Business context and reporting period
Advance Auto Parts, Inc. is a North American automotive aftermarket parts retailer and distributor serving professional, DIY and independent customers. This unaudited Form 10-Q covers the 12-week third quarter and 40 weeks year to date ended October 8, 2016; comparisons are to the corresponding 2015 periods. The company operated 5,058 stores and 127 distribution branches and served approximately 1,250 independently owned Carquest stores.
Financial performance
| Metric | Q3 2016 | Q3 2015 | 40 weeks 2016 | 40 weeks 2015 |
|---|---|---|---|---|
| Net sales | $2,248.9 million | $2,295.2 million | $7,484.8 million | $7,703.5 million |
| Gross profit | $988.2 million | $1,032.4 million | $3,348.4 million | $3,513.6 million |
| Gross margin | 43.9% | 45.0% | 44.7% | 45.6% |
| Operating income | $193.8 million | $205.5 million | $681.5 million | $725.1 million |
| Operating margin | 8.6% | 9.0% | 9.1% | 9.4% |
| Net income | $113.8 million | $120.5 million | $397.3 million | $418.6 million |
| Diluted EPS | $1.53 | $1.63 | $5.36 | $5.66 |
Cash flow, 40 weeks: Operating cash flow was $409.4 million, down from $520.1 million. Investing cash outflow was $205.4 million, including $204.2 million of capital expenditures. Financing cash outflow was $176.3 million. Cash increased $28.7 million to $119.5 million.
Balance sheet at October 8, 2016: Total debt was $1.043 billion, down $163.9 million from January 2; cash was $119.5 million. No borrowings were outstanding under the revolver, with $899.3 million available after letters of credit. Current assets were $5.262 billion and current liabilities $3.837 billion. Stockholders’ equity was $2.856 billion.
Material changes versus prior comparable periods
- Q3 sales declined 2.0%, including a 1.0% comparable-store sales decline; year-to-date sales fell 2.8%, with comparable-store sales down 2.4%.
- Q3 gross margin contracted 104 basis points, primarily from higher supply-chain costs, especially in Northeast and Great Lakes distribution centers during delivery-frequency transitions. Year-to-date gross margin fell 88 basis points.
- Q3 operating income decreased $11.8 million and diluted EPS fell $0.10. SG&A as a share of sales improved 70 basis points, mainly because integration and restructuring costs were lower; excluding those costs, the SG&A rate was essentially flat.
- Year-to-date operating cash flow fell $110.7 million, primarily due to working-capital outflows from inventory growth relative to accounts payable, as well as lower net income. Inventory was up $182.2 million, or 4.4%, from January 2.
- Debt declined following net repayments on credit facilities; the term loan was fully repaid. Interest expense also decreased year over year.
Outlook, management commentary, risks and unusual items
- Management’s stated 2016 priority was to regain sales growth. Its five-year strategic plan emphasizes growth, productivity, supply-chain improvements, Professional and DIY customer service, and people and culture. New supply-chain capabilities were planned for 2017 and beyond; management cited early improvement in availability and service metrics.
- Management expected fiscal 2016 capital expenditures of approximately $275 million and anticipated opening 65–75 stores and Worldpac branches for the year. It believed operating cash generation, cash on hand and revolver availability would fund primary obligations for the next fiscal year. No full-year earnings or sales guidance is provided in the filing text.
- Carquest integration continued: 316 acquired stores had been consolidated and 266 converted to the Advance format; 640 stores remained under the Carquest name. Management planned further conversions and consolidations over the next few years. Q3 integration and consolidation exit costs were $2.2 million; year-to-date costs were $17.6 million.
- Adjusted diluted EPS, a non-GAAP measure, was $1.73 for Q3 versus $1.95 a year earlier, excluding specified integration, consolidation, restructuring and acquired-intangible amortization costs. GAAP diluted EPS was $1.53 versus $1.63.
- The 40-week effective tax rate was 38.1%, versus 37.4%. It included a $7.7 million estimated settlement for a pre-acquisition GPI tax audit; the company recorded $6.7 million of related other income and expected substantial recovery under the purchase-agreement escrow. Q3 tax rate was lower year over year, partly due to state tax statute expirations and settlement of a state audit.
- Restructuring liabilities totaled $46.7 million, primarily closed-facility lease obligations. The company also guaranteed $27.3 million of loans to independent Carquest stores; management considered the likelihood of payment remote. Key risks include demand and competitive pressures, execution of GPI integration and supply-chain changes, leadership transitions, macroeconomic conditions, weather, cyber incidents, and legal or regulatory matters.
- Management reported compliance with credit covenants and effective disclosure controls; no material change in internal control over financial reporting was reported. The company noted that interim results are not necessarily indicative of full-year results and that sales are seasonal and weather-sensitive.
Important facts for investors to verify
- Whether comparable-store sales, product availability and service levels improve, particularly in the Northeast and Great Lakes regions.
- Whether supply-chain costs and gross margins recover as inventory positioning and delivery operations improve.
- Whether inventory growth and accounts-payable timing normalize and operating cash flow strengthens.
- Progress, remaining costs and expected benefits of Carquest integration, store conversions and consolidations.
- Achievement of the stated 2016 capital spending and store-opening plans, and maintenance of liquidity, leverage and credit ratings.
- Outcome and recoverability of the GPI tax-audit settlement under the acquisition escrow, and the adequacy of closed-store lease reserves and independent-store loan guarantees.