Advance Auto Parts, Inc. — Q3 2012 Form 10-Q
Reporting period: Twelve weeks ended October 6, 2012; year-to-date results cover the forty weeks ended that date. Comparisons are with the corresponding periods ended October 8, 2011. Dollar amounts below are in millions unless stated otherwise.
Business context and operating results
Advance Auto Parts is an automotive aftermarket retailer serving DIY and Commercial customers through 3,727 stores: 3,517 in the AAP segment and 210 in Autopart International (AI). The company also sells through online platforms.
| Metric | Q3 2012 | Q3 2011 | 40 weeks 2012 | 40 weeks 2011 |
|---|---|---|---|---|
| Net sales | $1,457.5 | $1,465.0 | $4,875.8 | $4,842.9 |
| Comparable-store sales | (1.8%) | 2.2% | (0.5%) | 2.0% |
| Gross margin | 49.8% | 49.5% | 49.9% | 49.9% |
| SG&A as % of sales | 39.4% | 37.3% | 38.8% | 38.5% |
| Operating income | $150.4 | $177.8 | $544.1 | $552.7 |
| Net income | $89.5 | $105.6 | $322.6 | $328.2 |
| Diluted EPS | $1.21 | $1.41 | $4.34 | $4.19 |
Financial position, cash flow and liquidity
- Cash and liquidity: Cash and equivalents were $479.4 at October 6, 2012, up $421.5 from year-end 2011. The company had no revolver borrowings, $88.5 of letters of credit and $661.5 of available revolving capacity under its $750 million facility, maturing in May 2016.
- Debt: Total debt was $600.2, comprising approximately $299 million of 5.75% notes due 2020, $300 million of 4.50% notes due 2022, and $1.3 million of other debt. Debt increased $184.3 from December 31, 2011, principally following issuance of the 2022 notes. The company reported compliance with its credit-facility covenants.
- Cash flow, 40 weeks: Operating cash flow was $504.8, down 17.4% from $611.0. Investing used $206.2, including $201.2 of capital expenditures. Financing provided $122.9; cash increased $421.5 to $479.4.
- Capital returns: The company paid $17.6 of dividends in the 40-week period. It repurchased $19.6 of shares under its program and had $492.4 remaining on the $500 million authorization. A $0.06-per-share dividend was declared for payment in January 2013.
- Working capital: Inventory was $2,193.4, up 4.0% from October 2011, to support availability initiatives. Receivables were $204.6; the company said the increase reflected the transition to processing Commercial credit transactions internally.
Material changes and management commentary
Q3 sales declined 0.5%, with comparable sales down 1.8%; 82 net new stores over the prior 12 months partly offset the comparable-sales decline. Management attributed softer demand to difficult economic conditions, high unemployment and fuel costs, low consumer confidence, and lingering effects of a warmer winter in colder markets. Promotional activity, lower transaction counts and product-cost deflation also affected sales and pricing.
Gross margin improved 31 basis points in Q3, reflecting better shrink, cost deflation and supply-chain efficiencies, partly offset by promotions. SG&A rose 213 basis points as a share of sales, primarily from higher store labor and advertising and expense deleverage. Operating margin consequently fell 182 basis points to 10.3%, driving lower Q3 net income and diluted EPS. For the 40 weeks, diluted EPS increased despite lower net income, largely because average diluted shares declined following prior-year buybacks.
Commercial sales represented 38% of Q3 sales, versus 37% a year earlier; management said comparable Commercial sales improved from Q2 to Q3. Strategic priorities include product availability and supply-chain efficiency, service execution, e-commerce, and Commercial growth. The new Remington, Indiana distribution center began outbound shipments during Q3.
Outlook, risks and unusual items
- Management anticipated constrained sales for the remainder of fiscal 2012, while remaining focused on Commercial growth and balancing operating costs with strategic investment. It expected to open approximately 110–120 AAP stores and 10–20 AI stores, with about 10 total closures, and projected fiscal-year capital expenditures of $275–$300 million.
- The Commercial credit in-sourcing was nearing completion. Management expected trade receivables of approximately $100–$115 million by fiscal year-end and said the working-capital impact would be primarily limited to fiscal 2012.
- Risks cited include demand weakness, competition and pricing, execution of strategy and store expansion, macroeconomic conditions, employee retention, legal and regulatory matters, cybersecurity incidents, and business interruptions. Seasonality and weather can affect sales. Results for interim periods may not indicate full-year performance.
- Approximately 95% of inventory was accounted for using LIFO. Estimated LIFO accounting reduced cost of sales by $20.7 in the 40 weeks, compared with a $16.7 increase in the prior-year period; the interim estimate depends on year-end inventory levels and costs.
- The filing reported no off-balance-sheet arrangements as defined by SEC rules and no material change in contractual obligations from year-end 2011. It disclosed $23.0 of contingent consideration from prior acquisitions, measured using estimates. Management stated disclosure controls were effective and reported no material changes in internal control during the quarter.
Key facts for investors to verify
- Whether comparable-sales trends and customer transactions improve, particularly in colder-weather markets, and whether Commercial growth continues.
- Whether higher labor, advertising and promotional costs moderate enough to restore operating-margin performance.
- Execution and returns on the Remington distribution center, store openings, inventory-availability projects and planned capital expenditures.
- Cash conversion and working-capital effects of Commercial credit in-sourcing, including the expected receivables balance.
- Debt levels, revolver availability, covenant compliance and the assumptions behind interim LIFO estimates and acquisition-related contingent consideration.