Business context and reporting period
Advance Auto Parts, Inc. is an automotive aftermarket parts retailer and distributor serving professional and do-it-yourself customers. This unaudited Form 10-Q covers the 12 weeks ended October 7, 2017 (Q3) and the 40 weeks ended October 7, 2017, compared with the corresponding 2016 periods. The company operated 5,074 stores and 129 distribution branches at period-end.
Financial results and liquidity
| Metric | Q3 2017 | Q3 2016 | 40 weeks 2017 | 40 weeks 2016 |
|---|---|---|---|---|
| Net sales | $2,182.2 million | $2,248.9 million | $7,336.8 million | $7,484.8 million |
| Gross margin | 43.4% | 43.9% | 43.8% | 44.7% |
| Operating income / margin | $156.6 million / 7.2% | $193.8 million / 8.6% | $483.1 million / 6.6% | $681.5 million / 9.1% |
| Net income | $96.0 million | $113.8 million | $291.0 million | $397.3 million |
| Diluted EPS | $1.30 | $1.53 | $3.93 | $5.36 |
- Q3 comparable-store sales declined 3.4%; sales fell 3.0% overall. Management reported adjusted diluted EPS of $1.43 versus $1.73, excluding specified integration, acquired-intangible amortization and transformation items.
- For the 40 weeks, operating cash flow was $401.0 million versus $427.0 million; capital expenditures were $161.0 million versus $204.2 million; investing cash outflow was $154.8 million versus $205.4 million.
- Cash and cash equivalents were $363.3 million at October 7, 2017, compared with $135.2 million at December 31, 2016. Long-term debt, including current portion, was $1,044.4 million, compared with $1,043.3 million. The company had no revolver borrowings and reported $576.1 million of borrowing availability, subject to covenant restrictions.
- Current assets were $5,368.0 million and current liabilities $3,537.4 million. Inventory was $4,219.3 million, down $106.5 million from year-end 2016. The quarterly dividend declared was $0.06 per share.
Material changes versus prior comparable periods
Q3 sales declined $66.6 million, operating income fell $37.2 million, and net income fell $17.8 million year over year. Gross margin contracted 51 basis points and operating margin 144 basis points. For the 40-week period, sales declined $148.0 million, operating income declined $198.4 million, and net income declined $106.3 million; gross margin fell 96 basis points and operating margin 252 basis points.
Management attributed weaker sales to industry softness, transformation-related short-term disruption and weather impacts in several regions. The gross-margin decline reflected higher supply-chain costs and shrink; year-to-date results also reflected inventory reduction costs. SG&A as a share of sales increased, with customer-facing investments, hurricane-related insurance costs and medical costs among the drivers.
Outlook, management commentary, risks and unusual items
- Management said it expects cash from operations, cash on hand and available credit to fund primary obligations for the next year. It anticipated approximately $250 million in 2017 capital expenditures, subject to business conditions. No specific earnings or comparable-sales guidance is provided in the filing text.
- Transformation initiatives include a common product catalog across four banners, demand-based assortment planning, supply-chain improvements, broader fleet telematics and enhanced digital/omnichannel capabilities. Management expects transformation expenses to continue over several years and acknowledged short-term execution disruption.
- The multi-year Carquest integration continued: 345 acquired stores had been consolidated and 414 converted to the Advance format by October 7. The company recorded $7.7 million in 2017 field and support-center restructuring severance expense; 40-week transformation expenses were $35.7 million.
- Other notable items include a $6.7 million indemnification-related income item in the 40-week period and a $4.5 million tax benefit from share-based compensation accounting adoption. Interim LIFO inventory calculations are estimates and may change at year-end.
- Risks identified include aftermarket demand and competition, execution of transformation and integration plans, supply-chain and supplier issues, weather and macroeconomic conditions, leverage and credit-rating changes, legal/regulatory exposure, cybersecurity and operational disruptions. The company reported compliance with credit-facility financial covenants. It also guaranteed $25.7 million of loans to independent Carquest stores and considered performance under those guarantees remote.
- Upcoming accounting changes: lease accounting adoption is expected to materially increase reported assets and liabilities, but the impact was not quantified; revenue-standard adoption was expected to have no material financial impact.
Important facts for investors to verify
- Whether comparable-sales trends and the transformation initiatives improve execution, customer service and operating margins.
- The scale and duration of inventory-reduction-related gross-margin pressure and whether inventory optimization delivers the expected cash-flow benefits.
- Progress, remaining costs and timing for Carquest integration and broader transformation spending.
- Actual capital spending versus the approximately $250 million estimate, and cash generation relative to dividends and other obligations.
- Available revolver capacity under leverage restrictions, covenant compliance, credit ratings and exposure from guaranteed independent-store loans.
- The eventual balance-sheet effect of lease-standard adoption and the year-end outcome of estimated LIFO inventory valuation.