AutoZone, Inc.
We have reviewed the condensed consolidated balance sheet of AutoZone, Inc. as of May 7, 2005, and the related condensed consolidated statements of income for the twelve and thirty-six week periods ended May 7, 2005 and May 8, 2004, and the condensed consolidated statements of cash flows for the thirty-six week periods ended May 7, 2005 and May 8, 2004. These financial statements are the responsibility of the Company’s management.
We conducted our review in accordance with the standards of the Public Company Accounting Oversight Board (United States). A review of interim financial information consists principally of applying analytical procedures to financial data and making inquiries of persons responsible for financial and accounting matters. It is substantially less in scope than an audit conducted in accordance with the standards of the Public Company Accounting Oversight Board, the objective of which is the expression of an opinion regarding the financial statements taken as a whole. Accordingly, we do not express such an opinion.
Based on our review, we are not aware of any material modifications that should be made to the condensed consolidated financial statements referred to above for them to be in conformity with U.S. generally accepted accounting principles.
We have previously audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheet of AutoZone, Inc. as of August 28, 2004, and the related consolidated statements of income, changes in stockholders’ equity, and cash flows for the year then ended, not presented herein, and, in our report dated September 21, 2004, we expressed an unqualified opinion on those consolidated financial statements. In our opinion, the information set forth in the accompanying condensed consolidated balance sheet as of August 28, 2004 is fairly stated, in all material respects, in relation to the consolidated balance sheet from which it has been derived.
Item 2. | Management’s Discussion and Analysis of Financial Condition and Results of Operations. |
Overview
We are the nation’s leading retailer of automotive parts and accessories, with most of our sales to do-it-yourself (“DIY”) customers. As of May 7, 2005, we operated 3,505 domestic stores and 73 stores in Mexico, compared with 3,337 domestic stores and 60 stores in Mexico at May 8, 2004. 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. In many of our 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 and service stations. We also sell the ALLDATA brand diagnostic and repair software. On the web, we sell diagnostic and repair information and automotive hard parts, maintenance items, accessories and non-automotive products through www.autozone.com. We do not derive revenue from automotive repair or installation.
Operating results for the twelve and thirty-six weeks ended May 7, 2005, are not necessarily indicative of the results that may be expected for the fiscal year ending August 27, 2005. Each of the first three quarters of our fiscal year consists of 12 weeks, and the fourth quarter consists of 16 or 17 weeks. Each of the fourth quarters of fiscal 2004 and 2005 has 16 weeks. Additionally, our business is somewhat seasonal in nature, with the highest sales generally occurring in the summer months of June through August and the lowest sales generally occurring in the winter months of December through February.
Twelve Weeks Ended May 7, 2005, Compared with Twelve Weeks Ended May 8, 2004
Net sales for the twelve weeks ended May 7, 2005, decreased $21.6 million, or 1.6%, from net sales of $1.36 billion for the comparable prior year period. This decrease in sales was primarily driven by a 5% decrease in comparable store sales (sales for domestic stores opened at least one year). DIY sales decreased 2% and commercial sales decreased 5%, while combined sales from our ALLDATA and Mexico operations increased 15%. While our average ticket has increased over the prior year, the number of customer transactions is below levels from the comparable prior year period.
Gross profit for the twelve weeks ended May 7, 2005, was $673.1 million, or 50.3% of net sales, compared with $676.2 million, or 49.7% of net sales, during the comparable prior year period. During the comparable prior year period, warranty negotiations with our vendors resulted in a $10.6 million, or 0.8%, of net sales, favorable impact to operating profit. The improvement in gross profit margin was primarily attributable to ongoing category management initiatives, which more than offset the prior year warranty benefit.
Operating, selling, general and administrative expenses for the twelve weeks ended May 7, 2005, was $413.6 million, or 30.9% of net sales, compared with $424.9 million, or 31.2% of net sales, during the comparable prior year period. Contributing to the decline in operating expenses is lower bad debt from improved collections on receivables and initiatives that have reduced operating expenses.
Interest expense, net for the twelve weeks ended May 7, 2005, was $24.2 million compared with $21.9 million during the comparable prior year period. This increase was primarily due to a higher average borrowing rate versus the comparable prior year period. Average borrowings for the twelve weeks ended May 7, 2005, were $1.94 billion, compared with $1.92 billion for the comparable prior year period. Weighted average borrowing rates were 5.0% at May 7, 2005, and 4.6% at May 8, 2004.
Our effective income tax rate was 37.2% of pretax income for the twelve weeks ended May 7, 2005, and 37.5% for the comparable prior year period.
Net income for the twelve-week period ended May 7, 2005, increased $4.4 million, or 3.1%, to $147.8 million, and diluted earnings per share increased by 10.5% to $1.86 from $1.68 in the comparable prior year period. The impact on current quarter diluted earnings per share from the stock repurchases since the end of the comparable prior year period was an increase of $0.07.
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Thirty-six Weeks Ended May 7, 2005, Compared with Thirty-six Weeks Ended May 8, 2004
Net sales for the thirty-six weeks ended May 7, 2005, increased $27.3 million, or 0.7%, over net sales of $3.80 billion for the comparable prior year period. This increase in sales was primarily driven by sales from new stores as comparable store sales (sales for domestic stores opened at least one year) decreased 3%. DIY sales increased 1%, commercial sales decreased 2% and combined sales from our ALLDATA and Mexico operations increased 14%. While our average ticket has increased over prior year, the number of customer transactions is below levels from the comparable prior year period.
Gross profit for the thirty-six weeks ended May 7, 2005, was $1.88 billion, or 49.0% of net sales, compared with $1.85 billion, or 48.8% of net sales, during the comparable prior year period. During the comparable prior year period, warranty negotiations with our vendors resulted in a $26.6 million, or 0.7% of net sales, favorable impact to gross profit. The improvement in gross profit margin was primarily attributable to reduced sales of discretionary, lower margin, merchandise as well as ongoing category management initiatives, which more than offset the prior year warranty.
Operating, selling, general and administrative expenses for the thirty-six weeks ended May 7, 2005, was $1.25 billion, or 32.7% of net sales, compared with $1.22 billion, or 32.1% of net sales, during the comparable year period. This increase is primarily related to the $40.3 million adjustment, or 1.1% of net sales, related to accounting for leases (see “Note K-Lease Accounting” in the accompanying Notes to Condensed Consolidated Financial Statements), which was partially offset by a decline in other expenses primarily due to lower bad debt from improved collections on receivables and initiatives that have reduced operating expenses.
Interest expense, net for the thirty-six weeks ended May 7, 2005, was $69.7 million compared with $64.1 million during the comparable prior year period. This increase was due to both higher average borrowing levels and rates versus the comparable prior year period. Average borrowings for the thirty-six weeks ended May 7, 2005, were $1.95 billion, compared with $1.75 billion for the comparable prior year period. Weighted average borrowing rates were 5.0% at May 7, 2005, and 4.6% at May 8, 2004.
Our effective income tax rate was 34.3% of pretax income for the thirty-six weeks ended May 7, 2005, and 37.5% for the comparable prior year period. The current year effective rate reflects $15.3 million in one-time tax benefits recorded during the quarter ended February 12, 2005, primarily related to the repatriation of Mexican earnings as a result of the American Jobs Creation Act of 2004.
Net income for the thirty-six week period ended May 7, 2005, increased $7.6 million, or 2.1%, to $364.4 million, and diluted earnings per share increased by 11.7% to $4.53 from $4.06 in the comparable prior year period. The impact on current period diluted earnings per share from the stock repurchases since the end of the comparable prior year period was an increase of $0.15.
Liquidity and Capital Resources
The primary source of our liquidity is our cash flows realized through the sale of automotive parts and accessories. For the thirty-six weeks ended May 7, 2005, our net cash flows from operating activities provided $403.5 million as compared with $334.4 million during the comparable prior year period. The year-over-year improvement in cash flows from operating activities is primarily due to changes in accounts payable and accrued expenses. The increase in merchandise inventories, required to support new-store development and sales growth, has largely been financed by our vendors, as evidenced by an 87% accounts payable to inventory ratio. Contributing to the favorable year-over-year change in accounts payable and accrued expenses is the use of pay-on-scan (“POS”) arrangements with certain vendors, whereby we will not purchase merchandise supplied by a vendor until just before that merchandise is ultimately sold to our customers. Title and certain risks of ownership remain with the vendor until the merchandise is sold to our customers. Since we do not own merchandise under POS arrangements until just before it is sold to a customer, such merchandise is not recorded on our balance sheet. Upon the sale of the merchandise to our customer, we recognize the liability for the goods and pay the vendor in accordance with the agreed upon terms. Although we do not hold title to the goods, we control pricing and have credit collection risk and therefore, revenues under POS arrangements are included gross in net sales in the income statement. We have financed the repurchase of existing merchandise inventory by certain vendors in order to convert such vendors to POS arrangements. These receivables have durations up to 25 months and approximated $57.3 million at May 7, 2005. The $38.0 million current portion of these receivables is reflected in accounts receivable and the $19.3 million long-term portion is reflected as a component of other long-term assets at May 7, 2005. Merchandise under POS arrangements was $140.7 million at May 7, 2005, and we continue to actively negotiate with our vendors to increase the use of POS arrangements.
Our net cash flows from investing activities for the thirty-six weeks ended May 7, 2005, used $186.4 million as compared with $121.9 million used in the comparable prior year period. Included in the current year amount was $3.1 million related to our acquisition of certain assets from a regional auto parts retailer. Four stores related to this transaction have been
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converted to AutoZone stores and are reflected in our store counts. Capital expenditures for the thirty-six weeks ended May 7, 2005, were $186.9 million compared to $112.2 million for the comparable prior year period. The increase in capital expenditures was driven by the investment in our new distribution facility in Texas, an increase in stores under development and other current year initiatives. During this thirty-six week period, we opened 85 net new domestic stores and 10 new stores in Mexico. In the comparable prior year period, we opened 118 net new domestic stores and 11 new stores in Mexico. Capital expenditures for this fiscal year are estimated at $250 million, primarily related to the planned opening of approximately 200 new stores during this year, our new distribution facility and other initiatives.
Our net cash flows from financing activities for the thirty-six weeks ended May 7, 2005, used $216.6 million compared to $217.8 million used for the comparable prior year period. The current period reflects $300.0 million in proceeds from the issuance of a bank term loan, and $252.7 million in net repayments of commercial paper borrowings. The comparable prior year period reflects $500.0 million in proceeds from the issuance of senior notes, $183.4 million in net proceeds from commercial paper and debt repayments of $431.3 million. Stock repurchases were $308.6 million in the current period as compared with $530.3 million in stock repurchases in the comparable prior year period. The settlement of interest rate hedge instruments provided $32.2 million in the comparable prior year period. For the thirty-six weeks ended May 7, 2005, exercises of stock options provided $68.6 million, including $23.4 million in related tax benefits that are reflected in cash flows from operating activities. In the comparable prior year period, exercises of stock options provided $44.9 million, including $20.6 million in related tax benefits. At May 7, 2005, options to purchase 1.8 million shares were exercisable at a weighted average exercise price of $48.
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 credit rating and favorable experiences in the debt market in the past.
At May 7, 2005, AutoZone had a senior unsecured debt credit rating from Standard & Poor’s of BBB+ and a commercial paper rating of A-2. Moody’s Investors Service had assigned us a senior unsecured debt credit rating of Baa2 and a commercial paper rating of P-2. As of May 7, 2005, Moody’s and Standard & Poor’s had AutoZone listed as having a “negative” and “stable” outlook, respectively. If our credit ratings drop, our interest expense may increase; similarly, we anticipate that our interest expense may decrease if our investment ratings are raised. If our commercial paper ratings drop below current levels, we may have difficulty continuing to utilize the commercial paper market and our interest expense will increase, as we will then be required to access more expensive bank lines of credit. If our senior unsecured debt ratings drop below investment grade, our access to financing may become more limited.
We maintain $1.0 billion of revolving credit facilities with a group of banks. On May 3, 2005, the expiration dates of the facilities were extended by one year as permitted under the original agreement. Of the $1.0 billion, $300 million now expires in May 2006 and $700 million now expires in May 2010. The credit facilities exist primarily to support commercial paper borrowings, letters of credit and other short-term unsecured bank loans. As the available balance is reduced by commercial paper borrowings and certain outstanding letters of credit, we had $598.6 million in available capacity under these facilities at May 7, 2005. The rate of interest payable under the credit facilities is a function of the London Interbank Offered Rate (LIBOR), the lending bank’s base rate (as defined in the facility agreements) or a competitive bid rate at our option.
On August 17, 2004, we filed a shelf registration with the Securities and Exchange Commission that allows us to sell up to $300 million 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. Based on changing market conditions, we chose to delay the issuance of debt securities and settled an outstanding forward-starting interest rate swap during November 2004.
On December 23, 2004, we entered into a Credit Agreement for a $300 million, 5-year term loan with a group of banks. The term loan consists of, at our election, base rate loans, Eurodollar loans or a combination thereof. Interest accrues on base rate loans at a base rate per annum equal to the higher of prime rate or the Federal Funds Rate plus 1/2 of 1%. Interest accrues on Eurodollar loans at a defined Eurodollar rate plus the applicable percentage, which can range from 40 basis points to 112.5 basis points, depending upon our senior unsecured (non-credit enhanced) long term debt rating, as published by Standard & Poor’s Ratings Services and/or Moody’s Investors Service, Inc. At our current ratings, the applicable percentage on Eurodollar loans is 50 basis points. On December 30, 2004, the full principal amount of $300 million was funded as a Eurodollar loan. We may select interest periods of one, two, three or six months for Eurodollar loans, subject to availability. Interest is payable at the end of the selected interest period, but no less frequently than quarterly. We entered into an interest rate swap agreement on December 29, 2004, to effectively fix, based on current debt ratings, the interest rate of the term loan at 4.55%. We have the option to extend loans into subsequent interest period(s) or convert them into loans of another interest rate type. The entire unpaid principal amount of the term loan will be due and payable in full on December 23, 2009, when the facility terminates. We may
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prepay the term loan in whole or in part at any time without penalty, subject to reimbursement of the lenders’ breakage and redeployment costs in the case of prepayment of Eurodollar borrowings.
We have agreed to observe certain covenants under the terms of our borrowing agreements, including limitations on total indebtedness, restrictions on liens and minimum fixed charge coverage. All of the repayment obligations under our borrowing agreements may be accelerated and come due prior to the scheduled payment date if covenants are breached or an event of default occurs. Additionally, the repayment obligations may be accelerated if we experience a change in control (as defined in the agreements) of AutoZone or its Board of Directors. As of May 7, 2005, we were in compliance with all covenants and expect to remain in compliance with all covenants.
As of May 7, 2005, the Board of Directors had authorized the Company to repurchase up to $4.4 billion of common stock in the open market. This includes the additional $500 million that was approved by the Board of Directors on March 16, 2005. From January 1, 1998 to May 7, 2005, the Company has repurchased a total of 85.8 million shares at an aggregate cost of $4.0 billion; including 3.6 million shares of its common stock at an aggregate cost of $308.6 million during the thirty-six week period ended May 7, 2005.
Off-Balance Sheet Arrangements
In conjunction with our commercial sales program, we offer credit to some of our commercial customers. Certain of the receivables related to the credit program are sold to a third party at a discount for cash with limited recourse. We have established a reserve for this recourse. At May 7, 2005, the receivables facility had an outstanding balance of $49.6 million and the balance of the recourse reserve was approximately $800,000.
Since fiscal year end, we have issued additional and increased existing stand-by letters of credit that are primarily renewed on an annual basis to cover premium and deductible payments to our workers’ compensation carrier. Our total standby letters of credit commitment at May 7, 2005 was $121.1 million compared with $97.2 million at August 28, 2004, and our total surety bonds commitment at May 7, 2005, was $10.7 million compared with $10.8 million at August 28, 2004.
AutoZone has entered into pay-on-scan (“POS”) arrangements with certain vendors, whereby AutoZone will not purchase merchandise supplied by a vendor until just before that merchandise is ultimately sold to AutoZone’s customers. Title and certain risks of ownership remain with the vendor until the merchandise is sold to AutoZone’s customers. Since the Company does not own merchandise under POS arrangements until just before it is sold to a customer, such merchandise is not recorded on the Company’s balance sheet. Upon the sale of the merchandise to AutoZone’s customers, AutoZone recognizes the liability for the goods and pays the vendor in accordance with the agreed-upon terms. Although AutoZone does not hold title to the goods, AutoZone controls pricing and has credit collection risk and therefore, gross revenues under POS arrangements are included in net sales in the income statement. Merchandise under POS arrangements was $140.7 million at May 7, 2005, and $146.6 million at August 28, 2004.
Critical Accounting Policies
As there have been no changes to our critical accounting policies during fiscal 2005, refer to our Annual Report to Shareholders, which is incorporated by reference in our Annual Report on Form 10-K for the fiscal year ended August 28, 2004, for a summary of our policies.
Forward-Looking Statements
Certain statements contained in this Quarterly Report on Form 10-Q are forward-looking statements. Forward-looking statements typically use words such as “believe,” “anticipate,” “should,” “intend,” “plan,” “will,” “expect,” “estimate,” “project,” “positioned,” “strategy,” and similar expressions. These are based on our assumptions and assessments made by our management in light of experience and perception of historical trends, current conditions, expected future developments and other factors that they believe to be appropriate. These forward-looking statements are subject to a number of risks and uncertainties, including without limitation, competition; product demand; the economy; the ability to hire and retain qualified employees; consumer debt levels; inflation; gasoline prices; war and the prospect of war, including terrorist activity; availability of commercial transportation; construction delays; access to available and feasible financing; changes in laws or regulations; and our ability to continue to negotiate POS arrangements and other terms with our vendors. Forward-looking statements are not guarantees of future performance and actual results; developments and business decisions may differ from those contemplated by such forward-looking statements, and such events could materially and adversely affect our business. 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 materially differ from
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anticipated results. Please refer to the Risk Factors section contained in our Annual Report on Form 10-K for the fiscal year ended August 28, 2004, for more details.
Item 3. | Quantitative and Qualitative Disclosures About Market Risk. |
At May 7, 2005, the only material changes to our instruments and positions that are sensitive to market risk since the disclosures in our 2004 Annual Report to Shareholders, which is incorporated by reference in our Annual Report on Form 10-K, were the proceeds from the $300.0 million term loan, a $252.7 million reduction in commercial paper, the settlement of an outstanding forward-starting interest rate swap and the execution of a new interest rate swap to fix the interest rate on the $300.0 million term loan.
We had $574.5 million of variable rate debt outstanding at May 7, 2005, and $529.3 million outstanding at August 28, 2004, both of which exclude the effect of any interest rate swaps designated and effective as cash flow hedges of such variable rate debt. At these borrowing levels for variable rate debt, a one percentage point increase in interest rates would have had an unfavorable impact on AutoZone’s pretax earnings and cash flows of $5.7 million in fiscal 2005 and $5.3 million in fiscal 2004, which excludes the effects of any interest rate swaps. The primary interest rate exposure on variable rate debt is based on LIBOR. We had fixed rate debt outstanding of $1.34 billion at May 7, 2005, and at August 28, 2004. A one percentage point increase in interest rates would reduce the fair value of our fixed rate debt by $66.0 million at May 7, 2005, and by $81.1 million at August 28, 2004.
Item 4. | Controls and Procedures. |
As of May 7, 2005, an evaluation was performed under the supervision and with the participation of our management, including the Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures. Based on that evaluation, our management, including the Chief Executive Officer and Chief Financial Officer, concluded that our disclosure controls and procedures were effective as of May 7, 2005. No significant changes in our internal controls or in other factors have occurred that could significantly affect controls subsequent to May 7, 2005.
PART II. OTHER INFORMATION
Item 1. | Legal Proceedings. |
AutoZone, Inc. is a defendant in a lawsuit entitled “Coalition for a Level Playing Field, L.L.C., et al., v. AutoZone, Inc. et al.,” filed in the U.S. District Court for the Southern District of New York in October 2004. The case was filed by approximately 159 plaintiffs, which are principally automotive aftermarket warehouse distributors and jobbers, against 18 defendants, five of which are principally automotive aftermarket retailers and 13 of which are principally aftermarket manufacturers (one aftermarket manufacturer subsequently settled, leaving 12 aftermarket manufacturer defendants). The plaintiffs allege, inter alia, that the automotive aftermarket retailer defendants have conspired with the aftermarket manufacturer defendants to receive benefits such as volume discounts, rebates, early buy allowances and other allowances, fees, inventory without payment, sham advertising and promotional payments, a share in the manufacturers’ profits and excessive payments for services purportedly performed for the manufacturers in violation of the Robinson-Patman Act and the Sherman Act (collectively, the “Acts”). Additionally, a subset of plaintiffs alleges a claim of fraud against the automotive aftermarket retailer defendants based on discovery issues in a prior litigation involving similar Robinson-Patman Act claims. In the prior litigation, the discovery dispute, as well as the underlying claims, was decided in favor of AutoZone and the other automotive aftermarket retailer defendants who proceeded to trial, pursuant to a unanimous jury verdict which was affirmed by the Second Circuit. In the current litigation, plaintiffs seek an unspecified amount of damages (including statutory trebling), attorneys’ fees, and a permanent injunction prohibiting the aftermarket retailer defendants from inducing and/or knowingly receiving discriminatory prices from any of the aftermarket manufacturer defendants and from opening up any further stores to compete with plaintiffs as long as defendants allegedly continue to violate the Acts. We believe this suit to be without merit and will vigorously defend against it.
Currently, and from time to time, we are involved in various other legal proceedings incidental to the conduct of our business. Although the amount of liability that may result from these proceedings cannot be ascertained, we do not currently believe that, in the aggregate, these other matters will result in liabilities material to our financial condition, results of operations or cash flows.
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