As of August 12, 2005, the registrant had outstanding 72,977,367 shares of Common Stock, par value $0.0001 per share (the only class of common stock of the registrant outstanding).
are an integral part of these statements.
The accompanying condensed consolidated financial statements include the accounts of Advance Auto Parts, Inc. and its wholly owned subsidiaries, or the Company. All significant intercompany balances and transactions have been eliminated in consolidation.
The condensed consolidated balance sheets as of July 16, 2005 and January 1, 2005, the condensed consolidated statements of operations for the twelve and twenty-eight week periods ended July 16, 2005, and July 17, 2004, and the condensed consolidated statements of cash flows for the twenty-eight week periods ended July 16, 2005, and July 17, 2004, have been prepared by the Company. In the opinion of management, all adjustments, consisting of only normal recurring adjustments, necessary for a fair presentation of the financial position of the Company, the results of its operations and cash flows have been made.
Certain information and footnote disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States of America have been condensed or omitted. These financial statements should be read in conjunction with the financial statements and notes thereto included in the Company’s consolidated financial statements for the fiscal year ended January 1, 2005.
The results of operations for the interim periods are not necessarily indicative of the operating results to be expected for the full fiscal year.
Use of Estimates
The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.
Earnings Per Share of Common Stock
Basic earnings per share of common stock has been computed based on the weighted-average number of common shares outstanding, less stock held in treasury, during the period. Diluted earnings per share of common stock reflects the increase in the weighted-average number of common shares outstanding assuming the exercise of outstanding stock options, calculated on the treasury stock method, and all currently outstanding deferred stock units.
Vendor Incentives
The Company receives incentives in the form of reductions to amounts owed and/or payments from vendors related to cooperative advertising allowances, volume rebates and other promotional considerations. The Company accounts for vendor incentives in accordance with Emerging Issues Task Force, or EITF, No. 02-16, “Accounting by a Customer (Including a Reseller) for Certain Consideration Received from a Vendor.” Many of the incentives are under long-term agreements (terms in excess of one year), while others are negotiated on an annual basis. Certain vendors require the Company to use cooperative advertising allowances exclusively for advertising. The Company defines these allowances as restricted cooperative advertising allowances and recognizes them as a reduction to selling, general and administrative expenses as incremental advertising expenditures are incurred. The remaining cooperative advertising allowances not restricted by the Company’s vendors and volume rebates are earned based on inventory purchases and recorded as a reduction to inventory and recognized through cost of sales as the inventory is sold.
Advance Auto Parts, Inc. and Subsidiaries
Notes to the Condensed Consolidated Financial Statements
For the Twelve and Twenty-Eight Week Periods Ended July 16, 2005 and July 17, 2004
(in thousands, except per share data)
(unaudited)
The Company recognizes other promotional incentives earned under long-term agreements as a reduction to cost of sales. These incentives are recognized based on the cumulative purchases as a percentage of total estimated purchases over the life of the agreement. The Company's margins could be impacted positively or negatively if actual purchases or results from any one-year differ from its estimates, however the impact over the life of the agreement would be the same. Short-term incentives (terms less than one year) are recognized as a reduction to cost of sales over the course of the annual agreements.
Amounts received or receivable from vendors that are not yet earned are reflected as deferred revenue in the accompanying condensed consolidated balance sheets. Management's estimate of the portion of deferred revenue that will be realized within one year of the balance sheet date has been included in other current liabilities in the accompanying condensed consolidated balance sheets. Earned amounts that are receivable from vendors are included in receivables, net on the accompanying condensed consolidated balance sheets, except for that portion expected to be received after one-year, which is included in other assets, net on the accompanying condensed consolidated balance sheets.
Hedge Activities
The Company has entered into interest rate swap agreements to limit its cash flow risk on its variable rate debt. In March 2005, the Company entered into three interest rate swap agreements on an aggregate of $175,000 of debt under its senior credit facility. The detail for the individual swaps is as follows:
| · | The first swap allows the Company to fix its LIBOR rate at 4.153% on $50,000 of debt for a term of 48 months, expiring March 2009. |
| · | The second swap allows the Company to fix its LIBOR rate at 4.255% on $75,000 of debt for a term of 60 months, expiring February 2010. |
| · | Beginning in March 2006, the third swap will allow the Company to fix its LIBOR rate at 4.6125% on $50,000 of debt for a term of 54 months, expiring August 2010. |
Additionally, the Company entered two interest rate swap agreements in March 2003 to limit its cash flow risk on an aggregate of $125,000 of its variable rate debt. The first swap allows the Company to fix its LIBOR rate at 2.269% on $75,000 of debt for a term of 36 months and expires in March 2006. The second swap, which allowed the Company to fix its LIBOR rate at 1.79% on $50,000 of variable rate debt, expired in March 2005.
In accordance with Statement of Financial Accounting Standard, or SFAS, No. 133, “Accounting for Derivative Instruments and Hedging Activities,” the fair value of these hedge arrangements is recorded as an asset or liability in the accompanying condensed consolidated balance sheet at July 16, 2005. The Company uses the “matched terms” accounting method as provided by Derivative Implementation Group Issue No. G9, “Assuming No Ineffectiveness When Critical Terms of the Hedging Instrument and the Hedge Transaction Match in a Cash Flow Hedge” for the interest rate swaps. Accordingly, the Company has matched the critical terms of each hedge instrument to the hedged debt. Therefore, the Company has recorded all adjustments to the fair value of the hedge instruments in accumulated other comprehensive income (loss) through the maturity date of the applicable hedge arrangement. The fair value at July 16, 2005, was an unrecognized gain of $648 on the swaps. Any amounts received or paid under these hedges will be recorded in the statement of operations as earned or incurred. Comprehensive income for the twelve and twenty-eight weeks ended July 16, 2005, and July 17, 2004 is as follows:
Advance Auto Parts, Inc. and Subsidiaries
Notes to the Condensed Consolidated Financial Statements
For the Twelve and Twenty-Eight Week Periods Ended July 16, 2005 and July 17, 2004
(in thousands, except per share data)
(unaudited)
| | | | Twelve Weeks Ended | | Twenty-Eight Weeks Ended | |
| | | | July 16, | | July 17, | | July 16, | | July 17, | |
| | | | 2005 | | 2004 | | 2005 | | 2004 | |
| | | | | | | | | | | |
| | Net income | | $ | 65,929 | | $ | 53,235 | | $ | 134,576 | | $ | 104,526 | |
| | Unrealized gain (loss) on hedge | | | | | | | | | | | | | |
| | arrangements, net of tax | | | 196 | | | 605 | | | (166 | ) | | 784 | |
| | Comprehensive income | | $ | 66,125 | | $ | 53,840 | | $ | 134,410 | | $ | 105,310 | |
Based on the estimated current and future fair values of the hedge arrangements at July 16, 2005, the Company estimates amounts currently included in accumulated other comprehensive income (loss) that will be reclassified to earnings in the next 12 months will consist of a gain of $654 associated with the interest rate swaps.
Sales Returns and Allowances
Our accounting policy for sales returns and allowances consists of establishing reserves for anticipated returns at the time of sale. We estimate anticipated returns based on current sales levels and our historical return experience on a specific product basis.
Warranty Costs
The Company's vendors are primarily responsible for warranty claims. Warranty costs relating to merchandise and services sold under warranty, which are not covered by vendors' warranties, are estimated based on the Company's historical experience and are recorded in the period the product is sold. The following table presents changes in the Company’s defective and warranty reserves.
| | | | July 16, | | January 1, | |
| | | | 2005 | | 2005 | |
| | | | (28 weeks ended) | | (52 weeks ended) | |
| | Defective and warranty reserve, beginning | | | | | |
| | of period (1) | | $ | 10,960 | | $ | 15,578 | |
| | Reserves established | | | 7,315 | | | 13,071 | |
| | Reserves utilized | | | (7,305 | ) | | (17,689 | ) |
| | Defective and warranty reserve, end of | | | | | | | |
| | period | | $ | 10,970 | | $ | 10,960 | |
| | (1) | Reserves at January 1, 2005 included $1,656 of reserves established for the transition of the discontinued operations of the wholesale dealer network, of which substantially all were utilized during fiscal 2004. |
Stock-Based Compensation
The Company has stock-based compensation plans, including fixed stock option plans, a deferred stock unit plan and an employee stock purchase plan. As permitted under SFAS No. 123, “Accounting for Stock-Based Compensation,” the Company accounts for its stock options using the intrinsic value method prescribed in Accounting Principles Board Opinion, or APB, No. 25, “Accounting for Stock Issued to Employees”, or APB No.
Advance Auto Parts, Inc. and Subsidiaries
Notes to the Condensed Consolidated Financial Statements
For the Twelve and Twenty-Eight Week Periods Ended July 16, 2005 and July 17, 2004
(in thousands, except per share data)
(unaudited)
25. Under APB No. 25, compensation cost for stock options is measured as the excess, if any, of the market price of the Company’s common stock at the measurement date over the exercise price. Accordingly, the Company has not recognized compensation expense on the issuance of its fixed stock options because in each instance the exercise price equaled the fair market value of the underlying stock on the grant date. The Company has not recognized stock-based compensation expense for its employee stock purchase plan since it is a plan that qualifies under Section 423 of the Internal Revenue Code of 1986, as amended. Additionally, the Company has recognized compensation expense, net of tax, related to the issuance of deferred stock units of $147 and $215 during the twelve and twenty-eight weeks ended July 16, 2005 and July 17, 2004, respectively.
As required by SFAS No. 148, “Accounting for Stock-Based Compensation - Transition and Disclosure an amendment of Financial Accounting Standards Board, or FASB, Statement No. 123,” the following table reflects the impact on net income and earnings per share as if the Company had adopted the fair value based method of recognizing compensation costs as prescribed by SFAS No. 123.
| | | | Twelve Weeks Ended | | Twenty-Eight Weeks Ended | |
| | | | July 16, | | July 17, | | July 16, | | July 17, | |
| | | | 2005 | | 2004 | | 2005 | | 2004 | |
| | | | | | | | | | | |
| | Net income, as reported | | $ | 65,929 | | $ | 53,235 | | $ | 134,576 | | $ | 104,526 | |
| | Add: Total stock-based employee compensation | | | | | | | | | | | | | |
| | expense included in reported net income, net | | | | | | | | | | | | | |
| | of related tax effects | | | 147 | | | 215 | | | 147 | | | 215 | |
| | Deduct: Total stock-based employee compensation | | | | | | | | | | | | | |
| | expense determined under fair value based method | | | | | | | | | | | | | |
| | for all awards, net of related tax effects | | | (2,342 | ) | | (1,755 | ) | | (4,695 | ) | | (3,332 | ) |
| | Pro forma net income | | $ | 63,734 | | $ | 51,695 | | $ | 130,028 | | $ | 101,409 | |
| | | | | | | | | | | | | | | |
| | Net income per share: | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | |
| | Basic, as reported | | $ | 0.91 | | $ | 0.71 | | $ | 1.87 | | $ | 1.41 | |
| | Basic, pro forma | | | 0.88 | | | 0.69 | | | 1.81 | | | 1.37 | |
| | Diluted, as reported | | | 0.90 | | | 0.70 | | | 1.84 | | | 1.37 | |
| | Diluted, pro forma | | | 0.87 | | | 0.68 | | | 1.78 | | | 1.33 | |
Financed Vendor Accounts Payable
During the first quarter of fiscal 2004, the Company entered a short-term financing program with a bank for certain merchandise purchases. The substance of the program is for the Company to borrow money from the bank to finance its purchases from vendors. The Company records any discount given by the vendor to the value of its inventory and accretes this discount to the resulting short-term payable to the bank through interest expense over the extended term. At July 16, 2005 and January 1, 2005, $120,825 and $56,896, respectively was payable to the bank by the Company under this program and is included in the accompanying condensed consolidated balance sheets as Financed Vendor Accounts Payable.
Advance Auto Parts, Inc. and Subsidiaries
Notes to the Condensed Consolidated Financial Statements
For the Twelve and Twenty-Eight Week Periods Ended July 16, 2005 and July 17, 2004
(in thousands, except per share data)
(unaudited)
Lease Accounting
The Company leases certain store locations, distribution centers, office space, equipment and vehicles, some of which are with related parties. Initial terms for facility leases are typically 10 to 15 years, followed by additional terms generally containing renewal options at 5 year intervals, and may include rent escalation clauses. The total amount of the minimum rent is expensed on a straight-line basis over the initial term of the lease. In the event, external economic factors exist such that renewals are reasonably assured the Company would include the renewal period in its amortization period. In those instances the renewal period would be included in the lease term for purposes of establishing an amortization period and determining if such lease qualified as a capital or operating lease. In addition to minimum fixed rentals, some leases provide for contingent facility rentals. Contingent facility rentals are determined on the basis of a percentage of sales in excess of stipulated minimums for certain store facilities as defined in the individual lease agreements. Most of the leases provide that the Company pay taxes, maintenance, insurance and certain other expenses applicable to the leased premises and include options to renew. Management expects that, in the normal course of business, leases that expire will be renewed or replaced by other leases.
Closed Store Liabilities
The Company continually reviews the operating performance of its existing store locations and closes certain locations identified as under performing. Closing an under performing location has not resulted in the elimination of the operations and associated cash flows from the Company’s ongoing operations as the Company has transferred those operations to another location in the local market. The Company maintains closed store liabilities that include liabilities for these exit activities. The Company also maintains liabilities assumed through past acquisitions for closed store liabilities which are similar in nature but recorded by the acquired companies prior to the Company's acquisition.
New provisions established for closed store liabilities include the present value of the remaining lease obligations and management’s estimate of future costs of insurance, property tax and common area maintenance. These new provisions are reduced by the present value of estimated revenues from subleases and are established by a charge to selling, general and administrative costs in the accompanying condensed consolidated statements of operations at the time the facilities actually close. The Company currently uses discount rates ranging from 4.5% to 7.8% for estimating these liabilities.
From time to time these estimates require revisions that affect the amount of the recorded liability. This change in estimate relates primarily to changes in assumptions associated with the revenue from subleases. The effect of changes in estimates for the closed store liabilities is netted with new provisions and included in selling, general and administrative expenses in the accompanying condensed consolidated statements of operations.
Recent Accounting Pronouncements
In November 2004, the FASB issued SFAS No. 151, "Inventory Costs.” The new statement amends Accounting Research Bulletin No. 43, Chapter 4, "Inventory Pricing," to clarify the accounting for abnormal amounts of idle facility expense, freight, handling costs and wasted material. This statement requires that those items be recognized as current-period charges and requires that allocation of fixed production overhead to the cost of conversion be based on the normal capacity of the production facilities. This statement is effective for fiscal years beginning after June 15, 2005. The Company does not expect the adoption of this statement to have a material impact on its financial condition or results of operations.
Advance Auto Parts, Inc. and Subsidiaries
Notes to the Condensed Consolidated Financial Statements
For the Twelve and Twenty-Eight Week Periods Ended July 16, 2005 and July 17, 2004
(in thousands, except per share data)
(unaudited)
In December 2004, the FASB issued SFAS No. 123 (revised 2004), “Share-Based Payment,” or SFAS No. 123R. SFAS No. 123R replaces SFAS No. 123, “Accounting for Stock-Based Compensation” and supersedes APB Opinion No. 25, “Accounting for Stock Issued to Employees”, and subsequently issued stock option related guidance. This statement establishes standards for the accounting for transactions in which an entity exchanges its equity instruments for goods or services, primarily on accounting for transactions in which an entity obtains employee services in share-based payment transactions. It also addresses transactions in which an entity incurs liabilities in exchange for goods or services that are based on the fair value of the entity’s equity instruments or that may be settled by the issuance of those equity instruments. Entities will be required to measure the cost of employee services received in exchange for an equity award based on the grant-date fair value of the award (with limited exceptions). That cost will be recognized over the period during which an employee is required to provide service in exchange for the award (usually the vesting period). The grant-date fair value of employee share options and similar instruments will be estimated using option-pricing models. If an equity award is modified after the grant date, incremental compensation cost will be recognized in an amount equal to the excess of the fair value of the modified award over the fair value of the original award immediately before the modification.
The Company is required to apply SFAS No. 123R to all awards granted, modified or settled as of the beginning of the next annual reporting period (as amended by the Securities and Exchange Commission’s release in April 2005). The statement also requires the Company to use either the modified-prospective method or modified-retrospective method. Under the modified-prospective method, the Company must recognize compensation cost for all awards subsequent to adopting the standard and for the unvested portion of previously granted awards outstanding upon adoption. Under the modified-retrospective method, the Company must restate its previously issued financial statements to recognize the amounts it previously calculated and reported on a pro forma basis, as if the prior standard had been adopted. Under both methods, the statement permits the use of either the straight line or an accelerated method to amortize the cost as an expense for awards with graded vesting. The standard permits and encourages early adoption.
The Company has commenced its analysis of the impact of SFAS No. 123R, but has not yet decided: (1) whether to elect early adoption, (2) the early adoption date, if elected, (3) whether to use the modified-prospective or modified-retrospective method, and (4) whether to elect to use straight line or an accelerated method. Accordingly, the Company has not determined the impact that the adoption of SFAS No. 123R will have on its financial position or results of operations.
In May 2005, the FASB issued SFAS No. 154, “Accounting Changes and Error Corrections.” This statement replaces APB Opinion No. 20, “Accounting Changes,” and FASB Statement No. 3 “Reporting Accounting Changes in Interim Financial Statements.” This Statement requires retrospective application to prior periods’ financial statements of changes in accounting principle, unless it is impracticable to determine either the period-specific effects or the cumulative effect of the change. The Company does not expect the adoption of this statement to have a material impact on its financial condition or results of operations.
Advance Auto Parts, Inc. and Subsidiaries
Notes to the Condensed Consolidated Financial Statements
For the Twelve and Twenty-Eight Week Periods Ended July 16, 2005 and July 17, 2004
(in thousands, except per share data)
(unaudited)
Receivables consist of the following:
| | | | July 16, | | January 1, | |
| | | | 2005 | | 2005 | |
| | | | | | | |
| | Trade | | $ | 39,583 | | $ | 34,654 | |
| | Vendor | | | 49,575 | | | 60,097 | |
| | Installment | | | 6,434 | | | 7,506 | |
| | Other | | | 5,735 | | | 7,815 | |
| | Total receivables | | | 101,327 | | | 110,072 | |
| | Less - Allowance for doubtful accounts | | | (6,947 | ) | | (8,103 | ) |
| | Receivables, net | | $ | 94,380 | | $ | 101,969 | |
Inventories are stated at the lower of cost or market, cost being determined using the last-in, first-out ("LIFO") method for approximately 92% of inventories at both July 16, 2005 and January 1, 2005. Under the LIFO method, the Company’s cost of sales reflects the costs of the most currently purchased inventories while the inventory carrying balance represents the costs relating to prices paid in prior years. The Company’s costs to acquire inventory have been decreasing in recent years as a result of its significant growth. Accordingly, the cost to currently replace inventory is less than the LIFO balances carried for similar product. As a result of the LIFO method and the ability to obtain lower product costs, the Company recorded reductions to cost of sales of $4,237 and $4,249 for the twenty-eight weeks ended July 16, 2005 and July 17, 2004, respectively.
An actual valuation of inventory under the LIFO method can be made only at the end of each fiscal year based on the inventory levels and costs at that time. Accordingly, interim LIFO calculations must be based on management’s estimates of expected fiscal year-end inventory levels and costs.
The remaining inventories are comprised of product cores, which consist of the non-consumable portion of certain parts and batteries and are valued under the first-in, first-out ("FIFO") method. Core values are included as part of our merchandise costs and are either passed on to the customer or returned to the vendor. Additionally, these products are not subject to the frequent cost changes like our other merchandise inventory, therefore resulting in no material difference from applying either the LIFO or FIFO valuation methods.
The Company capitalizes certain purchasing and warehousing costs into inventory. Purchasing and warehousing costs included in inventory, at FIFO, at July 16, 2005, and January 1, 2005, were $86,181 and $81,458, respectively.
Advance Auto Parts, Inc. and Subsidiaries
Notes to the Condensed Consolidated Financial Statements
For the Twelve and Twenty-Eight Week Periods Ended July 16, 2005 and July 17, 2004
(in thousands, except per share data)
(unaudited)
The following table sets forth inventories at July 16, 2005, and January 1, 2005:
| | | | July 16, | | January 1, | |
| | | | 2005 | | 2005 | |
| | | | | | | |
| | Inventories at FIFO | | $ | 1,249,780 | | $ | 1,128,135 | |
| | Adjustments to state inventories at LIFO | | | 77,552 | | | 73,315 | |
| | Inventories at LIFO | | $ | 1,327,332 | | $ | 1,201,450 | |
Replacement cost approximated FIFO cost at July 16, 2005, and January 1, 2005.
Inventory quantities are tracked through a perpetual inventory system. The Company uses a cycle counting program in all distribution centers; Parts Delivered Quickly warehouses, or PDQs; Local Area Warehouses, or LAWs, and retail stores to ensure the accuracy of both merchandise and core inventory. The Company establishes reserves for estimated shrink based on historical accuracy and effectiveness of the cycle counting program. The Company also establishes reserves for potentially excess and obsolete inventories based on current inventory levels of discontinued product and the historical analysis of the liquidation of discontinued inventory below cost. The nature of the Company’s inventory is such that the risk of obsolescence is minimal and excess inventory has historically been returned to the Company’s vendors for credit. The Company provides reserves when less than full credit is expected from a vendor or when liquidating product will result in retail prices below recorded costs. The Company’s reserves against inventory for these matters were $21,836 and $21,929 at July 16, 2005, and January 1, 2005, respectively.
Long-term debt consists of the following:
| | | | | July 16, | | | January 1, | |
| | | | | 2005 | | | 2005 | |
| | Senior Debt: | | | | | | | |
| | Tranche A, Senior Secured Term Loan at variable interest | | | | | | | |
| | rates (4.88% and 3.92% at July 16, 2005 and January 1, 2005, | | | | | | | |
| | respectively), due September 2009 | | $ | 185,000 | | $ | 200,000 | |
| | Tranche B, Senior Secured Term Loan at variable interest | | | | | | | |
| | rates (5.18% and 4.17% at July 16, 2005 and January 1, 2005, | | | | | | | |
| | respectively), due September 2010 | | | 169,150 | | | 170,000 | |
| | Delayed Draw, Senior Secured Term Loan at variable interest | | | | | | | |
| | rates (5.16% and 4.22% at July 16, 2005 and January 1, 2005, | | | | | | | |
| | respectively), due September 2010 | | | 100,000 | | | 100,000 | |
| | Revolving facility at variable interest rates | | | | | | | |
| | (4.88% and 3.92% at July 16, 2005 and January 1, 2005, | | | | | | | |
| | respectively) due September 2009 | | | - | | | - | |
| | | | | 454,150 | | | 470,000 | |
| | Less: Current portion of long-term debt | | | (32,200 | ) | | (31,700 | ) |
| | Long-term debt, excluding current portion | | $ | 421,950 | | $ | 438,300 | |
Advance Auto Parts, Inc. and Subsidiaries
Notes to the Condensed Consolidated Financial Statements
For the Twelve and Twenty-Eight Week Periods Ended July 16, 2005 and July 17, 2004
(in thousands, except per share data)
(unaudited)
At July 16, 2005, the Company’s senior credit facility provided for (1) $454,150 in term loans (as detailed above) and (2) $200,000 under a revolving credit facility (which provides for the issuance of letters of credit with a sub limit of $70,000). As of July 16, 2005, the Company had $56,090 in letters of credit outstanding, which reduced availability under the revolver to $143,910. In addition to the letters of credit, the Company maintains approximately $1,607 in surety bonds issued by its insurance provider primarily to utility providers and the departments of revenue for certain states. These letters of credit and surety bonds are generally for a term of one year or less.
The interest rates on the tranche A and B term loans, the delayed draw term loan and the revolver are based, at the Company’s option, on an adjusted LIBOR rate, plus a margin, or an alternate base rate, plus a margin. The initial margin for the tranche A term loan and revolver is 1.50% and 0.50% per annum for the adjusted LIBOR and alternate base rate borrowings, respectively. The initial margin for the tranche B term loan and the delayed draw term loan is 1.75% and 0.75% per annum for the adjusted LIBOR and alternate base rate borrowings, respectively. Additionally, a commitment fee of 0.375% per annum will be charged on the unused portion of the revolver, payable in arrears.
The tranche A term loan currently requires scheduled repayments of $7,500 on September 30, 2005 and quarterly thereafter through December 31, 2006, $10,000 on March 31, 2007 and quarterly thereafter through December 31, 2007, $12,500 on March 31, 2008 and quarterly thereafter through June 30, 2009 and $25,000 due at maturity on September 30, 2009. The tranche B term loan currently requires scheduled repayments of $425 on September 30, 2005 and quarterly thereafter, with a final payment of $160,650 due at maturity on September 30, 2010. The delayed draw term loan currently requires scheduled repayments of 0.25% of the aggregate principal amount outstanding on March 31, 2006 and quarterly thereafter, with a final payment due at maturity on September 30, 2010. The revolver expires on September 30, 2009.
Under the senior credit facility, the Company is required to comply with financial covenants with respect to limits on annual capital expenditures, a maximum leverage ratio, a minimum interest coverage ratio, a minimum current assets to funded senior debt ratio and a maximum senior leverage ratio. The Company was in compliance with the above covenants under the senior credit facility at July 16, 2005.
| 5. | Stock Repurchase Program: |
During the third quarter of fiscal 2004, the Company’s Board of Directors authorized a stock repurchase program of up to $200,000 of the Company's common stock plus related expenses. The program allows the Company to repurchase its common stock on the open market or in privately negotiated transactions from time to time in accordance with the requirements of the Securities and Exchange Commission. During the twenty-eight weeks ended July 16, 2005, the Company repurchased 987 shares of common stock at an aggregate cost of $42,939, or $43.53 per share, excluding related expenses. As of July 16, 2005, the Company has repurchased a total of 4,687 shares of common stock at an aggregate cost of $189,160, or $40.36 per share, excluding related expenses. Subsequent to the second quarter, remaining amounts under this program were cancelled and replaced by a new $300,000 stock repurchase program authorized by the Company's Board of Directors.
The Company provides certain health and life insurance benefits for eligible retired team members through a postretirement plan, or the Plan. These benefits are subject to deductibles, co-payment provisions and other
Advance Auto Parts, Inc. and Subsidiaries
Notes to the Condensed Consolidated Financial Statements
For the Twelve and Twenty-Eight Week Periods Ended July 16, 2005 and July 17, 2004
(in thousands, except per share data)
(unaudited)
limitations. The Plan has no assets and is funded on a cash basis as benefits are paid. The discount rate that the Company utilizes for determining its postretirement benefit obligation is actuarially determined. The discount rate utilized at January 1, 2005 was 5.75%, and remained unchanged through the twenty-eight weeks ended July 16, 2005. The Company expects fiscal 2005 plan contributions to completely offset benefits paid, consistent with fiscal 2004.
Effective for the second quarter of 2004, the Company amended the Plan to exclude outpatient prescription drug benefits to Medicare eligible retirees effective January 1, 2006. Due to this negative plan amendment, the Company’s accumulated postretirement benefit obligation was reduced by $7,557, resulting in an unrecognized negative prior service cost in the same amount. The unrecognized negative prior service cost is being amortized over the 13-year estimated remaining life expectancy of the plan participants, as prescribed under SFAS No. 106, "Employers Accounting for Postretirement Benefits Other Than Pensions." The components of net periodic postretirement benefit cost for the twelve and twenty-eight weeks ended July 16, 2005, and July 17, 2004, respectively, are as follows:
| | | | Twelve Weeks Ended | | Twenty-Eight Weeks Ended | |
| | | | July 16, | | July 17, | | July 16, | | July 17, | |
| | | | 2005 | | 2004 | | 2005 | | 2004 | |
| | | | | | | | | | | |
| | Service cost | | $ | - | | $ | - | | $ | - | | $ | 1 | |
| | Interest cost | | | 185 | | | 195 | | | 432 | | | 613 | |
| | Amortization of unrecognized net losses | | | 55 | | | 59 | | | 128 | | | 132 | |
| | Amortization of prior service cost | | | (134 | ) | | (145 | ) | | (312 | ) | | (145 | ) |
| | | | $ | 106 | | $ | 109 | | $ | 248 | | $ | 601 | |
Subsequent to July 16, 2005, the Company completed the acquisition of substantially all the assets of Lappen Auto Supply, consisting of 19 stores in the greater Boston metro area.
Subsequent to July 16, 2005, the Company also announced that its Board of Directors:
| · | Approved a three-for-two stock split to be effected as a 50% stock dividend payable on September 23, 2005 to stockholders of record on September 9, 2005. |
| · | Authorized a new $300,000 stock repurchase program, which cancelled and replaced the Company’s prior stock repurchase program authorized in August 2004. |
The following discussion of our consolidated historical results of operations and financial condition should be read in conjunction with our unaudited condensed consolidated financial statements and the notes thereto included elsewhere in this report. Our first quarter consists of 16 weeks and our other three quarters consist of 12 weeks each.
Certain statements in this report are "forward-looking statements" within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934, which are usually identified by the use of words such as "will," "anticipates," "believes," "estimates," "expects," "projects," "forecasts," "plans," "intends," "should" or similar expressions. We intend those forward-looking statements to be covered by the safe harbor provisions for forward-looking statements contained in the Private Securities Litigation Reform Act of 1995 and are included in this statement for purposes of complying with these safe harbor provisions.
These forward-looking statements reflect current views about our plans, strategies and prospects, which are based on the information currently available and on current assumptions.
Although we believe that our plans, intentions and expectations as reflected in or suggested by those forward-looking statements are reasonable, we can give no assurance that the plans, intentions or expectations will be achieved. Listed below and discussed in our annual report on Form 10-K for the year ended January 1, 2005 are some important risks, uncertainties and contingencies which could cause our actual results, performances or achievements to be materially different from the forward-looking statements made in this report. These risks, uncertainties and contingencies include, but are not limited to, the following:
· the implementation of our business strategies and goals;
· our ability to expand our business;
· competitive pricing and other competitive pressures;
· a decrease in demand for our products;
· the occurrence of natural disasters and/or extended periods of inclement weather;
· deterioration in general economic conditions;
· our ability to attract and retain qualified team members;
· integration of any future acquisitions;
· our relationship with our vendors;
· our involvement as a defendant in litigation or incurrence of judgments, fines or legal costs; and
· adherence to the restrictions and covenants imposed under our senior credit facility.
We assume no obligation to update publicly any forward-looking statements, whether as a result of new information, future events or otherwise. In evaluating forward-looking statements, you should consider these risks and uncertainties, together with the other risks described from time to time in our other reports and documents filed with the Securities and Exchange Commission, and you should not place undue reliance on those statements.
Management Overview
During the second quarter, we experienced strong sales and gross margin improvements allowing us to leverage our selling, general and administrative costs and expand our operating margins to 11% for the first time in our history as a public company. This produced record earnings for the second quarter, which generated strong cash flow and helped us to drive a higher return on our invested capital. Our strong sales were primarily driven by a 9.0% increase in comparable store net sales for the quarter, which completed our third consecutive quarter with 9% or greater comparable store net sales. Additionally, our average net sales per store increased to over $1.5 million for the first time on an annualized basis.
We remain focused on the following four goals:
1. Raising average sales per store;
2. Expanding operating margins;
3. Generating strong free cash flow; and
4. Increasing return on invested capital.
We believe our second quarter results are also a reflection of the progress made on the following key initiatives. These initiatives, which are specifically focused on driving higher sales per store thereby leveraging our fixed expenses, are as follows:
· Improving store execution to “best in class” retail;
· Continued execution of our category management program;
· Accelerating the implementation of our 2010 store remodeling program;
· Consistent growth and execution of our commercial delivery program;
· Enhanced national advertising; and
· Our focus on making our supply chain more responsive.
In addition to the above, we have recently added the following programs, which we believe provide a more complete shopping experience for our customers. These programs include Direct Importing, Factory Direct Ordering (or FDO), Local Purchase Ordering (or LPO), and the availability of salvage parts. These programs are especially important to us as they expand the availability of our SKU offerings. The FDO, LPO, and salvage parts programs will continue to drive our sales growth without requiring additional working capital investments in inventory.
Beyond the implementation of our key business initiatives, we remain positive about our industry dynamics. The number of registered vehicles on the road today has significantly increased from ten years ago, and the average age of vehicles also continues to increase and is now over nine years old. Additionally, technological changes in newer models and the shift from cars to light trucks and sport utility vehicles have resulted in more expensive replacement parts for these vehicles. We believe the combination of our execution on key business initiatives and favorable industry dynamics will drive our earnings per share growth by 20% or more for the next several years.
The following table highlights certain operating results and key metrics for the twelve and twenty-eight weeks ended July 16, 2005, and July 17, 2004.
| | | | Twelve Weeks Ended | | Twenty-Eight Weeks Ended | |
| | | | July 16, 2005 | | July 17, 2004 | | July 16, 2005 | | July 17, 2004 | |
| | | | | | | | | | | |
| | Total net sales (in thousands) | | | $1,023,146 | | | $908,412 | | | $2,281,510 | | | $2,031,330 | |
| | Comparable store net sales growth | | | 9.0 | % | | 5.0 | % | | 9.1 | % | | 6.1 | % |
| | DIY Comparable store net sales growth | | | 4.9 | % | | 1.8 | % | | 5.0 | % | | 3.3 | % |
| | DIFM Comparable store net sales growth | | | 27.1 | % | | 22.3 | % | | 27.2 | % | | 20.6 | % |
| | Average net sales per store (in thousands) | | | $1,520 | | | $1,433 | | | $1,520 | | | $1,433 | |
| | Inventory per store (in thousands) | | | $490,152 | | | $460,537 | | | $490,152 | | | $460,537 | |
| | Inventory turnover | | | 1.69 | | | 1.72 | | | 1.69 | | | 1.72 | |
| | Gross margin | | | 47.1 | % | | 46.5 | % | | 47.5 | % | | 46.4 | % |
| | Operating margin | | | 11.0 | % | | 10.0 | % | | 10.2 | % | | 8.9 | % |
| | Note: | These metrics should be read along with the footnotes to the table setting forth our selected store data in Item 6. "Selected Financial Data" in our annual report on Form 10-K for the fiscal year ended January 1, 2005, which was filed with the SEC on March 17, 2005. The footnotes describe the calculation of the metrics. Average net sales per store and inventory turnover for the interim periods presented above were calculated using results of operations from the last 13 accounting periods. |
Recent Developments
Subsequent to our second quarter, the following recent developments have occurred:
| | · | Acquired substantially all the assets of Lappen Auto Supply, consisting of 19 stores in the greater Boston metro area. |
| | | |
| | · | Announced a three-for-two stock split to be effected in the form of a 50% stock dividend. |
| | | |
| | · | Our Board of Directors authorized a new $300 million stock repurchase program. |
Market and Store Count
We are the second largest retailer, based on store count, in the United States automotive aftermarket industry, which includes replacement parts (excluding tires), accessories, maintenance items, batteries and automotive chemicals for cars and light trucks (pick-ups, vans, minivans and sport utility vehicles). We serve both do-it-yourself, or DIY, customers and commercial customers, also referred to as do-it-for-me, or DIFM, customers.
At July 16, 2005, we operated 2,708 stores. We operated 2,673 stores throughout 40 states in the Northeastern, Southeastern and Midwestern regions of the United States. These stores operated under the “Advance Auto Parts” trade name, except for certain stores in the state of Florida, which operated under “Advance Discount Auto Parts,” or “Discount Auto Parts” trade names. In addition, we operated 35 stores primarily under the “Western Auto” trade name in Puerto Rico and the Virgin Islands. The Western Auto stores offer automotive tires and service in addition to automotive parts, accessories and maintenance items. The following table sets forth information about our stores, including the number of new, closed and relocated stores, during the twelve and twenty-eight weeks ended July 16, 2005. We lease a significant portion of our stores.
| | | | Twelve | | Twenty-Eight | |
| | | | Weeks Ended | | Weeks Ended | |
| | | | July 16, 2005 | | July 16, 2005 | |
| | Number of stores at beginning of period | | | 2,675 | | | 2,652 | |
| | New stores | | | 36 | | | 62 | |
| | Closed stores | | | (3 | ) | | (6 | ) |
| | Number of stores, end of period | | | 2,708 | | | 2,708 | |
| | Relocated stores | | | 13 | | | 32 | |
| | Stores with commercial programs | | | 2,072 | | | 2,072 | |
We anticipate adding approximately 150 to 175 new stores during 2005 primarily through new store openings and selective acquisitions, including the recent acquisition of Lappen Auto Supply.
Critical Accounting Policies
Our financial statements have been prepared in accordance with accounting policies generally accepted in the United States of America. Our discussion and analysis of the financial condition and results of operations are based on these financial statements. The preparation of these financial statements requires the application of accounting policies in addition to certain estimates and judgments by our management. Our estimates and judgments are based on currently available information, historical results and other assumptions we believe are reasonable. Actual results could differ from these estimates. During the first and second quarters of fiscal 2005, we consistently applied the critical accounting policies discussed in our annual report on Form 10-K for the year ended January 1, 2005. For a complete discussion regarding these critical accounting policies, refer to this annual report on Form 10-K.
Components of Statement of Operations
Net Sales
Net sales consist primarily of comparable store net sales, new store net sales, service sales (offered only in the Western Auto retail locations) and finance charges on installment sales. We calculate comparable store net sales based on the change in net sales starting once a store has been opened for 13 complete accounting periods. We include relocations in comparable store sales from the original date of opening. We exclude net sales from the Western Auto retail stores from our comparable store net sales as a result of their unique product offerings, including automotive service and tires.
Cost of Sales
Our cost of sales consists of merchandise costs, net of incentives under vendor programs, inventory shrinkage and warehouse and distribution expenses. Gross profit as a percentage of net sales may be affected by variations in our product mix, price changes in response to competitive factors and fluctuations in merchandise costs and vendor programs. We seek to avoid fluctuation in merchandise costs and instability of supply by entering into long-term purchase agreements with vendors when we believe it is advantageous.
Selling, General and Administrative Expenses
Selling, general and administrative expenses consist of store payroll, store occupancy (including rent), net advertising expenses, other store expenses and general and administrative expenses, including salaries and related benefits of store support center team members, store support center administrative expenses, data processing, professional expenses and other related expenses.
Results of Operations
The following table sets forth certain of our operating data expressed as a percentage of net sales for the periods indicated.
| | | Twelve Week Periods Ended | | Twenty-Eight Week Periods Ended | |
| | | (unaudited) | | (unaudited) | |
| | | July 16, | | July 17, | | July 16, | | July 17, | |
| | | 2005 | | 2004 | | 2005 | | 2004 | |
| Net sales | | | 100.0 | % | | 100.0 | % | | 100.0 | % | | 100.0 | % |
| Cost of sales, including purchasing and warehousing costs | | | 52.9 | | | 53.5 | | | 52.5 | | | 53.6 | |
| Gross profit | | | 47.1 | | | 46.5 | | | 47.5 | | | 46.4 | |
| Selling, general and administrative expenses | | | 36.1 | | | 36.5 | | | 37.3 | | | 37.5 | |
| Operating income | | | 11.0 | | | 10.0 | | | 10.2 | | | 8.9 | |
| Interest expense | | | (0.7 | ) | | (0.4 | ) | | (0.7 | ) | | (0.6 | ) |
| Loss on extinguishment of debt | | | 0.0 | | | (0.0 | ) | | 0.0 | | | (0.0 | ) |
| Other income, net | | | 0.0 | | | 0.0 | | | (0.0 | ) | | 0.0 | |
| Provision for income taxes | | | (3.9 | ) | | (3.7 | ) | | (3.6 | ) | | (3.2 | ) |
| Income from continuing operations before income (loss) on | | | | | | | | | | | | | |
| discontinued operations | | | 6.4 | | | 5.9 | | | 5.9 | | | 5.1 | |
| Discontinued operations: | | | | | | | | | | | | | |
| Income (loss) from operations of discontinued Wholesale | | | | | | | | | | | | | |
| Dealer Network | | | - | | | 0.0 | | | - | | | (0.0 | ) |
| Provision (benefit) for income taxes | | | - | | | 0.0 | | | - | | | (0.0 | ) |
| Income (loss) on discontinued operations | | | - | | | 0.0 | | | - | | | (0.0 | ) |
| Net income | | | 6.4 | % | | 5.9 | % | | 5.9 | % | | 5.1 | % |
Twelve Weeks Ended July 16, 2005 Compared to Twelve Weeks Ended July 17, 2004
Net sales for the twelve weeks ended July 16, 2005 were $1,023.1 million, an increase of $114.7 million, or 12.6%, as compared to net sales for the twelve weeks ended July 17, 2004. The net sales increase was due to an increase in comparable store sales of 9.0% and contributions from new stores opened within the last year. The comparable store sales increase resulted from an increase in average ticket sales and customer traffic in both our DIFM and DIY business. Overall, we believe the execution of the growth initiatives discussed in the Management Overview section above drove our growth in net sales.
Gross profit for the twelve weeks ended July 16, 2005 was $482.1 million, or 47.1% of net sales, as compared to $422.3 million, or 46.5% of net sales, for the twelve weeks ended July 17, 2004. The increase in gross profit as a percentage of net sales reflects continued benefits realized from our category management and supply chain initiatives.
Selling, general and administrative expenses increased to $369.5 million, or 36.1% of net sales, for the twelve weeks ended July 16, 2005, from $331.1 million, or 36.5% of net sales, for the twelve weeks ended July 17, 2004. The decrease in selling, general and administrative expenses as a percentage of sales was primarily a result of our ability to leverage our payroll costs partially offset by increased expenses from our self-insurance programs and higher fuel costs.
Interest expense for the twelve weeks ended July 16, 2005 was $7.6 million, or 0.7% of net sales, as compared to $4.5 million, or 0.4% of net sales, for the twelve weeks ended July 17, 2004. The increase in interest expense is a result of both higher average outstanding debt levels and borrowing rates, as compared to the twelve weeks ended July 17, 2004.
Income tax expense for the twelve weeks ended July 16, 2005 was $40.1 million, as compared to $33.3 million for the twelve weeks ended July 17, 2004. The increase in income tax expense primarily reflects our higher
earnings. Our effective income tax rate was 37.8% and 38.5% for the twelve weeks ended July 16, 2005 and July 17, 2004, respectively.
We produced net income of $65.9 million, or $0.90 per diluted share, for the twelve weeks ended July 16, 2005, as compared to $53.2 million, or $0.70 per diluted share, for the twelve weeks ended July 17, 2004. As a percentage of net sales, net income for the twelve weeks ended July 16, 2005 was 6.4%, as compared to 5.9% for the twelve weeks ended July 17, 2004.
Twenty-Eight Weeks Ended July 16, 2005 Compared to Twenty-Eight Weeks Ended July 17, 2004
Net sales for the twenty-eight weeks ended July 16, 2005 were $2,281.5 million, an increase of $250.2 million, or 12.3%, as compared to net sales for the twenty-eight weeks ended July 17, 2004. The net sales increase was due to an increase in comparable store sales of 9.1% and contributions from new stores opened within the last year. The comparable store sales increase resulted from an increase in average ticket sales and customer traffic in both our DIFM and DIY business. These results reflect the execution of the growth initiatives discussed in the Management Overview section above.
Gross profit for the twenty-eight weeks ended July 16, 2005 was $1,083.0 million, or 47.5% of net sales, as compared to $943.2 million, or 46.4% of net sales, for the twenty-eight weeks ended July 17, 2004. The increase in gross profit as a percentage of net sales reflects continued benefits realized from our category management and supply chain initiatives.
Selling, general and administrative expenses increased to $850.2 million, or 37.3% of net sales, for the twenty-eight weeks ended July 16, 2005, from $761.9 million, or 37.5% of net sales, for the twenty-eight weeks ended July 17, 2004. The decrease in selling, general and administrative expenses as a percentage of sales was primarily a result of our ability to leverage our payroll costs.
Interest expense for the twenty-eight weeks ended July 16, 2005 was $16.5 million, or 0.7% of net sales, as compared to $10.8 million, or 0.6% of net sales, for the twenty-eight weeks ended July 17, 2004. The increase in interest expense is a result of both higher average outstanding debt levels and borrowing rates, as compared to the twenty-eight weeks ended July 17, 2004.
Income tax expense for the twenty-eight weeks ended July 16, 2005 was $83.0 million, as compared to $65.5 million for the twenty-eight weeks ended July 17, 2004. The increase in income tax expense primarily reflects our higher earnings. Our effective income tax rate was 38.2% and 38.5% for the twenty-eight weeks ended July 16, 2005 and July 17, 2004, respectively.
We produced net income of $134.6 million, or $1.84 per diluted share, for the twenty-eight weeks ended July 16, 2005, as compared to $104.5 million, or $1.37 per diluted share, for the twenty-eight weeks ended July 17, 2004. As a percentage of net sales, net income for the twenty-eight weeks ended July 16, 2005 was 5.9%, as compared to 5.1% for the twenty-eight weeks ended July 17, 2004.
Liquidity and Capital Resources
Overview of Liquidity
Our primary cash requirements include the purchase of inventory, capital expenditures and contractual obligations. In addition, we have used available funds to repurchase shares of common stock under our stock repurchase program. We have financed these requirements primarily through a combination of cash generated from operations and borrowings under our senior credit facility.
At July 16, 2005, our cash balance was $175.9 million, an increase of $119.6 million compared to January 1, 2005. Our cash balance increased primarily due to our increased earnings during the first and second quarters of 2005, in addition to a reduction in cash used to prepay indebtedness compared to the first and second quarters of 2004. At July 16, 2005, we had outstanding indebtedness consisting of borrowings of $454.2 million under our senior credit facility. Additionally, we had $56.1 million in letters of credit outstanding, which reduced our availability under the revolving credit facility to $143.9 million.
Capital Expenditures
Our primary capital requirements have been the funding of our continued store expansion program, including new store openings and store acquisitions, store relocations and remodels, inventory requirements, the construction and upgrading of distribution centers, the development and implementation of proprietary information systems and our strategic acquisitions.
Our future capital requirements will depend in large part on the number of and timing for new stores we open or acquire within a given year and the number of stores we relocate or remodel. We anticipate adding approximately 150 to 175 new stores during 2005 primarily through new store openings, of which 62 had been added as of July 16, 2005. Subsequent to the end of our second quarter, we completed the acquisition of substantially all the assets of Lappen Auto Supply in the greater Boston metro area. This acquisition will add 19 stores and result in the total addition of new stores during 2005 at the higher end of our previously disclosed range of 150 to 175 new stores.
Our capital expenditures were $119.8 million for the twenty-eight weeks ended July 16, 2005. These amounts included costs of $4.9 million for the completion of our Northeastern distribution center and additional amounts related to new store openings, tenant improvements, the upgrade of our information systems and remodels and relocations of existing stores, including the physical conversion of the stores acquired in the Discount acquisition to our Advance Auto Parts store format. In 2005, we anticipate that our capital expenditures will be approximately $200.0 million to $220.0 million, including the recent acquisition of Lappen Auto Supply.
Vendor Financing Program
Historically, we have negotiated extended payment terms from suppliers that help finance inventory growth, and we believe that we will be able to continue financing much of our inventory growth through such extended payment terms. During the first quarter of fiscal 2004, we entered into a short-term financing program with a bank for certain merchandise purchases. The substance of the program is for us to borrow money from the bank to finance purchases from our vendors. At July 16, 2005, $120.8 million was payable to the bank by us under this program. This program allows us to further reduce our working capital invested in current inventory levels and finance future inventory growth. Additionally, during the second quarter, our capacity under this program increased to $150 million.
Stock Repurchase Program
In August 2004, our Board of Directors approved a stock repurchase program authorizing the repurchase of up to $200.0 million of our common stock plus related expenses. As of July 16, 2005, we had repurchased a total of 4.7 million shares of common stock at an aggregate cost of $189.2 million, or $40.36 per share, excluding related expenses. Subsequent to the end of the second quarter, our Board of Directors authorized a new stock repurchase program of up to $300.0 million, which cancelled and replaced the $200.0 million program.
Deferred Compensation and Postretirement Plans
We maintain an unqualified deferred compensation plan established for certain of our key team members. This plan provides for a minimum and maximum deferral percentage of the team member base salary and bonus, as determined by our Retirement Plan Committee. We fund the plan liability by remitting the team members’ deferral to a Rabbi Trust where these deferrals are invested in trading securities. Accordingly, all gains and losses on these
underlying investments are held in the Rabbi Trust to fund the deferred compensation liability. At July 16, 2005, the liability related to this plan was $2.3 million, all of which is current.
We provide certain health care and life insurance benefits for eligible retired team members through our postretirement plan. At July 16, 2005, our accrued benefit cost related to this plan was $16.9 million. The plan has no assets and is funded on a cash basis as benefits are paid/incurred. The discount rate that we utilize for determining our postretirement benefit obligation is actuarially determined. The discount rate utilized at January 1, 2005 was 5.75%, and remained unchanged through the twenty-eight weeks ended July 16, 2005. We reserve the right to change or terminate the benefits or contributions at any time. We also continue to evaluate ways in which we can better manage these benefits and control costs. Any changes in the plan or revisions to assumptions that affect the amount of expected future benefits may have a significant impact on the amount of the reported obligation and annual expense. Effective second quarter of 2004, we amended the plan to exclude outpatient prescription drug benefits to Medicare eligible retirees effective January 1, 2006. Due to this negative plan amendment, our accumulated postretirement benefit obligation was reduced by $7.6 million, resulting in an unrecognized negative prior service cost in the same amount. The unrecognized negative prior service cost is being amortized over the 13-year estimated remaining life expectancy of the plan participants.
Analysis of Cash Flows
| | Twenty-Eight Week Periods Ended | |
| | | July 16, | | July 17, | |
| | | 2005 | | 2004 | |
| | | | | | |
| Cash flows from operating activities | | $ | 191.0 | | $ | 163.7 | |
| Cash flows from investing activities | | | (116.9 | ) | | (81.6 | ) |
| Cash flows from financing activities | | | 45.5 | | | (73.8 | ) |
| Net increase in cash and | | | | | | | |
| cash equivalents | | $ | 119.6 | | $ | 8.3 | |
Operating Activities
For the twenty-eight weeks ended July 16, 2005, net cash provided by operating activities increased $27.3 million to $191.0 million, as compared to the twenty-eight weeks ended July 17, 2004. Significant components of this increase consisted of:
| | · | $30.1 million increase in earnings compared to the same period in fiscal 2004; |
| | · | $22.1 million of additional cash generated from the collection of receivables; |
| | · | $50.1 million reduction of cash as a result of an increase in inventory driven by the build-up for our Northeast distribution center opened earlier in 2005 and expansion of the number of stores which carry an extended mix of parts; |
| | · | $22.3 million increase in accrued expenses related to the timing of normal operating expenses. |
Investing Activities
For the twenty-eight weeks ended July 16, 2005, net cash used in investing activities increased by $35.3 million to $116.9 million, as compared to the twenty-eight weeks ended July 17, 2004. The primary increase in net cash used in investing activities relates to an increase in capital expenditures of $32.7 million. Significant components of this net increase consisted of:
| | · | an additional $39.0 million of cash used to accelerate our square footage growth through new stores (including ownership of selected new stores), the acquisition of certain leased stores and an increase in store relocations during the twenty-eight weeks ended. |
| | · | offset by a reduction of $15.2 million of cash invested in our supply chain primarily due to the initial purchase of our Northeast distribution center during the second quarter of fiscal 2004. |
Financing Activities
For the twenty-eight weeks ended July 16, 2005, net cash provided by financing activities increased by $119.3 million to $45.5 million, as compared to the twenty-eight weeks ended July 17, 2004. Significant components of this increase consisted of:
| | · | $43.0 million used to repurchase shares of common stock under our stock repurchase program during the twenty-eight weeks ended July 16, 2005; |
| | · | a $25.0 million cash inflow resulting from timing in bank overdrafts; and |
| | · | a $23.7 million cash inflow associated with inventory purchased under our vendor financing program. |
| | · | offset by a $105.0 million reduction in cash used to prepay debt during the twenty-eight weeks ended July 16, 2005. |
Contractual Obligations
Our future contractual obligations, primarily related to long-term debt and operating leases, at July 16, 2005 were as follows:
Contractual Obligations at | | | | Fiscal | | Fiscal | | Fiscal | | Fiscal | | Fiscal | | | |
July 16, 2005 | | Total | | 2005 | | 2006 | | 2007 | | 2008 | | 2009 | | Thereafter | |
(in thousands) | | | | | | | | | | | | | | | |
| Long-term debt | | $ | 454,150 | | $ | 15,850 | | $ | 32,700 | | $ | 32,025 | | $ | 63,375 | | $ | 52,700 | | $ | 257,500 | |
| Interest payments | | $ | 105,573 | | $ | 11,467 | | $ | 24,668 | | $ | 23,314 | | $ | 20,697 | | $ | 17,400 | | $ | 8,027 | |
| Letters of credit | | $ | 56,090 | | $ | 5,379 | | $ | 50,711 | | $ | - | | $ | - | | $ | - | | $ | - | |
| Operating leases | | $ | 1,431,701 | | $ | 81,750 | | $ | 187,052 | | $ | 166,526 | | $ | 149,273 | | $ | 129,282 | | $ | 717,818 | |
Purchase obligations (1) | | $ | 903 | | $ | 739 | | $ | 164 | | $ | - | | $ | - | | $ | - | | $ | - | |
Other long-term liabilities(2) | | $ | 75,899 | | $ | - | | $ | - | | $ | - | | $ | - | | $ | - | | $ | - | |
| | (1) | For the purposes of this table, contractual obligations are defined as agreements that are enforceable and legally binding and that specify all significant terms, including: fixed or minimum quantities to be purchased; fixed, minimum or variable price provisions; and the approximate timing of the transaction. Our open purchase orders are based on current inventory or operational needs and are fulfilled by our vendors within short periods of time. We currently do not have minimum purchase commitments under our vendor supply agreements nor are our open purchase orders for goods and services binding agreements. Accordingly, we have excluded open purchase orders from the above table. The above purchase obligations represent the monthly amount of fuel required to be purchased by us under our fixed price fuel supply agreement. The agreement, which was entered into in February 2005, expires in January 2006. |
| | (2) | Primarily includes employee benefit accruals, restructuring and closed store liabilities and deferred income taxes for which no contractual payment schedule exists. |
Long Term Debt
Senior Credit Facility. At July 16, 2005, our senior credit facility consisted of (1) a tranche A term loan facility with a balance of $185.0 million, a tranche B term loan facility with a balance of $169.2 million, a delayed draw term loan with a balance of $100.0 million and (2) a $200.0 million revolving credit facility (including a letter of credit sub facility) (of which $143.9 million was available as a result of $56.1 million in letters of credit outstanding). The senior credit facility is jointly and severally guaranteed by all of our domestic subsidiaries and is secured by substantially all of our assets and the assets of our existing and future domestic subsidiaries.
The tranche A term loan currently requires scheduled repayments of $7.5 million on September 30, 2005 and quarterly thereafter through December 31, 2006, $10.0 million on March 31, 2007 and quarterly thereafter through December 31, 2007, $12.5 million on March 31, 2008 and quarterly thereafter through June 30, 2009 and $25.0 million due at maturity on September 30, 2009. The tranche B term loan currently requires scheduled repayments of $0.4 million on September 30, 2005 and quarterly thereafter, with a final payment of $160.7 million
due at maturity on September 30, 2010. The delayed draw term loan currently requires scheduled repayments of 0.25% of the aggregate principal amount outstanding on March 31, 2006 and quarterly thereafter, with a final payment due at maturity on September 30, 2010. The revolver expires on September 30, 2009.
The interest rates on the tranche A and B term loans, the delayed draw term loan and the revolver are based, at our option, on an adjusted LIBOR rate, plus a margin, or an alternate base rate, plus a margin. The initial margin for the tranche A term loan and revolver is 1.50% and 0.50% per annum for the adjusted LIBOR and alternate base rate borrowings, respectively. The initial margin for the tranche B term loan and the delayed draw term loan is 1.75% and 0.75% per annum for the adjusted LIBOR and alternate base rate borrowings, respectively. Additionally, a commitment fee of 0.375% per annum will be charged on the unused portion of the revolver, payable in arrears.
We are required to comply with financial covenants in the senior credit facility with respect to (a) limits on annual aggregate capital expenditures, (b) a maximum leverage ratio, (c) a minimum interest coverage ratio, (d) a ratio of current assets to funded senior debt and (e) a maximum senior leverage ratio. We were in compliance with the above covenants under the senior credit facility at July 16, 2005. For additional information regarding our senior credit facility, refer to our annual report on Form 10-K for the fiscal year ended January 1, 2005.
In March 2005 we entered into three interest rate swap agreements on an aggregate of $175 million of debt under our senior credit facility. The first swap allows us to fix our LIBOR rate at 4.153% on $50 million of debt for a term of 48 months, expiring March 2009. The second swap allows us fix our LIBOR rate at 4.255% on $75 million of debt for a term of 60 months, expiring February 2010. In March 2006, the third swap will allow us to fix our LIBOR rate at 4.6125% on $50 million of debt for a term of 54 months, expiring August 2010.
Credit Ratings
At July 16, 2005, we had a credit rating on our senior credit facility from Standard & Poor’s of BB+ and a credit rating of Ba2 from Moody’s Investors Service. The current pricing grid used to determine our borrowing rates under our senior credit facility is based on such credit ratings. If these credit ratings decline, our interest expense may increase. Conversely, if these credit ratings increase, our interest expense may decrease. Any adverse change to our credit risk would be partially mitigated by our outstanding interest rate swaps as discussed in market risk.
Seasonality
Our business is somewhat seasonal in nature, with the highest sales occurring in the spring and summer months. In addition, our business can be affected by weather conditions. While unusually heavy precipitation tends to soften sales as elective maintenance is deferred during such periods, extremely hot and cold weather tends to enhance sales by causing parts to fail.
New Accounting Pronouncements
In November 2004, the FASB issued SFAS No. 151, "Inventory Costs". The new statement amends Accounting Research Bulletin No. 43, Chapter 4, "Inventory Pricing," to clarify the accounting for abnormal amounts of idle facility expense, freight, handling costs and wasted material. This statement requires that those items be recognized as current-period charges and requires that allocation of fixed production overhead to the cost of conversion be based on the normal capacity of the production facilities. This statement is effective for fiscal years beginning after June 15, 2005. We do not expect the adoption of this statement to have a material impact on our financial condition or results of operations.
In December 2004, the FASB issued SFAS No. 123 (revised 2004), “Share-Based Payment”, or SFAS No. 123R. SFAS No. 123R replaces SFAS No. 123, “Accounting for Stock-Based Compensation” and supersedes APB Opinion No. 25, “Accounting for Stock Issued to Employees”, and subsequently issued stock option related guidance. This statement establishes standards for the accounting for transactions in which an entity exchanges its equity instruments for goods or services, primarily on accounting for transactions in which an entity obtains employee services in share-based payment transactions. It also addresses transactions in which an entity incurs
liabilities in exchange for goods or services that are based on the fair value of the entity’s equity instruments or that may be settled by the issuance of those equity instruments. Entities will be required to measure the cost of employee services received in exchange for an equity award based on the grant-date fair value of the award (with limited exceptions). That cost will be recognized over the period during which an employee is required to provide service in exchange for the award (usually the vesting period). The grant-date fair value of employee share options and similar instruments will be estimated using option-pricing models. If an equity award is modified after the grant date, incremental compensation cost will be recognized in an amount equal to the excess of the fair value of the modified award over the fair value of the original award immediately before the modification.
We are required to apply SFAS No. 123R to all awards granted, modified or settled as of the beginning of our next annual reporting period (as amended by the Securities and Exchange Commission’s release in April 2005). The statement requires us to use either the modified-prospective method or modified-retrospective method. Under the modified-prospective method, we must recognize compensation cost for all awards subsequent to adopting the standard and for the unvested portion of previously granted awards outstanding upon adoption. Under the modified-retrospective method, we must restate our previously issued financial statements to recognize the amounts we previously calculated and reported on a pro forma basis, as if the prior standard had been adopted. Under both methods, the statement permits the use of either the straight line or an accelerated method to amortize the cost as an expense for awards with graded vesting. The standard permits and encourages early adoption.
We have commenced our analysis of the impact of SFAS No. 123R, but have not yet decided: (1) whether to elect early adoption, (2) the early adoption date, if elected, (3) whether to use the modified-prospective or modified-retrospective method, and (4) whether to elect to use straight line or an accelerated method. Accordingly, we have not determined the impact that the adoption of SFAS No. 123R will have on our financial position or results of operations.
In May 2005, the FASB issued SFAS No. 154, “Accounting Changes and Error Corrections.” This statement replaces APB Opinion No. 20, “Accounting Changes,” and FASB Statement No. 3 “Reporting Accounting Changes in Interim Financial Statements.” This Statement requires retrospective application to prior periods’ financial statements of changes in accounting principle, unless it is impracticable to determine either the period-specific effects or the cumulative effect of the change. We do not expect the adoption of this statement to have a material impact on our financial condition or results of operations.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
We are exposed to cash flow risk due to changes in interest rates with respect to our long-term debt. Our long-term debt currently consists of borrowings under our senior credit facility and is primarily vulnerable to movements in the LIBOR rate. While we cannot predict the impact interest rate movements will have on our debt, exposure to rate changes is managed through the use of hedging activities.
Our future exposure to interest rate risk decreased during the twenty-eight weeks ended July 16, 2005 as a result of entering into three new interest rate swap agreements in March 2005 on an aggregate of $175 million of debt under our senior credit facility. The first swap allows us to fix our LIBOR rate at 4.153% on $50 million of debt for a term of 48 months, expiring March 2009. The second swap allows us to fix our LIBOR rate at 4.255% on $75 million of debt for a term of 60 months, expiring February 2010. Beginning in March 2006, the third swap will allow us to fix our LIBOR rate at 4.6125% on $50 million of debt for a term of 54 months, expiring August 2010.
In March 2003, we entered into two interest rate swap agreements on an aggregate of $125 million of our variable rate debt under our senior credit facility. The first swap allows us to fix our LIBOR rate at 2.269% on $75 million of variable rate debt for a term of 36 months, expiring first quarter fiscal 2006. The second swap, which allowed us to fix our LIBOR rate at 1.79% on $50 million of variable rate debt, expired in March 2005.
The table below presents principal cash flows and related weighted average interest rates on our long-term debt outstanding at July 16, 2005, by expected maturity dates. Additionally, the table includes the notional amounts of our debt hedged and the impact of the anticipated average pay and receive rates of our interest rate swaps through their maturity dates. Expected maturity dates approximate contract terms. Weighted average variable rates are base on implied forward rates in the yield curve at July 16, 2005, as adjusted by the limitations of the swap agreement. Implied forward rates should not be considered a predictor of actual future interest rates.
| | | | | | | | | | | | | | | | | Fair | |
| | | Fiscal | | Fiscal | | Fiscal | | Fiscal | | Fiscal | | | | | | Market | |
| | | 2005 | | 2006 | | 2007 | | 2008 | | 2009 | | Thereafter | | Total | | Value | |
| Long-term debt: | | (dollars in thousands) |
| | | | | | | | | | | | | | | | | | |
| Variable rate | | $ | 15,850 | | $ | 32,700 | | $ | 32,025 | | $ | 63,375 | | $ | 52,700 | | $ | 257,500 | | $ | 454,150 | | $ | 454,150 | |
| Weighted average | | | | | | | | | | | | | | | | | | | | | | | | | |
| interest rate | | | 5.4 | % | | 5.9 | % | | 6.0 | % | | 6.1 | % | | 6.2 | % | | 6.3 | % | | 5.9 | % | | - | |
| | | | | | | | | | | | | | | | | | | | | | | | | | |
| Interest rate swaps: | | | | | | | | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | | | |
Variable to fixed (1) | | $ | 200,000 | | $ | 250,000 | | $ | 175,000 | | $ | 175,000 | | $ | 175,000 | | $ | 125,000 | | | - | | $ | 648 | |
| Weighted average pay rate | | | 0.4 | % | | 0.2 | % | | 0.3 | % | | 0.2 | % | | 0.1 | % | | 0.1 | % | | 0.2 | % | | - | |
| Weighted average receive rate | | | 1.5 | % | | 0.2 | % | | 0.1 | % | | 0.2 | % | | 0.2 | % | | 0.3 | % | | 0.4 | % | | - | |
(1) Amounts presented may not be outstanding for the entire year.
Our management evaluated, with the participation of our principal executive officer and principal financial officer, the effectiveness of our disclosure controls and procedures as of the end of the period covered by this report. Based on this evaluation, our principal executive officer and our principal financial officer have concluded that, as of the end of the period covered by this report, our disclosure controls and procedures were effective. Disclosure controls and procedures mean our controls and other procedures that are designed to ensure that information required to be disclosed by us in our reports that we file or submit under the Securities Exchange Act of 1934 is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by us in our reports that we file or submit under the Securities Exchange Act of 1934 is accumulated and communicated to our management, including our principal executive officer and principal financial officer, as appropriate to allow timely decisions regarding required disclosure.
There have been no changes in our internal control over financial reporting that occurred during the quarter ended July 16, 2005 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.
PART II. OTHER INFORMATION
| | | SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS |
| | | | |
| | (a) | | We held our annual meeting of stockholders on May 18, 2005. |
| | | | |
| | (b) | | Not applicable. |
| | | | |
| | (c) | | The following matters were submitted to the vote of security holders at the annual meeting: |
| | | | 1. | Election of nominees to our board of directors. All nominees were elected as indicated by the following vote counts: |
| | | | | | | | | Votes | | |
| | | | | Nominee | | Votes For | | Withheld | | |
| | | | | | | | | | | |
| | | | | John C. Brouillard | | | 68,562,932 | | | 455,112 | | |
| | | | | Lawrence P. Castellani | | | 68,196,485 | | | 821,559 | | |
| | | | | Michael N. Coppola | | | 68,559,630 | | | 458,414 | | |
| | | | | Darren R. Jackson | | | 68,517,575 | | | 500,469 | | |
| | | | | William S. Oglesby | | | 68,517,679 | | | 500,365 | | |
| | | | | Gilbert T. Ray | | | 68,527,804 | | | 490,240 | | |
| | | | | Carlos A. Saladrigas | | | 68,562,294 | | | 455,750 | | |
| | | | | William J. Salter | | | 68,563,030 | | | 455,014 | | |
| | | | | Francesca Spinelli, Ph.D. | | | 68,562,988 | | | 455,056 | | |
| | | | | Nicholas F. Taubman | | | 64,736,877 | | | 4,272,667 | | |
| | | | 2. | The stockholders voted upon and approved the ratification of Deloitte & Touche LLP as our independent registered public accounting firm for 2005. The vote on the proposal was as follows: |
| | For | | Against | | Abstentions | | Broker Non-Votes | | |
| | | | | | | | | | |
| | 68,952,621 | | | 48,969 | | | 7,954 | | | 2,544,753 | | |
| | | | 3. | The stockholders voted upon and defeated a stockholder proposal requesting us to amend our employment opportunity policy. The vote on the proposal was as follows: |
| | For | | Against | | Abstentions | | Broker Non-Votes | | |
| | | | | | | | | | |
| | 18,552,210 | | | 31,496,517 | | | 9,024,359 | | | 12,481,211 | | |
ITEM 6. | | | EXHIBITS | |
| | | | | |
| | | | 3.1(1) | Restated Certificate of Incorporation of Advance Auto Parts, Inc. (“Advance Auto”) (as amended on May 19, 2004). |
| | | | | |
| | | | 3.2(2) | Bylaws of Advance Auto. |
| | | | | |
| | | | 10.43(3)* | Summary of Compensation Arrangements for Messrs. Coppola, Castellani, Wade and Oreson. |
| | | | | |
| | | | 31.1 | |
| | | | | |
| | | | 31.2 | |
| | | | | |
| | | | 32.1 | |
| | | | (*) | Management contract or compensatory plan or arrangement required to be filed as an exhibit to this report. |
| | | | | |
| | | | (1) | Filed on August 16, 2004 as an exhibit to the Quarterly Report on Form 10-Q of Advance Auto. |
| | | | | |
| | | | (2) | Filed on August 31, 2001 as an exhibit to Registration Statement on Form S-4 (No. 333-68858) of Advance Auto. |
| | | | | |
| | | | (3) | Filed on May 24, 2005 as an exhibit to Current Report on Form 8-K of Advance Auto. |
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
| | | |
| | ADVANCE AUTO PARTS, INC. |
|
|
|
| August 15, 2005 | By: | /s/ Jeffrey T. Gray |
| |
Jeffrey T. Gray Executive Vice President and Chief Financial Officer |
EXHIBIT INDEX
| Exhibit | | |
Number | | Exhibit Description |
| | | |
| 3.1(1) | | Restated Certificate of Incorporation of Advance Auto (as amended on May |
| | | 19, 2004). |
| | | |
| 3.2(2) | | Bylaws of Advance Auto. |
| | | |
| 10.43(3)* | | Summary of Compensation Arrangements for Messrs. Coppola, Castellani, Wade and Oreson. |
| | | |
| | |
| | | |
| | | |
| | |
| | | |
| | | |
| | |
| | | |
| | | |
| (*) Management contract or compensatory plan or arrangement required to be file as an exhibit to this report. |
| (1) Filed on August 16, 2004 as an exhibit to the Quarterly Report on Form 10-Q of Advance Auto. |
(2) Filed on August 31, 2001 as an exhibit to Registration Statement on Form S-4 (No. 333-68858) of Advance Auto. |
| (3) Filed on May 24, 2005 as an exhibit to Current Report on Form 8-K of Advance Auto. |
