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AZO > SEC Filings for AZO > Form 10-Q on 15-Dec-2011All Recent SEC Filings

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Form 10-Q for AUTOZONE INC


15-Dec-2011

Quarterly Report


Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations.

Overview
We are the nation's leading retailer and a leading distributor of automotive replacement parts and accessories in the United States. We began operations in 1979 and at November 19, 2011, operated 4,551 stores in the United States, including Puerto Rico, and 281 in Mexico. Each of our stores carries an extensive product line for cars, sport utility vehicles, vans and light trucks, including new and remanufactured automotive hard parts, maintenance items, accessories and non-automotive products. At November 19, 2011, in 2,733 of our domestic stores, we also have a commercial sales program that provides commercial credit and prompt delivery of parts and other products to local, regional and national repair garages, dealers, service stations and public sector accounts. We also sell the ALLDATA brand automotive diagnostic and repair software through www.alldata.com and www.alldatadiy.com. Additionally, we sell automotive hard parts, maintenance items, accessories, and non-automotive products through www.autozone.com, and our commercial customers can make purchases through www.autozonepro.com. We do not derive revenue from automotive repair or installation services.
Operating results for the twelve weeks ended November 19, 2011, are not necessarily indicative of the results that may be expected for the fiscal year ending August 25, 2012. Each of the first three quarters of our fiscal year consists of 12 weeks, and the fourth quarter consists of 16 or 17 weeks. The fourth quarters for fiscal 2011 and fiscal 2012 each have 16 weeks. Our business is somewhat seasonal in nature, with the highest sales generally occurring during the months of February through September and the lowest sales generally occurring in the months of December and January. Executive Summary
Net sales were up 7.4% for the quarter, driven by domestic same store sales growth of 4.6%. We experienced sales growth from both our retail and commercial customers. Earnings per share increased 24.0% for the quarter.
Over the past several years, various factors have occurred within the economy that affect both our consumer and our industry, including the impact of the recession, continued high unemployment and other challenging economic conditions, which we believe have aided our sales growth during the quarter. As consumers' cash flows have decreased due to these factors, we believe consumers have become more likely to keep their current vehicles longer and perform repair and maintenance in order to keep those vehicles well maintained. Given the nature of these macroeconomic factors, we cannot predict whether or for how long these trends will continue, nor can we predict to what degree these trends will impact us in the future.
More recently, we feel other macroeconomic factors have adversely impacted both our consumer and our industry. During the first quarter of fiscal 2012, the average price per gallon of unleaded gasoline in the United States was $3.50, up $0.72 or 26% from $2.78 in the comparable prior year period. We believe that the increase in gas prices is reducing discretionary spending for all consumers, and, in particular, our customers. While prices have declined since the end of our first quarter, given the unpredictability of gas prices, we cannot predict whether gas prices will increase or decrease, nor can we predict how any future changes in gas prices will impact our sales in future periods.
Our primary response to fluctuations in the demand for the products we sell are to adjust our inventory levels, store staffing, and advertising messages. We continue to believe we are well positioned to help our customers save money and meet their needs in a challenging macro environment.
Historically, the two statistics that we believed had the closest correlation to our market growth over the long-term were miles driven and the number of seven year old or older vehicles on the road. Prior to the recent recession, we had seen a close correlation between our net sales and the number of miles driven; however, recently we have seen minimal correlation in sales performance with miles driven. Sales have grown at an increased rate, while miles driven has either decreased or grown at a slower rate than what we have historically experienced. During this period of minimal correlation between net sales and miles driven, we believe net sales have been positively impacted by other factors, including the number of seven year old or older vehicles on the road. Since the beginning of fiscal year 2011 and through September 2011 (latest publicly available information), miles driven have decreased slightly as compared to the corresponding prior year period, and the average age of the U.S. light vehicle fleet continues to trend in our industry's favor. We believe that annual miles driven will return to a low single digit growth rate over time and that the number of seven year old or older vehicles will continue to increase; however, we are unable to predict the impact, if any, these indicators will have on future results.
In the first quarter, failure and maintenance related categories continued to represent the largest portion of our sales mix, at approximately 84% of total sales, with failure related categories continuing to be our strongest performers. While we have not experienced any fundamental shifts in our category sales mix over recent periods, we did experience a slight increase in sales of failure related categories as a percentage of sales. We remain focused on refining and expanding our product assortment to ensure we have the best merchandise at the right price in each of our categories.


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Twelve Weeks Ended November 19, 2011,
Compared with Twelve Weeks Ended November 20, 2010 Net sales for the twelve weeks ended November 19, 2011, increased $132.7 million to $1.924 billion, or 7.4%, over net sales of $1.792 billion for the comparable prior year period. Total auto parts sales increased by 7.4%, primarily driven by a domestic same store sales (sales for stores open at least one year) increase of 4.6% and net sales of $47.3 million from new stores. The domestic same store sales increase was driven by higher transaction value, partially offset by decreased transaction counts. Higher transaction value is attributable to product inflation due to more complex, costly products and commodity price increases.
Gross profit for the twelve weeks ended November 19, 2011, was $983.6 million, or 51.1% of net sales, compared with $907.7 million, or 50.7% of net sales, during the comparable prior year period. The improvement in gross margin was attributable to distribution costs leveraging on higher sales (23 basis points), lower shrink expense (18 basis points) and slightly higher merchandise margins. Operating, selling, general and administrative expenses for the twelve weeks ended November 19, 2011, were $642.7 million, or 33.4% of net sales, compared with $601.6 million, or 33.6% of net sales, during the comparable prior year period. The improvement in operating expenses was due to lower incentive compensation (33 basis points), favorable legal expense (32 basis points) and leverage from higher sales volumes. This leverage was partially offset by higher self insurance costs (51 basis points).
Net interest expense for the twelve weeks ended November 19, 2011, was $39.1 million compared with $37.3 million during the comparable prior year period. This increase was primarily due to the increase in debt over the comparable prior year period, offset by a decrease in borrowing rates. Average borrowings for the twelve weeks ended November 19, 2011, were $3.287 billion, compared with $2.861 billion for the comparable prior year period. Weighted average borrowing rates were 4.8% for the twelve weeks ended November 19, 2011, and 5.3% for the twelve weeks ended November 20, 2010.
Our effective income tax rate was 36.7% of pretax income for the twelve weeks ended November 19, 2011, and 36.0% for the comparable prior year period. Net income for the twelve week period ended November 19, 2011, increased by $19.0 million to $191.1 million, and diluted earnings per share increased by 24.0% to $4.68 from $3.77 in the comparable prior year period. The impact on current quarter diluted earnings per share from stock repurchases since the end of the comparable prior year period was an increase of $0.48. Liquidity and Capital Resources
The primary source of our liquidity is our cash flows realized through the sale of automotive parts, products and accessories. For the twelve weeks ended November 19, 2011, our net cash flows from operating activities provided $342.3 million as compared with $357.4 million provided during the comparable prior year period. The decrease is primarily due to higher income tax payments and a reduced benefit from the change in inventories net of payables, partially offset by higher net income. Our inventory increases are primarily attributable to an increased number of stores and to a lesser extent, our efforts to update product assortments in all of our stores. During the twelve weeks ended November 19, 2011, we continued to benefit from inventory being financed by our vendors. We had an accounts payable to inventory ratio of 112% at November 19, 2011, as compared to 107% at November 20, 2010.
Our net cash flows from investing activities for the twelve weeks ended November 19, 2011, used $61.9 million as compared with $47.9 million used in the comparable prior year period. Capital expenditures for the twelve weeks ended November 19, 2011, were $61.9 million compared to $45.8 million for the comparable prior year period. The increase is primarily driven by a shift in the mix of store openings from build-to-suit leases to ground leases and land purchases, which require a higher initial capital investment. During this twelve week period, we opened 19 net new stores. In the comparable prior year period, we opened 18 net new stores. Investing cash flows were also impacted by our wholly owned insurance captive, which purchased $11.1 million and sold $10.1 million in marketable securities during the twelve weeks ended November 19, 2011. During the comparable prior year period, the captive purchased $9.9 million in marketable securities and sold $7.3 million in marketable securities. Capital asset disposals provided $1.1million during the twelve week period ended November 19, 2011, and $0.5 million in the comparable prior year period.
Our net cash flows from financing activities for the twelve weeks ended November 19, 2011, used $280.7 million compared to $310.2 million used in the comparable prior year period. There were no proceeds from the issuance of debt for the current twelve week period ended November 19, 2011. During the comparable prior year, proceeds from the issuance of debt totaled $500 million. Those proceeds were used for the repayment of debt of $199.3 million, the repayment of a portion of our commercial paper borrowings, and general corporate purposes. For the twelve weeks ended November 19, 2011, net proceeds from borrowings of commercial paper and short-term borrowings were $5.8 million as compared to net repayments of $331.6 million in the comparable prior year period. Stock repurchases were $309.8 million in the current twelve week period as compared with $299.7 million in the comparable prior year period. For the twelve weeks ended November 19, 2011, proceeds from the sale of common stock and exercises of stock options provided $29.7 million, including $11.2 million in related tax benefits. In the comparable prior year period, proceeds from the sale of common stock and exercises of stock options provided $30.9 million, including $9.0 million in related tax benefits.
During fiscal 2012, we expect to invest in our business at an increased rate as compared to fiscal 2011. Our investment is expected to be directed primarily to our new-store development program and enhancements to existing stores and infrastructure. The amount of our investments in our new-store program is impacted by different factors, including such factors as whether the building and land are purchased (requiring higher investment) or leased (generally lower investment), located in the United States or Mexico, or located in urban or rural areas. During fiscal 2011 and fiscal 2010, our capital expenditures increased by approximately 2% and 16%, respectively, as compared to the prior year, and we expect our capital expenditures for fiscal 2012 to increase by 20% to 25% as compared to fiscal 2011. Our mix of store openings has moved away from build-to-suit leases (lower initial capital investment) to ground leases and land purchases (higher initial capital investment), resulting in increased capital expenditures per store during recent years, and we expect this trend to continue during the remainder of the fiscal year ending August 25, 2012.


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In addition to the building and land costs, our new-store development program requires working capital, predominantly for inventories. Historically, we have negotiated extended payment terms from suppliers, reducing the working capital required and resulting in a high accounts payable to inventory ratio. We plan to continue leveraging our inventory purchases; however, our ability to do so may be limited by our vendors' capacity to factor their receivables from us. Certain vendors participate in financing arrangements with financial institutions whereby they factor their receivables from us, allowing them to receive payment on our invoices at a discounted rate.
Depending on the timing and magnitude of our future investments (either in the form of leased or purchased properties or acquisitions), we anticipate that we will rely primarily on internally generated funds and available borrowing capacity to support a majority of our capital expenditures, working capital requirements and stock repurchases. The balance may be funded through new borrowings. We anticipate that we will be able to obtain such financing in view of our current credit ratings and favorable experiences in the debt markets in the past.
For the trailing four quarters ended November 19, 2011, our after-tax return on invested capital ("ROIC") was 32.1% as compared to 28.6% for the comparable prior year period. ROIC is calculated as after-tax operating profit (excluding rent charges) divided by average invested capital (which includes a factor to capitalize operating leases). ROIC increased primarily due to increased after-tax operating profit. We use ROIC to evaluate whether we are effectively using our capital resources and believe it is an important indicator of our overall operating performance.
Debt Facilities
In September 2011, we amended and restated our $800 million revolving credit facility, which was scheduled to expire in July 2012. The capacity under the revolving credit facility was increased to $1.0 billion. This credit facility is available to primarily support commercial paper borrowings, letters of credit and other short-term, unsecured bank loans. The capacity of the credit facility may be increased to $1.250 billion prior to the maturity date at our election and subject to bank credit capacity and approval, may include up to $200 million in letters of credit, and may include up to $175 million in capital leases each fiscal year. Under the revolving credit facility, we may borrow funds consisting of Eurodollar loans or base rate loans. Interest accrues on Eurodollar loans at a defined Eurodollar rate, defined as the London InterBank Offered Rate ("LIBOR") plus the applicable percentage, as defined in the revolving credit facility, depending upon our senior, unsecured, (non-credit enhanced) long-term debt rating. Interest accrues on base rate loans as defined in the revolving credit facility. We also have the option to borrow funds under the terms of a swingline loan subfacility. The revolving credit facility expires in September 2016.
As the available balance is reduced by commercial paper borrowings and certain outstanding letters of credit, we had $399.4 million in available capacity under our $1.0 billion credit facility at November 19, 2011.
We also maintain a letter of credit facility that allows us to request the participating bank to issue letters of credit on our behalf up to an aggregate amount of $100 million. The letter of credit facility is in addition to the letters of credit that may be issued under the revolving credit facility. As of November 19, 2011, we have $98.3 million in letters of credit outstanding under the letter of credit facility, which expires in June 2013.
On November 15, 2010, we issued $500 million in 4.000% Senior Notes due 2020 under our shelf registration statement filed with the Securities and Exchange Commission on July 29, 2008 (the "Shelf Registration"). The Shelf Registration allows us to sell an indeterminate amount in debt securities to fund general corporate purposes, including repaying, redeeming or repurchasing outstanding debt and for working capital, capital expenditures, new store openings, stock repurchases and acquisitions. During the quarter ended November 20, 2010, we used the proceeds from the issuance of debt to repay the principal due relating to the 4.750% Senior Notes that matured on November 15, 2010, to repay a portion of the commercial paper borrowings and for general corporate purposes. The 6.500% and 7.125% Senior Notes issued during August 2008, and the 5.750% Senior Notes issued in July 2009, are subject to an interest rate adjustment if the debt ratings assigned to the notes are downgraded. These notes, along with the 4.000% Senior Notes issued in November 2010, also contain a provision that repayment of the notes may be accelerated if AutoZone experiences a change in control (as defined in the agreements). Our borrowings under our other senior notes contain minimal covenants, primarily restrictions on liens. Under our other borrowing arrangements, covenants include limitations on total indebtedness, restrictions on liens, a minimum fixed charge coverage ratio and a change of control provision that may require acceleration of the repayment obligations under certain circumstances. All of the repayment obligations under our borrowing arrangements may be accelerated and come due prior to the scheduled payment date if covenants are breached or an event of default occurs. As of November 19, 2011, we were in compliance with all covenants and expect to remain in compliance with all covenants.
Our adjusted debt to earnings before interest, taxes, depreciation, amortization, rent and share-based expense ("EBITDAR") ratio was 2.4:1 as of November 19, 2011, and was 2.3:1 as of November 20, 2010. We calculate adjusted debt as the sum of total debt, capital lease obligations and rent times six; and we calculate EBITDAR by adding interest, taxes, depreciation, amortization, rent and share-based expenses to net income. Adjusted debt to EBITDAR is calculated on a trailing four quarter basis. We target our debt levels to a ratio of adjusted debt to EBITDAR in order to maintain our investment grade credit ratings. We believe this is important information for the management of our debt levels.


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Stock Repurchases
From January 1, 1998 to November 19, 2011, we have repurchased a total of 128.3 million shares at an aggregate cost of $10.5 billion, including 954,389 shares of our common stock at an aggregate cost of $309.8 million during the twelve week period ended November 19, 2011. On September 28, 2011, the Board of Directors (the "Board") voted to increase the authorization by $750 million to raise the cumulative share repurchase authorization from $10.4 billion to $11.15 billion. Considering cumulative repurchases as of November 19, 2011, we have $658.9 million remaining under the Board's authorization to repurchase our common stock. We had no share repurchases of our common stock subsequent to November 19, 2011.
Off-Balance Sheet Arrangements
Since our fiscal year end, we have cancelled, issued and modified stand-by letters of credit that are primarily renewed on an annual basis to cover deductible payments to our casualty insurance carriers. Our total stand-by letters of credit commitment at November 19, 2011, was $101.9 million compared with $96.6 million at August 27, 2011, and our total surety bonds commitment at November 19, 2011, was $26.5 million compared with $26.3 million at August 27, 2011.
Financial Commitments
As of November 19, 2011, there were no significant changes to our contractual obligations as described in our Annual Report on Form 10-K for the year ended August 27, 2011.
Reconciliation of Non-GAAP Financial Measures Management's Discussion and Analysis of Financial Condition and Results of Operations include certain financial measures not derived in accordance with U.S. generally accepted accounting principles ("GAAP"). These non-GAAP financial measures provide additional information for determining our optimum capital structure and are used to assist management in evaluating performance and in making appropriate business decisions to maximize stockholders' value. Non-GAAP financial measures should not be used as a substitute for GAAP financial measures, or considered in isolation, for the purpose of analyzing our operating performance, financial position or cash flows. However, we have presented the non-GAAP financial measures, as we believe they provide additional information that is useful to investors. Furthermore, our management and the Compensation Committee of the Board use the abovementioned non-GAAP financial measures to analyze and compare our underlying operating results and to determine payments of performance-based compensation. We have included a reconciliation of this information to the most comparable GAAP measures in the following reconciliation tables.


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Reconciliation of Non-GAAP Financial Measure: After-Tax Return on Invested Capital "ROIC"
The following tables reconcile the percentages of ROIC for the trailing four quarters ended November 19, 2011 and November 20, 2010.

                                              A                   B                 A-B=C                 D                    C+D
                                                                                                                          Trailing Four
                                         Fiscal Year           Twelve               Forty            Twelve Weeks           Quarters
                                            Ended            Weeks Ended         Weeks Ended            Ended                 Ended
                                          August 27,        November 20,         August 27,          November 19,         November 19,
(in thousands, except percentage)            2011               2010                2011                 2011                 2011
Net income                               $    848,974       $     172,076       $     676,898       $      191,125       $       868,023
Adjustments:
Interest expense                              170,557              37,253             133,304               39,094               172,398
Rent expense                                  213,846              47,546             166,300               51,303               217,603
Tax effect(1)                                (138,554 )           (30,565 )          (107,989 )            (32,583 )            (140,572 )

After-tax return                         $  1,094,823       $     226,310       $     868,513       $      248,939       $     1,117,452


Average debt(2)                                                                                                          $     3,211,046
Average deficit(3)                                                                                                            (1,115,290 )
Rent x 6(4)                                                                                                                    1,305,618
Average capital lease obligations(5)                                                                                              84,662

Pre-tax invested capital                                                                                                 $     3,486,036


ROIC                                                                                                                                32.1 %




                                               A                   B                 A-B=C                 D                    C+D
                                                                                                                           Trailing Four
                                          Fiscal Year           Twelve               Forty            Twelve Weeks           Quarters
                                             Ended            Weeks Ended         Weeks Ended            Ended                 Ended
                                          August 28,         November 21,         August 28,          November 20,         November 20,
(in thousands, except percentage)            2010                2009                2010                 2010                 2010
Net income                               $     738,311       $     143,300       $     595,011       $      172,076       $       767,087
Adjustments:
Interest expense                               158,909              36,340             122,569               37,253               159,822
Rent expense                                   195,632              44,397             151,235               47,546               198,781
Tax effect(1)                                 (128,983 )           (28,953 )          (100,030 )            (30,345 )            (130,375 )

After-tax return                         $     963,869       $     195,084       $     768,785       $      226,530       $       995,315


Average debt(2)                                                                                                           $     2,800,081
Average deficit(3)                                                                                                               (584,704 )
Rent x 6(4)                                                                                                                     1,192,686
Average capital lease obligations(5)                                                                                               68,271

Pre-tax invested capital                                                                                                  $     3,476,334


ROIC                                                                                                                                 28.6 %

(1) The effective tax rate over the trailing four quarters ended November 19, 2011 and November 20, 2010 is 36.0% and 36.4%, respectively.

(2) Average debt is equal to the average of our debt measured as of the previous five quarters.

(3) Average equity is equal to the average of our stockholders' deficit measured as of the previous five quarters.

(4) Rent is multiplied by a factor of six to capitalize operating leases in the determination of pre-tax invested capital.

(5) Average capital lease obligations are equal to the average of our capital lease obligations measured as of the previous five quarters.


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Reconciliation of Non-GAAP Financial Measure: Adjusted Debt to Earnings before Interest, Taxes, Depreciation, Rent and Share-Based Expense "EBITDAR" The following tables reconcile the ratio of adjusted debt to EBITDAR for the trailing four quarters ended November 19, 2011 and November 20, 2010.

                                    A                 B              A-B=C               D                  C+D
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