汽車地帶 (AZO) 2014 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 question-and-answer 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's second-quarter financial results.

Bill Rhodes, the 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 AM Central time, 11 AM 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 word such as believe, anticipate, should, intend, plan, will, expect, estimate, project, position, strategy and similar expressions.

These are based on assumption and assessments made by our management in light of experience or 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 credit market conditions, the impact of recessionary conditions, competition, product demand, the ability to hire and retain qualified employees, consumer debt level, inflation, weather, raw material costs of our suppliers, energy prices, war and the prospect of war including terrorist activity, availability of consumer transportation and construction delays, access to available and feasible financing and changes in laws and regulations.

Certain of these risks are discussed in more detail in the risk factors section contained in Item 1A under part one of our annual report on Form 10-K for the year ended August 31, 2013, and these risk factors should be read carefully.

Mr. Rhodes, you may now begin.

Good morning and thank you for joining us today for AutoZone's 2014 second quarter conference call.

With me today are Bill Giles, Executive Vice President and Chief Financial Officer, IT and ALLDATA, 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 are available on our website www.AutoZoneinc.com.

Please click on quarterly earnings conference calls to see them.

To begin this morning, I want to thank all AutoZoners across the globe for another very good quarter.

This morning we reported our 30th consecutive quarter of double-digit earnings per share growth.

That accomplishment is a testament to our organization's focus and discipline around delivering consistent wow customer service.

We will spend some time this morning discussing our sales results and provide you some details on regional and product sales trends.

We will also provide some detail on the cadence of sales throughout the 12-week quarter.

Next we will update you on our digital integration initiatives and our international store performance.

Finally we will highlight what we have been doing to improve our business model for today and beyond.

We are very excited about the initiatives we are working on and believe our recent learnings will help to shape our Company's future for years to come.

For the quarter, we reported total sales increase of 7.3% while same-store sales were up 4.3%.

This overall sales performance showed noticeable improvement from our Q1 results.

I do want to point out that part of the increase in DIY was due to the calendar shift resulting from our 53rd week in fiscal 2013.

Our DIY same-store sales would have been approximately 1% lower if we were comparing to the same weeks last year.

Commercial continued to outpace the growth of our retail business.

This quarter retail showed marked acceleration from recent trends.

The colder weather across much of the US drove robust traffic on batteries, antifreeze and wiper blades.

However, our West Coast stores experienced less favorable weather for parts failures.

Abnormally dry conditions led to fewer for example wiper blade sales in our stores on the West Coast.

We also experienced growth in both traffic and ticket across both our retail and commercial customer segments.

Our failure related hard part categories experienced the highest growth in both retail and commercial.

Clearly the weather was a significant factor but we also believe the work that we have been doing to improve inventory availability had us very well positioned to capitalize on the increased demand.

We feel as we continue to improve our hard parts product availability, this has led to increasing traffic and ticket especially in commercial where the vast majority of the business is in hard parts.

In regard to the cadence of sales trends for the quarter, November, December and through mid-January, our sales ran quite strong, above 5% in same store sales.

However for the last month of our quarter, our same store sales slowed.

During those weeks, our results dropped into the low single digit range.

We experienced a slowdown across both our retail and commercial businesses.

The culprit, strange as it is for me to say was the weather.

It seems I've spent a career talking about how weather in particular extreme weather drives positive results for us.

Bu by late January, by the time several of the US regions were experiencing their third or fourth heavy cold snap, the parts that were close to failing appeared to have already failed earlier in the season.

Additionally, the later storms, particularly across the Southeast caused us and our commercial customers to close due to severity of the storms and the poor driving conditions.

As we look at the balance of the year, we believe there will be a lingering positive effect on our industry.

Two years ago, the winter was quite mild and we highlighted that as a headwind for business for months.

Conversely, after the extensive winter we have had this year, we anticipate that demand will remain strong as we head into the spring and summer seasons.

While certain failure related categories were particularly strong during the second quarter, other categories, specifically maintenance categories that can be deferred were challenged.

We expect these deferred projects to be completed in the balance of the year.

Regarding the consumer, we continue to believe our consumer remains under pressure.

However, we feel 2014 has several positive items going forward.

One large headwind has now been anniversaried, the payroll tax reinstatement last year.

Another is gas prices have begun to abate and we believe this can have a positive effect on our customers' ability to spend on routine maintenance.

With approximately 10 billions of gasoline consumed monthly in the US, any sizable move in price could have a material stimulus on the economy.

Currently gasoline prices are approximately $3.35 a gallon, about $0.25 a gallon below this time last year.

As we are heading into what is forecast to be a more normal spring and summer weather pattern, we are optimistic on the sales front.

We continue to assume the most pronounced effect would be sales in the Midwest and Northeast markets as these have been the most challenged for a couple of years.

Regarding market share, the data we have available to us is showing we are gaining share on both the retail and commercial fronts.

We are especially focused on improving our trends in the application parts area where our efforts to improve our assortments will have the most impact.

And so far we are encouraged.

We feel the initiatives we are working on are making a difference.

For example, we have enhanced our electronic catalog to better serve our customers by further highlighting related items necessary to do the complete job.

We believe these enhancements will improve the customer experience and will complement the knowledge of our AutoZoners.

While we are early in our efforts the feedback we are receiving from AutoZoners and customers is encouraging.

Regarding DIY ticket and traffic trims, both increased for the quarter.

As I had previously mentioned, the traffic count was much stronger earlier in the quarter versus the last few weeks.

While we have experienced traffic growth in commercial for several years, it was exciting to see growth in the retail channel.

On the average ticket front, retail continues to be up but at a lower rate than our historical experience.

One driver of the lower retail ticket has been the lack of commodity based inflation.

Currently we don't see any indications of that trend changing materially in the short to midterm.

While that is good news for our customers, it has certainly challenged our results.

On the commercial front, we were pleased to see a higher average ticket tied to, as noted earlier, more hard parts sales.

Overall we don't have control over the macro factors that impact our business and that is why we have intensified our efforts on enhancing our offerings.

Our efforts on the initiatives we have underway or in test should lead to ongoing sales growth.

We are pleased with the progress we are making on our commercial business.

Our sales increased 12.2% from last year's second quarter and we opened 49 new programs to finish with 74% of our domestic stores having a commercial sales program.

This brings our year-to-date openings to 174.

We expect to open a similar number of programs this year as we did last year.

Our all Other Businesses increased approximately 31% over last year.

Starting this quarter we began to anniversary our acquisitions of AutoAnything.

The all other segment of our business includes AutoAnything, AutoZone.com and ALLDATA.

Regarding these businesses, we have introduced the idea of being more digitally integrated.

Therefore we have made this one of our four strategic growth priorities along with retail, commercial and international.

While at an early stage, we believe this can be an important and significant opportunity for us to deepen customer relationships and ultimately grow sales.

At this point in the evolution of our online offering, we are focusing more on data compilation and building a knowledge pool than on current sales.

Today shoppers use our websites for educating themselves on what they need for their vehicles and they continue to buy the vast majority of what they need from our stores which to us makes perfect sense and is in line with our operating plans.

Our objective is to satisfy our customers' needs regardless of how they want to interact with us.

Now I would like to update you on our initiatives.

Last quarter we discussed that we were testing a handful of initiatives that focused on increasing our ability to say yes to our customers' parts needs in both retail and commercial.

We established tests last summer focused on increasing the depth of coverage available at the store, hub stores and at our distribution centers.

Product additions at the hub stores and distribution centers also included tests around frequency of delivery to the stores that they service.

Over the last several months, we have significantly increased the pace of strategic assessments and challenged ourselves to review our test results very carefully.

The amount of time and effort going into this effort has been nothing short of extraordinary.

Our entire organization owes the subset of individuals who are leading in this effort tremendous gratitude.

On last quarter's call, we highlighted that one of our test initiatives was complete and in the process of being implemented.

This initiative was the enhanced modeling for store SKU placements where we would significantly add incremental inventory while simultaneously removing unproductive inventory.

At the end of the quarter, we were complete with about 75% of this initiative but it is important to note that much of this additional inventory began arriving at our stores very late in the quarter and some is still in the distribution centers.

This has been a massive understating and has caused considerable work at the stores and in the distribution centers.

As you can see our per store inventories increased significantly as a result of this initiative.

We have a high degree of confidence that these new assortments will drive meaningful profitable sales increases as we have tested this new methodology several times before implementation.

To date the sales are generally in line with our expectations but again, much of the inventory hasn't been positioned for sale or was positioned very late in the quarter.

We've also been testing additional inventory in our hub stores.

We continue to find opportunities to add productive inventory to all of our hubs and we expect this to continue especially as we further penetrate the highly fragmented commercial market.

Additionally, we are testing a much deeper product offering in a select few hub stores and these locations are leveraging that inventory across a wide network of additional hubs and satellites.

This allows us to significantly broaden the depth of the product offering closer to the customer with many stores having same-day access to the broad assortment.

In addition to testing broader SKU assortments in our distribution centers, we are also testing more frequent deliveries to both select hub and satellite stores.

All of these efforts are designed to assess the most effective way to service our customers' needs and to reduce the amount of unproductive activity we have transferring products from store to store.

It is still very early but what we have learned as we expected that more inventory closer to the customer increases sales.

At this stage we have not determined the optimal solution and we expect to continue to run these tests for an extended period of time.

We continue to execute on our strategies to improve the customer shopping experience.

We expanded five net additional hub locations during the quarter to take our total remodeled hubs to 115 locations.

These remodels entail expanding the size and capacity of these locations ensuring they are in the right physical locations and adding additional inventory into the market that benefits both retail and commercial.

We also opened three new hub stores finishing with 160.

Over time we do expect to open more hub locations but we believe our strategy on inventory deployment at the store level allows us to keep the number of openings at a moderate level.

Last quarter I also mentioned a new version of Z-net that was being deployed.

Over the last couple of years, we have reset our expectations in regard to technology investments in an effort to leverage technology to enhance the customer experience and leverage operating efficiencies.

The enhanced Z-net is the first of those efforts to be implemented.

Finally, I mentioned our goal is and remains to be growing market share in 2014 while continuing to deliver solid earnings.

We were successful with this objective in the last calendar quarter of 2013 according to the data available to us.

However, we compete against great companies in our industry and they too are aggressively modifying their business.

While we are improving, we clearly see where we can improve our selling proposition and we are focused on those areas.

Our organization understands the importance of balancing investments and returns and we have to invest our time and capital accordingly.

With the continued aging of the car population, we are optimistic regarding trends for our industry in both DIY and DIFM.

While new car sales have been very strong these past two years, we have seen those traded in vehicles be resold to new owners who are repairing and enhancing their "new vehicle".

With gas prices declining a bit here recently on a year-over-year basis, we believe miles driven can increase in 2014.

Historically lower gas prices and an improving economic outlook have led to more miles being driven.

We expect that trend to reemerge.

We remain bullish on our industry sales growth opportunities on both retail and the commercial front over the long term.

As the vehicle population remains at an all-time high and consumers continue to look for good values while maintaining their vehicles, we see AutoZone's opportunity to sell to these customers only growing.

Now let me review our operating theme priorities for 2014.

Our overarching operating theme this year is creating customers for life and the key priorities for the year are one, great people providing great service; two, profitably growing our commercial business; three, leveraging the Internet; four, leveraging technology to improve the customer experience while optimizing efficiencies; and finally, improving inventory availability.

On the retail front this past quarter under the great people providing great service theme, we continued with our intense focus on improving execution.

Along with the completion of the rollout of our new Z-net software we've spent a great bit of time training AutoZoners on the system enhancements.

We tried to make the system as intuitive as possible but along with change, we had to spend time teaching and discussing those changes.

We also learned from our store AutoZoners how to improve the way the information is presented on the screen.

This mutual respect for operations and technologies will lead in our belief to a superior selling tool in our stores.

We also invested more payroll in our stores this past quarter.

Last year we managed expenses tightly as our sales results were below our expectations.

This year as we expected sales to improve with all of our initiatives, we wanted to make sure we represented our brand well so we added additional payroll.

We should highlight another strong performance and return on invested capital as we finished Q2 at 32.3%.

While slightly below last year's Q2 ROIC excluding the acquisition of AutoAnything, we would have been slightly higher than last year.

We are very pleased with this metric as it is one of the best if not the best in all of hard lines retail.

Our primary focus has been and continues to be that we ensure every incremental dollar of capital that we deploy in this business provides an acceptable return well in excess of our cost of capital.

It is important to reinforce that we will always maintain our diligence regarding capital stewardship as the capital we invest is our investors' capital.

Now let me turn the call over to Bill Giles.

Bill?

Thanks, Bill.

Good morning, everyone.

To start this morning let me take a few moments to talk more specifically about our retail, commercial and international results for the quarter.

For the quarter total, auto parts sales which includes our domestic retail and commercial businesses, our Mexico stores and our four stores in Brazil increased 6.5% over the 12 weeks.

Regarding macro trends during the quarter, nationally unleaded gas prices started out at $3.29 a gallon and finished the quarter at $3.38 a gallon.

Last year gas prices increased $0.18 per gallon during the quarter starting at $3.43 and ending at $3.61 a gallon.

We continue to believe gas prices have a real impact on our customers' ability to maintain their vehicles and we continue to monitor prices closely in the future.

We also recognize that the impact of miles driven on cars over 10 years old, the current average, is much different than on newer cars in terms of wear and tear.

Miles driven data reported by the Department of Transportation are available only through December but October was up 2.3% while November was down 0.2% and December was up 1.1%.

The other statistic we have is the number of seven-year-old and older vehicles on the road which continues to trend in our industry's favor.

Another key macro headwind last year was the payroll tax reinstitution.

While we do not expect to benefit this year we simply are anniversarying a negative event from last year and it is hard to gauge what benefit this will have on our traffic but it won't be an additional pressure point like it was last year.

For the trailing four quarters, total sales for auto parts store was $1.754 million.

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

For the quarter, total commercial sales increased 12.2%.

Commercial represented 16.3% of our total Company sales and grew $35 million over the last year's second quarter.

Last year's commercial sales mix percent was 15.6%.

We believe there are ample opportunities for us to continue to improve many facets of our operations and offerings and therefore we are optimistic about the future of this business.

Year to date, we opened 174 new programs versus 93 programs opened last fiscal year.

We now have our commercial program at 3,595 stores supported by 160 hub stores.

Approximately 1,080 of our programs are three years old or younger.

With only 74% of our domestic stores having a commercial program and our average revenue per program below several of our competitors, we believe there is further opportunity for additional program growth in addition to improvement productivity opportunities in current programs.

The tests on inventory that we have conducted provide us with one of the pieces of information on how to close to gap with competitors that are more productive in commercial than us today on a per outlet basis.

We understand where share opportunities exist and we remain focused on closing that gap.

We believe we are on the right track when it comes to our ability to climb the call list to becoming our customers' first call.

In summary, we remain committed to our long-term growth strategy.

We have accelerated the growth of our commercial programs having opened over 1000 programs in the past 36 months, 30% of the programs are three years old or younger.

And we believe we are well-positioned to grow this business and capture market share.

Our Mexico stores continue to perform well.

We opened four new stores during the second quarter.

We currently have 367 stores in Mexico.

Our returns and profit growth continue to be in line with our expectations.

Regarding Brazil, we opened no new stores in the quarter and have four stores open as of the end of the quarter.

Our plans remain to open a total of about 10 stores, then pause our development as we refine our offerings and prove that our concept works for our customers and it's financially viable.

At that point we will talk more on our long-term growth plans.

Recapping this past quarter's performance for the Company in total our sales were $1.999 billion, an increase of 7.3% from last year's second quarter.

Domestic same-store sales or sales for stores open more than one year were up 4.3% for the quarter.

As Bill had mentioned earlier, our last four weeks sales results were below the run rate of the first eight weeks.

We attribute much of this decline to even harsher than expected winter weather in certain parts of the country keeping customers at home indoors along with an excessive amount of precipitation challenging customers to complete vehicle projects outdoors.

Additionally we believe many of the failure parts that were subject to failure during extreme temperatures had already failed earlier in the season.

Moving down to gross profit, the gross margin for the quarter was 52.1% of sales, up 25 basis points versus last year's second quarter.

The improvement in gross margin was attributable to higher merchandise margins, lower shrink expense, (inaudible) primarily by the inclusion of the recent acquisition of AutoAnything.

In regards to inflation, we continue to see modest decreases in costs year-over-year.

This is different than in past years.

At this point our assumption is we will experience subdued producer pricing for the foreseeable future and therefore we feel costs will be predictable and manageable.

We will remain cognizant of future developments regarding inflation and we will make the appropriate adjustments should they arise.

Looking forward, we continue to believe there remains opportunity for gross margin expansion within both the retail and commercial businesses; however, we do not manage to a targeted gross margin percentage.

As the growth of our commercial business has been a steady headwind on our overall gross margin rate for a few years, we have not bothered to call out the headwind quarterly as an integrated part of our business model.

Additionally, AutoAnything has been a slight drag on our gross margin since this business model operates at a lower gross margin rate.

As we anniversary our acquisition of AutoAnything during Q2, our margin comparisons will be comparable going forward.

Our primary focus remains growing absolute gross profit dollars.

SG&A for the quarter was 35.2% of sales, higher by 42 basis points from last year's second quarter.

The increase in operating expenses as a percentage of sales was primarily due to the timing of advertising expenditures in Q2 from Q1.

As I had mentioned a few moments ago, our investment in store payroll did leverage our domestic or did deleverage our domestic store operating expenses as a percentage of sales.

Advertising however, was the largest single component to the increase.

While expenses were higher than last year, they were budgeted to be higher and were in line with our expectations.

We continue to believe we are well-positioned to manage our cost structure in response to our sales environment.

EBIT for the quarter was $337 million, up 6.2% over last year's second quarter.

Our EBIT margin was 16.9%.

This represented a decrease of 17 basis points versus the previous year's second quarter.

Interest expense for the quarter was $39.5 million compared to $41.3 million in Q2 a year ago.

Debt outstanding at the end of the quarter was $4.311 billion or approximately $310 million more than last year's Q2 balance of $3.998 billion.

Our adjusted debt level metric finished the quarter at 2.5 times EBITDAR.

While in any given quarter we may increase or decrease our leverage metric based on management's opinion regarding debt and equity market conditions, we remain committed to both our investment grade rating and our capital allocation strategy.

Our share repurchases are an important element of that strategy.

For the quarter, our tax rate was approximately 35.3%, lower than last year's second quarter of 36.2%.

This quarter benefited from certain discrete tax items.

Net income for the quarter of $193 million was up 9.4% versus the prior year's second quarter.

Our diluted share count of 34.3 million was down 7.2% from last year's second quarter.

The combination of these factors drove earnings per share for the quarter to $5.63, up 17.8% over the prior year's second quarter.

Relating to the cash flow statement for the second fiscal quarter, we generated $151 million of operating cash flow.

Net fixed assets were up 6.5% versus last year.

Capital expenditures for the quarter totaled $77 million and reflected the additional expenditures required to open 32 new stores this quarter capital expenditures on existing stores, hub store remodels, work on development of new stores for upcoming quarters and information technology investments.

Additionally we purchased the rights to certain customer relationships in connection with our ALLDATA business.

These investments were approximately $11 million this year with an additional $20 million to be paid over the next two years.

For all of fiscal 2013, our CapEx was approximately $415 million.

With the new stores open, we finished this quarter with 4,871 stores in 49 states, the District of Columbia and Puerto Rico; 367 stores in Mexico; and four in Brazil for a total store count of 5,242.

Depreciation totaled $58.4 million for the quarter versus last year's second quarter expense of $52.3 million.

With our excess cash flow, we repurchased $200 million of AutoZone stock in the second quarter.

At quarter end we had $727 million remaining under our share buyback authorization.

Our leverage metric was 2.5 times this past quarter.

Again, I want to stress we managed through appropriate credit ratings and not any one metric.

The metric we report is meant as a guide only as each rating firm has its own criteria.

We continue to view our share repurchase program with an attractive capital deployment strategy.

Accounts payable as a percent of gross inventory finished the quarter at 113%.

Next I would like to update you on our inventory levels (inaudible) on a per store basis.

We reported an inventory balance of $3.1 billion, up 12% versus the Q2 ending balance last year.

Increased inventory reflects new store growth along with additional investments in coverage for select categories.

Inventory per store was up 8.3% at $589,000 per store reflecting our continued investments in hard parts coverage.

Finally as Bill previously mentioned, our continued disciplined capital management approach resulted in return on invested capital for the trailing four quarters of 32.3%.

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

Now I will turn it back to Bill Rhodes.

Thanks, Bill.

We are pleased to report our 30th consecutive quarter of double-digit earnings per share growth.

Our Company continues to be successful due to our long-term focus.

That focus on exceptional customer service is part of the AutoZone DNA.

We focus on executing at a very high level consistently which we believe can be a competitive advantage.

To execute at a high level, we have to consistently adhere to living the pledge, we cannot and will not take our eye off of execution.

Success will be achieved with a strong attention to detail but we also have to evolve and change to adapt to our ever-evolving industry.

The initiatives we are working around inventory assortment, hub stores, commercial growth, Mexico, ALLDATA, e-commerce, and Brazil are all very exciting to us.

We feel these efforts will lead to increasing sales for 2014 and beyond.

While our industry sales according to the NPD data made available to us accelerated this past quarter, we continued to experience share gains on both the retail and commercial fronts.

While this is exciting, we cannot be complacent.

We are just starting to implement our major initiatives and the best we believe is ahead of us.

Our long-term model is to grow new store square footage at a low single-digit growth rate and we expect to continue growing our commercial business at an accelerated rate.

As we continue to execute on our financial model, we look to routinely grow EBIT dollars in the mid single-digit range or better in times of strength.

And we leverage our very strong and predictable cash flow to repurchase shares, enhancing our earnings per share growth into double digits.

We feel the track we are on will allow us to continue winning for the long run.

We believe our steady consistent strategy is right.

It is the attention to details and consistent execution that will matter over time.

Our belief the solid consistent strategy combined with superior execution is a formula for success.

We are investing in the key initiatives that will drive our long-term performance.

In the end delivering strong EPS growth and ROIC each and every quarter is how we measure ourselves.

We remain committed to delivering on our strategic and financial objectives.

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

(Operator Instructions).

Alan Rifkin, Barclays.

Thank you very much.

A couple of questions if I may, the first one for Bill Rhodes.

Bill, you spoke about the lingering positive effect from weather on hard parts and while it is easy to probably determine what the immediate effect is on battery, can you maybe provide a little bit more color on how long you think that lingering effect is going to be and what proportion of the hard parts are typically expected longer-term from adverse weather?

Yes, Alan, I think the best proxy that we have in recent history was two years ago when we had a very mild winter of 2011, 2012.

If you recall in April and really on through October of that year, we continued to talk about the lingering impact in our business and it was really in the maintenance category, places like brakes and chassis that did not get replaced at the same rates that they had in previous years.

We attributed a lot of that to the lack of snow and ice, lack of snowplows, lack of potholes in the roads and clearly coming out of the winter that we just had, our expectation is that those categories should be robust.

Also those categories typically that I talked about, brakes and chassis and the like, they were challenged during Q2.

We had great performance in batteries and wipers and antifreeze but a lot of our categories where the customer could defer them, they did defer them and we expect those deferrals to come back.

So, Bill, would you say is the positive effect this year from the poor weather equal to the poor effect we had on revenues a couple of years ago from the unseasonably warm weather that we had?

Your guess is as good as mine on that one, Alan.

I am bullish about it but we are going to see how it plays out.

Thank you.

Second question maybe for Bill Giles.

Bill, with less than 30% of the hub stores under three years old, what does the ramp on the revenue growth at newly opened hub stores look like?

Is most of the maturity captured post three years?

If you can maybe provide a little bit more color on that we would appreciate it.

Actually on like a traditional retail new store, a lot of it is captured really in the first two to three years so there is a continued ramp in the maturation post that.

But there is a much more accelerated ramp in the first frankly couple of years and sometimes even shorter than that depending on the market that we get into.

Then the other thing that in addition to having an increase in the maturation process of the new commercial programs, it is just all the initiatives that we are doing.

So we are trying to make every program better every single day and a lot of the things that Bill talked about on the inventory availability we think will help in that process.

Okay.

One last question if I may for Bill Rhodes.

Obviously with one of your major competitors completing the acquisition of Carquest recently, there was certainly -- it was well documented that Carquest was on the auction block for quite some time.

Are you at liberty to maybe elaborate on what it was about Carquest that did not interest you in moving forward more aggressively?

That is a tough question, Alan.

I think I would rather keep our deliberations to ourselves.

I think those could have competitive implications over the long-term and (technical difficulty) industry consolidation.

I figured I would try.

I appreciate the question and I understand it.

I just don't think it would be appropriate for us to comment on it.

Thank you very much.

Dan Wewer, Raymond James.

Thanks, good morning.

Bill Rhodes, a question on the inventories entering the next quarter 8% higher than a year ago.

Is this all additional SKUs or were you finding you didn't have enough depth in the existing SKUs to fulfill commercial ordering?

So for example maybe your systems shows your (technical difficulty) stock was two pieces of a certain SKU, but I've got a commercial customer asking for four pieces and therefore you were having to say no.

What you have seen to date as the vast majority of it has been incremental coverage, not incremental quantities.

As I mentioned, we are testing a lot of different things and in some respects some of those tests are increasing or decreasing the quantities of the parts that we have based upon the delivery frequency of that store.

But what you have seen to date, the vast majority of it has been incremental coverage.

But I did want to reiterate that a lot of it came in right at the end of the quarter.

You talked about that your management is doing a lot of analytical work on the payback on the inventory investment.

Could you help us understand the implications for our GM ROI?

I'm assuming it is probably dilutive but if you could tell us what you are seeing in your tests?

Certainly.

As we go farther down the curve, farther down the bell curve, it is clearly GM ROI dilutive to where we are today.

Let's remember we are at 32.3% ROIC so a lot of decisions opening a new store a lot of times is dilutive to ROIC.

We are very comfortable that it is going to provide us with reasonable returns well ahead of our cost of capital.

And then just the last question and I know we have talked about this in the past but when you look at your tests improving your delivery capabilities in commercial, what do you think are the advantages and what are the disadvantages relative to competitors to build large distribution centers and then could achieve a lot of the same benefits?

Obviously the disadvantages of a significantly changed or a significantly broader distribution network is costly.

It is quite costly and so we are looking at several different things and we have made no decisions at this point in time on the other initiatives.

We have rolled out our improved algorithms for store placements but we have not made any decisions about distribution centers, hub stores or the like.

We are in the midst of testing all of those things but we are encouraged by all of the different things that we are testing and what we now have to do is figure out which one is the optimal approach, which one provides the best return at the lowest cost?

And I think that is going to take us a couple of two or three more quarters to figure that out.

Great.

Thank you and good luck.

Michael Baker, Deutsche Bank.

Thanks.

So a couple of questions on the commercial.

I just wanted to go back.

You said, Bill Giles, that stores that are two or three years old in the commercial business ramp up quite well in terms of the sales and in fact even faster than the retail business.

So I guess I don't fully understand why you wouldn't be seeing greater sales on the commercial business if you have so many immature store, so many stores in that 1% to 2% to 3% of three-year-old cohorts.

Shouldn't those be driving higher sales growth?

They do but at the same time, we still have -- keep in mind 30% of the commercial programs that we have opened today are all less than three years old so they are continuing to ramp and that is driving down a little bit of our productivity when you look at it on an average basis.

The other thing is obviously we are at 74% penetration and as we continue to ratchet that up there will be some level of cannibalization not significant but there will be a little bit and so we just continue to penetrate the market overall.

So I guess that explains why the sales per store would be lower.

But still I would think the growth rate would be higher and so perhaps and here's my second question, is it a function of increased competition in the commercial business or the West Coast O'Reilly is maturing more and more every year with their CSK stores and then in the Northeast, the VIP acquisition?

So is it possible that you are just seeing more competition in the commercial business?

I wouldn't say more because obviously those are replacements of existing competition so there is that (multiple speakers)

Better perhaps?

Yes, I would say that they are slightly better capitalized but look, we've got a 3% market share or less so we continue to believe there is a lot of greenfield opportunities and we have to continue to drive our productivity.

I also think the inventory availability and not to hang our hat just on that, we've got a lot of initiatives going on but I think more inventory in the marketplace is going to be beneficial to the commercial programs both DIY and commercial but specifically commercial as well.

Right, sure.

That makes sense.

Thanks.

I will pass it on to someone else.

(Operator Instructions).

Greg Melich, ISI Group.

Thanks.

My question is really about the inventory addition and its impact on ticket and what it does to the AP ratio going forward.

Specifically is it too early or did the increased SKUs help ticket in either do it for me or DIY in the quarter?

That is a great question.

I think it is a little too early for us to see whether or not that inventory -- and as Bill said, some of it is still in the pipeline -- has an impact on ticket.

We would expect it to drive it a little bit overall as we continue to be able to say yes to more demand in the future.

From an AP to inventory ratio perspective, I think over time that that will likely put a little bit of pressure on AP to inventory but I suspect that will be over a couple of year kind of a timeframe.

I don't see that in the immediate future necessarily.

But it also points to the fact that we've got opportunities to try to reduce some of the unproductive inventory that we have in the chain as we continue to replace this with other additional SKUs.

And net net, we are going to grow inventory, grow SKUs that will put a little bit of pressure on inventory churn which will put a little bit of pressure on AP to inventory ratio.

But I suspect that that will be over a couple of years and not something in the immediate future.

And you mentioned 75% of the initiative is done in terms of the enhanced SKU placements.

If you look at all the other things that you listed that are still on test, could you help us understand the magnitude if you decide to go through with those, would it be a lift of inventory similar to what we have seen so far per store?

Yes, Greg, this is Bill Rhodes.

Number one, a lot of the initiatives that we are working on are competing against each other so you have a delivery methodology frequency change out of the distribution centers which at the same time you also have a mega hub notion that is doing the same kind of work.

So we don't really -- it is hard to say what is going to happen.

When I look at it, I don't think there would be nearly as significant an increase in inventory as a result of these initiatives because you would be talking about deploying inventory in a fewer number of locations, either hubs or distribution centers.

This is not talking about additional inventories in the stores.

And if you increase the frequency of delivery you are also going to be able to bring the quantities of inventory in the stores down so that could actually be a benefit to inventory but it would require capital and operating expenses to get that benefit.

Thanks, good luck.

John Lawrence, Stephens and Company.

Good morning, guys.

Bill, would you comment a little bit a follow-up on Alan's question a little bit about the frequency change as far as the route deliveries.

Some of those hub stores were going maybe once, twice, maybe even three times a day to some of these stores.

Could you talk a little bit more about that and how does the bay or the garage know that you have this additional inventory?

That is a great question on how does the garage know.

They way that they know is our incredibly talented salesforce is out.

Any time you give a salesperson or an operator additional inventory, they are going to tell everybody and so that is a big part of our sales message right now.

As far as the frequency of deliveries in the standard hub stores, we really haven't changed those in the last two or three years.

We did increase them pretty significantly in the 2009, 2010 timeframe.

But now we are testing something and this is again just in test and it is kind of a mega hub notion where it is a hub serving additional hubs so think of one hub that might be servicing six or seven other hubs.

And if they are in the same major metropolitan area, it might be serving that additional hub multiple times a day and then for the far away hubs, it is only servicing them once a day.

And just to follow that in periods when these bays and garages are very busy, does that give the opportunity to that third and fourth player in the market to really move up on that call list because of the increased demand?

I think increased demand but more importantly increased availability.

When that shop finds that you have something that somebody else doesn't, that gives you a real opportunity to move up that list particularly if you are doing a great job with service.

Great, thanks.

Good luck.

Aram Rubinson, Wolfe Research.

Good morning.

Thanks, guys for taking the question.

One question and a follow-up.

The first one is about volatility.

Some of the metrics that we see are kind of steady as ever, EPS growth being in this 15% to 17% range, cash flow you mentioned very predictable and steady SG&A a little bit more volatile and sales a little bit more than historical.

But can you talk to us about the underlying patterns of customer behavior that you are seeing intra-quarter, intra-week to understand what it is that the customer is preferring and just wondering if you can give us a historical perspective on volatility?

Number one, the second quarter for us is always an incredibly volatile period of time.

It is the most volatile period of time that we have.

Number one, you have the holidays in there.

Number two, weather patterns can be extremely different one week to the next.

Last weekend it was 70 degrees here in Memphis, today the kids Shelby County schools are out because it is ice and snow.

So those kind of changes will really change the volatility of our customer traffic patterns.

The other thing that has been different for us we talked about is our average ticket.

Our average ticket for about the last nine months has been -- it is still growing but it has been more muted growth and a big part of that is due to the lack of commodity-based inflation.

We had significant commodity-based inflation for a couple of years and that's slowed down a little bit.

We think that will continue for a reasonable period going forward.

We don't see it changing.

Let me just follow-up if it is okay on your comment earlier, Bill Rhodes, about inventory and kind of wanting to put inventory in so long as it is kind of in excess of your cost of capital.

How do you philosophically think about inventory when your cost of capital is effectively zero and what are the guard rails telling us when it is going to hit that diminishing return?

We hold everything to a 15% after-tax IRR.

So regardless of what happens to our cost of capital we are going to hold every investment to a 15% IRR with the exception of a few real estate decisions that we make in strategic markets where we have to hold them to at least a 12%.

How does payables factor into that because that effectively makes the cost of adding inventory free in that regard?

Yes.

We charge the initiative with the payable with the inventory and don't give it the payables benefit although we let some of the inventory come back into the end of the IRR calculation period.

That is real helpful.

Thanks.

The burden of those costs are real and just because we are able to get the AP coverage on doesn't mean that we don't need to look at that very closely and make sure that we are making wise business decisions.

Thank you.

Bret Jordan, BB&T Capital Markets.

Good morning.

A couple of questions, and another question around the inventory.

I guess if you look at sort of the puts and takes the scale of purchasing the incremental inventory versus the possibly lower margin of growing the commercial business in the gross margin improvement year-over-year, could you sort of give us the impact of both sides of that?

I would say that the increase in the inventory during the quarter had some additional supply chain costs, etc.

but there wasn't a benefit per se from the additional purchasing of the inventory that would necessarily flow through gross margin at least at this stage.

It wouldn't happen until the inventory is sold necessarily.

So that is the financials of it, Bret.

Okay.

Then I guess as you talked about market share, could you give us any color regionally where there are markets that you gained relatively more share in?

The information that we get to day about market share is not at the same level of granularity on a regional basis.

We only get regional information on non-application products.

I don't really think it is wise for us to get into those discussions.

All right, thank you.

Michael Lasser, UBS.

Good morning.

Thanks a lot for taking my question.

Now that you have had time to see the results of both the inventory and the labor investments, do you think these initiatives will allow you to fully close the commercial productivity gap with your peers?

Is that the goal here or do you think that if you do close the productivity gap it will be returned dilutive so you don't necessarily want to get there?

Number one, we want to focus on us, not our competition.

We believe we have tremendous opportunities for increased business in the commercial business over time.

We don't think it is going to come one week or one quarter or one year, it is going to take us improving our model, continuing to work with our salesforce, continuing to deepen our relationship with our customers.

I believe that the initiatives that we are working on particularly the inventory availability initiatives will have a big benefit to us going forward but it is not going to be measured in quarters.

It is going to be measured in years.

As for the inventory that we added, again, I will reiterate that we added it right at the end of the quarter so you didn't see much of it.

As far as the payroll addition, and I appreciate you calling that out, we really last year the second quarter was really tight and our sales trends weren't very exciting and so we very aggressively managed our payroll and in hindsight, we felt like we too aggressively managed it.

So we didn't, we weren't that aggressive this time.

That was a one quarter event, that was not something that we did in Q3 and Q4, it was really a Q2 event that we have now annualized.

Okay, that is helpful.

Then my follow-up question, I think some of your comments around the cadence of the comp during the quarter have raised some questions about the sustainability of the recent industry performance.

Could you parse maybe on a regional perspective, did you see the same type of slow down on the West or the less weather-affected areas?

And have you seen that continue into the current quarter where maybe there has been less adverse weather?

Thanks a lot.

We kind of have a standing practice not to talk about the current quarter, but I appreciate you bringing that up.

So let me add a little bit more specifics to it.

In the last month that we talked about, there were three weeks, the first three weeks of that month where it was snow and ice across much of the Eastern United States including the South.

Those three weeks, we had significant pressure on our sales.

The final week of the quarter we had much improved weather and our business was materially better.

That also coincided with when the tax refunds started flowing in the marketplace.

So we had the combination of improved weather and tax refunds and we saw a material improvement in our business.

Seth Basham, Wedbush.

Thanks and good morning.

I think you just helped us understand the calendar shift a bit with that last week being so strong but going forward, should we expect any changes with calendar shifts in the balance of the year?

It cost us 70 basis points in the first quarter.

It helped us about 1% here.

I think it is certainly going to be neutral for the balance of the year.

Could there be a slight shift between Q3 and Q4?

It is going to depend.

Just like you picked up on, it wasn't going to be a big event until we had a really strong last week and then it became an event.

I know what the first week of this quarter is going to be but I don't know what they last week is going to be so I think it is anybody's guess.

Got you.

Just picking apart the SG&A deleverage in the quarter a bit, can you give us the puts and takes year-over-year as it relates to some of the line items around payroll and advertising, etc.?

And were there any incremental investments for your initiatives?

I would say that there wasn't a lot of incremental investments on the initiatives.

There was some additional costs.

I think payroll deleveraged probably less than 10 basis points or so but to Bill's point earlier, that was really a function of us kind of keeping more consistent with our payroll model.

Over the last year, we probably got off of that a little bit and we really made some cuts that in retrospect we didn't want to repeat as we went through Q2.

At Q1, we mentioned that there was going to be some timing related to advertising where we pushed some advertising from Q1 into Q2 and that was worth probably a little over 20 basis points.

So that is kind of the majority of that 42 basis points.

Thank you.

Brian Nagel, Oppenheimer.

Just a couple of really quick questions.

We have already discussed weather a lot but is there a way to simply look -- if you take the comp you had in the fiscal second-quarter how much of that was directly attributable to the weather?

And then the second question and I think to some extent you discussed this in your prepared comments but the buyback, looking at my model here, you have obviously continued to buy back stock but it would seem like a slight or modestly slower pace than it had been in prior quarters.

Any reasons we should be thinking something into that mix?

I will take the first and I will give Bill Giles the second one.

It is really difficult to quantify the impact of the weather and again it has puts and calls.

So we can see that our batteries and starters and alternators businesses are a pretty significantly; conversely brakes and chassis and the like are down.

I think it did have a benefit.

I would characterize it in the 1% to 2% range.

But I also think that we've got this pent-up demand which should help us going forward.

We love the extremes because if you don't get the extreme weather and those batteries don't fail, it is going to be the next extreme when they do fail.

So we've got that business and now hopefully we will get the deferrable maintenance business as we look forward.

I would just say I have nothing to really read on the stock repurchases.

We are trying to be relatively consistent year-over-year, quarter-over-quarter so I wouldn't read too much into that.

Okay, thanks.

Scot Ciccarelli, RBC Capital Markets.

You mentioned the tight payroll a couple of times just talking about the year-over-year SG&A.

And I am curious, did that lead to changes in employee turnover at all?

And in addition to that with some of the industry consolidation we have seen, is employee turnover a greater concern maybe than what it has been in the past?

No, we haven't seen any material change in employee turnover.

We did see a material reduction when the onset of the recession and we have seen it kick up 1% or 2% over certain quarters but it is nothing material whatsoever.

As far as the industry dynamics, I think number one, it is far too early to see what any ramifications on those changes are but we are always looking for great people that love the AutoZone culture and if they want to come and join a great team, we would love to have them.

When do you think that might play out?

You said it is still too early.

Just given your experience in the industry and obviously with acquisitions themselves, like when would we start to see when people are placing their longer-term bets?

Is it after three months, is it six months?

Is it a year?

Just given your experience wondering what your thought process is?

It all depends on what the strategy is and what the level of execution on that strategy is.

It can happen very quickly.

If there is a massive determination on what the integration plans are or it can take a year.

It is all going to depend on the implementation phase.

Got you.

Thank you, guys.

This concludes the question-and-answer session.

I would like to turn the call back over to the speakers for any closing comments.

Before we conclude the call, I would just like to take a moment to reiterate what separates us from the other players in our industry.

Our culture is very unique, being part of the AutoZone family and striving to improve is very unique across the entire retail landscape.

It is the passion to continue to build our culture that will carry us to new heights.

We are currently working on a variety of exciting new initiatives and tests that we believe will enhance our performance over time.

Ultimately our AutoZoners have delivered year in and year out and I am highly confident that with them leading the charge, our future is incredibly bright.

Thank you for participating in today's call.

Thank you.

This does conclude today's conference.

Thank you for joining us.

You may disconnect at this time.