Advance Auto Parts, Inc. — Q2 2014 Form 10-Q
Reporting period: Second quarter, the 12 weeks ended July 12, 2014; year-to-date figures cover 28 weeks. Financial statements are unaudited. Comparisons are with the corresponding 2013 periods. The January 2, 2014 acquisition of General Parts International (GPI) materially affects year-over-year comparisons.
Business context and key results
Advance operated 5,289 stores and 106 distribution branches across the U.S., Canada, Puerto Rico and the Virgin Islands, and served approximately 1,400 independently owned Carquest stores. Following the GPI acquisition, the company reported as one operating segment. Its brands include Advance Auto Parts, Carquest, Autopart International and Worldpac.
- Q2 revenue: $2.348 billion, up 51.5%; comparable-store sales increased 2.6%. The reported sales increase was driven mainly by GPI, along with comparable-store growth and new locations.
- Q2 profitability: Gross profit was $1.062 billion (45.2% margin, down 5.05 percentage points); operating income was $240.7 million (10.3% margin, down 2.31 points); net income was $139.5 million; diluted EPS was $1.89 versus $1.59.
- Year-to-date: Revenue was $5.317 billion, up 49.2%; comparable-store sales rose 2.5%. Operating income was $496.5 million (9.3% margin versus 11.2%); net income was $287.2 million; diluted EPS was $3.90 versus $3.23.
- Cash flow, year-to-date: Operating cash flow was $320.6 million, compared with $310.1 million. Capital expenditures were $106.3 million. Investing cash outflow was $2.165 billion, including $2.059 billion for acquisitions, net of cash acquired.
- Liquidity and debt at July 12: Cash was $67.4 million. Total debt was $1.868 billion, up $814.9 million from fiscal year-end, primarily due to GPI financing. Revolver availability was $741.1 million after $126.4 million of letters of credit. The company reported compliance with debt covenants.
- Other measures: Commercial sales were 57% of Q2 sales versus 40% a year earlier, largely reflecting GPI and B.W.P. Distributors (BWP). The quarterly dividend remained $0.06 per share.
Material changes and management commentary
- GPI was acquired for approximately $2.08 billion in an all-cash transaction. Its Q2 contribution was $737.1 million in sales and $23.7 million in net income; year-to-date contribution was $1.617 billion in sales and $39.6 million in net income. GPI results include acquired-intangible amortization and integration expenses.
- Higher Commercial mix, associated with lower gross margins, was the main reason gross margin declined. Lower SG&A as a percentage of sales—reflecting GPI’s cost profile and sales leverage—partly offset that pressure.
- Management cited Q2 costs of $9.4 million for GPI integration, $9.9 million for GPI intangible amortization and $2.8 million for BWP integration. Year-to-date costs were $20.9 million for GPI integration, $22.9 million for GPI amortization and $6.8 million for BWP integration.
- Management said GPI integration is expected to continue over three years and expects most integration costs to be offset by synergies. Plans include consolidating approximately 100 Carquest and Advance stores, substantially by the end of 2014, and relocating or consolidating certain support-center operations, substantially by the end of 2015. Restructuring expenses recorded through July 12 were immaterial; no stores had closed under this plan.
Outlook, risks and contingencies
- For fiscal 2014, management anticipated capital expenditures of $275 million to $300 million and opening approximately 120 to 140 stores and branches. It expected an effective tax rate of approximately 38% for the remainder of the year.
- Management said cash from operations, available cash and credit availability should fund primary obligations for the next fiscal year. It also stated a focus on reducing leverage and maintaining investment-grade ratings; the company reported BBB- and Baa3 ratings, both with stable outlooks.
- Risks include failure to realize GPI synergies or integration difficulties, increased debt and interest-rate exposure, competitive pressures, weaker demand or macroeconomic conditions, and supply-chain, employee, legal, cybersecurity and weather-related disruptions. Variable-rate term-loan and revolver borrowings totaled $815 million; no derivative instruments were outstanding.
- The company guaranteed $33.3 million of bank loans to independent store customers and said the likelihood of having to perform was remote. GPI’s acquired operating leases had future minimum payments of $831.1 million.
- Management reported effective disclosure controls. GPI was excluded from the internal-control evaluation while its controls were being assessed and integrated.
Important facts for investors to verify
- How much of reported sales and EPS growth is attributable to GPI versus comparable-store performance, and how comparable results evolve as acquired stores enter the comparison base.
- Whether gross-margin pressure from Commercial mix persists and whether SG&A leverage and expected integration synergies offset it.
- Progress against GPI integration, store-consolidation and relocation timelines, including total integration and restructuring costs.
- Debt reduction, interest expense and liquidity trends, particularly given variable-rate borrowings and the company’s stated leverage and ratings priorities.
- Capital spending and store-opening progress against fiscal 2014 expectations, and any changes to management’s outlook.