Good afternoon, everyone. Welcome to the second to last session of the conference. We're finishing big here. We're super excited to have AutoZone. We were at dinner last night, and someone described the prototypical capital allocation policy that AutoZone uses as AutoZoning. I think they could also use AutoZoning to describe the consistency of the operating performance, there's a lot to be proud of there. From the company, we have Rob Durkin, who's the VP of stores, Tom Newbern, who's the SVP of store ops and store development, the legendary head of investor relations at AutoZone, Brian Campbell.
Legendary.
I think a good place to start, a very timely topic, is two things. First, the impact that lower gas prices have on the business. There's been a lot of conversation about it. Where do you tend to see the most pronounced impact from a demand side on lower fuel prices?
No, go ahead, please.
Good afternoon, everyone. It would be easy to say that lower gas prices help primarily lower economic customers, folks that have smaller incomes. I would say, though, in the last several months, that benefit actually reverts to all consumers in the U.S. There's a benefit. The categories in particular that we look at, more maintenance-related items. We are not a big discretionary store, failure-related items, we can't make you folks buy something if it's not broken. In the maintenance categories, if gas prices are lower, you have a little more money in your pocket. You're more inclined to actually go have your oil changed, even though the light on the car says, "Change your oil," and you're not changing your oil. That happens quite a bit in America. That's a real cash savings.
Is it brake pads, filters, fluids, or is it kind of across the business?
The categories I'm talking about would be brake pads, fluids, belts, hoses, oil changes, categories that we bucketize our sales into three.
Could've been deferred.
Yeah.
Weather's been a very popular topic as well. I guess there's two sides to the weather impact as it relates to the auto parts business. When it's very cold, it leads to more failure, but once the spring comes, that tends to stimulate demand for more maintenance items, more spring cleanup products. When do we start to see that? Will the good news or the positive benefit from a really warm, reasonably timed spring offset the difficult compare you're going to face from the adverse weather conditions you experienced last year?
What do you think? We had a fairly tough comparing, too. The winter was a bit later than normal. What we normally start selling this time of the year would be those things that customers can defer. It's too darn cold to go out and change my oil. My brakes are squeaking, but they still stop. We would start to see that type of deferred maintenance now. Winter's drug on a couple of weeks longer than normal, but that demand doesn't go away. We would certainly anticipate seeing that pick back up as soon as
Hopefully, the snow melts.
Yeah, as soon as this is over.
Yeah. The nature and the composition demand changes in the next few weeks.
Right.
It gets into more the spring cleanup. If the weather gets nice, is it going to be sufficient to offset all of the demand that you experienced last year from it remaining so cold and precipitous well into the spring?
Well, I should ask Rob, too.
I would say we hope so.
Yeah.
From a size of those categories perspective, they're significant enough. Okay, good. From a longer-term perspective, for a while now, the nature of the vehicle population and AutoZone and the auto parts sector talked about the sweet spot being 6-10, 7-10-year-old vehicles. We're getting to that point where the smaller vintages of cars that were sold in 2008, 2009 are starting to graduate into the sweet spot of the sector. Surprisingly, or maybe not, it hasn't really had an impact on auto parts demand. Do you think it might, or are there offsetting factors such as more work on older cars?
I think it has had a very subtle impact, a negative impact, on sales results when there are less cars. You are correct. In the grand scheme of the number of registered vehicles in the U.S. being so large, north of 250 million vehicles, and a lack of car sales of more like single digits, 5 to 10 million units, that were sort of missing in those early years, that offset has been more than made up with just older vehicles on the road in general. That subclass, you're right, is a headwind, in general, we're seeing cars on the road longer, and older cars require more piece count, more units to be sold.
Okay. When we go out and talk to commercial customers, mechanics, we hear two-thirds of the volume could go to that 6 to 10, 7 to 10 demographic. Is it different than what you hear or does AutoZone over-index, under-index to different cohorts of cars?
Obviously, to answer that, there is a difference between retail and commercial customers. Commercial customers that are having someone else do it for them, they are dealing with primarily a younger car population. If you're surveying mechanics, it is going to be a younger customer base. When there are people going to shops that are one-year-old vehicles all the way up to 10-year-old vehicles, for example, we, in walk-in business, tend to see cars that are seven years old, basically 100,000 miles and older. They're just distinctly different customer bases. Is there something uniquely different going on today within those two sort of spheres? No, not really. You are seeing different ages, more miles being driven across these spectrums.
Okay. Got a question from the audience. Does consolidation amongst commercial customers threaten pricing or volume for that segment? Is there a possibility that these customers could go direct to manufacturers?
In the commercial segment?
Yeah.
I don't think so. I think that you look at some of the larger national players, the vehicle population is so diverse right now, it really doesn't make sense. In fact, we would try to sell them on the fact that they don't need to be keeping inventory. We have a store within 30 minutes of nearly every installer in the country. We would argue that we've got to carry that, and obviously it's a SKU-intensive business. Everyone shouldn't have to do that. That's the business model that we're in commercial, and it doesn't really make sense for them to do that.
Yeah, it doesn't make sense because a lot of these garages, just the storage space alone to keep these parts.
Right
If you had to go directly to a manufacturer, they're just not built that way. They're not built with a huge back room for storage. It's more efficient to utilize a parts store. There is a markup applied to those parts when passed through to the end consumer, it would be awfully difficult for them to do that.
Okay. A couple more questions on the commercial segment. Number one, is there a potential that AutoZone has been so strong on the consumer side of the market. It's been considered the leading player on the retail side. Has that, in any way, hindered the company's ability to further penetrate the commercial side of the market, where perhaps commercial customers have been less willing to do business with the company because of its strength on the retail side of the market? When you go out and talk to your operators in the stores, do you ever hear that, and what's the way that you overcome that perception in the marketplace?
That is an objection that we used to get years ago. It's something that rarely comes up now. The reason for that is the traditional players in this segment were NAPA, Carquest, and O'Reilly's to a certain extent. You've seen the evolution of all of those to a more of a split business, both DIY. Certainly, O'Reilly's and NAPA are trying to become more DIY-oriented. In fact, you've seen a shift in total. Part of the objection used to be, "Well, you're just a DIY store. You don't have the same parts expertise." Well, that's easily overcome. The next objection was, "Well, you have parts that are made for DIY people. They don't care about quality as much as we do." Then you have the age-old brand versus house brand inventory.
What you're seeing is an evolution among all of the key players, particularly, I think, on branding is a great example. NAPA is a house brand. They don't carry branded product. You're seeing O'Reilly shift more and talking openly about the fact that they're moving more towards house brands. I think that as all of manufacturing has essentially moved offshore and is consolidated, we're all getting the product from the same people. The installer consumer has become a little wiser, and I think that those arguments are just gone or waning.
Is there something that you've had to do at the store level to help overcome that objection, to help educate the installer customer, to educate some of the commercial customers that whether it's our capabilities, our product offering is just as good as the competition for that particular demographic?
Yeah. First of all, we have a very large sales organization whose sole responsibility is to get out in front of that installer customer and generate trial. We have a tremendous vendor base that are now out there making those joint sales calls with us, and it's the evolution. That's something that we've been doing for a long time. It's not new, but we do move a little slower than some.
Especially Brian.
Do I?
Especially Brian.
Especially Brian. I think that, again, we're starting to become more and more recognized as a legitimate commercial player. If you can define legitimate, it's more of an evolution now. I think that our
style of doing business and our model is the model that is out there now.
When talking about commercial, it's probably important to address that we're still very young. We have about 3,800 commercial programs in a store base of 5,000 stores. Of the 3,800, off the top of my head, I'm thinking in the last five years, probably 1,600-1,800 of them have just been opened.
Half the chain is open. When you talk about objections to selling, a lot of it is, hey, we're brand new in the market. The first thing is we're the new guy. Somebody's already selling to these accounts. How do you introduce yourself and differentiate yourself?
Is that part because for the last couple of years, you've talked about the mature commercial programs performing better than the newer programs. Is there an element to that where the mature programs have just become more seasoned at selling? In those local markets, they've established a presence, made the connections with the customers. I think the conventional wisdom has been that some of the newer programs have cannibalized the existing programs, and that's explained some of the performance more than anything.
Yeah. I think that certainly, as Brian said, when half of your commercial programs are less than a couple of years old, there's definitely cannibalization going on. We don't talk about that, and we certainly don't accept that as a reason why our productivity is sliding. In fact, we believe that it's a reason why our productivity should be improving. We've got this existing customer base, we've seeded a new program. We would expect their performance to be far better than programs where we didn't have store density or program density, and they're really just starting from scratch. I think the change that you've seen, certainly you've seen this quarter versus some of the previous quarters in productivity, is we slowed down that growth, particularly in Q2.
It's the worst time of the year to open a commercial program because of the weather and just the overall volume. We focus more on, A, identifying the leaky bucket and making sure that we're paying attention to those mature programs and, more importantly, existing customers. Every time we open a new program, we're spending an awful lot of our sales time prospecting. Prospecting doesn't always return revenue. Those existing customers are giving us revenue now, and particularly in this business, they need to feel like they're special.
Explain that on a local level. Does that mean you've got a number of people who are out in the field developing the relationships, and that can be both in the existing store, mature program, and a new program, and when you're opening fewer new programs, more of that time and attention is being placed on the existing programs?
Yeah, in its simplest terms, just with regards to how much face time our sales guys are spending with customers that are currently buying versus prospecting. As I said, prospecting does not always generate revenue. There are a lot of other things that go on into opening a program. You have to hire people. You have to train people. There's a different inventory mix in a store that has a commercial program. That inventory has to flow through, be set up. It can be a distraction for the local management team, particularly if in a district which is roughly 10 stores, suddenly they're adding 20% or 30% to their programs. That's a distraction.
Okay. There's a little bit of an arms race going on in the auto parts sector with frequency of delivery capabilities, parts availability. AutoZone is, in a way, starting to push the capabilities that the companies had. How well are the stores receiving and adapting to some of the new capabilities? There's a test of increasing the frequency of delivery. It's been in 150 to 200 stores, going to increase to several hundred in the near future. What's been, at a ground level, the response from the operators?
Rob, why don't you take that?
Stores love it. It's neat when you go into a store and you walk the store, everything gets topped off five times a week, versus our traditional top off, which oftentimes, most times, was one time a week. The in-stock is the first thing you notice. It's much better. Also when you get inventory in once a week, it becomes an event to put that inventory up on the shelves. When you get it in smaller increments over the course of the week, it tends to fit into the workflow much better. As far as how it lands with the store, it's very popular.
The store operators have received it quite well?
Absolutely.
Do you think it's going to be, at least what you've seen in the test, is it going to be scalable enough to roll out across the entire chain?
Yeah, that's why we test. Increasing stem miles, delivering five times a week can be very expensive.
Yeah.
In true AutoZone fashion, we'll make sure that we understand every possibility before we roll out to the chain.
You are all held to very high financial standards. You want to maintain-
Of course.
the margins, the profitability the company's achieved historically. From your perspective, how important might it be to sacrifice either the rate, mostly the rate, because arguably this is going to flow in incremental profit dollars if you have expanded capabilities. From your perspective, would it be a prudent decision to sacrifice some of the rate if you could flow in more dollars through having these advanced capabilities across the entire chain, increased frequency, more parts pros, drivers, et cetera?
Right. Clearly, we'll take dollars over rate any day.
Yeah.
The rate simply provides us guardrails to make sure that we continue to generate the dollars we need. We're not going to say that's going to be necessary. You could certainly see your way through to the possibility that it could be dilutive to rate, while certainly accretive to dollars. We wouldn't do it otherwise. We'll test it to death, until we understand the optimal level of delivery. The one thing I would say, clearly, it's not five times a week.
Done.
Much of our competitors do five times a week, and that's the Holy Grail. Five times a week cannot be right for 5,000 stores.
Why is that?
Because they're all different.
Yeah.
It's somewhere between there. For some stores, five times is absolutely right. For some stores, the most economic sense is going to be three times a week.
I think ultimately we'll get to a place where all of the stores are delivered based upon what adds the most economic value to AutoZone. There's a balance there between revenue and profitability.
There's probably a balance with the change management, because when you roll out these new capabilities, it's a lot for the stores to absorb. It's new labor. It's new schedules and changes, and not always easy. As you start to think about it, is there an optimal pace of expansion, or is it?
At the store level, in this case, it'd be very easy to operationalize. The time and the energy's already being spent. It's just a matter of allocation at the store level. It could create a significant burden on the supply chain.
You have to work through that, and you can expect whatever we do, and we certainly have high hopes and are encouraged, it's going to be a methodical roll and you would not see a step change overnight.
Thought you were going to have some.
Need some water?
Yeah. Thought you were going to have something insightful to say.
Where'd you go? No, I was just coughing.
As it puts pressure on the supply chain, how do you relieve and alleviate some of those bottlenecks? Some of the competition has larger distribution centers. AutoZone has followed more of a hub and spoke model with hub stores. Could you foresee a time when larger distribution centers would be economically reasonable?
I think that we've said that we certainly can see an increase in 1-2 distribution centers over the next 1-3 years. Quite honestly, that initiative stands alone.
Yeah.
It certainly would help us optimize delivery frequency, should we decide to go down that path. That decision is based on the economics of where we are today and the miles from the distribution centers that exist.
One other question along these lines. As capabilities level across Carquest, NAPA, O'Reilly, some of the buying alliances, so everyone can get the same parts within the same frequency, the same availability, does price become more of an issue? Do you see a time in the marketplace where there's other factors that everyone might be competing on?
Jason?
I think if you look at what we believe is important to our commercial customers, I think it's always relationship. That's always at the top of the list. Then, of course, you've got to either have the part or have availability of the part. As we've mentioned, we've done many things that will help us in that area. Perhaps that's been an opportunity for us in the past, and I think we're dealing with those things. I think price is down the list. I think our commercial shops find it important to turn bays. While they've got to be competitive with their other local competitors, I think the most important thing for them is to be able to turn the bays in the shop. It's where they make their money.
On both sides of the business, you've heard us say for a long time that our competitive set is very rational.
Yep.
We're very rational on both sides of the business. I think that if you were to see one of the Big Four start trying to use price, there's probably a lot of other things you should understand about what's driving that, because there's no reason to.
No reason to. What about some of the smaller players? This has been an industry that's gone through massive consolidation over the last 20 years. At what point can the Big Four players just not take share at the expense of some of the smaller ones? Are we near that point now?
I certainly wouldn't think so. I think that it's still an incredibly fragmented market. I can see years and years ahead of us where we, all four, continue to get share through consolidation. Certainly have an expectation of taking share from the other players as well. There's lots out there.
The other question on one of the longer-term drivers for the sector has been engineering complexity, where cars used to take copper spark plugs that cost $1-
last 10,000 miles. Now they're taking iridium spark plugs that last 30,000 miles cost $10. Is the industry anywhere near saturation point or a slowdown from the benefit it gets from engineering complexity? Could a new wave of demand be stimulated by the hybrid cars, the electronics, and digitization that's going into cars today versus where it was 10 years ago?
I think that to the second half of the question, for sure, the infotainment piece of vehicles is going to open up another avenue for sales to all of us that are in the business. Cars will continue to improve. There's more computing power in a single vehicle today than you can ever imagine having in your home or probably in your office. There's no reason to think that the current evolution is going to become revolution. You're going to have components that last longer, but they won't last forever, and they will cost a hell of a lot more than they do today.
Yeah.
That's kind of the cycle we've been in. That's not the entire vehicle. At the end of the day, it's fairly simple.
Just out of curiosity, we're starting to see more talk about driverless cars, and you guys spend a lot of time in the parts sector and talking to different industry participants. Is this something that folks within the industry consider to be feasible and have some influence on the industry over the next 10, 20, 30 years?
We've actually spent a fair amount of time on that topic last week. I've spent time with some of our key vendors, many of whom are our original equipment vendors. Those that are furthest out there on the technological front will tell you that they don't see a time when there's a driverless car. They could build one tomorrow, but the acceptance, first of all, for that to happen, every car has to be driverless, and every car has to be able to communicate with each other. Otherwise, you can't have a driverless car. Now, the technology that's been created to enable that exists today. Collision avoidance, for example, your mirrors let you know when somebody's beside you. Radar and sonar in the front of your cars. There's a lot of the ancillary work will definitely show up.
It's already showing up in cars, you're likely to see a much smarter car. The notion of an autonomous vehicle, while they could create it today, it only works if every other vehicle on the road is also autonomous, and that's very difficult to see.
Okay. I want to switch gears a little bit to talk about the competitive landscape. Been a lot of change within the industry, consolidation. Have you seen any different behaviors from your primary competitors, whether it's O'Reilly, Advance, who's in the midst of a sizable integration at a store level? Have you heard the feedback from your operators say, "Wow, Advance is really starting to be a little more aggressive," or they're becoming a tougher competitor, or O'Reilly the same?
Clearly, there's a lot of things going on with Advance right now. I can only imagine all the stuff that they've got going on with that integration. I've been asked that question more times than I can count, quite honestly, the answer is I have no clue what they're doing, which would lead me to believe that whatever it is not showing up. I can assure you that if wherever they are in that transitional period, the point at which it starts putting pressure on our local units, we'll know about it. Thus far, we're not feeling anything, it's certainly not showing up in share, at least for us.
Okay. There's a question from the field on the impact of the wage increases that we're starting to hear from certain retailers. Do you see that potentially impacting the auto parts sector and will it have an impact on the company's profitability?
I could make the argument that it will have an impact on all retail, effectively, the minimum wage has been reset by private industry as opposed to the federal government. To the extent that Walmart goes through with that, they have reset the minimum wage for retailers, certainly retailers within proximity of one of their stores. To answer your question, absolutely. It will be a significant number for all retailers, not just the automotive industry, all retailers. We don't have a lot of people that are under the minimum wage, but the impact, and we've been able to see this and study this, where states have raised the minimum wage ahead of the federal government. There's the compression between minimum wage and whatever wage the people are at now generally creates wage inflation.
It's a number, it would be a number that we would definitely have to talk to you about.
It's interesting, the labor market for workers at auto parts stores is a little different. You typically draw car enthusiasts.
Yeah
folks who really care about this particular topic. Did that influence Well, two things. Does that influence the wages you have to offer? Two, because we're seeing a proliferation of the market share held by the top players in the space, has that led to any wage pressure that you've seen in the last five years or so?
No, on the latter, not anything going on within our space that's really led to any inflation that you would step back and say, "Geez, this is the driver." Yeah, we are not immune to it, though. Although we do have to have a more technical person in general, and we pay very few people below the wage rates that we're talking about now. The compression that would come along with somebody that if we truly were to reset minimum wage, it's going to create wage inflation.
Where do you see your cost, to the extent that wage inflation picks up, it's going to help-
May not be a bad thing.
May not be a bad thing. Give your customers-
Yeah
a little more-
Sure
money to spend. Where do you see some of this deferred maintenance as a priority if your core DIY customer has a little bit more money to spend?
You would certainly see your way to the point that if that occurs, it's going to show up in deferred maintenance. Better than half of our business is failure-related. If it fails, it fails, and if you have to have your car, you're going to replace it now, and you're going to find a way to get the money to do that. It could and should show up in oil changes, brake jobs, maintenance items, spring cleaning as soon as this mess goes.
A few quarters ago, the company made an exciting acquisition of IMC. It gives AutoZone more access to import parts, which we know has become a bigger portion of the car population. How quickly do you see flowing the unique products that IMC offers into the core AutoZone stores? Is that something that you hear from the operators that, hey, look, we need to be empowered with the right parts because the nature of the vehicle population in our surrounding area has changed so much over the last few years and is dominated more by imports and the fancy cars like Brian drives?
First of all, we think that IMC is a great acquisition for AutoZone. While it's early, we're very pleased on where we are with the integration of the two companies. Our first priority is to get their catalog integrated into our catalog so that we activate that inventory. That's one piece, and we certainly would anticipate incremental sales growth in both our commercial and DIY channels as a result of having that inventory available. We also believe that IMC has a very nice business model in and of itself. We believe that just through organic growth. They had a great model. They just didn't have the capital.
We're confident in their model. If you're familiar with Worldpac, I think you can look at Worldpac and say, "Okay, there's the model," and you wouldn't be far from wrong. The first thing is to get the inventory visible to our stores. It's highly unlikely you'll see any of our stores stocking the inventory that IMC has. It's different. It appeals to a very specific customer that's, quite frankly, a different customer than we currently serve, which again, makes it a nice business for AutoZone.
Could you take elements of their model where there's deliveries on regular intervals?
That's it.
whatever it might be in transplant to the AutoZone business?
That's a great question. I was out in California, which is where their office is, two weeks ago, as we're starting to try to integrate with a small group of stores out there, that's how we're servicing those stores, is they're simply on the route that IMC serves. It's not a hotshot business. They're driving past your store every hour and a half, and if they have something for you, they drop it off. It's an interesting model that probably would work in a very dense market for us. So yeah, we're excited about learning things from them as well.
The other acquisition that took place within the last few years is AutoAnything. I think we recognize that that's kind of a nice to have business, not hugely impactful. What it does do is open the conversation to the distribution of auto parts online.
When you go out and talk to the stores, what are you hearing from them about customers coming in and saying, "I need this unique part or maybe commonplace part. I looked online, I couldn't find it," or, "Now that I'm educated, I'm just going to go buy it online.
Again, more than 50% of our business is failure related. We believe that we're a little more immune to the risk that exists from other e-commerce players getting into our channel. That doesn't mean that we shouldn't be prepared and understand that we think that the acquisition of AutoAnything gives us the structure that if that became a real threat, we have structure in place that we could deal with that. Again, it's a nice, affordable way to learn an awful lot about the e-commerce business and find ways that we can optimize it for AutoZone.
I think we've got 30 seconds left, last one for Brian. The most recent quarter, company only repurchased $26 million of stock. I think folks were wondering where all the money was going. Can you give us some sense on why that happened? Has there been any change in the philosophy towards capital allocation? Should we expect a change over time, especially as you might have to invest more in building out the capabilities that you're seeing success with in these test programs?
There was nothing special about the second quarter. We did buy less than the previous year, second quarter, we're committed to our capital allocation strategy. In some quarters, we buy more, in some quarters, we buy less. We manage toward a unique leverage metric of approximately two and a half times EBITDA, there wasn't anything in particularly driving the lower purchase amount. The second quarter is a lower volume quarter to begin with than other quarters, guys. The second quarter, the sales volumes are smaller, we are investing a little bit in inventory to get ready for the springtime. Nothing unique, and we are still on our game plan.
Okay. Please join me in thanking AutoZone for talking with us today.
Thank you.