AutoZone, Inc AZO CEO Bill Rhodes on Q2 2020 Results

Good morning and welcome to the AutoZone conference call. Your lines have been placed in listen-only mode until we enter the question and answer session of the conference. Please be advised that today's call is being recorded. If you have any objections, please disconnect at this time. This conference call will discuss AutoZone's second quarter earnings release. Bill Rhodes, the company's Chairman, President and CEO, will be making a short presentation on the highlights of the quarter. The conference call will end promptly at 10:00 AM Central Time, 11:00 AM Eastern Time. Before Mr. Rhodes begins, the company has requested that you listen to the following statement regarding forward-looking statements. Certain statements contained in this presentation constitute forward-looking statements subject to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. Forward-looking statements typically use words such as believe, anticipate, should, intend, plan, will, expect, and may. These are based on assumptions and assessments made by our management regarding historical trends, current conditions, expected future developments, and other factors we believe appropriate. These forward-looking statements are subject to a number of risks and uncertainties, including without limitation product demand, energy prices, weather, competition, credit market conditions, cash flows, access to available and feasible financing, future stock repurchases, the effect of recessionary conditions, changes in laws or regulations in the prospect of war including terrorist activity, inflation, hiring and retaining qualified employees, construction delays, compromising of confidentiality, availability or integrity of information including from cyberattacks, downgrade of our credit ratings, damage to our reputation, challenges in international markets, failure or interruption of our information technology systems, origin and raw material costs, supplier disruption in the supply chain due to public health epidemics or otherwise, impact of tariffs, anticipated impact of new accounting standards, and business interruptions. Certain of these risks and uncertainties are discussed in more detail in the Risk Factors section contained in Item 1A under Part 1 of our Annual Report on Form 10-K for the year ended August 31, 2019, and those risk factors should be read carefully. Forward-looking statements are not guarantees of performance, and as a result, developments and businesses may differ from those contemplated by such forward-looking statements. The events described above and the risk factors could materially and adversely affect our business, and forward-looking statements speak only as of the date made. Except as required by applicable law, we undertake no obligation to update publicly any forward-looking statements, whether as a result of new information, future events, or otherwise. Actual results may be materially different from anticipated results. Now I'd like to turn the call over to Mr. Bill Rhodes. Bill, go ahead.

Thanks, Bill. Good morning, everyone. To start this morning, let me take a few minutes to talk more specifically about our domestic retail, commercial, and international results for the quarter. Total auto parts sales, which includes our domestic, Mexico, and Brazil stores, increased 2.6%. For the trailing four quarters ended, total sales per AutoZone store were $1,867,000, which is up from an average of $1,800,000 at Q2 ending last year. Total commercial sales increased 8.2% in the quarter. Commercial represented 23% of our total sales and grew approximately $42 million over last year's Q2. Our average weekly sales per program were $9,400, up 5% on a per program basis versus $9,000 per week last year. As Bill mentioned earlier, we expect sales per program growth to do better in Q3 than this past quarter as we begin our summer selling season. We now have our commercial program in 4,942 stores, or 85% of our domestic stores. We remain committed to gaining market share with our commercial customers. We are encouraged by the initiatives we have in place and feel we can further grow sales and market share. Our Mexico stores continue to perform well. We opened two new stores during the second quarter, ending the quarter with 608 stores. We remain committed to open stores for many years to come. In Brazil, we now operate 38 stores. Our performance continues to improve and we remain optimistic about the long-term future of this market. This market has the potential to be much larger than Mexico, so while challenging and currently a drag on earnings, the potential size of the market is significant. Gross margin for the quarter was 54.3% of sales, up 28 basis points versus last year's second quarter. The increase in gross margin was primarily driven by supply chain levers. While our accelerated pace of commercial growth has weighed on our overall gross margin, we continue to see opportunities to lower our cost through sourcing. I do want to stress we remain committed to taking costs out of our business where appropriate. Our primary focus is always on growing absolute gross profit dollars in our total auto parts segment, and we have been pleased with our growth driven by the acceleration we have experienced in commercial. SG&A for the quarter was 38.1% of sales, leveraging 37 basis points to last year's second quarter. This was lower than our first quarter's deleverage of 65 basis points. In fact, our SG&A grew 3.6% over last year's second quarter. As we lap salary increases initiated in last year's first quarter and as our sales were challenged, our team aggressively managed costs and we returned to a more normal structure. SG&A will remain something we manage in accordance with sales volumes. As sales pick up, we would expect the spend rate to increase. The deleverage for this quarter was primarily driven by our plans and ongoing domestic store payroll investments, which negatively impacted operating expenses. EBIT for the quarter was $407.9 million. Our EBIT margin was 16.2%. Interest expense for the quarter was $44.3 million, up 7.2% from Q2 a year ago, but in line with our expectations. We are planning interest at $44.7 million for the third quarter of fiscal 2020 versus $43.2 million last year. Our higher forecast versus last year is driven mainly by the association with the bond issuance we had in April of 2019. Debt outstanding at the end of the quarter was $5,451 million, $340 million above last year's Q2 ending balance of $5,111 million. Our adjusted debt level metric finished the quarter at 2.6 times EBITDAR. While at any given quarter we may increase or decrease our leverage metric based on management's opinion regarding debt and equity market conditions, we remain committed to both our investment grade rating and our capital allocation strategy. Share repurchases are an important element of that strategy. For the quarter, our tax rate was 17.7% versus 17.8% in last year's second quarter. This quarter's rate benefited 412 basis points from stock options exercised, while last year it benefited 389 basis points. Stock option exercises aren't predictable, and as such they will affect our tax rate and ultimately our net income and EPS. For the third quarter of FY 2020, we suggest investors model us at approximately 23% before any assumption on credits due to stock option exercises. Because we cannot effectively predict this activity, we remain committed to reporting the stock option impact on the tax rate. Net income for the quarter was $299.2 million, up 1.6% versus last year's second quarter. Our diluted share count of 24.2 million was down 5.8% from last year's second quarter. The combination of these factors drove earnings per share for the quarter to $12.39, up 7.8% over the prior year second quarter. Related to the cash flow statement, for the second quarter we generated $205 million of operating cash flow. Net fixed assets were up 4.8% versus last year. Capital expenditures for the quarter totaled $89 million.

Two million dollars in reflected the additional expenditures required to open 28 net new stores this quarter. Capital expenditures on existing source and mega hub remodels or openings, work on development of new source for upcoming quarters, and information technology investments. With the new stores opened, we finish this past quarter with 5,814 stores in the US, 608 stores in Mexico, and 38 in Brazil for a total store count of 6,461. Depreciation totaled $19.7 million for the quarter versus last year's second quarter expense of $83.8 million. This is generally in line with our recent quarter growth rates. We repurchased $315 million of AutoZone stock in the quarter versus $350 million last year. At quarter end, we had $962 million remaining under our share buyback authorization, and our leverage metric was 2.6 times. Again, I want to stress we manage to appropriate credit rating, not any one metric. The metric report is meant as a guide only. Each rating agency has its own criteria. We continue to view our share repurchase program as an attractive capital deployment strategy. Next, I'd like to update you on our inventory levels. In total, the company's inventory increased 7% over the same period last year, driven by new stores and increased product placement. Inventory per location was $713,000 versus $690,000 last year and $694,000 last quarter. Net inventory, defined as merchandise inventories less accounts payable, on a per location basis was negative $41,000 versus negative $58,000 last year and negative $71,000 last quarter. As a result, accounts payable as a percent of gross inventory finished the quarter at 105.7% versus last year's Q2 of 108.5%. Finally, as Bill previously mentioned, our continued disciplined capital management approach resulted in return on invested capital for the trailing four quarters of 35.3%. We have and will continue to make investments that we believe will generate returns that significantly exceed our cost of capital. Now I'll turn it back to Bill Gross.

Thank you, Bill. Clearly our sales performance in Q2 was disappointing. We didn't achieve our plans nor our aspirations. We always know Q2, our shortest, lowest sales season, will be volatile, and this year due to a very mild winter, our performance suffered and suffered mightily in specific weather-sensitive categories and in particular markets. As we analyzed our performance in great detail, we are confident that the key driver this quarter was weather. As we cannot influence the weather and as we know weather impacts normalize over time, our goal is to ensure we understand the drivers of our business and then move on and focus on what we can control. Most of our senior team has been in this business and with this company for decades, and we have seen this in the past and are focused on delivering optimal performance in the short term in light of the sales environment, but our real focus isn't on any single quarter but building our business for the long term. We all have seen enough cycles to know them when we see them. As we have recited internally, we weren't brilliant in the first quarter and lost our touch in the second. This too shall pass. With half of fiscal 2020 behind us, we believe we continue to be very well positioned to grow sales and earnings for the remainder of the year. Many are now looking at previous mild winters and trying to extrapolate them for the balance of the year as a way, but there are always other key factors that impact our industry's performance. What is the timing of tax refunds? What's going to happen with other weather patterns? Where are we with the aging of the car park and sweet spots? And on and on and on. In the end, we believe our sales will strengthen from here, and our focus remains on managing this business to the optimum profitability based on the current industry sales environment, which will run through normal marginal cycles from time to time. Our team did just that in the second quarter. As we looked at the balance of the year, we permit that we will manage this business well and we will manage it for the long term. Our business model is amazingly consistent. We generate a healthy amount of cash flow each and every year, and this year will be no different. Each year we target to generate as much or more operating cash as the year before, and this year we have the same target. Let me reiterate: we believe we are in good shape for the back half of the year. For the new year, we must continue to execute consistently at a high level. We understand we must adhere to living the pledge and doing what is right for our customers. We cannot take our eye off of execution. Success will be achieved with an attention to detail and exceptional execution for the remainder of the year. We have a lot of deliverables from our IT initiatives, and we will remain focused on simplifying our store AutoZone owners' workloads to reduce clutter and unnecessary tasks that get in the way of making the customer experience better for both the DIY and the professional customers. We remain focused on growing our DIY business and continuing to grow our commercial business well in excess of industry growth rates. We promise to remain committed to both executing our strategies and getting better every single day. I'd like to take this opportunity to again recognize and thank our team of talented, dedicated, passionate AutoZone owners for what they do each and every day for our customers, which expands opportunities for AutoZone owners, allows us to support the communities we serve, and ultimately rewards our shareholders. Now we'd like to open up the call for questions. Thank you.

We will now begin a question-and-answer session for today's conference. To all participants, if you would like to ask a question, please press star followed by the number 1 on your phone and use your phone to record your name when prompted. Your name is required to introduce your question. To cancel your request, press star followed by the number 2. Our first question is from Michael Lazar from UBS. Your line is now open.

Good morning, this is a fool for Michael. Thanks a lot for taking our questions. Good morning to you. Good morning. I know you were expecting sales to accelerate for the remainder of the year, but can you provide some color on quarter-to-date trends? How much of sales improved compared to the -6% that you witnessed in the final two weeks of the quarter? I misread you. Driven to improvement?

Yes, I appreciate the question. We have a long-standing practice. We release our earnings usually within two weeks and a couple of days at the end of the quarter, and we have a long-standing practice to not talk about such a short period of time. As we evidenced with the last two weeks of the quarter, our business can be incredibly volatile over short periods of time. We don't want anybody to try to extrapolate that good or bad for a 12-week course. A week? We have the long-standing practice to not talk about it. What we do say is the second quarter is certainly more volatile than the third quarter. As we are entering the third quarter, we anticipate tax refunds coming. As I'm sure most of you have noticed, there was a significant amount of tax refunds, $67 billion, that were issued last Wednesday. That appears to be generally on track with where we were last year, and we're excited to enter this very important selling season.

Thank you, that's helpful. And then just a quick one on the calendar shift drag. When should we really expect this drag to reverse and become a benefit? That's not going to be in the third or the fourth quarter of this year?

Yeah, it's again one of those things that's very hard to tell. As we talked about what happened with the end of the quarter, that could have Q2 could have been a net positive or a net dip, net negative. In the end, it was a net negative because of the way weather hit at the very end of the season. We anticipate we will get what happened in the first half of the year back in the second, but it's going to depend somewhat on what happens around the beginning of the quarter and the ending of quarters.

Our next question is from Simeon from Morgan Stanley. Your line is open.

Good morning, hi everyone. I wanted to ask you, Bill, first on the guess the timing of bounce-back. I know you don't comment until your last answer, but the question is: do we have to wait for weather or do we have to wait for weather to normalize? Or no, it's not about weather at this point, it's about tax refunds and just the timing of the calendar to see the business normalize?

Yeah, I think you're right. I mean, I think it's the latter. As we begin to move into the spring season, what dominates our performance is no longer extreme weather patterns in the wintertime. A lot of people will look at what's happening with average temperatures, which is an indicator, but what really matters to us in the wintertime is only getting extreme cold for an extended period of time, three, four, or five days, that puts a lot of pressure on failure parts. The other part that really matters to us is what's happening with road conditions. If we get a lot of snow and ice and freezing temperatures, that puts the road conditions in pretty bad shape, which puts more pressure on undercar and brake systems. One of the things as we enter this period of time, it's more about the maintenance categories. And I mentioned in my prepared remarks that a lot of times everybody wants to compare to what happened in the last three or four mild winters, and it's absolutely right, and we're doing the same thing. But there are other things that are happening in the environment. One of the things that's happened in some of the previous mild winters is we had a significant amount of our maintenance businesses that were pulled forward into the second. You found not always, it's not extreme cold temperatures, but you had some very nice weekend weather and people did DIY jobs. We did not see that in Q2. So we're anticipating as these tax refunds flow, as the weather improves, that we should have more robust maintenance performance.

Great. My follow-up is on the commercial strategy. You've had, excuse me, great momentum. Can you talk about the inning that the mega hub strategy is in and then any incremental inventory investments you plan to make this year?

He has great questions. So we've now opened 39 mega hubs. We've stated it externally that we want to get to 70 to 90. We are very aggressively pursuing those at this point in time. Very pleased with the continued performance of our mega hubs and think that they are a key contributor to commercial. They're also a contributor to retail. Very pleased with progress. And I would say we're probably in the fourth or fifth inning on the mega hubs, and we'll continue to roll out on the hub strategies as well. And to Bill's point, we've been very pleased with the performance of both the mega hubs and the hubs, but in particular the mega hubs, both on DIY and on the commercial side of the business. Now at the same time, that does create a little bit more inventory in the system as we get more inventory out closer to the customer, but we believe one term is a winning strategy. Okay, thanks. Good luck to us for the year. All right, thank you.

Our next question is from Santa Sigmund from Credit Suisse. Your line is now open.

Hey guys, good morning. Just want to follow up on a couple of those points. First on the commercial side of the business, so it sounds like the slowdown is really weather-related and you're planning for trends to re-accelerate. Is there anything that you see that would suggest that you can't get back to double-digit growth in the commercial business in the next quarter or so?

I would say no. I think that if we look back over the quarter and see our performance, some of that was impacted by weather certainly geographically, as we talked about on the DIY business. It was similar on the commercial side of the business as well. So those cold-weather geographies underperformed considerably during the quarter. So we believe fairly confidently that we will get back to a more normalized double-digit growth rate as we head into Q3. So fundamentally, we don't believe that we've seen anything different in the distance. I think adding a little bit to that, we also as we talked about in our prepared remarks, our hub-and-down-the-street business continues to perform very, very well. We did see more challenges with our more national account businesses, many of which are concentrated in the Northeast and Midwest. So we're encouraged about that as well. Okay, thanks for that.

And then obviously in the quarter, the margin trends were quite healthy despite the sales shortfall. Your prior commentary had suggested an acceleration in operating profit growth as you move through this year. I guess getting back to a low single-digit EBIT growth, is that still a fair way to think about it? Any more parameters around that would be helpful. Thank you.

Yeah, I think and of course I think the organization did a great job of managing the way through a difficult quarter, being able to control SG&A leverage, improve gross margin, and be able to drive to EBIT growth of around 2%. And I believe last quarter we said that we would expect to grow on a positive basis, and yes, we do expect to get to that low single-digit, mid-single-digit kind of growth rate on a long-term basis. Okay, thank you.

Our next question is from Brett Jordan from Jefferies. Your line is now open.

Thank you. Good morning, guys. Hi. In your prepared remarks, you talked about market share gains. Did you talk about DIY versus commercial? And I guess, what regionally did you outperform in any particular market more than others?

Yeah, great question. I should have clarified that in the prepared remarks. We don't have good visibility to market share gains in commercial. So generally, when we're growing commercial at 8% and the market's grown by 4%, we're pretty confident we're gaining share. Not specific, but about growing share slightly. We come up from a few different indications that we have on the DIY side of the business. Okay, great.

And then I guess a question on inflation. I think Bill Giles was talking about, or maybe as you built roads about, not a material net benefit for the year. And I guess the supplier association, a lot of peers have been talking about, you know, 3% inflation seen in the last 12 months. Is it just that you haven't elected to pass through the costs you've seen come out of China? Or is there something different about your addressing inflation versus others?

I can't speak for theirs. We have certainly seen SKU-over-SKU year-over-year inflation. And the bigger change isn't that we've seen major inflation, that's generally that we've seen deflation. Because you think about it, our parts come into the lifecycle and they're very short runs until the costs are more expensive. As the part goes through the bell curve and becomes much higher volume, our costs go down and therefore we have significant deflation, as shown in our LIFO reserve that we've had forever. In the last 18 months or so, we have seen some inflation. We have been very careful about managing that inflation. And as we said in our prepared remarks, if we had a 25% tariff, we didn't go out and raise our price 25%. We went out and worked that in in tranches so that we didn't shock the customers. Over time, we think we've done a pretty good job of phasing those price increases in. We've also worked with several of our partners on not pushing the full amount to the customer. There have been some changes in currency, and we've taken advantage of that. So we've been very judicious about it. We don't think we saw a big net benefit. As costs go up, there is some dampening of demand. We don't think we saw a major significant net benefit, and therefore we don't think we'll see a major significant net deficit. Great, thank you. Thank you.

Our next question is from Seth Awesome from Wedbush Securities. Your line is now open.

Thanks a lot and good morning. My first question is just around the calendar shift. Now we've seen two quarters of a negative impact from a calendar shift. When do you expect to get that back? Is that more of a third quarter or fiscal fourth quarter event?

Yeah, as Bill said, we'll have to wait and see to see how the performance is at the end of each of those quarters. Our anticipation is that this is likely more back-end loaded in the second half of the year. Fair enough.

And secondly, as relates to your gross margins, you say supply chain leverage is your primary driver of improvement here. Does that include lower costs you're getting from sourcing, or is it really talking about savings within your supply chain and distribution?

That one was pretty much the savings within the supply chain and distribution. On a year-over-year basis, we are continuing to try to lower our acquisition costs and believe that overall our margin remains relatively healthy. But for this specific quarter, we were able to leverage on supply chain just by lowering some costs during the quarter. As a follow-up there, as we think about the impacts of tariff-driven inflation into your business over the last year and we're moving through inventory balances and your gross margins in last quarters, have you been getting a benefit from that or do you expect a headwind going forward in the back half of the year? I think that some of the tariff costs are going to continue to work their way through the average cost of the inventory. And still, I think the merchandising organization has done a nice job of being able to feather in the increases commensurate with the cost increases that we are experiencing. Our expectation is that we will continue to do this. It may be some pressure going forward, but our expectation is that we will be able to manage our way through that. Great, thank you very much.

Our next question is from Michael Montana from Evercore. Your line is now open.

My phone one penny or maybe a newt? Hello, can you hear me? Yes, yeah, okay great, sorry about that. Just wanted to follow up on the inflation front for a minute if I could. What kind of an impact did you see on same-store sales from inflation in particular for this quarter? And then on a related note, what kind of success you had at this point in getting rebate checks from tariff-related exemptions?

Yeah, just to kind of go backwards first. We're in that process. I think Bill called it out in the prepared remarks that we've gone through and made applications for some rebates relative to tariffs, and we've had some success, but we have more things in the works. So we'll see how it goes. We don't think it will be material by the way, but we think it will be certainly a help overall. I think on the inflation side of it, as we said, we probably have inflation of two plus percent on a year-over-year basis from a SKU-to-SKU basis. But at the same time, it's very difficult to measure out what the demand impact is. Some of the prices raise a little bit. So I think that's where we would say that we haven't seen a material impact overall from the inflation relative to comp store sales, because it is kind of a blended number with the demand as well. Okay, thanks.

If I could just follow up on one housekeeping thing: what was the capex and D&A outlook for this year for the full year? And then secondly, any initiatives that you all may have in the pipeline on the productivity front that could help offset some of those wage increases, whether that be automation in the DCs or potential outsourcing, etc.

Yeah, from a capex perspective, I think our expectation is around $600 million of capex for the year, and I believe depreciation is around $350 million. I would say overall from a capex investment perspective, obviously first and foremost we are investing in our stores. We're investing in the maintenance of our stores, continue to ensure that they look great. We're investing in hubs and mega hubs along the way. We also have a sizable investment in technology as well. We continue to invest in technology both to enhance our existing systems as well as to add new functionality in order to improve our customer experience both on the DIY and the commercial side of the businesses. So those are the major projects that we continue to work on. Okay, thanks for the productivity side. On the productivity, we're always working on different productivity initiatives. But if you're talking about are we changing the way we go to market in our supply chain by implementing a tremendous amount of new automation, those kinds of things? At this point, we're not. We're constantly looking at the calculations of where the IRRs make sense. As wage pressure goes up, it changes the economics, and we'll continue to look at it, but we don't have anything to talk about significantly currently. Okay, thank you.

Our next question is from Zac Freedom from Lowe's Fargo. Your line is now open.

Hey guys, first question on coronavirus. You touched on supply chain. Curious if you have any thoughts on the potential impact of miles driven and how that could impact your business.

It's a very interesting question. You know, as you would expect, over the last month or so, we have been very focused on the supply chain aspects of coronavirus. And in the last week or two, more and more focus on what's happening here in the United States and ultimately Mexico and Brazil. We see no indications at this point in time of any demand destruction as a result of coronavirus. But just like we said with the supply chain, it's an incredibly fluid situation. I think the next couple of weeks to a month are going to be critical to see what actually happens. We don't have good insights into this. Got it.

And then just bigger picture on the car park. Curious if you could speak to where you think we're at in terms of the sweet spot. How long do you believe the current tailwind can last? And whether it's more of a benefit to your DIY or your commercial business? Thanks.

Thanks for that question. Ah, yeah, we haven't been big on talking about the ramifications of the car park over the last 12 years, but we all know that there was a significant divot in new car sales in 2009, and that as those cars came into the float, quote unquote, sweet spot, there was a headwind for a while, and now it looks like it's turned into a tailwind. I think it's on the margin in both instances. What we like to see is steady-state new vehicles coming on the road, 16, 17 million. The scrappage rate doesn't appear to change much at all, and therefore we just have a steady state of new cars. I don't think there's anything in the next two, three, or four years that's going to be radically different than what we've seen in the past. Got it. Appreciate the time, Bill. Yep, thank you. Have a good day.

Our next question is from Guru Wright with Daniel Embree from Stephens. Your line is now open.

Hey guys, this is Andrew on for Daniel. I just got a quick question here. I was listening, your commentary sounded pretty upbeat on the second half. What gives you this confidence? And how would you weigh that between company-specific initiatives and improving demand outlook?

Yeah, terrific question. I think what gives us the confidence is that we've been here before. As I mentioned in our prepared remarks, most of our management team has been here for decades. We've seen times of strength, we've seen times of softness. We certainly saw softness in the second quarter. As we're looking at the second half of the year, we have concerns and we also have things we are very positive about. On the concern side, I mentioned earlier that the roads, particularly in the Midwest and the Northeast, haven't had the kind of difficult conditions that put stress on brake systems and undercar systems. That's likely to be a bit of a headwind as we go through the second half of the year. That said, unlike some other previous winters, we didn't see a significant pull-forward of demand in those exact categories which are heavily maintenance categories. So we're looking at where we are. We absolutely are disappointed with the second quarter, but we don't see anything that changed as a result of the second quarter other than those road conditions. And therefore, we've made zero changes in our plans for the second half of the year. Again, to us, we're disappointed. We hate a bad quarter, but we're not managing this business quarter to quarter. We're managing this business for the long term. And that's the approach we're going to continue to take. And we're very optimistic that just like we've been very successful over the last decades, we're going to continue to be successful as we look forward. And it's very helpful. Thank you. All right, thank you.

A further question is in here? I'd like to turn the call back over to Mr. Bill Rhodes for final comments. You may proceed.