You may recall that we had high hopes for AutoZone, and projected a great fourth quarter because winter was looking like it was going to be incredibly harsh. Well, as it turns out, our call for the weather was correct, but performance was lack luster. In this column we address the performance of the name and our take on the results

Sales were decent

Autozone today reported net sales of $2.4 billion for its second quarter (12 weeks) ended February 10, 2018, an increase of 5.4% from the second quarter of fiscal 2017 (12 weeks).  Domestic same store sales, or sales for stores open at least one year, increased 2.2% for the quarter. Both metrics were above our expectations for the the quarter. The Company’s inventory increased 4.7% over the same period last year, driven by new stores and increased product placement.  Inventory per location was $671 thousand versus $665 thousand last year and $663 thousand last quarter.  Net inventory, defined as merchandise inventories less accounts payable, on a per location basis, was a negative $46 thousand versus negative $36 thousand last year and negative $52 thousand last quarter. That said, expenses weighed a bit.

Expenses and margins

For the quarter, gross profit, as a percentage of sales, was 52.9% (versus 52.7% for the same period last year).  The increase in gross margin was attributable to lower distribution costs (17 bps) and higher merchandise margins.  Operating expenses, as a percentage of sales, were 44.4% (versus 35.9% the same period last year) and included impairment charges of approximately $193.2 million, or 8.0% of sales.  Operating expenses before impairment charges, as a percentage of sales, were higher than last year primarily due to incentive compensation (16 bps), higher advertising (12 bps) and deleverage on occupancy costs (10 bps).

Income boosted by tax reform

The Tax Cuts and Jobs Act of 2017 increased net income by $171.4 million, consisting of benefits from both revaluation of net deferred taxes of $136.7 million and a lower corporate tax rate of $59.5 million, partially offset by $24.8 million of tax expense related to repatriation taxes for accumulated earnings of foreign subsidiaries.  The Company also recorded approximately $193.2 million in intangible and other assets impairment charges from underperforming business lines which are being sold.

Net income for the quarter increased 22.1% over the same period last year to $289.5 million, while diluted earnings per share increased 28.5% to $10.38 per share from $8.08 per share in the year-ago quarter.  Adjusted for impairment charges, Tax Reform, excess tax benefits from option exercises and operating results from IMC and AutoAnything, adjusted net income for the quarter increased 3.9% over the same period last year to $236.3 million, while adjusted diluted earnings per share increased 9.3% to $8.47 per share from $7.75 per share in the year-ago quarter.

Our take

This is a nice increase but the stock was priced for perfection. The earnings per share of $8.47, while growing 9.3% from last year, was a whole $0.50 below our prior projections of $8.97. Truthfully we thought earnings would surpass $9.00. This was a disappointment and shares are getting hammered because of the miss.

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