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Edward Dostillio
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Edward is an independent financial services professional and is a graduate of Drexel University. He lives in the Hawaiian Islands.
  • AUTOZONE: HEAVILY LEVERAGED BUYBACKS AND POSSIBLE ACCOUNTING IRREGULARITIES

         I do not claim to be a securities law attorney, nor am I a CPA, but I am fairly astute in financial matters and enjoy digging into the fine print of corporate 10Q‘s. Upon reading the latest 10Q filing of Autozone Inc., I have come across some items that I seriously question as to whether they can be considered as Generally Accepted Accounting Principals, since they seem to lead to artificially inflated earnings being reported. These artificially inflated EPS figures resulted from AZO changing the way it accounts for domestic inventories.  Without the adjustment, EPS would have been reduced significantly.  These artificially inflated EPS figures combined with very aggressive  corporate buybacks have led to a significant, but what I believe is a potentially manipulated rise in AZO's stock price     The following is my own personal hypothesis as to how a once solid business is being used for the sole purpose of manipulating AZO’s stock price, to the benefit of current management, directors and 2 big hedge funds (ESL Investments and RBC Partners that control over 35% of the outstanding shares of AZO).  This comes at  the expense of suppliers, debt holders, and inevitably shareholders who do not cashout before the inevitable implosion in price.  It seems to me almost like a Corporate Ponzi Scheme ala Bernie Madoff or Enron. To understand why I say this, lets looks at the history of AZO starting with a comparison of their 1997 balance sheet 10Q below

    http://sec.gov/Archives/edgar/data/866787/0000866787-98-000002.txt

    to the most recent 10Q filed this March

    http://sec.gov/Archives/edgar/data/866787/000095012311026402/c12604e10vq.htm#C12604103

                                                     November 1997   February 2011
                                                                            
    Stockholder Equity (Deficit)    $1,131,766,000     $(1,038,412,000)
                                                           
    Net tangible assets                 $1,115,338,000     $(1,341,057,000)

    Shares Outstanding              153,823,000           44,378,000

     

    The most shocking aspect of this balance sheet is the extreme leverage provided by accounts payable and long term debt. In delaying payments to suppliers and issuing $3 Billion in long term debt over the last 13 years they have continually used this leverage to buyback shares on the open market at ever increasing prices even at the expense of shareholder equity. Notice in 1997 the shareholder equity and net tangible assets were +1 $Billion and now they are both deficits of -1 $Billion+.

    I must admit that it has provided shareholders extraordinary returns. By utilizing this leverage to provide a constant source of demand for AZO stock, the shares have risen an astonishing 900% over the 13 year period. It has also provided what I believe is great wealth to the perpetrators of my hypothetical corporate Ponzi Scheme as they are able to cash out their shares and employee stock options at artificially high prices. Below is a link to recent insider sales

     http://finance.yahoo.com/q/it?s=AZO+Insider+Transactions

     

    Look at the extraordinary amount of insider sales the past year making both management and Eddie Lampert quite richer. This at a time when the company itself has dramatically increased its share buyback program.  Seems to me, that if management is aggressively selling personal shares, then a conflict arises by recommending that the company itself buy those seemingly over priced shares.
     

     

    Ponzi Schemes always offer extraordinary returns to those who are fortunate enough to cash out early and to the perpetrators of the scheme, but as soon as the cash to continue the scheme runs dry it implodes in a wave of misery.

    As stated earlier I do not believe that the scheme itself is illegal at the current time, but I do believe it is short sighted and greed driven and will come at the ultimate expense to both suppliers, debt holders and shareholders alike.

    What I have found as potentially illegal and fraudulent is the way Autozone is keeping and reporting it’s inventory.

    THIS IS TAKEN FROM NOTES OF THE MOST RECENT 10Q 

    http://sec.gov/Archives/edgar/data/866787/000095012311026402/c12604e10vq.htm#C12604106

    SEE Note F — Merchandise Inventories

    Inventories are stated at the lower of cost or market using the last-in, first-out (“LIFO”) method for domestic inventories and the first-in, first-out (“FIFO”) method for Mexico inventories. Included in inventories are related purchasing, storage and handling costs. Due to price deflation on the Company’s merchandise purchases, the Company’s domestic inventory balances are effectively maintained under the FIFO method. The Company’s policy is not to write up inventory in excess of replacement cost. The cumulative balance of this unrecorded adjustment, which will be reduced upon experiencing price inflation on the Company’s merchandise purchases, was $255.6 million at February 12, 2011, and $247.3 million at August 28, 2010.

     

    What this disclosure says, in laymen’s terms, is we normally use LIFO method for accounting for domestic inventories, but because the price/value of that inventory using LIFO is actually lower then if we use the FIFO method, we are going to switch and use the FIFO method and hope the value of that inventory goes back up in price. By switching to FIFO we can record an ending inventory value that is higher which will reduce our Cost of Goods Sold and let us report earnings that are actually $255.6 million higher then if we stuck with the way we normally account for inventory using the LIFO Method. The reason we are doing this is to keep the EPS figures juiced so we can continue what I hypothesize is a Corporate Ponzi Scheme that is making management, directors, and the controlling hedge funds rich.

    Now as I stated in the begining of this article, I am neither a corporate lawyer nor a CPA, but I hope some of the seeking alpha readers can shed some light as to whether AZO is cooking the books or not?.

    If I am right but this is legal and has become Generally Accepted Accounting Practice, then all of us should be concerned with reported earnings, as it seems to give permission to management to play with earnings as they see fit.

     

    Disclosure: Edward Dostillio is Short Autozone stock and Long Autozone put options in accounts where he has trading discretion over

     





















    Disclosure: I am short AZO.

    Additional disclosure: I am also long AZO put options. These are not personal accounts just an account I have trading authority over and I receive no compensation from this account
    Mar 30 6:01 AM | Link | 3 Comments
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