汽車地帶 (AZO) 2014 Q3 法說會逐字稿

Good morning, and welcome to the AutoZone conference call.

(Operator Instructions)

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 third 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 10:00 AM Central time, 11:00 AM Eastern time.

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

(recording) Certain statements contained in this presentation are forward-looking statements.

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

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

These forward-looking statements are subject to a number of risks and uncertainties, including without limitation, 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, 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 Factor section contained in Item 1a under Part 1 of our Annual Report on Form 10-K for the year ended August 31, 2013 and these risk factors should be read carefully.

(end recording) Mr. Rhodes, you may now begin.

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

I hope everyone had a wonderful Memorial Day weekend.

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

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

Please click on quarterly earnings conference calls to see them.

To begin this morning, I want to thank all AutoZoners across our organization for delivering another solid quarter operationally and financially.

This morning, we reported our thirty-first consecutive quarter of double-digit earnings per share growth.

While past success is no guarantee for future performance, this consistency in earnings is something we strive to attain each and every quarter.

This morning, we'll discuss our sales results and provide you some details on regional and product sales trends.

We'll also provide some detail on the cadence of sales throughout the quarter.

Next, we will update you on our various initiatives.

We're very excited about all the initiatives being worked and believe our progress can benefit the Company's sales and earnings trajectory for years to come.

For the quarter, we reported a total sales increase of 6.2% while same-store sales were up 4%.

In retail, we experienced same-store growth in both traffic and ticket, although ticket growth continues to be subdued versus historical growth rates due to the lack of inflation.

As expected, during the quarter, the deferrable maintenance categories that were challenged during the harsh winter rebounded nicely while the failure-related categories that were so strong during the winter continued to grow but at slower rates than in the second quarter.

These category sales trends also existed in commercial, as well, but weren't as pronounced as they were in retail.

Overall, domestic commercial sales growth accelerated to 14% this quarter versus 12% last quarter.

We continue to be pleased with our progress in commercial, and we see tremendous opportunities for additional growth through further penetration of existing customers and acquisition of new customers.

For the quarter, we opened 137 new programs to finish with 76% of our domestic stores operating commercial.

This brings our year-to-date openings to 311.

We expect to open approximately 400 programs this fiscal year.

While weather has been a big topic throughout the retail sector recently, we felt weather in general didn't have a material impact on our results.

We felt the bigger story was the rebound in the deferrable maintenance categories.

However, our West Coast markets were challenged for the quarter and we attribute that to milder, wetter weather conditions in those markets.

During the quarter, our sales trends were strongest during the first part of the quarter when winter initially subsided and tax refunds began in earnest.

Tax refund season has become a more important driver of our business in recent years as our customers' discretionary spending has been more challenged.

During the latter part of the quarter, our sales fluctuated consistent with the weather patterns.

We continue to believe our customers are financially strained.

One recent additional pressure point has been the increase in gas prices.

During the quarter, gas prices increased $0.29 and are currently $0.07 higher than the same time last year.

Based on the dialogue we see across retail, the low-end consumer seems to be particularly challenged.

Our All Other businesses sales increased 7% over last year.

The deceleration versus the last several quarters is due to the annualization of the AutoAnything acquisition in December.

The All Other segment of businesses includes AutoAnything, autozone.com and ALLDATA.

These businesses performed in line with our expectations.

Now I'd like to review our initiatives for the year.

Our operating theme this year is creating customers for life and the key priorities for the year are: 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 five, 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.

We continued to enhance our operating systems to make them as intuitive as possible.

We also continued to invest more payroll in our stores.

Last year, we managed expenses especially tight 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 payroll.

One area of specific emphasis the last few years has been on the safety of our AutoZoners.

We felt our rate of injuries in our stores and in our vehicles were unacceptable.

We owe it to every AutoZoner to provide a safe working environment.

While these efforts are nowhere near complete, I'm quite pleased and impressed by our team's relentless focus on safety and our performance in this area has shown significant improvement.

After a strategic review in the winter of 2012-2013, last spring, we began to design, develop, and implement tests focused on improving our local market inventory availability.

Our efforts are designed to improve inventory coverage in all stores; increase the frequency of replenishment from our distribution centers; offer broader assortments from our hub stores; leverage the broadest assortment in select hub stores; increase stores' inventory holding capacity; and finally, improve our overnight delivery of hard to find products.

I'd first like to congratulate all of the AutoZoners that are working on these initiatives.

We have made more progress in the last 12 months than I would have expected.

To date, we have learned a tremendous amount.

Most of our efforts have had encouraging results, but this has led us to develop additional tests.

We aren't in a position today to have a definitive point of view on the ultimate outcomes.

It will likely take several additional quarters.

One of the initiatives was to improve the hard parts placement methodology in all stores.

We completed our testing last spring and began implementing last summer.

As of the end of Q3, the majority of this effort is complete.

We have been pleased with our results to date, as the new items we have added have performed generally consistent with our expectations.

While this effort certainly adds additional products, it also removes unproductive inventory at an accelerated rate compared to our previous methodology.

In this initial phase, we decided to be less aggressive with the deletes than the additions.

Based on our performance to date, we anticipate deleting the balance of those unproductive items over the course of the next year concurrent with our category reviews.

Regarding increased frequency of delivery from our distribution centers and/or leveraging select leverage hub stores with expanded assortment, we have substantial work and testing to complete, but the initial results are encouraging.

These initiatives are somewhat competing initiatives and our current focus is to determine the optimal methodology.

Additionally, we are beginning to test different delivery frequencies to determine the most effective approach.

Also this quarter, we opened a few stores with a quote/unquote new prototype.

To the casual observer, not much has changed as the majority of the changes are in the back room and are focused on increasing the holding capacity in the hard parts area.

This change significantly increases our holding capacity and we will be migrating to this new plan in the fourth quarter for new stores.

The combination of these tests has led to increased inventory and additional costs.

Again, we've learned a tremendous amount and we are encouraged by our results, but we still have substantial testing to complete.

We will keep you abreast of developments in future calls.

Additionally, we expanded our total hub locations by one, finishing at 161, and we continue to expand or relocate hubs.

We have now expanded or relocated 120 hubs.

We expect to continue to open a modest number of new hubs and our expansion relocation efforts are also continuing.

As we mentioned on last quarter's earnings call, we have introduced the idea of being more digitally integrated, and we've 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 grow sales.

At this point in the evolution of our online offering, we're focusing more on data compellation and building a knowledge portal 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.

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

As we head into the final quarter of our fiscal year, we remain optimistic on our prospects.

Although we have some concerns about the health of the consumer due to ongoing financial strains and increasing gas prices, we are pleased with our execution and excited about our ongoing strategies.

We are encouraged by increasing traffic counts and the increases we have experienced in the deferrable maintenance categories which we expect to continue through the summer.

Additionally, our acceleration in commercial further builds our confidence in our strategies and tactics to address this vitally important growth vehicle.

Over the long term, we remain bullish on our industry's sales growth opportunities in retail, commercial, international and on the digital front.

As our results highlight, we are intensely focused on delivering consistent performance, investing more aggressively in times of strength, and managing our expense structure tightly during more challenging periods.

We also reported another strong performance in return on invested capital as we finished Q3 at 32.4%, slightly ahead of last year.

We are proud of this metric as it is one of the best, if not the best, in all of hard lines retailing.

However, 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 I'd like to turn the call over to Bill Giles.

Bill?

Thanks, Bill, and 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, total auto parts sales, which includes our domestic retail and commercial businesses, our Mexico stores and our four stores in Brazil, increased 6.1% over the 12 weeks.

Regarding the macro trends during the quarter, nationally, unleaded gas prices started out at $3.38 a gallon and finished the quarter at $3.67 a gallon.

Last year, gas prices decreased $0.07 per gallon during the third quarter, starting at $3.61 and ending at $3.54 a gallon.

We continue to believe gas prices have a real impact on our customers' abilities to maintain their vehicles and we will 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 February.

January was down 1.3% while February was down 0.8%.

The other statistic we highlight is the number of seven-year 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 the benefit this year, we simply are anniversarying a negative event from last year.

It is hard to gauge what benefit this has had or will have on our traffic, but it won't be an additional pressure point like last year.

For the trailing four quarters, total sales per auto parts store was $1.767 million.

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

For the quarter, total domestic commercial sales increased 14%.

Domestic commercial sales represented 17.3% of our total Company sales and grew $50 million over last year's Q3.

Last year's commercial sales mix percent was 16.2%.

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 through Q3, we have opened 311 new programs versus 195 programs last fiscal year.

We now have our commercial program in 3,732 stores supported by 161 hub stores.

With only 76% 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 improved productivity opportunities in current programs.

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

With the support of additional inventory available in markets and a more seasoned sales force, we believe we have a long runway to grow both traffic and ticket with our commercial customer base.

As Q3 showed improvements from Q2, we believe we're on the right track to continue to show growth.

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

We have accelerated the growth of our commercial programs, having opened 1,200 programs in the past 36 months, which is 32% of the programs are three years old or younger.

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

Our Mexico stores continue to perform well.

We opened seven new stores during the third quarter, we currently have 374 stores in Mexico.

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

Regarding Brazil, we currently are operating four stores and our plans remain to open approximately five more stores over the next year, and then pause our development as we refine our offerings and prove that our concept works for our customers and is 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 $2.342 billion, an increase of 6.2% from last year's third quarter.

Domestic same-store sales or sales for stores open more than one year were up 4% for the quarter.

As Bill mentioned earlier, this quarter's results were very much in line with last quarter's.

We continue to evaluate our inventory additions and the impacts that we're having on sales results.

We feel we're well-positioned for the upcoming quarter to grow sales.

Gross margin for the quarter was 52% of sales, up 17 basis points versus last year's third quarter.

The improvement in gross margin was attributable to higher merchandise margins and lower shrink expense, partially offset by the higher supply chain costs associated with current-year inventory initiatives.

In regards to inflation, we continue to see modest decreases in costs year-over-year and this is different than in past years.

At this point, our assumption is we'll 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've not bothered to call out the headwind quarterly.

It is an integrated part of our business model.

Our primary focus remains growing absolute gross profit dollars.

SG&A for the quarter was 31.5% of sales, higher by 39 basis points from last year's third quarter.

The increase in operating expenses as a percentage of sales was primarily due to the higher store payroll and the benefit recorded last year for the net gain on disposable of certain assets.

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

EBIT for the quarter was $479 million, up 5% over last year's third quarter.

Our EBIT margin was 20.5%.

This represented a decrease of 22 basis points versus the previous year's third quarter.

Interest expense for the quarter was $36.2 million compared with $42.1 million in Q3 a year ago.

Debt outstanding at the end of the quarter was $4.378 billion, or approximately $380 million more than last year's Q3 balance of $4 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, and share repurchases are an important element of that strategy.

For the quarter, our tax rate was approximately 35.6%, slightly lower than last year's third quarter of 35.8%.

This quarter benefited from certain discrete tax items.

Net income for the quarter of $285 million was up 7.4% versus the prior year's third quarter.

Our diluted share count of 33.7 million was down 7.7% from last year's third quarter.

The combination of these factors drove earnings per share for the quarter to $8.46, up 16.4% over the prior year's third quarter.

Relating to the cash flow statement, for the third fiscal quarter we generated $463 million of operating cash flow.

Net fixed assets were up 6.3% versus last year.

Capital expenditures for the quarter totaled $102 million and reflected the additional expenditures required to open 37 new stores and four relocations this quarter.

Capital expenditures on existing stores help store remodels work on the development of new stores for upcoming quarters and information technology investments.

For all of FY14, our CapEx is expected to be approximately $440 million.

With the new stores opened, we finished this past quarter with 4,901 stores in 49 states, the District of Columbia and Puerto Rico, 374 stores in Mexico, and four in Brazil for a total store count of 5,279.

Depreciation totaled $58.1 million for the quarter versus last years third quarter expense of $52.9 million.

With our excess cash flow, we repurchased $420 million of AutoZone stock in the third quarter.

At quarter end, we had $307 million remaining under our share buyback authorization.

Our leverage metric of 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 as an attractive capital deployment strategy.

Accounts payable as a percent of gross inventory finished the quarter at 114%.

Next, I'd like to update you on our inventory levels in total and on a per-store basis.

We reported an inventory balance of $3.1 billion, up 12% versus the Q3 ending balance last year.

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

As we highlighted earlier, we have been focused on improving our local market inventory availability.

There are several aspects of this initiative, including improving the placement methodology of hard parts at the store level, which through Q3, is largely completed.

This activity contributed to an increase in inventory per store which was up 8.6% at $594,000 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 32.4%.

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

Now I'll turn it back to Bill Rhodes.

Thanks, Bill.

We're pleased to report our thirty-first consecutive quarter of double-digit EPS growth.

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

We focus on delivering exceptional customer service and executing at a high level consistently, which we believe is a competitive advantage.

To execute at a high level, we have to adhere to living the pledge.

Like our operating theme for this fiscal year states, we must focus on creating customers for life.

We cannot and will not take our eye off of execution.

Success will be achieved with strong attention to detail.

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

We feel these efforts will lead to increasing sales for many years to come.

While our industry sales, according to NPD data made available to us, were higher than last year's results we must remain focused on enhancing every facet of our business.

While it is exciting to see our industry doing well, we cannot become complacent.

We are just starting to implement our initiatives, and while encouraged, we still have a tremendous amount of work in front of us to determine the optimal approach.

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 in the double digits.

We believe our steady, consistent strategy is correct.

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

Our belief is a very thoughtful operating 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.

Thank you.

(Operator Instructions) The first question is from Alan Rifkin with Barclays.

Thank you very much, a question for Bill Rhodes.

Can you maybe just provide a little bit of color on the performance of the hubs that have so far been expanded relative to the ones that remain to be expanded?

What the productivity differences look like between the two?

And then I have a follow-up, if I may.

Yes, thanks, Alan.

They are fairly significant.

Now what happens in many of the cases is the hubs as they were didn't have the space necessary to the have the entire parts assortment that we wanted to have in those hubs.

And so when we relocate them we make sure -- or expand -- we make sure that they have the physical space to hold all of the inventory that we want.

That inventory, we've already determined in the other locations, is productive inventory, so it's just a function of getting the space.

So they perform fairly significantly better.

Any quantification of significantly better?

Are the expanded ones doing 20% better than non-expanded, or is it higher or lower than that?

I don't have the quantification in front of us.

What I can share with you is, like any other investment that we have, the expansions are generating a 15% after-tax IRR, because that's what we hold them to.

So that's not only the inventory load, but also the expense that goes into the remodel or move, as well as the additional square footage.

Okay.

And one follow-up, if I may.

With respect to trying to increase the frequency of delivery, if you look at your product assortment, what proportion of your products would you say need to be available for delivery, same day versus one day versus maybe two days?

Where are you relative to that today?

One of the interesting facts is 70% of the SKUs that are in our stores have one piece on the shelf.

So what that means is, if we sell it during the week we're out of it for up to eight days.

And so what we're finding in the daily replenishment model is that the biggest benefit comes from the items that are stock one and stock two.

So the frequency of delivery allows us to be in stock much quicker.

Now one of the things we're doing is testing five-day-a-week delivery.

Now we're saying we don't know what we're going to do.

We're going to go out and test other cycles two times a week, three times a week to determine what the optimal approach is.

Okay, thank you very much.

Yes, thank you.

Thank you.

The next question is from Gary Balter with Credit Suisse.

Thank you.

Just following up on Alan's question.

Is there a way to measure with your customers the fill rate that you're getting in these expanded hubs?

Are you asking are we able to --

Well, I know you measure it, but could you give us some quantification that way in terms of what percent of the orders are you satisfying from the customers versus what you were before you added the inventory?

Yes, I think one of the ways to think about it, Gary, from a hub perspective is what we look at is the lift that we get out of the satellite stores that are basically pulling merchandise product from the hubs.

In essence, that was product that they might not have otherwise been able to say yes to.

So I won't be able to quantify that for you right now.

But the fact is, is that as Bill said before, we've got our return metrics that we are looking at to determine what kind of lift each satellite store gets as we expand a hub and add more inventory into the hub.

That's kind of how we measure it going forward.

And so that ultimately is showing up in your comp store sales performance, as well.

Thanks, and then just a follow-up and I'll get off.

Bill, you talked about these seven-plus, like your type of vehicles has being growing and continuing growing, but there's some concern about the five- to seven-year-olds as the 2009s now start hitting the equation.

What are your thoughts on that?

Yes, there's a little bit of a dip in that five- to seven-year-old, but the more important point is that the number of registered vehicles hasn't really changed significantly.

So we still have the same number of vehicles out on the road.

So you do have a little bit of a dip, if you will, if you look at the time line.

But for us, the advantage is we do continue to see our vehicles age and that is helpful for us.

So we're finding that our life cycle of product is actually getting expanded out a little bit further.

Great.

Thank you very much.

Thank you.

The next question is from Matthew Fassler with Goldman Sachs.

Thanks a lot.

Good morning.

Thanks a lot for the color that you offered us on the composition of the mix of business as you made your way through the May quarter.

As you think about the August quarter, and you think about the weather that you've experienced year-to-date, particularly the after effects of the tough winter and you think about failure for a maintenance product, how do you envision the mix evolving?

I know it's somewhat forward weather dependent.

And if you could talk about the gross margin implications of that outlook?

Okay.

The best analog that I think we have for what a harsh winter will or will not do for your business performance is two years ago, Matt, when we had a very mild winter.

And if you remember, we called out for some time that that mild winter really hurt us, and it particularly hurt us in the deferrable maintenance categories.

Well, now we're coming off of a very harsh winter.

When we came into this quarter we said we anticipated that the failure items would slow down a bit, which they did, and we anticipated that we would see an increase in the deferrable maintenance categories, think about brake systems, chassis, and the like, and that's what we saw.

Our expectation is that those trends will continue for some time and certainly through the summer months.

As to the ramifications on our gross margin, it's not material one way or the other.

We typically, and I don't think we have ever called out, that we've had a shift in product mix that has been a key driver of our gross margins.

Great.

And then a second question that I want to ask, a brief one.

So, obviously, you disclosed commercial total revenues and it is sort of to us to think about what the comparable store trajectory might be like.

To do that we need to think about the productivity of the new units.

Can you talk about, as you've moved deeper into the base with the commercial rollout, how the sales for new commercial program has been evolving over the past couple, three years relative to recent trend?

Yes, I would say it's remarkable that the new stores, and we track them one period out to 13 periods, how are they doing on both sales and EBIT, and it's remarkable that the consistency of those new store openings, although they are getting slightly better year-over-year-over-year, which is counterintuitive.

You would think that they would be performing worse because, hopefully, we've opened the best programs earlier on life cycle.

But I think as we get better in commercial and as we learn how to open programs better, they're getting marginally better even as we go to the less desirable programs, although they are very desirable.

That's very helpful.

Thank you so much.

Thank you.

The next question is from Greg Melich with ISI Group.

Hi, thanks.

I have two questions, one on sales and a follow-up on inventory.

You talked about sales for the quarter starting strong with tax refunds and weather and failure, and then getting more volatile towards the end.

Could you help us with the magnitude of that?

Was the early part of the quarter 2x what the end of the quarter was?

Yes, I would say probably, I wouldn't say it exactly at 2x, but I think it certainly softened up a little bit towards the tail end of the quarter, and that's always an odd time of the year anyways.

We're kind of past the tax season, before the summer season really gets started.

So it's not unexpected for us to have a bit of sales volatility during that last period of the third quarter, and we experienced it this year, and I think part of it was that we just started out very strong.

I would also add, if you recall this quarter's call last year, we talked about a strong April and the fact that we were maybe we were getting out of the challenges that we had experienced.

So April was particularly tougher comparison versus last year.

Got it.

And would it be fair to say the traffic was positive through the whole quarter even though it may be a little more volatile towards the end?

I think that's fair to say.

Okay, great.

And then my follow-up was, Bill, you mentioned in your comments on inventory that now we're largely complete in terms of the additional items going in for commercial, and that we would now sort of flush out the slower turning SKUs in the ensuing year during normal negotiations.

What does that do to gross margin and working capital as you go through that?

Yes, and just to clarify, in some of the product placement where largely done, we still have some more things to do from a hub perspective, et cetera, in terms of adding inventory, et cetera.

So I still think we have some opportunities to improve our coverage overall.

I think from a gross margin perspective, we wouldn't anticipate that the inventory additions would have a significant impact on our gross margin rate by themselves necessarily.

Obviously, we continue to believe there's opportunity for us to improve gross margin rates.

And I think from a working capital perspective, we, obviously, reported AP to inventory of 114% this quarter versus 111% last year.

And as we've said before, we don't anticipate our AP to inventory percentage increasing significantly going forward.

We do believe that there will be a little bit of pressure on AP to inventory, or working capital, as we move in the next 6, 12, 18 months or so, but we believe that we can kind of maintain close to these levels.

That's great.

Thanks a lot.

Thank you.

Thank you.

The next question is from Dan Wewer with Raymond James.

Thanks.

A question for Bill Rhodes regarding inventory productivity.

You noted that inventory per store is up a little over 8.5%, yet if you look at gross profit dollars per store they were up slightly more than 4%.

So my question when you look at the, let's say, the [jimroy] on these new SKUs, are you seeing diminishing returns before you began the program?

Clearly.

The inventory that we're adding today is significantly less productive than the inventory that is in our base assortment, no question about it.

But when we run our models, we are very confident that even though it's less productive, that it can be a productive investment for us.

And we're pretty pleased with how they're performing so far.

And then as a follow-up, I believe this is the first instance since the fourth quarter of 2009 that operating margin rate declined year-over-year.

Interestingly, you achieved very good sales growth in 4Q 2009, as well, but it does raise questions that with your operating margins well above the industry average, and, obviously, the highest in the industry, do you think we're beginning to see a peak in operating margin rate?

Well, in fairness to full and fair disclosure, last quarter we had a declination in operating margin, as well, so that's --

Okay --

But you're right, though, 2009 was the previous spot, Dan.

At the end of the day, look, we're focused on growing operating profit dollars at high returns, so that's ultimately what we're focused on.

We want to grow sales, gain market share, and we want to deploy our capital which includes inventory and expenses in a manner in which continues to generate high returns.

So that is ultimately our objective.

And so we're not 100% focused on just increasing our EBIT margin necessarily quarter in and quarter out, although we've done a very good job of that consistently over the years.

So is this the peak?

I don't know the answer to that question.

We're not focused on the EBIT margin per se.

We're focused on operating profit dollars and generating high returns.

If I may, I would add one thing.

In 2005, when we created our reinvestment plan our operating margins were at an all-time high of 17.5%.

They went down to about 17% in 2006, and everybody was saying, okay, this is the beginning of the migration back to the mean in the industry.

And, clearly, over time, we found ways to be more productive and increased our operating margin almost 250 BPS above that point in time.

So I have a high degree of confidence that this team will continue to find ways to make this business more productive, but we're not going to get focused particularly on a quarter-to-quarter basis if we have some deterioration in the operating margin as long as we've got good returns.

Okay, great.

Thank you.

Thank you.

The next question is from Kate McShane with Citi Research.

Thanks, good morning.

Good morning.

I think when you start talking about testing changes that you're making in commercial business, about two quarters ago you thought it would take about a year to assess and complete the path.

Is this still the timeline, and once you do decide to take a direction how long will it take to implement?

And then, just in addition to that, how does private label come into play with the testing of your commercial strategies and the increases in inventory?

Okay, on the first one, as far as the timeline, I think we've been fairly vague about the timeline because we don't know what we don't know.

And I say that to say we had an initial test on daily deliveries.

Now we're saying, wait a minute, we need to go test different frequency of deliveries.

So that is going to push out our timeline a little bit.

But each initiative is not necessarily dependent upon the others.

So we've already finished what we call the optimal hurdle, which is [source] SKU placements.

We've now gone into a new prototype, we've made a decision on that and we're moving forward.

So every one of them is not necessarily going to be on the same timeline.

But the bigger, broader ones, which by the way, whatever decisions we make could have significant implications.

We want to be careful and we want to make sure that we've got the right amount of information, and that we have a long enough testing period so it's reliable.

As far as how private label plays into this, number one, we don't consider it a private label.

We think Duralast is the best and strongest brand in the automotive after-market.

And I hope you're enjoying our new marketing featuring Chuck Liddell.

But I don't see that any of this testing to date has proven to change any of our strategies.

I'll remind you that we have some very strong brands that are national brands in our stores, both on the sales floor and in hard parts, and where we find that there's a good value proposition that the customer thinks is important we will carry a brand [Diff], a Duralast brand or someone else's brand.

Thank you.

Thank you.

Thank you.

The next question is from Chris Horvers with JPMC.

Thanks, good morning.

So two follow-up questions.

First, on the gross margin.

Can you talk about the outlook there?

You had some pressure here in the supply chain from the inventory additions that you put into the stores.

Does that continue, and is it related to that deleting process that you mentioned earlier in the script?

Not so much the deleting process as it is just the overall increase in inventory movement, if you will.

And so I would expect us to continue to have a little bit of pressure on supply chain costs for the next few quarters.

From a marketing perspective, we continue to believe -- we haven't had a lot of inflation in the last probably year and a half, and sometimes inflation can be your friend from a gross margin perspective.

So we've done, our merchandising organization has done some really good things in order to try to improve costs from sourcing and optimizing how we're getting product into the country.

So I think that there continues to be some opportunity for us to continue to improve our gross margin rate.

Obviously, the Duralast product continues to do well, and as we continue to increase its penetration that will also help improve gross margin rate overall.

So although we have some pressures here and there, I think we feel pretty positive about our gross margin rate going forward.

And on the deleting side, does that create some sort of markdown risk at the store level that you need to clean out the SKUs that you don't want?

Typically not.

Many of the deletes we're able to push through the system and sometimes we are able to push it back to the vendors, as well.

So historically, deletes has not resulted in necessarily margin pressure.

And then the follow-up on the commercial share per store was according to our calculation down a couple percentage points year-to-year.

Following up on that productivity question, was there anything else that would have driven it down on a year-to-year basis besides the comments you provided previously?

Not too much other than just the number of stores that we're opening on a quarterly basis.

I think we've probably accelerated our commercial program growth rate on a quarterly basis higher this year than we did last year.

Okay, thanks very much.

Thank you.

Thank you.

The next question is from Bret Jordan of BB&T Capital Markets.

Good morning.

Good morning.

A quick question, a follow-up, I guess, on two questions ago around brand and Duralast versus national brand.

Do you have more national brand inventory in stock this quarter versus a year ago?

Is there any change in the weighting?

I wouldn't say it's material.

There's pushes and pulls in various categories, but I wouldn't say there's any material change.

And then, a follow-up, you'd commented on the new prototype store allowing more hard parts in the box.

Could you describe that a little bit more, maybe how much incremental product you get into the store and what type of investment is involved in reformatting?

Number one, we haven't made any decisions to go quote/unquote reformat.

These are for the new stores that we're going to be opening, some of them in the fourth quarter.

Certainly, after the fourth quarter, they will all be opening with this new prototype.

But it has a little bit incremental capital and expense to open the new store, but not material.

But it will carry more than 20% additional hard parts than the current prototype that we have today.

Now, over time, we're going to see how it performs.

We have some stores that do very high volumes so some of these elements we might want to go back and put them in there, but we haven't made any of those decisions at this point in time.

Okay.

And then, one last question.

On your Internet sales volumes, did AutoAnything, or the online initiative grow at a faster rate than the category, I guess, All Other was up 7%.

Did the online sales exceed that?

I'd say a little bit, yes.

Okay, great, thank you.

Thank you.

Thank you.

The next question is from Brian Nagel with Oppenheimer.

Hi, good morning.

Good morning.

I wanted to follow-up on the inventory issue, as well.

I think a couple questions ago someone asked about just the productivity of the new inventory you put in the stores, but I'll ask the question, if you look at the incremental inventory you'd continue to put in the stores for a longer period of time now, is there a way to think about what type of sales benefit should be derived from that, or maybe even said another way, what type of sales or not occurring because the inventory is not there?

Yes, I think in essence, Brian, that's what we're trying to figure out at some level.

So, obviously, we can quantify internally the productivity that we're getting out of our adds today.

But the real question will be is when we will be more expansive on our rollout of inventory and execute some of these tests that we're talking about as to what that will ultimately mean in sales.

So I couldn't give you a number today as to exactly what that would be.

But, obviously, we're continuing to monitor it internally.

Got it.

And then, just as a follow-up to that.

You continued to, the AP leverage is quite remarkable.

Will that change, or will the AP leverage kind of stay where it is even as you put more inventory in?

I think as we put more inventory in, the question is going to be the productivity of the inventory as a group overall.

And so, as inventory turns slow a little bit, if they do, then that will put a little bit of pressure on your AP to inventory ratio slightly.

Obviously, our merchandising organization continues to work with our vendors in order to optimize terms so that we'll continue to work hard at maintaining our AP to inventory ratio where it's been historically.

But I think looking forward, we don't necessarily expect it to increase at the levels it has historically.

Got it, thanks.

Thank you.

The next question is from Aram Rubinson with Wolfe Research.

Thanks, good morning.

A question around labor, I think you mentioned in the release, you were adding labor to some stores.

Can you help us think if that's more DIY-oriented, more commercial-oriented?

And then, I had a follow-up for you, thanks.

Yes, number one, I would say it's both, and we've really moved to managing our labor more on a holistic basis rather than just DIY or commercial over the last year or so as part of our One Team strategy to make sure we're serving all of our customers exceptionally regardless of how they interact with us.

And when you think about the labor increase this year, and it happened in the second quarter and it happened in the third quarter, the biggest reason for the labor increase is we really managed labor very tight last year, and in some respects we're annualizing that very aggressive management of labor because we had very tough sales trends.

One thing I'm proud of this organization, we've performed very well regardless of industry headwinds or tailwinds.

And last year, we had to be very aggressive.

So we're just annualizing that.

There's no change in strategy really.

So there's no change in where you're, let's say, sourcing your parts pros from as they're a mix of internal versus external, and if that should change.

And then, the follow-up I had was also around just the general winter, harsh winter that we had.

As you were coming into this quarter, I'm just wondering whether or not you thought the harsh winter weather would have given you even more benefit than you ended up getting, or how it compared to the expectations you might have had coming in?

Yes, I would say, number one, we're not sourcing our people from any different sources than we have on a historical basis.

Secondly, I would say that our sales performed a little bit better in the third quarter than our expectations, particularly when the winter subsided and the tax refunds were flowing we had some tremendous weeks in that period of time.

And so I would say it rebounded quicker, and then, we've been encouraged by the deferrable maintenance categories and how they continued to perform throughout the quarter.

In thinking about how to compare against these a year from now, if this was more favorable than you might have thought, and then I'll hop off?

I'll say the second quarter is going to be a daunting sales quarter.

We just had a tremendous weather pattern and our failure categories were off the charts in the second quarter.

Now on the other side, our deferrable maintenance categories were down, so it will be what it will be.

We're up to the challenge regardless of what we're lapping next year.

Thank you, best of luck.

Thank you.

Thank you.

The next question is from Michael Lasser with UBS.

Good morning, thank you for taking my question.

I'm curious about what performance metric you're seeking to maximize with all of the different initiatives you have going on, availability, inventory, payroll, is it return, is it margin, is it sales, what are you seeking to maximize and how do you think you'll get there?

Well, as we've said for a long time, our two performance metrics are EBIT dollar growth and return on invested capital.

That's been our incentive compensation program for 12 or 13 years now, it continues to be.

So if you think about what we've decided are the most important metrics, those are it.

Okay.

And then my second question, sorry go ahead.

Go ahead.

My second question was on some of the comments you made around productivity of your commercial programs, the new ones continue to do better.

So, I guess, inherently, that means some of the more mature ones are degrading a little bit.

Is there any -- A) is that true, and, B) are there any common characteristics about what's driving the degradation of performance in some of the older commercial programs?

Thank you.

Yes, I would not infer that the older commercial programs are degrading.

In fact, they are continuing to grow.

What's happening is we've opened 1,400 new locations over the last four years, though our maturity in the commercial programs is fairly significantly different than it was four years ago.

So I would not read anything into the average weekly sales being relatively constant.

They are all moving in the right direction, just a higher percentage of new programs.

Mr. Lasser, does that conclude your question?

We'll move on to the next question.

The next question is from John Lawrence with Stephens.

Good morning, guys.

Good morning.

Bill, would you comment a little bit, not to beat a dead horse with this inventory issue, but can we just talk a little bit about when you talk about those maturity of programs, I guess, the other factor is now that you're at 76% hub commercial program penetration, is what we're talking about is finding that optimization point to whether you can go to 90% commercial programs?

Or, the other way to look at it is how variable are these programs across the country when you open them in terms of breadth of inventory, say, compared to three or four years ago with import parts, et cetera?

Yes, it's a great question, John.

Number one, I wouldn't say across the country that there's great variation.

I would say it depends on the market and the demographics.

So they perform differently in dense, urban environments than they do in suburban environments versus the way they do in rural environments.

They do different in heavy Hispanic or African American or Caucasian environments.

But what we're finding as we go deeper and deeper is more and more stores have the potential than we thought, and so we're continuing to grow at a pretty rapid rate.

We are not closing a lot of programs, in fact, very, very few.

And I think as we continue to improve our commercial business then we find that we can operate in places we didn't think we could before.

So I don't think we know -- well, I'll tell you, we do not know what the ultimate answer is.

I think we suspect it's higher than we ever thought it was before, and the better we get, hopefully, those expectations will continue to go up.

And the last question there is, when you're in a new market is that incremental part that we're talking about here that may be stocked out today with this incremental inventory, can you move up on a call list when you have that incremental part?

Does that help?

Absolutely.

When you first engage with a customer you don't start at number one, at least not on very many occasions.

A lot of times you'll start as fourth or fifth call.

Well, if nobody else in town has it, now you've got an opportunity to impress that customer.

So they call you with something they didn't think you would have it, you have it, and then give them prompt, great service, and guess what, now you've got a chance to start moving up that list.

And all those tests were just trying to optimize the capital required to get that there?

That's correct, and the expense structure, as well.

It's a pretty heavy math problem, honestly.

Great.

Thanks.

Thank you.

Thank you.

I would now like to turn the call back over to Mr. Rhodes for closing comments.

Okay.

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

It's, of course, our culture, which is very special.

Being part of the AutoZone family is very unique across the retail landscape.

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

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

Thanks for participating in today's call.

Have a great day.

Thank you.

This does conclude today's conference.

Thank you for joining.

You may disconnect at this time.