Advance Auto Parts 10-K 2008
Documents found in this filing:
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
For the fiscal year ended December 29, 2007
For the transition period from ________ to ________.
Commission file number 001-16797
ADVANCE AUTO PARTS, INC.
(Registrant’s telephone number, including area code)
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes x No o
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes o No x
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 x No o
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§229.405 of this chapter) is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
Yes o No x
As of July 13, 2007, the last business day of the registrant’s most recently completed second fiscal quarter, the aggregate market value of the 106,659,839 shares of Common Stock held by non-affiliates of the registrant was $4,245,061,592, based on the last sales price of the Common Stock on July 13, 2007, as reported by the New York Stock Exchange.
As of February 22, 2008, the registrant had outstanding 94,517,071 shares of Common Stock, par value $0.0001 per share (the only class of common equity of the registrant outstanding).
Portions of the definitive proxy statement of the registrant to be filed within 120 days of December 29, 2007, pursuant to Regulation 14A under the Securities Exchange Act of 1934, for the 2008 Annual Meeting of Stockholders to be held on May 15, 2008, are incorporated by reference into Part III.
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 may not give assurance that the plans, intentions or expectations will be achieved. Listed below and discussed elsewhere in this report are some important risks, uncertainties and contingencies which could cause our actual results, performance 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:
We assume no obligations 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, or SEC, and you should not place undue reliance on those statements.
Unless the context otherwise requires, “Advance,” “we,” “us,” “our,” and similar terms refer to Advance Auto Parts, Inc., its predecessor, its subsidiaries and their respective operations. Our fiscal year consists of 52 or 53 weeks ending on the Saturday closest to December 31 of each year. Fiscal 2003 included 53 weeks of operations. All other fiscal years presented included 52 weeks of operations.
We primarily operate within the United States automotive aftermarket industry, which includes replacement parts (excluding tires), accessories, maintenance items, batteries and automotive chemicals for cars and light trucks (pickup trucks, vans, minivans and sport utility vehicles). We currently are the second largest specialty retailer of automotive parts, accessories and maintenance items to "do-it-yourself," or DIY, and “do-it-for-me,” or DIFM, customers in the United States, based on store count and sales.
We were formed in 1929 as Advance Stores Company, Incorporated and operated as a retailer of general merchandise until the 1980s. During the 1980s, we sharpened our focus to target sales of automotive parts and accessories to DIY customers. From the 1980s to the present, we have grown significantly as a result of strong comparable store sales growth, new store openings and strategic acquisitions. Since 1996, we have aggressively expanded our sales to DIFM customers through our commercial delivery program. Our parent company, Advance Auto Parts, Inc., was incorporated in 2001 in conjunction with the acquisition of Discount Auto Parts, Inc., or Discount. More recently in 2005, we acquired Autopart International, Inc., or AI.
Our Internet address is www.AdvanceAutoParts.com. We make available free of charge through our Internet website our annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and amendments to those reports filed or furnished pursuant to the Securities Exchange Act of 1934 as soon as reasonably practicable after we electronically file such material with, or furnish it to, the SEC.
We conduct our operations in two reportable segments: Advance Auto Parts, or AAP, and AI. The AAP segment is comprised of our store operations within the United States, Puerto Rico and the Virgin Islands which operate under the trade names “Advance Auto Parts,” “Advance Discount Auto Parts” and “Western Auto.” The AI segment consists solely of the operations of Autopart International, which continues to operate as an independent, wholly-owned subsidiary.
Financial information on our segments is included in Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations, of this Annual Report on Form 10-K. In addition, selected financial data for our segments is available in Note 18, Segment and Related Information, of the Notes to Consolidated Financial Statements, included in Item 15. Exhibits, Financial Statement Schedules, of this Annual Report on Form 10-K.
At December 29, 2007, we operated 3,153 stores within the United States, Puerto Rico and the Virgin Islands. We operated 3,123 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 the “Advance Discount Auto Parts” trade name. These stores offer a broad selection of brand name and proprietary automotive replacement parts, accessories and maintenance items for domestic and imported cars and light trucks. In addition, we operated 30 stores under the “Western Auto” and “Advance Auto Parts” trade names, located in Puerto Rico and the Virgin Islands, or Offshore.
We also provide our customers online shopping and access to over two million stock keeping units, or SKUs. Our online site allows our customers to pick up merchandise at a conveniently located store or have their purchases
shipped directly to their home or business.
Store Overview.> Our stores generally are located in freestanding buildings in areas with high vehicle traffic counts, good visibility and easy access to major roadways. We believe that our stores exhibit a customer-friendly format with the majority of our stores featuring an updated exterior and interior, brighter lighting, clean graphics and a well-designed and easily navigated floor plan. The average size of our stores is 7,400 square feet with the size of our new stores approximating 7,000 square feet. We have recently introduced a 6,000 square foot prototype store. Our stores generally are open from 7:30 a.m. to 9:00 p.m. six days a week and 9:00 a.m. to 9:00 p.m. on Sundays and most holidays to meet the needs of our DIY and DIFM customers. We offer extended hours in a limited number of our stores, including 24 hours per day in certain stores.
Our stores carry a standard SKU offering of approximately 16,000 SKUs while certain stores carry slightly more SKUs within centralized market locations where there is demand for a more customized assortment of merchandise. Additionally, certain of our stores serve as Local Area Warehouses, or LAWs, where they carry an additional customized assortment of 10,000 SKUs for next day delivery to selected stores within the service area of each respective LAW. The standard SKU offering within each of our stores is replenished from one of our eight distribution centers on an average of once per week.
We also utilize a network of Parts Delivered Quickly, or PDQ®, facilities and one Master PDQ® facility to ensure our stores have the right product at the right time for our customers’ needs. Our PDQ® and Master PDQ® network of facilities provide our customers an additional assortment of approximately 80,000 less common parts and accessories on same-day or overnight basis. Lastly, our customers have access to over 275,000 SKUs though our Special Order Center, an in-store kiosk where they order the requested item directly from one of our vendors for delivery to a particular store or other destination as chosen by the customer.
Store team members utilize our proprietary point-of-sale (“POS”) system, including a fully integrated electronic parts catalog to identify and suggest the appropriate quality and price options for the SKUs that we carry, as well as the related products, tools or additional information that is required by our customers to complete their automotive repair projects properly and safely. We strive to be the leader in the automotive aftermarket industry in serving our customers by providing quality products at the right price and backed by a good warranty and outstanding customer service. We offer many of the products in our stores at a good, better or best recommendation differentiated by price and quality.
Some of the products offered in our stores include the following:
We also provide a variety of services free of charge to our customers including:
Our retail stores are 100% company operated and are divided into four geographic areas. A senior vice president, who is supported by five to six regional vice presidents, manages each area of retail stores. Division managers report to the regional vice presidents and have direct responsibility for store operations in a specific division, which typically consists of 13 to 16 stores. Depending on store size and sales volume, each store is staffed by eight to 14 team members under the leadership of a store manager. We offer training to our employees, who we refer to as team members, including formal classroom workshops, online seminars and certification by the National Institute for Automotive Service Excellence ("ASE"), which is broadly recognized for training certification in the
automotive industry. We also continue to increase the number of bilingual team members in our stores to better serve an increasingly diverse customer base.
Commercial Sales.> In addition to the in-store customer service provided to our DIY customers, we also maintain a commercial sales team dedicated to the development of our commercial business and the support of our DIFM customers, certain of which consist of national and regional accounts. Since 1996, we have aggressively expanded our sales to DIFM customers through our commercial delivery program. Sales to DIFM customers represented approximately 25% of our AAP sales in 2007 and consisted of sales to both walk-in commercial customers and sales delivered to our commercial customers’ place of business, including independent garages, service stations and auto dealers. Our commercial strategy consists of the development of commercial marketing and merchandising initiatives with the continued focus on getting our DIFM customers to use us as their “first call” supplier. At December 29, 2007, we had 2,604 AAP stores with commercial delivery programs, or 83% of total AAP stores, which was slightly up from 81% at December 30, 2006.
Store Development.> Our store development program has historically focused on adding new stores within existing markets, relocating and remodeling existing stores and entering new markets. The addition of new stores, along with strategic acquisitions, has played a significant role in our growth and success. We believe the addition of new stores will continue to play a significant role in our future growth and success.
Our 3,153 AAP stores were located in the following states and territories at December 29, 2007:
The following table sets forth information concerning increases in the total number of our AAP stores during the past five years:
Store Technology. > Our store-based information systems, which are designed to improve the efficiency of our operations and enhance customer service, are comprised of a proprietary point-of-sale, or POS, system and electronic parts catalog, or EPC, system. Information maintained by our POS system is used to formulate pricing, marketing and merchandising strategies and to replenish inventory accurately and rapidly. Our POS system is fully integrated with our EPC system that enables our store team members to assist our customers in their parts selection and ordering based on year, make, model and engine type of their vehicles. Our centrally based EPC data management system enables us to reduce the time needed to exchange data with our vendors and ultimately catalog and deliver updated, accurate product information.
Our EPC system also contains enhanced search engines and user-friendly navigation tools that enhance our team members’ ability to look up any needed parts as well as additional products the customer needs to complete their automotive repair project. If a hard-to-find part or accessory is not available at one of our stores, the EPC system can determine whether the part is carried and in-stock through our PDQÒ system. Available parts and accessories are then ordered electronically from another store, LAW, PDQÒ or Master PDQÒ with immediate confirmation of price, availability and estimated delivery time.
We also support our store operations with additional proprietary systems. Our store-level inventory management system provides real-time inventory tracking at the store level. With the store-level system, store team members can check the quantity of on-hand inventory for any SKU, adjust stock levels for select items for store specific events, automatically process returns and defective merchandise, designate SKUs for cycle counts and track merchandise transfers. Our stores use radio frequency hand-held devices to help ensure the accuracy of our inventory. Our standard operating procedure, or SOP, system is a web-based, electronic data management system that allows our team members instant and quick access to any of our standard operating procedures through a comprehensive on-line search function. Additionally, we utilize a labor scheduling system known as management planning and training, or MPT. All of these systems are tightly integrated and together provide real-time, comprehensive information to store personnel, resulting in improved customer service levels, team member productivity and in-stock availability.
Store Support Center
Merchandising. > Purchasing for virtually all of the merchandise for our stores is handled by our centralized corporate offices in Roanoke, Virginia, or store support center. In 2007, we purchased merchandise from over 400 vendors, with no single vendor accounting for more than 7% of purchases. Our purchasing strategy involves negotiating agreements with certain vendors to purchase merchandise over a specified period of time along with other terms, including pricing, payment terms and volume.
Our merchandising team is skilled in sourcing high quality products globally and maintaining consistent inventory levels. The merchandising team has developed strong vendor relationships in the industry and, in a collaborative effort with our vendor partners, utilizes a category management process. We believe this process, which develops a customer focused business plan for each merchandise category, has been highly effective and is critical to improving comparable store sales, gross margin and inventory turns.
Our merchandising strategy is to carry a broad selection of high quality brand name automotive parts and accessories such as Bosch®, Castrol®, Sylvania®, Prestone®, Monroe®, Bendix®, Purolator®, Dayco® and Trico®, which generates DIY customer traffic and also appeals to commercial customers. In addition to these branded products, we stock a wide selection of high quality proprietary products that appeal to value conscious customers. These lines of merchandise include everything from chemical and wash-and-wax products to tools, batteries, parts and interior automotive accessories under the names of Professional’s FavoriteTM, Joe’s GarageTM, Mechanic’s ChoiceTM, Auto XpressTM, AutocraftTM, EnduranceTM, WeareverTM, JobmateTM and MirageTM.
Supply Chain.> Our supply chain consists of centralized inventory management and transportation functions which support a logistics network of distribution centers, PDQ® warehouses and stores. Our inventory management team utilizes a replenishment system, or E-3, to monitor the distribution center, PDQ® warehouse and store inventory levels and order additional product when appropriate while streamlining costs associated with the handling of that product. E-3 utilizes the most up-to-date information from our POS system as well as inventory movement forecasting based upon history, sales trends by SKU, seasonality and demographic shifts in demand. E-3
combines these factors with service level goals, vendor lead times and cost of inventory assumptions to determine the timing and size of purchase orders. A significant portion of our purchase orders are sent via electronic data interchange, with the remainder being sent by computer generated e-mail or facsimile.
Our transportation team utilizes a transportation management system for efficiently managing incoming shipments to the distribution centers and stores. Benefits from this system include reduced vendor to distribution center freight costs, visibility of purchase orders and shipments for the entire supply chain, a reduction in distribution center inventory, or safety stock, due to consistent transit times, decreased third party freight and billing service costs, decreased distribution center to store freight costs and higher store in-stock position.
We currently operate eight distribution centers. All of these distribution centers are equipped with our distribution center management system, or DCMS. Our DCMS provides real-time inventory tracking through the processes of receiving, picking, shipping and replenishing at our distribution centers. The DCMS, integrated with technologically advanced material handling equipment, significantly reduces warehouse and distribution costs, while improving efficiency. This equipment includes carousels, “pick-to light” systems, robotic picking, radio frequency technology, voice technology and automated sorting systems. Through the continued implementation of our supply chain initiatives we expect to further increase the efficient utilization of our distribution capacity. We believe our current capacity will allow us to support in excess of 3,400 stores. During 2007, we announced our plan to build a new distribution center in Indiana now scheduled to open in early-2010.
We currently offer approximately 58,000 SKUs to substantially support all of our retail stores via our 13 stand-alone PDQ® warehouses and/or our eight distribution centers (all of which stock PDQ® items). Stores have visibility to inventory in their respective facilities and can place orders to these facilities, or as an alternative, through an online ordering system to virtually any of the other facilities. Ordered parts are delivered to substantially all stores on a same day or next day basis through our dedicated PDQ® trucking fleet and third party carriers. Store inventories are replenished from our eight distribution centers. In addition, we operate a Master PDQ® warehouse that stocks 45,000 incremental SKUs of harder-to-find automotive parts and accessories and utilizes our existing PDQ® distribution infrastructure and/or third party arrangements to provide next day service to substantially all of our stores.
Advertising. > We have an extensive advertising program designed to communicate our merchandise offerings, parts assortment and availability, competitive prices, free services and commitment to customer service. The program is focused on establishing Advance Auto Parts as the resource for a customer's automotive needs. We use a mix of media that reinforces our brand image, including television, radio, promotional signage, outdoor media, print and our Internet site.
Our advertising plan is a brand-building program built around television and radio advertising. The plan is supported by in-store signage, online advertising and print. Our television advertising is a combination of national and regional media in both sports and entertainment programming. Radio advertising generally airs during peak drive times. We use Spanish-language radio and television advertising to market to our Hispanic customers. Our advertising program is also supported through sponsorships of sporting events, racing teams and other events at all levels in a grass-roots effort to positively impact individual communities, including Hispanic and other ethnic communities, to create awareness and drive traffic for our stores. Since 2004, we have used an integrated consumer education program to build our image as not only the source for parts, but also the best resource for vehicle information. Our goal with this initiative is to continue our long-term brand building success, increase customer loyalty and expand our customer base.
In February 2008, we launched a new branding campaign, “Keep the Wheels Turning.” This campaign was developed based on a strategic review of our business as well as extensive research conducted with our customers and team members. We believe this campaign, which targets both DIY and DIFM customers will differentiate Advance Auto Parts in our industry by positioning us as the source for brand name parts and products and as the resource for expert advice and knowledge to help customers keep their vehicles running. The campaign includes creative and compelling television and radio commercials designed to drive sales and build an enduring, positive image of Advance Auto Parts.
We acquired AI in September 2005. The acquisition, which included 61 stores throughout New England and New York, a distribution center and AI’s wholesale distribution business, complements our growing presence in the DIFM market in the Northeast.
AI’s business primarily serves the commercial market from its store locations. In addition, its North American Sales Division services warehouse distributors and jobbers throughout North America. We believe AI provides a high level of service to its commercial customers by providing quality parts, unsurpassed customer service and efficient parts delivery. As a result of its extensive sourcing network, AI is able to serve its customers in search of replacement parts for both domestic and imported cars and light trucks with a greater focus on imported parts. The vast majority of AI’s product is sold under its proprietary brand. The AI stores offer an average of 9,500 SKUs with access to an additional 17,000 unique SKUs through its logistics network.
At December 29, 2007, we operated 108 stores under the “Autopart International” trade name in the following states throughout the Northeast:
The following table sets forth information concerning increases in the total number of our AI stores:
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 or cold weather tends to enhance sales by causing automotive parts to fail at an accelerated rate.
At February 22, 2008, we employed 25,499 full-time team members and 18,566 part-time team members. Our workforce consisted of 88% of our team members employed in store-level operations, 9% employed in distribution and 3% employed in our corporate offices. We have never experienced any labor disruption and are not party to any collective bargaining agreements. We believe that our team member relations are good.
We own a number of trade names and own and have federally registered several service marks and trademarks, including “Advance Auto Parts,” “Western Auto,” “Parts America,” “Autopart International” and “PDQ” for use in connection with the automotive parts retailing business. In addition, we own and have registered a number of trademarks for our proprietary products. We believe that these trade names, service marks and trademarks are important to our merchandising strategy. We do not know of any infringing uses that would materially affect the use of these trade names and marks, and we actively defend and enforce them.
We operate in both the DIY and DIFM markets of the automotive aftermarket industry. Our primary competitors are (i) both national and regional retail chains of automotive parts stores, including AutoZone, Inc., O'Reilly Automotive, Inc., CSK Auto Corporation and The Pep Boys–Manny, Moe & Jack, (ii) discount stores and mass merchandisers that carry automotive products, (iii) wholesalers or jobber stores, including those associated with national parts distributors or associations, such as NAPA and Carquest, (iv) independent operators and (v) automobile dealers that supply parts. We believe that chains of automotive parts stores that, like us, have multiple locations in one or more markets, have competitive advantages in customer service, marketing, inventory selection, purchasing and distribution as compared to independent retailers and jobbers that are not part of a chain or associated with other retailers or jobbers. The principal methods of competition in our business include store location, availability, customer service and product offerings, quality and price.
We are subject to various federal, state and local laws and governmental regulations relating to the operation of our business, including those governing recycling of lead-acid batteries and used oil, and ownership and operation of real property. We sell consumer products containing hazardous materials as part of our business. In addition, our customers may bring lead-acid batteries or used oil onto our properties. We currently provide collection and recycling programs for used automotive, lead-acid batteries and used oil at all of our stores as a service to our customers. Pursuant to agreements with third party vendors, lead-acid batteries and used oil are collected by our team members, deposited onto pallets or into vendor supplied containers and stored by us until collected by the third party vendors for recycling or proper disposal. The terms of our contracts with the third party vendors provide that they are in compliance with all applicable laws and regulations. Persons who arrange for the removal, disposal, treatment or other handling of hazardous or toxic substances may be liable for the costs of removal or remediation at any affected disposal, treatment or other site affected by such substances. Based on our experience, we do not believe that there are any material environmental costs associated with the current business practice of accepting lead-acid batteries and used oil as these costs are borne by the respective third parties.
We own and lease real property. Under various environmental laws and regulations, a current or previous owner or operator of real property may be liable for the cost of removal or remediation of hazardous or toxic substances on, under or in such property. These laws often impose joint and several liability and may be imposed without regard to whether the owner or operator knew of, or was responsible for, the release of such hazardous or toxic substances. Other environmental laws and common law principles also could be used to impose liability for releases of hazardous materials into the environment or work place, and third parties may seek recovery from owners or operators of real properties for personal injury or property damage associated with exposure to released hazardous substances. From time to time, we receive notices from the Environmental Protection Agency and state environmental authorities indicating that there may be contamination on properties we own, lease or operate or may have owned, leased or operated in the past or on adjacent properties for which we may be responsible. Compliance with these laws and regulations has not had a material impact on our operations to date.
Item 1A. Risk Factors.
Risks Relating to Our Business
We may not be able to successfully implement our business strategy, including increasing comparable store sales, enhancing our margins and increasing our return on invested capital, which could adversely affect our business, financial condition, results of operations and cash flows.
We have implemented numerous initiatives to increase comparable store sales, enhance our margins and increase our return on invested capital in order to increase our earnings and cash flow. If these initiatives are unsuccessful, or if we are unable to implement the initiatives efficiently and effectively, our business, financial condition, results of operations and cash flows could be adversely affected.
Successful implementation of our business strategy also depends on factors specific to the retail automotive parts industry and numerous other factors that may be beyond our control. Adverse changes in the following factors could undermine our business strategy:
We will not be able to expand our business if our growth strategy is not successful, which could negatively impact our financial results.
We have increased our store count significantly from 814 stores at the end of 1997 to 3,261 stores at December 29, 2007. We intend to continue to expand our base of stores as part of our growth strategy, primarily by opening new stores. We may not assure you that the implementation of this strategy will be successful. The actual number of new stores to be opened and their success will depend on a number of factors, including, among other things:
We may not assure you that we will be able to open and operate new stores on a timely or sufficiently profitable basis or that opening new stores in markets we already serve will not harm existing store profitability or comparable store sales. The newly opened and existing stores' profitability will depend on our ability to properly merchandise, market and price the products required in their respective markets.
Furthermore, we may acquire stores or businesses from, make investments in, or enter into strategic alliances with, companies that have stores or distribution networks in our current markets or in areas into which we intend to expand our presence. Any future acquisitions, investments, strategic alliances or related efforts will be accompanied by risks, including:
We may not assure you that we will be successful in overcoming these risks or any other problems encountered with these acquisitions, investments, strategic alliances or related efforts. If we fail to successfully open and operate new stores or make strategic acquisitions or alliances, then our financial condition, results of operations and cash flows may be negatively impacted.
If overall demand for products sold by our stores slows, our business, financial condition, results of operations and cash flows will suffer.
Overall demand for products sold by our stores depends on many factors and may slow for any number of reasons, including:
If any of these factors cause overall demand for the products we sell to decline, our business, financial condition, results of operations and cash flows will suffer.
We depend on the services of many qualified team members and may not be able to attract and retain such qualified team members.>
Our success depends to a significant extent on the continued services and experience of our many team members. At February 25, 2008, we employed 44,065 team members. We cannot assure you that we will be able to retain our current qualified team members as well as attract and retain additional qualified team members that may be needed in the future. Our ability to maintain an adequate number of qualified team members is highly dependent on an attractive and competitive compensation and benefits package. If we fail to maintain such a package, our customer service and execution levels could suffer by reason of a declining quality of our workforce, which could adversely affect our financial condition, results of operations and cash flows.
If we are unable to compete successfully against other companies in the automotive aftermarket industry, we could lose customers and our revenues may decline.
The sale of automotive parts, accessories and maintenance items is highly competitive in many ways, including location, price, name recognition and customer service. We compete in both the DIY and DIFM categories of the automotive aftermarket industry, and primarily with (i) national and regional retail automotive parts chains, (ii) discount stores and mass merchandisers that carry automotive products, (iii) wholesalers or jobber stores, (iv) independent operators and (v) automobile dealers that supply parts. These competitors and the level of competition vary by market. Some of our competitors may possess advantages over us in certain markets we share, including a greater amount of marketing activities, a larger number of stores, longer operating histories, greater name recognition or larger and more established customer bases. Our response to these competitive disadvantages may require us to reduce our prices beyond our normal control or increase our promotional spending, which would lower revenue and profitability. Competitive disadvantages may also prevent us from introducing new product lines or require us to discontinue current product offerings or change some of our current operating strategies. If we do not have the resources or expertise or otherwise fail to develop successful strategies to address these competitive disadvantages, we could lose customers and our revenues may decline.
Disruptions in our relationships with vendors or in our vendors' operations could increase our cost of goods sold.
Our business depends on developing and maintaining close relationships with our vendors and upon the vendors' ability or willingness to sell quality products to us at favorable prices and terms. Many factors outside of our control may harm these relationships and the ability or willingness of these vendors to sell us products on favorable terms. For example, financial or operational difficulties that some of our vendors may face may increase the cost of the products we purchase from them or the ability for us to source product from them. In addition, the trend towards consolidation among automotive parts suppliers may disrupt or end our relationship with some vendors, and could lead to less competition and, consequently, higher prices.
Because we are involved in litigation from time to time, and are subject to numerous laws and governmental regulations, we could incur substantial judgments, fines, legal fees and other costs.
We are sometimes the subject of complaints or litigation from customers, employees or other third parties for various actions. From time to time, we are involved in litigation involving claims related to, among other things, breach of contract, tortious conduct, employment discrimination, payment of wages, asbestos exposure, real estate matters and product defects. The damages sought against us in some of these litigation proceedings are substantial. Although we maintain liability insurance for some litigation claims, if one or more of the claims greatly exceeds our coverage limits or our insurance policies do not cover a claim, it could have a material adverse affect on our business and operating results.
Additionally, we are subject to numerous federal, state and local laws and governmental regulations relating to employment matters, environmental protection, product quality standards and building and zoning requirements. If we fail to comply with existing or future laws or regulations, we may be subject to governmental or judicial fines or sanctions. In addition, our capital expenses could increase due to remediation measures that may be required if we are found to be noncompliant with any existing or future laws or regulations.
War or acts of terrorism or the threat of either may negatively impact availability of merchandise and adversely impact our sales.
War or acts of terrorism, or the threat of either, may have a negative impact on our ability to obtain merchandise available for sale in our stores. Some of our merchandise is imported from other countries. If imported goods become difficult or impossible to bring into the United States, and if we cannot obtain such merchandise from other sources at similar costs, our sales and profit margins may be negatively affected.
In the event that commercial transportation is curtailed or substantially delayed, our business may be adversely impacted, as we may have difficulty shipping merchandise to our distribution centers and stores.
Risks Relating to Our Financial Condition
The covenants governing our revolving and term loan facilities impose restrictions on us.
The terms of our revolving and term loan facilities impose operating and financial restrictions on us and our subsidiaries and require us to meet certain financial tests. These restrictions may also have a negative impact on our business, financial condition, results of operations and cash flows by significantly limiting or prohibiting us from engaging in certain transactions, including:
The failure to comply with any of these covenants would cause a default under our credit facilities. Furthermore, our credit facilities contain certain financial covenants, including a maximum leverage ratio and a minimum coverage ratio, which, if not maintained by us, will cause us to be in default under our credit facilities. Any of these defaults, if not waived, could result in the acceleration of all of our debt, in which case the debt would become immediately due and payable. If this occurs, we may not be able to repay our debt or borrow sufficient funds to refinance it. Even if new financing were available, it may be on terms that are less favorable or otherwise not acceptable to us.
The following table sets forth certain information relating to our distribution and other principal facilities:
At December 29, 2007, we owned 621 of our stores and leased 2,640 stores. The expiration dates, including the exercise of renewal options, of the store leases are summarized as follows:
We currently and from time to time are involved in litigation incidental to the conduct of our business, including litigation arising from claims of employment discrimination or other types of employment matters as a result of claims by current and former employees. Although we diligently defend against these claims, we may enter into discussions regarding settlement of these and other lawsuits, and may enter into settlement agreements, if we believe settlement is in the best interests of our shareholders. The damages claimed against us in some of these proceedings are substantial. Although the amount of liability that may result from these matters cannot be ascertained, we do not currently believe that, in the aggregate, they will result in liabilities material to our consolidated financial condition, future results of operations or cash flow.
Our Western Auto subsidiary, together with other defendants including automobile manufacturers, automotive parts manufacturers and other retailers, has been named as a defendant in lawsuits alleging injury as a result of exposure to asbestos-containing products. We and some of our other subsidiaries also have been named as defendants in many of these lawsuits. The plaintiffs have alleged that these products were manufactured, distributed and/or sold by the various defendants. To date, these products have included brake and clutch parts and roofing materials. Many of the cases pending against us or our subsidiaries are in the early stages of litigation. The damages claimed against the defendants in some of these proceedings are substantial. Additionally, some of the automotive parts manufacturers named as defendants in these lawsuits have declared bankruptcy, which will limit plaintiffs’ ability to recover monetary damages from those defendants. Although we diligently defend against these claims, we may enter into discussions regarding settlement of these and other lawsuits, and may enter into settlement agreements, if we believe settlement is in the best interests of our shareholders. We also believe that most of these claims are at least partially covered by insurance. Based on discovery to date, we do not believe the cases currently pending will have a material adverse effect on us. However, if we were to incur an adverse verdict in one or more of these claims and were ordered to pay damages that were not covered by insurance, these claims could have a material adverse effect on our operating results, financial position and liquidity. If the number of claims filed against us or any of our subsidiaries alleging injury as a result of exposure to asbestos-containing products increases substantially, the costs associated with concluding these claims, including damages resulting from any adverse verdicts, could have a material adverse effect on our operating results, financial position and liquidity in future periods.
Our common stock is listed on the New York Stock Exchange, or NYSE, under the symbol "AAP." The table below sets forth, for the fiscal periods indicated, the high and low sale prices per share for our common stock, as reported by the NYSE.
The closing price of our common stock on February 22, 2008 was $33.60. At February 25, 2008, there were 406 holders of record of our common stock.
On February 15, 2006, our Board of Directors declared a quarterly cash dividend, the first in our history. The $0.06 per share quarterly cash dividend has been declared in each quarter since its inception in fiscal 2006. Any payments of dividends in the future will be at the discretion of our Board of Directors and will depend upon our results of operations, earnings, capital requirements and other factors deemed relevant by our Board of Directors.
The following table sets forth the information with respect to repurchases of our common stock for the quarter ended December 29, 2007 (amounts in thousands, except per share amounts):
Equity Compensation Plan Information
The following table sets forth our shares authorized for issuance under our equity compensation plans at December 29, 2007.
Stock Price Performance
The following graph shows a comparison of our cumulative total return on our common stock, the Standard & Poor’s 500 Index and the Standard & Poor’s 500 Specialty Retail Index. The graph assumes that the value of an investment in our common stock and in each such index was $100 on December 28, 2002, and that any dividends have been reinvested. The comparison in the graph below is based solely on historical data and is not intended to forecast the possible future performance of our common stock.
COMPARISON OF CUMULATIVE TOTAL RETURN AMONG
ADVANCE AUTO PARTS, INC., S&P 500 INDEX
AND S&P 500 SPECIALTY INDEX
The following table sets forth our selected historical consolidated statement of operations, balance sheet and other operating data. The selected historical consolidated financial and other data at December 29, 2007 and December 30, 2006 and for the three years ended December 29, 2007 have been derived from our audited consolidated financial statements and the related notes included elsewhere in this report. The historical consolidated financial and other data at December 31, 2005, January 1, 2005 and January 3, 2004 and for the years ended January 1, 2005 and January 3, 2004 have been derived from our audited consolidated financial statements and the related notes that have not been included in this report. You should read this data along with "Management's Discussion and Analysis of Financial Condition and Results of Operations," and our consolidated financial statements and the related notes included elsewhere in this report.
The following discussion and analysis of financial condition and results of operations should be read in conjunction with "Selected Financial Data," our consolidated historical financial statements and the notes to those statements that appear elsewhere in this report. Our discussion contains forward-looking statements based upon current expectations that involve risks and uncertainties, such as our plans, objectives, expectations and intentions. Actual results and the timing of events could differ materially from those anticipated in these forward-looking statements as a result of a number of factors, including those set forth under “Forward Looking Statements” and "Risk Factors" elsewhere in this report.
Our fiscal year ends on the Saturday nearest December 31 of each year, which results in an extra week every several years (our next 53-week fiscal year is 2008). Our first quarter consists of 16 weeks, and the other three quarters consist of 12 weeks.
We primarily operate within the United States automotive aftermarket industry, which includes replacement parts (excluding tires), accessories, maintenance items, batteries and automotive chemicals for cars and light trucks (pickup trucks, vans, minivans and sport utility vehicles). We currently are the second largest specialty retailer of automotive parts, accessories and maintenance items to “do-it-yourself,” or DIY, and “do-it-for-me,” or DIFM, customers in the United States, based on store count and sales. At December 29, 2007, we operated 3,261 stores throughout 40 states.
We operate in two reportable segments: Advance Auto Parts, or AAP, and Autopart International, or AI. The AAP segment is comprised of our store operations within the United States, Puerto Rico and the Virgin Islands which operate under the trade names “Advance Auto Parts,” “Advance Discount Auto Parts” and “Western Auto.” At December 29, 2007, we operated 3,153 stores in the AAP segment, of which 3,123 stores operated under the trade names “Advance Auto Parts” and “Advance Discount Auto Parts” throughout 40 states in the Northeastern, Southeastern and Midwestern regions of the United States. These stores offer automotive replacement parts, accessories and maintenance items. In addition, we operated 30 stores under the “Western Auto” and “Advance Auto Parts” trade names, located in Puerto Rico and the Virgin Islands, or Offshore.
At December 29, 2007, we operated 108 stores in the AI segment under the “Autopart International” trade name. We acquired AI in September 2005, and AI operates as an independent, wholly-owned subsidiary. AI’s business primarily serves the commercial market from its store locations. In addition, its North American Sales Division services warehouse distributors and jobbers throughout North America.
The following table sets forth the total number of new, closed and relocated stores and stores with commercial delivery programs during fiscal 2007, 2006 and 2005. We lease approximately 81% of our stores.
We anticipate adding approximately 100 AAP and 15 AI stores during 2008.
Key Financial Metrics
The following table highlights certain consolidated operating results and key financial metrics for 2007, 2006 and 2005:
We recorded earnings per diluted share of $2.28 in fiscal 2007 compared to $2.16 for fiscal 2006. We continue to generate significant operating cash flow to allow us to invest in business initiatives and return capital to shareholders through cash dividends and share repurchases. We remain focused on increasing our sales, operating margins and return on invested capital and believe certain strategic initiatives introduced during 2007 are beginning to propel us toward achieving these goals. Specific updates on these initiatives, among other recent developments, during 2007 are discussed below:
New CEO> – We announced in November 2007 the appointment of a new CEO and President, Darren Jackson, which became effective in January 2008. Mr. Jackson, who previously served on our Audit Committee, Finance Committee and Board of Directors, had already been involved with management on the completion of certain strategic studies during 2007 and the formulation of certain initiatives discussed below.
Sales Initiatives – We believe our biggest opportunity is increasing our top line sales growth as we develop initiatives around a more customer-focused strategy and increased parts availability and related knowledge by the team members in our stores. Our sales per square foot and sales per employee are currently in the bottom half of the automotive aftermarket industry. In 2007, we began implementing our plan to increase DIY and DIFM sales through improving parts availability with an emphasis on late model and foreign vehicles. Our enhanced parts availability will be funded partially from available working capital as we transition from other less productive inventory.
We believe our DIFM business has started to improve as indicated by an 8.2% comparable store sales increase during the fourth quarter, although we continue to face a challenging macroeconomic environment, including higher fuel and credit costs faced by our customers, higher unemployment and lower consumer confidence. In order to structure our DIFM business for further growth, we continue to examine store staffing and training, compensation policies and truck utilization. Commercial sales represented approximately 27% of our total sales for fiscal 2007 as compared to approximately 25% for fiscal 2006. At December 29, 2007, we operated commercial programs in 83% of our total AAP stores compared to 81% for the prior fiscal year. Lastly, we began improving the productivity and efficiency of our sales floor in our stores by aligning functions performed by our sales associates with our increased parts focus, including the transition of less productive inventory.
SG&A Structure> – We took significant steps towards reducing and reallocating our selling, general and administrative expense structure during the second half of 2007. We eliminated 250 positions at our store support center and other field support areas and terminated our Advance TV network, which together resulted in $6.3 million of expense recognized in our 2007 operating results. Additionally, we reduced our real estate development by opening fewer new stores, relocating fewer stores and halting the 2010 store remodel program. During the fourth quarter of 2007, we introduced a 6,000 square foot prototype store. We believe this smaller model can support an adequate level of parts availability for both our DIY and DIFM customers while reducing our occupancy costs as a percentage of sales.
Lastly, we completed the further reduction and reallocation of certain advertising expenditures into a more focused effort in electronic media. We have recently introduced a new brand, “Keep the Wheels Turning.” This campaign was developed as part of our overall strategic review of the business as well as extensive research conducted with our customers and team members. We believe this campaign, which targets both DIY and DIFM customers, differentiates Advance Auto Parts in our industry by positioning us as the source for brand name parts and products and as the resource for expert advice and knowledge to help customers keep their vehicles running. The campaign includes creative and compelling television and radio commercials designed to drive sales and build an enduring, positive image of Advance Auto Parts. Due to the reallocation of our advertising expenditures, we expect 2008 advertising expense to remain generally consistent with 2007 levels.
Return on Invested Capital Improvements – We eliminated certain information technology, logistics and other investments that did not demonstrate acceptable returns. During the second half of 2007, we halted our store remodel program while we more closely examine the sales results and overall return from these remodels. Additionally, we have delayed the opening of our ninth distribution center to the beginning of 2010 as a result of fewer new store openings planned throughout 2008.
Stock Repurchase Program –> During 2007, our Board of Directors authorized a new stock repurchase program of up to $500 million of our common stock plus related expenses. The program, which became effective August 8, 2007, replaced the remaining portion of a $300 million stock repurchase program. During 2007, we repurchased 8.3 million shares of common stock for $286 million. Refer to further discussion of this program in the Liquidity section of this management’s discussion and analysis.
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.
The preparation of our financial statements included the following significant estimates.
We receive incentives from vendors as a result of purchasing and promoting their products through a variety of programs, including cooperative advertising allowances, volume rebates and other promotional incentives. We account 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. Cooperative advertising allowances and volume rebates are earned based on inventory purchases and initially recorded as a reduction to inventory. The deferred amounts are included as a reduction to cost of sales as the inventory is sold.
We recognize other promotional incentives earned under long-term agreements as a reduction to cost of sales. These incentives are recognized based on the cumulative net purchases as a percentage of total estimated net purchases over the life of the agreement. Our margins could be impacted positively or negatively if actual purchases or results from any one year differ from our 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 agreements.
Amounts received or receivable from vendors that are not yet earned are reflected as deferred revenue. Management's estimate of the portion of deferred revenue that will be realized within one year of the balance sheet date is included in other current liabilities. Earned amounts that are receivable from vendors are included in receivables except for that portion expected to be received after one year, which is included in other assets.
We establish reserves for inventory shrink, as an increase to our cost of sales, for our stores and distribution centers based on our extensive and frequent cycle counting program. Our estimates of these shrink reserves depend on the accuracy of the program, which is dependent on compliance rates of our facilities and the execution of the required procedures. We evaluate the accuracy of this program on an ongoing basis and believe it provides reasonable assurance for the established reserves. If estimates regarding our cycle counting program are inaccurate, we may be exposed to losses or gains that could be material.
We have recorded reserves for potentially excess and obsolete inventories based on current inventory levels and historical analysis of product sales and current market conditions. The nature of our inventory is such that the risk of obsolescence is minimal and excess inventory has historically been returned to our vendors for credit. We provide reserves where less than full credit is expected from a vendor or where we anticipate that items will be sold at retail prices that are less than recorded cost. We develop these estimates based on the determination of return privileges with vendors, the level of credit provided by the vendor and management’s estimate of the discounts to recorded
cost, if any, required by market conditions. Our total inventory reserves increased by $4.2 million in fiscal 2007 compared to fiscal 2006 primarily as the result of an increase in our total shrinkage, as a percentage of sales.
Future changes by vendors in their policies or willingness to accept returns of excess inventory could require us to revise our estimates of required reserves for excess and obsolete inventory and result in a negative impact on our consolidated statement of operations. A 10% difference in actual inventory reserves at December 29, 2007 would have affected net income by approximately $2.2 million.
Our vendors are primarily responsible for warranty claims. We are responsible for merchandise sold under warranty which is not covered by vendor warranties (primarily batteries). We record a reserve for future warranty claims as an increase in our cost of sales based on current sales of the warranted products and historical claim experience. If claims experience differs from historical levels, revisions in our estimates may be required, which could have an impact on our consolidated statement of operations. Our warranty reserves increased by $4.7 million in fiscal 2007 compared to fiscal 2006. This increase was primarily due to an increase in our defective return rate as well as an increase in the sale of premium batteries. A 10% change in the warranty reserves at December 29, 2007 would have affected net income by approximately $1.1 million for the fiscal year ended December 29, 2007.
We are self-insured for general and automobile liability, workers' compensation and the health care claims of our team members, although we maintain stop-loss coverage with third-party insurers to limit our total liability exposure. Our self-insurance program, started in 2001, has not reached full maturity. A reserve for liabilities associated with these losses is established for claims filed and claims incurred but not yet reported using actuarial methods followed in the insurance industry and our historical claims experience. Each year, our reserve for self-insurance increases over the prior year because each year adds an additional layer of reserves without an equal amount of prior year reserves being fully relieved. Generally, claims have historically taken several years to settle and thus are not relieved at the same rate as additional reserves are added each year. Our self-insurance reserves increased by $14.0 million in fiscal 2007 compared to fiscal 2006. This increase was primarily the result of the increase in the number of workers’ compensation claims and automobile accident claims as well as an increase in the total cost to settle workers’ compensation claims as compared to the prior year. The increase in the number of claims is driven by overall growth, including an increase in total number of stores, employees and commercial delivery vehicles.
While we do not expect the amounts ultimately paid to differ significantly from our estimates, our self-insurance reserves and corresponding selling, general and administrative expenses could be affected if future claim experience differs significantly from historical trends and actuarial assumptions. A 10% change in our self-insurance liabilities at December 29, 2007 would have affected net income by approximately $5.3 million for the fiscal year ended December 29, 2007.
The determination of our income tax liabilities is based upon the tax code, regulations and pronouncements of the taxing jurisdictions in which we do business. Our income tax returns are periodically examined by those jurisdictions. These examinations include, among other things, auditing our filing positions, the timing of deductions and allocation of income among the various jurisdictions. At any particular time, multiple years are subject to examination by various taxing authorities.
The accounting for our tax reserves changed with the adoption of FIN 48, “Accounting for Uncertainty in Income Taxes,” or FIN 48, on December 31, 2006. Refer to Note 12 for further discussion of the impact of adopting FIN 48 and change in reserves during fiscal 2007.
In evaluating our income tax positions, we record reserves for potential exposures. These tax reserves are adjusted in the period actual developments give rise to such change. Those developments could be, but are not limited to; settlement of tax audits, expiration of the statute of limitations, and the evolution of tax code and
regulations, along with varying application of tax policy and administration within those jurisdictions.
These tax reserves contain uncertainties because management is required to make assumptions and apply judgment to estimate exposures associated with our various filing positions. Although management believes that the judgments and estimates are reasonable, actual results could differ and the company may be exposed to gains or losses that could be material. To the extent that actual results differ from our estimates, the effective tax rate in any particular period could be materially affected. Favorable tax developments would be recognized as a reduction in our effective tax rate in the period of resolution. Unfavorable tax developments would require an increase in our effective tax rate and a possible use of cash in the period of resolution. A 10% change in the tax reserves at December 29, 2007 would have affected net income by approximately $1.4 million for the fiscal year ended December 29, 2007.
Components of Statement of Operations
Net sales consist primarily of comparable store sales and new store net sales. We calculate comparable store 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 from comparable store sales the net sales from the Offshore and AI stores.
Cost of Sales
Our cost of sales consists of merchandise costs, net of incentives under vendor programs; inventory shrinkage, defective and warranty costs; 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, vendor programs, inventory shrinkage, defective and warranty costs and warehouse and distribution costs. We seek to minimize fluctuations in merchandise costs and instability of supply by entering into long-term purchasing agreements, without minimum purchase volume requirements, with vendors when we believe it is advantageous. Our gross profit may not be comparable to those of our competitors due to differences in industry practice regarding the classification of certain costs. See Note 2 in our consolidated financial statements for additional discussion of these costs.
Selling, General and Administrative Expenses
Selling, general and administrative expenses consist of store payroll, store occupancy (including rent), advertising expenses, other store expenses and general and administrative expenses, including salaries and related benefits of store support center team members, share-based compensation expense, store support center administrative office expenses, data processing, professional expenses and other related expenses.
Consolidated Results of Operations
The following table sets forth certain of our operating data expressed as a percentage of net sales for the periods indicated.