AutoZone, Inc.
Q2 2007 Earnings Call Transcript

Published: 27 Feb 2007

[Operator:]

Welcome to the AZO second fiscal quarter year 2007 earnings conference call. There will be a question and answer session of today's conference. At that time you may press star 1 on your touch tone phone to ask a question. I'd also like to remind parties, this call is being recorded, if you have any objections, please disconnect at this time. Bill Rhodes, the company's president and CEO, will be making a short presentation on the highlights of the quarter. Conference will end promptly at 10

[Brian Campbell:]

Certain statements contained in this presentation are forward looking statements, forward looking statements typically use words such as believe, anticipate, should, intent, plan, will, expect, estimate, project, position, strategy and similar expressions. These are based by assumptions and assessments made by are management in light of the experience and perception of historical trend, 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 limitation, competition, product evaluation of the economy, including higher qualified employees, consumer death levels, weather, raw material cost of our suppliers, energy prices, the prospect of war including terrorist activity, availability of consumer transportation, constructability access to available financing, and changing laws and regulations. Consults our Forward 10K for official year ended August 26, 2006 for more information related to those risks, in addition to the financial statements said in courts with generally accepted accounting principles. AutoZone has provide metrics in this presentation that are not in those courts. For these metrics, please see AutoZone's press release in the investor relation section at www.autozone.com.

[Operator:]

Mr. Rhodes, you may now begin.

[William C. Rhodes:]

Thank you and good morning for joining us today for AutoZone's fiscal 2007 second quarter conference call. With me today are Bill Giles, Executive Vice President, Chief Financial Officer and Brian Campbell, Vice President and Treasurer, Investor Relations. Regarding second quarter, I hope you had an opportunity to read our press release and learn about the quarter's result. The press release along with the slide complementing our comments today, are available on our website at www.AutoZone.com. Please click on quarterly earnings conference calls to see them To begin I'd like to thank and congratulate our entire organization for their efforts living the AutoZone pledge in 2007. We continue to set new second quarter records for sales, earnings, and earnings per share. Our sales performance was up to our expectations. I could not have been more pleased with the consistency of financial model. We generated 15.5% growth in earnings per share through a combination of a solid earnings growth of 6.2% increase and leveraging our strong cash flow be reducing our shares outstanding. We continue to believe there is a great deal of opportunity to improve our customer shopping experience and the initiatives we have in place are building in momentum. Although our customers continue to be cautious in their buying papers, we believe our focus for 2007 on improving our historical levels will help increase sales in the future. As I said last quarter, 2007 continues to be about profitably, growing both retail and commercial sales. It will be about growing operating profit dollars, all while optimizing our ROIC. And we will continue to be exemplary stead of capital for our stockholders. Id also like to take a quick moment, before we get into our financial details, to congratulate Kevin Harvick and the #21 AutoZone racing team for winning the Bush Series Nascar car race two weekends ago. Richard Children's Racing at AutoZone found a new sponsorship agreement in January. So you can imagine how excited we were to see the AutoZone car cross the finish line at first place, on the first race of the season. I have received great comments from our AutoZoners and customers on this victory and hopefully we will continue our success on the track. It is important to note that one of our objectives with this sponsorship was to reinforce our winning culture. So far we are well on our way to meeting that objective. Congratulations Kevin and RCO. As in past quarters, I'll start with comments on our overall financial results and then go into details regarding our DLY sales initiatives and commercial sales initiatives. Then Bill Giles will provide an update on the remainder of the income statements and both our balance sheet and cash flow statements for this past quarter. Following I'll provide a few closing comments. Regarding the second quarter, for the 12 weeks ended January 10th, we reported sales of $1.3 billion, an increase of 3.7% from last year's second quarter. The in-store sales, or sales per-store open more than one year, were down 0.3% for the quarter. At the start of the quarter, we were cautiously optimistic regarding sales, the price went down in gas, and we were down to around $2.25 a gallon. And we believed our customers began to feel less pressure on their pocketbooks, but a sales improvement never really materialized when there were similar patterns across all regions of the country, our performance was somewhere in both higher competitive markets and in those markets where we're the only other part stool. While some of this could have been driven by unusual weather patterns in the country during the past 12 weeks, we're not satisfied with this level of performance. We continue to work diligently on our customer service initiatives to drive to improve performance. We absolutely believe our current store offer is strong and improving and we're confident we're ready for our peek sales period this spring and summer. In the second quarter, gross profit as of percentages sales was basically flat compared to last year's quarter while operating expenses as of percentages sales decreased by 29 basis points. This resulted in an operating margin of 14.5% up 30 basis points of last year's quarter. Operating profits increased 5.9% versus prior year. Net income for the quarter was $103 million and diluted earnings per share increased 15.5% to $1.45 from $1.25 in the year ago quarter. Our continued disciplined capital management approach resulted in return on invested capital for the quarter of 22.5%. We're very proud that this is the second consecutive quarter that this ratio has improved. We have, and will continue to make investments that generate returns that significantly exceed our working capital. We will not deviate from our efforts to optimize shareholder value over the long term. We continue to be fiscally prude with our investments while optimizing our earnings per share. Now I'd like to talk about DIY sales. Total domestic retail sales were up 3.6% for the quarter. During the second quarter we continue to focus on driving sales and profits for the long term. Our customer research continues to reaffirm what we've always known

[William T. Giles:]

Thank you, Bill. Gross margin for the quarter was 49.2% of sales consistent as the percentage of sales of the previous year's second quarter. In the second quarter, margins continued to benefit from our ongoing category management initiatives and import efforts. However, these gains were offset by a shift in sales to lower margin for seasonal products. As an example of a shift in product sales we had higher sales of antifreeze which typically carries the lower margin. This sales shift was due to generally mild weather during November and December with a cold spell in late January. While not necessarily affecting sales we think that the weather did have a negative effect on our margins in the quarter. We continue to be successful in partnering with our vendors to offer the right products at the right prices to our customers. This includes the ploy chain initiatives, tailoring merchandise mix, and a continued implementation of our Good, Better, Best product line. This all allows us to price our products appropriately while giving our customers great value. Going forward we believe there continues to be opportunity for margin expansion albeit at reduced rates. Our direct import initiative is in its early stages but we will continue to discuss it in future quarters. And we are extremely proud of our merchandising organization for their abilities to improve margins while pressures on procurement costs continue to exist. SG&A for the quarter was 34.6% of sales, down 29 basis points from last year. The decrease was due to favorable cost comparisons versus last year's second quarter and the organization completed its store reset initiative. Remainder of the decrease can largely be contributed to our ongoing focus on reducing expenditures throughout the organization. It is worthwhile to point the occupancy charges continue to be a detriment versus last year, increasing by approximately 26 basis points during the quarter. We are pleased with our progress today toward managing our expenses and we will continue our efforts into the future. EBIT for the quarter was $189 million, up 5.9% over last year. Interest expense for the quarter was $26.8 million compared with $24.3 million a year ago. Debt outstanding at the end of the quarter was $1.854 billion or approximately $75 million more than last year. The increase in interest expense reflects both the ongoing efforts to trim out the company's debts on a long term basis as well as the year over year increase in short term rates. Additionally, interest was higher due to the accounting for capitalized leases established in the first quarter of this year. We expect interest expense to remain higher than the previous year for the remainder of fiscal 2007. Our adjusted debt levels were maintained in line with our guidance of 2.1 times our trailing 12 month EBITDA. We had purposely managed our capital structure relative to our cash flow in order to maintain our credit ratings at investment grade while optimizing our cost of capital. For the quarter our tax rate was 36.5% below last year's rate of 37%. Over the next several quarters, we expect to maintain an approximate 37% effective tax rate. Net income for the quarter of $103 million was up 6.2% over the prior year. Earnings per share for the quarter of $1.45 were up 15.5% on 71.2 million diluted shares. Relating to the cash flow statement, in the second quarter we generated $168.5 million of operating cash flow and we repurchased $129 million of AutoZone stock as part of our ongoing stock repurchase program. Additionally, we reported this morning in our press release, our board is authorized an additional $500 million in capacity to our buy back program. AutoZone's strong financial health has allowed us to continue to repurchase our stock while maintaining strong credit ratios. We intend to continue to repurchase stock after we have appropriately allocated capital to our existing stores and new store openings as long as it is creative to earnings and consistent with our 2.1 times adjusted debt to EBITDA liquidity target, which we maintained again for the quarter. For the second quarter of this year, we again reported an industry leading return on invested capital of 22.5%. We are proud to report that this metric continues to improve over last year's already industry leading rate. Looking at our inventory level, inventory per store on the balance sheet plus the excluded pay on scan inventory was $496,000 versus Q2 of last year of $494,000. As Bill discussed earlier this inventory mounted in line with last year yet it includes the new products added in connection with our new product assorted initiatives. Accounts payable as a percent of gross inventory finished the quarter at 87% compared to 83% last year. We continue to be committed to our goal of achieving 100% AP to inventory and feel confident in our momentum. This quarter we reported a total of $50 million of inventory on TOS which in accordance with GAAP is not reflected on our balance sheet. As we had stated previously, TOS is about aligning the interest of AutoZone and it is one of the programs we use to achieve our financial goals. Total working capital was at $100 million versus last year's balance of $240 million. We will continue to focus on minimizing working capital as this reflects our ongoing focus on increasing cash flow. Net fixed assets were up 5.9% versus last year. Capital expenditures for the quarter totaled $50 million and reflect the additional expenditures required to open 47 new stores this quarter and the maintenance on existing stores and work on development of new stores for upcoming quarters. Depreciation totaled $36 million for the quarter, higher than last year due primarily to new stores and the accounting for new capital leases established in the first quarter. As of February 10th, 2007 AutoZone continues to be one of the few players in our industry to have investment grade debt ratings. Our senior unsecured debt ratings from Standard & Poor’s is triple B plus and we have a commercial paper rating of A2. With these facts, investor service is a signed up senior on secure debt credit rating of EAA2 and a commercial paper rating of T2. We continue to be comfortable with our long-term debt ratings and leverage ratio. Now I'll turn it back to Bill.

[William C. Rhodes:]

Thank you, Bill. In summarizing AutoZone's second quarter results, I would first highlight our EBIT growth of 5.9% over the prior year's second quarter and our 15.5% ETS growth. In an environment where we are seeing a more cautious consumer, the AutoZone model proved capable of generating double digit ETS growth. We definitely were not satisfied with this quarter's results, but quite frankly, we're never satisfied. We continue to feel confident in our plan. During the quarter we were excited to complete the roll-out of our Znet Electronic Parts Catalog, continued to refresh certain AutoZone stores and continue with our new product assortment initiatives but the most exciting thing about what we're doing is staying the course. Steady improvement over the long run. Our story continues to be one of steady, profitable sales improvements, refining inventory assortment, continual training of our AutoZoners, expanding our commercial focus, and prudent profitable paced growth in Mexico. We are about staying focused while making methodical improvements in the model so we would be well positioned for the future. We continue to be energized by our AutoZoners renewed commitment to our culture exhibited in the first half of the year. On the quarter, both our retail and commercial sales results were below our expectations. However, our survey results tell us the AutoZone shopping experience is better than it has been since we began measuring it. While we do not provide financial guidance, the entire AutoZone team and I continue to be enthusiastic about our future. We continue to feel confident in our long range plans. Our plan is a simple one, to provide our customers the parts they want at the prices they demand and to provide our AutoZoners a great place to work. If we do these things, we believe we will continue to enjoy tremendous success. We are very excited about the remainder of 2007. Customer service will continue to be our key point of differentiation and AutoZoners across the company are committed to providing that service to every customer. We will continue living the pledge in 2007. We continue to demonstrate industry leading financial metrics, being a disciplined company, we have proven our ability to manage cost appropriately and invest in incremental initiatives that exceed our stated 15% after tax or our hurdle rate. We are focused on operating this company to profitably grow sales, efficiently deploy capital, and optimize long term shareholder values while maintaining the highest levels of ethics. I thank you today for letting us share with you our company’s past accomplishments and touch on our ongoing initiatives. I look forward to keeping you abreast of our results well into the future. Now I would like to open up the floor for questions.

[Operator:]

At this time if you would like to ask a question please press star and then one on your touchtone phone. You’ll be prompted to record your name. To withdraw your question, press star two. Once again if you have a question, please press star one on your touchtone phone. Our first question comes from Gary Balter from Credit Suisse, your line is open.

[Seth Bashem:]

Hi, good morning this is actually Seth Bashem for Gary.

[William C. Rhodes:]

Good morning Seth.

[Seth Bashem:]

I was wondering first if you care to comment on how current trends are in this third quarter which we’re in now?

[William C. Rhodes:]

Yes, Seth when we announced our earnings we were two weeks and two days into the quarter so this is very fresh news on the last quarter and we don’t think it’s appropriate to get into two week trends.

[Seth Bashem:]

OK, fair enough. Secondly, moving onto some of the inventory assortment initiatives, perhaps you can provide move color on what you found in your tests and change the assortment, how that affect sales trends in those stores and what are you expecting as you role it out to the entire chain?

[William C. Rhodes:]

The rollout is not by individual store. In fact it is more category related. So, we will go in and we will look at a specific category and assess it across all of our stores, and then we will run those product assortments through our distribution supply chain networks. So it’s what we are seeing so far is individual category performance. As we mentioned this time I guess in the third quarter of last year, we had launched a new product assortment initiative but our initial results…we weren’t seeing what we anticipated it seems. So we stopped and reevaluated those and over the course of the last six or seven months have redone those category reviews and began rolling some of them out in the first part of last quarter. So far we’ve been pleased with our performance but the majority of those new product assortments will be hitting this quarter.

[Seth Bashem:]

OK, is it fair to say you expect a material pickup in sales on the commercial side as this one of the biggest areas you are changing the assortment?

[William C. Rhodes:]

One of the biggest areas, you know first of all, the products that we sell continue to grow on both sides of our business. A significant amount of this focus is on later model coverage, or newer car coverage. We would expect some higher penetration on the commercial side. We’ve also developed some very propelling marketing initiatives that we’re going to launch at the same time these products assortments hit the stores to introduce the new product assortments to our commercial customers.

[Seth Bashem:]

OK, thank you.

[Operator:]

Our next question comes from Bill Sims with Citigroup, your line is open.

[Bill Sims:]

Thank you and good morning.

[William C. Rhodes:]

Good morning.

[Bill Sims:]

Bill it sounds like you are a lot more optimistic from proven and commercial sales in the third and fourth quarter. But I just want to step back to the second quarter. Outside the sluggish environment, it looks like a lack of full assortment of products is one issue as well as the emotional environment by competitors that you maybe weren’t willing to meet was the other issue. If we could look at the individual commercial sales for any loss sales that you had, was it more a function of not having the availability of parts or a function of not being willing to necessarily compete on price? As we look into the third quarter, give me a feel for how you think these two issues will change and how you’ll mitigate both the price issue as well as the assortment issue?

[William C. Rhodes:]

Well I think the way to mitigate any price issues, is we’re building a differentiated model. We’re very focused on how do we differentiate ourselves with the standard differentiations for the long term. Obviously, price is not a very sustainable point of differentiation. We’re focused on making sure we have the right products for our customers and that we provide them with that trademark AutoZone customer service. We’re continuing to build what that customer service looks like on the commercial side. Our trends in the second quarter weren’t materially different than they have been over the last few quarters. We are not satisfied with that but as I said in the prepared remarks, “We’re not going to chase sales for the sake of sales.” We continue to have improving profitability in that business and we’re building strong relationships with customers that are based on things that we think are important; product assortment and customer service.

[Bill Sims:]

Can you give us an idea of which was the more the important issue dragging times? Was it product assortment or was it unwillingness to compete or unprofitable sales?

[William C. Rhodes:]

I think it’s a little bit of both. Obviously last year when we decided to slow down our product assortment, not only did we not gain the benefits from it but everyday that your product assortment sits out there it becomes older and older. So we needed to refresh our product assortment which is what’s going on now. There are certain players in the market place that want to compete on price and that’s not our point of differentiation. We are going to offer our customers very compelling prices and great values. But that’s going to be very good customer service.

[Bill Sims:]

And then once the product assortment is up, how do you communicate that to your commercial customers and what type lag do you think there will be before we do see a real pick up in sales?

[William C. Rhodes:]

I don’t want to try to predict the why. We’re creating really compelling marketing materials for our sales representatives be them the regional commercial sales managers, the territory managers, or commercial specialists to take to the street and have individual sales sessions with our customers. We are very excited about that.

[Bill Sims:]

Thank you very much. Good luck.

[William C. Rhodes:]

All right, thank you Bill.

[Operator:]

Our next question comes from Matthew Fassler with Goldman Sachs, your line is open.

[Matthew Fassler:]

Thanks a lot and good morning. I want to follow up on the sector issue. You know clearly it sounds like we are all scratching our heads a bit as to the sales melees across the sector with gas prices moving around whether it’s up or down etc. As you look at competitive expansion your own, those are some of the companies you face. Do you feel that there is any change in capacity that might be contributing to this or perhaps anything in the competitive front outside the traditional aftermarket retail channel? Just to go once again beyond the background to see if there might be anything else at work here.

[William C. Rhodes:]

You know Matt, I’ll start with first of all we have said in our script that we think there are thousands of opportunities to open additional stores. We’ve been very prudent with our store expansion and I said we’re going to maintain it in the mid single digit range. When a specific competitor opens in a specific market place does that put pressure on it? Absolutely, but it’s a localized pressure. It’s not a macro pressure. Certainly, there is some overall accumulation of those impacts on our sales performance but it’s not materially different than it has been over time in my opinion. As far as any outside competitive pressures, we are not aware of any.

[Matthew Fassler:]

Gotcha and then secondly on the weather front, just to check in on some of the things that you’ve seen. When the weather has cooled off during the winter for example, has the business responded? I am not asking about any one moment in time but have you seen the typical sensitivity that you would ordinary experience?

[William C. Rhodes:]

You know Matt, it is very difficult in our second quarter. First of all, our second quarter is, it starts before Thanksgiving and runs through Christmas and New Year’s. It is very difficult to monitor individual trends day to day and week to week. Because it’s a very low sales period for us and there are a lot of other things going on. Weather patterns make it a very tenuous situation. You can see them reacting one way or the other. Certain categories do very well when its warm, other categories do very well when it’s cold. What we said in the cold, we think it had a slight positive impact, that is run through our quantitative model but we don’t think it was a material impact one way or the other very much. Thank you, Matt.

[Operator:]

Our next question comes from Danielle Fox of Merrill Lynch. The line is open.

[Danielle Fox:]

Thanks, good afternoon. I just had a follow-up question on the inventory, just understanding sort-of the numbers. It looks like total inventories were up 11%, and sales was up about 4%. Could you just explain the differential given the trend per store inventory? Is it that you're holding more hard parts centrally that's causing the total number to increase?

[William C. Rhodes:]

Not necessarily, Danielle. I think the way to look at it is, your item total basis inventory up about 11%. If you adjust for the POS inventory, it's up about 6%. Keep in mind square footage is up about 5.7%. So when you look at it that way, you get right down to an inventory-per-store that's relatively consistent with last year, which we actually feel pretty good about considering that we're in the process of trying to expand some of the categories and some of the coverage that Bill just talked about. So I think overall, we feel our inventory is in good shape. Our AP inventory has got a little bit of strength to it. So, from a working-capital perspective, we feel really great about where the balance sheet is and our ability to manage inventory.

[Danielle Fox:]

OK, great. The other thing was…I'm just curious, you mentioned that occupancy was a 26 basis-point drag on SG&A. I'm wondering why that's going up, and whether or not we should start to see that level off at some point? Thank you.

[William T. Giles:]

No problem. It's basically, it's gone up a little bit, some of that is depreciation, some of that is a mix of lease stores that we take on versus stores that we outright purchase. So, that put a little bit of pressure on occupancy overall. As that mix adjusts we would expect it to level out, if the mix does adjust. But I think over all, we feel pretty good about what the organization has been capable of delivering this quarter from an expense management standpoint. And we were very pleased that we were able to leverage SG&A by 30 basis points during the quarter.

[Danielle Fox:]

Thank you.

[Operator:]

You have a question from Matt Nemer, Thomas Weisel. Your line is open.

[Matt Nemer:]

Hey, good morning. Two quick questions. First, could you elaborate a little more on the new product that you put into this store. As you mentioned, it was late model, but I'd love to know whether the mix between domestic and import, and then what categories you're adding in.

[William C. Rhodes:]

Yeah. First of all, it's going to be every category. As I mentioned, we created a new tool that takes into account a lot of new attributes and some of those attributes give us a better opportunity to forward-predict where demand is going to be. We have great data on historical demand, whether we could fulfill that demand or not. And we're leveraging that data now. So we're using that new tool across every individual category. In all categories we're adding products, and in all categories we're deleting products. Remember that we do our product assortment by individual store. So this is helping us define where the latest and greatest parts need to be in those stores.

[Matt Nemer:]

OK, and then secondly, are there any plans internally to leverage your inventory investment with an increased effort to sell products on line, either separately or with some sort of in-store pick-up functionality?

[William C. Rhodes:]

Yeah, we obviously believe that we still have an opportunity from an internet capability, and we continue to invest in there. It's not a significant portion of our business today. And the other aspect of the internet is that it's a great opportunity for customers to come to the site and get educated on certain products and get information, and then eventually buy on-line and pick-up at store. So yes, we believe that there's opportunity for that. It's not significant as it is today, but there is certainly opportunity for us to continue to plug that channel of distribution.

[Matt Nemer:]

Okay, and then lastly, as you look at the macro factors that are out there, have you spent any time looking at vehicle quality? The vehicle dealers are reporting warranty expense down double digits, primarily because of improved quality. I'm wondering if that's playing into the overall malaise here.

[William C. Rhodes:]

You know, first of all, the correlation between dealers, what they experience in overall quality, and what we experience, is very different because they're dealing with manufacturing problems, or they're dealing with a different life cycles of the vehicle. Remember, we start seeing the sweet spot of the car at the age of seven years old. Those are not going to be any warranty items for them. There's certainly places where technology has changed the quality of parts. Ten years ago, planning to go 100,000 miles on a tune-up was unheard-of. But, ten years ago you could buy a spark plug from us for $0.39. Today, there's higher than $9.99. So there are some technological places where the frequency of repairs are down, but the cost to provide that additional quality makes the prices go up. Today there's highs at $9.99, so there are some technological places where the frequency of repairs are down but the cost to provide that additional quality makes the prices go up.

[Matt Nemer:]

That's helpful. Thank you.

[William C. Rhodes:]

Thank you.

[Operator:]

Your next question comes from Dan Wewer, Raymond James. Your line is open.

[Dan Wewer:]

Thanks. Good morning, Bill. You had mentioned that one of the leading indicators of AutoZone's business is the number of vehicles that are seven years of age and older. And obviously the demographics there are favorable. Again at the same time, the additional inventory that you are adding is in late model vehicles. And it sounds at odds with where you see the sweet spot of the business. I wanted to see if you could help me understand that.

[William C. Rhodes:]

Well first of all, we are also attacking a new part of the business which is the commercial part which is earlier in the life cycle. But that sweet spot changes based upon the various categories. For instance, break pads, you're going to see them much earlier in the life cycle because it's a non warranty part and it wears out faster. You know, 30-40,000 miles most vehicles are getting their first brake job. Places like oil and air filters, if you don't have a 2007 in your store, you're going to dissatisfy your commercial customers as well as your DIY customers. So it depends on the product assortment. But we are skewing more towards later model coverage and a big part of that are our opportunities to service our commercial customer needs.

[Dan Wewer:]

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

[William T. Giles:]

It's a great question but we began automating it on a broad scale in December of 2006 so we now have two months of that. We are reviewing that data very frequently but quite frankly we don't know how to interpret it yet. It's just so new to us, you know, we're still learning how to interpret that data. There are things that we're seeing that surprise us and things that we're seeing that confirm what we've always known.

[Dan Wewer:]

And then the last question I have, Bill, was that you had noted that pricing remains stable in the industry and your competitors had made the same comment. But is it reasonable to expect that rational pricing behavior to continue if the industry wide slump continues through 2007?

[William T. Giles:]

Well I can't certainly predict what's going to happen in a competitive environment, but what I can say is what we've said many times. In so many cases, this is a failure driven business. We can all mark alternators down 50% and nobody's going to go out and buy them. So prices are not nearly as important in this business as making sure that you have the right product assortment and making sure that you help your customers do the jobs that they want to do and if they don't want to do them then you refer them to your great commercial customers.

[Dan Wewer:]

Great. Thanks and good luck.

[William T. Giles:]

OK. Thank you.

[Operator:]

Your next question comes from Michael Banker, Deutsche Bank. Your line is open.

[Michael Banker:]

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

[William C. Rhodes:]

I don't think so, Mike. I think that we believe, we continue to work hard on our overall expense management. And we certainly continue to identify areas where we will continue to make investments. But I don't think that you'll see any kind of increase in SG&A related to those initiatives. I think we will continue to balance them out as we have in the past.

[Michael Banker:]

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

[William C. Rhodes:]

Oh we think that we continue to manage SG&A and continue to make the appropriate investments both in service as well as training etc. So yeah the objective for us is to continue to provide a better shopping experience which we think will ultimately lead to improved sales performance.

[Michael Banker:]

OK. Well great. Thanks. Good luck.

[William C. Rhodes:]

Thanks, Mike.

[Operator:]

You have a question from David Cumberland, Robert Baird. Your line is open.

[David Cumberland:]

Thanks. Good morning. Can you give an update on your loyalty program including any changes to the reward system and also someone just touched on this also your ability to capture customer information, what kind of information are you getting?

[William C. Rhodes:]

First of all, as I've mentioned earlier, we just rolled it out across the nation virtually in early December and we are now doing an electronic card versus where before we had a manual punch card. There offerings are generally the same. We are testing a few different offerings in different parts of the country to see which ones are the most compelling to customers. But as far as customer information, we're receiving quite a bit of customer information. The most important part is we're seeing what the purchasing habit and frequency rate are for our individual customers. Again, it's too early in anything into that data but it's very nice that I have it.

[David Cumberland:]

Thank you.

[Operator:]

And a question from Armando Lopez, Morgan Stanley. Your line is open.

[Armando Lopez:]

Yeah hi. Thanks. Good morning. Just two quick questions. One in terms of Znet you had mentioned you had rolled out Znet it sounds like across the stores now. Can you maybe just talk a little bit about as you've rolled it out have you seen a pick up in sales at the stores as you have rolled it out throughout the last couple of quarters?

[William C. Rhodes:]

Yeah we really didn't roll it out over the last couple quarters. It really was rolled out in the most part in December. Just by the way, there are some stores in the company that still do not have Znet and the reason they don't have it is so that we can measure them as controlled points against the Znet performance. We haven't seen any drastic change in trends versus what the control stores are at this point in time but it's going to take a little while to leverage all the data. There is a tremendous amount of improved data in there. It helps our AutoZoners see it and visualize the parts to make sure that they get the right part to the customer. And then it also gives the customer a tremendous amount of vehicle specific repair information. So it helps them do their jobs.

[Armando Lopez:]

OK. And then second, on the inventory and adjusting the hard-parts used and stuff. Could you maybe talk a little bit about where you are on a store basis in terms of getting the right Q-count or the right mix on the store by store basis?

[William C. Rhodes:]

Yeah. First of all, I think we have always been very good at that. We're just going to get even better at it. So these are refinements. We've been doing store specific hard-part assortments since the early to mid '90s. And so this is another refinement that helps us and it's a pretty significant refinement. It's really leveraging a lot of different data that we haven't had the opportunity to leverage in the past. So we're excited about it but it is a refinement. Probably one of the biggest factors is because we had to stop last year. We're a little bit behind on updating those product assortments today. But we're excited about getting caught up and that would be substantially complete this quarter.

[Armando Lopez:]

OK and then just one last one. On the commercial side, or the stores which have the commercial programs, particularly the test stores, you mentioned that you had seen a pick up in a majority of the test stores. Maybe could you talk a little bit about the stores where you haven't seen the pickup that you had expected? Is there something specific to the stores as to why you may not have seen the same type of results?

[William C. Rhodes:]

You know, and a lot of the differences that we've come down to they are primarily based upon store level execution. That's the biggest difference that we find in the stores that do exceptionally well versus stores that don't. There are certainly market differences. Some stores don't have the market size that others do. But when we have the right team in that store, we are very effective.

[Armando Lopez:]

OK. Thank you.

[William C. Rhodes:]

Thank you.

[Operator:]

You have a question from Allen Rifkin, Lehman Brothers.

[Alan Rifkin:]

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

[William C. Rhodes:]

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

[Alan Rifkin:]

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

[William C. Rhodes:]

You know, first of all, these are not remodels. I've think I've said that from the last call. These are refreshes. We're painting the exteriors of the stores. We're painting on a slightly faster frequency than we did before. We quite frankly got behind on making sure that the appearance of our stores look great, like we say in our pledge, and so we're returning to normalized maintenance cycles.

[Alan Rifkin:]

OK. I mean, I guess, I'm just trying to put my finger on what catalyst we can maybe look for over the next six to twelve months that will, you know, absent weather which you have no control over and absent gas prices which you have no control over, what micro issues could we maybe take a look at to try to monitor to help you folks reverse the seamstress sales trend that we've seen for two and a half to three years at this point? Could you maybe try to help me better understand that?

[William C. Rhodes:]

You know, Alan, first of all, we are sticking with the initiatives that we have. We've added some new ones. We just rolled Znet. You know, that's two months old. We've just rolled an electronic loyalty card just two months ago. We are substantially updating our product assortments. We are incredibly focused on improving the customer shopping experience in our stores. I think, they look as good as they've looked in a long period of time. You know, we can't predict what the future's going to be but we are fairly optimistic that we're doing the things that are right for the long term of this business.

[Alan Rifkin:]

OK. Bill, thank you very much.

[William C. Rhodes:]

Alright. Thank you Alan.

[Operator:]

Our next question comes from Cid Wilson, Kevin Dann & Partners. Your line is open.

[Cid Wilson:]

Hi, good morning Bill. Question regarding your private label initiative. Can you give us some sense in terms of what you're seeing there compared to national brands? And also can you touch on that as it relates to commercial as well?

[William C. Rhodes:]

I think one of the things that we see with respect to our private label product is that we continue to gain market share there and we continue to gain acceptance from a quality perspective. I mean one of the things that we're very proud of is there is a high level of quality on our private label products. And we continue to work hard in communicating that to our customers. And I think that we're improving that. And you can tell that through surveys and customer surveys as well as research that we do that in fact our quality has improved in the eyes of the customer over time. From a commercial perspective, we talk a lot about expanded parts coverage etc. and again I would echo the same thing. I think that our private label product continues to gain increased acceptance in the commercial markets. But as we talk about it a lot it's all about quality, it's all about product coverage, and it's about service, and we got to have a compelling price. And it's all of these things taken together that will continue to improve our commercial business.

[Cid Wilson:]

OK. And my next question is regarding procurement costs. Can you talk a little further about what's your strategy to controlling it or improving it on?

[William C. Rhodes:]

Yeah I think that there's obviously a lot of merchandising strategies relative to procurement cost. One of which as an example would be increasing our penetration from the import standpoint and we believe that if we continue to do that, it would again be in the very early {inaudible} stages but there's a real opportunity for us to continue to reduce our overall procurement cost. At the same time there's a lot of commodity based aspects of the material to go into our products have risen over time. So we're battling those at the same time. But I think imports are probably an example of an opportunity for us to reduce our overall procurement cost on an ongoing basis.

[Cid Wilson:]

OK, and my final question is that regarding store openings. Is there anyway you can give us some sense into what you're seeing from the stores that are new stores and what kind of productivity you're seeing in those stores compared to year's past or a few years ago when you opened up new stores? And where are you seeing the most opportunity geographically? Is it further in the Northwest or the upper Midwest or are you still finding them in the Tennessee, Alabama, Southeast area?

[William C. Rhodes:]

Yeah, I'll probably give you a bit of a boring answer. The fact is that the productivity of the stores has been relatively consistent this year versus even the prior year. So we're pleased with the way new stores are opening. I think they've done a little bit of a better job at the timing of opening and spreading them out throughout the year. So from that perspective I think the productivity of the new stores has been reasonably strong. At the same time from the geographic perspective I can't really point to one particular area of the country that has more opportunity than others. We continue to find significant opportunities and at the same time we are continuing to find new market opportunities at the same time. So we believe that there is significant opportunity for us to expand our footprint across the United States.

[Cid Wilson:]

OK. Thank you very much.

[William C. Rhodes:]

Alright before we can close the call I would like to take a moment to reiterate that we still have much to accomplish in 2007. While we had an incredible business model built on a strong foundation of discipline processes focused on delivering great customer service, we understand that we cannot take anything for granted. We are committed to building a platform for profitable future growth and we believe the initiatives we have in place for 2007 and beyond will help to accomplish that goal. I thank you very much for participating in today's call.

[Operator:]

That concludes today's conference. Thank you for participating. You may disconnect at this time.