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PBY > SEC Filings for PBY > Form 10-Q on 10-Sep-2013All Recent SEC Filings

Show all filings for PEP BOYS MANNY MOE & JACK

Form 10-Q for PEP BOYS MANNY MOE & JACK


10-Sep-2013

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 second quarter and first half of fiscal 2013 and 2012 and significant developments affecting our financial condition as of August 3, 2013. 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 February 2, 2013.

Introduction

The Pep Boys-Manny, Moe & Jack and subsidiaries (the "Company") has been the best place to shop and care for your car since it began operations in 1921. Approximately 19,000 associates are focused on delivering the best customer service in the automotive aftermarket to our customers across our 750+ locations throughout the United States and Puerto Rico. Pep Boys satisfies all of a customer's automotive needs through our unique offering of service, tires, parts and accessories.

Our stores are organized into a hub and spoke network consisting of Supercenters and Service & Tire Centers. Supercenters average approximately 20,000 square feet (our new Supercenter format is approximately 14,000 square feet) and combine do-it-for-me service labor, installed merchandise and tire offerings ("DIFM") with do-it-yourself parts and accessories ("DIY"). Most of our Supercenters also have a commercial sales program that delivers parts, tires and equipment to automotive repair shops and dealers. Service & Tire Centers, which average approximately 6,000 square feet, provide DIFM services in neighborhood locations that are conveniently located where our customers live or work. Service & Tire Centers are designed to capture market share and leverage our existing Supercenters and support infrastructure. We also operate a handful of legacy DIY only Pep Express stores.

In the first half of 2013, we opened nine Service & Tire Centers and four Supercenters. We also closed one Service & Tire Center and one Supercenter. As of August 3, 2013, we operated 570 Supercenters, 193 Service & Tire Centers and six Pep Express stores located in 35 states and Puerto Rico. Subsequent to quarter end, the Company acquired 17 Service & Tire Centers in Southern California bringing our total to 211, including one Service & Tire Center opened subsequent to the second quarter.

EXECUTIVE SUMMARY

Net earnings for the second quarter of 2013 were $5.4 million, or $0.10 per share, as compared to $33.0 million, or $0.61 per share, for the second quarter of 2012. Current period net earnings include a $2.5 million income tax expense primarily due to recording a valuation allowance against state hiring credits as a result of tax law changes. The prior year period net earnings included, on a pre-tax basis, $43.0 million of merger termination fees, net of expenses. Operating profit increased by $1.4 million, or 9%, to $17.7 million in the second quarter of 2013 as compared to $16.3 million in the second quarter of 2012 primarily due to higher total gross profit, partially offset by increased selling, general and administrative expenses. Excluding a $1.7 million asset impairment charge in fiscal 2013, and a $0.7 million severance charge and the reclassification of $1.5 million of merger related costs in fiscal 2012, operating profit for the second quarter of 2013 increased by $3.9 million, or 25%, to $19.4 million as compared to $15.5 million for the second quarter of fiscal 2012.

Total revenues increased for the second quarter of 2013 by 0.4%, or $1.9 million, as compared to the second quarter of 2012 as a result of the contribution from our non-comparable store locations, offset by a 1.3% decrease in comparable store sales. The decline in comparable store sales (sales generated by locations in operation during the same period of the prior year) were comprised of a 0.2% increase in comparable store service revenues and a 1.7% decrease in comparable store merchandise sales, primarily due to lower tire sales. However, margin dollars from tire sales increased despite the sales decline.

We believe that the industry fundamentals of increasing vehicle complexity and customer preference for DIFM remain solid over the long-term resulting in consistent demand for maintenance and repair services. Consistent with this long-term trend, we have adopted a long-term strategy of growing our automotive service business, while maintaining our DIY customer base by offering the newest and broadest product assortment in the automotive aftermarket.

In the short-term, however, various factors within the economy affect both our customers and our industry, including the impact of the recent recession, continued high unemployment and the restoration of payroll taxes back to previous levels. Another macroeconomic factor affecting our customers and our industry is gasoline prices. Gasoline prices have not only increased to historical highs in recent years, but have also experienced significant spikes in prices during each year. We believe that these gasoline


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price trends challenge our customers' spending relative to discretionary and deferrable purchases. In addition, gasoline prices impact miles driven which, in turn, impact sales of our services and non-discretionary products. Given the nature of these macroeconomic factors, we cannot predict whether or for how long these trends may 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 product assortment, store staffing and advertising messages. We work continuously to make it easy for customers to choose us to do it for them and to expand our online efforts to make Pep Boys the most convenient place to shop for all of their automotive needs. Our more focused customer-centered strategy to ensure that Pep Boys is the best place to shop and care for your car is beginning to take hold. Through the first half of fiscal 2013, it has led to increased customer traffic in our service center line of business. We are optimistic that our efforts to build long lasting relationships with all of our customers, along with offering solutions for all of their automotive needs will yield consistent sales growth in all lines of business.

RESULTS OF OPERATIONS

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

Analysis of Statement of Operations

Thirteen weeks ended August 3, 2013 vs. Thirteen weeks ended July 28, 2012

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
                                           August, 2013      July 28, 2012          Favorable
Thirteen weeks ended                       (Fiscal 2013)      (Fiscal 2012)       (Unfavorable)

Merchandise sales                                   78.2 %             78.6 %                (0.3 )%
Service revenue (1)                                 21.8               21.4                   2.7
Total revenues                                     100.0              100.0                   0.4
Costs of merchandise sales (2)                      66.4 (3)           69.7 (3)               5.0
Costs of service revenue (2)                        99.9 (3)           95.3 (3)              (7.6 )
Total costs of revenues                             73.7               75.2                   1.6
Gross profit from merchandise sales                 33.6 (3)           30.3 (3)              10.6
Gross profit from service revenue                    0.1 (3)            4.7 (3)             (97.1 )
Total gross profit                                  26.3               24.8                   6.2
Selling, general and administrative
expenses                                            22.9               21.7                  (5.8 )
Net loss from dispositions of assets                   -                  -                (240.5 )
Operating profit                                     3.4                3.1                   8.8
Merger termination fees, net                           -                8.2                (100.0 )
Other income                                         0.1                0.1                 (10.7 )
Interest expense                                     0.7                1.2                  44.6
Earnings from continuing operations
before income taxes                                  2.8               10.2                 (72.6 )
Income tax expense                                  63.3 (4)           38.1 (4)              54.4
Earnings from continuing operations                  1.0                6.3                 (83.7 )
Discontinued operations, net of tax                    -                  -                 173.9
Net earnings                                         1.0                6.3                 (83.7 )



(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.


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Total revenues for the second quarter of 2013 increased by 0.4%, or $1.9 million, to $527.6 million from $525.7 million in the second quarter of 2012. Comparable store sales for the second quarter of 2013 decreased 1.3% as compared to the second quarter of 2012. This decrease in comparable store sales consisted of an increase of 0.2% in comparable store service revenue and a decrease of 1.7% in comparable store merchandise sales, primarily due to lower tire sales. Excluding tires sold through our service business, total comparable store sales were flat. While our total revenues were favorably impacted by the opening 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 $8.9 million of revenues in the second quarter of 2013 as compared to the second quarter of 2012.

Total merchandise sales for the second quarter of 2013 decreased 0.3%, or $1.1 million, to $412.3 million from $413.4 million for the second quarter of 2012. Comparable store merchandise sales decreased by 1.7%, or $7.2 million, mostly offset by a $6.1 million contribution from our non-comparable store locations. Comparable store merchandise sales decreased primarily due to lower tire sales. Excluding the impact of tires sold through our service business, comparable store merchandise sales were flat. Merchandise sold through our retail business declined by 2.6% which was entirely offset by an 8.5% increase in non-tire merchandise sold through our service business. For the retail business and our tire category, we believe that the difficult macroeconomic conditions continued to impact our customers and led to comparable store customer count declines. In our service business (excluding tires), comparable store customer counts increased due to the strength of our repair and maintenance service offerings and the heavy promotion of oil changes. The promotion of these oil changes is designed to attract new service customers to Pep Boys to introduce them to our full service capabilities in order to satisfy their future needs.

Total service revenue for the second quarter of 2013 increased 2.7%, or $3.0 million, to $115.3 million from $112.3 million for the second quarter of 2012 primarily due to a $2.7 million contribution from our non-comparable store locations combined with a slight increase in comparable store revenue.

Total gross profit for the second quarter of 2013 increased by $8.1 million, or 6.2%, to $138.7 million from $130.6 million for the second quarter of 2012. Total gross profit margin increased to 26.3% for the second quarter of 2013 from 24.8% for the second quarter of 2012. Excluding the impairment charge of $1.7 million in the second quarter of 2013, total gross profit margin increased by 180 basis points period over period. This increase in total gross profit margin was primarily due to higher product gross margins of 270 basis points, partially offset by higher payroll and related expenses of 80 basis points. The increase in product gross margins was primarily due to improved tire margins driven by reduction in costs, increased retail and service product (non-tire) margins related to increased selling prices and a shift in sales mix to higher margin products.

Gross profit from merchandise sales for the second quarter of 2013 increased by $13.2 million, or 10.6%, to $138.6 million from $125.3 million for the second quarter of 2012. Gross profit margin from merchandise sales increased to 33.6% for the second quarter of 2013 from 30.3% for the second quarter of 2012. Excluding the impairment charge of $0.4 million in the second quarter of 2013, gross profit margin from merchandise sales increased by 340 basis points period over period. The increase in gross profit margin was primarily due to higher product gross margins (significantly improved tire margins, higher retail and non-tire service merchandise margins and shift in sales mix to higher margin products) of 320 basis points and lower store occupancy costs of 20 basis points.

Gross profit from service revenue for the second quarter of 2013 decreased by $5.1 million to $0.2 million from $5.3 million for the second quarter of 2012. Gross profit margin from service revenue decreased to 0.1% for the second quarter of 2013 from 4.7% for the prior year quarter. In accordance with GAAP, service revenue is limited to labor sales (excludes any revenue from installed parts and materials). Costs of service revenue include the fully loaded service center payroll, and related employee benefits, and service center occupancy costs (rent, utilities and building maintenance). Excluding the impairment charge of $1.3 million in the second quarter of 2013, gross profit margin from service revenue decreased by 340 basis points period over period. Excluding the impact of Service & Tire Centers (which reduced margins by 730 basis points and 680 basis points in 2013 and 2012, respectively) and the impairment charge, gross profit from service revenue decreased to 8.6% for the second quarter of 2013 from 11.6% for the second quarter of 2012. This decrease in gross profit of 300 basis points was primarily due to higher payroll and related expense of 180 basis points and higher occupancy costs of 120 basis points (depreciation and utilities).

Selling, general and administrative expenses as a percentage of total revenues for the second quarter of 2013 increased to 22.9% from 21.7% for the second quarter of 2012. Selling, general and administrative expenses increased $6.7 million, or 5.8%, to $120.9 million in the second quarter of 2013 from $114.3 million in the prior year quarter primarily due to an increase in short term incentive compensation accruals of $1.8 million, higher media expense of $1.4 million, higher credit card fees of $0.7 million and higher claims and general liability expense of $0.4 million. In addition, selling, general and administrative expense benefited in the second quarter of 2012 from a $1.5 million reclassification of merger costs to merger termination fees, net.

In the second quarter of 2012, we terminated our proposed merger and recorded the settlement proceeds, net of merger related costs of $43.0 million in the consolidated statement of operations and comprehensive income.


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Interest expense for the second quarter of 2013 was $3.6 million, a decrease of $2.8 million from the $6.4 million reported for the second quarter of 2012. The decrease in interest expense was due to the debt refinancing completed in the third quarter of 2012 which reduced the total debt outstanding by approximately $95.1 million and lowered the interest rate.

Our income tax expense for the second quarter of 2013 was $9.3 million, or an effective rate of 63.3%, as compared to an expense of $20.3 million, or an effective rate of 38.1%, for the second quarter of 2012. The change in the tax rate was driven by a $2.5 million charge primarily due to recording a valuation allowance against state hiring credits as a result of tax law changes. 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 $5.4 million for the second quarter of 2013 as compared to net earnings of $33.0 million for the second quarter of 2012. Our diluted earnings per share were $0.10 for the second quarter of 2013 as compared to $0.61 for the second quarter of 2012.

Twenty-six weeks ended August 3, 2013 vs. Twenty-six weeks ended July 28, 2012

The following table presents for the periods indicated certain items in the consolidated statements of operations and comprehensive income 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
                                           August 3, 2013     July 28, 2012         Favorable
Twenty-six weeks ended                     (Fiscal 2013)      (Fiscal 2012)       (Unfavorable)

Merchandise sales                                    78.0 %            78.6 %                 0.5 %
Service revenue (1)                                  22.0              21.4                   4.4
Total revenues                                      100.0             100.0                   1.3
Costs of merchandise sales (2)                       68.8 (3)          70.1 (3)               1.4
Costs of service revenue (2)                         99.3 (3)          94.9 (3)              (9.2 )
Total costs of revenues                              75.5              75.4                  (1.4 )
Gross profit from merchandise sales                  31.2 (3)          29.9 (3)               4.9
Gross profit from service revenue                     0.7 (3)           5.1 (3)             (85.0 )
Total gross profit                                   24.5              24.6                   0.9
Selling, general and administrative
expenses                                             22.5              22.3                  (2.2 )
Net loss from dispositions of assets                    -                 -               (1255.3 )
Operating profit                                      2.0               2.3                 (12.3 )
Merger termination fees, net                            -               4.1                (100.0 )
Non-operating income                                  0.1               0.1                 (14.9 )
Interest expense                                      0.7               1.2                  44.1
Earnings from continuing operations
before income taxes                                   1.4               5.3                 (73.1 )
Income tax expense                                   37.4 (4)          38.2 (4)              73.6
Earnings from continuing operations                   0.9               3.3                 (72.8 )
Discontinued operations, net of tax                     -                 -                 (30.5 )
Net earnings                                          0.9               3.3                 (72.9 )



(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 half of 2013 increased by $13.5 million to $1,063.8 million from $1,050.3 million for the first half of 2012, while comparable store sales for the first half of 2013 decreased by $1.7 million, or 0.2%, as compared to the first half of 2012. The decrease in comparable store sales consisted of a decrease of 0.8% in comparable store merchandise sales partially offset by an increase of 2.2% in comparable store service revenues. The decrease in total comparable store sales was primarily due to lower tire


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sales. Excluding tires sold through our service business, total comparable store sales increased by 0.7%. 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 $15.3 million of total revenue in the first half of 2013 as compared to the prior year period.

Total gross profit for the first half of 2013 increased by $2.3 million, or 0.9%, to $260.5 million from $258.3 million for the first half of 2012. Total gross profit margin decreased to 24.5% for the first half of 2013 from 24.6% for the first half of 2012. Excluding the impairment charge of $2.8 million in the first half of 2013, total gross profit margin increased by 20 basis points period over period. The increase in total gross profit margin was primarily due to higher product gross margins of 120 basis points, partially offset by higher payroll and related expenses of 90 basis points and higher occupancy costs of 50 basis points.

Gross profit from merchandise sales for the first half of 2013 increased by $12.0 million, or 4.9%, to $258.8 million from $246.8 million for the first half of 2012. Gross profit margin from merchandise sales increased to 31.2% for the first half of 2013 from 29.9% for the prior year period. Excluding the impairment charge of $0.5 million in the first half of 2013, gross profit margin from merchandise sales increased by 140 basis points period over period. The increase in gross profit margin from merchandise sales was due to higher product gross margins in our service business primarily due to the significant improvement in tire margins.

Gross profit from service revenue for the first half of 2013 decreased by $9.7 million to $1.7 million from $11.4 million for the first half of 2012. Gross profit margin from service revenue for the first half of 2013 decreased to 0.7% from 5.1% for the first half of 2012. In accordance with GAAP, service revenue is limited to labor sales (excludes any revenue from installed parts and materials). Costs of service revenues include the fully loaded service center payroll and related employee benefits and service center occupancy costs. Excluding the impairment charge of $2.3 million in the first half of 2013, gross profit margin from service revenue decreased by 340 basis points period over period. The decrease in service revenue gross profit margin was primarily due to the growth of our Service & Tire Centers, which lowered margins by 710 and 700 basis points in the first half of 2013 and 2012, respectively. Excluding the impact of Service & Tire Centers and the 2013 impairment charge described above, gross profit from service revenue decreased to 8.9% for the first half of 2013 from 12.1% for the first half of 2012. The decrease in gross profit, exclusive of Service & Tire Centers and impairment charges, was mostly due to increased payroll and related benefit costs combined with higher store occupancy costs (utilities and depreciation).

Selling, general and administrative expenses, as a percentage of total revenues for the first half of 2013 increased to 22.5% as compared to 22.3% for the first half of 2012. Selling, general and administrative expenses increased $5.1 million, or 2.2%, compared to the first half of 2012 due to higher short term incentive compensation accruals of $3.6 million, higher legal and professional fees of $1.7 million, higher credit card fees of $1.3 million and higher depreciation expense of $0.8 million, partially offset by lower retail store payroll expense of $2.2 million and lower media expense of $1.0 million.

In the second quarter of 2012, we terminated our proposed merger and recorded the settlement proceeds, net of merger related costs of $43.0 million in the consolidated statement of operations and comprehensive income.

Interest expense for the first half of 2013 was $7.2 million, a decrease of $5.7 million compared to the $12.9 million reported for the first half of 2012. The decrease in interest expense was due to the debt refinancing completed in the third quarter of 2012 which reduced the total debt outstanding by approximately $95.1 million and lowered the interest rate.

Our income tax expense for the first half of 2013 was $5.6 million, or an effective rate of 37.4%, as compared to an expense of $21.1 million, or an effective rate of 38.2%, for the first half of 2012. 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 $9.2 million for the first half of 2013 as compared to net earnings of $34.1 million in the prior year period. Our diluted earnings per share were $0.17 as compared to $0.63 in the prior year period.

INDUSTRY COMPARISON

We operate in the U.S. automotive aftermarket, which has two general lines of business: (1) the Service business, defined as Do-It-For-Me (service labor, installed merchandise and tires) and (2) the Retail business, defined as Do-It-Yourself (retail merchandise) and commercial. Generally, specialized automotive retailers focus on either the Service or Retail area of the business. We believe that operation in both the Service and Retail areas of the business positively differentiates us from our competitors. Although we manage our store performance at a store level in aggregation, we believe that the following presentation, which includes the reclassification of revenue from installed products from retail sales to service center revenue, shows an accurate comparison against competitors within the two sales arenas. Our Service Center business competes in the Service area of the industry. We compete in the Retail area of the business through our retail sales floor and commercial sales business.


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