Advance Auto Parts Inc: Form 10-Q for the period ended Oct 8, 2022

The following discussion and analysis of financial condition and results of operations should be read in conjunction with the audited consolidated financial statements and notes included in our Annual Report on Form 10-K for the year ended January 1, 2022 (filed with the SEC on February 15, 2022), which we refer to as our 2021 Form 10-K, and our condensed consolidated financial statements and the notes to those statements that appear elsewhere in this report.

Management Overview

Net sales increased 0.8% in the third quarter of 2022 compared with the same period in the prior year, primarily driven by improvements in strategic pricing and growth in new store openings. Comparable store sales decreased 0.7% for the quarter primarily due to owned brand penetration. Category growth was led by batteries, fluids and chemicals and brakes.

We generated Diluted earnings per share (“Diluted EPS”) of $1.84 during our third quarter of 2022, inclusive of foreign currency impact of $0.20 per diluted share, compared with $2.68 for the comparable period of 2021. When adjusted for non-operational items outlined in the following table, our Adjusted diluted earnings per share (“Adjusted EPS”), a non-GAAP measure, for the twelve weeks ended October 8, 2022 and October 9, 2021 was $2.84 and $3.21.

Refer to “Reconciliation of Non-GAAP Financial Measures” for a definition and reconciliation of Adjusted EPS and other non-GAAP measures to the most directly comparable financial measures calculated and presented in accordance with GAAP.

A high-level summary of our financial results for the third quarter of 2022 includes:

• Net sales during the third quarter of 2022 was $2.64 billion, an increase of 0.8% compared with the third quarter of 2021, driven by improvements in strategic pricing and growth in new store openings. Comparable store sales decreased 0.7% primarily driven by an increase in owned brand penetration.
• Gross profit margin for the third quarter of 2022 was 44.7% of Net sales, a decrease of 44 basis points compared with the third quarter of 2021. Gross profit margin was negatively impacted by inflationary product costs, including the impact of LIFO related expenses, unfavorable channel mix and supply chain headwinds due to inflation in labor and transportation costs. These costs were partially offset by improvements in strategic pricing and owned brand expansion.
• Selling, General & Administrative (“SG&A”) expenses for the third quarter of 2022 were 38.0% of Net sales, an increase of 159 basis points compared with the third quarter of 2021. This increase was primarily driven by inflation in store labor, medical and fuel costs.

Business and Risks Update

We continue to make progress on the various elements of our strategic business plan, which is focused on improving the customer experience, margin expansion and driving consistent execution for both professional and DIY customers. To achieve these improvements, we have undertaken planned strategic initiatives to help build a foundation for long-term success across the organization, which include:

• Continued development of a demand-based assortment, leveraging purchase and search history from our common catalog, versus our existing push-down supply approach.
• Advancement towards optimizing our footprint by market, including consolidating our Worldpac and Autopart International businesses, to drive share, repurpose our in-market store and asset base and streamline our distribution network.
• Continued evolution of our marketing campaigns, which focus on our customers and how we serve them every day with care and speed and the iconic DieHard® brand.
• Progress in the implementation of a more efficient end-to-end supply chain process to deliver our broad assortment and to help lessen the impact of external constraints.
• Enhancement of Advance Same Day® Curbside Pick Up, Advance Same Day® Home Delivery and our mobile application and e-commerce performance.
• Actively pursuing new store openings, including through lease acquisition opportunities as available and appropriate, in existing markets and new markets, as well as expansion of our independent Carquest network.
• Continued negotiations with vendors on strategic sourcing and pricing to help mitigate inflationary pressures.

Industry Update

Operating within the automotive aftermarket industry, we are influenced by a number of general macroeconomic factors, many of which are similar to those affecting the overall retail industry, and include but are not limited to:

• Inflationary pressures, including logistics and labor
• Global supply chain disruptions
• Rising fuel costs
• Miles driven
• Unemployment rates
• Consumer confidence and purchasing power
• Competition
• Changes in new car sales
• Economic and geopolitical uncertainty
• Increased foreign currency exchange volatility

Stores and Branches

Key factors in selecting sites and market locations in which we operate include population, demographics, traffic count, vehicle profile, competitive landscape and the cost of real estate. During the forty weeks ended October 8, 2022, 115 stores and branches were opened and 27 were closed or consolidated, resulting in a total of 5,060 stores and branches compared with a total of 4,972 stores and branches as of January 1, 2022.

Results of Operations

($ in millions)

Note: Table amounts may not foot due to rounding.

($ in millions)

Note: Table amounts may not foot due to rounding.

Net Sales

Net sales for the twelve weeks ended October 8, 2022 increased 0.8% compared with the same period in 2021, driven by improvements in strategic pricing and growth in new store openings. Comparable store sales decreased 0.7% for the twelve weeks ended October 8, 2022 compared with the twelve weeks ended October 9, 2021, primarily driven by owned brand penetration. Category growth was led by batteries, fluids and chemicals and brakes.

Net sales for the forty weeks ended October 8, 2022 increased 0.9% compared with the same period in 2021, driven by improvements in strategic pricing and growth in new store openings, partially offset by softness in our DIY omnichannel. Comparable store sales declined slightly for the forty weeks ended October 8, 2022 compared with the forty weeks ended October 9, 2021. Category growth was led by fluids and chemicals as well as batteries.

We calculate comparable store sales based on the change in store or branch sales starting once a location has been open for 13 complete accounting periods (approximately one year) and by including e-commerce sales. Sales to independently owned Carquest stores are excluded from our comparable store sales. Acquired stores are included in our comparable store sales once the stores have completed 13 complete accounting periods following the acquisition date. We include sales from relocated stores in comparable store sales from the original date of opening.

Gross Profit

Gross profit for the twelve weeks ended October 8, 2022 was $1.18 billion, or 44.7% of Net sales, compared with $1.18 billion, or 45.1% of Net sales, for the twelve weeks ended October 9, 2021. During the twelve weeks ended October 8, 2022,

Gross profit margin was negatively impacted by inflationary product costs, including the impact of LIFO related expenses, unfavorable channel mix and supply chain headwinds due to increases in labor and transportation costs. These costs were primarily offset by improvements in strategic pricing as well as owned brand expansion.

Gross profit for the forty weeks ended October 8, 2022 was $3.87 billion, or 44.6% of Net sales, compared with $3.86 billion, or 44.8% of Net sales, for the forty weeks ended October 9, 2021. This decrease in Gross profit as a percentage of Net sales was primarily due to inflationary product costs, including the impact of LIFO related expenses and unfavorable channel mix, partially offset by strategic pricing, product mix and owned brand expansion.

As a result of changes in our LIFO reserve, an expense of $67.5 million and $29.4 million were included in the twelve weeks ended October 8, 2022 and October 9, 2021. An expense of $240.8 million and $71.6 million were included in the forty weeks ended October 8, 2022 and October 9, 2021.

Selling, General and Administrative Expenses

SG&A expenses for the twelve weeks ended October 8, 2022 were $1.0 billion, or 38.0% of Net sales, compared with $1.0 billion, or 36.4% of Net sales, for the twelve weeks ended October 9, 2021. The increase in SG&A as a percentage of Net sales for the twelve weeks ended was primarily driven by inflation in store labor, medical and fuel costs.

SG&A expenses for the forty weeks ended October 8, 2022 were $3.29 billion, or 37.9% of Net sales, compared with $3.13 billion, or 36.4% of Net sales, for the forty weeks ended October 9, 2021. For the forty weeks ended October 8, 2022, the increase was primarily driven by inflation in store labor and fuel costs as well as costs related to new store openings. These costs were partially offset by a year over year decrease in incentive compensation and COVID-19 related expenses.

Loss on Early Redemption of Senior Unsecured Notes

During the forty weeks ended October 8, 2022, we incurred charges related to a make-whole provision and debt issuance costs of $7.0 million and $0.4 million in connection with the early redemption of our 4.50% senior unsecured notes due December 1, 2023 (“2023 Notes”).

Provision for Income Taxes

Our Provision for income taxes for the twelve weeks ended October 8, 2022 was $36.4 million, compared with $52.6 million for the twelve weeks ended October 9, 2021. Our effective tax rate was 24.7% and 23.7% for the twelve weeks ended October 8, 2022 and October 9, 2021. The decrease in tax expense primarily resulted from lower Income before provision for income taxes compared with prior year.

Our Provision for income taxes for the forty weeks ended October 8, 2022 was $126.1 million, compared with $171.5 million for the forty weeks ended October 9, 2021. Our effective tax rate was 24.2% and 24.3% for the forty weeks ended October 8, 2022 and October 9, 2021. The decrease in tax expense resulted from lower Income before provision for income taxes compared with prior year.

Reconciliation of Non-GAAP Financial Measures

“Management’s Discussion and Analysis of Financial Condition and Results of Operations” includes certain financial measures not derived in accordance with accounting principles generally accepted in the United States of America (“GAAP”). Non-GAAP financial measures, including Adjusted net income and Adjusted EPS, should not be used as a substitute for GAAP financial measures, or considered in isolation, for the purpose of analyzing our operating performance, financial position or cash flows. We have presented these non-GAAP financial measures as we believe that the presentation of our financial results that exclude (1) LIFO impacts; (2) transformation expenses under our strategic business plan; (3) non-cash amortization related to the acquired GPI intangible assets; and (4) other non-recurring adjustments are useful and indicative of our base operations because the expenses vary from period to period in terms of size, nature and significance and/or relate to store closure and consolidation activity in excess of historical levels. These measures assist in comparing our current operating results with past periods and with the operational performance of other companies in our industry. The disclosure of these measures allows investors to evaluate our performance using the same measures management uses in developing internal budgets and forecasts and in evaluating management’s compensation. Included below is a description of the expenses we have determined are not normal, recurring cash operating expenses necessary to operate our business and the rationale for why providing these measures is useful to investors as a supplement to the GAAP measures.

LIFO Impacts — To assist in comparing our current operating results with the operational performance of other companies in our industry, the impact of LIFO on our results of operations is a reconciling item to arrive at non-GAAP financial measures.

Transformation Expenses — Costs incurred in connection with our business plan that focuses on specific transformative activities that relate to the integration and streamlining of our operating structure across the enterprise, that we do not view to be normal cash operating expenses. These expenses include, but are not limited to the following:

• Restructuring costs - Costs primarily relating to the early termination of lease obligations, asset impairment charges, other facility closure costs and team member severance in connection with our voluntary retirement program and continued optimization of our organization.
• Third-party professional services - Costs primarily relating to services rendered by vendors for assisting us with the development of various information technology and supply chain projects in connection with our enterprise integration initiatives.
• Other significant costs - Costs primarily relating to accelerated depreciation of various legacy information technology and supply chain systems in connection with our enterprise integration initiatives and temporary off-site workspace for project teams who are primarily working on the development of specific transformative activities that relate to the integration and streamlining of our operating structure across the enterprise.

GPI Amortization of Acquired Intangible Assets — As part of our acquisition of GPI, we obtained various intangible assets, including customer relationships, non-compete contracts and favorable lease agreements, which we expect to be subject to amortization through 2025.

We have included a reconciliation of this information to the most comparable GAAP measures in the following table:

(in thousands, except per share data)

(1) During the forty weeks ended October 8, 2022, we incurred charges related to a make-whole provision and debt issuance costs of $7.0 million and $0.4 million, in connection with the early redemption of our 2023 Notes.

(2) The income tax impact of non-GAAP adjustments is calculated using the estimated tax rate in effect for the respective non-GAAP adjustments.

Liquidity and Capital Resources

Overview

Our primary cash requirements necessary to maintain our current operations include payroll and benefits, inventory purchases, contractual obligations, capital expenditures, payment of income taxes, funding of initiatives under our strategic business plan and other operational priorities, including payment of interest on our long-term debt. Historically, we have used available funds to repay borrowings under our credit facility, to periodically repurchase shares of our common stock under our stock repurchase program, to pay our quarterly cash dividends and for acquisitions; however, in consideration of ongoing uncertainties related to general global macroeconomic conditions, our future uses of cash may differ if our relative priorities, including the weight we place on the preservation of cash and liquidity, change. Typically, we have funded our cash requirements primarily through cash generated from operations, supplemented by borrowings under our credit facilities and notes offerings as needed. We believe funds generated from our results of operations, available cash and cash equivalents and available borrowings under our credit facility will be sufficient to fund our obligations for the long term.

On March 4, 2022, we issued our 3.50% senior unsecured notes due 2032 (the “2032 Notes”). Refer to Note 6. Long-term Debt and Fair Value of Financial Instruments of the Notes to the Condensed Consolidated Financial Statements included herein for further details. Proceeds from our 2032 Notes were utilized to fund the early redemption of our 2023 Notes and supplement operational and capital expenditures.

Share Repurchase Program

On February 8, 2022, our Board of Directors authorized an additional $1.0 billion towards the existing share repurchase program. This authorization is incremental to the $1.7 billion that was previously authorized by our Board of Directors. Our share repurchase program permits the repurchase of our common stock on the open market and in privately negotiated transactions from time to time.

During the twelve weeks ended October 8, 2022 and October 9, 2021, we repurchased 0.4 million and 1.1 million shares of our common stock under our share repurchase program at an aggregate cost of $75.0 million and $228.3 million, or an average price of $168.93 and $205.65 per share. During the forty weeks ended October 8, 2022 and October 9, 2021, we repurchased 2.5 million and 4.2 million shares of our common stock under our share repurchase program. The shares repurchased in connection with our share repurchase program during the forty weeks ended October 8, 2022 and October 9, 2021 were at an aggregate cost of $523.2 million and $791.7 million, or an average price of $207.50 and $189.43 per share. We had $1.0 billion remaining under our share repurchase program as of October 8, 2022.

Analysis of Cash Flows

The following table summarizes our cash flows from operating, investing and financing activities:

(in thousands)

Operating Activities

For the forty weeks ended October 8, 2022, Cash flows provided by operating activities decreased by $441.8 million to $483.1 million compared with the same period of prior year. The net decrease in operating cash flows was primarily driven by lower Net income and a decrease in overall working capital compared with the same period of prior year. The decrease in working capital was primarily driven by an increase in cash used by Inventories, attributable to direct product cost increases driven by inflationary pressures and an increase of inventory on hand.

Investing Activities

For the forty weeks ended October 8, 2022, Cash flows used in investing activities increased by $142.9 million to $331.8 million compared with the same period of prior year. Cash used in investing activities for the forty weeks ended October 8, 2022 consisted primarily of purchases of property and equipment of $333.6 million attributable to investments in information technology, as we remain focused on a complete back office integration throughout the enterprise, as well as investments in leasehold improvements for new store openings.

Financing Activities

For the forty weeks ended October 8, 2022, Cash flows used in financing activities was $545.8 million, a decrease of $422.9 million compared with the same period of prior year. The net decrease in cash used in financing activities was attributable to net proceeds received from the issuance of the 2032 Notes, a decrease in share repurchases of our common stock of $266.9 million and proceeds from net borrowings under our unsecured revolving credit facility of $185.0 million during the forty weeks ended October 8, 2022. The decrease in cash used was partially offset by the early redemption of our 2023 Notes and an increase in dividends paid of $175.3 million during the forty weeks ended October 8, 2022 compared with the forty weeks ended October 9, 2021.

Our Board of Directors has declared a cash dividend every quarter since 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, cash flows, capital requirements and other factors deemed relevant by our Board of Directors.

Long-Term Debt

On March 4, 2022, we issued $350.0 million aggregate principal amount of our 2032 Notes. The 2032 Notes were issued at 99.61% of the principal amount of $350.0 million, are due March 15, 2032 and bear interest at 3.50% per year payable semi-annually in arrears on March 15 and September 15 of each year.

On April 3, 2022, we redeemed the remaining $193.2 million principal amount of our outstanding 2023 Notes. In connection with this early redemption, we incurred charges related to the make-whole provision and debt issuance costs of $7.0 million and $0.4 million.

For additional information, refer to Note 6. Long-term Debt and Fair Value of Financial Instruments of the Notes to the Condensed Consolidated Financial Statements included herein.

As of October 8, 2022, we had a credit rating from Standard & Poor’s of BBB- and from Moody’s Investor Service of Baa2. The current outlooks by Standard & Poor’s and Moody’s are positive and stable. The current pricing grid used to determine our borrowing rate under the Credit Agreement is based on our credit ratings. If these credit ratings decline, our interest rate on outstanding balances may increase and our access to additional financing on favorable terms may be limited. In addition, declines could reduce the attractiveness of certain vendor payment programs whereby third-party institutions finance arrangements to our vendors based on our credit rating, which could result in increased working capital requirements. Conversely, if these credit ratings improve, our interest rate may decrease.

With respect to all senior unsecured notes for which Advance Auto Parts, Inc. (“Issuer”) is an issuer or provides full and unconditional guarantee, Advance Stores, a wholly owned subsidiary of the Issuer, serves as the guarantor (“Guarantor Subsidiary”). The subsidiary guarantees related to our senior unsecured notes are full and unconditional and joint and several, and there are no restrictions on the ability of the Issuer to obtain funds from its Guarantor Subsidiary. Our captive insurance subsidiary, an insignificant wholly owned subsidiary of the Issuer, does not serve as guarantor of our senior unsecured notes.

Critical Accounting Policies and Estimates

Our financial statements have been prepared in accordance with GAAP. 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 materially from these estimates.

During the forty weeks ended October 8, 2022, there were no changes to the critical accounting policies discussed in our 2021 Form 10-K. For a complete discussion of our critical accounting policies, refer to the 2021 Form 10-K.

There have been no significant changes in our exposure to market risk since January 1, 2022. Refer to “Item 7A. Quantitative and Qualitative Disclosures about Market Risk” in our 2021 Form 10-K.

Disclosure Controls and Procedures

Disclosure controls and procedures (as that term is defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”)), are our controls and other procedures that are designed to ensure that information required to be disclosed by us in our reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms, and that such information is accumulated and communicated to our management, including our principal executive officer and principal financial officer, as appropriate to allow timely decisions regarding required disclosure. Internal controls over financial reporting, no matter how well designed, have inherent limitations, including the possibility of human error and the override of controls. Therefore, even those systems determined to be effective can provide only “reasonable assurance” with respect to the reliability of financial reporting and financial statement preparation and presentation. Further, because of changes in conditions, the effectiveness of our internal controls may vary over time.

Our management evaluated, with the participation of our principal executive officer and principal financial officer, the effectiveness of our disclosure controls and procedures as of October 8, 2022. Based on this evaluation, our principal executive officer and our principal financial officer have concluded that, as of the end of the period covered by this report, our disclosure controls and procedures were effective to accomplish their objectives at the reasonable assurance level.

Changes in Internal Control Over Financial Reporting

There were no changes in our internal control over financial reporting that occurred during our quarter ended October 8, 2022 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

Please refer to “Item 1A. Risk Factors” found in our 2021 Form 10-K filed for the year ended January 1, 2022 for risks that, if they were to occur, could materially adversely affect our business, financial condition, results of operations, cash flows and future prospects, which could in turn materially affect the price of our common stock.