Business context and reporting period
Advance Auto Parts, Inc. is a North American automotive aftermarket parts retailer serving Professional and DIY customers. This unaudited Form 10-Q covers the 12 weeks ended July 15, 2017 (second quarter) and the 28 weeks ended July 15, 2017 (year to date), compared with the corresponding 2016 periods. The company operated 5,073 stores and 131 distribution branches at quarter-end.
Financial performance and liquidity
- Second-quarter sales: $2.264 billion, up 0.3% year over year, primarily from new stores; comparable store sales were flat.
- Second-quarter earnings: Gross profit was $993.1 million (43.9% of sales versus 44.8%); operating income was $146.7 million (6.5% margin versus 9.6%); net income was $87.0 million versus $124.6 million; diluted EPS was $1.17 versus $1.68. Adjusted diluted EPS, a non-GAAP measure, was $1.58 versus $1.90.
- Year-to-date results: Sales were $5.155 billion versus $5.236 billion; net income was $195.0 million versus $283.4 million; diluted EPS was $2.63 versus $3.82. Comparable store sales declined 1.5%.
- Cash flow and investment: For the 28 weeks, operating cash flow was $267.3 million versus $208.4 million; capital expenditures were $122.4 million; investing cash outflow was $121.0 million. Cash increased by $122.1 million to $257.2 million. The cash flow statement reports 28-week cumulative amounts.
- Balance sheet and funding: Current assets were $5.326 billion and current liabilities $3.598 billion at July 15. Long-term debt, including current portion, was $1.044 billion. The company had no revolver borrowings and reported $591.1 million of revolver availability after letters of credit and covenant restrictions. It was compliant with credit agreement financial covenants.
- Margins and inventory: Year-to-date gross margin was 43.9% versus 45.1%, and operating margin was 6.3% versus 9.3%. Inventory was $4.293 billion, down $32.5 million from December 31, 2016.
Material changes and management commentary
Management attributed weaker profitability to lower gross margin and higher SG&A. Gross margin faced inventory-reduction effects, higher supply-chain costs, unfavorable mix and commodity headwinds, partly offset by material-cost initiatives. The company said continued inventory reduction should improve cash flow but may continue to pressure gross margin. SG&A reflected customer-service investments, transformation costs, severance, professional services, higher medical and insurance costs, and year-to-date sales deleverage.
Management cited temporary industry softness related to fewer vehicles aged six to ten years, economic and political uncertainty, and recent weather patterns. It maintained customer-facing investments and is pursuing supply-chain optimization, zero-based budgeting, and cost reductions; expected savings were to begin in the second half of 2017. The company continued integrating acquired Carquest stores: 342 had been consolidated and 377 converted by July 15, with remaining U.S. stores expected to be consolidated or converted over the next few years.
Outlook, unusual items and risks
- Outlook: No full-year earnings or sales guidance is provided in the filing. Management anticipated approximately $250 million of 2017 capital expenditures and 60–65 store and Worldpac branch openings. It believed operating cash generation, cash on hand and available credit would fund primary obligations for the next year.
- Transformation and integration: Second-quarter adjusted EPS excludes $32.8 million of transformation expenses, $6.9 million of GPI integration and store-consolidation costs, and $9.1 million of acquired-intangible amortization, among other adjustments. The company recorded $7.2 million of severance costs for its field and support-center restructuring. These non-GAAP adjustments should be considered alongside reported GAAP results.
- Other items: A $5.5 million reduction to cost of sales from LIFO reserve changes was recorded year to date, based on interim estimates. The company adopted a share-based compensation accounting standard, recording a $0.5 million reduction to beginning retained earnings. A new $1.0 billion unsecured revolving credit agreement runs through January 2022.
- Risks: Disclosed risks include demand and competitive pressures, execution of the business strategy and integration, supplier and employee risks, macroeconomic conditions, indebtedness and credit-rating changes, litigation and regulation, cybersecurity, business interruptions, and weather. The company reported stable outlooks from S&P and Moody’s; ratings were BBB- and Baa2, respectively.
Important facts for investors to verify
- Whether comparable sales stabilize and management’s cited industry softness proves temporary.
- Whether inventory reductions deliver cash benefits without further gross-margin deterioration.
- Whether customer-service investments and transformation spending produce the planned productivity and second-half cost savings.
- How much of the GAAP earnings decline reflects ongoing operations versus integration, amortization and transformation adjustments.
- Whether the $250 million capital-spending plan, store-opening outlook and available revolver capacity remain consistent with liquidity needs.