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AAP > SEC Filings for AAP > Form 10-Q on 28-May-2014All Recent SEC Filings

Show all filings for ADVANCE AUTO PARTS INC

Form 10-Q for ADVANCE AUTO PARTS INC


28-May-2014

Quarterly Report


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

The following discussion and analysis of financial condition and results of operations should be read in conjunction with our unaudited condensed consolidated financial statements and the notes to those statements that appear elsewhere in this report. Our first quarter consists of 16 weeks divided into four equal periods. Our remaining three quarters consist of 12 weeks with each quarter divided into three equal periods.

Certain statements in this report are "forward-looking statements" within the meaning of Section 27A of the Securities Act of 1933 (the "Securities Act") and
Section 21E of the Securities Exchange Act of 1934 (the "Exchange Act"). Forward-looking statements are usually identified by the use of words such as "anticipate," "believe," "could," "estimate," "expect," "forecast," "intend," "likely," "may," "plan," "position," "possible," "potential," "probable," "project," "projection," "should," "strategy," "will," or similar expressions. We intend for any forward-looking statements to be covered by, and we claim the protection under, the safe harbor provisions for forward-looking statements contained in the Private Securities Litigation Reform Act of 1995.

These forward-looking statements are based upon assessments and assumptions of management in light of historical results and trends, current conditions and potential future developments that often involve judgments, estimates, assumptions and projections. Forward-looking statements reflect current views about our plans, strategies and prospects, which are based on information currently available.

Although we believe that our plans, intentions and expectations as reflected in or suggested by any forward-looking statements are reasonable, we do not guarantee or give assurance that such plans, intentions or expectations will be achieved. Actual results may differ materially from our anticipated results described or implied in our forward-looking statements, and such differences may be due to a variety of factors. Our business could also be affected by additional factors that are presently unknown to us or that we currently believe to be immaterial to our business.

Listed below and discussed in our Annual Report on Form 10-K for the year ended December 28, 2013 (filed with the Securities and Exchange Commission, or SEC, on February 25, 2014), which we refer to as our 2013 Form 10-K, are some important risks, uncertainties and contingencies which could cause our actual results, performance or achievements to be materially different from any forward-looking statements made or implied in this report. These include, but are not limited to, the following:

a decrease in demand for our products;

competitive pricing and other competitive pressures;

the risk that the anticipated benefits of the acquisition of General Parts International, Inc. ("GPI"), including synergies, may not be fully realized or may take longer to realize than expected, that we may experience difficulty integrating GPI's operations into our operations, or that management's attention may be diverted from our other businesses in association with the acquisition of GPI;

the possibility that the acquisition of GPI may not advance our business strategy or prove to be an accretive investment or may impact third-party relationships, including customers, wholesalers, independently-owned and jobber stores and suppliers;

the risk that the additional indebtedness from the new financing agreements in association with the acquisition of GPI may limit our operating flexibility or otherwise strain our liquidity and financial condition;

the risk that we may experience difficulty retaining key GPI employees;

our ability to implement our business strategy;

our ability to expand our business, including the location of available and suitable real estate for new store locations, the integration of any acquired businesses and the continued increase in supply chain capacity and efficiency;

our dependence on our suppliers to provide us with products that comply with safety and quality standards;

our ability to attract and retain qualified employees, or Team Members;

the potential for fluctuations in the market price of our common stock and the resulting exposure to securities class action litigations;

deterioration in general macro-economic conditions, including unemployment, inflation or deflation, consumer debt levels, high fuel and energy costs, higher tax rates or uncertain credit markets;

regulatory and legal risks, including being named as a defendant in administrative investigations or litigation, and the incurrence of legal fees and costs, the payment of fines or the payment of sums to settle litigation cases or administrative investigations or proceedings;

a security breach or other cyber security incident;


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business interruptions due to the occurrence of natural disasters, extended periods of unfavorable weather, computer system malfunction, wars or acts of terrorism; and

the impact of global climate change or legal and regulatory responses to such change.

We assume no obligations to update publicly any forward-looking statements, whether as a result of new information, future events or otherwise. In evaluating forward-looking statements, you should consider these risks and uncertainties, together with the other risks described from time to time in our other reports and documents filed with the SEC and you should not place undue reliance on those statements.

Introduction

We are the largest automotive aftermarket parts provider in North America, serving both "do-it-yourself ", or DIY, and "do-it-for me", or Commercial, customers in the automotive aftermarket. At April 19, 2014, we operated a total of 5,276 stores and 105 distribution branches. We operated primarily within the United States, with additional locations in Canada, Puerto Rico and the Virgin Islands. Our stores operate primarily under the trade names "Advance Auto Parts", "Autopart International" and "Carquest" and our distribution branches operate under the "Worldpac" trade name. In addition, we serve approximately 1,400 independently owned Carquest stores. We acquired the Carquest and Worldpac operations as part of our acquisition of GPI on January 2, 2014.

Our stores and branches offer a broad selection of brand name, original equipment manufacturer ("OEM") and private label automotive replacement parts, accessories, batteries and maintenance items for domestic and imported cars and light trucks. Through our integrated operating approach, we serve our DIY and Commercial customers from our store locations, branches and online at www.AdvanceAutoParts.com, www.Carquest.com and www.Worldpac.com. Our online websites allow our DIY customers to pick up merchandise at a conveniently located store or have their purchases shipped directly to their homes or businesses. Our Commercial customers consist primarily of delivery customers for whom we deliver products from our locations to our Commercial customers' places of business, including independent garages, service stations and auto dealers. Our Commercial customers can conveniently place their orders online.

Management Overview

We generated earnings per diluted share, or diluted EPS, of $2.01 during our sixteen weeks ended April 19, 2014 (or the first quarter of Fiscal 2014) compared to $1.65 for the comparable period of Fiscal 2013. The increase in our diluted EPS was driven by the acquired GPI operations along with a solid performance by our Advance Auto Parts business driven by a comparable store sales increase of 2.4% and new store growth. Negatively impacting diluted EPS were $11.5 million of GPI integration costs, amortization expense of $13.1 million related to the acquired intangible assets from GPI and $4.0 million of expenses associated with the ongoing integration of B.W.P. Distributors, Inc. ("BWP"). Our diluted EPS for the first quarter of Fiscal 2013 included $1.7 million of BWP integration costs. Operating income for the first quarter of 2014 increased to $255.8 million, a 25.4% increase compared to the first quarter of 2013.

Our customer traffic continued to improve from our prior year experience and was more consistent throughout the quarter driven by higher demand resulting from the extreme winter weather. Sales in all markets accelerated from the fourth quarter, with our cold weather markets accelerating at a faster pace. We believe that consumers continue to remain cautious with their spending, focusing on needed repairs for part failure or safety to ensure vehicle reliability in tough winter conditions. Throughout our business, we remain focused on investments in those areas that will drive our sales growth, customer service excellence and profits. We used available cash generated from operations to invest in initiatives to support our two key strategies, Superior Availability and Service Leadership, which are discussed later in "Business and Industry Update."

On January 2, 2014, we acquired GPI in an all-cash transaction for $2.08 billion. GPI, formerly a privately-held company, is a leading distributor and supplier of original equipment and aftermarket replacement products for commercial markets operating under the Carquest and Worldpac brands. As of the acquisition date, GPI operated 1,233 Carquest stores and 103 Worldpac branches located in 45 states and Canada and served approximately 1,400 independently-owned Carquest stores. We believe the acquisition of GPI will allow us to expand its geographic presence, Commercial capabilities and overall scale to better serve customers. For additional information on the GPI acquisition, refer to Note 3, "Acquisitions," in the Notes to our Condensed Consolidated Financial Statements.


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Summary of First Quarter Financial Results

A high-level summary of our financial results for the first quarter of Fiscal 2014 is included below:

Total sales during the first quarter of Fiscal 2014 were $2,969.5 million, an increase of 47.3% as compared to the first quarter of Fiscal 2013. This increase was primarily driven by the acquisition of GPI, a comparable store sales increase of 2.4% and new stores opened during the past 12 months.

Our operating income for the first quarter of Fiscal 2014 was $255.8 million, an increase of $51.7 million from the comparable period of Fiscal 2013. As a percentage of total sales, operating income was 8.6%, a decrease of 151 basis points, due to a lower gross profit rate partially offset by a favorable SG&A rate.

Our inventory balance as of April 19, 2014 increased $1,487.2 million, or 61.4%, over our inventory balance as of April 20, 2013, driven mainly by the GPI acquisition as well as investments in additional availability through upgrades and additional HUB stores.

We generated operating cash flow of $81.1 million during the sixteen weeks ended April 19, 2014, a decrease of 40.0% from the comparable period in Fiscal 2013, primarily due to an increase in inventory, net of accounts payable, partially offset by an increase in net income.

Refer to the "Results of Operations" and "Liquidity and Capital Resources" sections for further details of our income statement and cash flow results, respectively.

Business and Industry Update

In 2014, we have two essential priorities - (i) deliver results by executing under our key strategies of Superior Availability and Service Leadership and
(ii) successfully achieve the first year goals of the multi-year GPI integration plan. Our key strategies remain consistent with 2013. Superior Availability is aimed at product availability and maximizing the speed, reliability and efficiency of our supply chain. Service Leadership leverages our product availability in addition to more consistent execution of customer-facing initiatives to strengthen our integrated operating approach of serving our customers in our stores and on-line. Through these two key strategies and the integration of GPI, we believe we can continue to build on the initiatives discussed below to produce favorable financial results over the long term. Sales to Commercial customers remain the biggest opportunity for us to increase our overall market share in the automotive aftermarket industry. Our Commercial sales, as a percentage of total sales, increased to 56% for the first quarter of Fiscal 2014 compared to 41% for the same period in Fiscal 2013. This increase is primarily due to the contribution of the acquired GPI and BWP operations which are significantly more heavily weighted in Commercial than our Advance Auto Parts stores.

Our strategic priorities include:

Growing our Commercial business through improved delivery speed and reliability, increased customer retention, increased volume with national and regional accounts, and the integrations of BWP and GPI;

Improving localized parts availability through the continued increase in the number of our larger HUB stores, an increased focus on in-store availability enabled by rolling out a second source network between store brands, and leveraging the advancement of our supply chain infrastructure, which began with our new Remington, IN, distribution center and is expanding to other distribution centers;

Maintaining a steady new store growth rate despite the focus on integrating GPI; and

Continuing our focus on store execution through more effective scheduling, increased productivity and simplification, improved product on-hand accuracy, expanded sales training and continued measurement of customer engagement.

The automotive aftermarket industry is influenced by a number of general macroeconomic factors similar to those affecting the overall retail and distribution industry. These factors include, but are not limited to, fuel costs, unemployment rates, consumer confidence and spending habits, and competition. While we believe the difficult conditions affecting the macroeconomic environment continue to constrain consumer spending in the automotive aftermarket, we remain confident that the long-term dynamics of the industry are positive. We believe the two key drivers of demand within the automotive aftermarket are (i) the number of miles driven and (ii) the number and average age of vehicles on the road.

Favorable industry dynamics include:

an increase in the number and average age of vehicles;

a long-term expectation that miles driven will continue to increase based on historical trends; and

less volatility in gas prices compared to prior years.


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Conversely, the factors negatively affecting the automotive aftermarket industry include:

deferral of elective automotive maintenance in the near term as more consumers contemplate new automobile purchases; and

longer maintenance and part failure intervals on newer cars due to improved quality.

We remain encouraged by (i) the long-term fundamentals of the automotive aftermarket industry and (ii) initiatives that we have underway to support of our key strategies. Our teams are focused on the importance of driving consistent sales outcomes for our customers and building on the comparable store sales momentum generated over the past two quarters. We expect to continue building on our operational and execution achievements and continue our investments in those areas that will drive our sales growth, customer service excellence and profit growth. We are pleased with the early integration progress with GPI as the work will allow us to fully leverage our breadth of capabilities, build market leading positions with our commercial customers, and enable us to capture economies of scale from the acquisition.

Store Development

We serve our DIY and Commercial customers in a similar fashion through four
different store brands. The below table sets forth detail of our store
development activity for the sixteen weeks ended April 19, 2014 and April 20,
2013, respectively, including the consolidation of stores as part of our
integration plans and the number of locations with Commercial delivery programs.
During Fiscal 2014, we anticipate adding approximately 120 to 140 new stores and
branches.
                           AAP         AI          BWP       CARQUEST       WORLDPAC       Total
December 28, 2013         3,741         217          91             -              -       4,049
New                          17           -           -             3              2          22
Closed                       (2 )        (1 )         -            (6 )            -          (9 )
Acquired (1)                  -           -           -         1,233            103       1,336
Consolidated (2)              -           -         (17 )           -              -         (17 )
Converted (3)                18           -         (18 )           -              -           -
April 19, 2014            3,774         216          56         1,230            105       5,381
Locations with
commercial delivery
programs                  3,422         216          56         1,230            105       5,029


December 29, 2012         3,576         218           -             -              -       3,794
New                          49           7           -             -              -          56
Closed                       (3 )        (2 )         -             -              -          (5 )
Acquired (1)                  -           -         124             -              -         124
April 20, 2013            3,622         223         124             -              -       3,969
Locations with
commercial delivery
programs                  3,319         223         124             -              -       3,666

(1) We acquired 1,233 Carquest stores and 103 Worldpac branches as a result of the acquisition of GPI on January 2, 2014. We acquired 124 stores operating under the Carquest brand as a result of the acquisition of BWP on December 31, 2012.

(2) Consolidated stores include BWP stores whose operations were consolidated into existing AAP locations as a result of the planned integration of BWP.

(3) Converted stores include BWP stores that were re-branded as an AAP store as a result of the planned integration of BWP.


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Critical Accounting Policies

Our financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America. Our discussion and analysis of the financial condition and results of operations are based on these financial statements. The preparation of these financial statements requires the application of accounting policies in addition to certain estimates and judgments by our management. Our estimates and judgments are based on currently available information, historical results and other assumptions we believe are reasonable. Actual results could differ materially from these estimates. With the exception of the below update, we consistently applied the critical accounting policies discussed in our 2013 Form 10-K during the sixteen weeks ended April 19, 2014. For a complete discussion regarding these critical accounting policies, refer to the 2013 Form 10-K.

Acquisition Impacts

We acquired GPI on January 2, 2014. The process of integrating GPI with AAP has begun, and we expect it to continue over the next three years. We used various valuation methodologies to estimate the fair value of assets acquired and liabilities assumed, including using a market participant perspective when applying certain generally accepted valuation techniques, supplemented with market appraisals where appropriate. Significant judgments and estimates were required in preparing these fair value estimates. Decisions about product offerings, brand usage, store conversions and other elements of the integration plan could be different from current plans. Accordingly, critical accounting policies and estimates such as, but not limited to, inventory valuation/obsolescence, asset impairments, goodwill and other intangible assets and income taxes may have additional acquisition-related impacts beyond what is described in these respective critical accounting policies in our 2013 Form 10-K.

Components of Statement of Operations

Net Sales

Net sales consist primarily of merchandise sales from our retail store locations to both our DIY and Commercial customers and sales from our e-commerce website. Our total sales growth is comprised of both comparable store sales and new store sales. We calculate comparable store sales based on the change in store sales commencing when a store has been open for 13 complete accounting periods (approximately one year) and by including e-commerce sales. We include sales from relocated stores in comparable store sales from the original date of opening. Acquired stores are included in our comparable store sales once the stores have completed 13 complete accounting periods following the acquisition date (approximately one year).

Cost of Sales

Our cost of sales consists of merchandise costs, net of incentives under vendor programs; inventory shrinkage, defective merchandise and warranty costs; and warehouse and distribution expenses, including depreciation and amortization. Gross profit as a percentage of net sales may be affected by (i) variations in our product mix, (ii) price changes in response to competitive factors and fluctuations in merchandise costs, (iii) vendor programs, (iv) inventory shrinkage, (v) defective merchandise and warranty costs and (vi) warehouse and distribution costs. We seek to minimize fluctuations in merchandise costs and instability of supply by entering into long-term purchasing agreements, without minimum purchase volume requirements, when we believe it is advantageous. Our gross profit may not be comparable to that of our competitors due to differences in industry practice regarding the classification of certain costs.

Selling, General and Administrative Expenses

SG&A expenses consist of store payroll, store occupancy costs (including rent and depreciation), advertising expenses, acquisition and integration related expenses, Commercial delivery expenses, other store expenses and general and administrative expenses, including salaries and related benefits of store support center Team Members, share-based compensation expenses, store support center administrative office expenses, data processing, professional expenses, self-insurance costs, depreciation and amortization, closed store expense and impairment charges, if any, and other related expenses.


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Results of Operations

The following table sets forth certain of our operating data expressed as a
percentage of net sales for the periods indicated.
                                                               Sixteen Week Periods Ended
                                                           April 19, 2014      April 20, 2013
Net sales                                                        100.0  %             100.0  %
Cost of sales, including purchasing and warehousing costs         54.4                 50.0
Gross profit                                                      45.6                 50.0
Selling, general and administrative expenses                      37.0                 39.9
Operating income                                                   8.6                 10.1
Interest expense                                                  (0.8 )               (0.5 )
Other expense, net                                                 0.0                  0.0
Provision for income taxes                                         2.9                  3.6
Net income                                                         5.0  %               6.0  %

Sixteen Week Periods Ended April 19, 2014 Compared to Sixteen Week Periods Ended April 20, 2013

Net Sales

Net sales for the sixteen weeks ended April 19, 2014 were $2,969.5 million, an increase of $954.2 million, or 47.3%, as compared to net sales for the sixteen weeks ended April 20, 2013. The sales increase was primarily due to the acquisition of GPI, our comparable store sales increase of 2.4% and the addition of 80 net new stores and two new branches. The comparable store sales increase was driven by an approximately flat transaction count coupled with an increase in transaction value, which is reflective of higher priced products sold and a higher mix of Commercial sales. Sales in all markets accelerated from the fourth quarter with our cold weather markets accelerating at a faster pace. Our customer traffic and sales were improved from our 2013 trends driven by the severe winter weather during the quarter and overall better execution in our stores. The severe winter caused more parts to fail and more consumers to complete critical maintenance to ensure reliability during the severe conditions. We generated double digit sales increases in batteries and anti-freeze as well as strong wiper sales.

Gross Profit

Gross profit for the sixteen weeks ended April 19, 2014 was $1,353.1 million, or 45.6% of net sales, as compared to $1,008.2 million, or 50.0% of net sales, for the comparable period of last year, representing a decrease of 446 basis points. The 446 basis-point decrease in gross profit rate was driven primarily by the acquisition of GPI which has a significantly higher mix of Commercial sales, with a lower gross profit rate, as compared to Advance Auto Parts. Our Commercial sales, as a percentage of total sales, increased to 56% for the first quarter of Fiscal 2014 compared to 41% for the same period in Fiscal 2013. Partially offsetting the decrease in our gross profit were cost synergies resulting from the acquisition and supply chain efficiencies driven primarily by the increase in our Advance Auto Parts inventory during the quarter.

SG&A

SG&A expenses for the sixteen weeks ended April 19, 2014 were $1,097.3 million, or 37.0% of net sales, as compared to $804.1 million, or 39.9% of net sales, for the comparable period of last year, representing a decrease of 295 basis points. This decrease as a percentage of net sales was primarily due to the lower SG&A profile of GPI as a result of their higher concentration of Commercial sales. Other drivers of our SG&A rate included fixed cost leverage from the positive sales performance partially offset by higher occupancy costs driven by the harsh winter weather, higher incentive compensation, GPI integration costs and amortization of the acquired GPI intangible assets.

Operating Income

Operating income for the sixteen weeks ended April 19, 2014 was $255.8 million, or 8.6% of net sales, as compared to $204.1 million, or 10.1% of net sales, for the comparable period of last year, representing a decrease of 151 basis points. This decrease was reflective of a decrease in our gross profit rate partially offset by a favorable change in our SG&A rate. These decreases on a rate basis were due to the gross profit and SG&A drivers previously discussed.


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