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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Form 10-Q
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended October 10, 1998
OR
[_] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the quarterly period from __________ to __________
Commission file number - 333-56031
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ADVANCE HOLDING CORPORATION
(Exact name of registrant as specified in its charter)
------------------------
Virginia 54-1622754
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
5673 Airport Road 24012
Roanoke, Virginia (Zip Code)
(Address of Principal Executive Offices)
(540) 362-4911
(Registrant's telephone number, including area code)
Not Applicable
(Former name, former address and former fiscal year, if changed
since last report).
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.
Yes [_] No [_] (Not applicable at this time)
APPLICABLE ONLY TO ISSUERS INVOLVED IN BANKRUPTCY
PROCEEDINGS DURING THE PRECEDING FIVE YEARS:
Indicate by check mark whether the registrant has filed all documents
and reports required to be filed by Sections 12, 13, or 15(d) of the Securities
Exchange Act of 1934 subsequent to the distribution of securities under a plan
confirmed by a court.
Yes [_] No [_]
The number of shares of Class A Common Stock, par value $.01 per share,
outstanding was 12,603,800 as of October 31, 1998. There were no outstanding
shares of Class B Common Stock, par value $.01 per share, as of October 31,
1998.
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ADVANCE HOLDING CORPORATION AND SUBSIDIARIES
Twelve Weeks Ended October 10, 1998
TABLE OF CONTENTS
Page
----
PART I. FINANCIAL INFORMATION
Item 1. Condensed Consolidated Financial Statements of Advance Holding Corporation
and Subsidiaries (Unaudited)
Condensed Consolidated Balance Sheets as of October 10, 1998 and
January 3, 1998 ........................................................................ 1
Condensed Consolidated Statements of Income for the Twelve Weeks
Ended October 10, 1998 and October 4, 1997 and for the Forty
Weeks Ended October 10, 1998 and October 4, 1997........................................ 2
Condensed Consolidated Statements of Cash Flows for the
Forty Weeks Ended October 10, 1998 and October 4, 1997.................................. 3
Notes to Unaudited Condensed Consolidated Financial Statements.......................... 5
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations................................................................... 14
Item 3. Quantitative and Qualitative Disclosures About Market Risks............................. 20
PART II. OTHER INFORMATION
Item 1. Legal Proceedings....................................................................... 21
Item 2. Changes in Securities and Use of Proceeds............................................... 21
Item 3. Defaults Upon Senior Securities......................................................... 21
Item 4. Submission of Matters to a Vote of Security Holders..................................... 21
Item 5. Other Information....................................................................... 21
Item 6. Exhibits and Reports on Form 8-K........................................................ 21
SIGNATURE................................................................................................... S-1
i
ADVANCE HOLDING CORPORATION AND SUBSIDIARIES
Condensed Consolidated Balance Sheets -- October 10, 1998 and January 3, 1998
(dollars in thousands)
OCTOBER 10, JANUARY 3,
ASSETS 1998 1998
-------------- ---------------
(UNAUDITED)
CURRENT ASSETS:
Cash and cash equivalents...................................................... $ 38,408 15,463
Marketable securities.......................................................... -- 2,025
Receivables, primarily from vendors............................................ 23,590 19,108
Trade receivables.............................................................. 5,672 3,359
Inventories.................................................................... 363,113 280,267
Prepaid expenses and other current assets...................................... 9,603 2,895
Refundable income taxes........................................................ 220 1,765
---------- ---------
Total current assets........................................................ 440,606 324,882
Property and equipment, net of accumulated amortization and depreciation of
$96,260 and $77,940............................................................ 146,881 134,896
Other assets, net of accumulated amortization of $1,254 and $0.................... 22,330 2,054
---------- ---------
$ 609,817 $ 461,832
========== =========
LIABILITIES AND STOCKHOLDERS' (DEFICIT) EQUITY
CURRENT LIABILITIES:
Bank overdrafts................................................................ $ -- $ 6,970
Borrowings secured by trade receivables........................................ 5,672 3,359
Notes payable and current portion of long-term debt............................ -- 3,959
Current portion of deferred revenue............................................ 2,256 1,530
Accounts payable............................................................... 217,415 157,096
Accrued expenses............................................................... 62,270 27,718
Deferred income taxes.......................................................... 2,909 3,110
---------- ---------
Total current liabilities................................................... 290,522 203,742
---------- ---------
Long-term debt.................................................................... 398,796 100,167
---------- ---------
Deferred revenue.................................................................. 1,638 693
---------- ---------
Deferred income taxes............................................................. 12,986 12,839
---------- ---------
Post-retirement benefits.......................................................... 1,198 843
---------- ---------
STOCKHOLDERS' (DEFICIT) EQUITY:
8% noncumulative, nonvoting preferred stock, $10 par value, redeemable by the
Company at par; liquidation value at par; 100,000 shares authorized;
77,300 shares issued and outstanding at January 3, 1998..................... -- 773
Common stock, Class A, voting, $.01 par value; 62,500,000 shares authorized;
12,603,800 and 2,412,500 issued and outstanding............................. 126 19
Common stock, Class B, nonvoting, $.01 par value; 437,500,000 shares
authorized; 0 and 21,875,000 shares issued and outstanding.................. -- 175
Additional paid-in capital..................................................... 107,654 --
Stockholder subscription receivables........................................... (2,528) --
Outstanding stock options...................................................... 3,731 --
Unamortized stock option compensation.......................................... (3,188) --
(Accumulated deficit) retained earnings........................................ (201,118) 142,581
---------- ---------
Total stockholders' (deficit) equity........................................ (95,323) 143,548
---------- ---------
$ 609,817 $ 461,832
========== =========
1
ADVANCE HOLDING CORPORATION AND SUBSIDIARIES
Condensed Consolidated Statements of Income
For the Twelve and Forty Week Periods Ended October 10, 1998 and October 4, 1997
(dollars in thousands)
(Unaudited)
Twelve Week Period Ended Forty Week Period Ended
------------------------- ---------------------------
October 10, October 4, October 10, October 4,
1998 1997 1998 1997
----------- ------------ ------------ -------------
Net sales............................................ $ 258,839 $ 206,409 $ 802,839 $ 642,289
Cost of sales........................................ 160,464 128,692 493,289 396,890
----------- ------------ ------------ -------------
Gross profit................................... 98,375 77,717 309,550 245,399
Selling, general, and administrative expenses........ 81,205 67,406 260,017 212,884
Expenses associated with recapitalization............ 225 -- 14,230 --
----------- ------------ ------------ -------------
Operating income............................... 16,945 10,311 35,303 32,515
----------- ------------ ------------ -------------
Other income (expense):
Interest expense.................................. (10,116) (1,190) (23,675) (4,653)
Other............................................. 543 (94) 860 (297)
----------- ------------ ------------ -------------
Total other expense, net....................... (9,573) (1,284) (22,815) (4,950)
----------- ------------ ------------ -------------
Income before income taxes........................... 7,372 9,027 12,488 27,565
Income tax expense................................... 3,279 3,692 5,822 11,275
----------- ------------ ------------ -------------
Net income........................................... $ 4,093 $ 5,335 $ 6,666 $ 16,290
=========== ============ ============ =============
2
ADVANCE HOLDING CORPORATION AND SUBSIDIARIES
Condensed Consolidated Statements of Cash Flows
For the Forty Week Periods Ended October 10, 1998 and October 4, 1997
(dollars in thousands)
(Unaudited)
Forty Week Period Ended
-----------------------------------
October 10, 1998 October 4, 1997
---------------- ---------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income............................................................... $ 6,666 $ 16,290
Adjustments to reconcile net income to net cash provided by operating
activities:
Depreciation and amortization of property and equipment............... 19,993 16,328
Loss on sale of property and equipment................................ 100 275
Amortization of deferred debt issuance costs.......................... 1,399 --
Amortization of bond discount......................................... 3,779 --
Amortization of stock option compensation............................. 243 --
(Benefit from) provision for deferred income taxes.................... (54) 1,647
Net periodic postretirement benefit expense, net of payments made..... 355 307
Sales (purchases) of marketable securities............................ 2,025 (137)
Net (increase) decrease in:
Receivables, primarily from vendors................................. (4,482) 1,937
Trade receivables................................................... (2,313) --
Inventories......................................................... (82,846) (40,617)
Prepaid expenses and other assets................................... (7,429) (2,847)
Refundable income taxes............................................. 1,545 --
Net increase in:
Accounts payable.................................................... 60,319 35,909
Accrued expenses.................................................... 33,213 12,655
---------- -----------
Net cash provided by operating activities........................ 32,513 41,747
---------- -----------
CASH FLOW FROM INVESTING ACTIVITIES:
Purchases of property and equipment...................................... (36,234) (29,749)
Proceeds from sale of property and equipment............................. 4,156 132
---------- -----------
Net cash used in investing activities............................ (32,078) (29,617)
---------- -----------
CASH FLOWS FROM FINANCING ACTIVITIES:
Decrease in bank overdrafts.............................................. (6,970) (2,461)
Net repayments under notes payable....................................... (2,959) (299)
Proceeds from issuance of long-term debt................................. 11,500 35,500
Payments on long-term debt............................................... (102,667) (44,833)
Borrowings under new credit facilities................................... 385,017 --
Payment of debt issuance costs........................................... (20,297) --
Proceeds from issuance of Class A Common Stock........................... 105,148 --
Payment for redemption of preferred and common stock..................... (351,000) --
Continued on following page
3
Forty Week Period Ended
-----------------------------------
October 10, 1998 October 4, 1997
---------------- ---------------
Other.................................................................... 4,738 (4)
---------- -----------
Net cash provided by (used in) financing activities.............. 22,510 (12,097)
---------- -----------
Net increase in cash and cash equivalents.................................. 22,945 33
Cash and cash equivalents at beginning of period........................... 15,463 14,833
---------- -----------
Cash and cash equivalents at end of period................................. $ 38,408 $ 14,866
========== ===========
Supplemental cash flow information:
Interest paid............................................................ $ 10,118 $ 4,495
========== ===========
Income taxes paid, net of refunds received............................... $ 2,850 $ 8,666
========== ===========
NON-CASH TRANSACTIONS:
Debt issuance and acquisition costs accrued at October 10, 1998.......... $ 1,339 $ --
========== ===========
Loans receivable related to issuance of common stock..................... $ 2,528 $ --
========== ===========
Stock options issued for redemption of stock............................. $ 300 $ --
========== ===========
4
Advance Holding Corporation and Subsidiaries
Notes to Unaudited Condensed Consolidated Financial Statements
Twelve and Forty Week Periods Ended October 10, 1998 and October 4,1997
(dollars in thousands, except per share data)
(unaudited)
1. Basis of Presentation:
The accompanying unaudited condensed consolidated financial statements
include the accounts of Advance Holding Corporation and its wholly owned
subsidiaries (the Company). All significant intercompany balances and
transactions have been eliminated in consolidation.
The condensed consolidated balance sheet as of October 10, 1998, and the
condensed consolidated statements of income for the 12-week and 40-week periods
ended October 10, 1998 and October 4, 1997, and the statements of cash flows for
the 40-week periods ended October 10, 1998 and October 4, 1997 have been
prepared by the Company and have not been audited. 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 disclosure normally included in financial
statements prepared in accordance with generally accepted accounting principles
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 3,
1998.
The results of operations for the 12-week and 40-week periods are not
necessarily indicative of the operating results to be expected for the full
fiscal year.
2. Inventories:
Inventories are stated at the lower of cost or market using the last-in,
first-out (LIFO) method. An actual valuation of inventory under the LIFO method
can be made only at the end of each year based on the inventory levels and costs
at that time. Accordingly, interim LIFO calculations must necessarily be based
on management's estimates of expected year-end inventory levels and costs.
Inventories consist of the following:
October 10, January 3,
1998 1998
----------- -----------
Replacement cost.......................... $ 360,763 $ 280,267
Reserve to state inventories at LIFO...... 5,374 2,274
----------- -----------
Inventories at LIFO....................... 366,137 282,541
Other reserves............................ (3,024) (2,274)
----------- -----------
$ 363,113 $ 280,267
=========== ===========
As of October 10, 1998 and January 3, 1998 replacement cost approximates
cost using the first-in, first-out (FIFO) method.
3. Other Assets:
As of October 10, 1998, other assets include deferred debt issuance costs
of $20,286. Such costs are being amortized over the term of the related debt (6
to 11 years). Other assets also include certain transaction costs of $1,235
relating to the acquisition (Note 12).
5
4. Stock Options:
The Company has elected to follow Accounting Principles Board Opinion No.
25, "Accounting for Stock Issued to Employees" (APB 25) and related
interpretations in accounting for its employee stock options and awards. Under
APB 25, compensation expense for stock options is measured as the excess, if
any, of the fair market value of the Company's common stock at the measurement
date over the exercise price.
5. Recapitalization:
On April 15,1998, the Company consummated its recapitalization pursuant to
an Agreement and Plan of Merger dated March 4, 1998 (the Merger Agreement). In
connection with the Merger, the Company's Board of Directors authorized a 12,500
to 1 split of the common stock and a change in the par value of the common stock
from $100 to $.01 per share. The effects of the 12,500-to-one stock split have
been retroactively applied to all common share information for all periods
presented in these financial statements.
Pursuant to the Merger Agreement, AHC Corporation (AHC), a corporation
controlled by an investment fund organized by Freeman Spogli & Co. Incorporated
(FS&Co.), merged into the Company (the Merger), with the Company as the
surviving corporation. In the Merger, a portion of the common stock and all of
the preferred stock of the Company were converted into the right to receive in
the aggregate approximately $351,000 in cash and certain stock options (see
below). Certain shares representing approximately 14% of the outstanding Class A
common stock remained outstanding upon consummation of the Merger. Immediately
prior to the Merger, FS&Co. purchased approximately $80,500 of the common stock
of AHC, which was converted in the Merger into approximately 64% of the
Company's outstanding common stock, and Ripplewood Partners, L.P. and its
affiliates (Ripplewood) purchased approximately $20,000 of the common stock of
A.C., which was converted in the merger into approximately 16% of the Company's
outstanding common stock. In connection with the Merger, management purchased
approximately $8,000, or approximately 6%, of the Company's outstanding common
stock. The purchase of common stock by management resulted in stockholder
subscription receivables. The notes provide for annual interest payments, at the
prime rate, with the entire principal amount due in five years.
On April, 15, 1998, the Company entered into a new bank credit facility
that provides for (i) three senior secured term loan facilities in the aggregate
amount of $250,000 and (ii) a secured revolving credit facility of up to
$125,000. At the closing of the Merger, $125,000 was borrowed under one of the
term loan facilities. On April 15, 1998, the Company also issued $200,000 of
senior subordinated notes and approximately $60,000 of senior discount
debentures. In connection with these transactions, the Company extinguished a
substantial portion of its existing notes payable and long-term debt.
The Merger, the retirement of debt, borrowings under the new bank credit
facility, the issuance of the senior discount debentures and the issuance of the
senior subordinated notes collectively represent the "Recapitalization". The
Company has accounted for the Recapitalization for financial reporting purposes
as the sale of common stock, the issuance of debt, the redemption of common and
preferred stock and the repayment of notes payable and long-term debt.
The stock options received by the existing stockholders are for 500,000
shares of common stock. The stock options are fully vested, nonforfeitable and
provide for a $10 per share exercise price, increasing $2.00 per share annually,
through the expiration date of April 2005. The Company retained a reputable firm
with expertise in valuing stock options to determine the fair value of these
options as of April 15, 1998 (the valuation date). Based on their analysis, the
fair value of the options is approximately $300 in the aggregate. The value of
the options has been reflected as additional consideration for the shares of
common stock repurchased in the Recapitalization.
Concurrent with the Recapitalization, the Company paid $11,500 in bonuses
to certain employees, including executive officers. The Company also incurred
$23,706 of Recapitalization related costs and fees, of which $20,201 has been
recorded as deferred debt issuance costs, $775 has been recorded as a reduction
of the proceeds from the sale of common stock and $2,730 has been expensed.
6
The employee bonuses and Recapitalization related expenses, primarily
professional service fees, are presented as expenses associated with
Recapitalization in the accompanying unaudited condensed consolidated statement
of operations for the 12-week and 40-week periods ending October 10, 1998.
As of October 10, 1998, accrued expenses include $740 of accrued
liabilities related to the Recapitalization, which include the Company's
estimate of certain unpaid professional services, and $986 of accrued
liabilities for certain transaction costs relating to the acquisition (Note 12).
In connection with the Recapitalization, FS&Co. and an affiliate of
Ripplewood collectively received a $5,000 fee for negotiating the
Recapitalization, advisory and consulting services, arranging financing and
raising equity funding.
6. Stockholders Agreement:
The Chairman of the Board and an affiliated trust (the Existing
Stockholders), FS&Co., Ripplewood and the Company have entered into a
Stockholders' Agreement (the Stockholders' Agreement). Under the Stockholders'
Agreement, FS&Co., Ripplewood and the Existing Stockholders have the right to
purchase their pro rata share of certain new issuances of common stock. In
addition, the Stockholders' Agreement provides for restrictions on the
transferability of the common stock of the Existing Stockholders and Ripplewood
for a period of two years following the Recapitalization and, thereafter, for
the following three-year period any transfers, with certain exceptions, are
subject to a right of first offer in favor of FS&Co., provided that Ripplewood's
obligation to make a first offer extends indefinitely. In addition, the
Stockholders' Agreement provides that upon certain transfers by FS&Co. of its
shares of common stock, the Existing Stockholders and Ripplewood will have the
right to participate in such sales on a pro rata basis. If FS&Co. sells all of
its common stock, Ripplewood and the Existing Stockholders will be obligated to
sell all of their shares of common stock at the request of FS&Co.
The Stockholders' Agreement further provides that FS&Co. will elect the
existing Chairman of the Board to the Board of Directors, and the Existing
Stockholders will elect nominees of FS&Co. Ripplewood has granted FS&Co. an
irrevocable proxy to vote Ripplewood's common stock on all matters, expiring
upon an initial public offering, but FS&Co. will nominate one director
designated by Ripplewood. The Ripplewood director will agree to vote with the
FS&Co. directors on all matters prior to an initial public offering. Pursuant to
Stockholders' Agreement, the existing Chairman of the Board has certain approval
rights with respect to major corporate transactions.
7. Long-term Debt:
Long-term debt consists of the following:
7
October 10, January 3,
1998 1998
------------ ------------
SENIOR DEBT:
Delayed draw facilities................................................................. $ -- $ --
Revolving facility...................................................................... -- --
Tranche B facility...................................................................... 125,000 --
Revolving credit arrangements, interest payable monthly at variable rates (ranging
from 6.1% to 6.5% in 1998), repaid in April 1998....................................... -- 84,500
Term note, interest payable monthly at variable rates (ranging from 6.4% to 6.5% in
1998), repaid in April 1998............................................................ -- 6,667
McDuffie County Authority taxable industrial development revenue bonds, interest at
an adjustable rate (5.45% at October 10, 1998)......................................... 10,000 10,000
SUBORDINATED DEBT:
Subordinated notes payable, interest due semi-annually at 10.25%, commencing on
October 15, 1998, due April 2008....................................................... 200,000 --
Discount debentures, at 12.875%, due April 2009 (subordinate to substantially all
other liabilities)..................................................................... 63,796 --
--------- ---------
Total long-term debt................................................................. 398,796 101,167
Less -- Current portion of long-term debt................................................. -- (1,000)
--------- ---------
Long-term debt, excluding current portion................................................. $ 398,796 $ 100,167
========= =========
The terms of the McDuffie County Authority taxable industrial development
revenue bonds remain unchanged from January 3, 1998, except that the letter of
credit obtained in connection with the issuance of these bonds has been
cancelled. The bonds are now secured by the letter of credit obtained in
connection with the Revolving Credit Facility.
The delayed draw facilities, new revolving facility and Tranche B facility
(New Credit Facility) are with a syndicate of banks. The New Credit Facility
provides for the Company to borrow up to $375,000 in the form of senior secured
credit facilities, consisting of (i) $50,000 senior secured delayed draw term
loan facility (the Delayed Draw Facility I), (ii) $75,000 senior secured delayed
draw term loan facility (the Delayed Draw Facility II) and, together with the
Delayed Draw Facility I, (the Delayed Draw Facilities), (iii) a $125,000 Tranche
B senior secured term loan facility (the Tranche B Facility), and (iv) a
$125,000 senior secured revolving credit facility (the Revolving Facility). The
Revolving Facility has a letter of credit sublimit of $25,000. Amounts available
under the Delayed Draw Facilities and the Revolving Facility are subject to a
borrowing base formula based on a specified percentage of the Company's eligible
inventory.
The Delayed Draw Facilities mature April 2004. The Tranche B Facility
matures in April 2006. These term facilities provide for nominal annual
amortization in the first five years and amortization of $149.0 million in 2004,
$60.0 million in 2005 and $30.0 million in 2006. The Revolving Facility will
mature in April 2004.
Borrowings under the New Credit Facility are required to be prepaid,
subject to certain exceptions, with (a) 50% of Excess Cash Flow (as defined),
(b) the net cash proceeds of all asset sales or other dispositions of property
(as defined), (c) the net proceeds of issuances of debt obligations and, (d) the
net proceeds of issuance of equity securities. Excess Cash Flow is defined as
the excess of (A) the sum of Advance Stores Company, Incorporated's (Stores) (i)
consolidated net income (excluding certain gains or losses and restricted
payments made to its parent), (ii) depreciation, amortization and other non-cash
charges, (iii) any decrease in Net Working Capital (as defined), (iv) increases
in deferred revenues, and (v) proceeds of certain indebtedness incurred, over
(B) the sum of (a) any non-cash gains, (b) any increases in Net Working Capital,
(c) decreases in consolidated deferred revenues, (d) capital expenditures, and
(e) repayments of indebtedness (subject to certain exceptions).
8
For the first four fiscal quarters after April 1998, the interest rates
under the Delayed Draw Facilities and the Revolving Facility are based, at the
option of the Company, on either a eurodollar rate plus 2.25% per annum or a
base rate plus 1.25% per annum. Thereafter, the interest rates under the Delayed
Draw Facilities and the Revolving Facility will be determined by reference to a
pricing grid that will provide for reductions in the applicable interest rate
margins based on the trailing Total Debt to EBITDA ratio, as defined, of Stores.
The initial margins will be 2.25% and 1.25% for eurodollar and base rate
borrowings, respectively, and can step down to 1.75% and 0.75%, respectively, if
Stores' Total Debt to EBITDA ratio is less than or equal to 4.00 to 1.00. The
interest rate under the Tranche B Facility is based, at the option of the
Company, an a eurodollar rate plus 2.5% or a base rate plus 1.5% (8.125% at
October 10, 1998). A commitment fee of 0.50% per annum will be charged on the
unused portion of the New Credit Facility.
The New Credit Facility is secured by substantially all of the assets of
the Company. The New Credit Facility contains covenants restricting the ability
of Stores and its subsidiaries to, among others, (i) declare dividends or redeem
or repurchase capital stock (ii) prepay, redeem or purchase debt, (iii) incur
liens or engage in sale-leaseback transactions, (iv) make loans and investments,
(v) incur additional debt (including hedging arrangements), (vi) make capital
expenditures, (vii) engage in mergers, acquisitions and asset sales, (viii)
engage in transactions with affiliates, (ix) change the nature of the business
conducted by the Company and its subsidiaries, (x) change the passive holding
company status of Advance Holding Corporation and (xi) amend existing debt
agreements. Stores is also required to comply with financial covenants with
respect to (a) a maximum leverage ratio, (b) a minimum interest coverage ratio,
and (c) a minimum retained cash earnings test.
The $200,000 Senior Subordinated Notes (the Notes) mature on April 15, 2008
and will bear interest at the rate of 10.25 % per annum, payable semi-annually
on April 15 and October 15 of each year, commencing October 15, 1998. The Notes
are unsecured and are subordinate in right of payment to all existing and future
Senior Debt. The Notes are redeemable at the option of the Company, in whole or
in part, at any time on or after April 15, 2003 in cash at the redemption prices
(as defined), plus accrued and unpaid interest and liquidated damages, if any,
thereon to the date of redemption. In addition, at any time prior to April 15,
2001, the Company may redeem up to 35% of the initially outstanding aggregate
principal amount of the Notes at a redemption price equal to 110.25% of the
principal amount thereof, plus accrued and unpaid interest and liquidated
damages, if any, thereon to the date of redemption, with the net proceeds of one
or more equity offerings; provided that, in each case, at least 65% of the
initially outstanding aggregate principal amount of the Notes remains
outstanding immediately after the occurrence of any such redemption; and
provided further, that such redemption shall occur within 90 days of the date of
the closing of such equity offering.
Upon the occurrence of a change of control, (as defined), each holder of
the Notes will have the right to require the Company to repurchase all or any
part of such holder's Notes at an offering price in cash equal to 101% of the
aggregate principal amount thereof plus accrued and unpaid interest and
liquidated damages, if any, thereon to the date of purchase.
The Notes are guaranteed by a wholly owned subsidiary of Stores, LARALEV,
INC., which holds certain trademarks and tradenames and other intangible assets,
for which it receives royalty income from Stores. The Notes contain certain
covenants that limit, among other things, the ability of Stores to incur
additional indebtedness, issue preferred stock, pay dividends or certain other
distributions, issue stock of subsidiaries, make certain investments, repurchase
stock and certain indebtedness, create or incur liens, engage in transactions
with affiliates, enter into new businesses and restrict Stores from engaging in
certain mergers or consolidations and selling assets.
The Senior Discount Debentures (the Debentures) are due on April 15, 2009.
Interest at 12.875% (computed on a semi-annual basis) is calculated from April
15,1998. The Debentures will accrete at a rate of 12.875%, compounded semi-
annually, to an aggregate principal amount of $112.0 million by April 15, 2003.
Cash interest will not accrue on the Debentures prior to April 15, 2003.
Commencing April 15, 2003, cash interest on the Debentures will accrue and be
payable, at a rate of 12.875% per annum, semi-annually in arrears on each April
15 and October 15. As of October 10, 1998, the Debentures have been accreted by
$1,774 and $3,779 in the twelve week and forty week periods ended October 10,
1998, respectively.
9
The Debentures are redeemable at the option of the Company, in whole or in
part, at any time on or after April 15, 2003, in cash at the redemption prices,
plus accrued and unpaid interest and liquidated damages, (as defined), if any,
thereon to the redemption date. In addition, at any time prior to April 15, 2001
the Company may, at its option, redeem up to 35% of the aggregate principal
amount at maturity of the Debentures originally issued at a redemption price
equal to 112.875% of the accredited value thereof, plus liquidated damages, if
any, with the net cash proceeds of one or more equity offerings; provide that at
least 65% of the original aggregate principal amount at maturity of the
Debentures will remain outstanding immediately following each such redemption.
Upon the occurrence of a change of control (as defined), each holder of the
Debentures will have the right to require the Company to purchase the Debentures
at a price in cash equal to 101% of the accreted value thereof plus liquidated
damages, if any, thereon in the case of any such purchase prior to April 15,
2003, or 101% of the aggregate principal amount thereof, plus accrued and unpaid
interest and liquidated damages, if any, thereon to the date of purchase in the
case of any such purchase on or after April 15, 2003. The Company may not have
any significant assets other than capital stock of Stores (which is pledged
to secure the Company's obligations under then New Credit Facility). As a
result, the Company's ability to purchase all or any part of the Debentures upon
the occurrence of a change in control will be dependent upon the receipt of
dividends or other distributions from Stores or its subsidiaries. The New Credit
Facility and the Senior Subordinated Notes have certain restrictions for Stores
with respect to paying dividends and making any other distributions.
The Debentures are effectively subordinated to all of the Company's other
liabilities. The Debentures contain certain covenants that, among other things,
limit the ability of the Company to incur indebtedness, issue preferred stock,
repurchase stock and certain indebtedness, engage in transactions with
affiliates, create or incur certain liens, pay dividends or certain other
distributions, make certain investments, enter into new business, sell stock of
subsidiaries, sell assets and engage in certain mergers and consolidations.
8. STOCK OPTIONS:
The Company has adopted a senior executive stock option plan and an
executive stock option plan (the Option Plans), which provide for the granting
of either incentive stock options or non-qualified stock options to purchase
shares of the Company's common stock to officers and key employees of the
Company. All options will terminate on the seventh anniversary of the Option
Agreement under which they were granted if not exercised prior thereto.
Shares available for grant under the senior executive and the executive
stock option plans are 507,500 and 450,000, respectively as of October 10, 1998.
Three different types of options were granted pursuant to the Option Plans.
Fixed Price Service Options will vest over a three year period in three equal
installments beginning in fiscal 1999. Performance Options will be earned in
installments based upon satisfaction of certain performance targets for the four
year period ending in fiscal 2001. Variable Price Service Options will vest in
equal annual installments over a two year period beginning in 1999, and have an
exercise price that increases over time.
Total options outstanding at October 10, 1998, were as follows:
Number of Shares Initial Exercise Price
--------------------- ----------------------
Variable Price Service Options.......... 397,085 $10
Performance Options..................... 397,085 $10
Fixed Price Service Options............. 104,580 $10
Other options (Note 5).................. 500,000 $10
---------------------
1,398,750
=====================
Options exercisable at October 10, 1998, were 500,000.
10
The Company has elected to account for employee stock option grants under
APB 25 and, at year-end, is required to provide pro forma disclosures of what
net income would have been had the Company adopted the new fair value method for
recognition purposes under Statement of Financial Accounting Standards No. 123
"Accounting for Stock-Based Compensation". Under APB 25, the Company did not
recognize compensation expense on the issuance of its stock options because the
exercise price equaled the fair market value of the underlying stock on the
grant date. Fair market value is determined by the Board of Directors. The fair
market value of the stock changed to $16.82 per share in August 1998 based upon
the commitment from stockholders of the Company to purchase certain shares in
connection with the acquisition (Note 12). The excess of the fair market value
per share over the exercise price per share for the Performance Options and
Variable Price Service Options is recorded as outstanding stock options and
unamortized stock option compensation in stockholders' (deficit) equity. This
compensation is amortized to expense over the vesting periods. Compensation
expense related to these options of $243 is included in selling, general and
administrative expenses in the accompanying consolidated statements of
operations for the twelve week and forty week periods ended October 10, 1998.
9. STOCKHOLDERS' (DEFICIT) EQUITY:
Changes in stockholders' (deficit) equity for the 40-week period ended
October 10, 1998 are as follows:
11
Class A Common Class B Common
Stock Stock Preferred Stock Additional
--------------------- -------------------- ---------------------- Paid-in
Shares Amount Shares Amount Shares Amount Capital
---------- -------- ----------- -------- ------------ -------- ---------
Balance, January 3, 1998................. 2,412,500 $ 19 21,875,000 $ 175 77,300 $ 773 $ --
Change in par value of
common stock............................ -- 5 -- 44 -- -- --
Redemption of stock...................... (662,500) (7) (21,875,000) (219) (77,300) (773) --
Issuance of Class A common
stock, net of issuance costs
of $775................................. 10,853,800 109 -- -- -- -- 107,654
Stockholder subscription
receivables............................. -- -- -- -- -- -- --
Unamortized stock option compensation.... -- -- -- -- -- -- --
Amortization of stock option
compensation............................ -- -- -- -- -- -- --
Net income............................... -- -- -- -- -- -- --
Preferred dividend, $.80 per
share................................... -- -- -- -- -- -- --
---------- -------- ----------- -------- ------------ -------- ---------
Balance, October 10, 1998................ 12,603,800 $126 -- $ -- -- $ -- $ 107,654
========== ======== =========== ======== ============ ======== =========
Retained
Stockholder Unamortized Earnings Total
Subscription Outstanding Stock Option (Accumulated Equity
Receivables Stock Options Compensation Deficit) (Deficit)
------------ ------------- ------------ ------------ ---------
Balance, January 3, 1998................. $ -- $ -- $ -- $ 142,581 $ 143,548
Change in par value of
common stock............................ -- -- -- (49) --
Redemption of stock...................... -- 300 -- (350,301) (351,000)
Issuance of Class A common
stock, net of issuance costs
of $775................................. -- -- -- -- 107,763
Stockholder subscription
receivables............................. (2,528) -- -- (2,528)
Unamortized stock option compensation.... -- 3,431 (3,431) -- --
Amortization of stock option
compensation............................ -- -- 243 -- 243
Net income............................... -- -- -- 6,666 6,666
Preferred dividend, $.80 per
share................................... -- -- -- (15) (15)
------- ------ ------- ---------- ----------
Balance, October 10, 1998................ $(2,528) $3,731 $(3,188) $ (201,118) $ (95,323)
======= ====== ======= ========== ==========
12
10. RELATED-PARTY TRANSACTIONS:
In April 1998, the Company sold its airplane to the Chairman of the Board,
an existing stockholder, for its net book value of approximately $4,100, which
approximated fair value.
11. CONTINGENCIES:
The employment agreements which existed at January 3, 1998 have been
terminated. The Company entered into new agreements that provide severance pay
benefits under certain circumstances.
Three lawsuits were filed against the Company on July 28, 1998, for
wrongful death relating to an automobile accident involving an employee of the
Company. Management believes that the financial exposure is covered by insurance
and, accordingly, believes that the ultimate resolution of these matters will
not materially affect the Company's financial position or results of operations.
12. SUBSEQUENT EVENT - ACQUISITION:
On August 17, 1998, the Company entered into an agreement and plan of
merger with Sears, Roebuck and Co. (Sears) to acquire Western Auto Supply
Company (Western), a wholly owned subsidiary of Sears. Western was acquired on
November 2, 1998, by a newly formed, wholly owned subsidiary of Stores for
$175,000 in cash and 11,474,606 shares of the Company's common stock. In
connection with the transaction, the Company sold 4,161,712 shares of common
stock to certain current stockholders (after the Recapitalization) for $70,000
and the Company borrowed $90,000 under a new senior credit facility with
substantially the same terms as the current Tranche B facility. The remainder of
the $175,000 was funded through cash on hand. The Company estimates it will
incur transaction related costs of approximately $10,000. As a result of the
transaction, Sears owns approximately 40.6% of the Company's issued and
outstanding common stock. The newly formed, wholly owned subsidiary will become
a full and unconditional, joint and several guarantor of the subordinated notes
and bank credit facilities.
Under the terms of a shared services agreement, Sears will provide certain
services to the Company, including payroll and payable processing, among other
services, until such activities are transitioned to the Company, which the
Company expects to occur in fiscal 1999. In addition, the Company and Sears have
entered into merchant agreements that provide for the acquired stores to honor
certain Sears and Western Auto credit cards for periods defined in the
agreements. The Company and Sears have also entered into agreements that provide
for the acquired stores to continue to purchase and carry certain Sears branded
products during periods defined in the agreements. The Company will also become
a first-call supplier of certain automotive products to certain Sears Automotive
Group stores.
The Company and Sears have entered into an agreement that provides for the
Company to lease certain employees to Sears to perform all operations and
services that were previously performed by Western Auto and its affiliates with
respect to certain credit card operations for stores in Puerto Rico. In
addition, the Company will continue to provide certain services to Sears that
were previously performed by Western until such services are transitioned to
Sears.
13
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
Advance Holding Corporation ("Holding") conducts all of its operations
through its wholly-owned subsidiary, Advance Stores Company, Incorporated (the
"Company"), the second largest retailer of automotive parts and accessories in
the United States (based on store count) with 936 stores operating under the
"Advance Auto Parts" name in 17 states as of October 10, 1998. Based on store
count, the Company believes it is the largest automotive retailer in a majority
of its markets. The Company serves the "do it yourself" market as well as the
"do it for me" market through its commercial delivery program. The following
discussion of the consolidated historical results of operations and financial
condition of Holding should be read in conjunction with the unaudited condensed
consolidated financial statements of Holding and the notes thereto included
elsewhere in this Form 10-Q. The following discussion and analysis covers
periods before completion of the Recapitalization, as described below. Holding's
first quarter consists of 16 weeks and its second and third quarters consists of
12 weeks.
FORWARD LOOKING STATEMENTS
This Management's Discussion and Analysis of Financial Condition and
Results of Operations and other sections of this quarterly report contain
certain "forward-looking statements" as defined in the Private Securities
Litigation Reform Act of 1995. These statements include without limitation the
words "believes," "anticipates," "estimates," "intends," "expects," and words of
similar import. Such forward-looking statements involve known and unknown risks,
uncertainties and other factors that may cause the actual results, performance
or achievements of Holding and the Company or the retail industry to be
materially different from any future results, performance or achievements
expressed or implied by such forward-looking statements.
These potential risks and uncertainties include, among others, the
following: general economic and business conditions; Holding's and the Company's
substantial leverage and debt service obligations; restrictions on Holding's and
the Company's ability to pursue its business strategies imposed by restrictive
loan covenants; changes in business strategy or development plans; competition;
weather conditions; integration of Western Auto (as defined below); extent of
the market demand for auto parts; availability of inventory supply; adequacy and
perception of customer service, product quality and defect experience;
availability of and ability to take advantage of vendor pricing programs and
incentives; rate of new store openings; cannibalization of store sites; mix and
types of merchandise sold; governmental regulation of products; new store
development; performance of information systems; effectiveness of deliveries
from distribution centers; ability to hire, train and retain qualified
employees; and environmental risks. Forward-looking statements regarding
revenues, expenses, cash flows and liquidity are particularly subject to a
variety of assumptions, some or all of which may not be realized. Given these
uncertainties, prospective investors are cautioned not to place undue reliance
on such forward-looking statements. Holding disclaims any obligation to update
any such factors or to publicly announce the results of any revisions to any of
the forward-looking statements contained herein to reflect future events or
developments.
THE RECAPITALIZATION
On April 15, 1998, Holding consummated its Recapitalization pursuant to an
Agreement and Plan of Merger dated as of March 4, 1998. See Note 5 of Part I,
Item 1 for a detailed description of the Recapitalization.
RECENT DEVELOPMENTS
On August 17, 1998, the Company and Holding entered into an agreement (the
"Merger Agreement") to acquire Western Auto Supply Company ("Western Auto"), a
Delaware corporation and wholly-owned subsidiary of Sears, Roebuck and Co.
("Sears"). Western Auto was acquired on November 2, 1998 (the "Acquisition") for
$175.0 million in cash and 11,474,606 shares of the Company's common stock. In
connection with the transaction, Holding sold 4,161,712 shares of common stock
to certain current stockholders for $70.0 million and the Company borrowed $90.0
million under a new facility under the New Credit Facility. The remainder of the
$175.0 million was funded through cash on hand. Holding estimates it will incur
transaction related costs of
14
approximately $10.0 million. As a result of the transaction, Sears owns
approximately 40.6% of the issued and outstanding Common Stock of Holding.
Based in Kansas City, Missouri, Western Auto is a specialty retailer of
automotive parts and accessories and also maintains an extensive wholesale
dealer network. As of November 2, 1998, Western Auto operated 612 stores in the
U.S. under the "Parts America" name and 36 stores in Puerto Rico, two stores in
the U.S. Virgin Islands and two domestic specialty stores under the "Western
Auto" name that provide service and parts sales.
The combined entity will operate domestic retail stores under the "Advance
Auto Parts" name in most markets. The wholesale dealer network and Puerto Rico
stores will continue to operate primarily under the "Western Auto" banner. The
Company and Western Auto together will operate over 1,500 retail stores in 37
states, Puerto Rico and the U.S. Virgin Islands and will supply through its
wholesale distribution center nearly 800 "dealer" stores in 48 states.
RESULTS OF OPERATIONS
The following tables set forth the statement of operations data for the
Company expressed in dollars and as a percentage of net sales for the periods
indicated.
15
Twelve Weeks Ended Forty Weeks Ended
(unaudited) (unaudited)
------------------------------- -------------------------------
October 4, October 10, October 4, October 10,
1997 1998 1997 1998
------------ ------------- ------------- ------------
(dollars in thousands) (dollars in thousands)
Net sales.......................................... $206,409 $258,839 $642,289 $802,839
Cost of sales...................................... 128,692 160,464 396,890 493,289
------------ ------------- ------------- ------------
Gross profit....................................... 77,717 98,375 245,399 309,550
Selling, general and administrative expenses....... 67,406 81,205 212,884 260,017
Expenses associated with recapitalization.......... -- 225 -- 14,230
------------ ------------ ------------- ------------
Operating profit................................... 10,311 16,945 32,515 35,303
Interest expense................................... 1,190 10,116 4,653 23,675
Other expense, net................................. 94 (543) 297 (860)
Income tax expense................................. 3,692 3,279 11,275 5,822
------------ ------------ ------------- ------------
Net income......................................... $ 5,335 $ 4,093 $ 16,290 $ 6,666
============ ============ ============= ============
Twelve Weeks Ended Forty Weeks Ended
(unaudited) (unaudited)
---------------------------------------- ------------------------------
October 4, October 10, October 4, October 10,
1997 1998 1997 1998
------------------ ------------------ -------------- -------------
................................................
Net sales.......................................... 100.0% 100.0% 100.0% 100.0%
Cost of sales...................................... 62.3 62.0 61.8 61.4
------ ------ ------ -------
Gross profit....................................... 37.7 38.0 38.2 38.6
Selling, general and administrative expenses....... 32.7 31.4 33.1 32.4
Expenses associated with recapitalization.......... -- 0.1 -- 1.8
------ ------- ------ -------
Operating profit................................... 5.0 6.5 5.1 4.4
Interest expense................................... 0.6 3.9 0.7 3.0
Other expense, net................................. -- (0.2) 0.1 (0.1)
Income tax expense................................. 1.8 1.2 1.8 0.7
------- ------ ------ ------
Net income......................................... 2.6% 1.6% 2.5% 0.8%
======= ====== ====== ======
Net sales consists primarily of comparable store net sales, last year store
net sales, and new store net sales. New stores become part of the comparable
store base on the first day of their second full fiscal year in operation.
The Company's cost of goods sold includes merchandise costs and warehouse
and distribution expenses. Gross profit as a percentage of net sales may be
affected by variations in the Company's product mix, price changes in response
to competitive factors and fluctuations in merchandise costs and vendor
programs.
Selling, general and administrative expenses are comprised of store
payroll, store occupancy, net advertising expenses, other store expenses and
general and administrative expenses, including salaries and related benefits of
corporate employees, administrative office expenses, data processing,
professional expenses and other related expenses.
Twelve Weeks Ended October 10, 1998 Compared to Twelve Weeks Ended October 4,
1997
Net sales for the twelve weeks ended October 10, 1998 increased by $52.4
million or 25.4% to $258.8 million as compared to $206.4 million for the
comparable twelve weeks ended October 4, 1997. This
16
increase was due to an increase in comparable store net sales of $11.1 million
or 5.8%, an increase in net sales from stores opened in fiscal 1997 of $20.7
million, the contribution of $20.8 million in net sales from stores opened in
fiscal 1998, and a decrease in miscellaneous net sales of $0.2 million. During
the twelve weeks ended October 10, 1998, Holding opened 29 new stores, relocated
one store, remodeled eleven stores, and closed two stores. As of October 10,
1998, Holding operated 936 stores as compared to 758 stores at October 4, 1997.
Gross profit for the twelve weeks ended October 10, 1998 was $98.4 million,
or 38.0% of net sales, as compared with $77.7 million, or 37.7% of net sales,
for the twelve weeks ended October 4, 1997. The increase in the gross profit
percentage was primarily due to decreased warehouse and delivery expenses as a
percentage of net sales.
Selling, general and administrative expenses for the twelve weeks ended
October 10, 1998 increased by $13.8 million as compared to the twelve weeks
ended October 4, 1997, and, as a percentage of net sales, decreased from 32.7%
to 31.4%. This decrease as a percent of net sales was due to the reduction in
certain private company expenses which were eliminated after the
Recapitalization and the elimination of an unusual medical claim which occurred
in the twelve weeks ended October 4, 1997. The Company also incurred
approximately $0.3 million of employee compensation expense related to executive
stock option plans that is included in selling, general and administrative
expenses for the twelve weeks ended October 10, 1998.
Operating profit for the twelve weeks ended October 10, 1998 increased by
$6.7 million or 64.3% to $16.9 million, or 6.5% of net sales, as compared to
$10.3 million or 5.0% of net sales, for the comparable twelve weeks ended
October 4, 1997.
Interest expense for the twelve weeks ended October 10, 1998 was $10.1
million as compared to $1.2 million for the twelve weeks ended October 4, 1997.
The increase was due to increased debt associated with the Recapitalization and
related higher interest rates.
Income tax expense for the twelve weeks ended October 10, 1998 was $3.3
million as compared to $3.7 million for the twelve weeks ended October 4, 1997,
with effective tax rates of 44.5% and 40.9%, respectively. This increase was
the result of increased permanent adjustments and lower pretax earnings due to
the Recapitalization.
As a result of the above factors, Holding reported net income of $4.1
million for the twelve weeks ended October 10, 1998 as compared to $5.3 million
for the twelve weeks ended October 4, 1997. As a percentage of net sales, net
income for the twelve weeks ended October 10, 1998 was 1.6% as compared to 2.6%
for the twelve weeks ended October 4, 1997.
Forty Weeks Ended October 10, 1998 Compared to Forty Weeks Ended October 4, 1997
Net sales for the forty weeks ended Oct ober 10, 1998 increased by $160.5
million or 25.0% to $802.8 million as compared to $642.3 million for the
comparable forty weeks ended October 4, 1997. This increase was due to an
increase in comparable store net sales of $38.1 million or 6.2%, an increase in
net sales from stores opened in fiscal 1997 of $83.5 million, the contribution
of $39.9 million in net sales from stores opened in fiscal 1998, and a decrease
in miscellaneous net sales of $1.0 million. During the forty weeks ended October
10, 1998, Holding opened 125 new stores, relocated five stores, remodeled 36
stores, and closed three stores. As of October 10, 1998, Holding operated 936
stores as compared to 758 stores at October 4, 1997.
Gross profit for the forty weeks ended October 10, 1998 was $309.6 million,
or 38.6% of net sales, as compared with $245.4 million, or 38.2% of net sales,
for the forty weeks ended October 4, 1997. The increase in the gross profit
percentage was primarily due to decreased warehouse and delivery expenses as a
percentage of net sales.
Selling, general and administrative expenses for the forty weeks ended
October 10, 1998 increased by $47.1 million as compared to the forty weeks ended
October 4, 1997, and, as a percentage of net sales, decreased from 33.1% to
32.4%. This decrease as a percent of net sales is due to the reduction in
certain private company expenses which were eliminated after the
Recapitalization and the elimination of an unusual medical claim which
17
occurred in the forty weeks ended October 4, 1997. The Company also incurred
approximately $0.3 million of employee compensation expense related to executive
stock option plans that is included in selling, general and administrative
expenses for the forty weeks ended October 10, 1998.
As part of the Recapitalization, $14.2 million in transaction expenses were
incurred which related to the Recapitalization. This expense consisted of $11.5
million of bonuses paid to certain employees for past performances, $0.2 million
in related employment taxes and $2.5 million for non-recurring expenses which
consisted primarily of professional fees.
Operating profit for the forty weeks ended October 10, 1998 increased to
$35.3 million or 4.4% of net sales from $32.5 million or 5.1% of net sales for
the period ended October 4, 1997. This increase in operating profit as a
percentage of net sales was primarily due to the expenses incurred with the
Recapitalization. Excluding the $14.2 million in transaction expenses, operating
profit increased by $17.0 million or 52.3% to $49.5 million, or 6.2% of net
sales, for the forty weeks ended October 10, 1998, compared to $32.5 million for
the forty weeks ended October 4, 1997 due to the factors cited above.
Interest expense for the forty weeks ended October 10, 1998 was $23.7
million compared to $4.7 million for the forty weeks ended October 4, 1997. The
increase was due to increased debt associated with the Recapitalization and
related higher interest rates.
Income tax expense for the forty weeks ended October 10, 1998 was $5.8
million as compared to $11.3 million for the forty weeks ended October 4, 1997,
with effective tax rates of 46.6% and 40.9%, respectively. This increase was
the result of increased permanent adjustments and lower pretax earnings due to
the Recapitalization.
As a result of the above factors, Holding reported net income of $6.7
million for the forty weeks ended October 10, 1998 as compared to net income of
$16.3 million for the forty weeks ended October 4, 1997. As a percentage of net
sales, net income for the forty weeks ended October 10, 1998 was 0.8% as
compared to net income of 2.5% for the forty weeks ended October 4, 1997.
LIQUIDITY AND CAPITAL RESOURCES
Holding's primary capital requirements have been the funding of its
continued store expansion program, store relocations and remodels, inventory
requirements, the construction and upgrading of distribution centers and the
development and implementation of proprietary information systems. Holding has
financed its growth through a combination of internally generated funds and
borrowings.
Holding's new stores require capital expenditures of approximately $120,000
per store and an inventory investment of approximately $400,000 per store. A
substantial portion of these inventories are financed through vendor payables.
Pre-opening expenses, consisting primarily of store set-up costs and training of
new store employees, average approximately $25,000 per store and are expensed
when incurred.
Historically, Holding has negotiated extended payment terms from suppliers
to finance inventory growth, and Holding believes that it will be able to
continue financing much of its inventory growth through such extended payment
terms. Holding anticipates that inventory levels will continue to increase
primarily as a result of new store openings and increased SKU levels.
For the forty weeks ended October 10, 1998, net cash provided by operating
activities was $32.5 million, which consisted primarily of depreciation and
amortization of $20.0 million, net income of $6.7 million, amortization of
deferred debt issuance costs and bond discounts of $5.2 million and other of
$0.6 million. Net cash used for investing activities was $32.1 million and
consisted primarily of $36.2 million for capital expenditures offset by proceeds
of $4.1 million from the sale of a corporate airplane. Net cash provided by
financing activities was $22.5 million and was primarily the result of the
Recapitalization.
18
Holding funded the Acquisition of Western Auto with the issuance to Sears
of 11,474,606 shares of Holding's Class A Common Stock, additional borrowings of
$90.0 million under a new deferred term loan facility under the New Credit
Facility, the sale of approximately $70.0 million of Holding Common Stock to
existing stockholders of Holding and cash on hand. In connection with the
Acquisition, at the request of the Company, Sears will attempt to sell the Parts
America and Western Auto credit card portfolios to a third party buyer. The
Company has agreed to participate in any losses incurred as a result of the
sale, but its share of such losses will not exceed $10.0 million. The Company
intends to close certain stores in overlapping markets and is in the process of
completing the analysis of how many stores may be closed as a result of the
Acquisition. Certain Parts America stores and Advance Auto Parts stores have
been identified to be closed in the fourth quarter or subsequent periods. Thus
far, management estimates the Company will accrue exit costs, primarily accruals
for closed stores, in purchase accounting of $8.0 million related to the closing
of certain Parts America stores. The Company also estimates it will recognize
approximately $13.3 million in expenses in the fourth quarter, primarily
accruals for the closure of certain Advance Auto Parts stores identified to
date and a loss on the early termination of a long-term contract. Related to the
Acquisition, the Company and Holding entered into several new long-term vendor
agreements in the fourth quarter that provide for price reductions on future
purchases.
Holding believes it will have sufficient liquidity to fund its debt service
obligations and implement its growth strategy over the next several years. As of
October 10, 1998, Holding and the Company had outstanding indebtedness
consisting of $64.0 million of Series A Debentures, $200.0 million of Senior
Subordinated Notes, borrowings of $135.0 million under the New Credit Facility
and the McDuffie County Development Authority Taxable Industrial Development
Revenue Bonds (the "IRB"). The Senior Subordinated Notes bear interest at a rate
of 10.25%, payable semiannually, and require no principal repayments until
maturity. The $10.0 million principal amount IRB bears interest at a variable
rate and requires no principal payments until maturity in November 2002. In
addition to its operating cash flow, the Company has access to a total of $465.0
million through the New Credit Facility. The New Credit Facility provides for
(i) a $125.0 million Tranche B term loan, which was made at the closing of the
Recapitalization; (ii) a revolver with maximum borrowings of approximately
$125.0 million, a minimal amount of which was drawn (including in connection
with the replacement of outstanding letters of credit in the amount of
approximately $2.0 million) in connection with the Recapitalization; (iii) a
$125.0 million delayed draw term loans, $50.0 million of which is available to
the Company through October 15, 1999 and $75.0 million of which is available to
the Company through April 15, 2001, and (iv) a $90.0 million deferred term loan
facility, which was made at the close of the Acquisition. The term loan
facilities, other than the Tranche B term loan, will mature on the sixth
anniversary of initial borrowing, and the Tranche B term loan will mature on the
eighth anniversary of initial borrowing. Annual principal payments on the term
loan facilities prior to the sixth anniversary of initial borrowing will be
nominal; thereafter, required principal payments will be approximately $236.0
million in 2004, $60.0 million in 2005 and $30.0 million in 2006, assuming the
term loan facilities have been fully borrowed. The revolving loan facility will
mature on the sixth anniversary of initial borrowing. None of the delayed draw
term loans have been drawn in connection with the Recapitalization or the
Acquisition. The loans under the New Credit Facility are secured by a first
priority security interest in substantially all tangible and intangible assets
of the Company. Amounts available to the Company under the revolver and delayed
draw term loans are subject to a borrowing base formula which is based on
certain percentages of the Company's inventories. The Company intends to use
borrowings under the revolver and delayed draw term loans for store expansion
and funding of working capital. Borrowings under the New Credit Facility are
required to be prepaid, subject to certain exceptions, with (a) 50% of excess
cash flow, (b) 100% of the net cash proceeds of all asset sales or other
dispositions of property by the Company and its subsidiaries (including certain
insurance and condemnation proceeds), subject to certain exceptions (including
exceptions for (i) reinvestment of certain asset sale proceeds within 360 days
of such sale and (ii) certain sale-leaseback transactions), (c) 100% of the net
proceeds of issuances of debt obligations of the Company and its subsidiaries,
and (d) 100% of the net proceeds of issuance of equity of the Company and its
subsidiaries. Because increases in net working capital, capital expenditures and
debt repayments are deducted in calculating excess cash flow, the Company does
not anticipate that the prepayment obligation under the New Credit Facility in
respect thereof will have a material effect on its operating strategy. With
respect to growth through acquisitions, the operation of this covenant may
result in the application of cash resources for prepayments which would require
the Company to secure additional equity or debt financing to fund an
acquisition, but while no assurance can be given, the Company does not
anticipate that this would have a material effect on its ability to finance
acquisitions in the future.
As a holding company, Holding relies on dividends from the Company as its
primary source of liquidity. Holding does not have and in the future may not
have any assets other than the capital stock of the Company. The ability of the
Company to pay cash dividends to Holding when required is restricted by law and
the terms of the Company's debt instruments, including the New Credit Facility
and the Senior Subordinated Notes. No assurance can be made that the Company
will be able to pay cash dividends to Holding when required on the Series B
Debentures.
Holding's business is somewhat seasonal in nature, with the highest sales
occurring in the spring and summer months. In addition, Holding's business is
affected by weather conditions. While unusually heavy
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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.
YEAR 2000 CONVERSION
A significant percentage of the software that runs most computers relies on
two-digit date codes to perform computations and decision-making functions.
Commencing on January 1, 2000, these computer programs may fail from an
inability to interpret date codes properly, misinterpreting "00" as the year
1900 rather than 2000. Holding has completed the identification of all
necessary internal software changes to ensure that it does not experience any
loss of critical business functionality due to the Year 2000 issue. Holding has
appointed an internal Year 2000 project manager and remediation team and has
adopted a four phase approach of assessment, remediation, testing, and
contingency planning. The scope of the project includes all internal software,
hardware, operating systems, and assessment of risk to the business from vendors
and other partners' Year 2000 issues. The assessment of all internal systems
has been completed, the remediation and testing phases are in progress, and
contingency planning for certain information technology systems has begun.
Holding believes that this approach of assessment (including prioritization by
business risk), remediation (including conversions to new software), testing of
necessary changes, and contingency planning will minimize the business risk of
Year 2000 from internal systems.
Holding is utilizing internal and external resources to correct, replace,
and test its software for Year 2000 compliance and plans to complete the Year
2000 project no later than June 30, 1999. The total cost of the Year 2000
project for Holding prior to the Acquisition was estimated at $3.7 million. Of
the total project cost, approximately $1.0 million represents the purchase of
new software and hardware which will be capitalized. The remaining will be
expensed as incurred during 1998 and 1999. As of the end of Holding's third
quarter, Holding has spent approximately $1.2 million on the Year 2000 project.
See below for a discussion of Year 2000 issues with respect to the Company's
Western Auto subsidiary.
Ongoing communications have been established with almost all vendors and
other partners to monitor their progress in resolving Year 2000 issues, most of
which Holding believes, are making substantial progress. However, Holding cannot
guarantee that Year 2000 related systems issues of its business partners will be
corrected in a timely manner or that the failure of its business partners to
correct these issues would not have a material adverse effect.
Holding has already begun to develop contingency plans in the event a
business interruption caused by Year 2000 problems should occur. For certain
information technology systems, contingency plans are in place. Elements of
Holding's contingency plans will include: switching of vendors, back-up systems
that do not rely on computers, and the stockpiling of certain products in the
months before the Year 2000.
Western Auto has adopted a Year 2000 strategy and believes it has retained
an adequate number of personnel to execute its strategy. Western Auto has
entered into a number of retention agreements to retain such key personnel and
is in the process of reviewing the Western Auto plan. There can be no assurance,
however, that Western Auto will attain sufficient Year 2000 compliance in a
timely manner.
The cost and time estimated for the Year 2000 project are based on
Holding's best estimates. There can be no guarantee that these estimates will be
achieved and that planned results will be achieved. Risks include, but are not
limited to, the retention of internal and external resources dedicated to the
project, the timely delivery of software corrections from external vendors, and
the successful completion of key business partners' Year 2000 projects.
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ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISKS
Not Applicable.
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PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
None.
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
None.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
None.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
ITEM 5. OTHER INFORMATION
None.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
27.1 Financial Data Schedule
(b) Reports on Form 8-K
None.
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SIGNATURE
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 HOLDING CORPORATION,
a Virginia corporation
November 23, 1998 By: /s/ J. O'Neil Leftwich
-----------------------------------
J. O'Neil Leftwich
Chief Financial Officer
(Duly Authorized Officer and Principal
Financial Officer)
S-1