AutoZone, Inc. — Q2 FY2018 Form 10-Q
Reporting period: Twelve and twenty-four weeks ended February 10, 2018; comparisons are to the periods ended February 11, 2017. AutoZone operates automotive-parts retail and distribution locations and related online and software businesses. The interim financial statements were reviewed, not audited. The company cautioned that seasonal results for the first half are not necessarily indicative of the full fiscal year.
Financial performance
Amounts are in millions, except per-share data and percentages.
| Metric | Q2 FY2018 | Q2 FY2017 | 24 weeks FY2018 | 24 weeks FY2017 |
|---|---|---|---|---|
| Net sales | $2,413 | $2,289 | $5,002 | $4,757 |
| Gross profit | $1,277 | $1,206 | $2,643 | $2,507 |
| Gross margin | 52.9% | 52.7% | 52.8% | 52.7% |
| Operating profit | $205 | $384 | $674 | $843 |
| Net income | $290 | $237 | $571 | $515 |
| Diluted EPS | $10.38 | $8.08 | $20.38 | $17.45 |
| Operating cash flow | Not reported by quarter | $752 | $564 | |
| Capital expenditures | Not reported by quarter | $215 | $216 |
- Q2 sales rose 5.4%; domestic same-store sales increased 2.2%. Domestic commercial sales grew 5.7%. For the first 24 weeks, domestic same-store sales rose 2.3% and commercial sales increased 6.2%.
- Gross-margin improvement reflected lower distribution costs and higher merchandise margins. Q2 operating profit included $193.2 million of asset impairment charges, equal to about 8.0% of sales.
- Management’s adjusted diluted EPS, excluding impairment, Tax Reform effects, excess tax benefits from option exercises, and IMC and AutoAnything operating results, was $8.47 in Q2, up 9.3%, and $18.47 year to date, up 7.8%. These are non-GAAP measures; reported diluted EPS was materially affected by unusual items.
Financial position, liquidity and debt
- At February 10, 2018, cash was $288.5 million; merchandise inventory was $4.086 billion; total current assets were $4.826 billion and current liabilities were $4.947 billion.
- Accounts payable was $4.366 billion, or 106.9% of gross inventory. Management cited supplier payment terms and inventory impairment as factors. The high payable-to-inventory ratio is important when assessing working-capital liquidity.
- Debt carrying value was $5.044 billion, including $1.116 billion of commercial paper; cash less debt was approximately $4.755 billion. The company had $1.997 billion available on its $2.0 billion revolving credit facility and reported compliance with debt covenants. The facility was extended to November 2022, with a potential additional one-year extension option.
- Operating cash flow increased to $752.3 million from $563.9 million. Investing cash use was $230.6 million and financing cash use was $524.3 million. Financing included $527.5 million of share repurchases. Cash decreased $4.7 million during the period.
- Stockholders’ deficit was $1.331 billion. Management reported trailing-four-quarter ROIC of 30.2%, versus 31.0%, and adjusted debt to EBITDAR of 2.5x, versus 2.6x.
Material changes and unusual items
- Business impairments and sales: The company recorded $193.2 million of impairment charges for IMC and AutoAnything, including inventory, goodwill, property and equipment, and intangible assets. It agreed in February 2018 to sell substantially all IMC assets and subsequently sold substantially all AutoAnything assets, each for consideration approximating the remaining net book value. IMC’s sale was expected to close in Q3 FY2018.
- Tax Reform: The company recorded a provisional $111.9 million tax benefit, comprising a $136.7 million benefit from remeasuring deferred taxes and $24.8 million of transition-tax expense. The Q2 effective tax rate was negative 74.7%; the 24-week rate was 4.2%. The company said its accounting remained incomplete and could change, possibly materially. It forecast a long-term effective tax rate of approximately 24.5%.
- Interest expense: Q2 net interest expense increased to $39.3 million from $34.2 million, primarily due to higher borrowing rates. Average borrowing rates were 3.1%, compared with 2.6%.
- Capital returns: The company repurchased $527.5 million of shares in the first half and had $296.2 million remaining under its authorization at quarter end. It repurchased another 382,928 shares for $264.9 million after quarter end.
Outlook, risks and contingencies
- Management expected FY2018 investment in the business at a rate consistent with FY2017, primarily for new locations, supply-chain infrastructure, existing locations and technology. The company opened 59 net new locations in the first half.
- AutoZone planned to implement more frequent distribution-center deliveries over the following months; approximately 25% of stores, representing 40% of sales and nearly half of commercial sales, were expected to receive deliveries at least three times weekly once implementation was complete.
- The company approved termination of its pension plans, effective March 15, 2018, and estimated a $20–$30 million cash contribution to fully fund plan liabilities at termination. Completion was expected by fiscal year-end.
- Risks discussed include product demand, weather, fuel and interest rates, competition, financing access, hiring, construction delays, cybersecurity and supplier costs. Management said the risk factors were not materially changed from its latest 10-K.
- Environmental matters and employee wage-and-hour and termination lawsuits were disclosed. The company said it had accrued probable and reasonably estimable amounts where applicable and did not expect the matters to have a material adverse effect; outcomes remain uncertain.
- Upcoming accounting changes include revenue recognition in FY2019 and lease accounting in FY2020. The company expected the lease standard to materially increase reported assets and liabilities, but had not quantified the effect.
Key facts for investors to verify
- How much reported earnings and EPS depended on the provisional Tax Reform benefit, option-related tax benefits and the $193.2 million impairment—and whether adjusted results are comparable across periods.
- Final sale terms and closing of IMC, and the effects of divesting IMC and AutoAnything on future sales, margins and cash flows.
- Working-capital and supplier-term sustainability, particularly the high accounts-payable-to-inventory ratio and inventory levels.
- Debt refinancing and interest-rate exposure, covenant headroom, and the company’s continued capacity to fund investment and share repurchases.
- Final Tax Reform accounting, pension-plan termination costs and funding, and developments in disclosed legal and environmental matters.