ADVANCE AUTO PARTS, INC. 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 endedDecember 28, 2019 (filed with theSEC onFebruary 18, 2020 ), which we refer to as our 2019 Form 10-K, and our condensed consolidated financial statements and the notes to those statements that appear elsewhere in this report.
Impact of COVID-19 on Our Business
During the COVID-19 pandemic we are prioritizing protecting the health and safety of our Team Members and customers; working to drive financial performance by preserving our cash position, scrutinizing planned spending and prioritizing various initiatives; and working to help ensure that when the current period of crisis passes, our team will emerge even stronger. In response to the COVID-19 pandemic, we have continued to take additional measures to help ensure the health and safety of our Team Members and customers. Such measures include retro-fitting our stores with plexiglass care shields, the continuation of certain labor-related benefits for Team Members, social distancing practices, sanitation practices, the use of health check screenings and offering contactless delivery. Government imposed restrictions and stay at home orders related to the pandemic occurred during our first quarter of 2020. These contributed to negative impacts to demand, primarily during the last six weeks of the sixteen weeks endedApril 18, 2020 . However, as the second and third quarters of 2020 progressed, we experienced a significant improvement in demand, particularly in our DIY Omnichannel business, that we believe was largely attributable to higher overall industry demand driven by external factors such as government stimulus, an increase in unemployment benefits, consumers' preference to use personal vehicles rather than public transportation and other factors that may have contributed to an increase in DIY automotive projects. In addition to these external factors, we believe the execution of prioritized internal initiatives, including our new marketing campaign and providing a variety of shopping choices for customers with our Advance Same Day options, contributed to the improvement in demand. We have also continued to make progress on the development of our key supply chain initiatives, including cross-banner replenishment and our single warehouse management system. Despite the increase in Net sales during the twelve and forty weeks endedOctober 3, 2020 , the COVID-19 pandemic remains an evolving situation. We continue to actively monitor developments that may cause us to take further actions that alter our business operations as may be required by federal, state or local authorities or that we determine are in the best interests of our Team Members, customers, suppliers and stockholders.
Management Overview
Net sales increased 9.9% in the third quarter of 2020 as compared to the same period in the prior year, primarily driven by an increase in comparable store sales resulting from growth in our DIY Omnichannel business. We experienced positive comparable store sales across every region, with theGulf Coast , Central and Southeast regions having the strongest growth. While still positive, the Northeast Mid-Atlantic andWest Coast regions had the lowest comparable store sales growth. We generated diluted earnings per share ("diluted EPS") of$2.13 during our third quarter of 2020 compared to$1.75 for the comparable period of 2019. When adjusted for the following non-operational items, our adjusted diluted earnings per share ("Adjusted EPS") for the twelve weeks endedOctober 3, 2020 andOctober 5, 2019 were$2.81 and$2.10 . Twelve Weeks Ended Forty Weeks Ended October 3, 2020 October 5, 2019 October 3, 2020 October 5, 2019 Transformation expenses$ 0.09 $ 0.28$ 0.39 $ 0.63General Parts International, Inc. ("GPI") amortization of acquired intangible assets 0.07 0.07 0.23 0.21 Other adjustments 0.52 - 0.52 0.25
Refer to "Reconciliation of Non-GAAP Financial Measures" for further details of our comparable adjustments and the usefulness of such measures to investors.
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Table of Contents
Summary of Third Quarter Financial Results
A high-level summary of our financial results for the third quarter of 2020 includes:
•Net sales during the third quarter of 2020 were$2.5 billion , an increase of 9.9% as compared to the third quarter of 2019, primarily driven by an increase in comparable store sales of 10.2%, led by growth in our DIY Omnichannel business. •Gross profit margin for the third quarter of 2020 was 44.4% of Net sales, an increase of 63 basis points as compared to the third quarter of 2019. This increase was primarily due to favorable channel mix, including growth in our DIY Omnichannel business, supply chain efficiencies and favorable pricing actions. •SG&A expenses for the third quarter of 2020 were 34.3% of Net sales, a favorable impact of 202 basis points as compared to the third quarter of 2019. This favorable impact was primarily due to our ability to leverage payroll and rent expenses and lower incident rate and claims that we attribute to continued focus on employee safety. 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 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 ourWorldpac andAutopart International businesses, to drive share, repurpose our in-market store and asset base and streamline our distribution network. •Continued development of our marketing campaigns, which focus on our customers and how we serve them every day with care and speed and the launch of the iconic DieHard® brand. •Progress in the development of a more efficient end-to-end supply chain to deliver our broad assortment. •Enhancement of 'Advance Same Day' Curbside Pick Up, 'Advance Same Day' Home Delivery and our mobile application and eCommerce performance.
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. For a complete discussion of these factors, refer to our 2019 Form 10-K, as updated by our subsequent filings with theSEC , including our Form 10-Q filed for the quarterly period endedApril 18, 2020 , and the "Impact of COVID-19 on Our Business" section included within this Form 10-Q. Stores and Branches Key factors in selecting sites and market locations in which we operate include population, demographics, traffic count, vehicle profile, number and strength of competitors' stores and the cost of real estate. During the forty weeks endedOctober 3, 2020 , 10 stores and branches were opened and 68 were closed or consolidated, resulting in a total of 4,979 stores and branches as ofOctober 3, 2020 , compared to a total of 5,037 stores and branches as ofDecember 28, 2019 . 15 -------------------------------------------------------------------------------- Table of Contents Results of Operations Twelve Weeks Ended (in millions) October 3, 2020 October 5, 2019 $ Increase/(Decrease) Basis Points Net sales$ 2,541.9 100.0 %$ 2,312.1 100.0 % $ 229.8 - Cost of sales 1,413.5 55.6 1,300.2 56.2 113.3 (63) Gross profit 1,128.5 44.4 1,011.9 43.8 116.5 63 SG&A 871.7 34.3 839.6 36.3 32.1 (202) Operating income 256.8 10.1 172.3 7.5 84.5 265 Interest expense (11.9) (0.5) (8.4) (0.4) (3.5) (10) Loss on early redemptions of senior unsecured notes (48.0) (1.9) 0.0 0.0 (48.0)
(189)
Other income (expense), net 0.7 0.0 (3.1) (0.1) 3.8
16
Provision for income taxes 50.1 2.0 37.1 1.6 13.0 37 Net income$ 147.5 5.8 %$ 123.7 5.3 % $ 23.8 45 Forty Weeks Ended (in millions) October 3, 2020 October 5, 2019 $ Increase/(Decrease) Basis Points Net sales$ 7,741.2 100.0 %$ 7,596.4 100.0 % $ 144.8 - Cost of sales 4,343.3 56.1 4,270.4 56.2 72.9 (11) Gross profit 3,397.9 43.9 3,326.0 43.8 71.9 11 SG&A 2,799.8 36.2 2,774.9 36.5 24.9 (36) Operating income 598.1 7.7 551.0 7.3 47.0 47 Interest expense (37.6) (0.5) (32.1) (0.4) (5.5) (6) Loss on early redemptions of senior unsecured notes (48.0) (0.6) (10.8) (0.1) (37.2)
(48)
Other (expense) income, net (2.2) 0.0 9.5 0.1 (11.7)
(15)
Provision for income taxes 129.2 1.7 126.7 1.7 2.5 - Net income$ 381.0 4.9 %$ 391.0 5.1 % $ (10.0) (23)
Note: Table amounts may not foot due to rounding.
Net sales for the twelve weeks endedOctober 3, 2020 increased 9.9% as compared to the same period of 2019, primarily driven by an increase in comparable store sales resulting from growth in our DIY Omnichannel business. We experienced positive comparable store sales across every region, with theGulf Coast ,Florida and Southeast regions having the strongest growth. While still positive, the Northeast Mid-Atlantic andWest Coast regions had the lowest comparable store sales growth. For the forty weeks endedOctober 3, 2020 , Net sales increased 1.9% compared to the same period of 2019, primarily driven by a 1.8% increase in comparable store sales resulting from an increase in demand in the second and third quarter of 2020, partially offset by less demand in the first quarter of 2020 caused principally by the COVID-19 pandemic, particularly in the six weeks endedApril 18, 2020 . 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 ownedCarquest 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. 16 -------------------------------------------------------------------------------- Table of Contents Gross Profit Gross profit for the twelve weeks endedOctober 3, 2020 was$1,128.5 million , or 44.4%, of Net sales, as compared to$1,011.9 million , or 43.8%, of Net sales for the twelve weeks endedOctober 5, 2019 . This increase in Gross profit as a percentage of Net sales was primarily due to favorable channel mix, including growth in our DIY Omnichannel business, supply chain efficiencies and favorable pricing actions. These improvements were partially offset by unfavorable product mix and headwinds associated with shrink and defectives. Gross profit for the forty weeks endedOctober 3, 2020 was$3,397.9 million , or 43.9% of Net sales, as compared to$3,326.0 million , or 43.8%, of Net sales for the forty weeks endedOctober 5, 2019 . This increase in Gross profit as a percentage of Net sales was primarily due to favorable channel mix, including growth in our DIY Omnichannel business, supply chain efficiencies and favorable pricing actions. These improvements were partially offset by unfavorable product mix. As a result of changes in our LIFO reserve, a benefit of$15.9 million and an expense of$33.8 million was included in the twelve weeks endedOctober 3, 2020 andOctober 5, 2019 . A benefit of$3.9 million and an expense of$76.7 million was included in the forty weeks endedOctober 3, 2020 andOctober 5, 2019 .
Selling, general and administrative expenses
SG&A expenses for the twelve weeks endedOctober 3, 2020 were$871.7 million , or 34.3% of Net sales, as compared to$839.6 million , or 36.3% of Net sales, for the twelve weeks endedOctober 5, 2019 . This decrease in SG&A expenses as a percentage of Net sales was primarily due to our ability to leverage payroll and rent expenses, lower incident rate and claims that we attribute to continued focus on employee safety and suspension of travel due to the COVID-19 pandemic. These improvements were partially offset by an increase in costs incurred in response to the COVID-19 pandemic and an increase in support contracts related to information technology solutions. SG&A for the forty weeks endedOctober 3, 2020 was$2,799.8 million , or 36.2% of Net sales, as compared to$2,774.9 million , or 36.5% of Net sales, for the forty weeks endedOctober 5, 2019 . This decrease in SG&A as a percentage of Net sales was primarily due to our ability to leverage payroll and rent expenses, lower incident rate and claims that we attribute to continued focus on employee safety and suspension of travel due to the COVID-19 pandemic. These improvements were partially offset by the factors discussed above.
Loss on early redemptions of senior unsecured notes
During the twelve weeks endedOctober 3, 2020 , we incurred charges of$48.0 million related to the early redemption of our 2022 and 2023 senior unsecured notes. During the sixteen weeks endedApril 20, 2019 , we incurred charges of$10.8 million related to the early redemption of our 2020 senior unsecured notes.
Provision for income taxes
Our Provision for income taxes for the twelve weeks endedOctober 3, 2020 was$50.1 million , as compared to$37.1 million for the twelve weeks endedOctober 5, 2019 . Our effective tax rate was 25.3% and 23.1% for the twelve weeks endedOctober 3, 2020 andOctober 5, 2019 . Our Provision for income taxes for the forty weeks endedOctober 3, 2020 was$129.2 million , as compared to$126.7 million for the forty weeks endedOctober 5, 2019 . Our effective tax rate was 25.3% and 24.5% for the forty weeks endedOctober 3, 2020 andOctober 5, 2019 . 17 -------------------------------------------------------------------------------- Table of Contents 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 inthe 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) transformation expenses under our strategic business plan; (2) non-cash amortization related to the acquired GPI intangible assets; and (3) 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. 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 will include, but not be 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 2018 Store Rationalization plan and 2017 Store and Supply Chain Rationalization plan. •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 leases agreements, which we expect to be subject to amortization through 2025. 18 -------------------------------------------------------------------------------- Table of Contents We have included a reconciliation of this information to the most comparable GAAP measures in the following table: Twelve Weeks Ended Forty Weeks Ended
(in thousands, except per share data)
October 3, 2020 October 5, 2019
Net income (GAAP) $ 147,476 $ 123,669 $ 381,024 $ 390,989
Cost of sales adjustments:
Transformation expenses:
Restructuring costs - 2,991 - 3,272
Other significant costs 79 - 1,627 -
Other adjustment (1) - - - 13,010
SG&A adjustments:
GPI amortization of acquired
intangible assets 6,324 6,362 21,086 21,157
Transformation expenses:
Restructuring costs 2,581 4,082 12,221 14,595
Third-party professional services 4,660 11,966 8,924 31,282
Other significant costs 1,438 7,338 13,560 10,756
Other income adjustment (2) 48,022 - 48,022 10,756
Provision for income taxes on
adjustments (3) (15,776) (8,185) (26,360) (26,207)
Adjusted net income (Non-GAAP) $ 194,804 $
148,223
Diluted earnings per share (GAAP) $ 2.13 $ 1.75 $ 5.50 $ 5.46 Adjustments, net of tax 0.68 0.35 1.14 1.09 Adjusted EPS (Non-GAAP) $ 2.81 $ 2.10 $ 6.64 $ 6.55 (1)During the sixteen weeks endedApril 20, 2019 , we made an out-of-period correction, which increased Cost of sales by$13.0 million , related to received not invoiced inventory. (2)During the twelve weeks endedOctober 3, 2020 , we incurred charges relating to a make-whole provision and tender premiums of$46.3 million and debt issuance costs of$1.7 million resulting from the early redemption of our 2022 and 2023 Notes. During the sixteen weeks endedApril 20, 2019 , we incurred charges relating to a make-whole provision and debt issuance costs of$10.1 million and$0.7 million resulting from the early redemption of our 2020 senior unsecured notes. (3)The income tax impact of non-GAAP adjustments is calculated using the estimated tax rate in effect for the respective non-GAAP adjustments. 19 -------------------------------------------------------------------------------- Table of Contents 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. 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, given uncertainties related to the COVID-19 pandemic, 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 expected results of operations, available cash and cash equivalents, and available borrowings under our credit facility will be sufficient to fund our obligations for the next year.
Share Repurchase Program
On
During the twelve weeks endedOctober 3, 2020 , we repurchased 0.7 million shares of our common stock at an aggregate cost of$109.6 million , or an average price of$153.06 per share, in connection with our share repurchase program. During the twelve weeks endedOctober 5, 2019 , we purchased 2.4 million shares of our common stock under the share repurchase program at an aggregate cost of$338.6 million , or an average price of$138.71 per share. During the forty weeks endedOctober 3, 2020 andOctober 5, 2019 , we repurchased 0.9 million and 3.3 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 endedOctober 3, 2020 andOctober 5, 2019 were at an aggregate cost of$138.6 million and$476.7 million , or an average price of$147.13 and$144.03 per share.
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