Advance Auto Parts, Inc. — Q1 2014 Form 10-Q
Reporting period: Sixteen weeks ended April 19, 2014. The company’s first quarter is 16 weeks; each of the remaining quarters is 12 weeks, so comparisons are not directly comparable by quarter length. Financial statements are unaudited.
Business context
Advance Auto Parts sells automotive replacement parts and related products to do-it-yourself and commercial customers. On January 2, 2014, it acquired General Parts International (GPI), including the Carquest and Worldpac businesses, for approximately $2.08 billion. The filing reports 5,276 stores and 105 distribution branches at quarter-end and service to approximately 1,400 independently owned Carquest stores. Management plans to integrate Carquest operations into Advance Auto Parts over approximately three years.
Financial results
| Metric | Q1 2014 | Prior-year comparable period | Change / context |
|---|---|---|---|
| Net sales | $2,969.5 million | $2,015.3 million | Up 47.3%, primarily reflecting GPI, 2.4% comparable-store sales growth, and new stores |
| Gross profit / margin | $1,353.1 million / 45.6% | $1,008.2 million / 50.0% | Margin down 446 basis points, largely due to GPI’s higher Commercial sales mix |
| Operating income / margin | $255.8 million / 8.6% | $204.1 million / 10.1% | Income up 25.4%; margin down 151 basis points |
| Net income / net margin | $147.7 million / 5.0% | $121.8 million / 6.0% | Net income up approximately 21% |
| Diluted EPS | $2.01 | $1.65 | Up approximately 22% |
| Operating cash flow | $81.1 million | $135.3 million | Down 40.0%, mainly from inventory investment net of accounts payable and lower accrued operating expenses |
| Capital expenditures | $60.5 million | $63.1 million | Excludes the GPI acquisition cash outlay |
GPI contributed $879.9 million in sales and $15.8 million in net income during the period; its net income included acquired-intangible amortization and integration expenses. Management cited $11.5 million of GPI integration costs, $13.1 million of GPI-related amortization, and $4.0 million of BWP integration expenses as items weighing on Q1 results. The company’s Commercial sales mix rose to 56% of sales from 41% in the prior-year period, contributing to gross-margin dilution; lower SG&A as a share of sales partly offset that pressure.
Liquidity, debt, and balance sheet
- Cash and cash equivalents were $83.4 million at April 19, 2014, down $1.029 billion from fiscal year-end, principally due to the GPI acquisition.
- Total debt was $2.073 billion, compared with $1.054 billion at December 28, 2013. Debt included a $700 million variable-rate term loan and $319 million drawn on the revolving facility, alongside $1.048 billion of senior notes and other debt.
- Revolver availability was reported as $548.0 million after considering the leverage-based borrowing limit; letters of credit outstanding were $133.0 million. The company said it was in compliance with its credit-agreement covenants.
- Net cash used in investing activities was $2.117 billion, including $2.057 billion for acquisitions, net of cash acquired. Financing activities provided $1.008 billion, mainly reflecting acquisition-related borrowings.
- Inventory was $3.911 billion, up 61.4% year over year, principally due to GPI and investments in product availability, assortment upgrades, and HUB stores.
Outlook, management commentary, and risks
- Management expects fiscal 2014 capital expenditures of approximately $325 million to $350 million and anticipates opening approximately 120 to 140 stores and branches.
- The company expects an effective tax rate of approximately 38% for the balance of fiscal 2014; Q1’s rate was 36.5%, including a favorable state tax settlement.
- Management said available operating cash, cash on hand, and borrowing capacity should be sufficient to fund primary obligations for the next fiscal year. It expects significant GPI integration costs over the next three years, largely offset by anticipated synergies, but the filing provides no quantified synergy target or full-year earnings guidance.
- Management attributed improved traffic and sales partly to severe winter weather, which increased failures and demand for certain products. It also noted cautious consumer spending and the possibility that elective maintenance may be deferred.
- Key risks include difficulty integrating GPI or realizing synergies, employee retention, customer or supplier disruption, and the effect of added debt on flexibility and liquidity. Other cited risks include demand and competitive pressures, macroeconomic conditions, weather or operational disruptions, cyber incidents, and legal or regulatory matters.
- The company had $33.8 million of guarantees for loans to independent store customers and said performance was considered remote. GPI also brought $859.6 million of future minimum operating lease payments. Management reported disclosure controls were effective; GPI was excluded from the internal-control evaluation while its controls were being assessed and integrated.
Most important facts for investors to verify
- Whether GPI integration proceeds on schedule and produces the expected synergies, and how integration expenses compare with the anticipated benefits.
- Whether comparable-store sales and underlying customer demand remain sound after separating GPI’s acquired sales and the quarter’s severe-weather benefit.
- Whether Commercial mix and integration-related amortization continue to pressure gross margin and operating margin.
- How the company manages increased debt, variable-rate exposure, cash levels, and inventory investment while maintaining covenant compliance and liquidity.
- How the preliminary GPI purchase-price allocation, including $811.3 million of acquisition goodwill and acquired intangible assets, changes as valuation work is finalized.