Yes, I guess our general focus at the moment is that we'll get back to 2.1 by the end of the year.

So I'd look at it that way.

That's very helpful.

Secondly, on the commercial front, obviously, there was a tad of deceleration there as there was in the broader business.

Is that something that you would view as a step back or just a focus, or rather, a function of the environment that we saw during the quarter across the board?

Yes Matt, I certainly don't think that it is a step back by any stretch of the imagination.

We didn't get into the details, but one of the thing that happens during this period time is, you have the holidays.

And this year, Christmas and New Year's hit on Monday and Tuesday and last year, they hit on Sunday and Monday.

We don't have a very robust business in commercial on Sundays, so there is some shift in the number of days, we see nothing that changes our outlook for the commercial business and we are very excited about what our team has been doing and also about the response that we're getting from our customers both in their purchasing habits, but also in the dialogue that we have with them.

Got you.

And then finally, real briefly, on the weather, you've spoken about it from time to time, when it impacts your mix in terms of sales of chemicals and other lower margin products.

Was the weather a factor in driving mix and consequently, margin in either direction this quarter?

I think one of the things that we've learned over time is a lot of this stuff evens out over a broader base period, so, as Bill had mentioned previously, we are going to get fluctuations on a weekly basis throughout a quarter, but on a 12 week basis, things seem to even out a little bit.

Actually, our gross margin improvements, I think our merchandise organization has done a very good job between just optimizing our merchandise assortment, some of the category line review than we have done, we've certainly added hard parts coverage, we are able to say yes more frequently.

So, I think we're delivering a better shopping experience to our customer today, certainly than we were a year ago.

Thanks so much.

Next question comes from John Lawrence of Morgan Keegan.

Your line is open.

Thanks, good morning guys.

Good morning John.

Bill, just to follow on Matt's question, just for a second on the commercial.

The first two priorities you pointed to were identifying the customer and then the categories themselves.

Can you talk a little about those categories?

Has -- as the process has evolved, have you brought those down to just, sort of, if you will, sort of a standard deviation of a certain group or percentage of the inventory?

Or is it just better overall experience?

I think what we have done over the last year and a half year, John, was, we focused really hard on making sure that we got the foundational elements of our business in good shape and that includes parts coverage, that includes high levels of service, we did some things like bringing our in house credit processing back in house.

So we got those foundational elements in place and then we began building some really strong sales culture.

We started it with making some powerful sales marketing collateral that our AutoZoners have that explain the high quality products that we have, show the depth and breadth of our offering and then we're also building a sales culture.

So it is kind of across the board.

And all of those things together allow someone to listen and to knock down some barriers that you didn't have, that were not able to be done, say a year or two ago?

I think that's exactly right.

The sales collateral that we provide gives our AutoZoners another reason to go talk to our existing customers and the customers that we are targeting.

Great, thanks.

And Bill, on the cost of goods side, can you give us a little feel for the inflation on some of those oil based products?

Is it -- where is that as far as sequentially -- are you seeing more pressure, less as percentage as we go forward?

Probably a little bit less, but I would say that we continue to see pressure, and, I don't know what the future holds for us, but our expectation is that we will continue to see some pressure on commodity based products.

Congratulations, thanks, guys.

Thanks, John.

Our next question is from Tony Cristello of BB&T.

Your line is open.

Thanks, good Morning, gentlemen.

Good morning Tony.

Bill, your gross margin does continue to show very nice year-over-year improvement.

And category management has been a primary driver.

Can you perhaps give a bit more detail on some of the success you are having now, versus maybe last year?

And what are some of the other areas that may provide some opportunity going forward?

I would say that there is a lot of different things.

And certainly I think, from merchandise assortment standpoint, that we're stronger today than certainly we were last year relative to some of the inventories that we have added.

Clearly, we talk about the import program, the direct import program, albeit that it's only 5% of our overall cost of goods sold.

Again, that's another important element of our ability to continue to lower product acquisition costs and our ability to respond to increasing prices, particularly commodity based prices.

And the timeliness of that has been important as well for our ability to continue to make improvements on our gross margin.

So there is a lot of moving parts overall on gross margin and we are pleased certainly with the gross margin rates we have experienced up to this point.

And we anticipate that we may have future improvements in gross margin, albeit reduced rates versus what you've seen up to this point.

And when you look at parts assortment, and maybe this is a two part question with respect to commercial, but has that been driven by adding more parts under the Duralast brand, or has that been another branded products that you have added to complement what you have already been doing there?

Tony, I think it has been a combination of both.

We have Duralast and Duralast Gold and Valuecraft in certain hard work categories, and in other categories, we don't -- we haven't restricted the increases to the places where we have our brands.

We've gone across the board from ignition to brake pads and basically every category in between.

I mean, is it a situation where, when you look over these 900 stores that are in this sort of test program, have they -- I mean, these have been better performing stores in general, and can you comment on, from a -- where they stand on the call list with respect to installers?

Have they -- were they already on a higher level or did his parts assortment cause that to move up and thus, the flow through on revenue?

I think there's is a little bit of a misnomer, that someone is first call and somebody is second call.

In a lot of cases, that happens on the individual category lines.

So you may be first call on breaks, second call on the engine management.

Obviously, we are moving up the call list.

We don't have great detail to tell us exactly where we are on each individual customer, but we are very pleased with the progress we're making.

We think the parts assortment has a material difference with our customer's response to us.

And is it the parts assortment or the customer service, the combination of all, and how easy is it to then transition what you've learned here, what you are applying to a much broader base of stores with respect to commercial?

We mentioned a little bit on the last call.

Part of our hesitancy in rolling this aggressively forward is, it has additional cost components to it, and it's easier to leverage that additional cost over the higher sales productivity stores and programs.

So we have continued to roll it out methodically.

And the more we refine it, the more stores that we can afford to add those additional resources to.

So I would look for us to continue to roll it, but also continue to be very prudent with that role.

Okay, great, thank you.

Yes, thank you Tony.

Our next question is from Mike Baker with Deutsche Bank.

You line is open.

Thanks.

Two questions.

First, so, it sounds like you did some more marketing, didn't really pay off.

So I'm wondering what your plan is on your marketing ahead.

And then secondly, if you have any comment on potential consolidation in the space of how that might impact you guys or what your view is there, thanks.

Yes, on the marketing piece, I don't want to oversell that discussion.

Around Christmas time, we went out and did four very hot promotions, and we did it to try to see what we could do with increasing customer traffic.

And we also supported that with some incremental radio.

We found that number one, it is just very hard to break through during the holiday shopping experience, there is a tremendous amount of people out there.

And we also found that because we can sell some promotional items at very aggressive prices, that does not translate into being able to drive profitable sales across the balance of our stores.

It goes back to the age-old discussion that your customers are not willing to buy an alternator if you put it off -- 50% off price.

They are not going to buy it unless they have a need to buy it.

On the consolidations front, the way we look at it, we have tremendous competitors across the entire country.

A lot of times people want to talk about Advance and O'Reilly's and CSK, and obviously, those are very strong competitors.

We have a lot of other very strong competitors like NAPA and Carquest, not to mention WDs and [mass] and lots of other folks.

So, any change in the competitive landscape, we will certainly monitor it and we'll react to it.

But we believe our success is determined by what we do and how we interact on a daily basis with our customers and our AutoZones.

Okay, so it sounds like you are more in the, as you said, monitor and react stage rather than something more proactive.

Is that fair to say?

I'm not going to get into any of those kind of discussions.

Fair enough, thought I would ask.

I don't blame you.

Thanks, I will pass it on now.

Alright, thank you Mike.

Our next question is from Cid Wilson, Kevin Dann and Partners.

Your line is open.

Hi, congratulations on a good quarter.

The question is, touching back about what you had mentioned regarding the strength in hard parts, can you give us some guidance in terms of, on a comparable basis, how hard parts did versus accessories and chemicals?

Traditionally, we don't break out that level of information between hard parts and chemicals and so on.

The only thing I will tell you is that I think that we have done a better job relative to increasing the amount of coverage that we have in the hard parts business that we think is actually helping both the commercial side of the business for our ability to say yes, particularly on later model coverage, and it also helps a little bit on the DIY side overall.

So, I certainly think that some of the inventory initiatives that we have undertaken over the last year, we are starting to see some benefits from.

Okay, and is there any change in terms of the percentage of your total inventory that is private label?

You know Cid, it is not materially changed.

We continue to look for ways to enhance our Duralast and Duralast Gold offerings.

And in some cases they get a little bit more focused because they are in some of our core categories, but I would not say there is anything material there.

Okay, and then my last question is, any color on your utilization of your DCs and where they are, and what your outlook is [inaudible]?

No, what we've always said is at the point in time that at that we make changes to our distribution strategy, we will communicate them.

At this point in time we have seven distribution centers in the continental United States and they are capable of servicing all of our stores.

We also have a DC in Mexico that serves as our Mexico store.

Okay, thank you very much.

A question from Rick Weinhart, BMO Capital Markets.

Your line is open.

Hi, good morning.

Two questions.

First, on the rent expense, you mentioned additional stores being leased versus owned, but even backing out the store openings the last year, it seems like you run expenses up pretty sharply over last year.

I was wondering if there was anything in there, either one time in nature, or what factors might have been attributed to that.

I think it's really just the mix of the stores that we are opening.

I think that we are seeing some higher rental for the places that we're going to geographically.

So obviously, we'd prefer to own more than we would lease.

But, certainly for some of the locations that we've been acquiring, or opening over the last year or so, we've wound up leasing more than we have owned, and so, that's really what's impacting the mix overall.

But I don't think we have seen a material change in our rent on a market by market basis, per se.

Okay, and my second question was on the inventory impact with the way you have been accounting for LIFO over the years.

I believe last quarter, [quarterly Qs] you had the first quarter I think in many years where your LIFO cushion against inflation came down.

I am assuming that with inflation the way it is, that perhaps that continued.

What kind of impact -- can you give us any kind of clarity on what kind of impact that has on your gross margins when we see that come down?

Really none.

I think that overall, it has been relatively flat lined.

It may have come down a little bit, but I wouldn't look at that as an impact on gross margins.

Our gross margin is really a reflection of our activity from a merchandising standpoint.

Okay, thanks very much.

Thanks

Our next question comes from and David Cumberland of Robert Baird.

Your line is open.

Thanks, hi.

For the commercial business, have you been able to maintain margins in the first half of the year while you have been investing in the business?

As far as gross margins have been, we have not seen any significant -- or had any significant shift one way or other in our gross margin.

As we make investments, particularly in some specific areas, we can see moderate contraction of the operating margin, but nothing material.

Thanks, and then on Z-net, can you elaborate on how much the system would need to develop or change from here and also, are all AutoZoners trained at this point?

Oh yes, certainly, they're fully trained.

t's interesting, we began rolling out Z-net in December of 2006 and within a quarter we had it in every store across the chain, and had turned off the old system.

The beauty of Z-net is that it is intuitive.

If you work on the internet today, it is basically the same philosophies on Z-net.

So everybody can jump to it pretty quickly.

It doesn't require hardly any training at all.

In fact, it is easier than our old system from a training perspective.

As to what is the future of Z-net, we have a terrific platform that we've put in place with Z-net and we're continuing to refine it every day, we continue to add pictures from more parts categories, we are continuing to add vehicle specific repair information on more and more vehicles on a continuous basis.

And, it also gives us the opportunity to do some things with our AutoZoners to make them more knowledgeable and also give them additional selling aids, from adding banners on there that explain the differentiation between our good, better and best products, and I think we have two or three further iterations of enhancements for Z-net in the pipeline, and we are continuing to roll through those methodically.

Sounds good, thanks.

Thank you.

We have a question from Danielle Fox of Merrill Lynch.

Your line is open.

Thanks, good morning.

I just wanted to follow-up on the issue of pricing.

We do our own survey which showed that industry pricing was down for the first time in years, and Advance Auto Parts actually mentioned on its recent call that it was trying to be more competitive on hard parts to attract commercial business.

You have addressed this issue somewhat, but I am just wondering, are there differences between the retail and commercial competitive dynamics that might be affecting your ability to move up prices on things like consumables and maintenance items versus hard parts?

So, is there a material difference in the pricing environment between retail and commercial?

Danielle, I'll start with yes, there are certainly differences in the competitive dynamics.

One is the delivery business.

So, a lot of people look at the profitability in that business, based upon a delivery of where the other one is, and in store customer experience.

So, they are -- they do have different pricing structures in place and we have different pricing structures in place.

They are not drastically different, but they do have some differences.

As far as, is there more challenge in one side versus the other, in making sure that -- or being able to move our prices up, we want to make sure, and we are going to ensure that we are competitive to all of our competitors in every market whether it is on the retail side or the commercial side from a comparative offering.

That is, if we have a better set of brakes, we will make sure our better set of brakes is priced competitively with our competition, regardless of which business it's in.

Okay, that is helpful.

Thank you.

Thank you.

You have a question Jack Balos at Midwood Research.

Regarding your commercial business, I estimate that in stores that have commercial departments, that they represent approximately 22% of that store's sales.

Is that approximately correct?

That is directionally correct, Jack, it might be just a slight bit less than that.

But that's in the ballpark.

Okay.

Well, as you know, in the case of CSK and Advance Auto, that ratio is over 30%.

And I was wondering if that differential is partially explainable in terms of distribution capabilities between the companies in terms of what the amount that they want to invest in DCs and hub stores and so forth, and the amount that you want to invest, because the more you invest in that area, the lower the ROI.

I don't think it's a function of what are we willing to invest in that business are in those distribution assets.

Our perspective on it is, if we can get the products to them in a timely manner, and we have daily delivery to almost every store in our chain, certainly over 80%, 80-some odd percent of our stores get a daily delivery from a hub store.

So we are able to provide that level of service.

As I mentioned in our prepared remarks, that we are looking at some incremental tests in our hub stores and we are excited about what we're doing there.

But we want to, as always, prove it works before we roll it out further.

But, as I said before, there is a significant difference between say, 22%, over 30% for CSK and Advance Auto.

How would you explain that difference?

I think there is a variety of reasons why that may exist.

I am not really focused on what they are doing.

I am focused on what we are doing, and how do we do it, and do it profitably over the long term?

Okay, thank you.

Thank you.

Okay, before we conclude the call, I would like to take a moment to reiterate that we are excited about our growth prospects for the remainder of our fiscal year.

We understand the challenges our customers face every day.

We also understand when times are challenging, we can offer a value proposition that really matters for our customers.

Remember, many of our customers shop with us out of economic necessity.

We believe we have that value proposition and we won't stop working to refine our offerings.

We have a solid game plan, but I want to stress that this is a marathon, and not a sprint.

Our focus is on our critical success factors.

As we continue to focus on the basics and never take our eye off of optimizing long-term shareholder values, we are confident we will continue to be incredibly successful.

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.