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PBY > SEC Filings for PBY > Form 10-Q on 6-Dec-2011All Recent SEC Filings

Show all filings for PEP BOYS MANNY MOE & JACK | Request a Trial to NEW EDGAR Online Pro

Form 10-Q for PEP BOYS MANNY MOE & JACK


6-Dec-2011

Quarterly Report


ITEM 2 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

OVERVIEW

The following discussion and analysis explains the results of operations for the third fiscal quarter and first nine months of 2011 and 2010 and significant developments affecting our financial condition for the nine months ended October 29, 2011. This discussion and analysis should be read in conjunction with the consolidated interim financial statements and the notes to such consolidated financial statements included elsewhere in this Quarterly Report on Form 10-Q, and the consolidated financial statements and the notes to such financial statements included in Item 8, "Financial Statements and Supplementary Data" of our Annual Report on Form 10-K for the fiscal year ended January 29, 2011.

INTRODUCTION

The Pep Boys-Manny, Moe & Jack is the leading national chain offering automotive service, tires, parts and accessories. This positioning allows us to streamline the distribution channel and pass the savings on to our customers facilitating our vision to be the automotive solutions provider of choice for the value-oriented customer. The majority of our stores are in a Supercenter format, which serves both "do-it-for-me" ("DIFM"), which includes service labor, installed merchandise and tires, and "do-it-yourself" ("DIY") customers with the highest quality service and merchandise offerings. Most of our Supercenters also have a commercial sales program that provides delivery of tires, parts and other products to automotive repair shops and dealers. In 2009, as part of our long-term strategy to lead with automotive service, we began complementing our existing Supercenter store base with Service & Tire Centers. These Service & Tire Centers are designed to capture market share and leverage our existing Supercenters and support infrastructure. This growth will occur both organically and through acquisitions. The growth is targeted at existing markets, but may include new markets opportunistically. The objective is to grow our market share and to leverage inventory, marketing, distribution and support costs. Acquisitions will be used to accelerate growth in markets where the Company is under-penetrated.

In the first nine months of fiscal 2011, we added 107 Service & Tire Centers, including 99 Service & Tire Centers acquired in three separate transactions, converted one Service & Tire Center to a Supercenter, and added one Supercenter. As of October 29, 2011, we operated 562 Supercenters and 159 Service & Tire Centers, as well as 8 legacy Pep Boys Express (retail only) stores throughout 35 states and Puerto Rico.

EXECUTIVE SUMMARY

Net earnings for the third quarter of 2011 were $7.0 million, a $1.3 million improvement over the $5.7 million reported for the third quarter of 2010. The increase in profitability was the result of increased total revenues and lower selling, general and administrative expense, partially offset by a decrease in total gross profit margins. Our diluted earnings per share for the third quarter and the first nine months of 2011 were $0.13 and $0.62, respectively, an improvement of $0.02 and $0.09 over the $0.11 and $0.53 recorded for the corresponding periods of 2010.

Total revenue increased for the third quarter of 2011 by 5.2% as compared to the same period of the prior year as a result of our aggressive growth strategy. This increase in total revenues was comprised of a 9.8% increase in service revenue and a 4.1% increase in merchandise sales. For the third quarter of 2011, comparable store sales (sales generated by locations in operation during the same period) decreased by 0.4%. This decrease in comparable store sales was comprised of a 0.4% increase in comparable store service revenue offset by a 0.6% decrease in comparable store merchandise sales.

Sales of our services and non-discretionary products are impacted by miles driven. From March through October 2011, unleaded gasoline prices averaged $3.66 per gallon (national average) as compared to $2.77 in the corresponding period of the prior year. We believe the significant increase in gasoline prices led to the decline in miles driven from March through September 2011, after growing moderately over the previous 12 months. This change in trend combined with the financial burden of higher gasoline prices, continued high unemployment and negative consumer confidence in the overall U.S. economy depressed our third quarter sales. We believe these factors have also led customers to maintain their existing vehicles, rather than purchasing new ones which, in turn has partially offset the negative impact the reduction in miles driven has had on our sales of services and non-discretionary products. These same factors have negatively affected sales in our discretionary product categories like accessories and complementary merchandise. As gasoline prices began to drop in October 2011, albeit not to October 2010 levels, we believe that miles driven once again began to stabilize and assisted our service sales in that month. 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 affect us in the future.

Our primary response to fluctuations in customer demand is to adjust our service and product pricing and assortment, store staffing and marketing efforts. We believe that we are well positioned to help our customers save money and meet their needs in a challenging


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macroeconomic environment. In 2011, we have continued our "surround sound" media campaign that utilizes television, radio and direct mail advertising to communicate our "DOES EVERYTHING. FOR LESS." brand message and have focused on "execution excellence" in our stores in order to earn the TRUST of our customers every day. The newest feature of our surround sound marketing initiatives was the launch of TreadSmart during the current year third quarter. TreadSmart allows customers to research, purchase and schedule the installation of tires online at pepboys.com.

RESULTS OF OPERATIONS

The following discussion explains the material changes in our results of operations.

Analysis of Statement of Operations

Thirteen weeks ended October 29, 2011 vs. Thirteen weeks ended October 30, 2010

The following table presents for the periods indicated certain items in the consolidated statements of operations as a percentage of total revenues (except as otherwise provided) and the percentage change in dollar amounts of such items compared to the indicated prior period.

                                              Percentage of Total Revenues          Percentage Change
                                          October 29, 2011     October 30, 2010         Favorable
Thirteen weeks ended                       (Fiscal 2011)         (Fiscal 2010)        (Unfavorable)

Merchandise sales                                     79.4 %               80.3 %                 4.1 %
Service revenue (1)                                   20.6                 19.7                   9.8
Total revenues                                       100.0                100.0                   5.2
Costs of merchandise sales (2)                        70.5 (3)             70.2 (3)              (4.5 )
Costs of service revenue (2)                          95.6 (3)             92.7 (3)             (13.3 )
Total costs of revenues                               75.7                 74.6                  (6.7 )
Gross profit from merchandise sales                   29.5 (3)             29.8 (3)               2.9
Gross profit from service revenue                      4.5 (3)              7.3 (3)             (33.3 )
Total gross profit                                    24.3                 25.4                   0.9
Selling, general and administrative
expenses                                              21.0                 22.3                   1.2
Net gain (loss) from dispositions of
assets                                                   -                    -                     -
Operating profit                                       3.3                  3.0                  14.7
Non-operating income                                   0.1                  0.1                  (3.5 )
Interest expense                                       1.3                  1.3                  (3.9 )
Earnings from continuing operations
before income taxes                                    2.1                  1.8                  21.2
Income tax expense                                    36.7 (4)             38.0 (4)             (17.1 )
Earnings from continuing operations                    1.3                  1.1                  23.8
Discontinued operations, net of tax                      -                    -                     -
Net earnings                                           1.3                  1.2                  22.6



(1) Service revenue consists of the labor charge for installing merchandise or maintaining or repairing vehicles, excluding the sale of any installed parts or materials.
(2) Costs of merchandise sales include the cost of products sold, purchasing, warehousing and store occupancy costs. Costs of service revenue include service center payroll and related employee benefits and service center occupancy costs. Occupancy costs include utilities, rents, real estate and property taxes, repairs and maintenance and depreciation and amortization expenses.
(3) As a percentage of related sales or revenue, as applicable.
(4) As a percentage of earnings from continuing operations before income taxes.

Total revenue for the third quarter of 2011 increased by $25.8 million to $522.2 million from $496.4 million in the third quarter of 2010, while comparable store sales for the third quarter of 2011 decreased 0.4% as compared to the third quarter of 2010. This decrease in comparable store sales consisted of an increase of 0.4% in comparable store service revenue offset by a decrease of 0.6% in comparable store merchandise sales. Total comparable store sales decreased due to lower customer counts in all three lines of business partially offset by an increase in the average transaction amount per customer. While our total revenue figures were favorably


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impacted by the opening or acquisition of new stores, a new store is not added to our comparable store sales until it reaches its 13th month of operation. Non-comparable stores contributed an additional $27.9 million of total revenue in the third quarter of 2011 as compared to the third quarter of 2010.

Total merchandise sales increased 4.1%, or $16.2 million, to $414.5 million in the third quarter of fiscal 2011, compared to $398.4 million during the prior year quarter. The increase in merchandise sales was due to our non-comparable stores which contributed an additional $18.6 million of sales in the quarter, partially offset by a decline in comparable store merchandise sales of 0.6%, or $2.5 million. The decrease in comparable store merchandise sales was comprised of a 2.0% decline in our retail business which was mostly offset by a 1.8% increase in merchandise sold through our service business as a result of increased tire and other maintenance part sales. Total service revenue increased 9.8%, or $9.6 million, to $107.6 million in the third quarter of 2011 from the $98.0 million recorded in the prior year quarter. The increase in service revenue was comprised of a $0.4 million, or 0.4%, increase in comparable store service revenue and $9.2 million was contributed by our new non-comparable stores

We believe that comparable store customer counts decreased due to macroeconomic conditions, while the average transaction amount per customer increased due to selling price increases implemented to reflect the inflation in material costs. We believe that the significant increase in gasoline prices led to a decline in miles driven, which combined with the financial burden of higher gasoline prices, continued high unemployment and negative consumer confidence in the overall U.S. economy depressed our third quarter sales. These negative economic conditions were somewhat mitigated by the continued aging of the U.S. light vehicle fleet as consumers spent more money on maintaining their vehicles as opposed to buying new vehicles. Over the long-term, we believe that utilizing innovative marketing programs to communicate our value-priced, differentiated service and product assortment will drive increased customer counts and that our continued focus on delivering a better customer experience than our competitors will convert those increased customer counts into sales improvements consistently over all lines of business.

Total gross profit increased by $1.0 million, or 0.9%, to $126.9 million for the third quarter of 2011 from $125.9 million in the third quarter of 2010. Gross profit margin decreased to 24.3% for the third quarter of 2011 from 25.4% for the third quarter of 2010. The decrease in total gross profit margin was primarily due to the opening or acquisition of new Service & Tire Centers. The 85 Big 10 locations acquired in the second quarter of 2011 lowered gross profit margin in the third quarter of 2011 by 70 basis points. The Big 10 locations were dilutive to gross profit margin primarily due to mix of sales being more highly concentrated in tires, which have lower product margins, combined with higher rent and payroll costs as a percent of total store sales. The organic new stores opened by the Company, which are still in their ramp up stage for sales while incurring their full amount of fixed expenses, including payroll and occupancy costs (rent, utilities and building maintenance), negatively affected total gross profit margin by 90 basis points and 50 basis points in the third quarter of 2011 and 2010, respectively. Excluding the impact of both the acquired and the new organic Service & Tire Centers, total gross profit margin remained relatively flat at 25.9 %. While the acquired and new organic Service & Tire Centers have had a negative impact on gross profit from service revenue, these Service & Tire Centers positively contributed to total gross profit for the current year third quarter.

Gross profit from merchandise sales increased by $3.5 million, or 2.9%, to $122.1 million for the third quarter of 2011 from $118.7 million in the third quarter of 2010. Gross profit margin from merchandise sales decreased to 29.5% for the third quarter of 2011 from 29.8% for the third quarter of 2010, primarily due to an increase in store occupancy costs of 20 basis points and a decrease in product gross margins of 10 basis points. The increase in store occupancy costs was due to the deleveraging effect of lower merchandise comparable store sales. The decrease in product gross margins was due to the shift in sales mix to tires which have lower margins.

Gross profit from service revenue decreased by $2.4 million, or 33.3%, to $4.8 million in the third quarter of 2011 from $7.2 million recorded in the third quarter of 2010. Gross profit margin from service revenue decreased to 4.5% for the third quarter of 2011 from 7.3% for the prior year quarter. In accordance with GAAP, service revenue is limited to labor sales (excludes any revenue from installed parts and materials) and costs of service revenues includes the fully loaded service center payroll and related employee benefits and service center occupancy costs. The decrease in gross profit from service revenue was due to the opening or acquisition of new Service & Tire Centers. Excluding the impact of both the acquired and the new organic (which are still in their ramp up stage for sales while incurring the full amount of expenses including payroll and occupancy costs) Service & Tire Centers, gross profit from service revenue improved to 11.2% for the third quarter of 2011 from 9.1% for the third quarter of 2010 due to higher service revenues, which better leveraged the fixed component of service payroll and store occupancy costs.

Selling, general and administrative expenses as a percentage of total revenues decreased to 21.0% for the third quarter of 2011 from 22.3% for the third quarter of 2010. Selling, general and administrative expenses decreased $1.3 million, or 1.2%, to $109.5 million in the third quarter of 2011 from $110.8 million in the prior year quarter. Lower short-term performance based compensation accruals of $3.1 million was partially offset by increased media expense of $0.8 million and increased store and administrative expenses of $1.4 million related to the addition of the 85 Big 10 locations in the second quarter of 2011. The reduction as a percent to sales reflects improved leverage of selling, general and administrative expenses achieved through increased sales volumes in the current year third quarter.

Interest expense increased by $0.3 million to $6.9 million in the third quarter of 2011 compared to $6.6 million in the third quarter of 2010.


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Our income tax expense for the third quarter of 2011 was $4.1 million, or an effective rate of 36.7%, as compared to an expense of $3.5 million, or an effective rate of 38.0%, for the third quarter of 2010. The annual rate depends on a number of factors, including the jurisdiction in which operating profit is earned and the timing and nature of discrete items.

As a result of the foregoing, we reported net earnings of $7.0 million in the third quarter of 2011 as compared to net earnings of $5.7 million in the prior year quarter. Our basic and diluted earnings per share were $0.13 as compared to $0.11 in the prior year period.

Thirty-nine weeks ended October 29, 2011 vs. Thirty-nine weeks ended October 30, 2010

The following table presents for the periods indicated certain items in the consolidated statements of operations as a percentage of total revenues (except as otherwise provided) and the percentage change in dollar amounts of such items compared to the indicated prior period.

                                             Percentage of Total Revenues          Percentage Change
                                         October 29, 2011     October 30, 2010         Favorable
Thirty-nine weeks ended                   (Fiscal 2011)         (Fiscal 2010)        (Unfavorable)

Merchandise sales                                    79.5 %               80.3 %                 2.0 %
Service revenue (1)                                  20.5                 19.7                   7.5
Total revenues                                      100.0                100.0                   3.1
Costs of merchandise sales (2)                       69.9 (3)             69.7 (3)              (2.3 )
Costs of service revenue (2)                         92.4 (3)             89.9 (3)             (10.5 )
Total costs of revenues                              74.5                 73.7                  (4.3 )
Gross profit from merchandise sales                  30.1 (3)             30.3 (3)               1.4
Gross profit from service revenue                     7.6 (3)             10.1 (3)             (19.3 )
Total gross profit                                   25.5                 26.3                  (0.2 )
Selling, general and administrative
expenses                                             21.3                 22.2                   1.2
Net gain (loss) from dispositions of
assets                                                  -                  0.2                     -
Operating profit                                      4.2                  4.3                   1.0
Non-operating income                                  0.1                  0.1                  (3.9 )
Interest expense                                      1.3                  1.3                   0.3
Earnings from continuing operations
before income taxes                                   3.1                  3.1                   1.3
Income tax expense                                   29.9 (4)             39.0 (4)              22.3
Earnings from continuing operations                   2.1                  1.9                  16.4
Discontinued operations, net of tax                     -                    -                     -
Net earnings                                          2.1                  1.9                  17.9



(1) Service revenue consists of the labor charge for installing merchandise or maintaining or repairing vehicles, excluding the sale of any installed parts or materials.
(2) Costs of merchandise sales include the cost of products sold, purchasing, warehousing and store occupancy costs. Costs of service revenue include service center payroll and related employee benefits and service center occupancy costs. Occupancy costs include utilities, rents, real estate and property taxes, repairs and maintenance and depreciation and amortization expenses.
(3) As a percentage of related sales or revenue, as applicable.
(4) As a percentage of earnings from continuing operations before income taxes.

Total revenue for the first nine months of 2011 increased by $47.1 million to $1,558.3 million from $1,511.3 million in the first nine months of 2010, while comparable store sales for the first nine months of 2011 decreased by $15.2 million, or 1.0%, as compared to the first nine months of 2010. The decrease in comparable store sales consisted of an increase of 0.8% in comparable store service revenue offset by a decrease of 1.4% in comparable store merchandise sales. Total comparable store sales decreased due to lower customer counts in all three lines of business partially offset by an increase in the average transaction amount per customer. While our total revenue figures were favorably impacted by the opening of the new stores, a new store is not added to our comparable store sales until it reaches its 13th month of operation. Non-comparable stores contributed an additional $62.3 million of total revenue in the first nine months of 2011 as compared to the prior year period.

Total gross profit decreased by $0.7 million, or 0.2%, to $397.3 million for the first nine months of 2011 from $398.0 million in the first nine months of 2010. Total gross profit margin decreased to 25.5% for the first nine months of 2011 from 26.3% for the first nine


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months of 2010. The decrease in total gross profit margin was primarily due to the opening or acquisition of new Service & Tire Centers. The 85 Big 10 locations acquired in the second quarter of 2011 lowered gross profit margin for the first nine months of 2011 by 40 basis points. The Big 10 locations were dilutive to gross profit margin primarily due to mix of sales being more highly concentrated in tires which have lower product margins combined with higher rent and payroll costs as a percent of total sales. The organic new stores opened by the Company, which are still in their ramp up stage for sales while incurring their full amount of fixed expenses, including payroll and occupancy costs (rent, utilities and building maintenance), negatively affected gross profit margin by 80 basis points and 60 basis points for the first nine months of 2011 and 2010, respectively. Excluding the impact of both the acquired and the new organic Service & Tire Centers, the gross profit margin declined by 30 basis points to 26.6% from 26.9 % in the prior year comprised of a decline in gross profit margins from merchandise sales of 50 basis points partially offset by an increase in gross profit margins from service revenues of 20 basis points. While the acquired and new organic Service & Tire Centers have had a negative impact on gross profit from service revenue, these Service & Tire Centers positively contributed to total gross profit for the first nine months of fiscal 2011.

Gross profit from merchandise sales increased by $5.1 million, or 1.4%, to $373.0 million for the first nine months of 2011 from $367.9 million in the first nine months of 2010. Gross profit margin from merchandise sales decreased slightly to 30.1% from 30.3% for the prior year period. Excluding the effect of the acquired and new Service and Tire Centers, gross profit margin from merchandise sales decreased by 50 basis points to 30.1% from 30.6% in the prior year primarily due to an increase in store occupancy costs of 40 basis points. The increase in store occupancy costs was due to (1) deleveraging effect of lower merchandise comparable store sales and (ii) an increase in the number of Superhub locations leading to higher delivery costs.

Gross profit from service revenue decreased by $5.8 million, or 19.3%, to $24.3 million for the first nine months of 2011 from $30.1 million in the first nine months of 2010. Gross profit margin from service revenue decreased to 7.6% from 10.1% for the prior year period. In accordance with GAAP, service revenue is limited to labor sales (excludes any revenue from installed parts and materials) and costs of service revenue includes the fully loaded service center payroll and related employee benefits and service center occupancy costs. Excluding the impact of both the acquired and the new organic (which are still in their ramp up stage for sales while incurring the full amount of expenses including payroll and occupancy costs) Service & Tire Centers, gross profit from service revenue increased to 12.7% for the first nine months of 2011 from 11.6% for the first nine months of 2010. The increase in gross profit, exclusive of all new locations, was primarily due to higher service revenues, which better leveraged the fixed component of service payroll and store occupancy costs.

Selling, general and administrative expenses, as a percentage of total revenues decreased to 21.3% for the first nine months of 2011 as compared to 22.2% in the prior year period. The reduction as a percent to sales reflects improved leverage of selling, general and administrative expenses achieved through increased sales volumes in the first nine months of 2011. Selling, general and administrative expenses decreased $3.9 million, or 1.2%, compared to the first nine months of 2010 due to lower short-term performance based compensation accruals of $4.6 million and lower media expense of $3.0 million, partially offset by increased store and administrative expenses of $3.3 million related to the addition of the 85 Big 10 locations in the second quarter of 2011 and acquisition and transition related costs of $1.5 million.

Net gains from the disposition of assets were not significant for the first nine months of 2011 and were $2.6 million for the first nine months of 2010. Interest expense for the first nine months of 2011 was $19.8 million, a decrease of $0.1 million compared to the prior year period.

Our income tax expense for the first nine months of 2011 was $14.2 million, or an effective rate of 29.9%, as compared to an expense of $18.3 million, or an effective rate of 39.0%, for the first nine months of 2010. The change was primarily due to the release of $3.6 million (net of federal tax) of valuation allowances on state net operating loss carry forwards and credits. The annual rate is dependent on a number of factors, including the jurisdiction in which operating profit is earned and the timing and nature of discrete items.

As a result of the foregoing, we reported net earnings of $33.3 million for the first nine months of 2011 as compared to net earnings of $28.3 million in the prior year period. Our basic and diluted earnings per share were $0.62, an increase of $0.09 as compared to $0.53 in the prior year period.

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