10-Q 1 r2q03fin.txt UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 ---------------------------------- 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 August 2, 2003 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 No. 1-3381 ------ The Pep Boys - Manny, Moe & Jack ------------------------------------------------------ (Exact name of registrant as specified in its charter) Pennsylvania 23-0962915 ------------------------------- --------------------------- (State or other jurisdiction of (I.R.S. Employer ID number) incorporation or organization) 3111 W. Allegheny Ave. Philadelphia, PA 19132 ---------------------------------------- ---------- (Address of principal executive offices) (Zip code) 215-430-9000 ---------------------------------------------------- (Registrant's telephone number, including area code) 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 and Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports); and (2) has been subject to such filing requirements for the past 90 days. Yes ( x ) No ( ) Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). Yes ( x ) No ( ) As of August 31, 2003 there were 52,522,000 shares of the registrant's Common Stock outstanding. 1 ------------------------------------------------------------------- Index Page ------------------------------------------------------------------- PART I - FINANCIAL INFORMATION ------------------------------ Item 1. Condensed Consolidated Financial Statements (Unaudited) Consolidated Balance Sheets - August 2, 2003 and February 1, 2003 3 Consolidated Statements of Operations - Thirteen and Twenty-six weeks ended August 2, 2003 and August 3, 2002 4 Consolidated Statements of Cash Flows - Twenty-six weeks ended August 2, 2003 and August 3, 2002 5 Notes to Condensed Consolidated Financial Statements 6-23 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations 24-32 Item 3. Quantitative and Qualitative Disclosures About Market Risk 33 Item 4. Controls and Procedures 33 PART II - OTHER INFORMATION --------------------------- Item 1. Legal Proceedings 34 Item 2. Changes in Securities and Use of Proceeds 35 Item 3. Defaults Upon Senior Securities 35 Item 4. Submission of Matters to a Vote of Security Holders 35 Item 5. Other Information 36 Item 6. Exhibits and Reports on Form 8-K 36 SIGNATURES 37 INDEX TO EXHIBITS 38 2 PART I - FINANCIAL INFORMATION ------------------------------ Item 1. Condensed Consolidated Financial Statements (Unaudited)
THE PEP BOYS - MANNY, MOE & JACK AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS (dollar amounts in thousands, except per share amounts) UNAUDITED Aug. 2, 2003 Feb. 1, 2003* ------------------------------------------------------------------------------------------------------ ASSETS Current Assets: Cash and cash equivalents $ 68,095 $ 42,770 Accounts receivable, net 24,405 17,916 Merchandise inventories 506,510 488,882 Prepaid expenses 29,430 43,746 Deferred income taxes 32,623 13,723 Other 51,505 56,687 Assets held for disposal 21,900 1,146 ------------------------------------------------------------------------------------------------------ Total Current Assets 734,468 664,870 ------------------------------------------------------------------------------------------------------ Property and Equipment-at cost: Land 264,121 279,109 Buildings and improvements 892,927 936,770 Furniture, fixtures and equipment 592,213 604,531 Construction in progress 26,886 19,450 ------------------------------------------------------------------------------------------------------ 1,776,147 1,839,860 Less accumulated depreciation and amortization 761,687 751,823 ------------------------------------------------------------------------------------------------------ Property and Equipment - Net 1,014,460 1,088,037 ------------------------------------------------------------------------------------------------------ Other 56,913 47,003 ------------------------------------------------------------------------------------------------------ Total Assets $1,805,841 $1,799,910 ------------------------------------------------------------------------------------------------------ LIABILITIES AND STOCKHOLDERS' EQUITY Current Liabilities: Accounts payable $ 319,223 $ 200,053 Accrued expenses 267,356 232,255 Current maturities of long-term debt and obligations under capital leases 72,362 101,882 ------------------------------------------------------------------------------------------------------ Total Current Liabilities 658,941 534,190 ------------------------------------------------------------------------------------------------------ Long-term debt and obligations under capital leases, less current maturities 314,711 375,577 Convertible long-term debt 150,000 150,000 Other long-term liabilities 28,924 25,156 Deferred income taxes 42,894 60,663 Deferred gain on sale leaseback 4,324 4,332 Commitments and Contingencies Stockholders' Equity: Common Stock, par value $1 per share: Authorized 500,000,000 shares; Issued 63,910,577 shares 63,911 63,911 Additional paid-in capital 177,244 177,244 Retained earnings 571,403 630,847 Accumulated other comprehensive income (loss) 3,749 (151) ------------------------------------------------------------------------------------------------------ 816,307 871,851 Less cost of shares in treasury - 9,352,311 shares and 10,070,729 shares 150,996 162,595 Less cost of shares in benefits trust - 2,195,270 shares 59,264 59,264 ------------------------------------------------------------------------------------------------------ Total Stockholders' Equity 606,047 649,992 ------------------------------------------------------------------------------------------------------ Total Liabilities and Stockholders' Equity $1,805,841 $1,799,910 ------------------------------------------------------------------------------------------------------ See notes to condensed consolidated financial statements. * Taken from the audited financial statements at February 1, 2003.
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THE PEP BOYS - MANNY, MOE & JACK AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS (dollar amounts in thousands, except per share amounts) UNAUDITED Thirteen weeks ended Twenty-six weeks Ended --------------------------- ----------------------------- Aug. 2, 2003 Aug. 3, 2002 Aug. 2, 2003 Aug. 3, 2002 ------------ ------------ -------------- ------------ Amount Amount Amount Amount ------------------------------------------------------------------------------------------------------ Merchandise Sales $ 451,285 $ 461,886 $ 862,417 $ 900,343 Service Revenue 104,745 103,745 204,523 204,943 ------------------------------------------------------------------------------------------------------ Total Revenues 556,030 565,631 1,066,940 1,105,286 ------------------------------------------------------------------------------------------------------ Costs of Merchandise Sales 344,903 320,485 635,243 628,123 Costs of Service Revenue 80,881 78,572 155,653 153,492 ------------------------------------------------------------------------------------------------------ Total Costs of Revenues 425,784 399,057 790,896 781,615 ------------------------------------------------------------------------------------------------------ Gross Profit from Merchandise Sales 106,382 141,401 227,174 272,220 Gross Profit from Service Revenue 23,864 25,173 48,870 51,451 ------------------------------------------------------------------------------------------------------ Total Gross Profit 130,246 166,574 276,044 323,671 ------------------------------------------------------------------------------------------------------ Selling, General and Administrative Expenses 143,049 129,048 290,826 254,738 ------------------------------------------------------------------------------------------------------ Operating (Loss) Profit (12,803) 37,526 (14,782) 68,933 Non-operating Income 851 997 1,901 1,820 Interest Expense 9,603 12,624 20,304 24,405 ------------------------------------------------------------------------------------------------------ (Loss) Earnings from Continuing Operations Before Income Taxes and Cumulative Effect of Change in Accounting Principle (21,555) 25,899 (33,185) 46,348 Income Tax (Benefit) Expense (7,976) 9,789 (12,279) 17,149 ------------------------------------------------------------------------------------------------------ Net (Loss) Earnings from Continuing Operations Before Cumulative Effect of Change in Accounting Principle (13,579) 16,110 (20,906) 29,199 Discontinued Operations, Net of Tax (22,802) 444 (22,208) 920 Cumulative Effect of Change in Accounting Principle, Net of Tax - - (2,484) - Net (Loss) Earnings (36,381) 16,554 (45,598) 30,119 ------------------------------------------------------------------------------------------------------ Retained Earnings, beginning of period 617,798 611,871 630,847 601,944 Cash Dividends 3,491 3,475 6,978 6,948 Effect of Stock Options 6,477 (16) 6,548 149 Dividend Reinvestment Plan 46 72 320 72 ------------------------------------------------------------------------------------------------------ Retained Earnings, end of period $ 571,403 $ 624,894 $ 571,403 $ 624,894 ------------------------------------------------------------------------------------------------------ Basic (Loss) Earnings Per Share: (Loss) From Continuing Operations Before Cumulative Effect of Change in Accounting Principle $ (0.26) $ 0.31 $ (0.40) $ 0.57 Discontinued Operations, net of tax (0.44) 0.01 (0.43) 0.02 Cumulative Effect of Change in Accounting Principle, net of tax - - (0.05) - ------------------------------------------------------------------------------------------------------ Basic (Loss) Earnings Per Share $ (0.70) $ 0.32 $ (0.88) $ 0.59 ------------------------------------------------------------------------------------------------------ Diluted (Loss) Earnings Per Share: (Loss) From Continuing Operations Before Cumulative Effect of Change in Accounting Principle $ (0.26) $ 0.29 $ (0.40) $ 0.54 Discontinued Operations, net of tax (0.44) 0.01 (0.43) 0.02 Cumulative Effect of Change in Accounting Principle, net of tax - - (0.05) - ------------------------------------------------------------------------------------------------------ Diluted (Loss) Earnings Per Share $ (0.70) $ 0.30 $ (0.88) $ 0.56 ------------------------------------------------------------------------------------------------------ Cash Dividends Per Share $ .0675 $ .0675 $ .1350 $ .1350 ------------------------------------------------------------------------------------------------------ See notes to condensed consolidated financial statements.
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THE PEP BOYS - MANNY, MOE & JACK AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (dollar amounts in thousands) UNAUDITED Twenty-six Weeks Ended Aug. 2, 2003 Aug, 3, 2002 ---------------------------------------------------------------------------------------------------------------- Cash Flows from Operating Activities: Net (Loss) Earnings $ (45,598) $ 30,119 (Loss) Earnings from discontinued operations (22,208) 920 ---------------------------------------------------------------------------------------------------------------- (Loss) Earnings from continuing operations (23,390) 29,199 Adjustments to Reconcile Net (Loss) Earnings From Continuing Operations to Net Cash Provided by Continuing Operations: Cumulative effect of change in accounting principle 2,484 - Depreciation and amortization 35,271 38,706 Accretion of asset disposal obligation 90 - Deferred income taxes (38,959) (377) Deferred gain on sale lease back (8) (45) Loss on asset impairment 2,121 - Loss on assets held for disposal - 1,360 Loss from sale of assets 34 179 Changes in operating assets and liabilities: Decrease in accounts receivable, prepaid expenses and other 9,289 22,518 Increase in merchandise inventories (17,628) (2,882) Increase in accounts payable 119,170 3,807 Increase (Decrease) in accrued expenses 40,593 (1,764) Increase in other long-term liabilities 3,768 440 ---------------------------------------------------------------------------------------------------------------- Net Cash Provided by Continuing Operations 132,835 91,141 Net Cash Provided by Discontinued Operations 4,591 3,290 ---------------------------------------------------------------------------------------------------------------- Net Cash Provided by Operating Activities 137,426 94,431 ---------------------------------------------------------------------------------------------------------------- Cash Flows from Investing Activities: Capital expenditures (21,420) (11,951) Proceeds from sales of assets 1,952 5,252 ---------------------------------------------------------------------------------------------------------------- Net Cash Used in Investing Activities (19,468) (6,699) ---------------------------------------------------------------------------------------------------------------- Cash Flows from Financing Activities: Net borrowings (payments) under line of credit agreements 1,441 (70,539) Repayment of life insurance policy loan - (20,686) Capital lease obligations (400) (308) Reduction of long-term debt (91,427) (65,769) Net proceeds from issuance of notes - 146,250 Dividends paid (6,978) (6,948) Proceeds from exercise of stock options 4,085 475 Proceeds from dividend reinvestment plan 646 677 ---------------------------------------------------------------------------------------------------------------- Net Cash Used in Financing Activities (92,633) (16,848) ---------------------------------------------------------------------------------------------------------------- Net Increase in Cash 25,325 70,884 ---------------------------------------------------------------------------------------------------------------- Cash and Cash Equivalents at Beginning of Period 42,770 15,981 ---------------------------------------------------------------------------------------------------------------- Cash and Cash Equivalents at End of Period $ 68,095 $ 86,865 ---------------------------------------------------------------------------------------------------------------- Non-cash financing activities: Equipment Capital Leases $ - $ 1,301 ---------------------------------------------------------------------------------------------------------------- See notes to condensed consolidated financial statements.
5 THE PEP BOYS - MANNY, MOE & JACK AND SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS NOTE 1. Condensed Consolidated Financial Statements The consolidated balance sheets as of August 2, 2003, the consolidated statements of operations for the thirteen and twenty-six week periods ended August 2, 2003 and August 3, 2002 and the consolidated statements of cash flows for the twenty-six week periods ended August 2, 2003 and August 3, 2002 have been prepared by the Company without audit. In the opinion of management, all adjustments necessary to present fairly the financial position, results of operations and cash flows at August 2, 2003 and for all periods presented have been made. Certain information and footnote disclosures normally included in financial statements prepared in accordance with generally accepted accounting principles have been condensed or omitted. It is suggested that these condensed consolidated financial statements be read in conjunction with the financial statements and notes thereto included in the Company's Annual Report on Form 10-K for the fiscal year ended February 1, 2003. The results of operations for the thirteen and twenty-six week periods ended August 2, 2003 are not necessarily indicative of the operating results for the full year. Certain reclassifications have been made to the prior year's consolidated financial statements to conform to the current year's presentation. NOTE 2. Accounting for Stock-Based Compensation The Company accounts for its stock-based employee compensation plans in accordance with the recognition and measurement principles of Accounting Principles Board (APB) No. 25, "Accounting for Stock Issued to Employees," and related interpretations. No stock-based employee compensation cost is reflected in net earnings, as all options granted under those plans had an exercise price equal to the market value of the underlying common stock on the date of grant. The following table illustrates the effect on net earnings and earnings per share if the Company had applied the fair value recognition provisions of Statement of Financial Accounting Standards (SFAS) No. 123, "Accounting for Stock-Based Compensation," to stock-based employee compensation:
(dollar amounts in thousands, except per share amounts) Thirteen weeks ended Twenty-six weeks ended --------------------------------- --------------------------------- August 2, 2003 August 3, 2002 August 2, 2003 August 3, 2002 -------------------------------------------------------------------------------------------------------------------- Net (loss) earnings: As reported $(36,381) $ 16,554 $ (45,598) $ 30,119 Less: Total stock-based compensation expense determined under fair value-based method, net of tax (636) (954) (1,447) (1,915) -------------------------------------------------------------------------------------------------------------------- Pro forma $(37,017) $ 15,600 $ (47,045) $ 28,204 -------------------------------------------------------------------------------------------------------------------- Net (loss) earnings per share: Basic: As reported $ (.70) $ .32 $ (.88) $ .59 Pro forma $ (.71) $ .30 $ (.91) $ .55 -------------------------------------------------------------------------------------------------------------------- Diluted: As reported $ (.70) $ .30 $ (.88) $ .56 Pro forma $ (.71) $ .28 $ (.91) $ .52 --------------------------------------------------------------------------------------------------------------------
6 The fair value of each option granted during the periods ending August 2, 2003 and August 3, 2002 is estimated on the date of grant using the Black-Scholes option-pricing model with the following weighted-average assumptions:
August 2, 2003 August 3, 2002 ------------------------------------------------------------------ Dividend yield 1.57% 1.44% Expected volatility 42% 41% Risk-free interest rate range: high 4.4% 5.4% low 1.5% 2.3% Ranges of expected lives in years 4-8 4-8 ------------------------------------------------------------------
NOTE 3. New Accounting Standards In May 2003, the Financial Accounting Standards Board (FASB) issued SFAS No. 150, "Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity." SFAS No. 150 establishes standards for how an issuer classifies and measures financial instruments that are within the pronouncement's scope as a liability because it embodies an obligation of the issuer. Provisions of this standard are consistent with the current definition of liabilities in FASB Concepts Statement No. 6, "Elements of Financial Statements," while other provisions revise that definition to include certain obligations that a reporting entity can or must settle through issuance of its own equity shares. SFAS No. 150 is effective for financial instruments entered into or modified after May 31, 2003, and otherwise shall be effective at the beginning of the first interim period beginning after June 15, 2003. The Company will adopt this statement in the third quarter of fiscal 2003 with no material effect on its consolidated financial statements. In April 2003, the FASB issued SFAS No. 149, "Amendment of Statement 133 on Derivative Instruments and Hedging Activities." SFAS No. 149 amends and clarifies financial accounting and reporting for derivative instruments and hedging activities, resulting primarily from decisions made by the FASB's Derivatives Implementation Group following the issuance of SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities." SFAS No. 149 is effective for contracts entered into or modified after June 30, 2003 and is effective for hedging relationships designated after June 30, 2003. The Company adopted this statement in the second quarter of fiscal 2003 with no material effect on its consolidated financial statements. In January 2003, the FASB issued Financial Interpretation Number (FIN) 46, "Consolidation of Variable Interest Entities." FIN 46, an interpretation of Accounting Research Bulletin No. 51, "Consolidated Financial Statements," changes the criteria by which one company includes another entity in its consolidated financial statements. FIN 46 requires a variable interest entity to be consolidated by a company if that company is subject to a majority of any expected losses from the variable interest entity's activities, is entitled to receive any expected residual returns of the variable interest entity, or both. FIN 46 applies immediately to variable interest entities created after January 31, 2003, and applies in the first fiscal year or interim period beginning after June 15, 2003, for variable interest entities created prior to February 1, 2003. The Company adopted this statement for variable interest entities created after January 31, 2003 in the fourth quarter of 2002 with no material effect on its consolidated financial statements. On August 1, 2003 the Company refinanced its real estate operating lease facility, which qualified as a variable interest entity into a new entity. The Company has evaluated this leasing transaction in accordance with FIN 46 and has determined it does not have to consolidate this leasing entity. The Company will adopt this statement for variable interest entities created prior to January 31, 2003 in the third quarter of 2003 with no material effect on its consolidated financial statements. 7 In May 2002, the FASB issued SFAS No. 145, "Rescission of FASB Statements No. 4, 44 and 64, Amendment of FASB Statement No. 13, and Technical Corrections." As a result of rescinding FASB Statement No. 4, "Reporting Gains and Losses from Extinguishment of Debt," gains and losses from extinguishment of debt should be classified as extraordinary items only if they meet the criteria of APB Opinion No. 30, "Reporting the Results of Operations." This statement also amends FASB Statement No. 13, "Accounting for Leases," to eliminate an inconsistency between the required accounting for sale-leaseback transactions and the required accounting for certain lease modifications that have economic effects that are similar to sale-leaseback transactions. Additional amendments include changes to other existing authoritative pronouncements to make various technical corrections, clarify meanings or describe their applicability under changed conditions. The Company has adopted the provisions of SFAS No. 145 for the thirteen weeks ended May 3, 2003 with no material effect on its consolidated statements of operations. Reclassifications of extraordinary items pertaining to the extinguishment of debt, if any, will be made throughout fiscal 2003 to maintain comparability for the reported periods. NOTE 4. Merchandise Inventories Merchandise inventories are valued at the lower of cost (last-in, first-out) or market. If the first-in, first-out method of valuing inventories had been used by the Company, the inventory valuation difference would have been immaterial on both August 2, 2003 and February 1, 2003. NOTE 5. Accrued Expenses The Company's accrued expenses for the periods ending August 2, 2003 and February 1, 2003 were as follows:
(dollar amounts in thousands) Aug. 2, 2003 Feb. 1, 2003 --------------------------------------------------------------------- Medical and casualty risk participation reserve $ 110,360 $ 124,571 Accrued compensation and related taxes 48,485 49,923 Legal Reserves 32,246 6,054 Other 76,265 51,707 --------------------------------------------------------------------- Total $ 267,356 $ 232,255 ---------------------------------------------------------------------
8 NOTE 6. Restructuring Building upon the Profit Enhancement Plan launched in October 2000, the Company conducted a comprehensive review of its operations including individual store performance, the entire management infrastructure and its merchandise and service offerings. On July 31, 2003, the Company announced several initiatives aimed at realigning its business and continuing to improve upon the Company's profitability. The Company expects these actions, including the disposal and sublease of the properties, to be substantially completed by the end of the second quarter 2004 and estimates the costs, including future costs that were not accrued, to be approximately $70,100,000. The Company anticipates this restructuring will result in an annual savings of approximately $11,000,000. The Company is accounting for these initiatives in accordance with the provisions of SFAS No. 146 "Accounting for Costs Associated with Exit or Disposal Activities" and SFAS No. 144 "Accounting for the Impairment or Disposal of Long-Lived Assets". These initiatives included: Closure of 33 under-performing stores on July 31, 2003 The charges related to these closures included a $33,887,000 write down of fixed assets, $1,122,000 in long-term lease and other related obligations, net of subleases, and $980,000 in workforce reduction costs. These charges are included in discontinued operations of the consolidated statement of operations. The write-down of fixed assets includes the adjustment to the market value of those owned stores that are now classified as assets held for disposal in accordance with SFAS 144 and the write-down of leasehold improvements. The assets held for disposal have been valued at the lower of their carrying amount or their estimated fair value, net of disposal costs. The long-term lease and other related obligations represent the fair value of such obligations less the estimated net sublease income. The workforce reduction costs represent the involuntary termination benefits payable to approximately 900 store employees, all of whom were notified on or prior to July 31, 2003. Severance for these employees was accrued in accordance with SFAS 146. Approximately 50% of these employees were terminated as of August 2, 2003. Discontinuation of certain merchandise offerings The Company recorded a $24,580,000 write-down of inventory as a result of a decision to discontinue certain merchandising offerings. This write-down was recorded in cost of merchandise sales on the consolidated statement of operations. Corporate realignment The charges related to this realignment included $3,070,000 in workforce reduction costs, $2,543,000 of expenses incurred in the development of the restructuring plan, a $536,000 write-down of certain assets and $467,000 in costs related to two warehouse lease terminations. The workforce reduction costs represent the involuntary termination benefits payable to 150 Store Support Center employees and field managers. Approximately 88% of these employees were terminated as of August 2, 2003. The realignment charges were primarily recorded in cost of merchandise sales and selling, general & administrative expenses on the consolidated statement of operations. 9 The following chart details the reserve balances through August 2, 2003. The reserve includes remaining rent on leases net of sublease income, other contractual obligations associated with leased properties and employee severance. (dollar amounts Lease Contractual in thousands) Severance Expenses Obligations Total --------------------------------------------------------------------------------- Reserve balance at Feb. 1, 2003 $ - $ - $ - $ - Original Reserve 4,050 2,332 887 7,269 Provision for Present value of liabilities - - - - Changes in assumptions about future sublease income, lease termination and severance - - - - Cash payments - - - - --------------------------------------------------------------------------------- Reserve Balance at August 2, 2003 $ 4,050 $ 2,332 $ 887 $ 7,269 ---------------------------------------------------------------------------------
Note 7. Discontinued Operations In accordance with SFAS 144, the Company's discontinued operations reflect the operating results for the 33 stores closed on July 31, 2003 as part of the Company's corporate restructuring. The results for the thirteen and twenty-six weeks ended August 2, 2003 and August 3, 2002 have been reclassified to show the results of operations for the 33 closed stores as discontinued operations. Below is a summary of these results: Thirteen weeks ended Twenty-six weeks Ended --------------------------- ----------------------------- Aug. 2, 2003 Aug. 3, 2002 Aug. 2, 2003 Aug. 3, 2002 ------------ ------------ -------------- ------------ (Amounts in thousands) Amount Amount Amount Amount ------------------------------------------------------------------------------------------------------ Total Revenues $ 19,408 $ 20,154 $ 37,714 $ 39,473 Total Gross Profit (31,124) 5,002 (26,116) 9,841 Selling, General and Administrative Expenses 5,070 4,288 9,135 8,380 (Loss) Earnings from Discontinued Operations Before Income Taxes (36,194) 714 (35,251) 1,461 Discontinued Operations, Net of Tax $(22,802) $ 444 $(22,208) $ 920 ------------------------------------------------------------------------------------------------------
In addition, the Company has reclassified to assets held for disposal $7,724,000 and $14,176,000 of building and land, respectively. NOTE 8. Pension and Savings Plan In April 2003, the Company made a settlement of approximately $12,600,000 related to the Supplemental Executive Retirement Plan obligation for the former Chairman and CEO. This obligation resulted in an expense for settlement accounting under SFAS No. 88, "Employers' Accounting for Settlements and Curtailments of Defined Benefit Pension Plans and for Termination Benefits" of approximately $4,900,000, during the quarter ended May 3, 2003. NOTE 9. Other Commitments In April 2003, the Company satisfied the commitment related to the non-renewal of the former Chairman and CEO's employment agreement for approximately $4,900,000. 10 NOTE 10. Net Earnings Per Share
THE PEP BOYS - MANNY, MOE & JACK AND SUBSIDIARIES COMPUTATION OF BASIC AND DILUTED EARNINGS PER SHARE (in thousands, except per share amounts) UNAUDITED Thirteen weeks ended Twenty-six weeks ended ----------------------------------- ---------------------------------- Aug. 2, 2003 Aug. 3, 2002 Aug. 2, 2003 Aug. 3, 2002 -------------- --------------- -------------- ------------ (a) (Loss) earnings from continuing operations before cumulative effect of change in accounting principle $ (13,579) $ 16,110 $ (20,906) $ 29,199 Adjustment for interest on convertible senior notes, net of income tax effect - 826 - 826 --------------------------------------------------------------------------------------------------------------------------------- (b) Adjusted net (loss) earnings from continuing operations before cumulative effect of change in accounting principle $ (13,579) $ 16,936 $ (20,906) $ 30,025 --------------------------------------------------------------------------------------------------------------------------------- (c) Average number of common shares outstanding during period 51,816 51,489 51,733 51,467 Common shares assumed issued upon conversion of convertible senior notes - 5,520 - 2,760 Common shares assumed issued upon exercise of dilutive stock options, net of assumed repurchase, at the average market price - 1,059 - 1,111 --------------------------------------------------------------------------------------------------------------------------------- (d) Average number of common shares assumed outstanding during period 51,816 58,068 51,733 55,338 --------------------------------------------------------------------------------------------------------------------------------- Basic (Loss) Earnings Per Share: (Loss) Income From Continuing operations Before Cumulative Effect of Change in Accounting Principle (a/c) $ (0.26) $ 0.31 $ (0.40) $ 0.57 Discontinued Operations, Net of Tax (0.44) 0.01 (0.43) 0.02 Cumulative Effect of Change in Accounting Principle, Net of Tax - - (0.05) - --------------------------------------------------------------------------------------------------------------------------------- Basic (Loss) Earnings Per Share $ (0.70) $ 0.32 $ (0.88) $ 0.59 --------------------------------------------------------------------------------------------------------------------------------- Diluted (Loss) Earnings Per share: (Loss) earnings income from continuing operations before cumulative effect of change in accounting principle (b/d) $ (0.26) $ 0.29 $ (0.40) $ 0.54 Discontinued Operations, Net of Tax (0.44) 0.01 (0.43) 0.02 Cumulative Effect of Change in Accounting Principle, Net of Tax - - (0.05) - --------------------------------------------------------------------------------------------------------------------------------- Diluted (Loss) Earnings Per Share $ (0.70) $ 0.30 $ (0.88) $ 0.56 ---------------------------------------------------------------------------------------------------------------------------------
Adjustments for the convertible senior notes were anti-dilutive during the thirteen and twenty-six week period ended August 2, 2003 and therefore excluded from the computation of diluted EPS. Adjustments for dilutive stock options of 939,000 and 676,000 shares were excluded from the Computation of diluted EPS due to the anti-dilutive effect related to the net losses for the thirteen and twenty-six week periods ended August 2, 2003,respectively. Options to purchase shares of common stock which were not included in the computation of diluted EPS because the options' exercise prices were greater than the average market price of the shares of common stock during the thirteen and twenty-six week periods ended August 2, 2003 and August 3, 2002 were as follows:
Thirteen weeks ended Twenty-six weeks ended (in thousands) ---------------------------------- ---------------------------------- Aug. 2, 2003 Aug. 3, 2002 Aug. 2, 2003 Aug. 3, 2002 --------------- -------------- --------------- -------------- Common shares associated with antidilutive stock options excluded from computation of diluted EPS ..... 4,687 4,250 4,825 4,225 --------------- -------------- --------------- --------------
11 NOTE 11. Warranty Reserve The Company provides warranties for both its merchandise sales and service labor. Warranties for merchandise are generally covered by its vendors, with the Company covering any costs above the vendor's stipulated allowance. Service labor warranties are covered in full by the Company on a limited lifetime basis. The Company establishes its warranty reserves based on historical data of warranty transactions. Components of the reserve for warranty costs for the twenty-six week period ending August 2, 2003 are as follows:
(dollar amounts in thousands) ------------------------------------------------------------------------ Beginning balance at February 1, 2003 $ 911 Additions related to current period sales 3,897 Warranty costs incurred in current period (3,838) Adjustments to accruals related to prior year sales - ------------------------------------------------------------------------ Ending Balance at August 2, 2003 $ 970 ------------------------------------------------------------------------
NOTE 12. Asset Retirement Obligation The Company has adopted the provisions of SFAS No. 143, "Accounting for Asset Retirement Obligations", in the first quarter of fiscal 2003. SFAS No. 143 requires that the fair value of a liability for an asset retirement obligation be recognized in the period in which it is incurred if a reasonable estimate of fair value can be made. SFAS No. 143 also requires the capitalization of any retirement obligation costs as part of the carrying amount of the long-lived asset and the subsequent allocation of the total expense to future periods using a systematic and rational method. Upon adoption, the Company recorded a non-cash charge to earnings of $3,943,000 ($2,484,000, net of tax) for the cumulative effect of this accounting change. This charge was related to retirement obligations associated with certain equipment used in the Company's service operation. In addition, the Company initially recognized an asset of $2,844,000, accumulated depreciation of $2,247,000 and a liability of $4,540,000 on its consolidated balance sheet. 12 At August 2, 2003, the Company has a liability pertaining to the asset retirement obligation in accrued expenses on its consolidated balance sheet. The following is a reconciliation of the beginning and ending carrying amount of the Company's asset retirement obligation as of August 2, 2003: (dollar amounts in thousands) ------------------------------------------------------------------------ Asset retirement obligation, February 1, 2003 $ - Asset retirement obligation recognized upon adoption 4,540 Asset retirement obligation incurred during the period 176 Asset retirement obligation settled during period (87) Accretion expense 95 ------------------------------------------------------------------------ Asset retirement obligation, August 2, 2003 $ 4,724 ------------------------------------------------------------------------
Had the Company adopted the provisions of SFAS No. 143 prior to February 2, 2003, the amount of the asset retirement obligations on a pro forma basis would have been as follows: (dollar amounts in thousands) ----------------------------------------------------------------- Asset retirement obligation, February 2, 2002 $4,156 Asset retirement obligation, February 1, 2003 $4,540 -----------------------------------------------------------------
The following table summarizes the pro forma net earnings and earning per share for the thirteen and twenty-six weeks periods ending August 3, 2002 had the Company adopted the provisions of SFAS No. 143 prior to February 2, 2003:
Thirteen Twenty-six (dollar amounts in thousands, weeks ended weeks ended except per share amounts) August 3, 2002 August 3, 2002 ------------------------------------------------------------------------------- Net Earnings: As reported $ 16,554 $ 30,119 Pro forma $ 16,483 $ 29,974 ------------------------------------------------------------------------------- Net earnings per share: Basic: As reported $ .32 $ .59 Pro forma $ .32 $ .58 Diluted: As reported $ .30 $ .56 Pro forma $ .30 $ .56 -------------------------------------------------------------------------------
13 NOTE 13. Debt and Financing Arrangements On August 1, 2003, the Company extended its revolving line of credit, which was set to expire September 22, 2004, to August 1, 2008. Thereafter, it automatically renews for annual periods, unless terminated by either party on 60 days notice prior to the applicable termination date. The line of credit provides up to $226,000,000 of borrowing availability, subject to certain required reserves, and is collateralized by inventory and accounts receivable. Funds may be drawn and repaid anytime prior to August 1, 2008. The loans bear interest at a rate equal to the LIBOR plus 2.00%, subject to 0.25% incremental increases as excess availability under the line of credit falls below $50,000,000. The line of credit is subject to financial covenants. On August 1, 2003, the Company refinanced $132,000,000 operating leases. These leases, which expire on August 1, 2008, have lease payments with an effective rate of LIBOR plus 2.06%. The Company has evaluated this transaction in accordance with FIN 46 and has determined that it is not required to consolidate the leasing entity. The leases include a residual value guarantee with a maximum value of approximately $105,000,000. The Company expects the fair market value of the leased real estate to substantially reduce or eliminate the Company's payment under the residual guarantee at the end of the lease term. In accordance with FIN 45, the Company has recorded a liability for the fair value of the guarantee related to this operating lease. The current value of this liability is $4,987,000, which is recorded in other long-term liabilities on the consolidated balance sheets. On May 15, 2003, upon maturity, the Company retired $75,000,000 aggregate principal amount of 6.625% notes. In the first quarter of fiscal 2003, the Company reclassified $32,000,000 aggregate principal amount of 6.75% Medium-Term Notes with a stated maturity date of March 10, 2004 and $25,000,000 aggregate principal amount of 6.65% Medium-Term Notes with a stated maturity date of March 3, 2004 to current liabilities on the consolidated balance sheet. NOTE 14. Interest Rate Swap Agreement On June 3, 2003, the Company entered into an interest rate swap for a notional amount of $130,000,000. The Company has designated the swap as a cash flow hedge of the Company's real estate operating lease payments. The interest rate swap converts the variable LIBOR portion of these lease payments to a fixed rate of 2.90% and terminates on July 1, 2008. If the critical terms of the interest rate swap or the hedge item do not change, the interest rate swap will be considered to be highly effective with all changes in fair value included in other comprehensive income. As of August 2, 2003, the fair value of the interest rate swap was $6,191,000 ($3,900,000, net of tax) and this change in value was included in accumulated other comprehensive income. 14 NOTE 15. Supplemental Guarantor Information - Convertible Senior Notes On May 21, 2002, the Company issued $150,000,000 aggregate principal amount of 4.25% Convertible Senior Notes. The notes are jointly and severally and fully and unconditionally guaranteed by the Company's wholly-owned direct and indirect operating subsidiaries ("subsidiary guarantors"), The Pep Boys Manny Moe & Jack of California, Pep Boys - Manny, Moe & Jack of Delaware, Inc. and Pep Boys - Manny, Moe & Jack of Puerto Rico, Inc. The following are consolidating balance sheets of the Company as of August 3, 2003 and February 1, 2003 and the related consolidating statements of operations for the thirteen and twenty-six weeks ended August 2, 2003 and August 3, 2002 and condensed consolidating statements of cash flows for the twenty-six weeks ended August 2, 2003 and August 3, 2002:
CONSOLIDATING BALANCE SHEET (dollar amounts in thousands) (unaudited) Non- Subsidiary guarantor August 2, 2003 Pep Boys Guarantors Subsidiaries Elimination Consolidated ----------------------------------------------------------------------------------------------------------------------------- ASSETS Current Assets: Cash and cash equivalents $ 48,174 $ 10,165 $ 9,756 $ - $ 68,095 Accounts receivable, net 10,905 13,500 - - 24,405 Merchandise inventories 177,102 329,408 - - 506,510 Prepaid expenses 27,808 9,798 8,049 (16,225) 29,430 Deferred income taxes 8,603 16,858 7,162 - 32,623 Other 2,758 4,658 44,089 - 51,505 Assets held for disposal 7,371 14,529 - - 21,900 ----------------------------------------------------------------------------------------------------------------------------- Total Current Assets 282,721 398,916 69,056 (16,225) 734,468 ----------------------------------------------------------------------------------------------------------------------------- Property and Equipment - at cost: Land 88,779 175,342 - - 264,121 Buildings and improvements 305,556 587,371 - - 892,927 Furniture, fixtures and equipment 286,976 305,237 - - 592,213 Construction in progress 24,045 2,841 - - 26,886 ----------------------------------------------------------------------------------------------------------------------------- 705,356 1,070,791 - - 1,776,147 Less accumulated depreciation and amortization 336,186 425,501 - - 761,687 ----------------------------------------------------------------------------------------------------------------------------- Property and Equipment - Net 369,170 645,290 - - 1,014,460 ----------------------------------------------------------------------------------------------------------------------------- Investment in subsidiaries 1,435,279 - 1,119,821 (2,555,100) - Intercompany receivable - 682,809 335,178 (1,017,987) - Other 51,747 5,166 - - 56,913 ----------------------------------------------------------------------------------------------------------------------------- Total Assets $ 2,138,917 $ 1,732,181 $ 1,524,055 $ (3,589,312) $ 1,805,841 ----------------------------------------------------------------------------------------------------------------------------- LIABILITIES AND STOCKHOLDERS' EQUITY Current Liabilities: Accounts payable $ 319,214 $ 9 $ - $ - $ 319,223 Accrued expenses 35,254 121,823 126,504 (16,225) 267,356 Current maturities of long-term debt and obligations under capital leases 72,362 - - - 72,362 ----------------------------------------------------------------------------------------------------------------------------- Total Current Liabilities 426,830 121,832 126,504 (16,225) 658,941 ----------------------------------------------------------------------------------------------------------------------------- Long-term debt and obligations under capital leases, less current maturities 313,418 1,293 - - 314,711 Convertible long-term debt 150,000 - - - 150,000 Other long-term liabilities 10,489 18,435 - - 28,924 Intercompany liabilities 602,534 415,453 - (1,017,987) - Deferred income taxes 28,288 14,606 - - 42,894 Deferred gain on sale leaseback 1,311 3,013 - - 4,324 Stockholders' Equity: Common stock 63,911 1,501 101 (1,602) 63,911 Additional paid-in capital 177,244 240,359 200,398 (440,757) 177,244 Retained earnings 571,403 915,689 1,197,052 (2,112,741) 571,403 Accumulated other comprehensive income 3,749 - - - 3,749 ----------------------------------------------------------------------------------------------------------------------------- 816,307 1,157,549 1,397,551 (2,555,100) 816,307 Less: Cost of shares in treasury 150,996 - - - 150,996 Cost of shares in benefits trust 59,264 - - - 59,264 ----------------------------------------------------------------------------------------------------------------------------- Total Stockholders' Equity 606,047 1,157,549 1,397,551 (2,555,100) 606,047 ----------------------------------------------------------------------------------------------------------------------------- Total Liabilities and Stockholders' Equity $ 2,138,917 $ 1,732,181 $ 1,524,055 $ (3,589,312) $ 1,805,841 -----------------------------------------------------------------------------------------------------------------------------
15
CONSOLIDATING BALANCE SHEET (dollar amounts in thousands) Non- Subsidiary guarantor February 1, 2003 Pep Boys Guarantors Subsidiaries Elimination Consolidated ----------------------------------------------------------------------------------------------------------------------------- ASSETS Current Assets: Cash and cash equivalents $ 32,654 $ 9,714 $ 402 $ - $ 42,770 Accounts receivable, net 8,122 9,794 - - 17,916 Merchandise inventories 166,166 322,716 - - 488,882 Prepaid expenses 29,176 16,308 17,637 (19,375) 43,746 Deferred income taxes 6,812 (819) 7,730 - 13,723 Other 107 - 56,580 - 56,687 Assets held for disposal - 1,146 - - 1,146 ----------------------------------------------------------------------------------------------------------------------------- Total Current Assets 243,037 358,859 82,349 (19,375) 664,870 ----------------------------------------------------------------------------------------------------------------------------- Property and Equipment - at cost: Land 92,540 186,569 - - 279,109 Buildings and improvements 313,927 622,843 - - 936,770 Furniture, fixtures and equipment 286,922 317,609 - - 604,531 Construction in progress 14,764 4,686 - - 19,450 ----------------------------------------------------------------------------------------------------------------------------- 708,153 1,131,707 - - 1,839,860 Less accumulated depreciation and amortization 326,820 425,003 - - 751,823 ----------------------------------------------------------------------------------------------------------------------------- Property and Equipment - Net 381,333 706,704 - - 1,088,037 ----------------------------------------------------------------------------------------------------------------------------- Investment in subsidiaries 1,455,877 - 1,121,299 (2,577,176) - Intercompany receivable - 631,438 335,640 (967,078) - Other 41,972 5,031 - - 47,003 ----------------------------------------------------------------------------------------------------------------------------- Total Assets $ 2,122,219 $ 1,702,032 $ 1,539,288 $ (3,563,629) $ 1,799,910 ----------------------------------------------------------------------------------------------------------------------------- LIABILITIES AND STOCKHOLDERS' EQUITY Current Liabilities: Accounts payable $ 200,044 $ 9 $ - $ - $ 200,053 Accrued expenses 59,625 48,567 143,438 (19,375) 232,255 Current maturities of long-term debt and obligations under capital leases 101,882 - - - 101,882 ----------------------------------------------------------------------------------------------------------------------------- Total Current Liabilities 361,551 48,576 143,438 (19,375) 534,190 ----------------------------------------------------------------------------------------------------------------------------- Long-term debt and obligations under capital leases, less current maturities 375,216 361 - - 375,577 Convertible long-term debt 150,000 - - - 150,000 Other long-term liabilities 5,955 19,201 - - 25,156 Intercompany liabilities 544,877 422,201 - (967,078) - Deferred income taxes 33,322 27,341 - - 60,663 Deferred gain on sale leaseback 1,306 3,026 - - 4,332 Stockholders' Equity: Common stock 63,911 1,501 101 (1,602) 63,911 Additional paid-in capital 177,244 240,359 200,398 (440,757) 177,244 Retained earnings 630,847 939,466 1,195,351 (2,134,817) 630,847 Accumulated other comprehensive loss (151) - - - (151) ----------------------------------------------------------------------------------------------------------------------------- 871,851 1,181,326 1,395,850 (2,577,176) 871,851 Less: Cost of shares in treasury 162,595 - - - 162,595 Cost of shares in benefits trust 59,264 - - - 59,264 ----------------------------------------------------------------------------------------------------------------------------- Total Stockholders' Equity 649,992 1,181,326 1,395,850 (2,577,176) 649,992 ----------------------------------------------------------------------------------------------------------------------------- Total Liabilities and Stockholders' Equity $ 2,122,219 $ 1,702,032 $ 1,539,288 $ (3,563,629) $ 1,799,910 -----------------------------------------------------------------------------------------------------------------------------
16
CONSOLIDATING STATEMENT OF OPERATIONS (dollar amounts in thousands) (unaudited) Non- Subsidiary guarantor Thirteen weeks ended August 2, 2003 Pep Boys Guarantors Subsidiaries Elimination Consolidated ----------------------------------------------------------------------------------------------------------------------------- Merchandise Sales $ 154,518 $ 296,767 $ - $ - $ 451,285 Service Revenue 36,402 68,343 - - 104,745 Other Revenue - - 6,676 (6,676) - ----------------------------------------------------------------------------------------------------------------------------- Total Revenues 190,920 365,110 6,676 (6,676) 556,030 ----------------------------------------------------------------------------------------------------------------------------- Costs of Merchandise Sales 119,374 225,529 - - 344,903 Costs of Service Revenue 28,803 52,078 - - 80,881 Costs of Other Revenue - - 10,762 (10,762) - ----------------------------------------------------------------------------------------------------------------------------- Total Costs of Revenues 148,177 277,607 10,762 (10,762) 425,784 ----------------------------------------------------------------------------------------------------------------------------- Gross Profit from Merchandise Sales 35,144 71,238 - - 106,382 Gross Profit from Service Revenue 7,599 16,265 - - 23,864 Gross Loss from Other Revenue - - (4,086) 4,086 - ----------------------------------------------------------------------------------------------------------------------------- Total Gross Profit (Loss) 42,743 87,503 (4,086) 4,086 130,246 ----------------------------------------------------------------------------------------------------------------------------- Selling, General and Administrative Expenses 40,251 98,635 77 4,086 143,049 ----------------------------------------------------------------------------------------------------------------------------- Operating Profit (Loss) 2,492 (11,132) (4,163) - (12,803) Equity in Earnings of Subsidiaries (21,248) - (3,602) 24,850 - Non-operating (Expense) Income (4,492) 12,305 4,557 (11,519) 851 Interest Expense 14,897 6,225 - (11,519) 9,603 ----------------------------------------------------------------------------------------------------------------------------- (Loss) Earnings From Continuing Operations Before Income Taxes (38,145) (5,052) (3,208) 24,850 (21,555) Income Tax (Benefit) Expense (6,252) (1,870) 146 - (7,976) ----------------------------------------------------------------------------------------------------------------------------- Net (Loss) Earnings From Continuing Operations (31,893) (3,182) (3,354) 24,850 (13,579) Discontinued Operations, Net of Tax (4,488) (18,314) - - (22,802) ----------------------------------------------------------------------------------------------------------------------------- Net (Loss) Earnings $ (36,381) $ (21,496) $ (3,354) $ 24,850 $ (36,381) -----------------------------------------------------------------------------------------------------------------------------
17
CONSOLIDATING STATEMENT OF OPERATIONS (dollar amounts in thousands) (unaudited) Non- Subsidiary guarantor Thirteen weeks ended August 3, 2002 Pep Boys Guarantors Subsidiaries Elimination Consolidated ----------------------------------------------------------------------------------------------------------------------------- Merchandise Sales $ 160,247 $ 301,639 $ - $ - $ 461,886 Service Revenue 36,207 67,538 - - 103,745 Other Revenue - - 6,409 (6,409) - ----------------------------------------------------------------------------------------------------------------------------- Total Revenues 196,454 369,177 6,409 (6,409) 565,631 ----------------------------------------------------------------------------------------------------------------------------- Costs of Merchandise Sales 111,804 208,681 - - 320,485 Costs of Service Revenue 26,841 51,731 - - 78,572 Costs of Other Revenue - - 5,897 (5,897) - ----------------------------------------------------------------------------------------------------------------------------- Total Costs of Revenues 138,645 260,412 5,897 (5,897) 399,057 ----------------------------------------------------------------------------------------------------------------------------- Gross Profit from Merchandise Sales 48,443 92,958 - - 141,401 Gross Profit from Service Revenue 9,366 15,807 - - 25,173 Gross Loss from Other Revenue - - 512 (512) - ----------------------------------------------------------------------------------------------------------------------------- Total Gross Profit 57,809 108,765 512 (512) 166,574 ----------------------------------------------------------------------------------------------------------------------------- Selling, General and Administrative Expenses 45,450 84,039 71 (512) 129,048 ----------------------------------------------------------------------------------------------------------------------------- Operating Profit 12,359 24,726 441 - 37,526 Equity in Earnings of Subsidiaries 22,500 - 19,454 (41,954) - Non-operating (Expense) Income (4,532) 12,755 5,248 (12,474) 997 Interest Expense 17,780 7,318 - (12,474) 12,624 ----------------------------------------------------------------------------------------------------------------------------- (Loss) Earnings From Continuing Operations Before Income Taxes 12,547 30,163 25,143 (41,954) 25,899 Income Tax (Benefit) Expense (3,792) 11,424 2,157 - 9,789 ----------------------------------------------------------------------------------------------------------------------------- Net Income From Continuing Operations 16,339 18,739 22,986 (41,954) 16,110 Discontinued Operations, Net of Tax 215 229 - - 444 ----------------------------------------------------------------------------------------------------------------------------- Net $ 16,554 $ 18,968 $ 22,986 $ (41,954) $ 16,554 -----------------------------------------------------------------------------------------------------------------------------
18
CONSOLIDATING STATEMENT OF OPERATIONS (dollar amounts in thousands) (unaudited) Non- Subsidiary guarantor Twenty-six weeks ended August 2, 2003 Pep Boys Guarantors Subsidiaries Elimination Consolidated ----------------------------------------------------------------------------------------------------------------------------- Merchandise Sales $ 296,766 $ 565,651 $ - $ - $ 862,417 Service Revenue 71,577 132,946 - - 204,523 Other Revenue - - 13,351 (13,351) - ----------------------------------------------------------------------------------------------------------------------------- Total Revenues 368,343 698,597 13,351 (13,351) 1,066,940 ----------------------------------------------------------------------------------------------------------------------------- Costs of Merchandise Sales 220,344 414,899 - - 635,243 Costs of Service Revenue 54,644 101,009 - - 155,653 Costs of Other Revenue - - 17,967 (17,967) - ----------------------------------------------------------------------------------------------------------------------------- Total Costs of Revenues 274,988 515,908 17,967 (17,967) 790,896 ----------------------------------------------------------------------------------------------------------------------------- Gross Profit from Merchandise Sales 76,422 150,752 - - 227,174 Gross Profit from Service Revenue 16,933 31,937 - - 48,870 Gross Loss from Other Revenue - - (4,616) 4,616 - ----------------------------------------------------------------------------------------------------------------------------- Total Gross Profit (Loss) 93,355 182,689 (4,616) 4,616 276,044 ----------------------------------------------------------------------------------------------------------------------------- Selling, General and Administrative Expenses 84,010 202,045 155 4,616 290,826 ----------------------------------------------------------------------------------------------------------------------------- Operating Profit (Loss) 9,345 (19,356) (4,771) - (14,782) Equity in Earnings of Subsidiaries (20,598) - (1,478) 22,076 - Non-operating (Expense) Income (8,589) 24,337 9,815 (23,662) 1,901 Interest Expense 32,874 11,092 - (23,662) 20,304 ----------------------------------------------------------------------------------------------------------------------------- (Loss) Earnings From Continuing Operations Before Income Taxes and Cumulative Effect of Change in Accounting Principle (52,716) (6,111) 3,566 22,076 (33,185) Income Tax (Benefit) Expense (11,884) (2,261) 1,866 - (12,279) ----------------------------------------------------------------------------------------------------------------------------- Net (Loss) Earnings From Continuing Operations Before Cumulative Effect of Change in Accounting Principle (40,832) (3,850) 1,700 22,076 (20,906) Discontinued Operations, Net of Tax (3,867) (18,341) (22,208) Cumulative Effect of Change in Accounting Principle, Net of Tax (899) (1,585) - - (2,484) ----------------------------------------------------------------------------------------------------------------------------- Net (Loss) Earnings $ (45,598) $ (23,776) $ 1,700 $ 22,076 $ (45,598) -----------------------------------------------------------------------------------------------------------------------------
19
CONSOLIDATING STATEMENT OF OPERATIONS (dollar amounts in thousands) (unaudited) Non- Subsidiary guarantor Twenty-six weeks ended August 2, 2002 Pep Boys Guarantors Subsidiaries Elimination Consolidated ----------------------------------------------------------------------------------------------------------------------------- Merchandise Sales $ 313,891 $ 586,452 $ - $ - $ 900,343 Service Revenue 72,230 132,713 - - 204,943 Other Revenue - - 12,668 (12,668) - ----------------------------------------------------------------------------------------------------------------------------- Total Revenues 386,121 719,165 12,668 (12,668) 1,105,286 ----------------------------------------------------------------------------------------------------------------------------- Costs of Merchandise Sales 219,865 408,258 - - 628,123 Costs of Service Revenue 53,165 100,327 - - 153,492 Costs of Other Revenue - - 12,187 (12,187) - ----------------------------------------------------------------------------------------------------------------------------- Total Costs of Revenues 273,030 508,585 12,187 (12,187) 781,615 ----------------------------------------------------------------------------------------------------------------------------- Gross Profit from Merchandise Sales 94,026 178,194 - - 272,220 Gross Profit from Service Revenue 19,065 32,386 - - 51,451 Gross Loss from Other Revenue - - 481 (481) - ----------------------------------------------------------------------------------------------------------------------------- Total Gross Profit 113,091 210,580 481 (481) 323,671 ----------------------------------------------------------------------------------------------------------------------------- Selling, General and Administrative Expenses 90,213 164,855 151 (481) 254,738 ----------------------------------------------------------------------------------------------------------------------------- Operating Profit 22,878 45,725 330 - 68,933 Equity in Earnings of Subsidiaries 42,859 - 37,923 (80,782) - Non-operating (Expense) Income (9,053) 24,101 10,554 (23,782) 1,820 Interest Expense 34,893 13,294 - (23,782) 24,405 ----------------------------------------------------------------------------------------------------------------------------- Income From Continuing Operations Before Income Taxes 21,791 56,532 48,807 (80,782) 46,348 Income Tax (Benefit) Expense (7,795) 20,917 4,027 - 17,149 ----------------------------------------------------------------------------------------------------------------------------- Net Earnings From Continuing Operations 29,586 35,615 44,780 (80,782) 29,199 Discontinued Operations, Net of Tax 533 387 - - 920 ----------------------------------------------------------------------------------------------------------------------------- Net Earnings $ 30,119 $ 36,002 $ 44,780 $ (80,782) $ 30,119 -----------------------------------------------------------------------------------------------------------------------------
20
CONDENSED CONSOLIDATING STATEMENT OF CASH FLOWS (dollar amounts in thousands) (unaudited) Non- Subsidiary guarantor Twenty-six weeks ended August 2, 2003 Pep Boys Guarantors Subsidiaries Elimination Consolidated ----------------------------------------------------------------------------------------------------------------------------- Cash Flows from Operating Activities: Net (Loss) Earnings from continuing operations $ (45,598) $ (23,776) $ 1,700 $ 22,076 $ (45,598) Loss from discontinued operations 3,867 18,341 - - 22,208 ----------------------------------------------------------------------------------------------------------------------------- (Loss) Earnings from continuing operations (41,731) (5,435) 1,700 22,076 (23,390) Adjustments to Reconcile Net (Loss) Earnings to Net Cash Provided By Operating Activities: Non-cash operating activities 27,516 (6,453) 2,046 (22,076) 1,033 Change in operating assets and liabilities 80,699 69,346 5,147 - 155,192 ----------------------------------------------------------------------------------------------------------------------------- Net Cash Provided by continuing operations 66,484 57,458 8,893 - 132,835 Net Cash Provided by discontinued operations 2,084 2,507 - - 4,591 ----------------------------------------------------------------------------------------------------------------------------- Net Cash Provided by Operating Activities 68,568 59,965 8,893 - 137,426 Cash Flows from Investing Activities: Net Cash Used in Investing Activities (17,000) (2,468) - - (19,468) Cash Flows from Financing Activities: Net Cash (Used in) Provided by Financing Activities (36,048) (57,046) 461 - (92,633) ----------------------------------------------------------------------------------------------------------------------------- Net Increase in Cash 15,520 451 9,354 - 25,325 Cash and Cash Equivalents at Beginning of Period 32,654 9,714 402 - 42,770 ----------------------------------------------------------------------------------------------------------------------------- Cash and Cash Equivalents at End of Period $ 48,174 $ 10,165 $ 9,756 $ - $ 68,095 -----------------------------------------------------------------------------------------------------------------------------
CONDENSED CONSOLIDATING STATEMENT OF CASH FLOWS (dollar amounts in thousands) (unaudited) Non- Subsidiary guarantor Twenty-six weeks ended August 3, 2002 Pep Boys Guarantors Subsidiaries Elimination Consolidated ----------------------------------------------------------------------------------------------------------------------------- Cash Flows from Operating Activities: Net Earnings from continuing operations $ 30,119 $ 36,002 $ 44,780 $ (80,782) $ 30,119 Earnings from discontinued operations 533 387 - - 920 ----------------------------------------------------------------------------------------------------------------------------- Earnings from continuing operations 29,586 35,615 44,780 (80,782) 29,199 Adjustments to Reconcile Net Earnings to Net Cash Provided By Operating Activities: Non-cash operating activities (26,232) 21,797 (36,524) 80,782 39,823 Change in operating assets and liabilities 21,388 (12,984) 13,715 - 22,119 ----------------------------------------------------------------------------------------------------------------------------- Net Cash Provided by continuing operations 24,742 44,428 21,971 - 91,141 Net Cash Provided by discontinued operations 1,325 1,965 - - 3,290 ----------------------------------------------------------------------------------------------------------------------------- Net Cash Provided by Operating Activities 26,067 46,393 21,971 - 94,431 Cash Flows from Investing Activities: Net Cash Used in Investing Activities (5,408) (1,291) - - (6,699) Cash Flows from Financing Activities: Net Cash Provided by (Used In) Financing Activities 35,615 (44,754) (7,709) - (16,848) ----------------------------------------------------------------------------------------------------------------------------- Net Increase in Cash 56,274 348 14,262 - 70,884 Cash and Cash Equivalents at Beginning of Period 4,796 10,874 311 - 15,981 ----------------------------------------------------------------------------------------------------------------------------- Cash and Cash Equivalents at End of Period $ 61,070 $ 11,222 $ 14,573 $ - $ 86,865 -----------------------------------------------------------------------------------------------------------------------------
21 NOTE 16. Contingencies The Company's California subsidiary is a defendant in a consolidated action entitled "Dubrow et al vs. The Pep Boys - Manny Moe & Jack" that is currently pending in the California Superior Court in Orange County. The two consolidated actions were originally filed on March 29, 2000 and July 25, 2000. Plaintiffs are former and current store management employees who claim that they were improperly classified as exempt from the overtime provisions of California law and seek to be compensated for all overtime hours worked. Plaintiffs' motion to certify the case as a class action to represent all persons employed in California since March 29, 1996 as salaried store managers, assistant store managers, service managers and assistant service managers was previously granted by the trial court. The Company's appeals of that decision through the California Supreme Court were unsuccessful. The parties have reached an agreement, subject to the court's approval, to submit this matter to binding arbitration. The Company has previously accrued an amount sufficient to satisfy the maximum liability that may be imposed on the Company by the arbitrator under the terms of the agreement. An action entitled "Tomas Diaz Rodriguez; Energy Tech Corporation v. Pep Boys Corporation; Manny, Moe & Jack Corp. Puerto Rico, Inc. d/b/a Pep Boys" was previously instituted against the Company in the Court of First Instance of Puerto Rico, Bayamon Superior Division on March 15, 2002. The action was subsequently removed to, and is currently pending in, the United States District Court for the District of Puerto Rico. Plaintiffs are distributors of a product that claims to improve gas mileage. The plaintiffs allege that the Company entered into an agreement with them to act as the exclusive retailer of the product in Puerto Rico that was breached when the Company determined to stop selling the product. The Company became aware of a Federal Trade Commission investigation regarding the accuracy of advertising claims concerning the product's effectiveness. The plaintiffs further allege that they were negotiating with the manufacturer of the product to obtain the exclusive distribution rights throughout the United States and that those negotiations failed. Plaintiffs are seeking damages including payment for the product that they allege Pep Boys ordered and expenses and loss of sales in Puerto Rico and the United States resulting from the alleged breach. The Company believes that the claims are without merit and continues to vigorously defend this action. The Company is also party to various other actions and claims, including purported class actions, arising in the normal course of business. The Company believes that amounts accrued for awards or assessments in connection with the foregoing matters are adequate and that the ultimate resolution of these matters will not have a material adverse effect on the Company's financial position or results of operations. 22 NOTE 17. Comprehensive Income The following are the components of comprehensive (loss) income: Thirteen weeks ended Twenty-six weeks ended --------------------------------- ---------------------------------- (Amounts in thousands) August 2, 2003 August 3, 2002 August 2, 2003 August 3, 2002 ----------------------------------------------------------------------------------------------------- Net (loss) earnings $ (36,381) $ 16,554 $ (45,598) $ 30,119 Other comprehensive income, net of tax: Derivative financial instrument adjustments 3,900 - 3,900 - ----------------------------------------------------------------------------------------------------- Comprehensive (loss) income $ (32,481) $ 16,554 $ (41,698) $ 30,119 -----------------------------------------------------------------------------------------------------
The components of accumulated other comprehensive income (loss) are: August 2, February 1, 2003 2003 ----------- ------------- Derivative financial instrument adjustment, net of tax $ 3,900 $ - Minimum pension liability adjustment, net of tax (151) (151) ----------- ------------- $ 3,749 $ (151) ----------- ------------- Note 18. Impairment Charges During the second quarter 2003, the Company, as a result of its ongoing review of the performance of its stores, identified certain stores whose cash flow trend indicated that their carrying value may not be fully recoverable. An impairment charge of $2,121,000 was recorded for these stores in costs of merchandise sales on the consolidated statement of operations. The charge reflects the difference between these stores' carrying value and fair value. Fair value was based on sales of similar assets or other estimates of fair value developed by Company management. Management's judgment is necessary to estimate fair value. Accordingly, actual results could vary from such estimates. 23 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations LIQUIDITY AND CAPITAL RESOURCES - August 2, 2003 ------------------------------------------------ The Company's cash requirements arise principally from the capital expenditures related to existing stores, offices and warehouses and to purchase inventory. During the first six months of fiscal 2003, the Company invested $21,420,000 in property and equipment. The Company's net inventory (net inventory includes the change in inventory less the change in accounts payable) decreased $101,542,000. This was due primarily to an increase in accounts payable of $119,170,000. Working Capital decreased from $130,680,000 at February 1, 2003 to $75,527,000 at August 2, 2003. At August 2, 2003, the Company had stockholders' equity of $606,047,000 and long-term debt, net of current maturities, of $464,711,000. The Company's long-term debt was 43% of its total capitalization at August 2, 2003 and 45% at February 1, 2003. As of August 2, 2003, the Company had an available line of credit totaling $159,203,000. Management estimates capital expenditures relating to existing stores, warehouses and offices during the remainder of fiscal 2003 will be approximately $33,580,000. The Company anticipates that its net cash provided by operating activities and its existing line of credit will exceed its principal cash requirements for capital expenditures and net inventory in fiscal 2003. The Company has reached an agreement, subject to court approval, to submit the action entitled "Dubrow et al vs The Pep Boys - Manny, Moe & Jack" to binding arbitration. The Company expects to have sufficient available cash to satisfy the maximum liability that may be imposed on the Company by the arbitrator under the terms of the agreement. On August 1, 2003, the Company extended its revolving line of credit, which was set to expire September 22, 2004, to August 1, 2008. Thereafter, it automatically renews for annual periods, unless terminated by either party on 60 days notice prior to the applicable termination date. The line of credit provides up to $226,000,000 of borrowing availability, subject to certain required reserves, and is collateralized by inventory and accounts receivable. Funds may be drawn and repaid anytime prior to August 1, 2008. The loans bear interest at a rate equal to the LIBOR plus 2.00%, subject to 0.25% incremental increases as excess availability under the line of credit falls below $50,000,000. The line of credit is subject to financial covenants. On August 1, 2003, the Company refinanced $132,000,000 operating leases. These leases, which expire on August 1, 2008, have lease payments with an effective rate of LIBOR plus 2.06%. The Company has evaluated this transaction in accordance with FIN 46 and has determined that it is not required to consolidate the leasing entity. The leases include a residual value guarantee with a maximum value of approximately $105,000,000. The Company expects the fair market value of the leased real estate to substantially reduce or eliminate the Company's payment under the residual guarantee at the end of the lease term. In accordance with FIN 45, the Company has recorded a liability for the fair value of the guarantee related to this operating lease. The current value of this liability is $4,987,000, which is recorded in other long-term liabilities on the consolidated balance sheets. On May 15, 2003, upon maturity, the Company retired $75,000,000 aggregate principal amount of 6.625% notes, with cash. 24 In the first quarter of fiscal 2003, the Company reclassified $32,000,000 aggregate principal amount of 6.75% Medium-Term Notes with a stated maturity date of March 10, 2004 and $25,000,000 aggregate principal amount of 6.65% Medium-Term Notes with a stated maturity date of March 3, 2004 to current liabilities on the consolidated balance sheet. The Company anticipates being able to repurchase these notes with cash from operations and its existing line of credit. In April 2003, the Company made a settlement of approximately $12,600,000 related to the Supplemental Executive Retirement Plan obligation for the former Chairman and CEO with cash. This obligation resulted in an expense for settlement accounting under Statement of Financial Accounting Standards (SFAS) No. 88, "Employers' Accounting for Settlements and Curtailments of Defined Benefit Pension Plans and for Termination Benefits" of approximately $4,900,000, during the quarter ended May 3, 2003. In April 2003, the Company satisfied the commitment related to the non-renewal of the former Chairman and CEO's employment agreement for approximately $4,900,000. The Company satisfied this commitment with cash. RESTRUCTURING Building upon the Profit Enhancement Plan launched in October 2000, the Company conducted a comprehensive review of its operations including individual store performance, the entire management infrastructure and its merchandise and service offerings. On July 31, 2003, the Company announced several initiatives aimed at realigning its business and continuing to improve upon the Company's profitability. The Company expects these actions, including the disposal and sublease of the properties to be substantially completed by the end of the second quarter 2004 and estimates the costs, including future costs that were not accrued to be approximately $70,100,000. The Company anticipates this restructuring will result in an annual savings of approximately $11,000,000. The Company is accounting for these initiatives in accordance with the provisions of SFAS No. 146 "Accounting for Costs Associated with Exit or Disposal Activities" and SFAS No. 144 "Accounting for the Impairment or Disposal of Long-Lived Assets". These initiatives included: Closure of 33 under-performing stores on July 31, 2003 The charges related to these closures included a $33,887,000 write down of fixed assets, $1,122,000 in long-term lease and other related obligations, net of subleases, and $980,000 in workforce reduction costs. These charges are included in discontinued operations of the consolidated statement of operations. The write-down of fixed assets includes the adjustment to the market value of those owned stores that are now classified as assets held for disposal in accordance with SFAS 144 and the write-down of leasehold improvements. The assets held for disposal have been valued at the lower of their carrying amount or their estimated fair value, net of disposal costs. The long-term lease and other related obligations represent the fair value of such obligations less the estimated net sublease income. The workforce reduction costs represent the involuntary termination benefits payable to approximately 900 store employees, all of whom were notified on or prior to July 31, 2003. Severance for these employees was accrued in accordance with SFAS 146. Approximately 50% of these employees were terminated as of August 2, 2003. Discontinuation of certain merchandise offerings The Company recorded a $24,580,000 write-down of inventory as a result of a decision to discontinue certain merchandising offerings. This write-down was recorded in cost of merchandise sales on the consolidated statement of operations. 25 Corporate realignment The charges related to this realignment included $3,070,000 in workforce reduction costs, $2,543,000 of expenses incurred in the development of the restructuring plan, a $536,000 write-down of certain assets and $467,000 in costs related to two warehouse lease terminations. The workforce reduction costs represent the involuntary termination benefits payable to 150 Store Support Center employees and field managers. Approximately 88% of these employees were terminated as of August 2, 2003. The realignment charges were primarily recorded in cost of merchandise sales and selling, general & administrative expenses on the consolidated statement of operations. The following chart details the reserve balances through August 2, 2003. The reserve includes remaining rent on leases net of sublease income, other contractual obligations associated with leased properties and employee severance. (dollar amounts Lease Contractual in thousands) Severance Expenses Obligations Total --------------------------------------------------------------------------------- Reserve balance at Feb. 1, 2003 $ - $ - $ - $ - Original reserve 4,050 2,332 887 7,269 Provision for present value of liabilities - - - - Changes in assumptions about future sublease income, lease termination and severance - - - - Cash payments - - - - --------------------------------------------------------------------------------- Reserve balance at August 2, 2003 $ 4,050 $ 2,332 $ 887 $ 7,269 ---------------------------------------------------------------------------------
DISCONTINUED OPERATIONS In accordance with SFAS 144, the Company's discontinued operations reflect the operating results for the 33 stores closed on July 31, 2003 as part of the Company's corporate restructuring. The results for the thirteen and twenty-six weeks ended August 2, 2003 and August 3, 2002 have been reclassified to show the results of operations for the 33 closed stores as discontinued operations. Below is a summary of these results: Thirteen weeks ended Twenty-six weeks Ended --------------------------- ----------------------------- Aug. 2, 2003 Aug. 3, 2002 Aug. 2, 2003 Aug. 3, 2002 ------------ ------------ -------------- ------------ (Amounts in thousands) Amount Amount Amount Amount ------------------------------------------------------------------------------------------------------ Total Revenues $ 19,408 $ 20,154 $ 37,714 $ 39,473 Total Gross Profit (31,124) 5,002 (26,116) 9,841 Selling, General and Administrative Expenses 5,070 4,288 9,135 8,380 (Loss) Earnings from Discontinued Operations Before Income Taxes (36,194) 714 (35,251) 1,461 Discontinued Operations, Net of Tax $(22,802) $ 444 $(22,208) $ 920 ------------------------------------------------------------------------------------------------------
In addition, the Company has reclassified to assets held for disposal $7,724,000 and $14,176,000 of building and land, respectively. IMPAIRMENT CHARGES During the second quarter 2003, the Company, as a result of its ongoing review of the performance of its stores, identified certain stores whose cash flow trend indicated that their carrying value may not be fully recoverable. An impairment charge of $2,121,000 was recorded for these stores in costs of merchandise sales on the consolidated statement of operations. The charge reflects the difference between these stores' carrying value and fair value. Fair value was based on sales of similar assets or other estimates of fair value developed by Company management. Management's judgment is necessary to estimate fair value. Accordingly, actual results could vary from such estimates. 26 Results of Operations - The following table presents for the periods indicated certain items in the consolidated statements of operations as a percentage of total revenues (except as otherwise provided) and the percentage change in dollar amounts of such items compared to the indicated prior period.
Percentage of Total Revenues Percentage Change ---------------------------------------------------------------------------------------------------------------- Thirteen weeks ended Aug. 2, 2003 Aug. 3, 2002 Fiscal 2003 vs. (Fiscal 2003) (Fiscal 2002) Fiscal 2002 ---------------------------------------------------------------------------------------------------------------- Merchandise Sales 81.2% 81.7% (2.3)% Service Revenue (1) 18.8 18.3 1.0 ---------------------------------------------------------------------------------------------------------------- Total Revenues 100.0 100.0 (1.7) ---------------------------------------------------------------------------------------------------------------- Costs of Merchandise Sales (2) 76.4 (3) 69.4 (3) 7.6 Costs of Service Revenue (2) 77.2 (3) 75.7 (3) 2.9 ---------------------------------------------------------------------------------------------------------------- Total Costs of Revenues 76.6 70.6 6.7 ---------------------------------------------------------------------------------------------------------------- Gross Profit from Merchandise Sales 23.6 (3) 30.6 (3) (24.8) Gross Profit from Service Revenue 22.8 (3) 24.3 (3) (5.2) ---------------------------------------------------------------------------------------------------------------- Total Gross Profit 23.4 29.4 (21.8) ---------------------------------------------------------------------------------------------------------------- Selling, General and Administrative Expenses 25.7 22.8 10.9 ---------------------------------------------------------------------------------------------------------------- Operating (Loss) Profit (2.3) 6.6 (134.1) Non-operating Income 0.1 0.2 (14.6) Interest Expense 1.7 2.2 (23.9) ---------------------------------------------------------------------------------------------------------------- (Loss) Earnings from Continuing Operations Before Income Taxes (3.9) 4.6 (183.2) Income Tax (Benefit) Expense 37.0 (4) 37.8 (4) (181.5) ---------------------------------------------------------------------------------------------------------------- Net (Loss) Earnings from Continuing Operations (2.4) 2.8 (184.3) Discontinued Operations, Net of Tax (4.1) 0.1 (5,235.6) Net (Loss) Earnings (6.5) 2.9 (319.8) ---------------------------------------------------------------------------------------------------------------- (1) Service revenue consists of the labor charge for installing merchandise or maintaining or repairing vehicles, excluding the sale of any installed parts or materials. (2) Costs of merchandise sales include the cost of products sold, buying, warehousing and store occupancy costs. Costs of service revenue include service center payroll and related employee benefits and service center occupancy costs. Occupancy costs include utilities, rents, real estate and property taxes, repairs and maintenance and depreciation and amortization expenses. (3) As a percentage of related sales or revenue, as applicable. (4) As a percentage of earnings before income taxes.
27 Thirteen Weeks Ended August 2, 2003 vs. Thirteen Weeks Ended August 3, 2002 ----------------------------------------------------------------------------- Total revenues for the second quarter decreased 1.7%. This decrease was due primarily to a decrease in comparable store revenues (revenues generated by stores in operation during the same period) of 1.6%. Comparable store merchandise sales decreased 2.1%, which was offset, in part, by an increase in comparable store service revenue of 0.8%. Gross profit from merchandise sales decreased, as a percentage of merchandise sales, to 23.6% in fiscal 2003 from 30.6% in fiscal 2002. This decrease, as a percentage of merchandise sales, was due primarily to a $24,580,000 inventory write-down associated with the corporate restructuring and an impairment charge of $2,121,000 offset, in part, by higher merchandise margins, as a percentage of merchandise sales. The improved merchandise margins were a result of a combination of an improvement in the mix of sales, selectively higher retail pricing, lower product acquisition costs and improved inventory controls. Gross profit from service revenue decreased, as a percentage of service revenue, to 22.8% in fiscal 2003 from 24.3% in fiscal 2002. This decrease, as a percentage of service revenue, was due primarily to an increase in workers' compensation expense, as a percentage of service revenue. Selling, general and administrative expenses increased, as a percentage of total revenues, to 25.7% in fiscal 2003 from 22.8% in fiscal 2002. This was a 10.9% or $14,001,000 increase over the prior year's quarter. This increase, as a percentage of total revenues, was due primarily to an increase in general office costs, as a percentage of total revenues. The increase in general office costs was due primarily to an increase in the Company's legal reserves of approximately $6,500,000 for on-going litigation and $5,613,000 of costs associated with the corporate restructuring. Interest expense decreased 23.9% or $3,021,000 due primarily to lower debt levels coupled with lower average interest rates. Discontinued Operations decreased $23,246,000 due primarily to the charges, net of tax associated with the corporate restructuring. Net earnings decreased, as a percentage of total revenues, due primarily to a decrease in gross profit from merchandise sales, as a percentage of merchandise sales, a decrease in gross profit from service revenue, as a percentage of service revenue, an increase in selling, general and administrative expenses, as a percentage of total revenues, and the decrease in discontinued operations. These decreases were offset, in part, by a decrease in interest expense. 28 Results of Operations - The following table presents for the periods indicated certain items in the consolidated statements of operations as a percentage of total revenues (except as otherwise provided) and the percentage change in dollar amounts of such items compared to the indicated prior period.
Percentage of Total Revenues Percentage Change ---------------------------------------------------------------------------------------------------------------- Twenty-six weeks ended Aug. 2, 2003 Aug. 3, 2002 Fiscal 2003 vs. (Fiscal 2003) (Fiscal 2002) Fiscal 2002 ---------------------------------------------------------------------------------------------------------------- Merchandise Sales 80.8% 81.5% (4.2)% Service Revenue (1) 19.2 18.5 (0.2) ---------------------------------------------------------------------------------------------------------------- Total Revenues 100.0 100.0 (3.5) ---------------------------------------------------------------------------------------------------------------- Costs of Merchandise Sales (2) 73.7 (3) 69.8 (3) 1.1 Costs of Service Revenue (2) 76.1 (3) 74.9 (3) 1.4 ---------------------------------------------------------------------------------------------------------------- Total Costs of Revenues 74.1 70.7 1.2 ---------------------------------------------------------------------------------------------------------------- Gross Profit from Merchandise Sales 26.3 (3) 30.2 (3) (16.6) Gross Profit from Service Revenue 23.9 (3) 25.1 (3) (5.0) ---------------------------------------------------------------------------------------------------------------- Total Gross Profit 25.9 29.3 (14.7) ---------------------------------------------------------------------------------------------------------------- Selling, General and Administrative Expenses 27.3 23.0 14.2 ---------------------------------------------------------------------------------------------------------------- Operating (Loss) Profit (1.4) 6.3 (121.4) Non-operating Income 0.2 0.1 4.5 Interest Expense 1.9 2.2 (16.8) ---------------------------------------------------------------------------------------------------------------- (Loss) Earnings from Continuing Operations Before Income Taxes and Cumulative Effect of Change in Accounting Principle (3.1) 4.2 (171.6) Income Tax (Benefit) Expense 37.0 (4) 37.0 (4) (171.6) ---------------------------------------------------------------------------------------------------------------- Net (Loss) Earnings from Continuing Operations Before Cumulative Effect of Change in Accounting Principle (2.0) 2.6 (171.6) Discontinued Operations, Net of Tax (2.1) 0.1 (2,513.9) Cumulative Effect of Change in Accounting Principle, Net of Tax (0.2) - N/A Net (Loss) Earnings (4.3) 2.7 (251.4) ---------------------------------------------------------------------------------------------------------------- (1) Service revenue consists of the labor charge for installing merchandise or maintaining or repairing vehicles, excluding the sale of any installed parts or materials. (2) Costs of merchandise sales include the cost of products sold, buying, warehousing and store occupancy costs. Costs of service revenue include service center payroll and related employee benefits and service center occupancy costs. Occupancy costs include utilities, rents, real estate and property taxes, repairs and maintenance and depreciation and amortization expenses. (3) As a percentage of related sales or revenue, as applicable. (4) As a percentage of earnings before income taxes.
29 Twenty-six Weeks Ended August 2, 2003 vs. Twenty-six Weeks Ended August 3, 2002 -------------------------------------------------------------------------------- Total revenues for the first twenty-six weeks decreased 3.5%. This decrease was due primarily to a decrease in comparable store revenues (revenues generated by stores in operation during the same period) of 3.5%. Comparable store merchandise sales decreased 4.2%, while comparable store service revenue decreased 0.4%. Gross profit from merchandise sales decreased, as a percentage of merchandise sales, to 26.3% in fiscal 2003 from 30.2% in fiscal 2002. This decrease, as a percentage of merchandise sales, was due primarily to a $24,580,000 inventory write-down associated with the corporate restructuring and an impairment charge of $2,121,000 offset, in part, by higher merchandise margins, as a percentage of merchandise sales. The improved merchandise margins were a result of a combination of an improvement in the mix of sales, selectively higher retail pricing, lower product acquisition costs and improved inventory controls. Gross profit from service revenue decreased, as a percentage of service revenue, to 23.9% in fiscal 2003 from 25.1% in fiscal 2002. This decrease, as a percentage of service revenue, was due primarily to an increase in workers' compensation expense, as a percentage of service revenue offset, in part, by improved service payroll as a percentage of service revenue. Selling, general and administrative expenses increased, as a percentage of total revenues, to 27.3% in fiscal 2003 from 23.0% in fiscal 2002. This was a 14.2% or $36,088,000 increase over the prior year. This increase, as a percentage of total revenues, was due primarily to an increase in general office costs and employee benefits, as a percentage of total revenues. The increase in general office costs was due primarily to an increase in the Company's legal reserves of approximately $26,500,000 for on-going litigation and $5,613,000 of costs associated with the corporate restructuring. The increase in employee benefits was due primarily to the settlement of a retirement plan obligation. Interest expense decreased 16.8% or $4,101,000 due primarily to lower debt levels coupled with lower average interest rates. Discontinued Operations decreased $23,128,000 due primarily to the charges, net of tax associated with the corporate restructuring. Net earnings decreased, as a percentage of total revenues, due primarily to a decrease in gross profit from merchandise sales, as a percentage of merchandise sales, a decrease in gross profit from service revenue, as a percentage of service revenue, an increase in selling, general and administrative expenses, as a percentage of total revenues, a cumulative effect of change in accounting principle of $2,484,000 and the decrease in discontinued operations. These decreases were offset, in part, by a decrease in interest expense. 30 NEW ACCOUNTING STANDARDS ------------------------ In May 2003, the Financial Accounting Standards Board (FASB) issued SFAS No. 150, "Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity." SFAS No. 150 establishes standards for how an issuer classifies and measures financial instruments that are within the pronouncement's scope as a liability because it embodies an obligation of the issuer. Provisions of this standard are consistent with the current definition of liabilities in FASB Concepts Statement No. 6, "Elements of Financial Statements," while other provisions revise that definition to include certain obligations that a reporting entity can or must settle through issuance of its own equity shares. SFAS No. 150 is effective for financial instruments entered into or modified after May 31, 2003, and otherwise shall be effective at the beginning of the first interim period beginning after June 15, 2003. The Company will adopt this statement in the third quarter of fiscal 2003 with no material effect on its consolidated financial statements. In April 2003, the FASB issued SFAS No. 149, "Amendment of Statement 133 on Derivative Instruments and Hedging Activities." SFAS No. 149 amends and clarifies financial accounting and reporting for derivative instruments and hedging activities, resulting primarily from decisions made by the FASB's Derivatives Implementation Group following the issuance of SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities." SFAS No. 149 is effective for contracts entered into or modified after June 30, 2003 and is effective for hedging relationships designated after June 30, 2003. The Company adopted this statement in the second quarter of fiscal 2003 with no material effect on its consolidated financial statements. In January 2003, the FASB issued Financial Interpretation Number (FIN) 46, "Consolidation of Variable Interest Entities." FIN 46, an interpretation of Accounting Research Bulletin No. 51, "Consolidated Financial Statements," changes the criteria by which one company includes another entity in its consolidated financial statements. FIN 46 requires a variable interest entity to be consolidated by a company if that company is subject to a majority of any expected losses from the variable interest entity's activities, is entitled to receive any expected residual returns of the variable interest entity, or both. FIN 46 applies immediately to variable interest entities created after January 31, 2003, and applies in the first fiscal year or interim period beginning after June 15, 2003, for variable interest entities created prior to February 1, 2003. The Company adopted this statement for variable interest entities created after January 31, 2003 in the fourth quarter of 2002 with no material effect on its consolidated financial statements. On August 1, 2003 the Company refinanced its real estate operating lease facility, which qualified as a variable interest entity into a new entity. The Company has evaluated this leasing transaction in accordance with FIN 46 and has determined it does not have to consolidate this leasing entity. The Company will adopt this statement for variable interest entities created prior to January 31, 2003 in the third quarter of 2003 with no material effect on its consolidated financial statements. 31 In May 2002, the FASB issued SFAS No. 145, "Rescission of FASB Statements No. 4, 44 and 64, Amendment of FASB Statement No. 13, and Technical Corrections." As a result of rescinding FASB Statement No. 4, "Reporting Gains and Losses from Extinguishment of Debt," gains and losses from extinguishment of debt should be classified as extraordinary items only if they meet the criteria of APB Opinion No. 30, "Reporting the Results of Operations." This statement also amends FASB Statement No. 13, "Accounting for Leases," to eliminate an inconsistency between the required accounting for sale-leaseback transactions and the required accounting for certain lease modifications that have economic effects that are similar to sale-leaseback transactions. Additional amendments include changes to other existing authoritative pronouncements to make various technical corrections, clarify meanings or describe their applicability under changed conditions. The Company has adopted the provisions of SFAS No. 145 for the thirteen weeks ended May 3, 2003 with no material effect on its consolidated statements of operations. Reclassifications of extraordinary items pertaining to the extinguishment of debt, if any, will be made throughout fiscal 2003 to maintain comparability for the reported periods. In June 2001, the FASB issued SFAS No. 143, "Accounting for Asset Retirement Obligations." SFAS No. 143 addresses accounting standards for obligations associated with the retirement of tangible long-lived assets and the associated asset retirement costs and is effective for fiscal years beginning after June 15, 2002. The Company has adopted the provisions of SFAS No. 143 in the first quarter of fiscal year 2003 and has recognized an initial asset of $2,844,000, accumulated depreciation of $2,247,000, a liability of $4,540,000 and a cumulative effect of a change in accounting principle before taxes of $3,943,000 ($2,484,000 net of tax) on its consolidated financial statements. CRITICAL ACCOUNTING POLICIES AND ESTIMATES ------------------------------------------ Management's Discussion and Analysis of Financial Condition and Results of Operations discusses the Company's consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of these financial statements requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenues and expenses during the reporting period. On an on-going basis, management evaluates its estimates and judgments, including those related to customer incentives, product returns and warranty obligations, bad debts, inventories, income taxes, financing operations, restructuring costs, retirement benefits, risk participation agreements and contingencies and litigation. Management bases its estimates and judgments on historical experience and on various other factors that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions. For a detailed discussion of significant accounting policies that may involve a higher degree of judgment or complexity, refer to "-Critical Accounting Policies and Estimates" as reported in the Company's Form 10-K for the year ended February 1, 2003, which disclosures are hereby incorporated by reference. 32 FORWARD-LOOKING STATEMENTS -------------------------- Certain statements contained herein constitute "forward-looking statements" within the meaning of The Private Securities Litigation Reform Act of 1995. The words "guidance," "expect," "anticipate," "estimates," "forecasts" and similar expressions are intended to identify such forward-looking statements. Forward-looking statements include management's expectations regarding future financial performance, automotive aftermarket trends, levels of competition, business development activities, future capital expenditures, financing sources and availability and the effects of regulation and litigation. Although the Company believes that the expectations reflected in such forward-looking statements are based on reasonable assumptions, it can give no assurance that its expectations will be achieved. The Company's actual results may differ materially from the results discussed in the forward-looking statements due to factors beyond the control of the Company, including the strength of the national and regional economies, retail and commercial consumers' ability to spend, the health of the various sectors of the automotive aftermarket, the weather in geographical regions with a high concentration of the Company's stores, competitive pricing, the location and number of competitors' stores, product and labor costs and the additional factors described in the Company's filings with the Securities and Exchange Commission (SEC). The Company assumes no obligation to update or supplement forward-looking statements that become untrue because of subsequent events. Item 3. Quantitative and Qualitative Disclosures About Market Risk The Company does not utilize financial instruments for trading purposes and holds no derivative financial instruments which could expose the Company to significant market risk. The Company's primary market risk exposure with regard to financial instruments is to changes in interest rates. Pursuant to the terms of its revolving credit agreement and senior secured credit facility, changes in the lenders' prime rate or London Interbank Offered Rate (LIBOR) could affect the rates at which the Company could borrow funds thereunder. At August 2, 2003, the Company had outstanding borrowings of $28,157,000 under these credit facilities. On June 3, 2003, the Company entered into an interest rate swap for a notional amount of $130,000,000. The Company has designated the swap as a cash flow hedge of the Company's real estate operating lease payments. The interest rate swap converts the variable LIBOR portion of these lease payments to a fixed rate of 2.90% and terminates on July 1, 2008. If the critical terms of the interest rate swap or the hedge item do not change, the interest rate swap will be considered to be highly effective with all changes in fair value included in other comprehensive income. As of August 2, 2003, the fair value of the interest rate swap was $6,191,000 ($3,900,000, net of tax) and this change in value was included in accumulated other comprehensive income. Except as noted above, there have been no material changes to the market risk disclosures as reported in the Company's Form 10-K for the fiscal year ended February 1, 2003. Item 4. Controls and Procedures EVALUATION OF DISCLOSURE CONTROLS AND PROCEDURES Under SEC rules, the Company is required to maintain disclosure controls and procedures designed to ensure that information required to be disclosed by the Company in the reports that it files or submits under the Securities Exchange Act of 1934 is recorded, processed, summarized and reported within the time periods specified in the SEC's rules and forms. The Company has carried out an evaluation of the effectiveness of the design and operation of its disclosure controls and procedures as of the end of the period covered by this Quarterly Report, August 2, 2003. The Company's management, including the chief executive officer and chief financial officer, supervised and participated in the evaluation. Based on this evaluation, the chief executive officer and the chief financial officer concluded that the Company's disclosure controls and procedures were effective as of August 2, 2003. CHANGES IN INTERNAL CONTROLS There were no significant changes in the Company's internal controls or in other factors that could significantly affect these controls subsequent to the date of their evaluation. 33 PART II - OTHER INFORMATION --------------------------- Item 1. Legal Proceedings The Company's California subsidiary is a defendant in a consolidated action entitled "Dubrow et al vs. The Pep Boys - Manny Moe & Jack" that is currently pending in the California Superior Court in Orange County. The two consolidated actions were originally filed on March 29, 2000 and July 25, 2000. Plaintiffs are former and current store management employees who claim that they were improperly classified as exempt from the overtime provisions of California law and seek to be compensated for all overtime hours worked. Plaintiffs' motion to certify the case as a class action to represent all persons employed in California since March 29, 1996 as salaried store managers, assistant store managers, service managers and assistant service managers was previously granted by the trial court. The Company's appeals of that decision through the California Supreme Court were unsuccessful. The parties have reached an agreement, subject to the court's approval, to submit this matter to binding arbitration. The Company has previously accrued an amount sufficient to satisfy the maximum liability that may be imposed on the Company by the arbitrator under the terms of the agreement. An action entitled "Tomas Diaz Rodriguez; Energy Tech Corporation v. Pep Boys Corporation; Manny, Moe & Jack Corp. Puerto Rico, Inc. d/b/a Pep Boys" was previously instituted against the Company in the Court of First Instance of Puerto Rico, Bayamon Superior Division on March 15, 2002. The action was subsequently removed to, and is currently pending in, the United States District Court for the District of Puerto Rico. Plaintiffs are distributors of a product that claims to improve gas mileage. The plaintiffs allege that the Company entered into an agreement with them to act as the exclusive retailer of the product in Puerto Rico that was breached when the Company determined to stop selling the product. The Company became aware of a Federal Trade Commission investigation regarding the accuracy of advertising claims concerning the product's effectiveness. The plaintiffs further allege that they were negotiating with the manufacturer of the product to obtain the exclusive distribution rights throughout the United States and that those negotiations failed. Plaintiffs are seeking damages including payment for the product that they allege Pep Boys ordered and expenses and loss of sales in Puerto Rico and the United States resulting from the alleged breach. The Company believes that the claims are without merit and continues to vigorously defend this action. The Company is also party to various other actions and claims, including purported class actions, arising in the normal course of business. The Company believes that amounts accrued for awards or assessments in connection with the foregoing matters are adequate and that the ultimate resolution of these matters will not have a material adverse effect on the Company's financial position or results of operations. 34 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 An annual meeting of shareholders was held on May 28, 2003. The shareholders approved the election of directors shown below. Directors Elected at Annual Meeting of Shareholders ---------------------------------------------------- Name Votes For Votes Withheld ---- --------- -------------- Lester Rosenfeld 36,037,587 16,755,465 Benjamin Strauss 36,039,062 16,753,990 Bernard J. Korman 35,147,593 17,645,459 J. Richard Leaman, Jr. 35,939,621 16,853,431 Malcolmn D. Pryor 36,056,665 16,736,387 Peter A. Bassi 36,085,622 16,707,430 Jane Scaccetti 36,099,430 16,693,622 John T. Sweetwood 36,085,595 16,707,457 William Leonard 36,056,149 16,736,903 .................................................................... The shareholders also approved the appointment of the Company's independent auditors, Deloitte & Touche, LLP, with 52,141,071 affirmative votes, 528,293 negative votes, and 123,688 abstentions. .................................................................... The shareholders also approved a shareholder proposal regarding the Company's Shareholder Rights Plan with 27,433,996 affirmative votes, 12,929,831 negative votes, 11,963,191 non-votes, and 466,034 abstentions. .................................................................... 35 Item 5. Other Information None. Item 6. Exhibits and Reports on Form 8-K (a) Exhibits (10.1) Amended and Restated Loan And Security Agreement, dated August 1, 2003, by and among the Company, Congress Financial Corporation, as Agent, The CIT Group/Business Credit, Inc. and General Electric Capital Corporation, as Co-Documentation Agents, and the Lenders from time to time party thereto. (10.2) Participation Agreement, dated as of August 1, 2003, among the Company, Wachovia Development Corporation, as the Borrower and the Lessor, the Lenders and Wachovia Bank, National Association, as Agent for the Lenders and the Secured Parties. (10.3) Amended and Restated Lease Agreement, dated as of August 1, 2003, between Wachovia Development Corporation, as Lessor, and the Company. (10.4)* Amendment number Two to The Pep Boys - Manny, Moe & Jack 1999 Stock Incentive Plan. (31.1) Certification of Chief Executive Officer by Rule 13a-14(a) (31.2) Certification of Chief Financial Officer by Rule 13a-14(a) (32.1) Chief Executive Officer Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (32.2) Chief Financial Officer Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 * Management contract or compensatory plan or arrangement. (b) Reports on Form 8-K. The Company furnished a Form 8-K on May 15, 2003 announcing its results of operations for the first quarter ended May 3, 2003. An exhibit containing the press release dated May 14, 2003 was attached. The Company filed a Form 8-K on July 31, 2003, announcing its corporate restructuring. An exhibit containing the Company's press release announcing the restructuring was attached. 36 SIGNATURES ---------- 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. THE PEP BOYS - MANNY, MOE & JACK -------------------------------- (Registrant) Date: September 16, 2003 By: /s/ George Babich, Jr. ----------------------- -------------------------- George Babich, Jr. President & Chief Financial Officer 37 INDEX TO EXHIBITS ----------------- (10.1) Amended and Restated Loan And Security Agreement, dated August 1, 2003, by and among the Company, Congress Financial Corporation, as Agent, The CIT Group/Business Credit, Inc. and General Electric Capital Corporation, as Co-Documentation Agents, and the Lenders from time to time party thereto. (10.2) Participation Agreement, dated as of August 1, 2003, among the Company, Wachovia Development Corporation, as the Borrower and the Lessor, the Lenders and Wachovia Bank, National Association, as Agent for the Lenders and the Secured Parties. (10.3) Amended and Restated Lease Agreement, dated as of August 1, 2003, between Wachovia Development Corporation, as Lessor, and the Company. (10.4) Amendment number two to The Pep Boys - Manny, Moe & Jack 1999 Stock Incentive Plan. (31.1) Certification of Chief Executive Officer by Rule 13a-14(a) (31.2) Certification of Chief Financial Officer by Rule 13a-14(a) (32.1) Chief Executive Officer Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (32.2) Chief Financial Officer Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 38