Thank you. Okay. Good afternoon, everyone. We are representatives of AutoZone. My name is Brian Campbell. To my right is Tom Newbern. Tom is Executive Vice President of Store Operations for all of our domestic stores. He runs the retail operations as well as the commercial business for us, as well as loss prevention. We have approximately 5,200 stores in the U.S., another 450 stores outside of the U.S., plus we have an internet business and an electronic B2B business, ALLDATA. Just 2 weeks ago, we reported our earnings for our fiscal second quarter. We're already firmly into 2016 now, starting our third fiscal quarter. The theme for AutoZone this year, our operating theme, is Live the Pledge. Excuse me, Live the Pledge. Live the Pledge is an ongoing theme for AutoZone. It's constantly about customer service, doing the right thing, helping customers with their automotive needs.
No presentation would be without a forward-looking statement. Prospects of war, including terrorism and the like, we refer you to our annual report. The AutoZone pledge or Live the Pledge that you saw earlier, these four lines were written many years ago, 1986, by a former retired AutoZoner. We live and lead most large meetings by these words. We do a cheer and a pledge, putting customers first, knowing the parts and products in our stores, making sure that the stores look good, and we've got the right prices and the best merchandise. As an overview for the company, we finished Q2 with these 5,200 stores. The purpose of the slide here is just to show consistency. Guys, we consistently grow sales. You're seeing 6%, 7%, 6% average growth rates per annum consistently for AutoZone. In fact, I was chuckling a little bit.
We are a company that's been fortunate enough not to have adjusted earnings. It's been well over a decade since we've reported adjusted earnings on any quarter, and that's nice. We're just trying to stay steady without surprising many folks here. In terms of EBIT or operating profit growth, you're seeing the same consistency, roughly 7%, 8%, 10-year, 5-year, and 3-year basis. Earnings per share at a slightly greater clip than operating profit. You see that growth in the teens, 17%, 19%, 15%, so very steady, very consistent growth performance. Here's our second fiscal quarter's results. We reported, seems like a lifetime ago, it was March 1st, our second quarter's results. Our sales results were up 5%. Our gross margin was up 50 basis points. We de-levered SGA through investments in operating expenses, 40 basis points, picking up 10 basis points in operating margin. We have a 17% operating margin.
Interest, taxes to bring net income up 8%. Our diluted share count was down roughly five percentage points and change for EPS growth of 14%. I started talking to you folks about consistency in results. I'm going to flip the slide and show you year-to-date. When you study these numbers, you're going to see 50, 40, and 10 for basis points, 8 and 14. Oh, boy. Year-to-date, 8 and 14, 47, 28, and 19. Very consistent both of the quarters and year-to-date end results. In fact, sales were up very consistently 5%. AutoZone is always incrementally working on projects, always testing, always working for the next quarter, driving both retail and commercial business strategies. This slide talks about the industries that we compete and sell through. The retail segment is a very large space.
It's estimated at $50 billion, 51 on the slide. You're seeing that it grows at just under 3% per year. We rank with the largest share in this space. These are walk-in customers. This is the origin of our history. The company started, again, in 1979, selling retail. This is a key focus, and I'll put words in Tom Newbern's mouth, but his primary focus day in, day out, growing the retail business. The next space we talk about in selling to is the delivery customer or do it for me. This customer has different demands, different expectations than the walk-in customer. This is made up of both small independent garage owners plus larger chain accounts. Who are chains? Very average names. You've heard them. Household names. Goodyear, Firestone, larger national footprint automotive repair shops.
It's a little bit bigger industry, whereas we talked about $50 billion for walk-in, this is a $60 billion at wholesale business. This is the revenues that parts houses sell through to these garages for. Its growth rate is roughly equivalent over time to the retail side, 2.2%. Depending upon the investor in the audience, some are enamored with retail, some are enamored with commercial. We're enamored with both. We're looking to grow both sides of the business. We have a very small share of this business, guys. We are only a 3% market share holder right now, a couple billion dollars of revenue. We do about $10 billion, to give you an idea, in total sales, just over. You can see this is only about 20% or just under of our total company's business. Our growth strategies are retail. We talked about commercial.
Lastly, we do talk about international. International for us right now is Mexico and Brazil. It keeps us busy and focused. We have digital integration. The retail side, we talked about the industry size. We do plan on opening about 150 stores a year, taking that 5,200 domestic stores up a couple hundred stores or 150 each year. We want to provide every year exceptional customer service. We utilize the internet to do that, as both to sell through as well as for picking up in-store items. We establish marketing themes around driving customers and foot traffic into this. We're pushing hard on inventory assortment. We're making sure that we're adding more breadth of coverage today. Today it's 100-plus thousand SKUs available in a market for our customers.
We're also doing things like, and I'm sure you'll ask questions about this, but availability through distribution center delivery models and mega hubs. We can talk about that in a little bit. Basically, providing and adjusting inventory more frequently from different touchpoints. The commercial growth, we have about 80% of our stores with commercial today, just over that. Not every AutoZone store supports commercial customers. Why is that? Some stores are in parts of towns that just don't have any commercial customers around, so they will never have it. We will add programs over time, and we also are opening new stores, most likely with commercial programs as well. We're opening somewhere around two to 300 stores, probably right in the middle, 250 programs a year for commercial. We're driving performance through a sales force that calls on customers, commercial specialists in our stores.
We are also focusing on brands in this area. We are building our own brand. We have our brands of Duralast and Duralast Gold. Plus, we purchased a company called Interamerican Motor Corporation based in Southern California. They have today over 20 stores that specialize in Tier 1 OE brands, mainly German and high-end Japanese makes and models. But it supports also AutoZone and its model. We talked about the national accounts versus the up and down the street. Very quickly, to get to your Q&A, I'll make sure to tell you that Mexico has 450 stores today. We're in just about every state now, I guess, including the D.F. in Mexico City. We are expanding about 40 stores a year. It's been a very good model for AutoZone Mexico.
However, we've been more recently challenged by exchange rates when you talk about translation of the peso versus the U.S. dollar. The peso especially tied oftentimes, we see it to oil in the oil industry. We've been converting equivalent growth in pesos to fewer dollars because of exchange rate devaluation. Brazil has eight stores today. I talked to you a little bit about the Mexican peso and devaluation. The Brazilian real has depreciated even further than the Mexican peso. The peso has devalued about 30% year-over-year. The real is down about 45% year-over-year. But it's a good business on a top-line basis, but we're still growing and learning there. It is not profitable yet for us, so Brazil keeps us focused. Lastly, before summarizing, ALLDATA is a software company that supports 80,000 customers.
It is a suite of products that's offered to garages and professional mechanics. It's service diagnostic software. It's a shop management package. It's support for shop websites. It's even a learning garage for mechanics. Many customers, this is a way for us to converse with our commercial accounts as well as to introduce them to our parts availability of both AutoZone parts and IMC products. So a solid business for us and ALLDATA's been part of our portfolio since, I want to say 1996. So in summary, what is our business? We're going to grow stores. We're adding commercial programs. We're investing in inventory because availability is absolutely essential in the industry. We're expanding a hub network. We're growing the Interamerican Motor stores, that we recently acquired. We're going to continue to expand internationally. We'll refine and expand e-commerce.
Albeit, if you ask, e-commerce is not as big in our space, fortunately or unfortunately, as other spaces. It tends not to get as much conversation. Within e-commerce, we have both a B2C business, the consumer, and B2B. Lastly, to share opportunities and make sure that we work the store, one store with one concept appropriately. So that's in summary who we are, and thank you for your time. Without further ado, I'll pass the baton over to Ms. Denise Chai. Thank you.
Thank you, Brian. I'll just open up the questions here. Tom, in commercial, what do you think it takes to accelerate growth beyond 8%? Should we expect a gradual acceleration, or are you doing something from a productivity standpoint that can take you to the next level?
I think that our model is not to swing for the fences. I don't know that I would try to model anything beyond where we are. I think that if we can consistently deliver 8% year-over-year, we would certainly be very happy with that. We have a number of initiatives, many of them benefiting both DIY and commercial. Some of them we've discussed, the inventory availability initiatives. I think the key to our evolution in commercial right now is a focus on people. We think about it in three tranches. You build a world-class sales organization, which we've done over the last four or five years. You focus on inventory availability because you have to have the part when the call comes in, and now we're focused on the people side in the store.
We think once we've tackled that third leg, we will probably be at a high water mark, hoping to improve that share.
Is that a one or a two-year project in terms of people?
I would say it's multi-year for sure.
Okay.
Quite frankly, not sure how long.
Okay. Is the focus more on national accounts or independents? Where do you see the most opportunity?
The largest part of our business is up and down the street, so the local shop or local garage. We have a sales organization that is solely focused on business development, primarily with large national accounts.
Okay.
Good business, a little lower gross than you would have up and down the street, which is why we like that customer. Certainly, something that we spend a lot of time focusing on talking about.
Right. Okay. Could you talk some more about your supply chain initiatives, the mega hubs, the distribution centers, how you decide what's right for a particular market?
Okay, we've got two primary initiatives with regards to supply chain. The first is a more frequent delivery schedule. Currently and historically, we've delivered our stores from the distribution center one time a week. We're now expanding that to, we'll probably land at three. In some cases, it may be a little more, some cases it may be a little less. Currently, we've rolled that out to, I believe we said 1,300 stores, Brian. We hope to have the more frequent deliveries rolled to an additional 700 this year, taking us to 2,000, and then another 1,000 in the coming year. We think that 3,000 is about the right number.
Not every store has the volume to support more frequent deliveries. We have our mega hub initiative, which really focuses on the tail with regards to SKUs. It's got about 100,000 SKUs in each of the mega hubs. We use that inventory across anywhere from 250-500 store network, hoping to improve the productivity of those very slow-moving pieces.
I think we are at five now. Probably have another handful, four or five this year. As we stand, we have plans for upward to 30 mega hubs across the country.
Okay. As you increase delivery frequency, what kind of sales lift do you see and how long does it take for the customer to know that you've got that improved capability?
We've talked about Between $1,000 and $1,500 a store-
the combined impact of both initiatives.
What I will tell you, I believe is that with regards to the mega hubs commercial will have a much longer tail, because it takes time to generate the call and the trial. We have the availability. I think that we'll see that continuing to improve our sales for some time.
Okay. Just kind of back to the question of DC versus mega hub. What factors sway into that decision?
Brian, you want to take that?
Sure. The answer for us is ultimately both.
Right.
We actually are going to open two to three, I guess, distribution centers over the next two or three years.
Okay.
Today we have eight domestic distribution centers, and then we're utilizing mega hubs. For us, we tested both in all seriousness to say, "Should we open more distribution centers? Should we open more of these larger stores called mega hubs, and what's the right answer?" For us, working backward into the answer, it was, how quickly can we make inventory available in a particular market? Our solution was by placing extra unique SKUs in mega hubs, which are tucked into markets that will beat the timeframe that a distribution center can deliver from outside of a town. It's a balancing act. If a distribution center is very close to a town, sure, it's absolutely just as fast.
For us, we wanted to utilize these mega hubs and even run sort of a milk run strategy to make SKUs available when they're ordered at same day, multiple times a day. It's a combination of both, Denise.
Okay. What does that mean for inventory per store? Where are you now? Where do you think you need to be? It seems like parts proliferation kind of has no end.
It does. It's been a little bit of a learning experience by utilizing these different touch points for inventory. Initially, you folks see a one number, inventory per store. What you can't see easily is inventory per store distribution center, inventory per store. For us, because we had eight domestic DCs, when you calculate your number, it's predominantly what's really in the store. What ends up happening with these larger stores and distribution centers is inventory gets kind of reallocated between stores and distribution centers like mega hubs. While the absolute number doesn't change materially, the allocation does. Why would inventory, for example, come out of a store? Because safety stocks can get pulled down. Because you're delivering more frequently to your store, you don't need five bottles of X.
Because the replenishment cycle says tomorrow the next delivery truck to a store is happening, I don't need to keep so many inches on the shelves. What I would tell you is inventory per store in absolute numbers may go up a little bit, but not materially, but where it's sitting will start to evolve between the different answers.
Okay, thanks. Gas prices have been such a nice tailwind.
Is there any way to kind of parse out the benefit from the increase in miles driven or how do we anniversary this eventually?
It's not a perfectly scientific answer. In our own analysis, we have seen that as a definite benefit to our business, our industry. Because of the decline in the prices as we begin to lap, we have to ask the same question: Do we feel like the sustainability of miles driven will continue without further declines? While we're in favor of gas prices continuing to go down, we can't imagine that'll happen. Knowing that, our opinion is, at a certain price, Americans drove, and they always did. In fact, every year they were picking up their mileage, up until the recession. Gas prices were relatively in this range, $1.50-$2 a gallon. Our opinion is it doesn't have to keep going down, and have miles driven continue-
is our position. We watch it mindfully. If prices go up, we would expect miles driven to be challenged somewhat. We have a long way to go because prices are definitely in our favor in our industries today.
Definitely. Thanks. In terms of Advance Auto Parts, are you seeing anything changing, anything worth noting? More broadly, what's happening in the competitive landscape?
I think that the lack of visibility to what's going on with Advance's transition is remarkable. We're seeing very, very little. Certainly would've had expectations of some consolidation, not seeing a lot of that. It is fairly quiet. It's my understanding that it's disruptive internally, partially because of some cataloging and content stuff, but that's not showing up on the outside. Now, I certainly would offer that we know that we're picking up share. There has to be a rather large donor there because our other large competitor, O'Reilly's, is gaining as well.
Yeah. Okay. When we look at your industry, extremely fragmented, yet you've got industry gross margins above 50%, and they keep on grinding higher. What's driving this improvement, and do you think that there are any sort of natural limitations here that we might kind of start to bump up against?
Well, I certainly hope not. One has to assume that there is, Denise. We have been very fortunate in this industry not to have reached that point yet. I think that what we would tell people is that you can look for a very similar growth rate in gross year-over-year, maybe a little more conservative than what you've seen recently. We've opened an office in China. We look to do more direct importing ourselves. We think that's going to create some tailwinds for us. It's just a very rational, competitive base, so when we take costs, we're able to pass those on. When we lower costs, we're able to hang on to our retails.
Yeah. Is there-
Nirvana.
Evidently, yeah. Is there any way to size the opportunity from direct sourcing with your own sourcing office?
I'm certain that we've not talked about that.
Does it make you faster?
I'll toss that.
Well, I mean.
I think we're cautious about how we talk about it. Right now, we have a small presence, and we do a small amount of direct importing. The industry, and our company, does a lot of importing. It's just done through domestic vendors-
Partners
that do their own importing. More recently, we have opened up an office in China and hired AutoZoners and moved a few AutoZoners from the Memphis market, in fact, to Shanghai, China. As we learn, what we're finding is that there are Well, we need to understand the vendor base, how easy it is to move product from the ports over to the States. As you can imagine, there's a large amount of product that we buy and sell that is sourced from Asia. Can all of this product, for example, ultimately come from Asia through direct sourcing? While in theory it could, most likely, no. We're taking it gradually. We're negotiating vendor by vendor and seeing and learning, and we hope that that can be a tailwind for years to come.
We're aggressive internally, but we're cautious still externally when we talk about it.
Mm-hmm. Okay. One of the headwinds for gross margin has been distribution costs as you've rolled out the new mega hubs, and you're at five now with a target of, I don't know, 30 or 40 eventually. How do we think about the pressure from distribution on gross margin?
It's been ongoing. We've tried to collar it around maybe a 20- to 30-basis-point headwind on an ongoing basis. As we roll out more frequent deliveries, we've been able to offset that through some of the importing and procurement savings that we've had. What causes that pressure point to continue?
It's important to note that you mentioned mega hubs. They're really not the source of the margin pressure. That's coming from the more frequent delivery initiative.
It's more from the distribution centers that are doing the frequency of delivery. We're adding folks, AutoZoners, in the distribution centers to make sure that we ship more frequently. We're learning as we go, too. Initially, when we put stores onto the program, we'll heavy up our distribution center AutoZoners. As we learn, we'll be able to back that off, or at least lap that deleverage. I'd hope to tell you next year we'll get a little bit better and more efficient on it. As of the moment, we believe conservatively it's that 20 to 30 basis points kind of headwind.
Thanks. Just my last question, and then we'll open it up. Thinking about industry consolidation, Icahn recently took a stake in The Pep Boys: Manny, Moe & Jack. Do you have any insights as to what you think his motivation might have been, and how does this change the landscape for you, either in terms of customers or vendors?
All we have are theories.
From the outside looking in, based on some of the moves, some of the conversation, you have to assume that he's trying to create his own vertical where he has Federal-Mogul, and he's looking for a source for his product. The Pep Boys thing is a little different than what we've seen from in the past, in that they have the service bays attached to the facilities. We've not heard anything about him trying to sublet that to someone else. In fact, the original deal, he had a partnership, I think that he's working with Firestone. I don't think that'll work out for him. I think he intends to run them himself at this point. Who knows? I don't know.
It's unique in that he is the first player we can remember in quite some time that is looking at the manufacturing side, as well as all the way through to the retail side.
Both parts and service. I think it just has yet to play out.
Right. Okay. Still early, of course. Are there any questions from the audience?
We'll have questions for you guys.
Yes.
All right.
Could you guys, I guess, just quickly talk about how technological change impacts your business, whether it's more complex vehicles, which is probably positive, to higher gas mileage rates.
Yeah. Always a question. We've yet to see the impact of the reality that vehicles have become more complex, and they can't work on it, therefore DIY is dying. That has simply not been the case. Once you get under the hood, it is the same internal combustion engine that it's been forever. The drivetrain is the same. The chassis is the same. We spend a lot of time with our large manufacturers, many of whom work directly with the OEs. The OEs are not tooling up to build a whole bunch of new hybrid vehicles. If they did, the demand for most of the parts on the vehicle is the same. From that end, we don't see technology as a headwind anytime in the near future. In fact, on the complexity piece, the parts cost more. We like that. It's different.
Used to be able to buy eight spark plugs for nine bucks. You can buy four for $60. You don't have to change them very often, but the cost of the parts themselves are so high that it seems to be mitigating the risk of the improved performance of the parts.
Okay. Is there any way to size the amount of deferred maintenance in the market, and how are you thinking about the consumer now? What are they doing with the extra gas savings?
Well, I don't get the sense, and who knows, we'll know at the end of the year, but I don't get the sense that there is a tremendous amount of deferred maintenance. What we're seeing, in fact, you've heard us talk before about the impact of weather extremes, and we certainly have not had an extreme winter. We're not seeing a headwind from that because we're seeing maintenance items kick up.
I don't get the sense that there is any deferral going on. I think that the consumer is out there spending the money. The miles driven are up. They require more maintenance, and I think they have a little more comfort with their pocketbook and are doing the work on their cars.
Mm-hmm. Yes.
Yes.
Can you give us a sense of collision components are an important part of the mix, or is it mostly mechanical? The question relates to as we make advances in collision avoidance technology, would that ultimately impact your business? Understanding that the fleet is probably 200 some million cars right now.
It would be a slow process.
Collision is a very small part of our overall business, not material in any way. On the commercial side, we think that there is a market there for us. Not so much with the collision parts, but the mechanical parts as a result of a collision. If that makes sense. Great talk.
Any more questions? How's the last questions?
Yes, ma'am.
You mentioned the margin pressure that you'll have from these initiatives that you're doing for the more frequent deliveries. You're building out the hub network. How long will all of these efforts take, and at what point do we cross over and start having margin accretion from this?
The net margin has actually been up, even with the headwinds. When does the pressure points from the supply chain rollouts end? All we've talked about so far is this fiscal year. The year that we're in, and we're halfway through it. We're very consistent, though, in the number of programs and stores that are affected through the initiative. You'd have to say probably something similar, maybe a little bit less pressure starting next year because you're starting to lap those rollouts. We expect ultimately about two-thirds, maybe 70% of our stores to have more frequent delivery plus mega hubs. The goal, if you can hear it in our voices, is to be very consistent, very steady, not surprise investors with big ups and downs with performance and initiatives.
We think that it's a steady way to handle the spend and have the field AutoZoners be able to roll out and learn the processes. We don't want to have to push too hard, too fast and make a lot of mistakes.
All right. Okay, maybe I'll just close with one more question. Over the next 24 months, what are you most excited about? What do you see as your biggest opportunities? Conversely, what do you see as the biggest risks?
Certainly, the biggest opportunity continues to be commercial. We're excited about where we are. We think that we've got a number of initiatives and put a number of legs in place to really start becoming a more consistent player in commercial and start peeling back some share that some of our other competitors currently enjoy, while not driving up the cost of doing business. Very excited about that, where we are and where we're going. Needless to say, we're always excited about DIY. It is our core business. It is always a priority for us, and it is the cash cow, if you will, that allows us to continue to invest in some of our other initiatives, like commercial. In terms of what makes us nervous: regulation, environmental, and governmental interference. We've got a number of things going on now with regards to minimum wage.
Not the typical minimum wage you may think of, a salaried minimum wage, which will affect all retailers. It would leave a mark if it were to go through today. Everybody's trying to understand what that means, but government regulation interference would be keeping us awake right now.
Understood. Okay, great. Last question, last call. If not, then we'll wrap it up here. Thank you so much.
Great. Thank you.
Appreciate it. Yeah. Thank you.