AUTOZONE INC quarterly report, Q3 FY2016

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AutoZone, Inc. — Q3 FY2016 Form 10-Q

Business context and reporting period. The filing covers the 12 weeks ended May 7, 2016 (third quarter) and the 36 weeks ended May 7, 2016 (year to date), compared with the periods ended May 9, 2015. AutoZone operates an automotive parts retail and distribution business, with 5,717 locations across the United States, Puerto Rico, Mexico and Brazil, plus IMC branches. Its interim financial statements are unaudited; the independent accountant performed a review, not an audit.

Financial performance and position

  • Third-quarter revenue and earnings: Net sales were $2.594 billion, up 4.0% year over year. Domestic same-store sales grew 2.0%; new stores contributed $42.7 million in sales. Net income was $327.5 million, up from $309.1 million; diluted EPS rose 12.6% to $10.77.
  • Year-to-date: Sales were $7.237 billion, up 4.9%; net income was $814.2 million, up from $759.1 million. Diluted EPS rose 13.4% to $26.46.
  • Margins: Third-quarter gross margin improved to 52.8% from 52.3%, mainly from higher merchandise margins, partly offset by supply-chain costs related to inventory initiatives. SG&A was 32.2% of sales versus 31.6%, reflecting higher legal expense and store payroll. Year-to-date gross margin was 52.7% versus 52.2%; SG&A was 34.0% versus 33.6%.
  • Interest and taxes: Quarterly net interest expense rose to $34.1 million from $31.8 million as average borrowings increased, partly offset by lower borrowing rates. Year-to-date interest expense declined to $101.9 million from $103.4 million. Effective tax rates were 34.8% for the quarter and 35.1% year to date, down from 35.9% and 35.7%, respectively, due to discrete tax items.
  • Cash flow and investment: Year-to-date operating cash flow was $1.047 billion, compared with $999.1 million. Capital expenditures were $299.9 million; 103 net new locations opened. Investing cash outflow was $316.3 million. Financing cash outflow was $689.0 million, including $1.083 billion of share repurchases. Cash increased $38.1 million to $213.4 million.
  • Debt and liquidity: Total debt was $4.979 billion, including $1.029 billion of commercial paper; long-term debt carrying value was $4.954 billion. The company had $1.709 billion available under $1.75 billion of revolving facilities and no revolver borrowings. Certain commercial paper and notes due in 2016 and 2017 were classified as long-term based on management’s ability and intent to refinance. Adjusted debt/EBITDAR was 2.6x versus 2.5x a year earlier; management said it targets debt levels consistent with investment-grade ratings.
  • Balance sheet: At May 7, cash was $213.4 million, inventory $3.597 billion, and current liabilities $4.648 billion. Stockholders’ deficit was $1.863 billion, reflecting the company’s substantial share-repurchase activity.

Material changes and management commentary

  • Sales growth reflected same-store gains, new stores, and a 5.0% year-to-date increase in total auto-parts sales. Management cited lower gas prices, tax-refund timing, regional weather, merchandise assortment and miles driven as relevant demand factors; outcomes from these factors are uncertain.
  • The company continued expanding more frequent store deliveries and its “mega hub” strategy to improve inventory availability. Management expects to continue these initiatives.
  • Management expects fiscal 2016 investment to exceed fiscal 2015 levels, primarily for new locations, supply-chain infrastructure, existing-store enhancements and technology. The filing gives no specific full-year sales or EPS guidance.
  • After-tax ROIC was 31.2%, versus 31.3% a year earlier. Management attributed the slight decline primarily to higher average debt and recent investments that are currently diluting returns.
  • On April 21, 2016, AutoZone issued $400 million of 3.125% notes due 2026 and $250 million of 1.625% notes due 2019 for general corporate purposes. The board increased the repurchase authorization by $750 million to $17.15 billion. The company repurchased $1.083 billion of stock during the 36-week period and a further $259.0 million after May 7.
  • Inventory cost uses LIFO for domestic inventory. Due to purchase-price deflation, the LIFO reserve was exhausted; the difference between LIFO cost and replacement cost was $349.4 million at May 7, compared with $332.6 million at August 29, 2015.

Risks, contingencies and unusual items

  • Management identified risks including competition, consumer demand and economic conditions, weather, fuel and energy prices, inflation and supplier costs, hiring and retention, financing access, construction delays, cybersecurity, and legal or regulatory changes. Gas prices and tax-refund timing may affect customer spending.
  • Environmental and regulatory matters include a California hazardous-waste investigation, a New Jersey contamination dispute, and an April 2016 California Air Resources Board letter concerning aftermarket emissions parts. The company said it could not predict the hazardous-waste matter’s outcome, but did not expect these matters to have a material adverse effect. It also disclosed employment-related lawsuits and other routine proceedings.
  • Variable-rate debt was $1.029 billion; a 1 percentage-point increase in rates would have an estimated $10.3 million annual unfavorable effect on pretax earnings and cash flows. Debt covenants were reported in compliance.
  • Quarterly EPS benefited by $0.53 from share repurchases since the prior-year comparison period; year-to-date EPS benefited by $0.99. The effective tax rate also benefited from a discrete tax item. These effects qualify the interpretation of reported per-share growth.
  • Management cautioned that interim results may not indicate full-year performance; the business is seasonal, with sales generally highest February through September. The filing reports no material change in risk factors from the prior annual report.

Important facts for investors to verify

  • Whether same-store sales growth and higher merchandise margins persist, and whether supply-chain initiatives and store payroll pressure affect future margins.
  • How much future EPS growth depends on continued buybacks, and how repurchases are funded relative to debt, investment and cash generation.
  • Refinancing and interest-rate exposure, particularly commercial paper and near-term maturities, alongside available revolver capacity and leverage trends.
  • Actual returns and execution costs from planned store, supply-chain and technology investments; management’s ROIC measure is non-GAAP.
  • Developments and potential costs in the disclosed environmental, emissions and employment matters, for which the filing provides no clear ultimate liability value.