Okay. Thank you very much for joining us today. I'm Denise Chai, a hardline retail analyst at Bank of America, and it's my great pleasure to introduce AutoZone. Here we have Brian Campbell, who's VP of Investor Relations, Thomas Newbern on his left, who is SVP of Store Operations, and Robert Durkin, DVP of Store Operations. I'll turn it over to Brian for a brief presentation.
Thank you. Good afternoon, everyone. I promise to be very quickly, very brief. All of you are well today. Yesterday, AutoZone reported its second fiscal quarter 2015 financial results. This is our pledge, by the way, before I get started with our information, all of our meetings start and begin with these four simple lines. This is the code by which the company and our AutoZoners live by. Basically, it's very simple. It basically tells you how to act to do your job when you're an employee of AutoZone, an AutoZoner. We always put our customers first. We know our parts and products. We make sure that our stores look great every day, and we want to make sure they got the best merchandise at the right price. That starts everything we do. Let me just jump to discuss some results. This was yesterday's financial results for our company.
We're basically a straightforward company. We have approximately 5,000 U.S. stores. We have just over 400 stores in Mexico. We have a handful of stores in Brazil, and we have several different software ventures. We have a .com, autozone.com website that supports AutoZone's stores. We have an AutoAnything business that predominantly focuses on automotive accessories. We also have an ALLDATA system software B2B business based in Northern California. It's been part of AutoZone now for about 20 years. That business is expanding as well. Very quickly, our sales, we were up 8% last quarter that ended through the middle of February. Our gross margin was up 15 basis points. Our operating expense ratio was higher as a % of sales than last year by 25 basis points, leading to an operating margin basis points down 10 basis points. It's rounding, that looks identical here.
It basically translated into a net income growth of 10%. We bought back 5% of our shares year-over-year to have 5% accretion from buyback, and we were up 16%. Tied into this is our same-store sales results for last quarter. Our same-store sales were 3.6%. That number is our domestic business only. We do not report a same-store sales, either in absolutes or in constant currency for our foreign businesses. If you guys remember what I said about being up 10% net income and 15, 16% for EPS, but this is the year-to-date P&L. Maybe not so coincidentally, and fortunately for us, we have very similar numbers year-to-date as we did for the quarter. We were up 10% in net income, 5% in diluted shares, accretion, and EPS growth of 16%.
This is our 34th quarter in a row of double-digit EPS growth and the 25th quarter in a row of 15% or greater EPS. We are based in Memphis, Tennessee, and Ms. Denise Chai has followed us for several years now. She knows us very well. Without further ado, Mr. Tom Newbern, I encourage you guys to ask questions. Tom's in charge of all 5,000 stores in the U.S. To his left is Rob Durkin, who has many, many markets. I always think of him as the Mid-Atlantic, the North Carolina states, Virginia, but he's got stores all over the country, approximately 800-900 stores as well. Both these gentlemen are 20-30-year veterans of the company and the industry. Without further ado, if there are any questions, please ask. Thank you.
Okay. Thank you, Brian. I'll just kick it off. You've seen some very nice growth in commercial the last few quarters. Can you talk about your supply chain and inventory initiatives and kind of how that's supporting it and where you are in those tests?
Sure. We've been talking about inventory availability and how to improve upon our inventory availability, all for the last probably year's time. Through this initiative, we have added inventory on a per store basis. We have also tested delivery frequency to our stores to improve inventory availability and reduce the out-of-stock %s. This past quarter, we talked about going from mid-100-store range of stores getting approximately five times a week deliveries to adding just about 300 stores at the end of our quarter here to expand that test. Now basically 400-450 stores doing more than one time a week, which was the norm for us, delivery to stores. How has that been going? Very, very well. We are still sort of learning, though, which is the right number of deliveries to complete in a week's time.
Should we deliver three times a week, for example, to a store for replenishment, or should we deliver five times a week? Each one has different cost considerations, obviously. A more expensive deliver to deliver five times, and we're still learning about in each market, which one has the higher payoff. It goes without saying that, is it worth the incremental cost of going the extra two times? That's what we're still studying. We can talk more about that if you'd like. The other test that we're doing and expanding upon is something called Mega Hub. In markets, we're taking a centrally located store and adding a whole bunch of inventory to it. An average store has 20,000 SKUs. We're going up to 50,000, 60,000, 70,000, 80,000 SKUs in these Mega Hub stores, and we're making those incremental SKUs available to surrounding stores.
We're going from two of those giant stores to five, and it's supporting lots of stores in the immediate vicinity. Those Mega Hubs not only support surrounding stores, but can even support and feed other hub stores in the surrounding markets. That's adding to unique SKU coverage beyond the core store inventory.
Do you foresee additional inventory investments being made at this point?
Always, I guess, is the answer. Through these tests, for example, increasing store frequency, we continue to learn about safety stock and the ability possibly to minimize safety stock in stores, and with that, space considerations to allow us to put incremental new SKUs in the stores. There's always a need with new makes and models of vehicles to add inventory into our supply chain.
Okay, thanks. You also announced that this year you're adding about 300 new commercial programs. That's a slowdown from last year because you're going to be focusing more on improving productivity of existing programs. What are some of the main initiatives that you've got in place to get productivity up?
Yeah. I think that anytime you're growing your program base at 20-plus% a year, and you look back over the last 24-28 months, we have over 30% of our programs are less than two years old. Certainly, they have not hit the point in maturation that we would start maximizing our returns on those programs. Slowing down the growth and focusing on our mature, not just our mature store base, but our mature customer base, was something we felt we had to do. If you followed us, you know that we had seen a decline in productivity of our commercial programs for multiple quarters in a row, and quite honestly, it was just a distraction of trying to open a third of your store base over two years.
Mm-hmm. A very wide disparity between productivity of existing programs?
No. We're fairly consistent. You could find some, but generally, not a lot of variability between programs.
Right. Okay. At this point, you still have a market share in commercial that's probably in the low single digits somewhere because it is such a fragmented market. How do you think about the longer-term market share opportunity in both DIY and commercial? Who is your share going to come from? How should we think about the timeframe for that?
In commercial, as you mentioned, such a low share base at this point that we expect share just to come. We have no idea where it's coming from. We have so little. We know it's coming from everywhere. On the DIY side, it's an entirely different story, where we're the clear leader in share across the country. Unlike some of our competitors, though, we still believe DIY is an incredibly viable business. We anticipate growth rates in the 1%-2% a year-over-year. We haven't changed our point of view on that, and it is still a high priority for us. The beautiful thing about our business is investments we make, and we've made a lot lately, benefit both sides of the business. We don't tend to focus solely on DIY or solely on commercial. We focus on initiatives that can benefit both.
Okay. Thanks. Just in terms of DIY, you opened your presentation by saying that you have 5,000 stores now in the U.S. How do you think about the long-term potential for store growth? Do you think you keep on going at this sort of 3% clip? When does the market get saturated?
Yes. We think we can continue to grow at this 3% rate, we don't see a point at which that's no longer possible. If you look back 10 years ago and you would have said, "Show me all the potential trade areas out there in the U.S.," we would have said at the time, "1,200." We've said the same thing every year for the last 15 years. If you ask us today, we would say 1,200 to 1,400. The trade areas and our operating model keeps evolving, we will find ways to operate in trade areas where our current model doesn't hit the hurdle rates that we require. Those are things that we look at through our initiatives every year.
How do we become more efficient in lower volume trade areas, for example, rural trade areas, more urban trade areas like we're standing in right now.
What are some of the initiatives that you've put into place to be able to target those markets that previously weren't viable?
The biggest thing that has allowed us to penetrate new trade areas is commercial. Again, we hold all of our new stores to a 15% internal rate of return, and we had never considered commercial as part of that number. Adding commercial to mix and increasing your revenue possibilities by upwards of 25% or more changes the number of trade areas you can get in.
Okay. You also said that you're going to be opening a couple of new DCs over time. Can you kind of give us something guiding the thinking there?
As we were thinking about delivering more frequently and looking at our supply chain, the way it's laid out today, going from one time a week delivery to replenish the core set of SKUs in a store to more than that put pressure on drive distances for some of our routes, I'll say. With eight domestic distribution centers today, there are pockets of the country that we were not servicing, or it's just not efficient to drive long, long distances more than once a week, for example. In those markets, as we were thinking about expanding our driving, our number of deliveries, it became readily apparent that we had pockets we needed to have distribution centers.
In looking at this, I would say even away from three times a week, four times a week decisions, the distribution center decision was a relatively easy one for us to say, over time, over a two to three-year basis, we are talking about adding these two to three distribution centers. While we haven't procured any land, and it's not happening imminently, it will take us some time to purchase and/or lease this land and build buildings. It makes sense for us to go from 8 to approximately 11 distribution centers.
Okay. Just thinking about your core business, setting aside weather, setting aside the timing of tax rebates, how should we think about just the underlying health and growth rate of your core business and to the extent that lower gas prices are benefiting that? Do you see that more on the maintenance or discretionary side?
It is a consistent business. We are fortunate. When we visit and listen to other companies present at Bank of America, we hear about the inconsistencies, the volatility. Looking back on the auto parts space, sales are relatively consistent from year to year. What are the drivers that deviate from that consistency? Traditionally, it's been macro shocks, some factor. These are gas prices, extreme weather, precipitation. In general, to answer your question, the walk-in business, the do-it-yourself business for us, we think about it growing somewhere between maybe 1% and 2% a year over the long run. Over the last decade or over the last 20 years, that's a very normal growth rate. When we exceed that growth rate, something is happening within the industry. To get a little bit more into detail about the mix of business, about half of our business is failure related.
Your car breaks, you need to get to work. You need to go somewhere. You come to AutoZone. That is just over 50% of the business. It's even a higher percentage of the business during the winter months. When the business is showing signs where maintenance is growing, it's other factors, gas prices going down, that allows people just maintain their vehicles, do the repairs they need to do, not necessarily to drive the car, but maintenance related, every 12,000 mile type incidents repairs. More recently, we've talked about how the maintenance business has improved for us. Again, failure is just over half of the business. Truly discretionary for us, it's a very small percentage. It's really in the teens.
As gas prices, for example, benefited again, it was maintenance that we've talked positively about that's helped our business, and I believe it's helped our industry as well.
When did you start to see maintenance pick up, and is there a lag time between lower gas and maintenance?
There is a lag time. We like to say it happens right away, but it takes at least a month to start seeing some activity with the consumer, but it's quicker than six or eight months. When people are able to save money, especially a lower-end consumer, the folks that don't have a lot of money in their pocket, it's a big benefit to them to save money and to be able to spend to help their car.
Okay, thanks. Open up to questions.
Assuming in pretty much every market you're in, there's an O'Reilly or there's an AAP, what do you think you do better? What do you think they do better, such that what makes someone come to you versus them, all things being equal?
I think I'll turn that over to Rob, who is much closer to our stores.
That, in my opinion, is certainly our AutoZoners, the service levels that we offer, and the culture that we've built over the last 35 years within the organization. One of the things I think we get a lot of credit for is we help customers solve their problems. We test parts in our stores. We help customers identify the problem, and we help provide them with solutions. We'll oftentimes go into the parking lot and install a wiper blade or a headlight or a battery. Things that our professional shops oftentimes wouldn't be interested in doing, and we've built the organization one customer at a time over 35 years doing just that. I think we get a lot of credit for that, and I think we've earned a lot of loyalty from our customers.
I guess just going back to a question before, at least related subject. I guess talk about any potential wage pressure given what developments we've seen over the past couple of months in some of the retailers.
First of all, everybody in retail has wage pressure every year. Ours historically has been in the 2.5%-3% range, plus, as we've discussed, we're opening our store base or growing our store base at 3%. You've got second-year stores that you have to compare against, and then you have wage increases in the 2.5%-3% range. We have a process in place at AutoZone that we've had in place for at least 10 years, Our teams start working on it, really work on it for a calendar year on coming up with ways to save money, to find expense that we can do without to overcome that wage inflation, which we have no control over. I think specifically you're referring to recent developments with Walmart, some of the other soft goods retailers.
I have a very clear understanding of what that means to us financially. Unlike Walmart, we'll not be pioneers on that. If, as some people suggest, Walmart has effectively reset the minimum wage, we'll deal with it, When we have to, it'll be very clear. We'll talk about what that impact is to our financials. We clearly have a very good understanding of what that would mean to us. The question is anybody else going to go out there? We'll see.
Could you talk a bit about your Brazil stores? I know it's still very early, you don't have very many, It's also such a volatile market. What are you seeing, Does the macro give you pause in terms of how you move forward?
It does give us pause. I'll try to answer that. It's a positive tone for us. We like Brazil, The potential for what Brazil represents a great deal. For anybody that's visited São Paulo, it's easy to see why. It's extremely populated. It's lots of cars. The opportunity to sell auto parts to us is a great one, and the potential for customers to do it yourself is high. The part that gives us pause as we develop the market is there are not large chains, There's a tremendous amount of regulation in Brazil with reporting, taxation, that keeps us on our toes. From an infrastructure standpoint, to make sure our systems are up to speed and communicating with the Brazilian government appropriately, there's an investment that goes along with that up front.
To run five stores, for example, is very expensive from a back office standpoint. We are not at a point right now in Brazil where scale is perfect for us. We need to add stores. We also realize that no store looks just like an AutoZone, a prototypical AutoZone, to what we build and how we've built these five so far. Said differently, we're being very methodical with our pace in Brazil. We would expect to open another handful of stores. Thus far, the five that we've opened from a top-line perspective have done a great job. They've met our expectations. The decision now as we move forward is how quickly can we leverage the infrastructure costs to manage all the back office, I'll call it, expenses.
How about Mexico? You're up to 400 stores there. Have you kind of mapped out what the long-term potential for store growth looks like and if that market can ever generate the same returns as the U.S.?
As a percent of sales and return on investment, Mexico is a great story. It does as well as the U.S. We've opened a little over 400 stores. We open around 40 stores a year. We'll continue to do that. Mexico, more recently, relative to the U.S., has been challenged with some devaluation. The Mexican peso is closer to 15 pesos to the dollar than it was just a year ago that was at 13 and a half pesos to the dollar. While we do basically everything in country, we source in country, employees, payroll, everything is managed in the local currency. From a conversion standpoint, there is exposure. Right now, in Latin America, especially in Mexico, while our percent of sales is as good as it's been, we are not making as much because of FX exposure.
It's a wonderful place to do business, and we hope to continue at the current store opening pace for many years, around 40 stores a year.
I guess I'll just ask the perpetual question on any commentary on the buyback, any change of strategy, just considering 2Q was a little lighter than we usually do see. Is that perhaps just a timing issue or anything else to consider?
No. No, there's not. In terms of absolute dollars, the second fiscal quarter of every year for us, the wintertime, is a lower selling quarter. It's also a quarter where CapEx is a little higher, and investment inventory is a little higher because we have to get ready for our springtime. While slightly lower than last year, we fully expect to have the third and the fourth quarter look more normalized. We obviously reserve the right to adjust that as the quarter goes on. No, there's no real story to tell you in terms of cadence. No, nothing.
Okay. I'll ask the perpetual weather question. How would you characterize weather this year compared to weather last year and the impact on your business?
We're seeing snow here, obviously, as we land. More recently, the weather has been challenging in parts of the country with heavy precipitation and cold weather. We think about in terms of pockets. One investor reminded me today that for years and years, our industry didn't talk about weather at all. This industry is always exposed to weather. Why is that? Because many of our customers are repairing their vehicles without the privilege of doing it indoors. Many don't own garages and are working on their cars outside. This exposure to the extremes creates volatility in sales around these months. As you'd expect, last year in December, very cold. This past December was more mild, especially in this part of the world. I know it's hard to remember, but December was actually warm for you guys that live here.
It's obviously cold now, but that volatility is very normal in our industry and does end up telling a story, but it happens every year for us.
Hey, Brian, would it be fair to say that, in general, you guys root for extreme weather, whether extreme cold or extreme hot? I mean.
We do like it.
You guys are kind of a weather-proof business, like if weather is okay, then more people can shop and whatnot, but extreme winters and extreme summers are not negative at all for you guys, right?
No, they're not. Extreme weather, separating from just precipitation, but extreme heat and extreme cold puts pressure on parts and causes failure to items on the car. That's a benefit to us, absolutely.
Over the course of the past few years, you don't actually see negative impacts from extreme weather situations. Is that fair to say over the course of-
You don't. We end up becoming weathermen about how we did last year in that weather pattern until we start talking about, "Well, remember last year was a very cold month in this section of the country." No, weather in general is our friend. Precipitation is more choppy. When it's really wet outside, people don't want to go outside and fix things. No, extreme cold and extreme heat is good because once it thaws out or cools down and people are working on their cars, there are items that break. With cars, also older. When I say old, Americans are driving vehicles longer and the wear and tear from the extremes cause failure.
Just to follow up to that, I could see Tom is sitting there saying, "Man, is this what all investors care about?" Yes, this is-
I'm sorry?
Tom's sitting there thinking, "Is this all investors care about?" Unfortunately, yes, investors talk about weather way too much. In terms of store traffic, do you guys have official traffic counters in your store, or how do you guys gauge store traffic in a given month?
We don't have video analytics, or any way of capturing traffic, pure traffic, in every store. We obviously capture transactions. We have enough going on in a sample of stores that we have a good understanding of conversion and then back into it through transactions.
Have you had any initiative to drive conversion over the past few years, how does your conversion fare? I guess in DIFM, you're pretty failure-driven, in your DIY, how does your conversion fare against other retail? Forget your competitors, how is conversion in your sector versus other
I can't speak to any of our close-in competitors in retail benchmarks in general. We convert at a fairly high rate, which makes sense because people are coming in with a very specific need. Generally speaking, you don't come to AutoZone to shop around. That would make sense to me. As far as initiatives in place, things that Rob and his peers and their teams talk about all the time are really just the cultural cornerstones of AutoZone, and that is provide trustworthy advice, take care of the customer, and focus on those every day, and you don't need trick plays to worry about conversion. Always looking for an opportunity to get a leg up, for sure.
Could you talk a bit about IMC, what your strategies for that business is and what it brings in terms of vendor and customer relationships?
Sure. IMC, for those of you who know, is a company we purchased a few months ago. First of all, our strategy with IMC is to let them continue to operate as they are. They have a plan to gain scale. We like their operating model, and at this point, have no intention of changing that. We believe it will be a profitable, accretive model in and of itself. We also happen to have 5 million customers that walk in the door and a tremendous number of commercial programs that currently don't have those customers that IMC has. We consider IMC a unique customer base that we're currently not serving. If you can activate that inventory for our 5 million DIY customers a week as well as all of our installer base, we certainly think that there's incremental upside there. We like their business model.
If you're familiar with Worldpac, that is probably the most analogous to IMC and who they are and what we think they can be.
Would we see that incremental upside this year or next year?
Certainly not this year. It's a very small number. I don't know that you would see a material upside for some time to come. Again, we're very happy with it. We're happy with the progress we're making in integrating them. We're looking forward to some very positive results from IMC. We think it's a great business model. I'm going to say, guys, in the interest of time, we actually have to catch a flight. We apologize with the weather, the inclemency. If we could just ask one more question. Any client?
Okay. Well, thank you so much.