Advance Auto Parts, Inc. — Q3 2018 Form 10-Q
Business context and reporting period. Advance Auto Parts sells aftermarket automotive parts to professional installers and DIY customers through company-operated stores and branches and independently owned Carquest stores. The unaudited quarter covered 12 weeks ended October 6, 2018; year-to-date figures cover 40 weeks. The company operated 4,981 stores and 139 branches and served 1,229 independent Carquest stores at quarter-end.
Financial performance
| Metric | 12 weeks ended Oct. 6, 2018 | Comparable 2017 period | 40 weeks ended Oct. 6, 2018 | Comparable 2017 period |
|---|---|---|---|---|
| Net sales | $2,275.0 million | $2,182.2 million | $7,475.5 million | $7,336.8 million |
| Operating income | $154.2 million | $156.6 million | $520.0 million | $483.1 million |
| Net income | $115.8 million | $96.0 million | $370.4 million | $291.0 million |
| Diluted EPS | $1.56 | $1.30 | $4.99 | $3.93 |
| Operating cash flow | — | $681.5 million | $401.0 million |
- Third-quarter gross margin was 44.3%, up from 43.4%; operating margin was 6.8%, down from 7.2%; net margin was 5.1%, up from 4.4%.
- Year-to-date gross margin was 44.0% versus 43.8%, and operating margin was 7.0% versus 6.6%.
- Forty-week investing cash outflow was $103.7 million, mainly capital expenditures of $105.1 million. Financing cash outflow was $153.7 million. Cash and cash equivalents rose to $970.0 million from $546.9 million at year-end 2017.
- At October 6, long-term debt was $1,045.4 million. The company had no revolver borrowings and reported $896.0 million of borrowing availability. It was in compliance with financial covenants. Current liabilities were $3,721.2 million and current assets were $6,024.3 million.
Changes and management commentary
- Quarterly sales increased 4.3%; comparable-store sales rose 4.6%, driven by higher units per transaction and average ticket value, with growth in both DIY omni-channel and Professional businesses. Year-to-date comparable-store sales increased 2.0%.
- Management attributed gross-margin improvement to product mix, more disciplined inventory sourcing and use, and material-cost optimization. Higher fuel costs and expenses at newer distribution centers partly offset gains.
- Quarterly SG&A increased, primarily due to higher bonus and medical expenses, partly offset by lower insurance costs. Operating income declined $2.3 million despite higher sales.
- Net income benefited from a lower effective tax rate: 21.2% for the quarter versus 33.3% in 2017, and 23.7% year to date versus 34.8%. Management attributed the lower rate primarily to the Tax Cuts and Jobs Act; the lower federal corporate rate contributed $20.6 million, or $0.27 per diluted share, to quarterly net income and $68.0 million, or $0.92 per diluted share, year to date. A separate $5.7 million tax benefit arose from completing the 2017 tax-return accounting.
- Management’s non-GAAP adjusted diluted EPS was $1.89 for the quarter versus $1.43, and $5.96 year to date versus $4.60. Adjustments include transformation costs, GPI integration and acquired-intangible amortization, and tax-related items; these measures supplement, rather than replace, GAAP results.
Outlook, risks and unusual items
- Management said cash from expected operations, cash on hand and available credit should fund primary obligations for the next year. 2018 capital expenditures were expected to be up to $220 million, subject to business conditions. No specific sales or earnings guidance was stated in the supplied filing text.
- The company was undertaking a store and supply-chain rationalization, with total expected charges of up to $70 million. It recorded $36.8 million of related costs in the 40-week period, including $31.0 million in SG&A and $5.8 million in cost of sales. Store and supply-chain actions, alongside broader transformation work, may continue to generate costs.
- A new $600 million share-repurchase authorization was approved in August. The company repurchased approximately 720,000 shares under the program for $119.9 million through October 6, with $480.1 million remaining. The quarterly dividend was $0.06 per share; a further $0.06 dividend was declared for payment January 4, 2019.
- Adoption of the new lease standard was planned for the beginning of 2019. Management expected a material increase in reported assets and liabilities, but did not expect a material effect on operating results.
- Management cited higher fuel costs, execution of its transformation and supply-chain plans, and possible credit-rating effects as relevant considerations. Ratings were BBB- from S&P and Baa2 from Moody’s, both with stable outlooks. A securities class action filed in February 2018 remained in preliminary stages; the company disputed the allegations and said it would defend the case.
Key facts for investors to verify
- Whether comparable-sales momentum and gross-margin gains persist, given the quarter’s lower operating income and higher SG&A.
- How much reported earnings growth reflects recurring operations versus tax-rate changes, the $5.7 million tax benefit, LIFO inventory accounting, and non-GAAP adjustments. The filing reports a $22.0 million quarterly reduction to cost of sales from the interim LIFO valuation.
- Actual transformation and rationalization costs compared with the stated ceiling of up to $70 million, and their effects on margins and cash flow.
- Capital spending versus the up-to-$220-million 2018 expectation, working-capital trends, and cash returned through repurchases and dividends.
- The eventual balance-sheet impact of lease-standard adoption, and developments in the securities litigation and other contingencies.