Thank you. Morning, everyone. I'm Michael Lasser, the Hardline/Broadline retail analyst from UBS. Thank you for joining us. We're super thrilled to have AutoZone with us this morning. AutoZone really doesn't need an introduction, especially in the investment community, given how much value has been created over the last 15-20 years by this company. It's been a model of consistency, a remarkable one, with a stellar record of producing great results, generating free cash flow, and returning that cash back to shareholders. I think a lot of that credit goes to the finance team, more Giles than Campbell, but that's fine.
Today we are fortunate to have with us Kristen Wright, who is the company's general counsel, makes sure everything we say is kosher, Bill Giles, who's the Executive Vice President, Chief Financial Officer, and Brian Campbell, who needs no introduction to the investment community, who is the Vice President of Tax, Treasury, and IR. As a reminder, everyone, we do have the Crowd Mics app. Please feel free to throw some wild cards out there. We want to keep these guys on their toes. I want to start with the big picture. It's just been a remarkable run for the sector for some time, and I think there's two elements.
It's the basic building blocks of what's been happening in the auto parts sector with more cars on the road, cars are lasting longer, and being driven harder, along with share gains by the leading players with the industry. Bill, maybe you could take those two pieces-
Sure
provide us some perspective on what you think the long-term outlook for both is.
Yeah, it's interesting because if you look over the last, maybe call it 15, 17 years, you've had a period of time where we had growth of around 4 comp or so in maybe those first five years from 2000 to 2005. Then it was a little bit lower and flatter leading up to 2008 or so. Then since 2008, it's been somewhere around this 4% kind of comp store sale increase over time. I think that seems to me to be a better indication of where we're at and where we're going from the perspective of the fact that the consumer, our consumer, seems to be in a pretty good spot at the moment. Unemployment rates are low, gas prices are low, low food inflation, et cetera, so they've got some more discretionary income.
The average age of vehicles, which is another big metric that we look at repeatedly, is up and has increased, and has increased pretty steadily really over the last 15 years. That's an example of the technology that's being added in the automobile. Cars are lasting longer, and so that helps. It creates more wear and tear. Miles driven has been a number that has moved up over time, but frankly, over the last year, has increased at 3.5%, which frankly is probably one of the biggest increases we've had in decades. There's been a real strong increase in miles driven, creates more wear and tear on vehicles. The complexion of vehicles being sold today is getting more weighted toward trucks and SUVs, heavier vehicles that wind up wearing more down on their automobiles.
We feel really good about where we have been and where we are going. We think we have a lot of initiatives in place, we can expand on those a little bit more, that will continue to put us in a position to provide terrific customer service, both on the DIY side and on the commercial side, that will allow us to continue to gain market share. We feel good about it as to where we're going. We think there's significant opportunities for us to continue to improve our margin, both gross margin, optimizing our expense structure, et cetera. As we sit here today, we feel pretty good.
Sure. I guess the near-term outlook will be influenced by the weather. There's been talks and some of the skeptics are saying, "Well, there's an abnormally warm and dry winter, so there's not going to be potholes and the corrosive material that eats away at the underbelly of cars." Gas prices are low.
Miles driven are increasing. Are those latter two factors going to be more influential for the more intermediate term than the actual-
I think we'll have to wait and see because it's interesting, we did have a milder winter, slightly milder than certainly last year, which was very cold. As we finished up our Q2 numbers, which ended in the middle of February, our quarter ended February 13th, we indicated that their failure-related product led the way. You would intuitively believe in a softer winter that failure-related products might not be as strong because the weather didn't allow them to fail. We had good, strong performance there. The question is, because of the mild weather, did we pull forward some maintenance? I think we won't know that until we get further down the road, and we can look back. It doesn't feel to us, if we look back over historical times, that there will be some gyrations.
Look, we've always said weather evens itself out over time, like you said, more importantly, the consumer's in a good place. There's a lot more miles being driven. There's a lot more wear and tear on the vehicles, et cetera. We've got some initiatives that we think are going to provide better customer service today than we had yesterday, we just think that there's more momentum.
You mentioned previously, just a minute ago, that the period leading up to the Great Recession was a little slower time of growth for the industry. Looking back, is there any lessons that you were able to learn that will guide you to understand if and when this cycle were to ever slow within the auto parts space? Is it just that was a-
Yeah
this procyclical period that people were buying new cars, so they didn't need to replace their existing vehicle?
It's possible that there were some macro effects, and I'm sure, just to be very transparent and fair, that there probably were some things that we were doing that contributed to it. We're accountable for our own performance.
We have to be accountable for that performance during that time period, too. It was a little bit softer. I think that as we look out, it feels as though we don't see any catalyst that's in front of us relative to changing the consumer's behavior, either up or down, at the moment. We feel as though they're in a pretty good place. We think the macro picture is pretty good. The industry situation, like we talked about, aged vehicles, et cetera, technology advancements, are all favorable and all good. That doesn't mean there won't be some headwinds. I'm sure there will be some headwinds as time goes on. Overall, it feels more positive than negative.
One of the misunderstood elements of the industry is that there is a subtle amount of inflationary benefit.
Yep.
Not necessarily pricing, but inflationary benefit from parts complexity. It used to be that we bought-
Yeah
copper spark plugs that would last 10,000 miles and cost $1, and now we're buying iridium spark plugs that last 30,000 miles and cost $10. Do you see that trend slowing anytime soon?
I'm impressed.
Yeah. Please, especially for a guy doesn't own a car.
Right.
That's pretty good.
I would say that, yeah, we don't see that changing necessarily. One of the things we always used to say is that one of the things that is inherent in the industry is the slowdown in traffic, and part of it is the spark plug example. One is that the parts are lasting longer, and they're more technologically advanced, which creates inflation. In essence, we may not see you as frequently as we used to, although we will likely sell you more in $ than we did previously, because the parts are more expensive.
Sure.
When you look over time from a modeling equation perspective, what you've seen is traffic being flat to slightly negative with an inflation on your average ticket of two, three, four, five, which could be either a mix of business, commodity-based inflation, or technological inflation. The technology inflation exists over time pretty consistently. Commodity inflation will come and go as time goes on. Today, we're sitting in an environment where we actually have positive traffic and some increase in ticket.
That may be due to the miles driven or.
It could be due to the miles driven, et cetera.
Okay.
There's a lot of things like that. To your point before, is that we've lived in an environment from a commodity basis that we've had very little inflation. In fact, we've had no real inflation over the last two years, which one could argue is a little bit of a headwind from the standpoint that obviously you've got inflation, wage rates, and other things, you're not getting that on your price points necessarily. We'll see how that pans out over time.
Just to round out the industry discussion from a longer-term perspective, the nature of the vehicle population is changing. There's more electrics, there's more hybrids. Does that have any influence on the demand for aftermarket auto parts, or do you just change with the dynamic nature of the vehicle population?
I think over the, not even short-term, over the next several years, that those changes will not have a significant impact. Because when you step back and think, there's 242 million registered vehicles in the United States today, whatever rate of sale you can conceptualize on electric or hybrids or whatever, that it's just going to take a very long time. If there is a change in the complexion, we'll see it coming a long ways away. Having said that, hybrid cars are still using almost all the same parts for the most part, there's still brakes, batteries, and so on and so forth. There's a lot of activity going on in the car that still is right in our wheelhouse.
Even on electric vehicles, which I think is going to be slow to come, there's still elements of the car that are still right in our wheelhouse. There are a ton of products that we sell that I would argue that most of us in the room could do. We all are capable of washing and waxing our car. We probably could change our wiper blades. We could put light bulbs into our car, maybe with a little bit of help. Maybe ones that might be a little bit more difficult would be an oil change, but that's a pretty accessible job to be done. If you were pinched for dollars and you needed to repair your brakes, maybe your neighbor could help you, et cetera. You could certainly change your battery in your car.
I'm close to 50% of our business at that point. There's a big chunk of our business that's very accessible to the consumer.
Sure. I want to move the discussion over to some of the competitive dynamics that are taking place. Number one, there seems to be a little bit of an arms race developing within the industry. Everyone's putting more capital-
more expense to work to be better positioned for the commercial side of the market, to where perhaps over the long term, as cars become more complex, you'll see customers migrate out of the DIY market into the DIFM side of the market. To some degree, AutoZone's leading the charge. Maybe you could talk about the initiatives that the company's been undertaking, and then I'll have a few follow-ups on that.
Okay. I'm looking forward to that.
Yeah, for sure.
I would say that from an initiative perspective, you're right. I like the terminology on an arms race because, to a large extent in this industry, inventory wins. That it is not one that just lives and dies on a one-day sale or a promotional or coupon, et cetera, or fashion-oriented business. It really is about being able to say yes to the customer, whether that be a DIY customer or a commercial customer. There's a lot of parts proliferation that exist in the industry over time. It's imperative upon us to be able to get more parts into the marketplace, and that's really what our initiatives are really focused on. We've got two big ones that I would call more frequent delivery.
We have today, our stores get delivered about once a week from the distribution centers, and there's about 25,000 SKUs in those retail locations. We've tested doing three times a week or five times a week, settled in on three times a week, and we're rolling out about 300 locations a quarter. Currently are at 1,300 locations as we exist today, with the onset of doing about 300 a quarter over the next year and a half, and probably get about two-thirds of the chain or a little better on that program. Look, intellectually, you would sit there and say, "Look, the company turns at about a 1.4 or five times a year, therefore, why wouldn't you deliver once a month? Wouldn't that be enough?" The reality of it is, there's a very large portion of the SKUs that are one or zero.
Over 70% of the SKUs are one or zero, and there's a relatively high level of randomness in the sale. We've tested it, and we believe that we're getting an adequate return. That more frequent delivery, that three times a week, is really focused on those core SKUs that exist within the retail stores. Then on the hub stores, which we have about 200 hub stores today, which carry up to 40,000 to 50,000 SKUs. You've got that next 20,000 SKUs available to those retail and commercial programs, and the hubs deliver three times a day. If a customer comes in looking for a SKU that's between that 25 and 50, we can get it there within a few hours. Then the mega hubs have SKUs from 50 to 100,000 SKUs.
Now we're in a longer tail, and those SKUs can be there possibly the same day or no later than the following morning because the mega hubs will deliver through a hub and then out to the satellite stores. From an inventory arms race perspective, as you call it, you're right. It becomes a more capital-intensive business. I don't know if that creates barriers to entry for others or if it creates economic challenges for some to compete on a more effective basis, but it clearly is a key element, and we're very well-positioned in order to be able to manage our capital in a way that can allow us to compete very well. We recognize that that's a need that we have. If I can jump on one other piece-
Yeah
that you asked about was that on the I always find it interesting because we talk about, just to be very clear, all those initiatives that we do are to benefit DIY and commercial. Over the years, the one thing we've always discovered is that whenever we have an initiative to focus either on commercial or DIY, the other business always helps because it's about inventory. The reality of it is that most of the customers are looking for those parts, either a commercial customer or a DIY customer who's doing it mostly out of economic necessity, to repair it themselves. You mentioned before about the complexion of the car, and there's no question the cars are far more complicated today than certainly when I was growing up as a kid. Here's a couple other ways to think about it.
One is that the car today can tell you what's wrong with it, which it really couldn't do certainly when I was growing up. There's a diagnostic trouble code that the car, you have a check engine light on, and you can plug a device underneath the dashboard, which you can drive into an AutoZone, by the way. If you have a check engine light, I encourage you to drive into an AutoZone and allow them to plug it in under your car, and then they will be able to tell you what the issue is with the car. It could be an oxygen sensor, et cetera. It could be something you could do yourself, or if it's over your head, then they could refer you to a commercial customer. You could get online and get repair information that we can give to you.
You could watch a video, a YouTube video probably, on how to repair it. I would argue that there's more accessibility to DIY consumer today in order to repair their car than there probably was when I was growing up, for sure.
Certainly when Campbell grew, was growing up, when there were Model T around. Two more questions on these initiatives, because, A, I think there was some debate as you were working down this path on how dilutive it was going to be to your margins-
Yep
to your capital, to your free cash flow production. Consistent with AutoZone's very deft management, it really hasn't been an issue for the last couple of quarters. Does it make sense to even accelerate the pace of rollout because you have some financial capacity to do so? I'll have a follow-up on that one.
Okay. I'll let Brian take the follow-up.
Yeah.
I would say that the pace by which we will grow the initiatives is less a function of the capital and more a function of our ability to digest and execute at a very high level. We're all about execution. Our teams work very hard and believe that that 300 is a pretty good number for them to roll out on a quarterly basis. The mega hubs are going to be a function of whether there's real estate availability in the marketplaces. I suspect that may come a little chunkier as we find locations. The other one is really about execution.
I think an important piece of all this is how you get recognition from your customer base for the initiatives that you're putting in place. Because, to its credit, AutoZone has done a phenomenal job on the retail business. It's 80% of the sales. To some degree, it's been known as a consumer play. How do you alter that perception in the mind of the commercial customers as you're laying out capital to help them?
One day at a time.
Yeah.
What you do is you communicate the capital that is being deployed in the business. You talk to them. You let them know how we're changing, and the tools that we have at our discretion to compete against these other players that they're buying from today. It does take time, because they are conducting business with other parts houses.
It's not a perfect fit, and these folks have been probably doing business with them for years. We know that it takes resources, it takes communication, it takes visiting with salesmen on the street, calling on these accounts. It's a time consideration.
Do you have to be there when there's some disruption in that relationship and move up the call list, or is there a way that you can push the issue a little bit more aggressively?
I think we try to push it. The most likely scenario is what you said, their go-to guy has failed them on a busy Saturday morning, and they'll call us for the part purchase.
Yeah.
The garages understand that they need multiple houses to complete orders. They know somebody's not going to have something because of the randomness of the repairs. What do you do to keep communicating or to jumpstart that even faster? It's to get in front of them and say, "Hey," communicate with the marketing messages that we have on the product or the assortment or the warranty, the labor warranties that we offer if repairs are done incorrectly. Yeah, it's not easy to get one big block of businesses. Mike's talking about national accounts versus up and down the street accounts too, and that's important. There are larger chains out there that companies can negotiate on the front end for business with. As you'd expect, that's a little pricier, less margin happy than the up and down the street guys. Different messages.
It's a good segue, because is there any risk that over time as all the players in the industry increase their capabilities, and everyone's got good service levels, that price becomes more of an issue, that that's the competing factor?
It's possible, but it's down the list, I think, at the moment, because one of the things that, and you've hit on it before, and I think rightly so, is that it's about inventory availability because we always say that there's no point in discussing the price if you don't have the product. At the end of the day, it's about do you have the product, and can you get it here in a reasonable amount of time, particularly on the commercial side of the business, because their objective is to flip the bay as quickly as possible and as efficiently as possible as they can. I'm sure that at some point there may be some pricing pressures, but the elasticity on the pricing has certainly not proven out over time.
It does feel as though your capital and your intellectual abilities are really more along the supply chain and the inventory availability and service, and particularly on the DIY side as well. Because that is a huge value proposition that we bring to the party, is that when you walk into a store with a problem or you're working on something, that you've got somebody behind the counter who's knowledgeable, who can help you and assist you in resolving the problem that you have, and then maybe pull up some information that we've invested in from a technology perspective and an electronic catalog which shows you the complete job and all the parts that go with it, et cetera.
We have seen some consolidation in the industry, which has created disruption in market share opportunities.
Yes
For others. Are you satisfied with the share that you've been able to gain in the wake of some of the disruption? Have there been lessons that you've been able to learn that you can now apply moving forward that will maybe accelerate some of the pace of share gains?
I'll take the first one. Let Brian take the second one. I would say that you know our culture. Obviously we wouldn't be satisfied until we get 100% of the market share. I think that we feel good about what we've executed and how we're performing over time, and we know there'll be ebbs and flows within our competitors. Some will have off days and on days, and they'll all get better at some point in time. We're all about providing great customer service and ensuring that we are satisfying the needs of our customers every day, and that's our 100% focus. We're happy that we're gaining market share, and we are gaining market share on both sides of the business.
Yeah, I think that I'll try to address some of these jumps in the business or potential with the investments that we're making. I think on this latest conference call, we just reported earnings. It feels like a year ago, doesn't it?
Right.
It was last week, with Rhodes and everything else, and traveling. The CEO at the time, Bill Rhodes, said he was not satisfied with the performance at this point. He's being aggressive. He's being competitive there. He's saying, "Look, we are putting these resources in place. We have a 3% market share. While our growth is very good, in fact, most likely industry leading, we still have this small piece of the business. Go out there and reinvigorate the troops with all the rest of the things that are happening in the marketplace these days. See if you can win business." We're not sitting still.
Sure. On the subject of industry consolidation, AutoZone's done some bolt-on acquisitions to enhance its position over time. Is that the right strategy or right now there's four, maybe five big players in the space. Over the long term, is that too many, or could we see some further combinations that could accelerate.
That's a good question. I don't know if there'll be further combinations or not. We've got to be able to just continue to execute our strategy. We really do believe that the culture of the organization is a competitive advantage. We talk a lot about in our canned presentations, we always go through, we've got this Pledge that you've heard.
We live it.
Yes, we live the Pledge. We have a Pledge and cheer that we start every meeting with, and it's really important. It may sound kind of corny, but it's really an important element of the fabric of the organization. Culture is exceptionally important to us. That's why some of these bolt-on acquisitions that we've done have been smaller in scale, and it's helped us really maintain our culture, and that's something that we've worked on hard over the last 36 years, frankly. I think that that's important. Whether or not there will be some consolidation in the industry, over time, I suspect there will be. If history is any lesson, then it likely will have some consolidation.
The reality of it is you have consolidation taking place today, it's just that you don't see it necessarily because there are thousands of independent players out there, et cetera. They're just not household names.
Sure.
When you look at the number of units that are outstanding in the industry, 37 or 39,000, whatever the number is, it's been relatively consistent over the last 15 years, literally. Obviously, we've opened 1,000 stores. Our competitors have opened 1,000 stores. There has been some natural consolidations that have taken place. It's just that you haven't seen them because they're not household names. I suspect that will continue over time.
Have you been forceful in going out, opening stores, taking some business from those local players, and then hiring some of those local players? Or is it that the strategy just let some of the share fall to you as it is?
I'd say probably a combination of both, maybe more of the latter than the former, but at the same time that, yes, we're always obviously looking for good people, and on the commercial side of the business, it's a relationship business. To the extent that there are people in the marketplace that have a strong relationship with that commercial community out there, then they could be great AutoZoners at some point.
Yeah. AutoZone has a remarkable financial model. The vendors finance more than 100% of the company's inventory. Perhaps part of that has been due to a very low interest rate environment. Does your vendor financing program change as the rate environment changes? Should it be pretty stable from here on out?
It does change over time. There are costs of capital, costs of input for all vendors, be it commodity prices or interest rates. Mike is alluding to if rates go up, for example, and cost of borrowing increase for our vendors, would they come back to AutoZone and ask for cost increases? For example, the answer would be yes. That'd be normal. What you do with a diverse vendor base, we have several hundred vendors. We are able to diversify and challenge with vendors and with our house brands, our brands of Duralast and Duralast Gold, we're able to negotiate well against those things. From a capacity standpoint or borrowings or what are banks making available for borrowing, the truth is we're playing just like all other companies in the macro world. To make a call on capacity on credit, that's a greater call than AutoZone.
Nothing on the horizon would suggest to you that you're going to see a shock to your vendor financing program if rates rise?
No, I think it becomes a discussion point, but no, I don't expect a shock. These type of programs have been around for many, many years, but our vendors have borrowed and factored effectively receivable balances Mike was talking about for at least 15 or 20 years with AutoZone.
Okay. The industry has a remarkable economic structure where gross margins have continued to rise over time. Do you see anything on the horizon that might stand in the way of continued increases on the gross profit rate?
Yeah, I think that the merchandising organization has done a terrific job, and we've done very successful in lowering our acquisition costs, either through vendor management, sourcing, global sourcing, doing more direct importing, expanding the use of private label product, which we're pretty well penetrated today, but there's always opportunity in certain categories. The headwinds on the other side are accelerating growth in our commercial business, which operates at a lower margin. Some of the other divisions like Interamerican Motor Corporation or AutoAnything that just naturally operate at lower margins, and they're growing faster than the overall organization, so that creates pressure the other way. The initiatives that we have in place will put a little bit of pressure on gross margin from a supply chain perspective.
Now, all of those things have existed over time as well, and so we have been able to successfully manage our way through that and result in some improvement in gross margin. I don't know if gross margin will increase at the rate at which it's increased historically, but we certainly believe that it's a healthy environment and that we would expect some slight improvement in gross margin over time.
If there is a challenge of having such a juicy margin structure within the industry, is that it might invite competition from outsiders. The intrusion from Amazon has been a very popular topic in our conference over the last couple of days. Do you see the online-only retailers, Amazon, having a role within the auto parts industry over time, especially on the, or maybe on both segments of the market?
I think over time it's possible. It certainly is not lost on us. We take a look at it all the time, and we're monitoring it. No one's made huge strides on an online basis. Frankly, we don't do a significant amount of volume online directly as well, and I suspect our competitors don't either. We do have a lot of traffic that comes to our website for people wanting to learn whether we have the product, what the price is, learn about the product, maybe look up some repair information, et cetera. A high portion of those people that come visit our website are converting in the store later.
There's also a value proposition that exists when you walk into an AutoZone store and you've got a problem or something you're working on, like I always say, it's like having a consultant, and they typically confirm what you already know, but there's value in that. There's value in them telling you, "Yes, you're on the right track. You'll need this. You'll want to do this. Here's the repair information. Let me give you some information on how to execute that," et cetera. The other aspect, too, is that, again, we're not immune to online transactions, but like a battery, for example, can't be mailed, so that's not going to be able to get through. Our average ticket's in the 20s, so it's not a high average ticket.
Some of the ones that do have higher average ticket prices, like a starter or an alternator, there's usually a core that is returned back, so now it's a two-way transaction. Some of the more complicated jobs, we have Loan-A-Tool programs , where we allow you to borrow a tool that you'd need just for that job. There's no point in you buying it. There's all sorts of value, which is why we wouldn't price to an online-only retailer.
Yes.
Because we're providing a value to the transaction that's just simply different than what you're going to get online. We're not immune to it.
Yeah.
I mean, we certainly are investing in autozone.com. We're investing in autoanything.com, which does performance and accessories, very SKU-intensive business. We're positioning ourselves in order to make sure that we learn what's going on online, that we have the capabilities to compete online. At the moment, we don't see that as a huge threat.
AutoAnything's a business you bought a few years ago, performance, accessories. Has there been anything that you've seen from that acquisition that would suggest that maybe that part of the business becomes a little bigger online, but the rest is insulated?
Actually, no. To be honest with you, I think what we've learned is that that's a good, solid business and a bit of a steady business. There are some things that we've learned about operating online, that we've transferred some knowledge to the broader organization. I would say from a market potential, no.
Okay. You've also made forays down south into Mexico-
Brazil. What should we expect about the pace of further expansion in international markets?
Yeah. It's a real opportunity for us. I mean, Mexico has been terrific. Keep in mind, we've been in Mexico now for, I think, probably 17, 18 years roughly, and certainly the first eight years was probably just some gradual, casual growth. Then it really had taken off over the last 10 years. We've got about 450 stores down there now. The concept has been received well, the culture has been received well, et cetera. We've got about eight stores in Brazil. We're still feeling our way there, trying to make sure we have a viable market, a model, pardon me, that will continue to grow. I mention the Mexico example because that could take several years before Brazil is meaningful to the organization, but we needed to plant the flag and get started.
I'm sure there will be some other Latin American countries that may be possibilities over time.
No plans yet today. Over time, there'll probably be some opportunities.
Well, let's end the conversation where we started, which is the remarkable performance of the stock price and the value that the company's created over the years, that's in large part from the consistency, the durability of the formula, which is effectively generate mid-single-digit operating income growth, then be very generous and consistent in how you return capital to shareholders. Over the next five years, what could potentially disrupt that formula?
I'm sure there are some things that can disrupt the formula. I mean, we feel really good about that formula. We think it's very consistent, by the way. I know that we'll have some additional capital expenditures relative to opening some distribution centers over the next 18 months. If I really think about it over a long-term basis, that formula has worked remarkably well, we anticipate sticking with that playbook, that's a playbook that's worked very well for us. We look over time and have challenged that playbook, if history is a good lesson, that playbook has worked very well for us, we don't see any reason to change that playbook going forward.
Sounds great. Well, thank you so much for joining us today.
Thank you.
Well, join me in thanking me, thanking the AutoZone team for joining us.
Thank you.