Full Transcript of AutoZone’s F1Q06 (Qtr Ending Nov 19, 2005) Conference Call - Q&A (AZO)

| About: AutoZone, Inc (AZO)

Here’s the entire text of the Q&A from AutoZone’s (ticker: AZO) fiscal Q1 2006 conference call. The prepared remarks are here. We recognize that this transcript may contain inaccuracies - if you find any, please post a comment below and we’ll incorporate your corrections. And please note: this conference call transcript is a Seeking Alpha product, so feel free to link to it but reproduction is not permitted without the explicit permission of Seeking Alpha.

Questions and Answers

Operator

Thank you.

Operator Instructions

Our first question comes from John Lawrence with Morgan Keegan. You may ask your question.

Q - John Lawrence

Bill, can you comment just a little bit more, I don't know, Brian if you can go one more step into the SG&A a little bit, and just give us a little more feel as to how much of that spending of 40, $45 million, X the charges, how much continues, how much, what can you, just go one step further on that, please?

A - Bill Rhodes

Well, John, as we've mentioned on the call, some of it was directly related to resetting our stores. That portion will not continue. It will continue in the second quarter, as we finish that initiative. But the rest of it will continue. And some of it is specifically related to these initiatives that we talked about, and then some of it is the growth in new stores as we highlighted on occupancy expenses. But we are very, very excited about resetting the stores. We've reset 2250 stores in the quarter, and when you walk into those stores, they all look and feel exactly the same. And it is much easier for our AutoZoners to know where our products are, and it is much easier for our customers to know where our products are. I am very excited about what that is going to mean to our future.

Q - John Lawrence

And once again, I know you don't want to give the amount, but is that the magnitude or a small amount of that increase?

A - Bill Rhodes

It was a significant amount, but it certainly wasn't the biggest portion of it.

Q - John Lawrence

Okay. Thanks.

Operator

Thank you. Our next question comes from Bill Sims with Citigroup. You may ask your question.

Q - Bill Sims

Bill, just a follow-up on the resets. Can you give us a little more color in terms of, were these in car store resets how disruptive, if it was at all, were the resets, what was your strategy, in terms of picking the first 2250 stores? Was it geographically based? The oldest stores? Can you give us any color there?

A - Bill Rhodes

Okay. Terrific. Let me address why we did it. Over the last several years, many of our stores had become, they put different planograms in different places. We had an initiative to go and merchandise the stores in the stores so some of the store managers put things in different places and we also had hundreds if not thousands of different prototypes. We made the decision that we wanted our stores to look and feel exactly the same. So our store operations team took the initiative on themselves to go out and reset them all. They were not geographically determined. They were determined by each individual district manager. So the majority, a district manager has done 60 or 70% of their stores. What they do is they reset the entire sales force. All of the gondolas to make sure the right merchandise is in the right place on the gondolas. So when you walk into a wide prototype store, all the merchandise is in the same place in all the wide prototype stores. When you walk into a narrow prototype store, all of the merchandise is in the same place in those prototype stores. Was it disruptive? Yes, it was a little bit disruptive, Bill, but I don't want to overstate that. Our team really did a remarkable job of resetting them. They did a lot of it at night. And they did a lot of it in off-hours with specific crews that were dedicated to completing that project.

Q - Bill Sims

My second question is starting in the fourth quarter you started increasing staffing levels, you increased the hours. Where do we stand at that? Are you now comfortable with the staffing levels in the store or the hours raised at all the stores you wanted to be increased? And then other than the system's upgrade in the back half of fiscal '06, are there any other incremental expenses we should come to expect?

A - Bill Rhodes

Are we comfortable with where our staffing levels are? Today we're comfortable with them but this is retail and every day we're trying different things we try higher levels of service, or of labor, we try lower levels of labor to make sure that we have always got it right. We have launched all of the initiatives as of the end of the quarter that we intended to launch. They were staggered somewhat throughout the quarter but at the end of the quarter they have all been launched.

Q - Bill Sims

My final question is Bill, you have been at the helm now for a little over two quarters I believe, how are things going relative to your initial expectations, relative to your plans? Are they going better, the same, or slightly worse than were you planning?

A - Bill Rhodes

I didn't have a lot of time to create that plan. I wasn't planning to be in this role on March the 12th, and on March the 13th, I was, so it wasn't really something I sat down and reflected on a tremendous amount. I will tell you I am very proud of what we're doing. I'm very proud of our AutoZoners. We have a wonderful management team from our executive committee and our CEO team all the way down into our stores. I am very excited by what I hear from our store operators, from being in our stores, they're excited about what they're doing, they understand what our strategy is, they embrace our strategy, and they're out executing our plan.

Q - Bill Sims

All right. Thank you very much. Congratulations.

A - Bill Rhodes

Thank you.

Operator

Thank you. Our next question comes from Matthew Fassler. You may ask your question. Goldman Sachs.

Q - Matthew Fassler

I would like to ask you just a couple of questions. First of all, following up on the labor question, if you forget for a moment about the resets and the costs and hours associated with that and also about the extra store operating hours and just sort of think on a comp basis, can you say whether your payroll hours on the store are up versus the prior year?

A - Bill Rhodes

We haven't given specific guidance on specific payroll hours, Matt, and I don't really want to get into that because we constantly managed our payroll based upon the trends that we're seeing in the business each and every week, so I don't want to get into a routine of communicating whether payroll was up or down and we kind of had a history of not doing that. I can tell you that I am very comfortable with the payroll that we are spending in our stores today. I think it is the right amount.

Q - Matthew Fassler

But let me ask you another sort of related question then. If you look at the increase in SG&A dollars, did some of that reflect increases in say fuel costs and energy costs and related nonlabor items that seem to be rising from the entire marketplace?

A - Bill Rhodes

Unquestionably. It wasn't the broader part of it, but there are clearly some inflationary pressures from energy costs and the like.

Q - Matthew Fassler

Got you. Okay. Just a couple of others. On the buyback front, obviously you're buying back stock commensurate with your targeted levels of debt coverage. Based on your plan, is it your expectation that you will be able to buy back stock over the course of this year?

A - Bill Rhodes

Without a doubt. What we said is we have two governors on our stock repurchase program, one governor is 2.1 times EBITDAR and the other governor is, as long as it is accretive to earnings. It is clearly very accretive to earnings at these levels. But as you've seen, over time, and this quarter was not inconsistent with what you saw last quarter, the first and second quarters are our seasonably low cash flow quarters. The third and the fourth quarter are where we generate a tremendous amount of cash. We are absolutely committed to our share repurchase program. And it has provided a lot of value over a long period of time.

Q - Matthew Fassler

Got you. And finally, can you give us any update on new progress in naming a CFO?

A - Bill Rhodes

We have initiated a search. I think we put it in a press release about six or seven weeks ago. I'm pleased with the progress that we're making on the search but don't have an announcement that is imminent at this point in time.

Q - Matthew Fassler

Understood. Thanks a lot.

A - Bill Rhodes

I also want to say, I am very proud of our finance team that we have in place here. We have a great group of finance leaders and they are doing a fantastic job. And so I'm not in any rush, I certainly want to hurry up and get it done, but I'm also very comfortable with the team that we have in place, and really want to thank them for stepping up, and leading the finance organization over these last couple of months.

Q - Matthew Fassler

Got you. Thank you so much.

A - Bill Rhodes

Thank you, Matt.

Operator

Thank you. Our next question comes from Matt Nemer with Thomas Weisel Partners. You may ask your question.

Q - Matt Nemer

The first question is, on proprietary brands, can you give us an update on what percentage that is of the mix, and where you think that can go?

A - Bill Rhodes

Yes, Matt. We have said over time that our proprietary brands represent over 50% of our sales. And that really hasn't changed that significantly. It has grown a little bit in recent months. I think there is this misperception out there that we have evolved into this private label house, we call it our brands where we were all using national brands before, and that's simply not the case. What we've done over the last 18 months or so is we have migrated a bunch of brands that didn't, that were so small, they didn't have any meaning in our stores so nobody knew they existed but they were proprietary brands at that point in time and we have taken those brands and rolled them into Duralast and Duralast Gold brands so many categories before, we had Deutsche oil and air filters, well, those are gone now, we had Ultra Spark, spark plug wires, those are now Duralast spark plug wires, we had Albany brake pads which are now Duralast brake pads so it is pulling all of those, in some respects, meaningless brands into one powerful brand that we can communicate the qualities of those brands to our customers so they have great meaning with them.

Q - Matt Nemer

And then just to follow up on the new product that you've introduced, in your stores, how big is the, are the catalog sales for you right now? Is that, I know you've introduced a performance catalog. lower log, I think you have a salvage catalog, how big of a piece is that?

A - Bill Rhodes

We haven't specifically disclosed that but I can tell you I am very excited with what we've done, we call it "project got it" and we're continuing to find more ways that we can say yes to our customers. First of all, it gives us that sale at that point in time when the customer is in our stores but it also, our main objective is to make sure that we're the only store our customer shops. And if we ever say no to them, then they're going to have to go fill their needs somewhere else. So "project to it" is about making sure we say yes and we deepen the relationship that we have with those customers.

Q - Matt Nemer

And then lastly, can you give us some guidance on the break down between ticket and traffic this quarter?

A - Bill Rhodes

Our ticket continues to grow. Our traffic was down slightly. But we're pleased with the trends that we're seeing in our traffic as well.

Q - Matt Nemer

Great. Thanks so much.

Operator

Thank you. Our next question comes from David Cumberland with Robert Baird. You may ask your question.

Q - David Cumberland

Thanks. A couple of questions on the commercial business. The number of stores was unchanged from the end of Q4. Do you expect to add programs in fiscal '06? And then also in commercial, you mentioned some tests. What types of things are you trying in the commercial business?

A - Bill Rhodes

Our commercial store count didn't change during the quarter. We continue to look for different ways to make sure that we have the right programs in the right places. We think we do right now. But we also don't want to open a bunch of commercial programs going into the winter selling season. It is our least profitable selling season, especially on the commercial side of the business, so we don't look to ramp up commercial stores as we go into the winter. We will be continuing with our assessment of which stores need to be on the commercial program as we go into the spring, and we will continue to open new programs during the, as far as the specific test, I'm not going to get into too many specifics, it is too early to tell, but our team went back and said okay, what are all the different things that we need to do to improve this business. And we're trying those in a couple of different markets, and we will see how they do. I'm very excited from what we've learned to date and look forward to taking the learnings and rolling them into our commercial program across the country.

Q - David Cumberland

Great. And one other question, on the loyalty program, planning for that, for six more months, are you making any changes for the program from the first version?

A - Bill Rhodes

I think the only thing that changed was the picture that was on the loyalty card so that it looks a little bit different. It was launched on December the 1st. It is in stores now, if you want to go see it. But it is the same program. Five punches, five purchases of $20 or more equates to a $20 gift certificate. We've been very pleased with the performance of the loyalty card so far. It is giving people a reason to come back into our stores more frequently. And at this point in time, when we're proud of what we're doing in our stores, we want them to keep coming back and getting new experiences.

Q - David Cumberland

Thank you.

A - Bill Rhodes

Thank you.

Operator

Thank you. Our next question comes from Greg Melich with Morgan Stanley. You may ask your question.

Q - Greg Melich

Hi, thanks. I have two questions. One was just to make sure I got the numbers right on the resets. It was 2200 stores that you did during the quarter?

A - Brian Campbell

Approximately, Greg. The number was 2,250 stores.

Q - Greg Melich

Approximately. And then the rest will be done in the second quarter?

A - Brian Campbell

Correct.

Q - Greg Melich

And were all the stores done, were there any that were done late last year or were they pretty much all in the first quarter?

A - Brian Campbell

No, pretty much all in the first quarter.

Q - Greg Melich

Okay. And then the--.

A - Bill Rhodes

For the second question, they were the majority of them were done later in the quarter.

Q - Greg Melich

Okay. Toward the back part, great. Is the working capital and the payables ratio, if you just look at the free cash flow in the quarter, and I guess what resulted in lower share buyback, a lot of it was that being up also versus a year ago. Could you just describe why the payables drip down a little bit versus inventory?

A - Brian Campbell

Sure. Again, our goal by the end of the year is obviously to continue to improve on the payables ratio, and we expect to be driving towards that. In the quarter, it was just seasonality, Greg. There wasn't anything special. It was based on the mix of goods that were sold. And the process. And we were close to the number of last year, but again, we look to show improvement. So it was nothing more than seasonality with accounts payable to inventory. We have our goal of reaching 100% accounts payable to inventory, and that is, we have every option and initiative to go forward to get that number.

Q - Greg Melich

Great. And did any direct sourcing have any influence on that?

A - Brian Campbell

I think that it is still early in the process, while we've reached out,and started to do due diligence on the initiative, it has had some early impacts but it is very early, still. We expect that initiative to just gain traction as the year goes on.

Q - Greg Melich

All right. But that didn't have any impact on working capital?

A - Brian Campbell

Not materially.

Q - Greg Melich

Okay. Thanks.

Operator

Thank you. Our next question comes from Jerry Marks with Raymond James. You may ask your question.

Q - Jerry Marks

How much of the purchases that you have come from overseas? You said it is pretty negligible right now and how much do you expect that to go to?

A - Bill Rhodes

Well, first of all, we haven't disclosed exactly what the percentage of purchases that come from overseas are today, but understand, as far as us direct importing, virtually that number is zero. Now, we have started some over the last couple of quarters but it is very insignificant at this point in time. Now, that being said, we have many people that are buying things, are buying products overseas, and selling them to us, so we have gained some portion of the benefit over time by encouraging our vendors to move their manufacturing facilities over there or finding importers who can do that for us. But what we're doing now is looking at certain opportunities where we can directly import it, and cut out the middle person.

Q - Jerry Marks

And I mean any idea in terms of with the year-over-year improvement in gross margin, how much of that came from, would you say the bulk of the improvement came from these initiatives of you trying to push your vendors overseas and move more towards overseas?

A - Brian Campbell

No, I wouldn't, Jerry, it would still be premature. That is an initiative that is just beginning at this point. No, it is just the standard process of us working with our vendor community, and sales mix, to grow our margins.

Q - Jerry Marks

Okay. Did I hear right, Brian, did you mention that rent charges were up 49 basis points, added 49 basis points to your SG&A on a year-over-year basis? Did you guys increase your percent of lease versus owned?

A - Brian Campbell

Over the last year and a half or so the rent-to-own mix has changed. A lot of that has driven by where the new store openings have been. In the northeast and on the West Coast where it has more of a challenge for us to find purchased property, we have been leasing and what we have said was a combination of rent and depreciation expense was up 49 basis points, a combination of the two of those.

Q - Jerry Marks

Oh, okay. So are you guys maybe down like 65%, lease versus owned now?

A - Brian Campbell

Yes, approximately, just under, around 65%, that is exactly right.

Q - Jerry Marks

And last question. Bill, you kind of talked about your customer research in the commercial end of the market being more towards those customers saying the biggest thing that they care about is reliability. Have you done any research toward the actual end customer who shops those repair shops and what they're looking for, because it just seems to me like there is that, that they're missing out on the opportunity of realizing how much lower cost they could get if they were buying from AutoZone?

A - Bill Rhodes

I think that is a great point. No, we haven't done specific research of our end consumer, of the ultimate end consumer from the shops. We have spent a lot of time working with our partners, our customer partners, on how we can help them improve their business. And clearly, one of the things that we continue to reinforce with them is using us will, one, give you high quality products, great service, but also lower economics,, or improved economics, that's one of the things that we talk about a lot of times when people talk about our brands versus the national brands. I'm a big believer in over the long term economics win, and when we can provide our products at the same or better values for lower costs, over the long term economics are going to win.

Q - Jerry Marks

Okay. Got you. Thanks.

A - Bill Rhodes

Thank you.

Operator

Thank you. Our next question comes from Alan Rifkin from Lehman Brothers. You may ask your question.

Q - Brad Thomas

Yes, hi, it's actually Brad Thomas for Alan. Most of my questions have been answered but just wanted to follow up quickly on some of the sales. You had talked about the commodity prices being up low single digits. I was wondering if you had had any benefit from inflation in your comps?

A - Brian Campbell

Not materially. It was, while there are certain corrections on certain lines to the overall mix it was not a material impact.

Q - Brad Thomas

Okay. Then I know you all continue to talk about having a correlation in your business with gasoline prices. Would it be fair to believe then that your business accelerated towards the end of the quarter?

A - Brian Campbell

We have not provided guidance on run rates throughout the quarters. What we have said is that gas prices, we continue to see correlation but we're just continuing, we more firmly believe that as long as we execute on the initiatives that we have in place, working with our customers, we can provide a solid opportunity for growth in the future. But we have not given the guidance on performance throughout the quarter.

Q - Brad Thomas

Okay. Then just lastly, any comments geographically on areas of weakness or strength?

A - Bill Rhodes

Yes, Brad, we have a practice of not discussing individual regional differences, but what I can tell you is we've been pleased with the improvements we've seen across the country.

Q - Brad Thomas

Okay. All right. Great, well, thank you very much.

A - Bill Rhodes

Thank you, Brad.

Operator

Thank you, our next question comes from Cid Wilson with Kevin Dann Partners. You may ask your question.

Q - Cid Wilson

Hi, good morning. Most of my questions have been answered as well but just two. First, is can you touch a little more on your strategy regarding your, keeping within that adjusted debt to EBITDAR, because this one had came at 2.0 times and it looks like you paid down some debt and the follow-up is what your, what your strategy is in the event of a rise in interest rates?

A - Bill Rhodes

Okay. A couple of different questions there. First, it did come out at 2.0, Cid, but I think it is 2.047, and these two quarters are our seasonably lowest quarters for cash flow. So we want to make sure that we stick within our guide of 2.1 times EBITDAR. So it is very close. It wasn't anything specific other than making sure that we were in good shape as we go into the second quarter. Second question regarding interest rate fluctuations, if you look at our debt, about 85% of our debt is fixed today. So certainly, over the medium term we're hedged well against any rises in interest rates.

Q - Cid Wilson

Okay. And then my actual second question is, if you can touch a little more on your advertising strategy, as it relates to Duralast, and any color in terms of the cost and what we can expect going forward?

A - Bill Rhodes

Well, we rolled out a new Duralast battery commercial during the latter part of the summer. And early into this quarter. And it is a fantastic commercial. We have been very pleased with the results of that commercial. And I think it is airing in a market near you today. So we're continuing to find different ways to build the Duralast brand. It is a great brand. They are great products. And they're very well received by our customers. So we're going to continue to exploit that brand by telling the consumer how powerful it is.

Q - Cid Wilson

Any color on the cost in terms of how much you're spending now versus a year ago?

A - Bill Rhodes

Not materially different. Just in different places. What we want to do is make sure that we, it is not about how much we spend, but how effective we spend it. And we're doing some different things to make sure that we hit our customers in different ways. And I mean the whole Kenny Wallace number 22 Busch car is a different way to go hit our customers, and clearly, I went to a couple of races this year, clearly, that is very focused on our core customer. And it is hitting them in a different way than we have ever hit them before. Focusing on Duralast, that is another new way to hit them rather than the same messages. So I'm very excited. I'm very pleased with what our marketing department has done from those various marketing initiatives to the loyalty card program.

Q - Cid Wilson

Okay. Thank you very much.

A - Bill Rhodes

Thank you, Cid.

Operator

Thank you. Our next question comes from Michael Cox with Piper Jaffray. You may ask your question.

Q - Michael Cox

My only question here is on the Z-Net system upgrade. I was wondering if you could provide some additional details how that differs from the previous parts lookup system you had in your stores?

A - Bill Rhodes

Well, our parts lookup system that we have in our stores today is a green screen. I will tell you, it is a very powerful tool. It has more information, more robust information behind it than any other tool that I've seen in the marketplace. It is a very intuitive and very easy for someone to learn but it is based on green screen technology. Our new Z-Net tool is going to be based on the latest and greatest technologies, XML, GUI interface, those kinds of things and what those advances in technology do is allow us to provide even stronger information for our customers and our AutoZoners. We can provide graphics, we can provide diagrams, we can deploy more specific repair information and it will allow us to use ALLDATA in our stores as well. So we're very excited about it. It is going to be, it is going to beta test this quarter and then be rolled out sometime later in the second half of the year.

Q - Michael Cox

All right. Thank you very much.

A - Bill Rhodes

All right. Thank you.

Operator

Thank you. Our next question comes from Scot Ciccarelli with RBC Capital Markets. You may ask your question.

Q - Scot Ciccarelli

One clarifying item, first. Option expense, should we see comparable levels in the next few quarters?

A - Brian Campbell

Yes. In fact, Scot, good morning.

Q - Scot Ciccarelli

Hi, Brian.

A - Brian Campbell

An indication reviewing last year is your best guidepost for this year's option exposure. So if, in our footnotes we pro forma from the previous year's 10-Qs what our expense exposure would be and we encourage you to look at those numbers.

Q - Scot Ciccarelli

Okay, that's fine. Also, can you guys help me understand a little bit better the difference between the remodels that you've previously referenced and the resets and are the resets in addition to the remodels, is the remodel program still going on or this is instead of? Just help me understand what is incremental and what is kind of just a continuation of?

A - Bill Rhodes

There are actually two completely different programs, Scott. A remodel is we will go in and change the tile in the store and we will change the layout of the store and we will change out parts counters and make them into parts pods, those kinds of things so it is a fairly extensive remodel of the whole store. I almost said reset. But the resets are taking the planograms that are in the stores and putting them in the same exact place in every individual AutoZone store that is set on that prototype. So it is like setting our wiper blades on the insides of the gondola in every store that is set to a wide prototype. It is about setting the tools on a high gondola in every store that is second high gondola in every store, and what has happened, especially when we went back and made our gondolas higher, in some cases, we had categories that were designed to be on a low gondola but they're actually set on a high gondolas, so the AutoZoners had to spread the merchandise out. So it was not a very compelling presentation to the customer. With this initiative, all of those issues are done.

Q - Scot Ciccarelli

And so that, the cost for a reset is significantly less than it is for a remodel?

A - Bill Rhodes

Oh, yes.

Q - Scot Ciccarelli

Okay. All right. That's all I had. Thank you.

Bill Rhodes, President, Chief Executive Officer

Thank you, Scott. Okay. Before we conclude the call, I would like to take a moment to reiterate that we know we have an incredible business built on a strong foundation of disciplined processes, focused on delivering great customer service. As we continue to focus on the basics, we are confident that we will continue to be incredibly successful while continuing to optimize long-term shareholder value. I want to thank each of you for participating in today's call. And look forward to talking to you soon. Wish you all very happy holidays.

Operator

Thank you. And that ends today's conference. At this time you may disconnect your lines.

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