Good morning. Welcome and thank you for attending the 14th Annual Oppenheimer Consumer Conference here in Boston. My name is Brian Nagel. I am the hard lines analyst at Oppenheimer. I'm very pleased to introduce our next presenting company, AutoZone. Before I turn the podium over to Brian Campbell from AutoZone, I thought I'd just make a couple quick comments. I've followed AutoZone now for a number of years, and I think most people in this room would agree that AutoZone really has been the model for a lot of other retailers. This company was early to figure out that made a lot of sense and drove a lot of share gains to focus on cost controls, excess cash and then using that cash to aggressively buy back the stock.
The company is very much the leader in the aftermarket auto parts business with both the DIY, and then they're growing out their commercial business as well. We very much view AutoZone as, like I said, the model for other retailers and one of the best-run companies in the hard lines retail sector. With that, I'm going to turn it over to Brian Campbell.
Good morning, everyone. I wanted to introduce the gentleman that's with me this morning, Charlie Pless, who I have known for many years, 15 plus years at AutoZone. He has been with AutoZone probably 20 plus years and its predecessor company. We were talking this morning, being in grocery wholesale. We came from another publicly traded chain called Malone & Hyde many years ago that was associated with Piggly Wiggly grocery stores. That's our predecessor company. It's funny to talk about that. Many years have gone by. Charlie is the Senior Vice President of AutoZone. He is the controller, and he's also in charge of planning. A lot of the initiatives that you hear our company talk about run through his group. Without further ado, why don't we talk a little bit about AutoZone and what we're up to, and then answer your questions.
It'll just be free-flowing. You guys hear a lot of presentations about companies. Hopefully, what we're doing is no big surprise to many, but we're trying to keep it interesting and trying to focus on our growth initiatives, and we're excited about what we're here to talk about this morning. We're interested in hearing what you folks are thinking as well in this marketplace. The theme, Creating Customers for Life, that is our initiative this year. Every year, we have a new slogan, a new theme. It's always around customers. Don't be surprised. Next fiscal year when we start, it'll have something to do with customers. It'll be a little twang on that niche. We're all about customer service, that's what we talk about internally, and focusing on helping people every day. A forward-looking statement.
We just, in the last couple weeks, reported our earnings for the third fiscal quarter. Our quarter ended in early May. The quarter that we're in right now is 100 years long, kind of jokingly saying that. It's a 16-week quarter, so we won't again report our numbers until the end of September. We'll update you here this morning a little bit on what we did present. Before I do that, it's important to talk about our pledge statement. AutoZone has a pledge and a cheer that goes along with it that at every corporate meeting and every internal meeting, we start off with that verbiage. You've probably heard it if you ever visit us in person at the corporate office, at the store support center, you'll hear this cheer.
We live by this mandate, helping customers, having the right products at the right price, and making sure that our stores look great. This initiative, everyone knows it, and this is really the mantra that all AutoZoners live by. All right. Here's our fiscal third quarter. Kind of to summarize, you're gonna see the quarter and the year look very similar, guys. Our sales grew 6%. We did have an improvement in gross margin up 17 basis points. We de-levered operating expenses, and therefore, it flowed through to de-lever operating margin. We have a high operating margin in retail at 20%. You'll see our net income growth at 7%. You'll see diluted share count, we were about 8% lower than last year, so we were up 16% for the quarter. That looks very similar, guys, to year-to-date for through three quarters. Sales were up 6%.
Gross margin was up 15%. We de-levered year-to-date operating expenses. We can talk a little about that, or I encourage you guys to ask questions about, "All right, what are you doing there? What are your initiatives to have some de-leverage?" Operating margin was down therefore 11 basis points, coincidentally or not so coincidentally, net income growth was similar, 8% up. The diluted share count was down 8%, and we grew 17%. Just to conceptualize, last week we did a press release reauthorizing share buybacks. We bought $14 billion worth of stock over the last decade. We have a $17 billion market cap. Maybe when it wasn't so in vogue, in 1998, we initiated a share buyback program. We had a little over 160 million shares. Today, we have a diluted share count of 34 million on a year-to-date basis.
A part of our model is to grow net income. It is our operating and capital structure model. Net income at mid-single digit range. Buyback shares, that gives us five to high single digit diluted share count reductions to have a flow-through of EPS of mid-teen rate without a lot of volatility, knock on wood. That's the model. We also utilize leverage. You'll see that here in a second, but we target a stable BBB, Baa2 rating with Moody's and Standard & Poor's. On retail, let me just jump to that real quickly. This is AutoZone. We have 4,900 domestic stores. We have 370 plus Mexico stores. We have 5,300 stores overall. We have four stores in Brazil.
If you guys are World Cup watchers, Charlie and I were joking, we said that Mexico played Brazil the other day in a soccer match to a draw, and we noticed it. The whole country, everybody goes crazy with soccer, and it played to a draw. Both countries and management teams were crazy fanatical for that game. Here's our story. We're the largest. We're tied basically for the largest auto parts number chain out there with a couple other players in our space. Our commercial model, we're talking about some of that deleverage we talked about on SGA. We're growing this business. We have 3,700 of the 5,000 odd stores have a commercial desk in them, and what that means is we're taking phone calls and delivering auto parts to garages.
We sell about $1 billion, $600 million worth of the $9 billion in sales a year we do coming from this business. This is a growth vehicle for us. We're doing a lot of initiatives, a lot of expenditures, a lot of investment in this side of the business. This is our cash flow. You'll see that we have an EBITDA number north of basically $2 billion. We have $4 billion of debt. Here's our buyback math. We've bought back $900 million year to date in stock versus $827 million last year. Very consistent year-over-year. Here's our balance sheet. Our inventory has been a big initiative for us. Our inventory is up year-over-year 9% on a per store basis. Inventory is up 12%. That's some of the projects that we're working on. Last but not least, these are our initiatives for growth.
Who are we? We constantly focus on being first and foremost a retailer, helping folks that walk in with their service needs. How can we help you? What are folks working on every day? Our AutoZoners ask. We're focused on growing commercial. Lastly, international profit growth. Big focus on Central/South America for us. Lastly, management on cost initiatives. That's our company, and hopefully you guys are interested and ask some of the questions. Without further ado, Charlie and I can answer here. Thank you.
Brian, Charlie, maybe I'll start off with some kind of bigger picture questions. Two big, I think right now investors are thinking about two bigger things on both of those. One, competition within the space. What you see, sort of say anything evolving there. Second, and I'll just mention this because it's so nice in Boston today, but the weather. Like for a lot of retailers, I mean, weather, that caused some volatility to results over the past few quarters, several quarters. How should we think about that basically going forward?
Competition, I think the competition's always been healthy in this space. Continues to be. From our perspective, hasn't been a significant change in the landscape. All the players in our space tend to be fairly rational as far as pricing is concerned, and that's good for the business as well.
The weather, it is nice. I know that Boston, coincidentally, has had a very difficult winter. I feel for folks that are natives up here, but that's good for our industry, especially if cold weather beats up roads. I don't mean to be tongue in cheek about it, but when people bounce through potholes, it damages under cars or vehicles. Our hope is that there will be a tail associated with that cold weather. Last quarter, we did benefit, and we talked about on our conference call the benefits in the cold weather markets of that having a benefit for us. There's pushes and pulls on all this stuff, but in general, we've been pretty consistent for the last, I guess, 24 weeks reported. We've basically run a four comp as a retailer. Hopefully, does that mean we can continue that? No guarantees.
What we're hoping to do is keep benefiting from weather swings. I'll tell you that the industry will benefit if it gets hot. We hope that the weather will continue in that trend.
Question there in the back.
Can you talk about the off-site aging of the auto fleet, number one, how much further you think you can go? Number two, what sort of a tailwind that's meant for your business?
off-site. Yeah. I want to make sure you can repeat that off-site fleet?
Sorry. The aging of the auto fleet.
Oh, the aging.
The aging.
The aging of the auto fleet.
I'll kind of go to the crux of that. There's two different angles on it. Starting in 2009, the U.S., there were less vehicles sold than normal. You heard about 17 million vehicles sold in the U.S. in 2007 and 2008, there was a dip. In 2009, 2010, 2011, less vehicles were sold. Around 10 million fewer vehicles across those three years cumulatively were not sold. As fewer of those vehicles are moving through the pipeline out of warranty, we're asked oftentimes, "Hey, will that hurt you?" That won't help us, to be blunt. What's benefited our industry is a lot of the old ones have remained, most of them, in fact, have remained on the road. Last year, there was an uptick in units sold, and it flowed through to more registered vehicles.
Last year, there were over 252 million vehicles registered instead of just the 250. The incremental 2 million we got back up to 15-plus million vehicles remain in the marketplace. People are flipping vehicles, selling used cars, and it's benefiting. We are repairing and customers are repairing older cars. What does it mean? There's a few less new ones, a few more old ones, and beneficially speaking, it's sort of been a push at this point. It's not been a thesis for us in talking about the health of the industry.
You've seen the life extend for those, what used to be 7-year-old vehicles and sweet spots shifting between 7 and 10 years.
Yeah.
You used to label those OKV or end-of-vehicle folks. Are those older now?
Yes. The label we talk about OKV was 7 years and older. 7 years, if you think about it, most Americans drive 12,000 to 15,000 miles a year. At 7 years, you basically hit 100,000 miles on your car, and that means it's an older vehicle and you're working on stuff and tooling around with your car. The age life cycle has stretched out. We still like 7 years and older. That's a sweet spot. People are still working on their car. There's absolutely no doubt about it that the camel, the bell curve of repairs continues to elongate, stretch out. The sweet spot isn't just 7 years at the hump, but past that.
People are keeping them longer and the family unit is now growing as far as number of vehicles per family. Those older vehicles are coming, not only just going away from family, going to the young ones. You see that life extending.
Yeah. Go ahead.
In the marketplace, where you have a bit of a priority in that marketplace, do you have a focus of where you're going with that in terms of the kind of buyer you're looking for? Is it truly an independent shop? Are you looking for people that have networks of service locations? What's the contemplated there?
We kind of think about it in two different forms, like national accounts is one, that was the chain I think you referred to at the end. Then what we call up and down the street customers, which are the independents. Both are very important to us. We service those customers equally through our process. With really the focus on getting the parts there that they need in a timely fashion.
Where you're kind of a little more penetrated in your own internally, not so much in the marketplace, but where are you focused right now? More so on the independent side or more on the national account side?
The mix of our business is predominantly the independents.
Yeah.
It's well more than a majority of the business. How we focus isn't so much one particular type of customer, it's around the program itself.
Right.
We really are driving around a store and saying who's there and really trying to get the bigger accounts. Basically, guys that have bigger garages and more cars moving in and out. We're agnostic, I guess, to which type of customer. The fact is we are a majority independent.
You're really focused around the proximity of the store and all of those shops that are within proximity of the store. It could be that your majority around that location's independents, and if it is, that's who we're servicing.
Do you have any sort of target customer base target? If you've got a 2.5% market share, do you have some long-range target that you're looking to guide yourself towards in that space?
Well, we want to grow. There's not a ratio of our mix of business that we're focused on, but we were showing up here on one of the slides $1 billion, $600 million in sales. There is a productivity gap from ourselves to the industry leader in this space on a per program basis or in absolute sales. We're also pretty new at it. We're a chain that established a sales force in 2007.
The industry leader has been doing it for 80 years. As we've matured and gone out and called on customers, it's street by street and store by store, we would expect to improve on that productivity gap. A measuring stick is the highest productive player out there. We would look at them as being probably 40% more productive than we are today on a per program basis. We also understand that it takes a little time and there's a ramp associated with it. Some of those inventory initiatives are there to help us to close that gap.
Thanks.
Yeah. Thank you.
Thought about paying any dividends at any point?
We absolutely think about it. It's debated internally, at this point, the answer's no. We look at the buyback strategy as being a consistent strategy. If we were inconsistent or a one-time buyback, that would be fair. What we've tried to articulate our strategy in buyback is it's the most cost-conscientious. It has EPS ramifications that compound, that benefit us. We believe if, and we're so consistent, we almost look at the buyback to say if folks really need a dividend, we would encourage peeling back a share or two and creating your own dividend. At this point, the cost benefit on accretion math says we're still benefiting from buyback over dividend, we do rerun the math internally. At this point, the buyback is still the primary strategy.
Brian, how should we think? We'll just jump in there for a second, the buyback. You mentioned the numbers when you're preparing, going down to 34 million shares.
Yeah.
Maybe a bit of an unfair question, what's the end game? Next year, you'll be at a conference, there'll be less shares. The year after, there'll be less shares, we'll be less shares. How should we think about what ultimately you guys are working towards with this very aggressive and productive buyback?
There are some retailers and some other big companies that have gone through time and cycles of trying to buy back. There's a few guys that you guys can probably mention the names of some of the serial buyer backers that are out there. Some no longer exist that started some of these strategies in the '70s. For us, as long as the daily volume of trading is there enough for us to be able to not move the market, we want to disappear into the woodwork and do our part. We'll continue to do it. What's the end game? Maybe Charlie and I are vying for the last share, that strategy. The math would tell you that as long as it continues to work, it's probably no change. You'll just see fewer shares.
Right.
Probably lower daily volume traded, a similar percentage of buyback to market cap.
You've seen over the years, the number of shares obviously have decreased on the purchase simply because of the math.
Yeah.
Higher price.
There's no doubt about it. We talk to folks in this room, absolutely the highest cost of our capital is shareholders. We love you guys in the room. It's nice to have you. We're shareholders, Charlie and I. It's an expensive form of capital. It absolutely is. When you look at the debt markets, liquidity in the commercial paper markets, it's difficult to justify a secondary offering, for example. You're not going to see AutoZone doing that anytime soon.
I have.
Okay.
I have two questions. The first is with respect to your suppliers. Has anything changed in the last five years? Where's it going in the next five years?
You all right? Okay. I just wanted to get a picture on the supply side. Are you seeing different things within your industry and in particular to yourselves? The second question, and I should preface this by saying that I'm not familiar with your company. In fact, I'm coming from a different marketplace. Is there anything on the insurance side that is impacting where you think your industry will go? In terms of auto insurance.
Insurance
that may be different from the last five years?
I'll take the first one maybe. On the supplier side, over the years, you've seen some consolidation, depending on categories. The larger players obviously have maintained their strength. Batteries is an example that's maintained its strength. Some of the hard part guys have seen some pressures from overseas competition. A lot of those guys have embraced that competition and have worked to create their own supply chains through that process. By and large, healthy industry. They're impacted, obviously, by what happens within our space, whether it's our competitors or us and the consolidation on that side as well. By and large, over the past five years, you really haven't seen much change in the players that are in that space.
On the auto insurance side, the auto insurers are probably an easier way to answer that. What's happening in their world, and are they changing on how they have cars maintained?
Again, a bulk of our business, 80-odd% of it, is people just walk in that are just getting quick repairs. The inverse of that is garages that are repairing things. Auto insurers will get involved in collision-related stuff.
We cater to the under the hood and the under car. Also the interior of the car, inside the driving compartment. Body panels, siding, bumpers, small accidents, collision shops. We're glad to supply parts to them. What the insurers are providing in the credit and the OE brand versus aftermarket on the body panels and things, that's constantly being debated. It is changing over time. It doesn't directly affect us, but it's in our sphere, if you know what I mean. There's not really a story there. It's not one of our slides, let's say. It's in the life cycle of cars, but I can't say anything's fast-moving there.
What we do supply to those collision shops in addition to parts is, through ALLDATA, we supply software for them to be able to locate parts on cars and be able to do those repairs.
Yeah. One hint, guys, is that sometimes people are fistfighting about, "What's the brand I can use to replay?" Repair your car kind of thing, or the body panel, that's debated. It doesn't play necessarily directly in our niche.
In the do-it-yourself marketplace, the diagnostic requirements starting to move more towards software-type technologies that might create some barriers for some people to keep up?
Yeah. Arguably, we've been hopefully at the forefront when I say that, talking about this. We have a software company that we bought in the mid-90s, 1996, if I remember, but it's called ALLDATA, and ALLDATA serves diagnostics, definitely benefits us. It is a subscription-based service, basically internet-based. It used to be before the internet proliferation, it was more CDs and DVDs, but it helps garages fix cars. It's all makes and all models, and it's technical service bulletins and all that stuff. The technology of helping that cross over, one stop to help retail customers, that availability, it's there. People are using the internet more to learn how to fix cars. There's no doubt about it, that I'll say digital integration and technology will help customers, especially younger people that are more tech-savvy, work on cars, and that's a big push for us.
It's one of the four. We talk about retail, commercial, international. The other initiative that we have internally is something called digital integration, where we're trying to amalgamate the internet sites that we have, along with ALLDATA to help provide more data. We think that's the big push. How to. Because most customers, like most of you guys, when you go into a store, you'll say, "Hey, I want to go buy a tube of toothpaste." You know what you want. Most guys that when they come into our stores or order parts, they ask questions. "We're not sure exactly. What are you hearing about this?" That advice matters a lot.
We've got one of the larger banks of YouTube videos on how to repair this part, this issue or that issue. We see a lot of hits on our YouTube sites for repair information.
Can you just talk a little bit about the evolution of technology? There's stainless steel mufflers. The muffler business is what it was. The brake business has picked that up at certain shops. In one of your stores, I'm just curious the breakdown between replacement parts and consumables and then the evolution in replacement parts. Certainly, the ignition with solid state, there's less repair. I'm just curious where that's been and where you think it's going.
Look, we had an example, if you remember the coil and plug illustration where you had most cars in the '70s and '80s, they had a single coil, and you had a spark plug that came to it. Over the years, we had one of our merchants do an example of that process. He showed the evolution of that coil. Back then, you'd pay $20 for a coil. These days, you find that you have a coil ignition attached at each cylinder. Now you had instead of a $20 part, you've moved to six parts or eight parts that fail probably at a similar rate, but they're $25 a piece. What we've seen is the evolution has really been an evolution of parts proliferation. You've seen a lot of SKUs where used to one starter would fit 15 different models or five different models.
Now you've got 15 different models with starters for each of those cars, the prices have gone up. Cost on the individual part has gone up. That tends to impact your number of transactions, but the ticket moves up to essentially offset that. Those are the two things you've seen. You've seen parts proliferation where there's more SKUs and everybody has to carry more inventory, for that matter, at a higher dollar cost overall. There is some concession from the span of how long things last. When you do have to do the repair, it costs you more from an overall perspective.
It will sound like a commercial, the discretionary purchases in our stores are very low. They're in the mid-teen to high teen percentage of the mix. In fact, of the hard parts that we sell, the inverse of that mid-teens, basically more than half of that 80%-plus is failure-related stuff. Literally, the car works or it doesn't. You mentioned changes in mufflers. That's either you need it or you don't. Stainless steel, lifetime warranty kind of stuff. Sure, those businesses have evolved. Brake pads are more of a maintenance item over time. You have more driving, it wears down like an eraser head on a pencil. You have to repair the car. What we're mindful of is the health of the consumer.
For those folks that are financially strapped, there's a lot of Americans that are based on certain price points, they might drive that car a little longer you might hear a squeaking a little bit longer, or you change and stretch out the oil changes. Instead of doing it every three, four, five, you're doing it every seven, eight, nine, 10. That's the kind of stuff we mind based on segmentation. Failure, which we benefit from in our industry, you either fix it or your car doesn't work. That benefits our industry, and that's basically half of the business. The other stuff, we're encouraging you to maintain your car. Please get in, do those things to save it and make it drive longer.
Brian mentioned earlier, the trustworthy advice, it becomes even more critical the more complicated things become. Great examples, fuel pumps used to be to where you could actually access them on the bottom of the cars. Now they're inside the gas tank. It's not as easy to do that job, and once you do, you want to make sure whatever you take that part out of there, it lasts. You don't want to have to do it again. We've been really focused on helping customers understand how to do those jobs and then ensuring that the quality parts are there for them to make it last.
I think, Morgan, you mentioned that pricing in your industry is usually very rational.
I wanted to know why you think that is and what might disrupt that in the future?
Well, the thing about price, said bluntly, is if you put it on sale, because a majority of the stuff is sold, either it breaks or it doesn't, either you need it or you don't. To put it on sale, the industry realizes it probably just gives up margin, said bluntly. Now, the other side of that is the maintenance items or the discretionary items. That stuff is the stuff that's put on sale. That's the stuff that you see in window signage that, "Hey, buy one, get one," that kind of item. Why doesn't it benefit? Because price transparency is out there between the internet and just knowledge. People realize if one guy drops price, the transparency is there. For example, everybody sort of matches it.
Right.
It becomes a zero-sum game.
The items that you normally, as Brian said, that you see that discretionary side on. Oil, as an example, everybody has the same brands, and they're highly visible brands. It's not something that you couldn't match if they were going that way. We tend to all be very rational in that space, because they are, as he said, highly visible brands.
The alternative for the walk-in customer is the do-it-for-me. The do-it-for-me has labor associated with it. In some industries, you hear about the cost of the parts tend to be a little bit cheaper than the cost of labor. There's always an alternative. The average ticket on the parts tends to be a little more elastic on the pricing. Some people say when you get Do you see price passthroughs from manufacturers if there's cost increases? The industry over time has benefited with its ability to pass price through because the average ticket is not a big number. Our retail average ticket, for example, is in the mid $20s.
It's a low price.
Should I be excited about Brazil and Mexico, or is it just a small part?
No, we're excited about it, the way that we go developing it is methodical.
For many years to come, you'll continue to see growth.
Brazil specifically, because it is really early in its stage of growth. We only have four stores. As we've said before, we'll probably grow at another five and then pause just to make sure that we get our model to a place to where you could scale it. It's going to take some time. Just as Mexico did in the early days. It took time to get it to the point to where it is today and an exciting proposition for us.
We really manage it. Mexico has never closed a store of the 370. Never had one closure. The benefit of that is, I would say, Charles, I give him kudos. Charles and his team in managing it, we've really been smart about how to handle the foreign currency and exchange rate. You see some wild deviations. Mexico in the mid-1990s had real fluctuations with the peso, and of course, we report everything in dollars. We've got that really well anchored down. We're sourcing in country. We've done that all greenfield. In these markets, there's not a lot of people that look like us. In fact, there's almost no one. We've built everything greenfield in Mexico. We're doing that in Brazil. That's why we're methodical about the approach. If you were sort of the runner of the business in Mexico, you'd love the business.
It's just a methodical pace. We open basically 40-50 stores a year in Mexico kind of strategy.
When you see the stores in Mexico, as Brian said, they look just like the stores in the U.S. The model travels very well.
Maybe we have time for one more quick one, and then we have to wrap it up. Sir.
Just really quick. Of the parts that you do sell, how many of them would you say are NAFTA-made, and how many of them are made abroad?
What was that?
How many of them are made in North America, including Mexico, and how many of them are made abroad, of the parts that you sell manufactured? Best guess.
A majority are made offshore outside of the U.S. and Mexico, but there's a fair amount that are made in Mexico now.
Are you speaking specifically of the parts that are purchased from Mexico?
I'm speaking of the parts that you sell either in the Mexican market or not.
Oh, in Mexico.
The U.S. market.
Okay.
Okay.
I just want to know how much of it is coming from the NAFTA zone and how much of it is coming from outside, let's just say China or other third parties. Really rough guess.
Each country, Mexico supplies its own purchasing. It has its own buying organization. It's buying. We do very little direct purchase. We're growing that business. Indirectly, the answer is You'd laugh. There are some very large American manufacturers that I could go, "Oh, that's an American product." If you really get down into the supply chain, it might not be all manufactured, let's just say. It's going indirectly from sources. I would say a majority still comes from Asia, it's evolved. It's a world economy where stuff is manufactured.
When you think in terms of Mexico as an example, quite a bit of the product that we sell down there is actually sourced in Mexico.
It's like Mexico, there's heavy duties for importation from China because it's a direct competitor for manufacturing in the Maquiladora industry. In Brazil, it's highly defensive.
100% sourced there.
Brazilian authorities do not want you to be shipping stuff. That's why you see, Charlie and I were saying it, you're buying a pair of Nike in Brazil, you're going to pay more money.