Business context and reporting period
Advance Auto Parts, Inc. filed this unaudited Form 10-Q for the 12 weeks ended July 16, 2016 (second quarter of fiscal 2016), with year-to-date comparisons covering 28 weeks. The company serves commercial and DIY automotive aftermarket customers through 5,066 stores and 126 distribution branches, as well as approximately 1,300 independently owned Carquest stores.
Financial performance and position
- Second-quarter sales: $2.256 billion, down 4.8% from $2.370 billion; comparable store sales declined 4.1%.
- Profitability: Gross profit was $1.010 billion, with gross margin of 44.8% versus 45.9%. Operating income was $216.7 million, down $40.4 million, and operating margin was 9.6% versus 10.8%. Net income was $124.6 million versus $150.0 million; diluted EPS was $1.68 versus $2.03. Company-reported adjusted diluted EPS was $1.90 versus $2.27, excluding specified integration, restructuring and acquired-intangible amortization costs.
- Year to date: Sales were $5.236 billion, down 3.2%, and comparable store sales declined 2.8%. Net income was $283.4 million versus $298.1 million; diluted EPS was $3.82 versus $4.03. Gross margin was 45.1% versus 45.9%, and operating margin was 9.3% versus 9.6%.
- Cash flow: For the 28 weeks, operating cash flow was $192.9 million versus $330.8 million. Capital expenditures were $137.9 million; investing cash use was $139.1 million and financing cash use was $41.3 million. Cash increased $14.0 million to $104.8 million.
- Liquidity and debt: Current assets were $5.280 billion and current liabilities $3.841 billion. Debt was approximately $1.170 billion, down $36.8 million from January 2, 2016. Revolver borrowings were $45.5 million, term-loan borrowings $80.0 million, and available revolver capacity $849.9 million after letters of credit. The company reported compliance with debt covenants.
- Other: Inventory rose $246.5 million, or 5.9%, from January 2, 2016, to $4.421 billion. The quarterly dividend declared was $0.06 per share.
Material changes and management commentary
Management attributed weaker sales chiefly to product availability and service-level problems, the impact of daily replenishment on distribution-center operations, a slow spring season in colder markets, and a net reduction in store count. Lower comparable sales and higher supply-chain costs reduced gross margin; sales weakness also drove fixed-cost deleverage. SG&A as a percentage of sales increased in the quarter, although it declined year to date.
The company said its 2016 priority is to regain sales growth and improve execution, inventory availability and fill rates while reducing distribution complexity. A new CEO joined in April 2016. Carquest integration continues: by July 16, 294 acquired Carquest stores had been consolidated and 231 converted to the Advance format; 696 locations still operated under the Carquest name.
Outlook, risks and unusual items
- Outlook: Management expects 2016 capital expenditures of approximately $260–$280 million and anticipates opening 65–75 stores and Worldpac branches. It expressed confidence that operating cash generation, cash on hand and credit availability would fund primary obligations for the next fiscal year. No full-year earnings or sales guidance is provided in the supplied filing text.
- Notable item: The quarter included a $7.7 million estimated tax settlement accrual related to a pre-acquisition GPI audit, partly offset by $6.7 million of other income. The company expected the settlement to be largely recoverable under the acquisition escrow.
- Integration and contingencies: Year-to-date GPI integration, store consolidation and support-center restructuring costs, together with acquired-intangible amortization, totaled $70.5 million before tax. Restructuring liabilities were $49.1 million at July 16. Guarantees of independent Carquest customer loans totaled $27.6 million; management considered performance unlikely. The filing also identifies competitive, demand, macroeconomic, weather, integration, leadership, cybersecurity, legal and interest-rate risks.
- Debt and market risks: Variable-rate revolver and term-loan borrowings expose the company to interest-rate changes; it reported no outstanding derivatives. Credit-rating declines could increase borrowing costs or constrain financing access. Both major rating outlooks were stable at the reporting date.
Important facts for investors to verify
- Whether comparable sales, product availability and customer service improve, and whether replenishment changes resolve distribution-center disruption.
- Whether inventory growth converts into stronger sales and operating cash flow without further margin pressure.
- Progress and remaining costs of Carquest integration, including the pace of planned consolidations and conversions.
- Whether the GPI tax settlement is recovered through escrow and how restructuring and integration costs develop.
- Capital-spending and store-opening plans, debt levels, credit capacity, covenant compliance and the independent-store loan guarantees.