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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
FORM 10-Q
(MARK ONE)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE
ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED OCTOBER 10, 1998
OR
[_] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM ________ TO ________.
COMMISSION FILE NUMBER - 333-56013
____________
ADVANCE STORES COMPANY, INCORPORATED
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
_____________
VIRGINIA 54-0118110
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
5673 AIRPORT ROAD 24012
ROANOKE, VIRGINIA (Zip Code)
(Address of Principal Executive Offices)
(540) 362-4911
(Registrant's telephone number, including area code)
NOT APPLICABLE
(Former name, former address and former fiscal year, if changed since last
report).
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.
Yes [_] No [_] (Not applicable at this time)
APPLICABLE ONLY TO ISSUERS INVOLVED IN BANKRUPTCY
PROCEEDINGS DURING THE PRECEDING FIVE YEARS:
Indicate by check mark whether the registrant has filed all documents and
reports required to be filed by Sections 12, 13, or 15(d) of the Securities
Exchange Act of 1934 subsequent to the distribution of securities under a plan
confirmed by a court.
Yes [_] No [_]
The number of shares of Class A Common Stock, par value $100 per share,
outstanding (the only class of common stock of the Company outstanding) was 273
as of October 31, 1998.
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ADVANCE STORES COMPANY, INCORPORATED AND SUBSIDIARIES
Twelve Weeks Ended October 10, 1998
TABLE OF CONTENTS
<TABLE>
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Page
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PART I. FINANCIAL INFORMATION
Item 1. Condensed Consolidated Financial Statements of Advance Stores Company,
Incorporated and Subsidiaries (Unaudited)
Condensed Consolidated Balance Sheets as of October 10, 1998 and
January 3, 1998............................................................. 1
Condensed Consolidated Statements of Income for the
Twelve Weeks Ended October 10, 1998 and October 4, 1997 and for the
Forty Weeks Ended October 10, 1998 and October 4, 1997...................... 2
Condensed Consolidated Statements of Cash Flows for the Forty Weeks
Ended October 10, 1998 and October 4, 1997.................................. 3
Notes to Unaudited Condensed Consolidated Financial Statements.............. 5
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations....................................................... 13
Item 3. Quantitative and Qualitative Disclosures About Market Risks................. 20
PART II. OTHER INFORMATION
Item 1. Legal Proceedings............................................................ 21
Item 2. Changes in Securities and Use of Proceeds.................................... 21
Item 3. Defaults Upon Senior Securities.............................................. 21
Item 4. Submission of Matters to a Vote of Security Holders.......................... 21
Item 5. Other Information............................................................ 21
Item 6. Exhibits and Reports on Form 8-K............................................. 21
SIGNATURE........................................................................................S-1
</TABLE>
i
<PAGE>
ADVANCE STORES COMPANY, INCORPORATED AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS -- OCTOBER 10, 1998 AND JANUARY 3, 1998
(dollars in thousands)
<TABLE>
<CAPTION>
Assets October 10, January 3,
1998 1998
----------- -----------
(Unaudited)
<S> <C> <C>
CURRENT ASSETS:
Cash and cash equivalents........................................................... $ 36,940 $ 7,447
Receivables, primarily from vendors................................................. 23,515 19,117
Trade receivables................................................................... 5,672 3,359
Inventories......................................................................... 363,113 280,267
Prepaid expenses and other current assets........................................... 9,603 2,893
Refundable income taxes............................................................. 1,752 168
-------- --------
Total current assets............................................................. 440,595 313,251
Property and equipment, net of accumulated amortization and depreciation of...........
$96,260 and $77,940................................................................. 146,881 134,896
Other assets, net of accumulated amortization of $1,139 and $0........................ 19,766 2,054
-------- --------
$607,242 $450,201
======== ========
LIABILITIES AND STOCKHOLDER'S (DEFICIT) EQUITY
CURRENT LIABILITIES:
Bank overdrafts..................................................................... $ -- $ 7,235
Borrowings secured by trade receivables............................................. 5,672 3,359
Current portion of deferred revenue................................................. 2,256 1,530
Accounts payable.................................................................... 217,415 157,096
Accrued expenses.................................................................... 61,378 27,762
Deferred income taxes............................................................... 2,932 3,133
-------- --------
Total current liabilities........................................................ 289,653 200,115
-------- --------
Long-term debt........................................................................ 335,000 106,542
-------- --------
Deferred revenue...................................................................... 1,638 693
-------- --------
Deferred income taxes................................................................. 14,327 12,839
-------- --------
Post-retirement benefits.............................................................. 1,198 843
-------- --------
STOCKHOLDER'S (DEFICIT) EQUITY:
Common stock, Class A, voting, $100 par value; 5,000 shares authorized; 273
shares issued and outstanding..................................................... 27 27
Additional paid-in capital.......................................................... 11,199 940
Outstanding stock options........................................................... 3,431 --
Unamortized stock option compensation............................................... (3,188) --
(Accumulated deficit) retained earnings............................................. (46,043) 128,202
-------- --------
Total stockholder's (deficit) equity............................................. (34,574) 129,169
-------- --------
$607,242 $450,201
======== ========
</TABLE>
1
<PAGE>
ADVANCE STORES COMPANY, INCORPORATED AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
For the Twelve and Forty Week Periods Ended
October 10, 1998 and October 4, 1997
(dollars in thousands)
(Unaudited)
<TABLE>
<CAPTION>
Twelve Week Period Ended Forty Week Period Ended
------------------------------ --------------------------------
October 10, October 4, October 10, October 4,
1998 1997 1998 1997
------------ ------------- ------------- --------------
<S> <C> <C> <C> <C>
Net sales............................................... $ 258,839 $ 206,409 $ 802,839 $ 642,289
Cost of sales........................................... 160,464 128,692 493,289 396,890
--------- --------- --------- ---------
Gross profit....................................... 98,375 77,717 309,550 245,399
Selling, general, and administrative expenses........... 81,189 67,370 259,889 212,803
Costs associated with the recapitalization of the
Parent............................................ 225 -- 14,230 --
--------- --------- --------- ---------
Operating income............................... 16,961 10,347 35,431 32,596
--------- --------- --------- ---------
Other income (expense):
Interest expense................................... (8,287) (1,511) (20,108) (5,893)
Other.............................................. 470 (215) 589 (665)
--------- --------- --------- ---------
Total other expense, net....................... (7,817) (1,726) (19,519) (6,558)
--------- --------- --------- ---------
Income before income taxes.............................. 9,144 8,621 15,912 26,038
Income tax expense...................................... 3,891 3,609 7,007 10,900
--------- --------- --------- ---------
Net income.............................................. $ 5,253 $ 5,012 $ 8,905 $ 15,138
========= ========= ========= =========
</TABLE>
2
<PAGE>
ADVANCE STORES COMPANY, INCORPORATED AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE FORTY WEEK PERIODS ENDED OCTOBER 10, 1998 AND OCTOBER 4, 1997
(DOLLARS IN THOUSANDS)
(UNAUDITED)
<TABLE>
<CAPTION>
FORTY WEEK PERIOD ENDED
---------------------------------------
OCTOBER 10, 1998 OCTOBER 4, 1997
------------------ ---------------
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income................................................................. $ 8,905 $ 15,138
Adjustments to reconcile net income to net cash provided by operating
activities:
Depreciation and amortization of property and equipment.................. 19,993 16,328
Loss on sale of property and equipment................................... 100 275
Amortization of deferred debt issuance costs............................. 1,283 --
Amortization of stock option compensation................................ 243 --
Provision for deferred income taxes...................................... 1,287 1,717
Net periodic postretirement benefit expense, net of payments made........ 355 307
Net (increase) decrease in:
Receivables, primarily from vendors................................... (4,398) 1,906
Trade receivables..................................................... (2,313) --
Inventories........................................................... (82,846) (40,617)
Prepaid expenses and other assets..................................... (7,431) (2,847)
Refundable income taxes............................................... (1,584) --
Net increase in:
Accounts payable...................................................... 60,319 35,909
Accrued expenses...................................................... 32,377 14,728
--------- --------
Net cash provided by operating activities.......................... 26,290 42,844
--------- --------
CASH FLOW FROM INVESTING ACTIVITIES:
Purchases of property and equipment........................................ (36,234) (29,749)
Proceeds from sale of property and equipment............................... 4,156 132
--------- --------
Net cash used in investing activities.............................. (32,078) (29,617)
--------- --------
CASH FLOWS FROM FINANCING ACTIVITIES:
Decrease in bank overdrafts................................................ (7,235) (2,381)
Proceeds from issuance of long-term debt................................... 575 1,820
Payments on long-term debt................................................. (97,117) (12,710)
Borrowings under new credit facilities..................................... 325,000 --
Payment of debt issuance costs............................................. (17,717) --
Contributed capital from Advance Holding Corporation....................... 10,259 --
Dividend paid to Advance Holding Corporation............................... (183,150) --
Other...................................................................... 4,666 42
--------- --------
Net cash provided by (used in) financing activities................ 35,281 (13,229)
</TABLE>
Continued on following page
3
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<TABLE>
<CAPTION>
FORTY WEEK PERIOD ENDED
---------------------------------------
OCTOBER 10, 1998 OCTOBER 4, 1997
------------------ ---------------
<S> <C> <C>
Net increase (decrease) in cash and cash equivalents......................... 29,493 (2)
Cash and cash equivalents at beginning of period............................. 7,447 6,932
-------- --------
Cash and cash equivalents at end of period................................... $ 36,940 $ 6,930
======== ========
SUPPLEMENTAL CASH FLOW INFORMATION:
Interest paid........................................................... $ 8,271 $ 6,502
======== ========
Income taxes paid, net of refunds received.............................. $ 6,222 $ 5,536
======== ========
NON-CASH TRANSACTION:
Debt issuance and acquisition costs accrued at October 10, 1998......... $ 1,239 $ --
======== =========
</TABLE>
4
<PAGE>
ADVANCE STORES COMPANY, INCORPORATED AND SUBSIDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
TWELVE AND FORTY WEEK PERIODS ENDED OCTOBER 10, 1998 AND OCTOBER 4, 1997
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
(UNAUDITED)
1. BASIS OF PRESENTATION:
Advance Stores Company, Incorporated is a wholly owned subsidiary of
Advance Holding Corporation (the Parent). The accompanying unaudited condensed
consolidated financial statements include the accounts of Advance Stores
Company, Incorporated and its wholly owned subsidiaries (the Company). All
significant intercompany balances and transactions have been eliminated in
consolidation.
The condensed consolidated balance sheet as of October 10, 1998 and the
consolidated statements of income for the 12-week and 40-week periods ended
October 10, 1998, and October 4, 1997, and the statements of cash flows for the
40-week periods ended October 10, 1998 and October 4, 1997, have been prepared
by the Company and have not been audited. In the opinion of management, all
adjustments, consisting of only normal recurring adjustments, necessary for a
fair presentation of the financial position of the Company, the results of its
operations and cash flows have been made.
Certain information and footnote disclosure normally included in financial
statements prepared in accordance with generally accepted accounting principles
have been condensed or omitted. These financial statements should be read in
conjunction with the financial statements and notes thereto included in the
Company's consolidated financial statements for the fiscal year ended January 3,
1998.
The results of operations for the 12-week and 40-week periods arc not
necessarily indicative of the operating results to be expected for the full
fiscal year.
2. INVENTORIES:
Inventories are stated at the lower of cost or market using the last-in,
first-out (LIFO) method. An actual valuation of inventory under the LIFO method
can be made only at the end of each year based on the inventory levels and costs
at that time. Accordingly, interim LIFO calculations must necessarily be based
on management's estimates of expected year-end inventory levels and costs.
Inventories consist of the following:
October 10, January 3,
1998 1998
---------- ----------
Replacement cost.......................... $360,763 $280,267
Reserve to state inventories at LIFO...... 5,374 2,274
---------- ----------
Inventories at LIFO....................... 366,137 282,541
Other reserves............................ (3,024) (2,274)
---------- ----------
$363,113 $280,267
========== ==========
As of October 10, 1998 and January 3, 1998 replacement cost approximates
using the first-in, first-out (FIFO) method.
3. OTHER ASSETS:
As of October 10, 1998, other assets include deferred debt issuance costs
of $17,607. Such costs are being amortized over the term of the related debt (6
to 10 years). Other assets also include certain transaction costs of $1,235
relating to the acquisition (Note 12).
5
<PAGE>
ADVANCE STORES COMPANY, INCORPORATED AND SUBSIDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
TWELVE AND FORTY WEEK PERIODS ENDED OCTOBER 10, 1998 AND OCTOBER 4, 1997
(CONTINUED)
4. STOCK OPTIONS:
The Company has elected to follow Accounting Principles Board Opinion No.
25, "Accounting for Stock Issued to Employees" (APB 25) and related
interpretations on accounting for its employees' participation in the Parent's
employee stock options and awards. Under APB 25, compensation expense of stock
options is measured as the excess, if any, of the fair market value of the
Parent's common stock at the measurement date over the exercise price.
5. RECAPITALIZATION:
On April 15, 1998, Advance Holding Corporation (the Parent) consummated its
recapitalization pursuant to an Agreement and Plan of Merger dated March 4, 1998
(the Merger Agreement). In connection with the Merger, the Parent's Board of
Directors authorized a 12,500 to 1 split of the Parent's common stock and a
change in the par value of the Parent's common stock from $100 to $.01 per
share. Pursuant to the Merger Agreement, AHC Corporation ("AHC"), a corporation
controlled by an investment fund organized by Freeman Spogli & Co. Incorporated
(FS&Co.), merged into the Parent (the Merger), with the Parent as the surviving
corporation. In the Merger, a portion of the Parent's common stock and all its
preferred stock were converted into the right to receive in the aggregate
approximately $351,000 in cash and certain stock options for 500,000 shares of
the Parent's common stock. Certain shares representing approximately 14% of the
Parent's outstanding Class A common stock remained outstanding upon consummation
of the Merger. Immediately prior to the Merger, FS&Co. purchased approximately
$80,500 of the common stock of AHC, which was converted in the Merger into
approximately 64% of the Parent's outstanding common stock, and Ripplewood
Partners, L.P., and its affiliates ("Ripplewood") purchased approximately
$20,000 of the common stock of AHC, which was converted in the merger into
approximately 16% of the Parent's outstanding common stock. In connection with
the Merger, management purchased approximately $8,000, or approximately 6%, of
the Parent's outstanding common stock.
On April 15, 1998, the Company entered into a new bank credit facility that
provides for (i) three senior secured term loan facilities in the aggregate
amount of $250,000 and (ii) a secured revolving credit facility of up to
$125,000. At the closing of the Merger, $125,000 was borrowed under one of the
term loan facilities. On April 15, 1998, the Company also issued $200,000 of
senior subordinated notes and the Parent issued approximately $60,000 of senior
discount debentures. Proceeds from the new bank facility and senior
subordinated notes were used to pay a $183,000 dividend to the Parent and to
extinguish a substantial portion of the Company's long-term debt.
The Merger, the dividend, the retirement of debt, borrowings under the new
bank credit facility, the Parent's issuance of the senior discount debentures
and the Company's issuance of the senior subordinated notes collectively
represent the "Recapitalization". The Recapitalization transactions effecting
the Company have been accounted for as the issuance of debt, the repayment of
intercompany debt to affiliated company (the Parent, Note 6) and as a dividend
to the Parent for financial reporting purposes.
Concurrent with the Recapitalization, the Company paid $11,500 in bonuses
to certain employees, including executive officers. In addition, the Company
incurred expenses of $2,730, primarily professional services, related to the
Recapitalization, of which $1,808 has been allocated to the Company by the
Parent for expenses incurred by the Parent on behalf of the Company. Such
bonuses and expenses are presented as expenses associated with the
Recapitalization of the Parent in the accompanying unaudited condensed
consolidated statement of income for the 12-week and 40-week periods ending
October 10, 1998.
The Company has deferred $17,521 of debt issuance costs related to the new
debt incurred in connection with the Recapitalization.
6
<PAGE>
ADVANCE STORES COMPANY, INCORPORATED AND SUBSIDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
TWELVE AND FORTY WEEK PERIODS ENDED OCTOBER 10, 1998 AND OCTOBER 4, 1997
(CONTINUED)
As of October 10, 1998, accrued expenses include $586 of accrued
liabilities related to the Recapitalization, which include the Company's
estimate of certain unpaid professional services, and $986 of accrued
liabilities for certain transaction costs relating to the acquisition (Note 12).
In connection with the Recapitalization, FS&Co. and an affiliate of
Ripplewood collectively received a $5,000 fee for negotiating the
Recapitalization, advisory and consulting services, arranging financing and
raising equity funding. Approximately $3,935 of the fee has been recorded by
the Company, with $2,935 classified as deferred debt issuance costs and $1,000
charged to expenses associated with the Recapitalization of the Parent.
Approximately $1,065 of the fee has been recorded by the Parent.
6. LONG-TERM DEBT:
Long-term debt consists of the following:
<TABLE>
<CAPTION>
October 10, January 3,
1998 1998
------------ ------------
<S> <C> <C>
SENIOR DEBT:
Delayed draw facilities............................................................ $ -- $ --
Revolving facility................................................................. -- --
Tranche B facility................................................................. 125,000 --
Revolving notes payable to affiliated company, repaid in April 1998................ -- 46,856
Revolving note payable to affiliated company, repaid in April 1998................. -- 47,764
McDuffie County Authority taxable industrial development revenue bonds, interest at
an adjustable rate (5.45% at October 10, 1998).................................... 10,000 10,000
Other notes payable to affiliated company, repaid in April 1998.................... -- 1,922
SUBORDINATED DEBT:
Subordinated notes payable, interest due semi-annually at 10.25%, commencing on
October 15, 1998, due April 2008.................................................. 200,000 --
------------ ------------
Total long-term debt............................................................... 335,000 106,542
Less -- Current portion of long-term debt.......................................... -- --
------------ ------------
Long-term debt, excluding current portion.......................................... $335,000 $106,542
============ ============
</TABLE>
The terms of the McDuffie County Authority taxable industrial development
revenue bonds remain unchanged from January 3, 1998, except that the letter of
credit obtained in connection with the issuance of these bonds has been
canceled. The bonds are now secured by the letter of credit obtained in
connection with the Revolving Credit Facility.
The delayed draw facilities, new revolving facility and Tranche B facility
(New Credit Facility) are with a syndicate of banks. The New Credit Facility
provides for the Company to borrow up to $375,000 in the form of senior secured
credit facilities, consisting of (i) $50,000 senior secured delayed draw term
loan facility (the Delayed Draw Facility I), (ii) $75,000 senior secured delayed
draw term loan facility (the Delayed Draw Facility II) and, together with the
Delayed Draw Facility I, (the Delayed Draw Facilities), (iii) a $125,000 Tranche
B senior secured term loan facility (the Tranche B Facility), and (iv) a
$125,000 senior secured revolving credit facility (the Revolving Facility). The
Revolving Facility has a letter of credit sublimit of $25,000. Amounts
available under
7
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ADVANCE STORES COMPANY, INCORPORATED AND SUBSIDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
TWELVE AND FORTY WEEK PERIODS ENDED OCTOBER 10, 1998 AND OCTOBER 4, 1997
(CONTINUED)
the Delayed Draw Facilities and the Revolving Facility are subject to a
borrowing base formula based on a specified percentage of the Company's eligible
inventory.
The Delayed Draw Facilities mature April 2004. The Tranche B Facility
matures in April 2006. These term facilities provide for nominal annual
amortization in the first five years and amortization of $149.0 million in 2004,
$60.0 million in 2005 and $30.0 million in 2006. The Revolving Facility will
mature in April 2004.
Borrowings under the New Credit Facility are required to be prepaid,
subject to certain exceptions, with (a) 50% of Excess Cash Flow (as defined),
(b) the net cash proceeds of all asset sales or other dispositions of property
(as defined), (c) the net proceeds of issuances of debt obligations and, (d) the
net proceeds of issuance of equity securities. Excess Cash Flow is defined as
the excess of (A) the sum of (i) consolidated net income (excluding certain
gains or losses and restricted payments made to the Parent), (ii) depreciation,
amortization and other non-cash charges, (iii) any decrease in Net Working
Capital (as defined), (iv) increases in deferred revenues, and (v) proceeds of
certain indebtedness incurred, over (B) the sum of (a) any non-cash gains, (b)
any increases in Net Working Capital, (c) decreases in consolidated deferred
revenues, (d) capital expenditures, and (e) repayments of indebtedness (subject
to certain exceptions).
For the first four fiscal quarters after April 1998, the interest rates
under the Delayed Draw Facilities and the Revolving Facility are based, at the
option of the Company, on either a eurodollar rate plus 2.25% per annum or a
base rate plus 1.25% per annum. Thereafter, the interest rates under the
Delayed Draw Facilities and the Revolving Facility will be determined by
reference to a pricing grid that will provide for reductions in the applicable
interest rate margins based on the Company's trailing Total Debt to EBITDA
ratio, as defined. The initial margins will be 2.25% and 1.25% for eurodollar
and base rate borrowings, respectively, and can step down to 1.75% and 0.75%,
respectively, if the Company's Total Debt to EBITDA ratio is less than or equal
to 4.00 to 1.00. The interest rate under the Tranche B Facility is based, at
the option of the Company, on a eurodollar rate plus 2.5% or a base rate plus
1.5% (8.125% at October 10, 1998). A commitment fee of 0.50% per annum will be
charged on the unused portion of the New Credit Facility.
The New Credit Facility is guaranteed by the Parent and is secured by
substantially all of the assets of the Parent and the Company. The New Credit
Facility contains covenants restricting the ability of the Company and its
subsidiaries to, among others, (i) declare dividends or redeem or repurchase
capital stock (ii) prepay, redeem or purchase debt, (iii) incur liens or engage
in sale-leaseback transactions, (iv) make loans and investments, (v) incur
additional debt (including hedging arrangements), (vi) make capital
expenditures, (vii) engage in mergers, acquisitions and asset sales, (viii)
engage in transactions with affiliates, (ix) change the nature of the business
conducted by the Company and its subsidiaries, (x) change the passive holding
company status of the Parent and (xi) amend existing debt agreements. The
Company is required to comply with financial covenants with respect to (a) a
maximum leverage ratio, (b) a minimum interest coverage ratio, and (c) a minimum
retained cash earnings test.
The $200,000 Senior Subordinated Notes (the Notes) mature on April 15, 2008
and will bear interest at the rate of 10.25 % per annum, payable semi-annually
on April 15 and October 15 of each year, commencing October 15, 1998. The Notes
are unsecured and are subordinate in right of payment to all existing and future
Senior Debt. The Notes are redeemable at the option of the Company, in whole or
in part, at any time on or after April 15, 2003 in cash at the redemption prices
(as defined), plus accrued and unpaid interest and liquidated damages, if any,
thereon to the date of redemption. In addition, at any time prior to April 15,
2001, the Company may redeem up to 35% of the initially outstanding aggregate
principal amount of the Notes at a redemption price equal to 110.25% of the
principal amount thereof, plus accrued and unpaid interest and liquidated
damages, if any, thereon to the date of redemption, with the net proceeds of one
or more equity offerings; provided that, in each case, at least 65% of the
initially outstanding aggregate principal amount of the Notes remains
outstanding immediately after the occurrence
8
<PAGE>
ADVANCE STORES COMPANY, INCORPORATED AND SUBSIDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
TWELVE AND FORTY WEEK PERIODS ENDED OCTOBER 10, 1998 AND OCTOBER 4, 1997
(CONTINUED)
of any such redemption; and provided further, that such redemption shall occur
within 90 days of the date of the closing of such equity offering.
Upon the occurrence of a change of control, (as defined), each holder of
the Notes will have the right to require the Company to repurchase all or any
part of such holder's Notes at an offering price in cash equal to 101% of the
aggregate principal amount thereof plus accrued and unpaid interest and
liquidated damages, if any, thereon to the date of purchase.
The Notes are guaranteed by a wholly owned subsidiary, LARALEV, INC., which
holds certain trademarks and tradenames and other intangible assets for which it
receives royalty income from the Company. The Notes contain certain covenants
that limit, among other things, the ability of the Company to incur additional
indebtedness, issue preferred stock, pay dividends or certain other
distributions, issue stock of subsidiaries, make certain investments, repurchase
stock and certain indebtedness, create or incur liens, engage in transactions
with affiliates, enter into new businesses and restrict the Company from
engaging in certain mergers or consolidations and selling assets.
7. STOCK OPTIONS:
The Parent has adopted a senior executive stock option plan and an
executive stock option plan (the Option Plans), which provide for the granting
of either incentive stock options or non-qualified stock options to purchase
shares of the Parent's common stock to officers and key employees of the
Company. All options will terminate on the seventh anniversary of the Option
Agreement under which they were granted if not exercised prior thereto.
Shares available for grant under the senior executive and the executive
stock option plans are 507,500 and 450,000, respectively as of October 10, 1998.
Three different types of options were granted pursuant to the Option Plans.
Fixed Price Service Options will vest over a three year period in three equal
installments beginning in fiscal 1999. Performance Options will be earned in
installments based upon satisfaction of certain performance targets for the four
year period ending in fiscal 2001. Variable Price Service Options will vest in
equal annual installments over a two year period beginning in 1999, and have an
exercise price that increases over time.
Options outstanding at October 10, 1998, were as follows:
<TABLE>
<CAPTION>
Number of Shares Initial Exercise Price
--------------------- ----------------------
<S> <C> <C>
Variable Price Service Options............ 397,085 $10
Performance Options....................... 397,085 10
Fixed Price Service Options............... 104,580 10
---------------------
898,750
=====================
</TABLE>
No options were exercisable at October 10, 1998.
The Company has elected to account for employee stock option grants under
APB 25 and, at year-end, is required to provide pro forma disclosures of what
net income would have been had the Company adopted the new fair value method for
recognition purposes under Statement of Financial Accounting Standards No. 123
"Accounting for Stock-Based Compensation." Under APB 25, the Company did not
recognize compensation expense on the issuance of its stock options because the
exercise price equaled the fair market value of the
9
<PAGE>
ADVANCE STORES COMPANY, INCORPORATED AND SUBSIDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
TWELVE AND FORTY WEEK PERIODS ENDED OCTOBER 10, 1998 AND OCTOBER 4, 1997
(CONTINUED)
underlying stock on the grant date. Fair market value is determined by the Board
of Directors of the Parent. The fair market value of the stock changed to $16.82
per share in August 1998 based upon the commitment from stockholders of the
Parent to purchase certain shares in connection with the acquisition (Note 12).
The excess of the fair market value per share over the exercise price per share
for the Performance Options and Variable Price Service Options is recorded as
outstanding stock options and unamortized stock option compensation in
stockholder's (deficit) equity. This compensation is amortized to expense over
the vesting periods. Compensation expense related to these Options of $243 is
included in selling, general and administrative expenses in the accompanying
consolidated statements of operations for the twelve week and forty week periods
ended October 10, 1998.
8. STOCKHOLDER'S (DEFICIT) EQUITY:
Changes in stockholder's (deficit) equity for the 40-week period ended
October 10, 1998, are as follows:
<TABLE>
<CAPTION>
OUTSTANDING UNAMORTIZED (ACCUMULATED TOTAL
COMMON ADDITIONAL STOCK STOCK OPTION DEFICIT) STOCKHODER'S
STOCK PAID-IN COMPEN- COMPEN- RETAINED (DEFICIT)
CLASS A CAPTIAL SATION SATION EARNINGS EQUITY
------- ---------- ----------- ---------- ------------ ------------
<S> <C> <C> <C> <C> <C> <C>
Balance, January 3, 1998 as previously
reported...................................... -- $ 967 $ -- $ -- $ 128,202 $ 129,169
Effect of stock split-up....................... 27 (27) -- -- -- --
------- ---------- ----------- ---------- ------------ ------------
Balance, January 3, 1998 as adjusted........... 27 940 -- -- 128,202 129,169
Dividend to Parent............................ -- -- -- -- (183,150) (183,150)
Contributed Capital from Parent............... -- 10,259 -- -- -- 10,259
Unamortized stock option compensation......... -- -- 3,431 (3,431) -- --
Amortization of stock option compensation..... -- -- -- 243 -- 243
Net income.................................... -- -- 8,905 8,905
------- ---------- ----------- ---------- ------------ ------------
Balance, October 10, 1998...................... $27 $11,199 $ 3,431 $ (3,188) $ (46,043) $ (34,574)
======= ========== =========== ========== ============ ============
</TABLE>
9. RELATED-PARTY TRANSACTIONS:
In April, 1998, the Company sold its airplane to its Chairman of the Board,
an existing stockholder, for its net book value of approximately $4,100, which
approximated fair value.
10. CONSOLIDATED SUBSIDIARY:
The Company has a wholly owned subsidiary LARALEV, INC., that is a
guarantor of the subordinated notes, new term loan and revolving credit facility
that the Company entered into as part of the Recapitalization. The guarantee is
joint and several in addition to full and unconditional. LARALEV, INC. holds
certain trademarks, tradenames and other intangible assets for which it receives
royalty income from the Company. LARALEV, INC. comprises all direct and
indirect subsidiaries, other than inconsequential subsidiaries, of the Company.
The Company has not presented separate financial statements for LARALEV, INC.
because management has determined that such information is not material to
investors.
10
<PAGE>
ADVANCE STORES COMPANY INCORPORATED AND SUBSIDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
TWELVE AND FORTY WEEK PERIODS ENDED OCTOBER 10, 1998 AND OCTOBER 4, 1997
(CONTINUED)
Unaudited summarized financial information for this wholly owned subsidiary
is as follows:
<TABLE>
<CAPTION>
TWELEVE WEEK PERIOD ENDED FORTY WEEK PERIOD ENDED
-------------------------------------- --------------------------------------
October 10, 1998 October 4, 1997 October 10, 1998 October 4, 1997
---------------- --------------- ---------------- ---------------
<S> <C> <C> <C> <C>
Royalty income from the Company................ $5,178 $4,128 $16,058 $12,846
Other income................................... 798 493 2,241 1,469
Income from operations......................... 5,968 4,615 18,281 14,213
Net income..................................... 3,997 2,977 12,058 9,169
<CAPTION>
October 10, 1998
----------------
<S> <C>
Current assets............................................................. $ 5,863
Noncurrent assets.......................................................... 43,938
Current liabilities........................................................ 128
Noncurrent liabilities..................................................... 0
</TABLE>
At October 10, 1998, current and noncurrent assets include $49,457 of
receivables from the Company.
11. CONTINGENCIES:
The employment agreements which existed at January 3, 1998 have been
terminated. The Company entered into new agreements that provide severance pay
benefits under certain circumstances.
Three lawsuits were filed against the Company on July 28, 1998, for
wrongful death relating to an automobile accident involving an employee of the
Company. Management believes that the financial exposure is covered by
insurance and, accordingly, believes that the ultimate resolution of these
matters will not materially affect the Company's financial position or results
of operations.
12. SUBSEQUENT EVENT - ACQUISITION:
On August 17, 1998, the Company and its Parent entered into an agreement
and plan of merger with Sears, Roebuck and Co. (Sears) to acquire Western Auto
Supply Company (Western), a wholly owned subsidiary of Sears. Western was
acquired on November 2, 1998, by a newly formed, wholly owned subsidiary of the
Company for $175,000 in cash and 11,474,606 shares of the Parent's common stock.
In connection with the transaction, the Parent sold 4,161,712 shares of common
stock to certain current stockholders (after the Recapitalization) for $70,000
and the Company borrowed $90,000 under a new senior credit facility with
substantially the same terms as the current Tranche B facility. The remainder
of the $175,000 was funded through cash on hand. The Company estimates it will
incur transaction related costs of approximately $10,000. As a result of the
transaction, Sears owns approximately 40.6% of the Parent's issued and
outstanding common stock. The newly formed, wholly owned subsidiary will become
a full and unconditional, joint and several guarantor of the subordinated notes
and bank credit facilities.
11
<PAGE>
ADVANCE STORES COMPANY INCORPORATED AND SUBSIDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
TWELVE AND FORTY WEEK PERIODS ENDED OCTOBER 10, 1998 AND OCTOBER 4, 1997
(CONTINUED)
The Board of Directors declared a stock split-up effected as a dividend of
authorized but unissued Company common stock to the stockholders of record as of
October 30, 1998, payable at a rate of 272 shares on the one issued and
outstanding share of Company common stock, for a total of 273 shares of Company
common stock. As such, the par value of $100 per share was unchanged and
thereby increasing capital stock by $27 with a corresponding reduction in
additional paid-in capital. The effect of the stock split-up effected as a
dividend has been applied retroactively to all periods presented in these
financial statements.
Under the terms of a shared services agreement, Sears will provide certain
services to the Company, including payroll and payable processing, among other
services, until such activities are transitioned to the Company, which the
Company expects to occur in fiscal 1999. In addition, the Company and Sears
have entered into merchant agreements that provide for the acquired stores to
honor certain Sears and Western Auto credit cards for periods defined in the
agreements. The Company and Sears have also entered into agreements that
provide for the acquired stores to continue to purchase and carry certain Sears
branded products during periods defined in the agreements. The Company will
also become a first-call supplier of certain automotive products to certain
Sears Automotive Group stores.
The Company and Sears have entered into an agreement that provides for the
Company to lease certain employees to Sears to perform all operations and
services that were previously performed by Western Auto and its affiliates with
respect to certain credit card operations for stores in Puerto Rico. In
addition, the Company will continue to provide certain services to Sears that
were previously performed by Western until such services are transitioned to
Sears.
12
<PAGE>
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
Advance Stores Company, Incorporated (the "Company"), a wholly-owned
subsidiary of Advance Holding Corporation ("Holding"), is the second largest
retailer of automotive parts and accessories in the United States (based on
store count) with 936 stores operating under the "Advance Auto Parts" name in 17
states as of October 10, 1998. Based on store count, the Company believes it is
the largest automotive retailer in a majority of its markets. The Company
serves the "do it yourself" market as well as the "do it for me" market through
its commercial delivery program. The following discussion of the consolidated
historical results of operations and financial condition of the Company should
be read in conjunction with the unaudited condensed consolidated financial
statements of the Company and the notes thereto included elsewhere in this Form
10-Q. The following discussion and analysis covers periods before completion of
the Recapitalization, as described below. The Company's first quarter consists
of 16 weeks and its second and third quarters consist of 12 weeks.
FORWARD LOOKING STATEMENTS
This Management's Discussion and Analysis of Financial Condition and
Results of Operations and other sections of this quarterly report contain
certain "forward-looking statements" as defined in the Private Securities
Litigation Reform Act of 1995. These statements include without limitation the
words "believes," "anticipates," "estimates," "intends," "expects," and words of
similar import. Such forward-looking statements involve known and unknown risks,
uncertainties and other factors that may cause the actual results, performance
or achievements of Holding and the Company or the retail industry to be
materially different from any future results, performance or achievements
expressed or implied by such forward-looking statements.
These potential risks and uncertainties include, among others, the
following: general economic and business conditions; Holding's and the Company's
substantial leverage and debt service obligations; restrictions on Holding's and
the Company's ability to pursue its business strategies imposed by restrictive
loan covenants; changes in business strategy or development plans; competition;
weather conditions; integration of Western Auto (as defined below); extent of
the market demand for auto parts; availability of inventory supply; adequacy and
perception of customer service, product quality and defect experience;
availability of and ability to take advantage of vendor pricing programs and
incentives; rate of new store openings; cannibalization of store sites; mix and
types of merchandise sold; governmental regulation of products; new store
development; performance of information systems; effectiveness of deliveries
from distribution centers; ability to hire, train and retain qualified
employees; and environmental risks. Forward-looking statements regarding
revenues, expenses, cash flows and liquidity are particularly subject to a
variety of assumptions, some or all of which may not be realized. Given these
uncertainties, prospective investors are cautioned not to place undue reliance
on such forward-looking statements. The Company disclaims any obligation to
update any such factors or to publicly announce the results of any revisions to
any of the forward-looking statements contained herein to reflect future events
or developments.
THE RECAPITALIZATION
On April 15, 1998, Holding consummated its Recapitalization pursuant to an
Agreement and Plan of Merger dated as of March 4, 1998. See Note 5 of Part I,
Item 1 for a detailed description of the Recapitalization.
RECENT DEVELOPMENTS
On August 17, 1998, the Company and Holding entered into an agreement and
plan of merger with Sears, Roebuck and Co. ("Sears") to acquire Western Auto
Supply Company ("Western Auto"), a wholly owned subsidiary of Sears. Western was
acquired on November 2, 1998 (the "Acquisition") for $175.0 million in cash and
11,474,606 shares Holding's common stock. In connection with the transaction,
Holding sold 4,161,712 shares of common stock to certain current stockholders
for $70.0 million and the Company borrowed $90.0 million under a new facility
under the New Credit Facility. The remainder of the $175.0 million was funded
through cash on hand. The Company estimates it will incur transaction related
costs of approximately $10.0
13
<PAGE>
million. As a result of the transaction, Sears owns approximately 40.6% of
Holding's issued and outstanding common stock.
Based in Kansas City, Missouri, Western Auto is a specialty retailer of
automotive parts and accessories and also maintains an extensive wholesale
dealer network. As of November 2, 1998, Western Auto operated 612 stores in the
U.S. under the "Parts America" name, and 36 stores in Puerto Rico, two stores in
the U.S. Virgin Islands and two domestic specialty stores under the "Western
Auto" name that provide service and parts sales.
The combined entity will operate domestic retail stores under the "Advance
Auto Parts" name in most markets. The wholesale dealer network and Puerto Rico
stores will continue to operate primarily under the "Western Auto" banner. The
Company and Western Auto together will operate over 1,500 retail stores in 37
states, Puerto Rico and the U.S. Virgin Islands and will supply through its
wholesale distribution center nearly 800 "dealer" stores in 48 states.
Results of Operations
The following tables set forth the statement of operations data for the
Company expressed in dollars and as a percentage of net sales for the periods
indicated.
14
<PAGE>
<TABLE>
<CAPTION>
Twelve Weeks Ended Forty Weeks Ended
(unaudited) (unaudited)
------------------------------ ---------------------------------
October 4, October 10, October 4, October 10,
1997 1998 1997 1998
------------ ------------- --------------- -------------
(dollars in thousands) (dollars in thousands)
<S> <C> <C> <C> <C>
Net sales........................................... $206,409 $258,839 $642,289 $802,839
Cost of sales....................................... 128,692 160,464 396,890 493,289
------------ ------------- --------------- -------------
Gross profit........................................ 77,717 98,375 245,399 309,550
Selling, general and administrative expenses........ 67,370 81,189 212,803 259,889
Expenses associated with recapitalization........... -- 225 -- 14,230
------------ ------------- --------------- -------------
Operating profit.................................... 10,347 16,961 32,596 35,431
Interest expense.................................... 1,511 8,287 5,893 20,108
Other expense, net.................................. 215 (470) 665 (589)
Income tax expense.................................. 3,609 3,891 10,900 7,007
------------ ------------- --------------- -------------
Net income.......................................... $ 5,012 $ 5,253 $ 15,138 $ 8,905
============ ============= =============== =============
<CAPTION>
Twelve Weeks Ended Forty Weeks Ended
(unaudited) (unaudited)
------------------------------ ---------------------------------
October 4, October 10, October 4, October 10,
1997 1998 1997 1998
------------ ------------- --------------- -------------
<S> <C> <C> <C> <C>
Net sales........................................... 100.0% 100.0% 100.0% 100.0%
Cost of sales....................................... 62.3 62.0 61.8 61.4
------------ ------------- --------------- -------------
Gross profit........................................ 37.7 38.0 38.2 38.6
Selling, general and administrative expenses........ 32.7 31.4 33.1 32.4
Expenses associated with recapitalization........... -- .1 -- 1.8
------------ ------------- --------------- -------------
Operating profit.................................... 5.0 6.5 5.1 4.4
Interest expense.................................... 0.7 3.2 0.9 2.5
Other expense, net.................................. 0.1 (0.2) 0.1 (0.1)
Income tax expense.................................. 1.8 1.5 1.7 0.9
------------ ------------- --------------- -------------
Net income.......................................... 2.4% 2.0% 2.4% 1.1%
============ ============= ============== =============
</TABLE>
Net sales consists primarily of comparable store net sales, last year store
net sales, and new store net sales. New stores become part of the comparable
store base on the first day of their second full fiscal year in operation.
The Company's cost of goods sold includes merchandise costs and warehouse
and distribution expenses. Gross profit as a percentage of net sales may be
affected by variations in the Company's product mix, price changes in response
to competitive factors and fluctuations in merchandise costs and vendor
programs.
Selling, general and administrative expenses are comprised of store
payroll, store occupancy, net advertising expenses, other store expenses and
general and administrative expenses, including salaries and related benefits of
corporate employees, administrative office expenses, data processing,
professional expenses and other related expenses.
15
<PAGE>
Twelve Weeks Ended October 10, 1998 Compared to Twelve Weeks Ended October 4,
1997
Net sales for the twelve weeks ended October 10, 1998 increased by $52.4
million or 25.4% to $258.8 million as compared to $206.4 million for the
comparable twelve weeks ended October 4, 1997. This increase was due to an
increase in comparable store net sales of $11.1 million or 5.8%, an increase in
net sales from stores opened in fiscal 1997 of $20.7 million, the contribution
of $20.8 million in net sales from stores opened in fiscal 1998, and a decrease
in miscellaneous net sales of $0.2 million. During the twelve weeks ended
October 10, 1998, the Company opened 29 new stores, relocated one store,
remodeled eleven stores, and closed two stores. As of October 10, 1998, the
Company operated 936 stores as compared to 758 stores at October 4, 1997.
Gross profit for the twelve weeks ended October 10, 1998 was $98.4 million
or 38.0% of net sales as compared with $77.7 million or 37.7% of net sales for
the twelve weeks ended October 4, 1997. The increase in the gross profit
percentage was primarily due to decreased warehouse and delivery expenses as a
percentage of net sales.
Selling, general and administrative expenses for the twelve weeks ended
October 10, 1998 increased by $13.8 million as compared to the twelve weeks
ended October 4, 1997, and, as a percentage of net sales, decreased from 32.7%
to 31.4%. This decrease as a percent of net sales was due to the reduction in
certain private company expenses which were eliminated after the
Recapitalization and the elimination of an unusual medical claim which occurred
in the twelve weeks ended October 4, 1997. The Company also incurred
approximately $0.3 million of employee compensation expense related to executive
stock option plans that is included in selling, general and administrative
expenses for the twelve weeks ended October 10, 1998.
Operating profit for the twelve weeks ended October 10, 1998 increased by
$6.7 million or 63.9% to $17.0 million or 6.5% of net sales, as compared to
$10.3 million or 5.0% of net sales for the comparable twelve weeks ended October
4, 1997.
Interest expense for the twelve weeks ended October 10, 1998 was $8.3
million compared to $1.5 million for the twelve weeks ended October 4, 1997.
The increase was due to increased debt associated with the Recapitalization and
related higher interest rates.
Income tax expense for the twelve weeks ended October 10, 1998 was $3.9
million as compared to $3.6 million for the twelve weeks ended October 4, 1997,
with effective tax rates of 42.6% and 41.9%, respectively. This increase is the
result of increased permanent adjustments and lower pretax earnings due to the
Recapitalization.
As a result of the above factors, the Company reported net income of $5.3
million for the twelve weeks ended October 10, 1998 as compared to $5.0 million
for the twelve weeks ended October 4, 1997. As a percentage of net sales, net
income for the twelve weeks ended October 10, 1998 was 2.0% as compared to 2.4%
for the twelve weeks ended October 4, 1997.
Forty Weeks Ended October 10, 1998 Compared to Forty Weeks Ended October 4, 1997
Net sales for the forty weeks ended October 10, 1998 increased by $160.5
million or 25.0% to $802.8 million as compared to $642.3 million for the
comparable forty weeks ended October 4, 1997. This increase was due to an
increase in comparable store net sales of $38.1 million or 6.2%, an increase in
net sales from stores opened in fiscal 1997 of $83.5 million, the contribution
of $39.9 million in net sales from stores opened in fiscal 1998, and a decrease
in miscellaneous net sales of $1.0 million. During the forty weeks ended
October 10, 1998, the Company opened 125 new stores, relocated five stores,
remodeled 36 stores, and closed three stores. As of October 10, 1998, the
Company operated 936 stores as compared to 758 stores at October 4, 1997.
Gross profit for the forty weeks ended October 10, 1998 was $309.6 million
or 38.6% of net sales as compared with $245.4 million or 38.2% of net sales for
the forty weeks ended October 4, 1997. The increase in the gross profit
percentage was primarily due to decreased warehouse and delivery expenses as a
percentage of net sales.
16
<PAGE>
Selling, general and administrative expenses for the forty weeks ended
October 10, 1998 increased by $47.1 million as compared to the forty weeks ended
October 4, 1997, and, as a percentage of net sales, decreased from 33.1% to
32.4%. This decrease as a percent of net sales was due to the reduction in
certain private company expenses which were eliminated after the
Recapitalization and the elimination of an unusual medical claim which occurred
in the forty weeks ended October 4, 1997. The Company also incurred
approximately $0.3 million of employee compensation expense related to executive
stock option plans that is included in selling, general and administrative
expenses for the forty weeks ended October 10, 1998.
As part of the Recapitalization, $14.2 million in transaction expenses were
incurred in the forty weeks ended October 10, 1998 which related to the
Recapitalization. This expense consisted of $11.5 million of bonuses paid to
certain employees for past performances, $0.2 million in related employment
taxes and $2.5 million for non-recurring expenses which consisted primarily of
professional fees.
Operating profit for the forty weeks ended October 10, 1998 increased to
$35.4 million or 4.4% of net sales from $32.6 million or 5.1% of net sales for
the period ended October 4, 1997. This decrease in operating profit as a
percentage of net sales was primarily due to the expenses incurred with the
Recapitalization. Excluding the $14.2 million in transaction expenses, operating
profit increased by $17.0 million or 52.4% to $49.6 million or 6.2% of net sales
for the forty weeks ended October 10, 1998, compared to $32.6 million for the
forty weeks ended October 4, 1997 due to the factors cited above.
Interest expense for the forty weeks ended October 10, 1998 was $20.1
million compared to $5.9 million for the forty weeks ended October 4, 1997. The
increase was due to increased debt associated with the Recapitalization and
related higher interest rates.
Income tax expense for the forty weeks ended October 10, 1998 was $7.0
million as compared to $10.9 million for the forty weeks ended October 4, 1997
with effective tax rates of 44.0% and 41.9%, respectively. This increase is the
result of increased permanent adjustments and lower pretax earnings due to the
Recapitalization.
As a result of the above factors, the Company reported net income of $8.9
million for the forty weeks ended October 10, 1998 as compared to net income of
$15.1 million for the forty weeks ended October 4, 1997. As a percentage of net
sales, net income for the forty weeks ended October 10, 1998 was 1.1% as
compared to net income of 2.4% for the forty weeks ended October 4, 1997.
LIQUIDITY AND CAPITAL RESOURCES
The Company's primary capital requirements have been the funding of its
continued store expansion program, store relocations and remodels, inventory
requirements, the construction and upgrading of distribution centers and the
development and implementation of proprietary information systems. The Company
has financed its growth through a combination of internally generated funds and
borrowings.
The Company's new stores require capital expenditures of approximately
$120,000 per store and an inventory investment of approximately $400,000 per
store. A substantial portion of these inventories are financed through vendor
payables. Pre-opening expenses, consisting primarily of store set-up costs and
training of new store employees, average approximately $25,000 per store and are
expensed when incurred.
Historically, the Company has negotiated extended payment terms from
suppliers to finance inventory growth, and the Company believes that it will be
able to continue financing much of its inventory growth through such extended
payment terms. The Company anticipates that inventory levels will continue to
increase primarily as a result of new store openings and increased SKU levels.
For the forty weeks ended October 10, 1998, net cash provided by operating
activities was $26.3 million, which consisted primarily of a reduction in net
working capital of $5.9 million, depreciation and amortization of $20.0 million,
net income of $8.9 million, amortization of deferred debt issuance costs of $1.3
million and other of $2.0 million. Net cash used for investing activities was
$32.1 million and consisted primarily of
17
<PAGE>
$36.2 million for capital expenditures, offset by proceeds of $4.1 million from
the sale of a corporate airplane. Net cash provided by financing activities was
$35.3 million and was primarily the result of the Recapitalization.
The Company funded the Acquisition of Western Auto with the issuance to
Sears of 11,474,606 shares of Holding's Class A Common Stock, additional
borrowings of $90.0 million under a new deferred term loan facility under the
New Credit Facility, the sale of approximately $70.0 million of Holding Common
Stock to existing stockholders of Holding and cash on hand. In connection with
the Acquisition, at the request of the Company, Sears will attempt to sell the
Parts America and Western Auto credit card portfolios to a third party buyer.
The Company has agreed to participate in any losses incurred as a result of the
sale, but its share of such losses will not exceed $10.0 million. The Company
intends to close certain stores in overlapping markets and is in the process of
completing the analysis of how many stores may be closed as a result of the
Acquisition. Certain Parts America stores and Advance Auto Parts stores have
been identified to be closed in the fourth quarter or subsequent periods. Thus
far, management estimates the Company will accrue exit costs, primarily accruals
for closed stores, in purchase accounting of $8.0 million related to the closing
of certain Parts America stores. The Company also estimates it will recognize
approximately $13.3 million in expenses in the fourth quarter, primarily
accruals for the closure of certain Advance Auto Parts stores identified to date
and a loss on the early termination of a long-term contract. Related to the
Acquisition, the Company and Holding entered into several new long-term vendor
agreements in the fourth quarter that provide for price reductions on future
purchases.
The Company believes it will have sufficient liquidity to fund its debt
service obligations and implement its growth strategy over the next several
years. The Company has outstanding indebtedness consisting of $200.0 million of
Series A Notes, borrowings of $135.0 million under the New Credit Facility and
the McDuffie County Development Authority Taxable Industrial Revenue Bonds
("IRB"). Holding has outstanding $64.0 million of Debentures. The Series A
Notes bear interest at a rate of 10.25%, payable semiannually, and require no
principal payments until maturity. The $10.0 million principal amount IRB bears
interest at a variable rate and will require no principal payments until
maturity in November 2002. In addition to its operating cash flow, the Company
has access to a total of $465.0 million through the New Credit Facility. The
New Credit Facility provides for (i) a $125.0 million Tranche B term loan, which
was made at the closing of the Recapitalization; (ii) a revolver with maximum
borrowings of approximately $125.0 million, a minimal amount of which was drawn
(including in connection with the replacement of outstanding letters of credit
in the amount of approximately $2.0 million) in connection with the
Recapitalization, (iii) a $125.0 million delayed draw term loan $50.0 million of
which is available to the Company through October 15, 1999 and $75.0 million of
which is available to the Company through April 15, 2001, and (iv) a $90.0
million deferred term loan facility, which was made at the closing of the
Acquisition. The term loan facilities, other than the Tranche B term loan, will
mature on the sixth anniversary of initial borrowing, and the Tranche B term
loan will mature on the eighth anniversary of initial borrowing. Annual
principal payments on the term loan facilities prior to the sixth anniversary of
initial borrowing will be nominal; thereafter, required principal payments will
be approximately $236.0 million in 2004, $60.0 million in 2005 and $30.0 million
in 2006, assuming the term loan facilities have been fully borrowed. The
revolving loan facility will mature on the sixth anniversary of initial
borrowing. None of the delayed draw term loans have been drawn in connection
with the Recapitalization or the Acquisition. The loans under the New Credit
Facility are secured by a first priority security interest in substantially all
tangible and intangible assets of the Company. Amounts available to the Company
under the revolver and delayed draw term loans are subject to a borrowing base
formula which is based on certain percentages of the Company's inventories. The
Company intends to use borrowings under the revolver and delayed draw term loans
for store expansion and funding of working capital. Borrowings under the New
Credit Facility are required to be prepaid, subject to certain exceptions, with
(a) 50% of defined excess cash flow, (b) 100% of the net cash proceeds of all
asset sales or other dispositions of property by the Company and its
subsidiaries (including certain insurance and condemnation proceeds), subject to
certain exceptions (including exceptions for (i) reinvestment of certain asset
sale proceeds within 360 days of such sale and (ii) certain sale-leaseback
transactions), (c) 100% of the net proceeds of issuances of debt obligations of
the Company and its subsidiaries, and (d) 100% of the net proceeds of issuance
of equity of the Company and its subsidiaries. Because increases in net working
capital, capital expenditures and debt repayments are deducted in calculating
excess cash flow, the Company does not anticipate that the prepayment obligation
under the New Credit Facility in respect thereof will have a material effect on
its operating strategy. With respect to growth through acquisitions, the
operation of this covenant may result in the application of cash resources for
prepayments which would require the Company to secure additional equity or debt
financing to fund an acquisition, but while no assurance can be given, the
Company does not anticipate that this would have a material effect on its
ability to finance acquisitions in the future.
The Company's business is somewhat seasonal in nature, with the highest
sales occurring in the spring and summer months. In addition, the Company's
business is affected by weather conditions. While unusually heavy precipitation
tends to soften sales as elective maintenance is deferred during such periods,
extremely hot and cold weather tends to enhance sales by causing parts to fail.
18
<PAGE>
YEAR 2000 CONVERSION
A significant percentage of the software that runs most computers relies on
two-digit date codes to perform computations and decision-making functions.
Commencing on January 1, 2000, these computer programs may fail from an
inability to interpret date codes properly, misinterpreting "00" as the year
1900 rather than 2000. The Company has completed the identification of all
necessary internal software changes to ensure that it does not experience any
loss of critical business functionality due to the Year 2000 issue. The Company
has appointed an internal Year 2000 project manager and remediation team and has
adopted a four phase approach of assessment, remediation, testing, and
contingency planning. The scope of the project includes all internal software,
hardware, operating systems, and assessment of risk to the business from vendors
and other partners' Year 2000 issues. The assessment of all internal systems
has been completed, the remediation and testing phases are in progress, and
contingency planning for certain information technology systems has begun. The
Company believes that this approach of assessment (including prioritization by
business risk), remediation (including conversions to new software), testing of
necessary changes, and contingency planning will minimize the business risk of
year 2000 from internal systems.
The Company is utilizing internal and external resources to correct,
replace, and test its software for Year 2000 compliance and plans to complete
the Year 2000 project no later than June 30, 1999. The total cost of the Year
2000 project for the Company prior to the Acquisition was estimated at $3.7
million. Of the total project cost, approximately $1.0 million represents the
purchase of new software and hardware which will be capitalized. The remaining
will be expensed as incurred during 1998 and 1999. As of the end of the
Company's third quarter, the Company has spent approximately $1.2 million on the
Year 2000 project. See below for a discussion of Year 2000 issues with respect
to the Company's Western Auto subsidiary.
Ongoing communications have been established with almost all vendors and
other partners to monitor their progress in resolving Year 2000 issues, most of
which the Company believes, are making substantial progress. However, the
Company cannot guarantee that Year 2000 related systems issues of its business
partners will be corrected in a timely manner or that the failure of its
business partners to correct these issues would not have a material adverse
effect.
The Company has already begun to develop contingency plans in the event a
business interruption caused by Year 2000 problems should occur. For certain
information technology systems, contingency plans are in place. Elements of the
Company's contingency plans will include: switching of vendors, back-up systems
that do not rely on computers, and the stockpiling of certain products in the
months before the Year 2000.
Western Auto has adopted a Year 2000 strategy and believes it has retained
an adequate number of personnel to execute its strategy. Western Auto has
entered into a number of retention agreements to retain such key personnel and
is in the process of reviewing the Western Auto plan. There can be no assurance,
however, that Western Auto will attain sufficient Year 2000 compliance in a
timely manner.
The cost and time estimated for the Year 2000 project are based on the
Company's best estimates. There can be no guarantee that these estimates will
be achieved and that planned results will be achieved. Risks factors include,
but are not limited to, the retention of internal and external resources
dedicated to the project, the timely delivery of software corrections from
external vendors, and the successful completion of key business partners' Year
2000 projects.
19
<PAGE>
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISKS
Not Applicable.
<PAGE>
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
None.
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
None.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
None.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
ITEM 5. OTHER INFORMATION
None.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
27.1 Financial Data Schedule
(b) Reports on Form 8-K
None.
21
<PAGE>
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
ADVANCE STORES COMPANY, INCORPORATED,
a Virginia corporation
November 23, 1998 By: /s/ J. O'Neil Leftwich
---------------------------------------
J. O'Neil Leftwich
Chief Financial Officer
(Duly Authorized Officer and Principal
Financial Officer)
S-1
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE
CONDENSED CONSOLIDATED FINANCIAL STATEMENTS OF ADVANCE STORES COMPANY,
INCORPORATED FOR THE FORTY WEEK PERIOD ENDED OCTOBER 10, 1998 AND IS QUALIFIED
IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS.
</LEGEND>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> OTHER
<FISCAL-YEAR-END> JAN-02-1999
<PERIOD-START> JUL-19-1998
<PERIOD-END> OCT-10-1998
<CASH> 36,940
<SECURITIES> 0
<RECEIVABLES> 5,672
<ALLOWANCES> 0
<INVENTORY> 363,113
<CURRENT-ASSETS> 440,595
<PP&E> 243,141
<DEPRECIATION> 96,260
<TOTAL-ASSETS> 607,242
<CURRENT-LIABILITIES> 289,653
<BONDS> 0
0
0
<COMMON> 27
<OTHER-SE> (34,601)
<TOTAL-LIABILITY-AND-EQUITY> 607,242
<SALES> 802,839
<TOTAL-REVENUES> 802,839
<CGS> 493,289
<TOTAL-COSTS> 493,289
<OTHER-EXPENSES> 14,230
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 20,108
<INCOME-PRETAX> 15,912
<INCOME-TAX> 7,007
<INCOME-CONTINUING> 8,905
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 8,905
<EPS-PRIMARY> 0
<EPS-DILUTED> 0
</TABLE>
