ADVANCE AUTO PARTS INC annual report, FY2020

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Advance Auto Parts, Inc. — 2019 Form 10-K

Business context and reporting period. Advance Auto Parts is a North American automotive aftermarket retailer and distributor serving professional installers and DIY customers. The fiscal year ended December 28, 2019 and comprised 52 weeks; the fourth quarter comprised 12 weeks. The company operated 4,877 stores and 160 branches at year-end and reported one aggregated reportable segment.

Financial performance and position

  • Full-year revenue and earnings: Net sales were $9.709 billion, up 1.3% from 2018; comparable store sales rose 1.1%. Net income was $486.9 million versus $423.8 million, and diluted EPS was $6.84 versus $5.73. Non-GAAP adjusted EPS was $8.19 versus $7.13.
  • Fourth quarter: Net sales were $2.113 billion versus $2.105 billion in Q4 2018. Net income was $95.9 million versus $53.4 million; diluted EPS was $1.38 versus $0.74.
  • Margins: Gross profit was $4.255 billion, or 43.8% of sales, versus 44.0% in 2018. Operating income increased to $677.2 million, or 7.0% of sales, from $604.3 million, or 6.3%. Net margin was 5.0% versus 4.4%.
  • Cash flow and investment: Operating cash flow was $866.9 million, up 6.9%. Capital expenditures were $270.1 million, up from $193.7 million. Investing cash outflow was $462.9 million, including the DieHard brand purchase; financing cash outflow was $882.2 million. Cash declined to $418.7 million from $896.5 million.
  • Debt and liquidity: Total debt was $747.3 million, down from $1.046 billion, following early repayment of $300 million in 2020 notes. No revolving-credit borrowings were outstanding; $1.0 billion was available under the revolver. Current assets were $5.696 billion and current liabilities $4.478 billion.
  • Leases: Operating lease liabilities totaled $2.495 billion. Adoption of the lease accounting standard resulted in recognition of $2.4 billion in right-of-use assets; total assets at year-end were $11.249 billion.

Material changes versus the prior period

  • Sales growth was modest but improved year over year; management attributed the increase primarily to Professional business growth and product mix.
  • Operating margin improved 67 basis points, principally from lower labor-related and insurance-claim costs and expense management. Gross margin fell 22 basis points, reflecting loyalty-program costs and unfavorable LIFO adjustments.
  • The LIFO reserve change increased 2019 cost of sales by $101.3 million; in 2018 it reduced cost of sales by $39.8 million.
  • The company spent $487.4 million to repurchase 3.4 million shares in 2019, compared with $272.8 million in 2018. It also redeemed the 2020 notes and purchased the DieHard brand.

Outlook, commentary, risks and unusual items

  • Management forecast 2020 capital expenditures of $275 million to $325 million, subject to business conditions. It expressed confidence in the industry’s long-term growth prospects but provided no sales or earnings guidance in the supplied filing text.
  • Strategic priorities include improving customer experience, demand-based assortment, supply-chain efficiency, digital and omnichannel capabilities, loyalty, store-footprint optimization, and Professional-market growth. Management noted increased IT costs as it develops digital capabilities and integrates technology platforms.
  • A $200.0 million cash purchase price, plus $1.5 million of capitalizable transaction costs, was paid for the DieHard brand in December 2019. The brand was recorded as an indefinite-lived intangible asset.
  • A 2019 out-of-period correction related to received-not-invoiced inventory increased cost of sales by $13.0 million. The company also recorded $10.1 million of make-whole charges and $0.7 million of debt issuance costs from early note redemption.
  • Key disclosed risks include competitive and pricing pressure, execution of the transformation and supply-chain initiatives, ERP and other technology implementation, cybersecurity, labor and wage costs, weather and macroeconomic conditions, supplier and tariff disruptions, and vehicle technology changes.
  • A securities class action survived a motion to dismiss in part in February 2020 and proceeded to discovery; the company disputes the allegations. The filing also discusses asbestos-related lawsuits and environmental obligations, while management did not expect pending matters to materially affect consolidated results. The company reported effective disclosure controls and internal control over financial reporting, with unqualified audit opinions.

Important facts for investors to verify

  • Whether Professional-sales growth, comparable-store sales and execution of the transformation plan continue to improve.
  • How gross margin responds to loyalty initiatives, LIFO costs, inventory management and pricing competition.
  • Whether planned IT and supply-chain investment delivers expected operating benefits and remains within the stated 2020 capital-expenditure range.
  • The cash-flow and capital-allocation effects of share repurchases, the DieHard investment, debt maturities and substantial lease obligations.
  • Developments in the securities litigation and asbestos claims, and the realization of vendor incentives, tax assets and other significant estimates.