UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Form 10-Q
(Mark One)
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þ
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QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
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For the quarterly period ended May 4, 2008
or
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o
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TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
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For the transition period from
to
Commission File Number 001-13927
CSK Auto Corporation
(Exact name of registrant as specified in its charter)
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Delaware
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86-0765798
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(State or other jurisdiction of
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(I.R.S. Employer
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incorporation or organization)
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Identification No.)
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645 E. Missouri Ave.
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85012
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Suite 400
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(Zip Code)
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Phoenix, Arizona
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(Address of principal executive offices)
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(602) 265-9200
(Registrants telephone number, including area code)
N/A
(Former name, former address and former fiscal year,
if changed since last report)
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by
Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for
such shorter period that the registrant was required to file such reports), and (2) has been
subject to such filing requirements for the past 90 days. Yes
þ
No
o
.
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a
non-accelerated filer or a smaller reporting company. See definitions of large accelerated
filer, accelerated filer and smaller reporting company in Rule 12b-2 of the Exchange Act.
(Check One):
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Large accelerated filer
þ
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Accelerated filer
o
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Non-accelerated filer
o
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Smaller reporting company
o
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(Do not check if a smaller reporting company)
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Indicate by check mark whether the registrant is a shell company (as defined in Exchange Act
Rule 12b-2). Yes
o
No
þ
As of June 6, 2008, there were 44,036,813 shares of our common stock outstanding.
TABLE OF CONTENTS
As used herein, the terms CSK, CSK Auto, the Company, we, us, and our refer to CSK
Auto Corporation and its subsidiaries, including its operating subsidiary, CSK Auto, Inc., and its
subsidiary, CSKAUTO.COM, Inc. The term Auto as used herein refers to our operating subsidiary,
CSK Auto, Inc., and its subsidiary, CSKAUTO.COM, Inc.
You may obtain, free of charge, copies of this Quarterly Report on Form 10-Q for the quarterly
period ended May 4, 2008 (this Quarterly Report) as well as our Annual Report on Form 10-K for
the fiscal year ended February 3, 2008, as amended by the filing of Form 10-K/A on June 2, 2008 (the
2007 10-K), and Current Reports on Form 8-K filed with or furnished to the Securities and
Exchange Commission (SEC) as soon as reasonably practicable after such reports have been filed or
furnished by accessing our website at www.cskauto.com, then clicking Investors. Information
contained on our website is not part of this Quarterly Report.
Note Concerning Forward-Looking Information
Certain statements contained in this Quarterly Report are forward-looking statements and are
usually identified by words such as may, will, expect, anticipate, believe, estimate,
continue, could, should or other similar expressions. We intend forward-looking statements to
be covered by the safe harbor provisions for forward-looking statements contained in the Private
Securities Litigation Reform Act of 1995. These forward-looking statements reflect current views
about our plans, strategies and prospects and speak only as of the date of this Quarterly Report.
We believe that it is important to communicate our future expectations to our investors.
However, forward-looking statements are subject to risks, uncertainties and assumptions often
beyond our control, including, but not limited to, competitive pressures, the overall condition of
the national and regional economies, factors affecting import of products, factors impacting
consumer spending and driving habits such as high gas prices, war and terrorism, natural disasters
and/or extended periods of inclement weather, consumer debt levels and inflation, demand for our
products, integration and management of any past and future acquisitions, conditions affecting new
store development, relationships with vendors, risks related to compliance with Section 404 of the
Sarbanes-Oxley Act of 2002 (SOX and such Section, SOX 404) and litigation and regulatory
matters. Actual results may differ materially from anticipated results described in these
forward-looking statements. For more information related to these and other risks, please refer to
the Risk Factors section in the 2007 10-K. In addition to causing our actual results to differ, the
factors listed and referred to above may cause our intentions to change from those statements of
intention set forth in this Quarterly Report. Such changes in our intentions may cause our results
to differ. We may change our intentions at any time and without notice based upon changes in such
factors, our assumptions or otherwise.
Except as required by applicable law, we do not intend and undertake no obligation to update
publicly any forward-looking
2
statements, whether as a result of new information, future events or
otherwise. Given the uncertainties and risk factors that could cause our actual results to differ
materially from those contained in any forward-looking statement, you should not place undue
reliance upon forward-looking statements and should carefully consider these risks and
uncertainties, together with the other risks described
from time to time in our other reports and documents filed with the SEC.
3
PART I
FINANCIAL INFORMATION
Item 1.
Financial Statements
CSK AUTO CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(Unaudited)
(In thousands, except share data)
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May 4,
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February 3,
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2008
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2008
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ASSETS
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Cash and cash equivalents
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$
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19,679
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$
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16,520
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Receivables, net
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36,721
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37,322
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Inventories, net
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549,002
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494,651
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Deferred income taxes
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44,527
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50,649
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Prepaid expenses and other current assets
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50,434
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35,842
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Total current assets
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700,363
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634,984
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Property and equipment, net
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159,267
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165,115
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Intangibles, net
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61,905
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63,020
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Goodwill
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224,937
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224,937
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Deferred income taxes
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17,288
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15,380
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Other assets, net
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33,667
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35,254
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Total assets
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$
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1,197,427
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$
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1,138,690
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LIABILITIES AND STOCKHOLDERS EQUITY
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Accounts payable
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$
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291,225
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$
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236,879
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Accrued payroll and related expenses
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59,666
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57,593
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Accrued expenses and other current liabilities
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98,950
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107,211
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Current
maturities of long-term debt (Notes 1 and 7)
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493,443
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50,551
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Current maturities of capital lease obligations
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5,982
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6,351
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Total current liabilities
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949,266
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458,585
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Long-term
debt (Notes 1 and 7)
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16,131
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452,420
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Obligations under capital leases
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8,469
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9,866
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Other liabilities
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52,662
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53,281
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Total non-current liabilities
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77,262
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515,567
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Commitments and contingencies
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Stockholders equity:
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Common stock, $0.01 par value, 90,000,000 shares authorized, 44,035,913
and 44,030,644 shares issued and outstanding at May 4, 2008 and February
3, 2008, respectively
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440
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440
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Additional paid-in capital
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439,086
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438,092
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Accumulated deficit
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(268,627
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(273,994
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Total stockholders equity
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170,899
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164,538
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Total liabilities and stockholders equity
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$
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1,197,427
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$
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1,138,690
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The accompanying notes are an integral part of these consolidated financial statements.
4
CSK AUTO CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
(In thousands, except per share data)
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Thirteen Weeks Ended
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May 4,
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May 6,
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2008
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2007
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Net sales
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$
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461,104
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$
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473,035
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Cost of sales
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243,801
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252,437
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Gross profit
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217,303
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220,598
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Other costs and expenses:
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Operating and administrative
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205,810
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199,234
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Investigation, litigation and restatement costs
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983
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4,564
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Insurance recovery (Note 12)
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(15,000
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)
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Store closing costs
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785
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706
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Operating profit
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24,725
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16,094
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Interest expense, net
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15,445
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13,322
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Income before income taxes
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9,280
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2,772
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Income tax expense
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3,913
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1,102
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Net income
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$
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5,367
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$
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1,670
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Earnings per common share:
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Basic
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$
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0.12
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$
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0.04
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Diluted
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$
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0.12
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$
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0.04
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Weighted average shares outstanding:
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Basic
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44,032
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43,951
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Diluted
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44,101
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44,697
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The accompanying notes are an integral part of these consolidated financial statements.
5
CSK AUTO CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF STOCKHOLDERS EQUITY
(Unaudited)
(In thousands, except share data)
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Common Stock
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Additional
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Accumulated
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Total
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Shares
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Amount
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Paid-in Capital
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Deficit
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Equity
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Balances at February 3, 2008
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44,030,644
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$
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440
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$
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438,092
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$
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(273,994
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$
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164,538
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Restricted stock
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990
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(3
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(3
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Exercise of options
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4,279
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40
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40
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Stock-based compensation expense
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957
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957
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Net income
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5,367
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5,367
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Balances at May 4, 2008
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44,035,913
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$
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440
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$
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439,086
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$
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(268,627
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$
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170,899
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The accompanying notes are an integral part of these consolidated financial statements.
6
CSK AUTO CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
(In thousands)
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Thirteen Weeks Ended
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May 4,
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May 6,
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2008
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2007
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Cash flows provided by (used in) operating activities:
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Net income
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$
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5,367
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$
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1,670
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Adjustments:
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Depreciation and amortization on property and equipment
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9,395
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9,947
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Amortization of other items
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1,384
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1,336
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Amortization of debt discount and deferred financing costs
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1,782
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1,319
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Stock-based compensation expense
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1,244
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1,367
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Write downs of property, equipment and other assets
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447
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1,398
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Deferred income taxes
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3,756
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1,046
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Changes in operating assets and liabilities:
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Receivables
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(229
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(2,344
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)
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Inventories
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(54,351
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(25,559
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Prepaid expenses and other current assets
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(14,592
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(773
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Accounts payable
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54,347
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13,630
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Accrued payroll, accrued expenses and other current liabilities
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(6,401
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)
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4,838
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Other operating activities
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189
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(192
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)
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Net cash provided by operating activities
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2,338
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7,683
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Cash flows used in investing activities:
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Capital expenditures
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(4,046
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(8,858
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Other investing activities
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(320
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)
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(477
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Net cash used in investing activities
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(4,366
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)
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(9,335
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Cash flows provided by (used in) financing activities:
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Borrowings under senior credit facility line of credit
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85,900
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65,600
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Payments under senior credit facility line of credit
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(79,400
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)
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(57,100
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)
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Payments under term loan facility
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(864
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)
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(873
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)
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Payment of debt financing costs
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(125
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)
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Payments on capital lease obligations
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(1,694
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)
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(2,684
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)
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Proceeds from seller financing arrangements
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1,550
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Payments on seller financing arrangements
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(168
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)
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(156
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)
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Proceeds from exercise of stock options
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40
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Other financing activities
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(52
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)
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(44
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)
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Net cash provided by financing activities
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5,187
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4,743
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Net increase in cash
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3,159
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3,091
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Cash and cash equivalents, beginning of period
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16,520
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20,169
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Cash and cash equivalents, end of period
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$
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19,679
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$
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23,260
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The accompanying notes are an integral part of these consolidated financial statements.
7
CSK AUTO CORPORATION AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
CSK Auto Corporation is a holding company. At May 4, 2008 and for the periods presented in
this Quarterly Report, CSK Auto Corporation had no business activity other than its investment in
CSK Auto, Inc. (Auto), a wholly owned subsidiary. On a consolidated basis, CSK Auto Corporation
and its subsidiaries are referred to herein as the Company.
Auto is a specialty retailer of automotive aftermarket parts and accessories. At May 4, 2008,
the Company operated 1,345 stores in 22 states, with its principal concentration of stores in the
Western United States, under the following four brand names: Checker Auto Parts, founded in 1969
and operating in the Southwestern, Rocky Mountain and Northern Plains states and Hawaii; Schucks
Auto Supply, founded in 1917 and operating in the Pacific Northwest and Alaska; Kragen Auto Parts,
founded in 1947 and operating primarily in California; and Murrays Discount Auto Stores, founded
in 1972 and operating in the Midwest.
Note 1 Merger Agreement and Matters Related to the Companys Indebtedness
Merger Agreement
On April 1, 2008, the Company entered into an Agreement and Plan of Merger (the Merger
Agreement) with OReilly Automotive, Inc. (OReilly) and an indirect wholly-owned subsidiary of
OReilly pursuant to which the Company is expected to become a wholly-owned subsidiary of OReilly
(the Acquisition).
In order to effectuate the Acquisition, OReilly has agreed to commence an exchange offer (the
Exchange Offer) pursuant to which each share of the Companys common stock tendered in the
Exchange Offer will be exchanged for (a) a number of shares of OReillys common stock equal to the
exchange ratio (as calculated below), plus (b) $1.00 in cash (subject to possible reduction as
described below). Pursuant to the Merger Agreement, the exchange ratio will equal $11.00 divided
by the average trading price of OReillys common stock during the five consecutive trading days
ending on and including the second trading day prior to the closing of the Exchange Offer;
provided, that if such average trading price of OReillys common stock is greater than $29.95 per
share, then the exchange ratio will be 0.3673, and if such average trading price is less than
$25.67 per share, then the exchange ratio will be 0.4285. If such average trading price is less
than or equal to $21.00 per share, the Company may terminate the Merger Agreement unless OReilly
exercises its option to issue an additional number of its shares or increase the amount of cash to
be paid such that the total value of OReilly common stock and cash exchanged for each share of the
Companys common stock is at least equal to $10.00 (less any possible reduction of the cash
component of the offer price as described below).
Upon completion of the Exchange Offer, any remaining shares of the Companys common stock will
be acquired in a second-step merger at the same price at which shares of the Companys common stock
were exchanged in the Exchange Offer.
The Acquisition is expected to be completed during the second quarter of the Companys fiscal
year ending February 1, 2009 (fiscal 2008) and is subject to regulatory review and customary
closing conditions, including that at least a majority of the Companys outstanding shares of
common stock be tendered in the Exchange Offer and the expiration or termination of any waiting
period under the Hart-Scott-Rodino Antitrust Improvements Act of 1976, as amended (which waiting
period terminated on April 17, 2008).
The Merger Agreement includes customary representations, warranties and covenants by the
Company, including covenants (a) to cease immediately any discussions and negotiations with respect
to an alternate acquisition proposal, (b) not to solicit any alternate acquisition proposal and,
with certain exceptions, not to enter into discussions concerning or furnish information in
connection with any alternate acquisition proposal, and (c) subject to certain exceptions, for the
Companys Board of Directors not to withdraw or modify its recommendation that the Companys
stockholders tender shares into the Exchange Offer. In addition, the Company has agreed to use
reasonable best efforts to obtain appropriate waivers or consents under the Companys credit or
debt agreements and instruments if needed or if requested by OReilly to remedy any default or
event of default thereunder that may arise after the date of the Merger Agreement (the Credit
Agreement Waivers). The $1.00 cash component of the offer price for each share of the
Companys common stock tendered in the Exchange Offer will be subject to reduction in the event
that the Company pays more than $3.0 million to its lenders in order to obtain any Credit Agreement
Waivers. The $1.00 cash component may be reduced by an amount equal to the quotient obtained by
dividing (x) by (y), where (x) equals the sum of any amount paid by the Company or its subsidiaries
to the lenders under its credit agreements in connection with obtaining any bank consent, waiver,
or amendment under the credit agreements after April 1, 2008, minus $3,000,000, and (y) equals the
sum of (i) the total number of shares of the Companys common stock outstanding immediately prior
to the expiration of the Exchange Offer and (ii) a number of shares of the Companys common stock
determined by OReilly up to a maximum of the total number of shares of the Companys common stock
issuable upon the exercise or conversion of all options, warrants, rights and convertible
securities (if any) that will be vested on or before the date that is 180 days after April 1, 2008.
The Company does not anticipate a need to obtain any Credit Agreement Waivers prior to the
anticipated closing of the Exchange Offer.
8
CSK AUTO CORPORATION AND SUBSIDIARIES
NOTES
TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
The Merger Agreement contains certain termination rights for both the Company and OReilly,
including if the Exchange Offer has not been consummated or if the expiration or termination of any
waiting period (and any extension thereof) under the Hart-Scott-Rodino Antitrust Improvements Act
of 1976, as amended, had not occurred, in either case on or before the date that is 180 days after
the date of the Merger Agreement, and provisions that permit termination in connection with the
exercise of the fiduciary duties of the Companys Board of Directors with respect to superior
offers. The Merger Agreement further provides that upon termination of the Merger Agreement under
specified circumstances, the Company may be required to pay OReilly a termination fee of
$22.0 million.
In connection with the Acquisition, it is anticipated that OReilly will repay at the time of
the closing of the Exchange Offer all amounts outstanding and other amounts payable under the
Companys $350.0 million floating rate term loan facility (the Term Loan Facility) and
$325.0 million senior secured revolving line of credit (the Senior Credit Facility). Thus,
although the consummation of the Exchange Offer would result in an event of default and the
possible acceleration of indebtedness under those facilities, it is contemplated that those
facilities will be repaid in full and cease to exist at the closing of the Exchange Offer. If the
Acquisition is
completed as planned, the Companys $100.0 million of 6
3
/
4
% senior exchangeable notes (the 6
3
/
4
%
Notes) will remain outstanding.
The
Company engaged J.P. Morgan Securities, Inc. (JPMorgan) to act as its financial advisor in
connection with the Companys analysis and consideration of its
strategic alternatives. Pursuant to an engagement letter dated
January 12, 2008, the Company agreed to pay JPMorgan 0.90% of the
consideration for the Merger, less any amount, up to $500,000, paid
to another financial advisor in connection with the delivery of an
opinion as to the fairness, from a financial point of view, of the
consideration to be paid to the Companys stockholders. This amount is payable upon consummation of a transaction. For
purposes of such engagement letter, Consideration means
the total amount of cash and the fair market value of OReilly
common stock payable to the Company and its stockholders in
connection with the Merger, including amounts payable in respect of
convertible securities, options, or similar rights, whether or not
vested, plus the principal amount of all indebtedness for borrowed
money of the Company. The Company has also agreed to reimburse
JPMorgans expenses and indemnify JPMorgan against certain
liabilities arising out of engagement.
Term Loan Facility Financial Covenants
The Companys Term Loan Facility contains a maximum leverage ratio covenant that
the Company does not believe at this time it will be able to satisfy beginning in the first quarter of the
Companys fiscal year ending January 31, 2010 (fiscal 2009). As the Company did not obtain a
waiver or amendment of that covenant prior to the completion of these financial statements for the
first quarter of fiscal 2008, the Companys belief that it is probable that this covenant will not
be satisfied for the first quarter of fiscal 2009 has caused the Company to classify all of the its
indebtedness under the Term Loan Facility and the Senior Credit Facility, as well as the 6
3
/
4
% Notes,
as current liabilities in the Companys financial statements beginning with its financial
statements for the first quarter of fiscal 2008. Furthermore, beginning with the second quarter of
fiscal 2008, the Company will be required to reduce (to twelve months) the time period over which
it amortizes debt issuance costs and debt discount, increasing the interest costs it reports in its
financial statements. The classification of all such indebtedness as current liabilities and the
acceleration of the amortization of interest costs will not cause a default under the Companys
borrowing agreements. However, any such classification could have adverse consequences upon the
Companys relationships with, and the credit terms upon which it does business with, its vendors.
The Company expects such consequences, if any, to be limited due to the expected closing of the
Exchange Offer in the second quarter of fiscal 2008. The Company does not expect to seek any
waivers or amendments under its credit facilities prior to the closing of the Exchange Offer as
these credit facilities are expected to be repaid and terminated upon closing of the Exchange
Offer.
If the Exchange Offer were to fail to close, prior to the end of the first quarter of fiscal
2009, the Company would seek to obtain a waiver or amendment of certain covenants contained in the
Term Loan Facility, including the maximum leverage ratio covenant. No assurance can be given that
the Company would be able to obtain such a waiver or amendment on terms that would be satisfactory
to the Company. Failure to comply with the financial covenants of the Term Loan Facility would
result in an event of default under the Term Loan Facility after the first quarter of fiscal 2009,
which could result in the acceleration of all of the Companys indebtedness thereunder, under the
Senior Credit Facility and under the indenture under which the 6
3
/
4
% Notes were issued, all of which
could have a material adverse effect on the Company.
Note 2 Basis of Presentation
The accompanying unaudited consolidated financial statements as of May 4, 2008 and for the
thirteen weeks ended May 4, 2008 (the first quarter of fiscal 2008) and May 6, 2007 (the first
quarter of fiscal 2007) included herein have been prepared in accordance with accounting
principles generally accepted in the United States of America (GAAP) for interim financial
information and with instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, the
financial statements do not include all information and footnotes required by GAAP for audited
financial statements. In the opinion of management, the consolidated financial statements reflect
all adjustments, which are of a normal recurring nature, necessary for a fair statement of the
Companys financial position and the results of its operations. The results of operations for the
thirteen weeks ended May 4, 2008 are not necessarily indicative of the operating results for the
full year. The accompanying consolidated financial statements should be read in conjunction with
the consolidated financial statements and related notes thereto for the fiscal year ended February
3, 2008 (fiscal 2007) as included in the Companys Annual Report on Form 10-K filed with the
Securities and Exchange Commission (the SEC) on April 18, 2008, as amended by the filing of Form
10-K/A on June 2, 2008 (the 2007 10-K).
Use of Estimates
The preparation of financial statements in conformity with GAAP requires management to make
estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure
of contingent assets and liabilities at the date of the financial
9
CSK AUTO CORPORATION AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
statements and the reported
amounts of revenues and expenses during the reporting period. Actual results could differ from
these estimates.
For the description of the Companys significant accounting policies, see Note 2 Summary of
Significant Accounting Policies to the consolidated financial statements included in Item 8 of the
Companys 2007 10-K.
Reclassifications
Certain
amounts have been reclassified to be consistent with the presentation
for all periods, with no effect on net income or stockholders
equity.
Note 3 Recent Accounting Pronouncements
In September 2006, the FASB issued SFAS No. 157,
Fair Value Measurements
, which clarifies the
definition of fair value, establishes a framework for measuring fair value within GAAP and expands
the disclosures regarding fair value measurements. In February 2008, the FASB issued a staff
position that delays the effective date of SFAS No. 157 for nonfinancial assets and liabilities
except for those recognized or disclosed at least annually. Except for the delay for nonfinancial
assets and liabilities, SFAS No. 157 is effective for fiscal years beginning after November 15,
2007 and interim periods within such years. The implementation of SFAS No. 157 for financial assets
and financial liabilities, effective January 1, 2008, did not have a material impact on the
Companys consolidated financial position, results of operations or cash flows. The Company is
currently assessing the impact of SFAS No. 157
for nonfinancial assets and liabilities on its consolidated financial position, results of
operations and cash flows.
In February 2007, the FASB issued SFAS No. 159,
The Fair Value Option for Financial Assets and
Financial Liabilities
, which permits entities to choose to measure many financial instruments and
certain other items at fair value. SFAS No. 159 is effective for fiscal years beginning after
November 15, 2007. The Company elected not to measure any financial instruments or other items at
fair value as of February 4, 2008 in accordance with SFAS No. 159.
In December 2007, the FASB issued SFAS No. 141R,
Business Combinations
, which establishes how
an acquiring company recognizes and measures acquired assets, liabilities, goodwill and minority
interests. It also defines how an acquirer should account for a gain from a bargain purchase and
determines what information to disclose to enable users of the financial statements to evaluate the
nature and financial effects of the business combination. SFAS No. 141R applies prospectively to
business combinations for which the acquisition date is on or after the beginning of the first
annual reporting period beginning on or after December 15, 2008. Early adoption is not permitted.
The Company will be required to apply the provisions of SFAS No. 141R to any future business
combinations consummated after its effective date.
In December 2007, the FASB issued SFAS No. 160,
Noncontrolling Interests in Consolidated
Financial Statements an amendment of ARB No. 51
, which provides guidance and establishes amended
accounting and reporting standards for a parent companys noncontrolling interest in a subsidiary.
SFAS No. 160 is effective for fiscal years beginning on or after December 15, 2008. The Company
does not expect the adoption of SFAS No. 160 to have a material impact on its financial condition,
results of operations or cash flows.
In December 2007, the SEC staff issued Staff Accounting Bulletin (SAB) 110,
Share-Based
Payment
, which amends SAB 107,
Share-Based Payment
, to permit public companies, under certain
circumstances, to use the simplified method of determining the expected term of stock options
contained in SAB 107 for employee option grants after December 31, 2007. Use of the simplified
method after December 2007 is permitted only for companies whose historical data about their
employees exercise behavior does not provide a reasonable basis for estimating the expected term
of the options. Based on the significant restrictions on employee trading during the period
commencing prior to the completion and filing of the Companys restated financial statements until
the Company became current in its financial reporting
(see Note 12 Legal
Matters),
the Company
has not experienced regular employee exercise behavior since the implementation of Statement of
Financial Accounting Standards No. 123R,
Share-Based Payment
, (SFAS No. 123R) on January 20,
2006, and thus has been using the simplified method as allowed under SAB 110.
Note 4 Inventories
Inventories are valued at the lower of cost or market, cost being determined utilizing the
First-In, First-Out (FIFO) method. At each balance sheet date, the Company adjusts its inventory
carrying balances by an allowance for inventory shrinkage that has occurred since the most recent
physical inventory and an allowance for inventory obsolescence, each of which is discussed in
greater detail below.
|
|
|
The Company reduces the FIFO carrying value of its inventory for estimated loss due to
shrinkage since the most recent physical inventory. Shrinkage expense for the thirteen weeks
ended May 4, 2008, and May 6, 2007 was approximately $7.0 million and $7.5 million,
respectively. While the shrinkage accrual is based on recent experience, there is a risk
that actual losses may be higher or lower than expected.
|
10
CSK AUTO CORPORATION AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
|
|
|
In certain instances, the Company retains the right to return obsolete and excess
merchandise inventory to its vendors. In situations where the Company does not have a right
to return, the Company records an allowance representing an estimated loss for the
difference between the cost of any obsolete or excess inventory and the estimated retail
selling price. Inventory levels and margins earned on all products are monitored monthly. On
a quarterly basis, the Company assesses whether it expects to sell any significant amount of
inventory below cost and, if so, estimates and records an allowance.
|
At each balance sheet reporting date, the Company also adjusts its inventory carrying balances
by the capitalization of certain operating and administrative overhead costs associated with the
purchasing and handling of inventory and estimates of vendor allowances that remain in ending
inventory. The components of ending inventory are as follows (in thousands):
|
|
|
|
|
|
|
|
|
|
|
May 4,
|
|
|
February 3,
|
|
|
|
2008
|
|
|
2008
|
|
FIFO cost
|
|
$
|
592,296
|
|
|
$
|
540,094
|
|
Overhead costs
|
|
|
32,882
|
|
|
|
29,848
|
|
Vendor allowances
|
|
|
(60,270
|
)
|
|
|
(60,067
|
)
|
Shrinkage
|
|
|
(14,016
|
)
|
|
|
(13,030
|
)
|
Obsolescence
|
|
|
(1,890
|
)
|
|
|
(2,194
|
)
|
|
|
|
|
|
|
|
Inventories, net
|
|
$
|
549,002
|
|
|
$
|
494,651
|
|
|
|
|
|
|
|
|
Note 5 Property and Equipment
Property and equipment are comprised of the following (in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
May 4,
|
|
|
February 3,
|
|
|
|
|
|
2008
|
|
|
2008
|
|
|
Estimated Useful life
|
Land
|
|
$
|
348
|
|
|
$
|
348
|
|
|
|
Buildings
|
|
|
18,941
|
|
|
|
18,221
|
|
|
15 - 25 years
|
Leasehold improvements
|
|
|
166,831
|
|
|
|
165,380
|
|
|
Shorter of lease term or useful life
|
Furniture, fixtures and equipment
|
|
|
177,646
|
|
|
|
182,172
|
|
|
3 - 10 years
|
Property under capital leases
|
|
|
55,040
|
|
|
|
55,417
|
|
|
5 - 15 years or life of lease
|
Purchased software
|
|
|
12,955
|
|
|
|
12,725
|
|
|
5 years
|
|
|
|
|
|
|
|
|
|
|
|
|
431,761
|
|
|
|
434,263
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Less: accumulated depreciation and
amortization
|
|
|
(272,494
|
)
|
|
|
(269,148
|
)
|
|
|
|
|
|
|
|
|
|
|
|
Property and equipment, net
|
|
$
|
159,267
|
|
|
$
|
165,115
|
|
|
|
|
|
|
|
|
|
|
|
|
Depreciation expense for property and equipment, including amortization of capital leases,
totaled $9.4 million and $9.9 million for the thirteen weeks ended May 4, 2008 and May 6, 2007,
respectively. Accumulated amortization of property under capital leases totaled $39.8 million and
$38.6 million at May 4, 2008 and February 3, 2008, respectively.
The Company evaluates the carrying value of long-lived assets on an annual basis to determine
whether events or changes in circumstances indicate that the carrying amount of an asset may not be
recoverable and an impairment loss should be recognized. Such evaluation is based on the expected
utilization of the related asset and the corresponding useful life.
Note 6 Store Closing Costs
On an on-going basis, store locations are reviewed and analyzed based on several factors
including market saturation, store profitability, and store size and format. In addition, the
Company analyzes sales trends, geographical factors and competitive factors to determine the
viability and future profitability of its store locations. If a store location does not meet the
Companys required performance criteria, it is considered for closure. As a result of past
acquisitions, the Company has closed numerous stores due to overlap with previously existing store
locations.
The Company accounts for the costs of closed stores in accordance with SFAS No. 146,
Accounting for Costs Associated with Exit or Disposal Activities
. Under SFAS No. 146, the fair
value of future costs of operating lease commitments for closed stores are recorded as a liability
at the date the Company ceases operating the store. Fair value of the liability is the present
value of future cash
11
CSK AUTO CORPORATION AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
flows discounted by a credit-adjusted risk free rate. Accretion expense
represents interest on the Companys recorded closed store liabilities and is calculated by using
the same credit-adjusted risk free rate used to discount the cash flows. In addition, SFAS No. 146
also requires that the amount of remaining lease payments owed be reduced by estimated sublease
income (but not to an amount less than zero). Sublease income in excess of costs associated with
the lease is recognized as it is earned and included as a reduction to operating and administrative
expenses in the accompanying financial statements.
The allowance for store closing costs is included in accrued expenses and other long-term
liabilities in the accompanying financial statements and represents the discounted value of the
following future net cash outflows related to closed stores: (1) future rents and other contractual
expenses to be paid over the remaining terms of the lease agreements for the stores (net of
estimated sublease income); and (2) lease commissions associated with obtaining store subleases.
Certain operating expenses related to closed stores, such as utilities and repairs, are expensed as
incurred. In addition, the Company expenses as incurred and reports as store closing costs
operating expenses it incurs when closing a store. These expenses include temporary labor and
transportation costs for inventory, fixtures and other assets owned in the store being closed. The
Company does not incur employee termination costs when stores are closed.
The following tabular presentation provides detailed information regarding the Companys
SFAS No. 146 store closing costs (in thousands):
|
|
|
|
|
|
|
|
|
|
|
Thirteen Weeks Ended
|
|
|
|
May 4,
|
|
|
May 6,
|
|
|
|
2008
|
|
|
2007
|
|
SFAS No. 146 liability balance, beginning of year
|
|
$
|
3,027
|
|
|
$
|
4,911
|
|
|
|
|
|
|
|
|
SFAS No. 146 provision for contractual obligations, net of
estimated sublease income for stores closed during the period
|
|
|
270
|
|
|
|
831
|
|
Revisions in SFAS No. 146 estimates
|
|
|
452
|
|
|
|
(386
|
)
|
Accretion
|
|
|
32
|
|
|
|
58
|
|
|
|
|
|
|
|
|
SFAS No. 146 store closing costs expensed in the period
|
|
|
754
|
|
|
|
503
|
|
|
|
|
|
|
|
|
Payments:
|
|
|
|
|
|
|
|
|
Contractual obligations, net of sublease recoveries
|
|
|
(783
|
)
|
|
|
(580
|
)
|
Sublease commissions and buyouts
|
|
|
|
|
|
|
(43
|
)
|
|
|
|
|
|
|
|
Total payments
|
|
|
(783
|
)
|
|
|
(623
|
)
|
|
|
|
|
|
|
|
SFAS No. 146 liability balance, end of period
|
|
$
|
2,998
|
|
|
$
|
4,791
|
|
|
|
|
|
|
|
|
Store closing costs incurred during the periods are comprised of (in thousands):
|
|
|
|
|
|
|
|
|
|
|
Thirteen Weeks Ended
|
|
|
|
May 4,
|
|
|
May 6,
|
|
|
|
2008
|
|
|
2007
|
|
SFAS No. 146 store closing costs expensed in the period
|
|
$
|
754
|
|
|
$
|
503
|
|
Period costs related to closed stores
|
|
|
31
|
|
|
|
203
|
|
|
|
|
|
|
|
|
Total store closing costs
|
|
$
|
785
|
|
|
$
|
706
|
|
|
|
|
|
|
|
|
During the first quarter of fiscal 2008 and fiscal 2007, the Company incurred $0.0 million and
$0.2 million, respectively, of other operating expenses such as store closing expenses and
utilities, repairs and maintenance costs related to closed stores that are expensed as incurred.
At May 4, 2008, the Companys $3.0 million liability for store closing costs consisted of (in
thousands):
|
|
|
|
|
Future contractual commitments for rent and occupancy expenses
|
|
$
|
17,685
|
|
Estimated sublease income, net of sublease commissions
|
|
|
(14,143
|
)
|
Accretion expense to be recognized in future periods
|
|
|
(544
|
)
|
|
|
|
|
Total liability for store closing costs
|
|
$
|
2,998
|
|
|
|
|
|
Stores are included in the liability for store closing costs when a store is closed with a
remaining contractual obligation under a lease agreement. Stores that are closed at the end of a
contractual lease period are not included in the Companys liability for store
12
CSK AUTO CORPORATION AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
closing costs. It is
the Companys practice to sublease or attempt to sublease any vacant locations for which it
maintains a contractual lease obligation. Locations are removed from the liability for store
closing costs when the contractual lease agreement has expired or is terminated through early
buyout.
Location activity for stores and service centers included in the liability for store closing
costs is as follows:
|
|
|
|
|
|
|
|
|
|
|
Thirteen Weeks Ended
|
|
|
May 4,
|
|
May 6,
|
|
|
2008
|
|
2007
|
Number of closed locations, beginning of period
|
|
|
148
|
|
|
|
175
|
|
|
|
|
|
|
|
|
|
|
Locations added during the period
|
|
4
|
|
|
5
|
Locations removed during the period
|
|
|
(9
|
)
|
|
|
(3
|
)
|
|
|
|
|
|
|
|
|
|
Net locations added (removed) during the period
|
|
|
(5
|
)
|
|
|
2
|
|
|
|
|
|
|
|
|
|
|
Number of closed locations, end of period
|
|
|
143
|
|
|
|
177
|
|
|
|
|
|
|
|
|
|
|
As of May 4, 2008, 143 locations (93 store locations and 50 service centers) were included in
the liability for store closing costs. Of the store locations, 17 locations were vacant and 76
locations were subleased. Of the service centers, 3 were vacant and 47 were subleased.
Approximately 56 locations included in the liability as of May 4, 2008 have contractual lease terms
that expire in fiscal 2008.
Note 7 Long-Term Debt
Overview
Outstanding debt, excluding capital leases, is as follows (in thousands):
|
|
|
|
|
|
|
|
|
|
|
May 4,
|
|
|
February 3,
|
|
|
|
2008
|
|
|
2008
|
|
Term loan facility
|
|
$
|
344,783
|
|
|
$
|
345,647
|
|
Senior credit facility
|
|
|
53,000
|
|
|
|
46,500
|
|
6
3
/
4
% senior exchangeable notes
(1)
|
|
|
95,050
|
|
|
|
94,635
|
|
Seller financing arrangements
|
|
|
16,741
|
|
|
|
16,189
|
|
|
|
|
|
|
|
|
Total debt
|
|
|
509,574
|
|
|
|
502,971
|
|
Less
current portion:
|
|
|
|
|
|
|
|
|
Term loan facility
|
|
|
344,783
|
|
|
|
3,444
|
|
Senior credit facility
|
|
|
53,000
|
|
|
|
46,500
|
|
6
3
/
4
% senior exchangeable notes
(1)
|
|
|
95,050
|
|
|
|
|
|
Current maturities of seller financing arrangements
|
|
|
610
|
|
|
|
607
|
|
|
|
|
|
|
|
|
Total debt (non-current)
|
|
$
|
16,131
|
|
|
$
|
452,420
|
|
|
|
|
|
|
|
|
|
|
|
(1)
|
|
Carrying balance reduced by discount of $4.9 million and $5.4 million at May 4, 2008 and February 3, 2008, respectively, in accordance with EITF No. 06-6.
|
13
CSK AUTO CORPORATION AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
Term Loan Facility
In the second quarter of the fiscal year ended February 4, 2007 (fiscal 2006), Auto entered
into its $350.0 million Term Loan Facility. The loans under the Term Loan Facility (Term Loans)
bear interest at a base rate or the LIBOR rate, plus a margin that fluctuates depending upon the
rating of the Term Loans. At May 4, 2008, loans under the Term Loan Facility bore interest at
9.75%. The Term Loans are guaranteed by the Company and CSKAUTO.COM, Inc., a wholly owned
subsidiary of Auto. The Term Loans are secured by a second lien security interest in certain
assets, primarily inventory and receivables, of Auto and the guarantors and by a first lien
security interest in substantially all of their other assets. The Term Loans call for repayment in
consecutive quarterly installments, which began on December 31, 2006, in an amount equal to 0.25%
of the aggregate principal amount of the Term Loans, with the remaining balance payable in full on
the sixth anniversary of the closing date, June 30, 2012. Costs associated with the Term
Loan Facility were approximately $10.7 million and are being amortized over the six-year term of
the facility.
On October 10, 2007, the Company entered into the third amendment to the Term Loan Facility.
An amendment fee of approximately $0.9 million was paid in connection with this amendment and was
being amortized over the remaining term of the Term Loan Facility through May 4, 2008. Commencing
in the second quarter of fiscal 2008, the Company will be required to reduce (to twelve months)
the
time period over which it amortizes debt issuance costs and debt discount. The amendment increased
the spreads used to calculate the rate at which funds borrowed under the Term Loan Facility accrue
interest by either 0.25% or 0.50% and changed the basis for determining the spread amount from the
rating of the Term Loans to the Companys corporate rating. Based on the Companys corporate rating
at the time of the amendment, the interest rate on funds borrowed under the Term Loan Facility
increased by 0.50% as a result of the amendment. The amendment also altered certain covenant
provisions, which were subsequently amended by a fourth amendment to the Term Loan Facility.
On December 18, 2007, the Company entered into a fourth amendment to the Term Loan Facility.
An amendment fee of approximately $3.5 million was paid in connection with this amendment and the
cost was being amortized over the remaining term of the Term Loan Facility through May 4, 2008.
Commencing in the second quarter of fiscal 2008, the Company will be required to reduce (to twelve
months) the time period over which it amortizes debt issuance costs and debt discount. The
amendment increased the spreads used to calculate the rate at which funds borrowed under the Term
Loan Facility accrue interest to 5.00%, 6.00% or 7.00% in the case of loans bearing interest based
on the LIBOR rate, and 4.00%, 5.00% or 6.00%, in the case of loans bearing interest at a base rate,
in each case depending on the Companys then-current corporate ratings. At December 18, 2007, the
applicable interest rate under the Term Loan Facility became LIBOR plus 5.00%, an increase of
1.25%, as a result of the amendment. The amendment also modified the minimum fixed charge coverage
ratio and the maximum leverage ratio requirements contained in the Term Loan Facility for the
fourth quarter of fiscal 2007 and each of the quarters of fiscal 2008.
14
CSK AUTO CORPORATION AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
In addition to the covenant and interest rate changes, the fourth amendment added a prepayment
penalty with respect to optional prepayments and mandatory prepayments required in connection with
debt and equity issuances, asset sales and recovery events, equal to 1% of any loans under the Term
Loan Facility that are prepaid prior to the second anniversary of the fourth amendment. The
amendment also added the option, the availability of which depends on the Companys then-current
corporate ratings, to pay in kind 50 basis points per annum or 100 basis points per annum,
depending on the Companys then-current corporate ratings, of any interest accruing on and after
January 8, 2008 by adding such amount to the principal of the loans under the Term Loan Facility as
of the interest payment date on which such interest payment is due. The amendment also added a
limitation on annual capital expenditures by the Company of $25 million for each of fiscal 2008 and
fiscal 2009 (which is approximately $10 million less than the average amount the Company has spent
annually on capital expenditures over the last three fiscal years), provided that any portion of
such amount not expended in fiscal 2008 may be carried over for expenditure during the first two
quarters of fiscal 2009.
The Term Loan Facility contains, among other things, limitations on liens, indebtedness,
mergers, disposition of assets, investments, payments in respect of capital stock, modifications of
material indebtedness, changes in fiscal year-ends, transactions with affiliates, lines of
business, and swap agreements. Auto is also subject to financial covenants under the Term Loan
Facility measuring its performance against standards set for leverage and fixed charge coverage.
Under the maximum leverage covenant (total debt to EBITDA) contained in the Term Loan Facility, as
amended on December 18, 2007 to increase the maximum leverage ratios permitted under the Term Loan
Facility, at May 4, 2008, the Company would have only been permitted to have $117.2 million of
additional debt outstanding, regardless of which facility such debt was borrowed under.
Senior Credit Facility Revolving Line of Credit
At May 4, 2008 and February 3, 2008, Auto had in place its $325.0 million Senior Credit
Facility. Auto is the borrower under the agreement, while the Company and CSKAUTO.COM, Inc. are
guarantors. Borrowings under the Senior Credit Facility bear interest at a variable interest rate
based on either (i) LIBOR plus an applicable margin that varies (1.25% to 1.75%) depending upon
Autos average daily availability under the agreement measured using certain borrowing base tests,
or (ii) the Alternate Base Rate (as defined in the agreement). At May 4, 2008, loans under the
Senior Credit Facility bore interest at the weighted average rate of 4.28%. The Senior Credit
Facility matures in July 2010.
During fiscal 2006 and fiscal 2007, the Company entered into several waivers under the Senior
Credit Facility that allowed it to delay filing certain periodic reports with the SEC. Upon the
filing of the Quarterly Report for the second quarter of fiscal 2007 on October 12, 2007, the
Company had filed all previously delinquent periodic SEC filings, and the waiver of the filing
deadlines described above was terminated.
Availability under the Senior Credit Facility is limited to the lesser of the revolving
commitment of $325.0 million and an amount determined by a borrowing base limitation. The borrowing
base limitation is based upon a formula involving certain percentages of eligible inventory and
accounts receivable owned by Auto. As a result of the limitations imposed by the borrowing base
formula, at May 4, 2008, Auto could borrow up to an additional $185.9 million under the Senior
Credit Facility. However, the maximum leverage covenant of the Term Loan Facility described above
limits the total amount of indebtedness the Company can have outstanding and, as of May 4, 2008,
would have only permitted approximately $117.2 million of additional borrowings, regardless of
which facility they were borrowed under.
Loans under the Senior Credit Facility are collateralized by a first priority security
interest in certain of the Companys assets, primarily inventory and accounts receivable, and a
second priority security interest in certain of the Companys other assets. The Senior Credit
Facility contains negative covenants and restrictions on actions by Auto and its subsidiaries
including, without limitation, restrictions and limitations on indebtedness, liens, guarantees,
mergers, asset dispositions, investments, loans, advances and acquisitions, payment of dividends,
transactions with affiliates, change in business conducted, and certain prepayments and amendments
of indebtedness. In addition, Auto is, under certain circumstances not applicable during the
thirteen weeks ended May 4, 2008, subject to a minimum ratio of consolidated earnings before
interest, taxes, depreciation, amortization and rent expense, or EBITDAR, to fixed charges (as
defined in the agreement, the Fixed Charge Coverage Ratio). However, under the second waiver the
Company entered into during fiscal 2006 and under all subsequent waivers, Auto was required to
maintain a minimum 1:1 Fixed Charge Coverage Ratio imposed by such waivers until the termination of
such waivers. The filing of the Quarterly Report for the second quarter of fiscal 2007 resulted in
the termination of the requirement to maintain the minimum 1:1 Fixed Charge Coverage Ratio imposed
by these waivers.
6
3
/
4
% Notes
The Company had $100.0 million of 6
3
/
4
% Notes outstanding at May 4, 2008 and February 3, 2008.
The 6
3
/
4
% Notes are exchangeable into cash and shares of the Companys common stock. Upon exchange of
the 6
3
/
4
% Notes, the Company will deliver
15
CSK AUTO CORPORATION AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
cash equal to the lesser of the aggregate principal amount of notes to be exchanged and the
Companys total exchange obligation and, in the event the Companys total exchange obligation
exceeds the aggregate principal amount of notes to be exchanged, shares of the Companys common
stock in respect of that excess. The following table sets forth key terms of the 6
3
/
4
% Notes:
|
|
|
|
Terms
|
|
6
3
/
4
% Notes
|
Interest Rate
|
|
6.75% per year until December 15, 2010; 6.50% thereafter
|
|
|
|
Exchange Rate
|
|
60.6061 shares per $1,000 principal (equivalent
to an initial exchange price of approximately $16.50 per share)
|
|
|
|
Maximum CSK shares exchangeable
|
|
6,060,610 common shares, subject to adjustment in certain circumstances
|
|
|
|
Maturity date
|
|
December 15, 2025
|
|
|
|
Guaranteed by
|
|
CSK Auto Corporation and all of Autos present and future domestic subsidiaries, jointly and severally, on a senior basis
|
|
|
|
Dates that the noteholders may require Auto to repurchase some or all for cash at a repurchase price equal to 100% of the principal amount of the notes being repurchased, plus any accrued and unpaid interest
|
|
December 15, 2010, December 15, 2015, and December 15, 2020 or following a fundamental change as described in the indenture
|
|
|
|
Issuance costs being amortized over a 5-year period, corresponding to the first date the noteholders could require repayment (see Debt Covenants below)
|
|
$3.7 million
|
|
|
|
Auto will not be able to redeem notes
|
|
Prior to December 15, 2010
|
|
|
|
Auto may redeem for cash some or all of the notes
|
|
On or after December 15, 2010, upon at least 35 calendar days notice
|
|
|
|
Redemption price
|
|
Equal to 100% of the principal amount plus any accrued and unpaid interest and additional interest, if any, to, but not including, the redemption date
|
|
|
|
Prior to their stated maturity, the 6
3
/
4
% Notes are exchangeable by the holder only under the
following circumstances:
|
|
|
During any fiscal quarter (and only during that fiscal quarter) commencing after
January 29, 2006, if the last reported sale price of the Companys common stock is greater
than or equal to 130% of the exchange price for at least 20 trading days in the period of 30
consecutive trading days ending on the last trading day of the preceding fiscal quarter;
|
|
|
|
|
If the 6
3
/
4
% Notes have been called for redemption by Auto; or
|
|
|
|
|
Upon the occurrence of specified corporate transactions, such as a change in control, as
described in the indenture under which the 6
3
/
4
% Notes were issued.
|
Under these terms, if the 6
3
/
4
% Notes had become exchangeable, the corresponding debt would have
been required to be reclassified from long-term to current for as long as the notes remained
exchangeable. These notes have been reclassified to current as a result of the Companys belief
that it is probable that the maximum leverage ratio covenant of the Term Loan Facility will not be satisfied
in the first quarter of fiscal 2009.
EITF No. 00-19,
Accounting for Derivative Financial Instruments Indexed to, and Potentially
Settled in, a Companys Own Stock
, provides guidance for distinguishing between permanent equity,
temporary equity, and assets and liabilities. The embedded exchange feature in the 6
3
/
4
% Notes
provides for the issuance of common shares to the extent the Companys exchange obligation exceeds
the debt principal. The share exchange feature and the embedded put options and call options in the
debt instrument meet the requirements of EITF No. 00-19 to be accounted for as equity instruments.
As such, the share exchange feature and the embedded options have not been accounted for as
derivatives (which would be marked to market each reporting period). In the event the 6
3
/
4
% Notes are
exchanged, the exchange will be accounted for in a similar manner to a conversion with no gain or
loss, as the cash payment of principal reduces the liability equal to the face amount of the
6
3
/
4
% Notes recorded at the time of their issuance. Any accrued interest on the debt will not be paid
separately upon an exchange and will be reclassified to equity. Incremental net shares for the
6
3
/
4
% Notes exchange feature were not included in the diluted earnings per share calculation for the
thirteen weeks ended May 4, 2008, since the Companys average common stock price did not exceed
$16.50 per share for this period.
16
CSK AUTO CORPORATION AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
The Company entered into a registration rights agreement with respect to the 6
3
/
4
% Notes and the
underlying shares of its common stock into which the 6
3
/
4
% Notes are potentially exchangeable. Due to
the Companys failure in certain prior periods to meet certain filing and effectiveness deadlines
with respect to the registration of the 6
3
/
4
% Notes and the underlying shares of its common stock,
the Company was required to pay additional interest of 50 basis points on the 6
3
/
4
% Notes until the
earlier of the date the 6
3
/
4
% Notes were no longer outstanding or the date two years after the date
of their issuance. The latter condition was met during the fourth quarter of fiscal 2007 and,
accordingly, the Company is no longer paying additional interest of 50 basis points on the
6
3
/
4
% Notes.
The Company entered into a supplemental indenture during fiscal 2006 that increased the
exchange rate of the 6
3
/
4
% Notes to the current terms. The Company recorded the increase in the fair
value of the exchange option as a debt discount with a corresponding increase in additional
paid-in-capital within stockholders equity. The debt discount was $7.7 million and is being
amortized to interest expense following the interest method to the first date the noteholders could
require repayment. Total amortization on the debt discount was $0.4 million for each of the
thirteen week-periods ended May 4, 2008 and May 6, 2007.
Seller Financing Arrangements
Seller financing arrangements relate to debt established for stores where the Company was the
seller-lessee and did not recover substantially all construction costs from the lessor. In those
situations, the Company recorded its total cost in property and equipment and amounts funded by the
lessor as a debt obligation in the accompanying consolidated balance sheet in accordance with EITF
No. 97-10,
The Effect of Lessee Involvement in Asset Construction
. Rental payments under these
arrangements are allocated between interest expense and reduction of the underlying obligation
based on a related amortization schedule.
Debt Covenants
Certain of the Companys debt agreements at May 4, 2008 contained negative covenants and
restrictions on actions by the Company and its subsidiaries including, without limitation,
restrictions and limitations on indebtedness, liens, guarantees, mergers, asset dispositions,
investments, loans, advances and acquisitions, payment of dividends, transactions with affiliates,
change in business conducted, and certain prepayments and amendments of indebtedness.
Auto is, under certain circumstances not applicable during the thirteen weeks ended May 4,
2008, subject to a minimum Fixed Charge Coverage Ratio under a Senior Credit Facility financial
maintenance covenant. However, under the second waiver the Company entered into during the second
quarter of fiscal 2006 and under all subsequent waivers, a minimum 1:1 Fixed Charge Coverage Ratio
was required until the termination of such waivers. The filing of the Quarterly Report for the
second quarter of fiscal 2007 resulted in the termination of the requirement to maintain the
minimum 1:1 Fixed Charge Coverage Ratio imposed by these waivers. For the thirteen weeks ended
May 4, 2008, the Company would have been in compliance with this ratio had it been applicable.
The Term Loan Facility contains certain financial covenants, one of which is the requirement
of a minimum fixed charge coverage ratio (as defined in the Term Loan Facility). At May 4, 2008,
the minimum fixed charge coverage ratio requirement was 1.20:1 for the first quarter of fiscal
2008, 1.15:1 for the second quarter of fiscal 2008, 1.20:1 for the third and fourth quarters of
fiscal 2008, and 1.45:1 thereafter. For the thirteen weeks ended May 4, 2008, the Companys actual
ratio was 1.31:1. The minimum ratios for fiscal 2008 reflect the December 18, 2007 fourth amendment
to the Term Loan Facility.
The Term
Loan Facility also requires compliance with a maximum leverage ratio
covenant. The
December 18, 2007 fourth amendment to the Term Loan Facility increased the maximum leverage ratio
permitted under the Term Loan Facility for the fourth quarter of fiscal 2007 and for each of the
quarters of fiscal 2008. The amendment increased the maximum leverage ratio permitted as of May 4,
2008 to 5.80:1 for the first quarter of fiscal 2008, 6.00:1 for the second quarter of fiscal 2008,
5.75:1 for the third quarter of fiscal 2008, and 4.50:1 for the fourth quarter of fiscal 2008,
while leaving all other ratios unchanged. The maximum leverage ratio permitted declines to 3.25:1
after the end of fiscal 2008 and further decline to 3.00:1 at the end of fiscal 2009. As of May 4,
2008, the Companys actual leverage ratio was 4.74:1.
Based on its current financial forecast, the Company believes it will remain in compliance
with the financial covenants of the Senior Credit Facility and Term Loan Facility during fiscal
2008. A significant decline in the Companys net sales or gross margin from what is currently
anticipated could limit the effectiveness of discretionary actions management could take to
maintain compliance with the financial covenants in fiscal 2008. Although the Company does not
expect such significant declines to occur, if they did occur, the Company may seek to obtain a
covenant waiver or amendment from its lenders or seek a refinancing, which the Company believes are
viable options should the Acquisition not occur. However, there can be no assurances a waiver or
amendment could be obtained or a refinancing achieved.
17
CSK AUTO CORPORATION AND SUBSIDIARIES
NOTES
TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
The maximum leverage ratio permitted in the first quarter of fiscal 2009 decreases
significantly to 3.25:1 from 5.75:1 in the third quarter of fiscal 2008 and 4.50:1 in the fourth
quarter of fiscal 2007. Based on its current financial forecast, the Company does not expect to be
able to satisfy this covenant for the first quarter of fiscal 2009, and, as a result, the Company
has classified all of the indebtedness under the Term Loan Facility, the Senior Credit Facility and
the 6
3
/
4
% Notes as current liabilities in the consolidated balance sheet as of May 4, 2008.
Furthermore, beginning with the second quarter of fiscal 2008, the Company will be required to
reduce (to twelve months) the time period over which it amortizes debt issuance costs and the debt
discount, increasing the interest costs the Company reports in its financial statements. See Note
1 Merger Agreement and Matters Related to the Companys Indebtedness.
A breach of the covenants or restrictions contained in the Companys debt agreements could
result in an event of default thereunder. Upon the occurrence and during the continuance of an
event of default under the Companys Senior Credit Facility or the Term Loan Facility, the lenders
could elect to terminate the commitments thereunder (in the case of the Senior Credit Facility
only), declare all amounts outstanding thereunder, together with accrued interest, to be
immediately due and payable and exercise the remedies of a secured party against the collateral
granted to them to secure such indebtedness. If the Company were unable to repay those amounts, the
lenders could proceed against the collateral granted to them to secure the indebtedness. If the
lenders under either the Senior Credit Facility or the Term Loan Facility accelerate the payment of
the indebtedness due thereunder, the Company cannot be assured that its assets would be sufficient
to repay in full that indebtedness, which is collateralized by substantially all of its assets. At
May 4, 2008, the Company was in compliance with the covenants under all its debt agreements.
Note 8 Accounting for Share-Based Compensation
In accordance with SFAS No. 123R, the Company recognizes compensation expense for its
share-based compensation plans based on the fair value of the awards. Share-based payments include
stock option grants, restricted stock, and a share-based compensation plan under the Companys
long-term incentive plan (the LTIP). Amounts are expensed over the applicable service periods
(generally the vesting period). In the event of a change in control of the Company (as such term is
described in the governing equity plan or agreement), certain equity instruments would vest
immediately.
Long-Term Incentive Plan
Under the terms of the LTIP, cash-based incentive bonus awards may be granted by the Board
based upon the satisfaction of specified performance criteria. Upon the original adoption of the
LTIP, the Companys Board approved and adopted forms of Incentive Bonus Unit Award Agreements used
to evidence the awards under the LTIP. Under the terms of the LTIP, participants (senior executive
officers only) were awarded a certain number of incentive units that are subject to a four-year
vesting period (25% per year, with the first vesting period ending in fiscal 2007) as well as stock
performance criteria. Subject to specific terms and conditions governing a change in control of the
Company, each incentive bonus unit, when vested, represents the participants right to receive cash
payments from the Company on specified payment dates equal to the amounts, if any, by which the
average of the per share closing prices of the Companys common stock on the New York Stock
Exchange over a specified period of time (after release by the Company of its fiscal year earnings)
(the measuring period) exceeds $20 per share (which figure is subject to certain adjustments in
the event of a change in the Companys capitalization). For the thirteen weeks ended May 4, 2008
and May 6, 2007, the Company increased the liability for the LTIP units by $0.3 million and $0.4
million, respectively, as a result of the increase in market price of the Companys stock price
when compared to the previous fiscal year-end.
As a liability based instrument, the LTIP awards will be remeasured at each balance sheet date,
such that the net compensation expense recorded over the full four-year vesting period of the LTIP
units will equal the cash payments, if any, made by the Company to the LTIP participants.
Accrued payroll and related expenses included $1.0 million and $0.8
million relating to the LTIP as of May 4, 2008 and February 3, 2008,
respectively.
Company Stock Plans
The CSK Auto Corporation 2004 Stock and Incentive Plan (the Plan) provides for the grant of
incentive stock options, non-qualified stock options, stock appreciation rights, restricted stock,
stock units, incentive bonuses and other stock unit awards. Plan participation is limited to
employees of the Company, any subsidiary or parent of the Company and directors of the Company. In
no event will any option be exercisable more than 10 years after the date the option is granted. In
general, the stock awards vest in three years. As of May 4, 2008, there were approximately
2.0 million shares remaining available for grant under the Plan.
In addition to the Plan, the Company has stock options outstanding
under its 1999 Employee Stock Option Plan, 1996 Executive Stock
Option Plan and 1996 Associate Stock Option Plan. In the first
quarter of fiscal 2008, these plans were amended to provide for a one
year exercise period upon termination of the optionees
employment (other than for cause) within one year following a change
in control.
Options Activity
Activity in the Companys stock option plans is summarized as follows:
18
CSK AUTO CORPORATION AND SUBSIDIARIES
NOTES
TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted
|
|
Weighted Average
|
|
|
|
|
|
|
|
|
Average
|
|
Remaining
|
|
Aggregate
|
|
|
Number of
|
|
Exercise
|
|
Contractual
|
|
Intrinsic
|
|
|
Shares
|
|
Price
|
|
Term (Years)
|
|
Value
(1)
|
Balance at February 3, 2008
|
|
|
3,835,792
|
|
|
$
|
13.70
|
|
|
|
|
|
|
|
|
|
Granted at market price
|
|
|
|
|
|
$
|
|
|
|
|
|
|
|
|
|
|
Exercised
|
|
|
(4,279
|
)
|
|
$
|
9.16
|
|
|
|
|
|
|
|
|
|
Cancelled
|
|
|
(103,136
|
)
|
|
$
|
13.73
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance at May 4, 2008
|
|
|
3,728,377
|
|
|
$
|
13.71
|
|
|
|
4.41
|
|
|
$
|
2,085,700
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Ending
vested and expected to vest
|
|
|
3,391,056
|
|
|
$
|
13.81
|
|
|
|
4.23
|
|
|
$
|
1,772,400
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Ending exercisable
|
|
|
1,918,098
|
|
|
$
|
14.39
|
|
|
|
2.67
|
|
|
$
|
494,500
|
|
|
|
|
(1)
|
|
Based on the Companys closing stock price of $12.01 on May 2, 2008.
|
The following table summarizes information about the Companys stock options at May 4, 2008:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Options Outstanding
|
|
Options Exercisable
|
|
|
|
|
|
|
|
|
Weighted
|
|
|
|
|
|
|
|
|
|
Weighted
|
|
|
|
|
|
|
|
|
Average
|
|
Weighted
|
|
|
|
|
|
Average
|
|
Aggregate
|
Range of
|
|
Number
|
|
Remaining
|
|
Average
|
|
|
|
|
|
Exercisable
|
|
Intrinsic
|
Exercise Prices
|
|
Outstanding
|
|
Contractual Life
|
|
Exercise Price
|
|
Exercisable
|
|
Price
|
|
Value
|
$5.88 - $10.15
|
|
|
288,902
|
|
|
|
4.00
|
|
|
$
|
9.65
|
|
|
|
128,902
|
|
|
$
|
9.19
|
|
|
|
|
|
$10.53 - $10.80
|
|
|
1,053,245
|
|
|
|
6.45
|
|
|
$
|
10.79
|
|
|
|
4,850
|
|
|
$
|
10.69
|
|
|
|
|
|
$10.93 - $13.32
|
|
|
834,579
|
|
|
|
2.08
|
|
|
$
|
12.96
|
|
|
|
834,579
|
|
|
$
|
12.96
|
|
|
|
|
|
$13.46 - $16.62
|
|
|
1,170,132
|
|
|
|
4.04
|
|
|
$
|
16.27
|
|
|
|
868,248
|
|
|
$
|
16.16
|
|
|
|
|
|
$16.62 - $19.83
|
|
|
381,519
|
|
|
|
5.35
|
|
|
$
|
18.62
|
|
|
|
81,519
|
|
|
$
|
18.51
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$5.88 - $19.83
|
|
|
3,728,377
|
|
|
|
4.41
|
|
|
$
|
13.71
|
|
|
|
1,918,098
|
|
|
$
|
14.39
|
|
|
$
|
494,500
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
There were no stock option grants during the thirteen weeks ended May 4, 2008 or May 6, 2007.
Total unrecognized compensation expense from stock options, including any forfeiture estimate,
was $4.9 million as of May 4, 2008, which is expected to be recognized over a weighted-average
period of approximately 2.2 years.
Restricted Stock Activity
On
April 30, 2008, the Company issued
to the Companys Chief Executive Officer,
89,899 shares of restricted stock, at a
market price of
$11.93, pursuant to the Plan, 50% of which
vest March 1,
2009, and the remaining 50% of which vest March 1, 2010, subject to acceleration under certain
circumstances as set forth in the governing agreement. Total unrecognized compensation expense from
restricted stock, including any forfeiture estimate, was $3.1 million as of May 4, 2008, which is
expected to be recognized over a weighted-average period of approximately two years.
Activity for the Companys restricted stock is summarized as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted
|
|
Aggregate
|
|
|
Number of
|
|
Average
|
|
Intrinsic
|
|
|
Shares
|
|
Grant Price
|
|
Value
(1)
|
Non-vested at February 4, 2008
|
|
|
281,621
|
|
|
$
|
13.23
|
|
|
|
|
|
Granted
|
|
|
89,899
|
|
|
$
|
11.93
|
|
|
|
|
|
Released
|
|
|
(1,570
|
)
|
|
$
|
4.92
|
|
|
|
|
|
Cancelled
|
|
|
(935
|
)
|
|
$
|
12.78
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Non-vested at May 4, 2008
|
|
|
369,015
|
|
|
$
|
12.91
|
|
|
$
|
380,100
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(1)
|
|
Based on the Companys closing stock price of $ 12.01 on May 2, 2008.
|
19
CSK AUTO CORPORATION AND SUBSIDIARIES
NOTES
TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
Note 9 Income Taxes
The
income tax expense for the first quarter of fiscal 2008 was $3.9 million, compared to $1.1
million for the same period in 2007. The Companys effective tax rate was 42.2% in the first
quarter of fiscal 2008 compared to 39.8% for the first quarter of fiscal 2007. The increase in
effective tax rate in the first quarter of fiscal 2008 was primarily attributable to
the recognition of the insurance recovery described in Note 12
Legal Matters as well as the impact of
a new
gross receipt tax in the state
of Michigan.
As of May 4, 2008, the Companys unrecognized tax benefits totaled approximately $9.4 million,
and the total amount of such unrecognized benefits that, if recognized, would favorably affect the
effective income tax rate in future periods, was approximately $3.2 million.
The Company and its subsidiaries are subject to the following significant taxing
jurisdictions: U.S. federal, Arizona, California, Colorado, Illinois, Michigan and Minnesota. The
Company has had net operating losses in various years dating back to the tax year 1993. The statute
of limitations for a particular tax year for examination by the Internal Revenue Service is three
years subsequent to the last year in which the loss carryover is finally used, and three to four
years for the states of Arizona, California, Colorado, Illinois, Michigan and Minnesota.
Accordingly, there are multiple years open to examination.
Note 10 Earnings per Share
SFAS No. 128,
Earnings Per Share
(EPS) requires earnings per share to be computed and
reported as both basic EPS and diluted EPS. Basic EPS is computed by dividing net income by the
weighted average number of common shares outstanding for the period. Diluted EPS is computed by
dividing net income by the weighted average number of common shares and dilutive common stock
equivalents (convertible notes and interest on the notes, stock awards and stock options)
outstanding during the period. Diluted EPS reflects the potential dilution that could occur if
options to purchase common stock were exercised for shares of common stock. The following is a
reconciliation of the number of shares (denominator) used in the basic and diluted EPS computations
($ and share data in thousands):
|
|
|
|
|
|
|
|
|
|
|
Thirteen Weeks Ended
|
|
|
|
May 4,
|
|
|
May 6,
|
|
|
|
2008
|
|
|
2007
|
|
Numerator for basic and diluted earnings per share:
|
|
|
|
|
|
|
|
|
Net income
|
|
$
|
5,367
|
|
|
$
|
1,670
|
|
|
|
|
|
|
|
|
|
|
Denominator for basic earnings per share:
|
|
|
|
|
|
|
|
|
Weighted average shares outstanding (basic)
|
|
|
44,032
|
|
|
|
43,951
|
|
|
|
|
|
|
|
|
|
|
Denominator for diluted earnings per share:
|
|
|
|
|
|
|
|
|
Weighted average shares outstanding (basic)
|
|
|
44,032
|
|
|
|
43,951
|
|
Effect of dilutive securities
|
|
|
69
|
|
|
|
746
|
|
|
|
|
|
|
|
|
Weighted average shares outstanding (diluted)
|
|
|
44,101
|
|
|
|
44,697
|
|
|
|
|
|
|
|
|
|
|
Shares excluded as a result of anti-dilution:
|
|
|
|
|
|
|
|
|
Stock options and restricted stock
|
|
|
3,788
|
|
|
|
769
|
|
Incremental net shares for the exchange feature of the $100.0 million 6
3
/
4
% senior exchangeable
notes due in 2025 will be included in the Companys future diluted earnings per share calculations
for those periods in which the Companys average common stock price exceeds $16.50 per share.
Note 11 Employee Severance and Store Asset Impairment Charges
During the third quarter of fiscal 2007, the Company commenced a comprehensive strategic
review aimed at improving its profitability and restoring top line growth. As part of the initial
strategic planning process, the Company made the decision to close approximately 40 stores during
fiscal 2008. During the first quarter of fiscal 2008, the Company closed 13 of the approximately 40
stores. For the identified store closures, the Company performed an asset impairment review in
accordance with SFAS No. 144,
Accounting for the Impairment of Disposal of Long-Lived Assets
, and
during the fourth quarter of fiscal 2007, recorded a non-cash impairment charge of $1.2 million for
leasehold improvements and store fixtures that will be sold or otherwise disposed of significantly
before the end of their originally estimated useful lives.
The strategic review of the Company continued into the fourth quarter of 2007. As part of this
review, the Companys executive management team also evaluated the current management structure and
eliminated approximately 160 non-sales positions, primarily in
20
CSK AUTO CORPORATION AND SUBSIDIARIES
NOTES
TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
the corporate and field administration areas, reorganized the staffing in the Companys
corporate offices, consolidated certain corporate functions, and eliminated several vice president
and other management positions during the third and fourth quarters of fiscal 2007. A number of
executives were reassigned in order to leverage existing skills and experience across the team in
an effort to continue reducing operating costs. During the third and fourth quarters of fiscal
2007, the Company incurred $2.0 million in employee severance costs related to these strategic
personnel reductions. As of May 4, 2008, the remaining liability for employee severance costs was
approximately $0.4 million.
All store locations currently planned for closure in fiscal 2008 are leased, and substantially
all of these closures are expected to occur near the end of a noncancellable lease term, resulting
in minimal closed store costs. The costs of any remaining operating lease commitments will be
recognized in accordance with SFAS No. 146,
Accounting for Costs Associated with Exit or Disposal
Activities
, at the date the Company ceases operating the store.
Note 12 Legal Matters
Fiscal 2006 Audit Committee Investigation and Restatement of the Consolidated Financial Statements
In its Annual Report on Form 10-K for the fiscal year ended January 29, 2006 (fiscal 2005)
(the 2005 10-K), the Companys consolidated financial statements for the fiscal year ended
January 30, 2005 (fiscal 2004) and the fiscal year
ended February 1, 2004 (fiscal 2003) and
quarterly information for the first three quarterly periods in fiscal 2005 and all of fiscal 2004
were restated to correct errors and irregularities identified in an Audit Committee-led independent
accounting investigation (referred to herein as the Audit Committee-led investigation) and other
accounting errors and irregularities identified by the Company in the course of the restatement
process.
On September 28, 2006, the Company announced the substantial completion of the Audit
Committee-led investigation, and that the investigation had identified accounting errors and
irregularities that materially and improperly impacted various inventory accounts, vendor allowance
receivables, other accrual accounts and related expense accounts. In addition, the Company
announced personnel changes and also announced its intent to implement remedial measures in the
areas of enhanced accounting policies and internal controls and employee training.
The Audit Committee-led investigation and restatement process resulted in legal, accounting
consultant and audit expenses of approximately $25.7 million in fiscal 2006. Legal, accounting
consultant and audit expenses relative to the securities class action and shareholder derivative
litigation, regulatory investigations, completion of the restatement process (relative to the 2005
10-K filed May 1, 2007) and completion of the Companys fiscal 2006 delinquent filings continued
into fiscal 2007 and totaled approximately $12.3 million. The Company incurred approximately $1.0
million of legal expenses related to its response to the governmental investigations associated
with the matters that were reviewed in the Audit Committee-led investigation and the defense of the
securities class action lawsuit in the first quarter of fiscal 2008. The Company expects to continue
to incur legal expenses in the remainder of fiscal 2008 related to the regulatory investigations
and securities class action litigation.
Securities Class Action Litigation
On June 9 and 20, 2006, two shareholder class actions alleging violations of the federal
securities laws were filed in the United States District Court for the District of Arizona against
the Company and four of its former officers: Maynard Jenkins (who also was a director), James
Riley, Martin Fraser and Don Watson. The cases are entitled Communication Workers of America Plan
for Employees Pensions and Death Benefits v. CSK Auto Corporation, et al., No. CV-06-1503 PHX DGC
(Communication Workers) and Wilfred Fortier v. CSK Auto Corporation, et al., No. CV-06-1580 PHX
DGC. The cases were consolidated on September 18, 2006 with Communication Workers as the lead case.
The consolidated actions have been brought by lead plaintiff Communication Workers of America Plan
for Employee Pensions and Death Benefits (the Lead Plaintiff) on behalf of a putative class of
purchasers of CSK Auto Corporation stock between March 20, 2003 and April 13, 2006, inclusive. Lead
Plaintiff filed an Amended Consolidated Complaint on November 30, 2006. Lead Plaintiff voluntarily
dismissed James Riley by not naming him as a defendant in the Amended Consolidated Complaint. The
Company and Messrs. Jenkins, Fraser and Watson (collectively referred to as the Defendants) filed
motions to dismiss the Amended Consolidated Complaint, which the court granted on March 28, 2007.
The court allowed Lead Plaintiff leave to amend its complaint, and it filed their Second Amended
Consolidated Complaint on May 25, 2007.
The Second Amended Consolidated Complaint alleges violations of Section 10(b) of the
Securities Exchange Act of 1934, as amended (the Exchange Act), and Rule 10b-5 promulgated
thereunder, as well as Section 20(a) of the Exchange Act. The Second Amended Consolidated Complaint
alleges that Defendants issued false statements before and during the putative class period about
the Companys income, earnings and internal controls, allegedly causing the Companys stock to
trade at artificially inflated prices during the putative class period. It seeks an unspecified
amount of damages. Defendants filed motions to dismiss the Second Amended
21
CSK AUTO CORPORATION AND SUBSIDIARIES
NOTES
TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
Consolidated Complaint on July 13, 2007. On September 27, 2007, the court issued an order
granting the motion to dismiss Mr. Fraser with prejudice and denying the motions to dismiss the
Company and Messrs. Jenkins and Watson. On October 24, 2007, the court issued a scheduling order
setting forth a pretrial schedule that contemplates a trial if necessary, in March 2009, Lead
Plaintiff filed its motion to certify the class on January 18, 2008 and the Company filed its
response on February 15, 2008. Lead Plaintiff filed its reply in support of its motion for class
certification on March 14, 2008. A hearing on the motion was scheduled to take place on March 21,
2008.
On March 21, 2008, as a result of ongoing settlement discussions regarding the securities
class action litigation, Lead Plaintiff and the defendants (including the Company) reached an
agreement in principle to settle the case. At a hearing on April 22, 2008, the United States
District Court for the District of Arizona preliminarily approved the settlement. Pursuant to the
settlement, the settlement amount will be $10.0 million in cash (which will be paid by the
Companys directors and officers liability insurance) and $1.7 million in Company stock (to be
contributed by the Company and valued at the closing price of the Companys stock on March 20,
2008). The settlement also includes certain corporate governance and contracting policy terms that
would apply so long as the Company remains an independent company. A hearing on the final approval
of the settlement is scheduled for July 1, 2008.
Insurance Recovery
On May 1, 2008, the Company and its primary layer directors and officers liability insurer
entered into an agreement whereby the insurer agreed to fund $10.0 million into an interest-bearing
escrow account to effect the proposed settlement of the securities class action litigation
discussed above. The insurer also agreed not to pursue any future claims for recovery against the
Company for $5.0 million of defense costs (primarily legal fees) relating to such litigation and
the shareholder derivative litigation and governmental investigations
discussed below that the
insurer had agreed to reimburse to the Company or pay directly to third parties. The Company had
previously expensed such costs as they were incurred. Pursuant to
such agreement, the Company agreed to release (upon
the insurers payment to the $15.0 million policy limit) the insurer from any further claims under
the related policy. The insurer funded the escrow account on April 28, 2008.
As also mentioned above, the United States District Court for the District of Arizona granted
preliminary approval to the proposed settlement of the securities class action litigation on April
22, 2008, and a hearing on the final approval is scheduled for July 1, 2008. Although not anticipated, in the event
that the final settlement is not approved by the Court in July, the $10.0 million and all accrued
interest will be repaid to the insurer and once again become available pursuant to the terms of the
policy.
During the first quarter of fiscal 2008, the Company recognized a $15.0 million insurance
recovery as a result of, among other things, the previously mentioned agreement with the insurer
and managements conclusion, which was based in part on the advice of counsel, that it is probable
that the Court will grant final approval of the settlement. Other
current assets in the consolidated
balance sheet at May 4, 2008 included $10.0 million relating to the Companys beneficial interest
in the escrow account which will be used to satisfy the Companys settlement obligation which the
Company accrued in the fourth quarter of fiscal 2007.
Shareholder Derivative Litigation
On July 31, 2006, a shareholder derivative suit was filed in the United States District Court
for the District of Arizona against certain of CSKs former officers and certain current and former
directors. The Company was a nominal defendant. On June 11, 2007, plaintiff filed a Second Amended
Complaint alleging claims under Section 304 of the Sarbanes-Oxley Act of 2002 and for alleged
breaches of fiduciary duties, abuse of control, gross mismanagement, waste of corporate assets, and
unjust enrichment. The Second Amended Complaint sought, purportedly on behalf of the Company,
damages, restitution, and equitable and injunctive relief. On June 22, 2007, the Company filed a
motion to dismiss the Second Amended Complaint for failure to plead demand futility adequately or,
in the alternative, to stay the case until the shareholder class action litigation is resolved. The
individual defendants joined in the Companys motion. On August 24, 2007, the court granted the
Companys motion to dismiss the suit based on plaintiffs failure to adequately plead demand
futility. The court entered a judgment in defendants favor on October 22, 2007. Plaintiff did not
file a notice of appeal in the 30 days allowed for doing so, and the judgment in defendants favor
is now final.
Governmental Investigations
The SEC is conducting an investigation related to certain historical accounting practices of
the Company. On November 27, 2006, the SEC served a subpoena on the Company seeking the production
of documents from the period January 1, 1997 to the date of the subpoena related primarily to the
types of matters identified in the Audit Committee-led investigation, including internal controls
and accounting for inventories and vendor allowances. On December 5, 2006, the SEC also served
document subpoenas on Messrs. Jenkins, Fraser and Watson. Since that time, the SEC has served
subpoenas for documents and testimony on, and requested testimony from, current and former
employees, officers, directors and other parties it believes may have information relevant to the
22
CSK AUTO CORPORATION AND SUBSIDIARIES
NOTES
TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
investigation. The Companys Audit Committee has shared with the SEC the conclusions of the
Audit Committee-led investigation and other information related to its investigation.
On May 1, 2008, the Company received a notification from the Staff of the Pacific Regional
Office (the Staff) of the SEC relating to the SEC investigation described above. The
notification, commonly referred to as a Wells Notice, indicates that the Staff is considering
recommending to the SEC that the SEC bring an enforcement action against the Company alleging that
it violated certain provisions of the federal securities laws, including Section 10(b) of the
Exchange Act and Rule 10b-5 promulgated thereunder.
Under applicable procedures, before the Staff can make a formal recommendation regarding what
action, if any, should be taken by the SEC, the Company has the opportunity to make (and made on
June 6, 2008) a written submission outlining why it believes an enforcement action should not be
instituted. If the Staff ultimately makes an enforcement recommendation to the SEC, the Companys
submission will be forwarded to the SEC for purposes of the SECs consideration before making a
final determination on the matter. As previously disclosed, the Company has been cooperating with
the Staff and the SEC since the Company first publicly disclosed these matters in fiscal 2006, and
it continues to do so.
In addition, the U.S. Attorneys office in Phoenix (the USAO) and the U.S. Department of
Justice in Washington, D.C. (the DOJ) have opened an investigation related to these historical
accounting practices. Counsel for the Companys Audit Committee has met with the USAO and DOJ and
has shared with them requested information from the Audit Committee-led investigation. At this
time, the Company cannot predict when these investigations will be completed or what their outcomes
will be.
Other Litigation
The Company currently and from time to time is involved in other litigation incidental to the
conduct of its business, including but not limited to asbestos and similar product liability
claims, slip and fall and other general liability claims, discrimination and employment claims,
vendor disputes, and miscellaneous environmental and real estate claims. The damages claimed in
some of this litigation are substantial. Based on internal review, the Company accrues reserves
using its best estimate of the probable and reasonably estimable contingent liabilities. The
Company does not currently believe that any of these other legal claims incidental to the conduct
of its business, individually or in the aggregate, will result in liabilities material to its
consolidated financial position, results of operations or cash flows.
Note 13 Subsequent Events
On April 1, 2008, the Company entered into the Merger Agreement with OReilly and an indirect
wholly-owned subsidiary of OReilly pursuant to which the Company is expected to become a
wholly-owned subsidiary of OReilly. On June 11, 2008, OReillys newly
formed, wholly-owned subsidiary, OC Acquisition Company, commenced the Exchange Offer.
The Exchange Offer is described
in detail above in Note 1 Merger Agreement and Matters Related to the Companys
Indebtedness. The Exchange
Offer is currently
scheduled to expire at 12:00 midnight, EDT, on July 10, 2008, but, pursuant to
the terms of the
Merger Agreement, the expiration date may be extended under certain circumstances.
23
Item 2. Managements Discussion and Analysis of Financial Condition and Results of Operations
The following discussion and analysis of financial condition and results of operations should
be read in conjunction with our consolidated historical financial statements and the notes to those
statements that appear elsewhere in this report. Our discussion contains forward-looking statements
based upon current expectations that involve risks and uncertainties, such as our plans,
objectives, expectations and intentions. Actual results and the timing of events could differ
materially from those anticipated in these forward-looking statements as a result of a number of
factors, including those set forth or referenced under Note Concerning Forward Looking
Information above.
In the following discussion, we refer to our current fiscal year ending February 1, 2009 as
fiscal 2008 and the prior fiscal year ended February 3, 2008 as fiscal 2007. We refer to the
thirteen-week periods ended on May 4, 2008 and May 6, 2007 as the first quarter and the thirteen
weeks of those respective fiscal years.
General
CSK Auto Corporation (CSK) is the largest specialty retailer of automotive parts and
accessories in the Western United States and one of the largest such retailers in the U.S., based,
in each case, on store count. As of May 4, 2008, through our wholly owned subsidiary CSK Auto,
Inc., we operated 1,345 stores in 22 states under one fully integrated operating format and the
following four brand names (referred to collectively as CSK stores):
|
|
|
Checker Auto Parts, founded in 1969, with 487 stores in the Southwestern, Rocky Mountain
and Northern Plains states and Hawaii;
|
|
|
|
|
Schucks Auto Supply, founded in 1917, with 218 stores in the Pacific Northwest and
Alaska;
|
|
|
|
|
Kragen Auto Parts, founded in 1947, with 499 stores primarily in California; and
|
|
|
|
|
Murrays Discount Auto Stores, founded in 1972, with 141 stores in the Midwest.
|
During the first quarter of fiscal 2008, we opened 9 stores, relocated 2 stores and closed 15
stores (including the 2 relocated stores), resulting in a net decrease of 4 stores.
Recent Developments
Merger Agreement
On April 1, 2008, we entered into an Agreement and Plan of Merger (the Merger Agreement)
with OReilly Automotive, Inc. (OReilly) and an indirect wholly-owned subsidiary of OReilly
pursuant to which we are expected to become a wholly-owned subsidiary of OReilly (the
Acquisition).
In order to effectuate the Acquisition, OReilly has agreed to commence an exchange offer (the
Exchange Offer) pursuant to which each share of our common stock tendered in the Exchange Offer
will be exchanged for (a) a number of shares of OReillys common stock equal to the exchange
ratio (as calculated below), plus (b) $1.00 in cash (subject to possible reduction as described
below). Pursuant to the Merger Agreement, the exchange ratio will equal $11.00 divided by the
average trading price of OReillys common stock during the five consecutive trading days ending on
and including the second trading day prior to the closing of the Exchange Offer; provided, that if
such average trading price of OReillys common stock is greater than $29.95 per share, then the
exchange ratio will be 0.3673, and if such average trading price is less than $25.67 per share,
then the exchange ratio will be 0.4285. If such average trading price is less than or equal to
$21.00 per share, we may terminate the Merger Agreement unless OReilly exercises its option to
issue an additional number of its shares or increase the amount of cash to be paid such that the
total value of OReilly common stock and cash exchanged for each share of our common stock is at
least equal to $10.00 (less any possible reduction of the cash component of the offer price as
described below).
Upon completion of the Exchange Offer, any remaining shares of our common stock will be
acquired in a second-step merger at the same price at which shares of our common stock were
exchanged in the Exchange Offer.
The Acquisition is expected to be completed during the second quarter of fiscal 2008 and is
subject to regulatory review and customary closing conditions, including that at least a majority
of our outstanding shares of common stock be tendered in the Exchange Offer and the expiration or
termination of any waiting period under the Hart-Scott-Rodino Antitrust Improvements Act of 1976,
as amended (which waiting period terminated on April 17, 2008).
24
The Merger Agreement includes customary representations, warranties and covenants by us,
including covenants (a) to cease immediately any discussions and negotiations with respect to an
alternate acquisition proposal, (b) not to solicit any alternate acquisition proposal and, with
certain exceptions, not to enter into discussions concerning or furnish information in connection
with any alternate acquisition proposal, and (c) subject to certain exceptions, for our Board of
Directors not to withdraw or modify its recommendation that our stockholders tender shares into the
Exchange Offer. In addition, we have agreed to use reasonable best efforts to obtain appropriate
waivers or consents under our credit or debt agreements and instruments if needed or if requested
by OReilly to remedy any default or event of default thereunder that may arise after the date of
the Merger Agreement (the Credit Agreement Waivers). The $1.00 cash component of the offer price
for each share of our common stock tendered in the Exchange Offer will be subject to reduction in
the event that we pay more than $3.0 million to our lenders in order to obtain any Credit Agreement
Waivers. The $1.00 cash component per share may be reduced by an amount equal to the quotient
obtained by dividing (x) by (y), where (x) equals the sum of any amount paid by us or our
subsidiaries to the lenders under our credit agreements in connection with obtaining any bank
consent, waiver, or amendment under the credit agreements after April 1, 2008, minus $3,000,000,
and (y) equals the sum of (i) the total number of shares of the Companys common stock outstanding
immediately prior to the expiration of the Exchange Offer and (ii) a number of shares of the
Companys common stock determined by OReilly up to a maximum of the total number of shares of the
Companys common stock issuable upon the exercise or conversion of all options, warrants, rights
and convertible securities (if any) that will be vested on or before the date that is 180 days
after April 1, 2008. We do not anticipate a need to obtain any Credit Agreement Waivers prior to
the anticipated closing of the Exchange Offer.
The Merger Agreement contains certain termination rights for both us and OReilly, including
if the Exchange Offer has not been consummated or if the expiration or termination of any waiting
period (and any extension thereof) under the Hart-Scott-Rodino Antitrust Improvements Act of 1976,
as amended, had not occurred, in either case on or before the date that is 180 days after the date
of the Merger Agreement, and provisions that permit termination in connection with the exercise of
the fiduciary duties of our Board of Directors with respect to superior offers. The Merger
Agreement further provides that upon termination of the Merger Agreement under specified
circumstances, we may be required to pay OReilly a termination fee of $22.0 million.
In connection with the Acquisition, OReilly has received a commitment letter from Lehman
Commercial Paper Inc., Lehman Brothers Inc., Lehman Brothers Commercial Bank, Bank of America,
N.A., and Banc of America Securities LLC to provide a $1,200.0 million first lien senior secured
revolving credit facility, which OReilly is expected to use, in part, to repay at the time of the
closing of the Exchange Offer all amounts outstanding and other amounts payable under our
$350.0 million floating rate term loan facility (the Term Loan Facility) and $325.0 million
senior secured revolving line of credit (the Senior Credit Facility), following which such
Facilities will be terminated. Thus, although the consummation of the Exchange Offer would result
in an event of default and the possible acceleration of indebtedness under those facilities, it is
contemplated that those facilities will be repaid in full and cease to exist at the closing of the
Exchange Offer. If the Acquisition is completed as planned, our $100.0 million of 6
3
/
4
% senior
exchangeable notes (the 6
3
/
4
% Notes) will remain outstanding and will become exchangeable pursuant
to their terms into shares of OReilly common stock. OReillys acquisition of our company and the
closing of the Exchange Offer are not conditioned upon the completion of, or availability of
funding under, its committed $1,200.0 million credit facility.
Term Loan Facility Financial Covenants
Our Term Loan Facility
contains a maximum leverage ratio covenant that we do not believe at this time
we will be able to satisfy beginning in the first quarter of our fiscal year ending January 31,
2010 (fiscal 2009). As we did not obtain a waiver or amendment of that covenant prior to the
completion of our financial statements for the first quarter of fiscal 2008, our belief that it is
probable that this covenant will not be satisfied for the first quarter of fiscal 2009 has caused
us to have to classify all of our indebtedness under the Term Loan Facility and the Senior Credit
Facility, as well as the 6
3
/
4
% Notes, as current liabilities in our financial statements beginning
with our financial statements for the first quarter of fiscal 2008. Furthermore, beginning with the
second quarter of fiscal 2008, we will be required to reduce (to twelve months) the time period
over which we amortize debt issuance costs and debt discount, increasing the interest costs we
report in our financial statements. The classification of all such indebtedness as current
liabilities and the acceleration of the amortization of interest costs will not cause a default
under our borrowing agreements. However, any such classification could have adverse consequences
upon our relationships with, and the credit terms upon which we do business with, our vendors,
although we expect such consequences, if any, to be limited due to the expected closing of the
Exchange Offer in the second quarter of fiscal 2008. We do not expect to seek any waivers or
amendments under our credit facilities prior to the closing of the Exchange Offer as these credit
facilities are expected to be repaid and terminated upon closing of the Exchange Offer.
If the Exchange Offer were to fail to close, prior to the end of the first quarter of fiscal
2009, we would seek to obtain a waiver or amendment of certain covenants contained in the Term Loan
Facility, including the maximum leverage ratio covenant. No assurance can be given that we would be
able to obtain such a waiver or amendment on terms that would be satisfactory to us. Failure to
comply with the financial covenants of the Term Loan Facility would result in an event of default
under the Term Loan Facility after the first quarter of fiscal 2009, which could result in the
acceleration of all of our indebtedness thereunder, under the Senior Credit Facility and under the
indenture under which the 6
3
/
4
% Notes were issued, all of which could have a material adverse effect
on us. See Factors
25
Affecting Liquidity and Capital Resources Debt Covenants below.
Securities Class Action Litigation
On March 21, 2008, as a result of ongoing settlement discussions regarding the securities
class action litigation (described in Note 12
Legal Matters in the notes to the unaudited
consolidated financial statements included in Item 1 of this Quarterly Report), Lead Plaintiff and
the defendants (including the Company) reached an agreement in principle to settle the case. At a
hearing on April 22, 2008, the United States District Court for the District of Arizona
preliminarily approved the settlement. Pursuant to the settlement, the settlement amount will be
$10.0 million in cash (which was funded by our directors and officers liability insurance carrier)
and $1.7 million in our stock (to be contributed by us and valued at the closing price of our stock
on March 20, 2008). The settlement also includes certain corporate governance and contracting
policy terms that would apply so long as we remain an independent company. A hearing on the final
approval of the settlement is scheduled for July 1, 2008.
Insurance Recovery
On May 1, 2008, we and our primary layer directors and officers liability insurer entered into
an agreement whereby the insurer agreed to fund $10.0 million into an interest-bearing escrow
account to effect the proposed settlement of the securities class action litigation. The insurer
also agreed not to pursue any future claims for recovery against us for $5.0 million of defense
costs (primarily legal fees) relating to such litigation and the shareholder derivative litigation
and governmental investigations discussed below, that the insurer had agreed to reimburse to us or
pay directly to third parties. We had previously expensed such costs as they were incurred.
Pursuant to such agreement, we agreed to release (upon the insurers payment to the $15.0 million policy limit) the
insurer from any further claims under the related policy. The insurer funded the escrow account on
April 28, 2008.
As mentioned above, the United States District Court for the District of Arizona granted
preliminary approval to the proposed settlement of the securities class action litigation on April
22, 2008, and a hearing on the final approval is scheduled for July 1, 2008. Although not anticipated, in the event
that the final settlement is not approved by the Court in July, the $10.0 million and all accrued
interest will be repaid to the insurer and once again become available pursuant to the terms of the
policy.
During the first quarter of fiscal 2008, we recognized a $15.0 million insurance recovery as a
result of, among other things, the previously mentioned agreement with the insurer and managements
conclusion, which was based in part on the advice of counsel, that it is probable that the Court
will grant final approval of the settlement. Other assets in the consolidated balance sheet at May
4, 2008 included $10.0 million relating to our beneficial interest in the escrow account which will
be used to satisfy our settlement obligation which we accrued in the fourth quarter of fiscal 2007.
Governmental Investigations
The Securities and Exchange Commission (the SEC) is conducting an investigation related to
certain of our historical accounting practices. On November 27, 2006, the SEC served a subpoena on
us seeking the production of documents from the period January 1, 1997 to the date of the subpoena
related primarily to the types of matters identified in the Audit Committee-led independent
accounting investigation (referred to here in as the Audit Committee-led Investigation),
including internal controls and accounting for inventories and vendor allowances. On December 5,
2006, the SEC also served document subpoenas on former executives Messrs. Jenkins, Fraser and
Watson. Since that time, the SEC has served subpoenas for documents and testimony on, and requested
testimony from, current and former employees, officers, directors and other parties it believes may
have information relevant to the investigation. Our Audit Committee has shared with the SEC the
conclusions of the Audit Committee-led investigation and other information related to its
investigation.
On May 1, 2008, we received a notification from the Staff of the Pacific Regional Office (the
Staff) of the SEC relating to a previously disclosed investigation that was prompted by matters
that had been raised by our internal audit and accounting personnel in late 2005 and early 2006.
The notification, commonly referred to as a Wells Notice, indicates that the Staff is considering
recommending to the SEC that the SEC bring an enforcement action against us alleging that it
violated certain provisions of the federal securities laws, including Section 10(b) of the
Securities Exchange Act of 1934, as amended (the Exchange Act) and Rule 10b-5 promulgated
thereunder.
Under applicable procedures, before the Staff can make a formal recommendation regarding what
action, if any, should be taken by the SEC, we have the opportunity to make (and made on June 6,
2008) a written submission outlining why we believe an enforcement action should not be instituted.
If the Staff ultimately makes an enforcement recommendation to the SEC, our submission will be
forwarded to the SEC for purposes of the SECs consideration before making a final determination on
the matter. As previously disclosed, we have been cooperating with the Staff and the SEC since we
first publicly disclosed these matters in 2006, and we continue to do so.
26
In addition, the U.S. Attorneys office in Phoenix (the USAO) and the Department of Justice
in Washington, D.C. (the DOJ) have opened an investigation related to these historical accounting
practices. Counsel for our Audit Committee-led investigation has met with the USAO and DOJ and has
shared with them requested information from the Audit Committee-led investigation. At this time,
the Company cannot predict when these investigations will be completed or what their outcomes will
be.
Results of Operations
The following discussion summarizes the significant factors affecting our operating results
for the thirteen weeks ended May 4, 2008 and May 6, 2007. This discussion and analysis should be
read in conjunction with the consolidated financial statements and the related notes included in
this Quarterly Report as well as our Annual Report on Form 10-K for fiscal 2007 (the 2007 10-K).
The following table expresses the statements of operations as a percentage of sales for the
periods shown:
|
|
|
|
|
|
|
|
|
|
|
Thirteen Weeks Ended
|
|
|
May 4,
|
|
May 6,
|
|
|
2008
|
|
2007
|
Net sales
|
|
|
100.0
|
%
|
|
|
100.0
|
%
|
Cost of sales
|
|
|
52.9
|
%
|
|
|
53.4
|
%
|
|
|
|
|
|
|
|
|
|
Gross profit
|
|
|
47.1
|
%
|
|
|
46.6
|
%
|
Other costs and expenses:
|
|
|
|
|
|
|
|
|
Operating and administrative
|
|
|
44.6
|
%
|
|
|
42.1
|
%
|
Investigation, litigation and restatement costs
|
|
|
0.2
|
%
|
|
|
1.0
|
%
|
Insurance recovery
|
|
|
-3.3
|
%
|
|
|
0.0
|
%
|
Store closing costs
|
|
|
0.2
|
%
|
|
|
0.1
|
%
|
|
|
|
|
|
|
|
|
|
Operating profit
|
|
|
5.4
|
%
|
|
|
3.4
|
%
|
Interest expense, net
|
|
|
3.3
|
%
|
|
|
2.8
|
%
|
|
|
|
|
|
|
|
|
|
Income before income taxes
|
|
|
2.1
|
%
|
|
|
0.6
|
%
|
Income tax expense
|
|
|
0.8
|
%
|
|
|
0.2
|
%
|
|
|
|
|
|
|
|
|
|
Net income
|
|
|
1.3
|
%
|
|
|
0.4
|
%
|
|
|
|
|
|
|
|
|
|
Thirteen Weeks Ended May 4, 2008 Compared to Thirteen Weeks Ended May 6, 2007
Retail sales represent sales to the do-it-yourself customer. Commercial sales represent sales
to commercial accounts, including such sales from stores without commercial sales centers. We
evaluate comparable (or same-store) sales based on the change in net sales commencing after the
time a new store has been open or an acquired store has been owned by us for 12 months. Therefore,
sales for the first 12 months a new store is open or an acquired store is owned are not included in
the comparable store calculation. Stores that have been relocated are included in the comparable
store sales calculations immediately.
Net sales for the first quarter of fiscal 2008 decreased 2.5%, or $11.9 million, compared to
the first quarter of fiscal 2007. Net sales were $461.1 million in the first quarter of fiscal
2008, compared to $473.0 million in the first quarter of fiscal 2007. The decrease in sales was
primarily due to decreased same store sales, which was partially offset by sales from nine net new
stores added from May 7, 2007 through May 4, 2008. Although net sales decreased overall, commercial
sales continued to increase, which we believe was due, in part, to
our continued emphasis on growing our commercial business, which has
a higher potential growth rate than the retail market.
Total same store sales declined by 3.1%. Same store retail sales, which make up the majority
of our sales, declined 5.1%, compared to a 2.5% decline in the comparable period of fiscal 2007.
Same store commercial sales increased 6.1%, compared to a 10.3% increase in the comparable period
in fiscal 2007. The decline in total same store sales was due to a decline in customer count of
6.7% (measured by the number of in-store transactions in stores that have been opened more than one
year), which was partially offset by an increase in the average transaction size of 3.9% (measured
by dollars spent per sale transaction). We believe that same store sales during this period were
adversely affected by persistent high gas prices and the deterioration in general economic
conditions.
Gross profit consists primarily of net sales less the cost of sales. Costs of sales includes
the total cost of merchandise sold including freight expenses associated with moving merchandise
inventories from our vendors to our distribution centers and warehouses, vendor allowances and cash
discounts on payments to vendors, inventory shrinkage, warranty costs, costs associated with
purchasing and operating the distribution centers and warehouses, and freight expense associated
with moving merchandise inventories from the distribution centers to our retail stores. Gross
profit as a percentage of net sales may be affected by net sales volume, variations in our
channel mix and our product mix, price changes in response to competitive factors, changes in
our shrink expense, warranty expense and warehousing and distribution costs, and fluctuations in
merchandise costs and vendor programs. Gross profit may not be
27
comparable to that of other companies as it does not include payroll, occupancy, and
depreciation costs for our retail locations.
Gross profit for the first quarter of fiscal 2008 decreased 1.5%, or $3.3 million, compared to
the first quarter of fiscal 2007. Gross profit was $217.3 million, or 47.1% of sales, for the first
quarter of fiscal 2008, as compared to $220.6 million, or 46.6% of sales, for the first quarter of
fiscal 2007. The decrease in gross profit dollars was the result of the decline in sales, offset in
part by increased purchasing and handling costs capitalized in the first quarter of fiscal 2008
relative to increased inventory purchases compared with the same period in fiscal 2007. The
increase in the gross margin percentage was primarily due to the higher purchasing and handling
costs capitalized in the first quarter of fiscal 2008 compared with the same period in fiscal 2007.
These factors were partially offset by increased commercial sales, as commercial sales carry lower
margins than retail sales.
Operating and administrative expenses are comprised of store payroll, store occupancy,
advertising expenses, other store expenses and general and administrative expenses, which include
salaries and related benefits of corporate employees, administrative office occupancy expenses,
data processing, professional expenses and other related expenses.
Operating and administrative expenses were $205.8 million, or 44.6% of net sales, in the first
quarter of fiscal 2008, compared to $199.2 million, or 42.1% of net sales, in the first quarter of
fiscal 2007. Operating and administrative expenses increased $6.6 million as a result of expenses
associated with the nine net new stores added from May 7, 2007 through May 4, 2008, as well as
expenses of approximately $2.7 million related to the pending Acquisition (discussed in Recent
Developments above) and an increase of compensation expense of approximately $1.4 million due to
increased employee incentive compensation costs.
Our response to the governmental investigations associated with the
matters that were reviewed in the Audit
Committee-led investigation and the defense of the securities class action and derivative lawsuits
described in Note 12 Legal Matters in the notes to the unaudited consolidated financial
statements included in Item 1 of this Quarterly Report resulted in investigation, litigation and
restatement expenses of $1.0 million in the first quarter of fiscal 2008, compared to $4.6 million
incurred in the first quarter of fiscal 2007.
On
May 1, 2008, we and our primary layer directors and officers liability insurer entered into
an agreement whereby the insurer agreed to fund $10.0 million into an interest-bearing escrow
account to effect the proposed settlement of the securities class action litigation. The insurer
also agreed not to pursue any future claims for recovery against us for $5.0 million of defense
costs (primarily legal fees) relating to such litigation, the shareholder derivative litigation
and the governmental investigations, that the insurer had agreed to reimburse to us or
pay directly to third parties. We had previously expensed such costs as they were incurred.
Pursuant to such agreement, we agreed to release (upon the insurers payment to the $15.0 million policy limit)
the
insurer from any further claims under the related policy. The insurer funded the escrow account on
April 28, 2008.
The United States District Court for the District of Arizona granted
preliminary approval to the proposed settlement of the securities class action litigation on April
22, 2008, and a hearing on the final approval is scheduled for July 1, 2008. Although not anticipated, in the event
that the final settlement is not approved by the Court in July, the $10.0 million and all accrued
interest will be repaid to the insurer and once again become available pursuant to the terms of the
policy.
During the first quarter of fiscal 2008, we recognized a $15.0 million insurance recovery as a
result of, among other things, the previously mentioned agreement with the insurer and managements
conclusion, which was based in part on the advice of counsel, that it is probable that the Court
will grant final approval of the settlement. Other current assets in the consolidated balance sheet at May
4, 2008 included $10.0 million relating to our beneficial interest in the escrow account which will
be used to satisfy our settlement obligation which we accrued in the fourth quarter of fiscal 2007.
Store closing costs include amounts for new store closures, revisions in estimates for stores
currently in the closed store reserve, accretion expense, and operating and other expenses. Store
closing costs in the first quarter of fiscal 2008 were $0.8 million, compared to $0.7 million for
the comparable period in fiscal 2007. Costs increased primarily due to revisions in store closing
costs expensed during the first quarter of fiscal 2008.
Interest expense for the first quarter of fiscal 2008 increased to $15.4 million from $13.3
million for the first quarter of fiscal 2007, primarily as a result of the higher rates paid by us
following our Term Loan Facility amendments in fiscal 2007. Our weighted average interest rate for
the first quarter of fiscal 2008 increased to approximately 10.0% as compared to approximately
8.83% for the comparable period of fiscal 2007.
The income tax expense for the first quarter of fiscal 2008 was $3.9 million, compared to $1.1
million for the same period in 2007. Our effective tax rate was 42.2% in the first quarter of
fiscal 2008 compared to 39.8% for the first quarter of fiscal 2007. The increase in the effective
tax rate in the first quarter of fiscal 2008 is primarily
attributable to the recognition of the previously mentioned insurance
recovery as well as the impact of a
new gross receipt tax in the state of
Michigan.
During the first quarter of fiscal 2008, we had net income of $5.4 million, or $0.12 per
diluted common share, compared to net income of $1.7 million, or $0.04 per diluted common share,
for the first quarter of fiscal 2007.
28
Liquidity and Capital Resources
Overview of Liquidity
Debt is an important part of our overall capitalization. Our outstanding debt balance
(excluding capital leases) as of May 4, 2008 and February 3, 2007 was $509.6 million and $503.0
million, respectively. Our primary cash requirements include working capital (primarily inventory),
interest on our debt and capital expenditures. As a result of the borrowing base limitations of our
Senior Credit Facility, at May 4, 2008, we had approximately $185.9 million of availability under
our Senior Credit Facility. However, the maximum leverage covenant under our Term Loan Facility
limits the total amount of indebtedness we can have outstanding and, as of May 4, 2008, would have
only permitted additional borrowings of approximately $117.2 million, regardless of which facility
they were borrowed under. The Term Loan Facility was amended on October 10, 2007 and further
amended on December 18, 2007 to, among other things, modify the minimum fixed charge coverage ratio
and the maximum leverage ratio covenants contained in the Term Loan Facility for the fourth quarter
of fiscal 2007 and each of the quarters of fiscal 2008. See the Factors Affecting Liquidity and
Capital Resources Debt Covenants section below for a discussion of our compliance with debt
covenants.
We are required to make quarterly debt principal payments of 0.25% of the aggregate principal
amount of the loans under our Term Loan Facility beginning December 31, 2006. We paid approximately
$0.9 million in debt principal payments under this Facility in the first quarter of fiscal 2008. We
are not required to make debt principal payments on our Senior Credit Facility until 2010. Our
6
3
/
4
% Notes become exchangeable if our common stock price exceeds $21.45 per share for at least 20
trading days in the period of 30 consecutive trading days ending on the last trading day of the
preceding fiscal quarter. Such an exchange would require repayment of the principal amount of the
6
3
/
4
% Notes in cash and any premium in our common stock. If not exchangeable sooner, the earliest
date that the noteholders may require us to repurchase the 6
3
/
4
% Notes is December 15, 2010.
We intend to fund our cash requirements with cash flows from operating activities, borrowings
under our Senior Credit Facility and short-term trade credit relating to payment terms for
merchandise inventory purchases. We believe these sources should be sufficient to meet our cash
needs for the foreseeable future. However, if we become subject to significant judgments,
settlements or fines related to the matters discussed in Note 12 Legal Matters in the notes to
the unaudited consolidated financial statements included in Item 1 of this Quarterly Report or any
other matters, we could be required to make significant payments that could materially and
adversely affect our financial condition, potentially impacting our credit ratings, our ability to
access the capital markets and our compliance with our debt covenants.
Analysis of Cash Flows
Net cash provided by operating activities was $2.3 million in the first quarter of fiscal
2008, compared to $7.7 million during the first quarter of fiscal 2007, or a decrease of
$5.4 million. The decrease in operating cash flow was due to an increase in inventories, the timing
of prepaid expenses, and a decrease in current accrued liabilities. Reduced cash inflow relative to
these factors was partially offset by an increase in accounts payable.
Net cash used in investing activities totaled $4.4 million for the first quarter of fiscal
2008, compared to $9.3 million for the first quarter of fiscal 2007. The decrease in cash used in
investing activities in the first quarter of fiscal 2008 was primarily caused by our cost-saving
efforts related to capital expenditures, which decreased approximately $4.9 million.
Net cash provided by financing activities totaled $5.2 million for the first quarter of fiscal
2008, compared to $4.7 million for the first quarter of fiscal 2007. In the first quarter of fiscal
2008, we had net borrowings of $6.5 million under our Senior Credit Facility, compared to
$8.5 million of net payments in fiscal 2007.
Off-Balance Sheet Arrangements and Contractual Obligations
We lease our office and warehouse facilities, all but one of our retail stores, and most of
our vehicles and equipment. Certain of the vehicles and equipment leases are classified as capital
leases and, accordingly, the asset and related obligation are recorded on our balance sheet.
Substantially all of our store leases are operating leases with private landlords and provide for
monthly rental payments based on a contractual amount. The majority of these lease agreements are
for base lease periods ranging from 10 to 20 years, with three to five renewal options of five
years each. Certain store leases also provide for contingent rentals based upon a percentage of
sales in excess of a stipulated minimum. We believe that the long duration of our store leases
offers security for our store locations without the risks associated with real estate ownership.
We have seller financing arrangements related to debt established for stores where we were the
seller-lessee and did not recover substantially all of the related construction costs. In those
situations, we recorded our total cost in property and equipment, and recorded amounts funded by
the lessor as a debt obligation on our balance sheet. Rental payments under these arrangements are
29
allocated between interest expense and reduction of the underlying obligation based on the
related amortization schedule.
As of May 4, 2008, there are no material changes to the contractual obligations table
disclosed in Managements Discussion and Analysis of Financial Condition and Results of Operations
in our 2007 10-K. The contractual obligations table in the 2007 10-K excludes liabilities with
respect to unrecognized tax benefits. We adopted FASB Interpretation No. 48,
Accounting for
Uncertainty in Income Taxes
(FIN 48) at the beginning of fiscal 2007. At May 4, 2008, we had
approximately $9.4 million of unrecognized tax benefits as a result of our adoption of FIN 48. We
do not expect these unrecognized income tax benefits to result in cash payments over the next 12
months. Beyond the next year, timing of any cash payments is uncertain.
We have contractual obligations for stores for which we closed prior to the end of the lease
term. We attempt to sublease closed locations and reduce the remaining lease payments owed by the
estimated sublease income. We expect net cash outflows for closed store locations as of fiscal
2007 year-end of approximately $0.9 million during fiscal 2008. These future cash outflows are
expected to be funded from normal operating cash flows. It is anticipated that approximately 48
stores in fiscal 2008 will be closed or relocated. We anticipate that the majority of these
closures will occur near the end of the lease terms, resulting in minimal closed store costs. As a
result, closed store expenses for these stores will principally relate to the period costs of
actually closing the stores and transporting our inventory, fixtures and other assets we own in the
store.
During the first quarter of fiscal 2008, the Compensation Committee of our Board of Directors
approved several new and enhanced severance and retention arrangements for headquarters staff and
our officers based on the non-management directors determination that it was in our stockholders
best interests that our personnel remain focused on their assigned duties and the operations of the
business in the context of the uncertainty and potential for distraction associated with the near
term likelihood of a change in control. These arrangements included:
|
|
|
New severance plan for corporate headquarters facilities personnel not covered by other
agreements or arrangements that provides for enhanced severance benefits for certain
position levels in the context of termination of employment in conjunction with a change in
control;
|
|
|
|
|
New severance agreements providing for standard and change in control severance benefits
for Regional Vice Presidents;
|
|
|
|
|
Amendments to existing corporate Vice President severance agreements that eliminate
mitigation and offset requirements upon a termination of employment in a change in control
context;
|
|
|
|
|
Amendments to existing severance and retention arrangements for senior officers
providing for enhanced severance benefits upon termination of employment in the context of
a change in control; and
|
|
|
|
|
Retention bonuses for certain personnel.
|
Store Closing Costs
Store closing costs include amounts for new store closures, revisions in estimates for stores
currently in the closed store reserve, accretion expense, and operating and other expenses. See
Note 6 Store Closing Costs in the notes to the unaudited consolidated financial statements
included in Item 1 of this Quarterly Report.
We expect net cash outflows for closed locations included in our 2007 ending liability balance
to be approximately $0.9 million during the remainder of fiscal 2008. Of these net outflows,
approximately $5.1 million is expected to relate to rent and occupancy expenses. These expenses are
expected to be offset by estimated sublease income of $4.2 million. The expected accretion to be
expensed in the remaining three quarters of fiscal 2008 on the liability as of the end of the first
quarter of fiscal 2007 is approximately $0.4 million. The cash flow amounts above only relate to
contractual commitments and do not include period expenses incurred when a store is closed and also
the period costs incurred related to closed stores.
Factors Affecting Liquidity and Capital Resources
Sales Trends
Our business is somewhat seasonal in nature, with the highest sales occurring in the months of
June through October (overlapping our second and third fiscal quarters). In addition, our business
is affected by weather conditions. While unusually severe or inclement weather tends to reduce
sales, as our customers are more likely to defer elective maintenance during such periods,
extremely hot and cold temperatures tend to enhance sales by causing auto parts to fail and sales
of seasonal products to increase. Higher gasoline prices, such as we are experiencing in fiscal
2008 and experienced in fiscal 2007, may also adversely affect our revenues because our customers
may defer purchases of certain items as they use a higher percentage of their income to pay for
gasoline. Additionally, we believe that our sales are impacted by general economic conditions, and
that our sales in the first quarter of fiscal 2008 were adversely affected by the deterioration in
general economic conditions.
30
Inflation
We do not believe our operations have been materially affected by inflation. We believe that
we will be able to mitigate the effects of future merchandise cost increases principally through
economies of scale resulting from increased volumes of purchases, selective forward buying and the
use of alternative suppliers and price increases. If we are not able to mitigate the effects of
future merchandise cost increases through these or other measures, the fixed cost of our organic
growth will adversely affect our profitability. We also experience inflationary increases in rent
expense as some of our lease agreements are adjusted based on changes in the consumer price index.
Debt Covenants
Certain of our debt agreements at May 4, 2008 contained negative covenants and restrictions on
actions by us and our subsidiaries including, without limitation, restrictions and limitations on
indebtedness, liens, guarantees, mergers, asset dispositions, investments, loans, advances and
acquisitions, payment of dividends, transactions with affiliates, change in business conducted, and
certain prepayments and amendments of indebtedness.
Auto is, under certain circumstances not applicable during the quarter ended May 4, 2008,
subject to a minimum ratio of consolidated earnings before interest, taxes, depreciation,
amortization and rent expense, or EBITDAR, to fixed charges (as defined in the agreement, the
Fixed Charge Coverage Ratio) under a Senior Credit Facility financial maintenance covenant;
however, under the second waiver we entered into during the second quarter of the fiscal year ended
February 4, 2007 and under all subsequent waivers, Auto was required to maintain a minimum 1:1
Fixed Charge Coverage Ratio until the termination of such waiver and all subsequent waivers. The
filing of the Quarterly Report for the second quarter of fiscal 2007 resulted in the termination of
the requirement to maintain the minimum 1:1 Fixed Charge Coverage Ratio imposed by these waivers.
For the twelve months ended May 4, 2008, we would have been in compliance with this covenant had it
been applicable.
The Term Loan Facility contains certain financial covenants, one of which is the requirement
of a minimum fixed charge coverage ratio (as separately defined in the Term Loan Facility). At May
4, 2008, the minimum fixed charge coverage ratio was 1.20:1 for the first quarter of fiscal 2008,
1.15:1 for the second quarter of fiscal 2008, 1.20:1 for the third and fourth quarters of fiscal
2008, and 1.45:1 thereafter. For the thirteen weeks ended May 4, 2008, our actual ratio was 1.31:1.
The minimum ratios for fiscal 2008 reflect the December 18, 2007 fourth amendment to the Term Loan
Facility.
The Term Loan Facility also requires compliance with a maximum
leverage ratio covenant. The December
18, 2007 fourth amendment to the Term Loan Facility increased the maximum leverage ratio permitted
under the Term Loan Facility for the fourth quarter of fiscal 2007 and for each of the quarters of
fiscal 2008. The amendment increased the maximum leverage ratio permitted as of May 4, 2008, to
5.80:1 for the first quarter of fiscal 2008, 6.00:1 for the second quarter of fiscal 2008, 5.75:1
for the third quarter of fiscal 2008, and 4.50:1 for the fourth quarter of fiscal 2008, while
leaving all other ratios unchanged. The maximum leverage ratio permitted declines to 3.25:1 after
the end of fiscal 2008 and further declines to 3.00:1 at the end of fiscal 2009. As of May 4, 2008,
our actual leverage ratio was 4.74:1.
The maximum leverage ratio permitted in the first quarter of fiscal 2009 decreases
significantly to 3.25:1 from 5.75:1 in the third quarter of fiscal 2008 and 4.50:1 in the fourth
quarter of fiscal 2007. Based on our current financial forecast, we do not expect to be able to
satisfy this covenant for the first quarter fiscal 2009, and, as a result, we have classified all
of our indebtedness under the Term Loan Facility and the Senior Credit Facility, as well as the 6
3
/
4
%
Notes, as current liabilities in the consolidated balance sheet as of May 4, 2008. Furthermore,
beginning with the second quarter of fiscal 2008, we will be required to reduce (to twelve months)
the time period over which we amortize debt issuance costs and debt discount, increasing the
interest costs we report in our financial statements. The classification of all such indebtedness
as current liabilities and the acceleration of the amortization of interest costs will not cause a
default under our borrowing agreements. However, any such classification could have adverse
consequences upon our relationships with, and the credit terms upon which we do business with, our
vendors, although we expect such consequences, if any, to be limited due to the expected closing of
the Exchange Offer in the second quarter of fiscal 2008. We do not expect to seek any waivers or
amendments under its credit facilities prior to the closing of the Exchange Offer as these credit
facilities are expected to be repaid and terminated upon closing of the Exchange Offer.
If the Exchange Offer were to fail to close, prior to the end of the first quarter of fiscal
2009, we would seek to obtain a waiver or amendment of certain covenants contained in the Term Loan
Facility, including the maximum leverage ratio covenant. No assurance can be given that we would be
able to obtain such a waiver or amendment on terms that would be satisfactory to us. Failure to
comply with the financial covenants of the Term Loan Facility would result in an event of default
under the Term Loan Facility following the first quarter of fiscal 2009, which could result in
possible acceleration of all of our indebtedness thereunder, under the Senior Credit Facility and
under the indenture under which the 6
3
/
4
% Notes were issued, all of which could have a material
adverse effect on us.
Upon the occurrence and during the continuance of an event of default under the Senior Credit
Facility or the Term Loan Facility, the lenders thereunder could elect to terminate the commitments
thereunder (in the case of the Senior Credit Facility only), declare all
31
amounts owing thereunder to be immediately due and payable and exercise the remedies of a
secured party against the collateral granted to them to secure such indebtedness. If the lenders
under either the Senior Credit Facility or the Term Loan Facility accelerate the payment of the
indebtedness due thereunder, we cannot be assured that our assets would be sufficient to repay in
full such indebtedness, which is collateralized by substantially all of our assets.
At May 4, 2008, we were in compliance with the covenants under all our debt agreements.
Interest Rates
Financial market risks relating to our operations result primarily from changes in interest
rates. Interest earned on our cash equivalents as well as interest paid on our variable rate debt
are sensitive to changes in interest rates.
Under our current debt and capital lease agreements, as of May 4, 2008, 76% of our outstanding
debt and capital leases was at variable interest rates and 24% of our outstanding debt was at fixed
interest rates. As of May 4, 2008, with $397.8 million in variable rate debt outstanding, a 1%
change in the LIBOR rate to which this variable rate debt is tied would result in a $4.0 million
change in our annual interest expense. This estimate assumes that our debt balance remains constant
for an annual period and the interest rate change occurs at the beginning of the period. Our
variable rate debt relates to borrowings under our Senior Credit Facility and Term Loan Facility,
which are vulnerable to movements in the LIBOR rate.
Critical Accounting Matters
For a discussion of our critical accounting matters, please refer to Item 7, Managements
Discussion and Analysis of Financial Condition and Results of Operations, in our 2007 10-K under
the heading Critical Accounting Matters.
Recent Accounting Pronouncements
For a discussion of recent accounting pronouncements, please refer to Note 3 Recent
Accounting Pronouncements in the notes to the unaudited consolidated financial statements included
in Item 1 of this Quarterly Report.
32
Item 3.
Quantitative and Qualitative Disclosures about Market Risk
See Factors Affecting Liquidity and Capital Resources above in Item 2, Managements
Discussion and Analysis of Financial Condition and Results of Operations.
Item 4.
Controls and Procedures
An evaluation of the effectiveness of the design and operation of our disclosure controls and
procedures (as such term is defined in Rule 13a-15(e) and 15d15(e) under the Exchange Act was
performed as of May 4, 2008, under the supervision and with the participation of our management,
including our Chief Executive Officer and Chief Financial Officer. Our disclosure controls and
procedures have been designed to ensure that information we are required to disclose in our reports
that we file or submit under the Exchange Act is recorded, processed, summarized and reported
within the time periods specified by the SECs rules and forms and that such information is
accumulated and communicated to our management, including our Chief Executive Officer and Chief
Financial Officer, to allow timely decisions regarding required disclosures.
Based on this evaluation, our Chief Executive Officer and our Chief Financial Officer
concluded that our disclosure controls and procedures were not effective as of May 4, 2008 because
of the material weaknesses identified in our evaluation of internal control over financial
reporting as disclosed in our 2007 10-K.
The Company performed additional analyses and other post-closing procedures to ensure that our
consolidated financial statements contained within this Quarterly Report were prepared in
accordance with generally accepted accounting principles. Accordingly, management believes that the
consolidated financial statements included in this Quarterly Report fairly present in all material
respects our financial position, results of operations and cash flows for the periods presented.
MATERIAL WEAKNESSES IN INTERNAL CONTROL OVER FINANCIAL REPORTING
A material weakness is a deficiency, or a combination of deficiencies, in internal control
over financial reporting, such that there is a reasonable possibility that a material misstatement
of the Companys annual or interim financial statements will not be prevented or detected on a
timely basis. A deficiency in internal control over financial reporting exists when the design or
operation of a control does not allow management or employees, in the normal course of performing
their assigned functions, to prevent or detect misstatements on a timely basis.
Management identified the following material weaknesses in the Companys internal control over
financial reporting as of May 4, 2008:
|
1)
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|
Resources, and Policies and Procedures to Ensure Proper and Consistent Application of
GAAP
The Company failed to have a sufficient complement of personnel with a level of
accounting knowledge, experience and training in the application of GAAP commensurate with
the Companys financial reporting requirements. This material weakness in the Companys
resources, and policies and procedures contributed to the following additional material
weakness:
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a)
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|
Financial Reporting
The Company did not maintain effective controls over the
completeness and accuracy of its period-end financial reporting process. Specifically,
effective controls, including monitoring, were not maintained to ensure (i) timely
resolution of reconciling items and review of account reconciliations over certain
balance sheet accounts, (ii) timely recording of required period-end adjustments, and
(iii) accumulation and review of all required supporting information to ensure the
completeness and accuracy of the consolidated financial statements and disclosures.
|
These material weaknesses contributed to the following additional material weaknesses and
resulted in adjustments to the Companys fiscal 2007, 2006 and 2005 annual and interim
consolidated financial statements and in adjustments to the Companys consolidated financial
statements for the first fiscal quarter of 2008 prior to the inclusion of their annual and interim financial statements in the Companys periodic
filings with the SEC and to the restatement of the Companys previously filed fiscal 2004 and the fiscal year ended February 1, 2004 (fiscal 2003) annual
consolidated financial statements and consolidated financial statements for each of the first
three quarter of fiscal 2005 and for each of the quarters of fiscal 2004 as described in the
Companys Form 10-K for fiscal 2005 filed May 1, 2007. Additionally, these material weaknesses
could result in misstatements of any of the Companys consolidated financial statement accounts
and disclosures that would result in a material misstatement to the annual or interim
consolidated financial statements that would not be prevented or detected.
2) Accounting for Inventory
The Company did not maintain effective controls over the
completeness, accuracy, existence and valuation of its inventory. Specifically, effective controls,
including monitoring, were not maintained to ensure that the Companys inventory systems completely
and accurately processed and accounted for inventory movements within the Companys distribution
network, particularly the disposition of inventory returns from customers. Additionally, the
Company did not maintain effective
33
monitoring and review over in-transit inventory, defective product warranty costs, core
inventory and related core return liability accounts and shrink expense and shrink accruals.
Furthermore, reconciliations of distribution center and warehouse physical inventory counts to the
general ledger balances were not performed accurately, resulting in adjustments to year-end
inventory balances.
3) Accounting for Vendor Allowances
The Company did not maintain effective controls over
the completeness, accuracy and valuation of its vendor allowances. Specifically, effective
controls, including monitoring, were not maintained to ensure that (i) errors were prevented or
detected in interim and annual estimates of vendor allowances under certain contracts and that
vendor allowances were recorded in the appropriate general ledger accounts to allow for appropriate
inventory cost capitalization calculations, (ii) all final contracts were reviewed by accounting
personnel on a timely basis, and (iii) accounting of vendor allowances were recorded in the proper
periods.
4) Accounting for Certain Accrued Expenses
The Company did not maintain effective controls
over the completeness, accuracy and valuation of certain of its accrued expense accounts and
related cost of sales, operating and administrative expenses, and store closing costs.
Specifically, effective controls including monitoring, and review and analysis were not maintained
to ensure certain accrued expense accounts were complete and accurate.
These material weaknesses described in 2 - 4 above resulted in adjustments to the aforementioned
accounts within the Companys fiscal 2007, 2006 and 2005 annual and interim consolidated financial
statements and in adjustments to the Companys consolidated financial statements for the first fiscal quarter of 2008 prior to the inclusion of their annual and interim financial statements in
the Companys periodic filings with the SEC, and to the restatement of the Companys previously filed fiscal 2004
and 2003 annual consolidated financial statements and consolidated financial statements for each of
the first three quarters of fiscal 2005 and for each of the quarters of fiscal 2004, as described
in the Companys Form 10-K for fiscal 2005 filed on May 1, 2007. In
addition, each of the material weaknesses described above could result in a misstatement of the
aforementioned accounts that would result in a material misstatement to the Companys annual or
interim consolidated financial statements and disclosures that would not be prevented or detected
on a timely basis.
PLAN FOR REMEDIATION OF MATERIAL WEAKNESSES
Remediation Initiatives
The Board of Directors created a Remediation Committee comprised of certain positions within
key functional areas of the Company and co-chaired by the General Counsel and the Chief Financial
Officer to develop and implement a remediation plan to address the material weaknesses and other
deficiencies noted from the completion of the Companys evaluation of internal controls over
financial reporting. The remediation plan that the Remediation Committee has been working with
reflects the input of the disinterested directors (the five of our seven directors who were not
current or former members of management at the time the remediation plan was developed) and
includes (1) ethics and compliance training; (2) hotline awareness and education; (3) corporate
governance training; (4) conflicts of interest training; (5) awareness and education of the
Companys Codes of Business Conduct and Ethics; and (6) targeted training geared toward certain
functional areas on such topics as vendor arrangements and the Sarbanes-Oxley Act of 2002.
To remediate the material weaknesses described above, the Company has implemented or plans to
implement the remedial measures described below. In addition, the Company plans to continue its
evaluation of its controls and procedures and may, in the future, implement additional
enhancements:
Resources and Policies and Procedures to Ensure Proper and Consistent Application of GAAP
The Company plans to prepare or enhance formal written accounting policies and procedures and
establish procedures and processes for their periodic update. In addition, procedures are being prepared
to provide for the ability to effectively audit compliance with such policies and procedures.
The Company continues to assess staffing requirements to ensure the Finance organization has
the necessary resources that have knowledge, experience and training in the application of GAAP to
handle the Companys operations and related financial reporting requirements. These personnel,
along with a rigorous monthly financial statement review and comparison of actual results to
budget, are intended to assist in substantiating that our financial reporting is in compliance with
GAAP and SEC rules and regulations. The Company plans to increase the accounting, internal control,
and SEC reporting acumen and accountability of its Finance organization employees with training,
which is planned to include, among other things, in-house training and development programs to
enhance their competency with respect to GAAP and financial reporting.
34
Financial Reporting Formalized procedures are being enhanced to provide for the proper
preparation of account reconciliations and their independent review and approval. The Company is
also automating certain procedures so that it will be more effective and efficient in completing
and reviewing account reconciliations and preparing complete, accurate and timely supporting
documentation for the account reconciliations. The inclusion of this supporting documentation is
intended to allow the approver to more effectively and efficiently ascertain whether the account
reconciliations are correct and in accordance with the Companys policies and procedures.
Accounting for Inventory The Company has instituted monitoring processes to ensure
compliance with its established policies to assure timely reconciliations of all physical
inventories and evaluation of the results of the reconciliations in the general ledger, as well as
independent supervisory review of the reconciliations. Review and approval processes are in place
for distribution centers, warehouses and stores to ensure inventory shrink estimates are calculated
in accordance with established procedures. We plan to enhance our reconciliation process of the
book and perpetual inventory for each reporting period to mitigate the risk of material
unsubstantiated balances accumulating in general ledger accounts. Longer term, we plan to make
system enhancements so that our book and perpetual systems function as one system that is used to
replenish the inventory and utilize the same information to account for on-hand merchandise
inventory and cost of sales. Currently, the Company uses an estimation technique for determining
its in-transit inventory rather than halting operations to enable a physical inventory of
in-transit merchandise to be conducted. This estimate is reviewed and approved on a monthly basis.
In the future, the inventory department expects its systems will be modified that will allow for a
systematic method of determining the in-transit inventory balances. In connection with the
adjustments of inventory and cost of sales for warranty, cores and allowance for sales returns, the
Company has developed more rigorous processes for the independent review of the methodology and
underlying judgments used in developing the estimates that underlie the related accounts.
Accounting for Vendor Allowances The Companys remediation activities have improved the
contract review and approval process and accounting for vendor allowances. However, during fiscal
2007, we continued to experience issues inherent in our manual vendor allowance process and we rely
on management monitoring to detect and correct errors that could be material. That monitoring has
reduced the frequency of errors, but not quite enough to conclude we have fully remediated this
material weakness. Management plans to implement new procedures and increase its monitoring by:
a) performing fluctuation analysis in the recording of estimates, b) implementing additional
required approvals to allow increased oversight to help in accuracy and general ledger coding, c)
enhancing the period-end recognition review meetings effectiveness and use of the contract log to
identify open contracts for timely approval, d) reviewing certain contracts quarterly for valuation
instead of annually to reduce potential large year-end correcting entries, and e) reviewing large
valued vendor agreements recorded in the vendor contract log with much more depth at quarter-end to
potentially avoid large adjustments in subsequent quarters.
Accounting for Certain Accrued Expenses The Companys remediation measures planned to
address the material weakness related to the Companys recording of accrued expenses include the
development of a standardized checklist of expected accrual items and the implementation of a
process of enhanced review of invoices, disbursements and other supporting documentation at the end
of each quarter to provide for proper recording of accrued expenses and liabilities. In addition,
we believe that the formal review procedures for period-end closings and account reconciliations
and the knowledge and experience the new Finance organization management brings, along with written
policies and procedures, should remediate this material weakness.
Interim Measures Pending Completion of Remediation Initiatives
Management has not yet implemented all of the measures described above or adequately tested
those controls already implemented. Nevertheless, management believes those remediation measures
already implemented, together with the additional measures undertaken by the Company described
below, satisfactorily address the material weaknesses described above as they might affect the
consolidated financial statements and information included in this Quarterly Report. These
additional measures included the following:
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Additional planning, analysis and procedures, and management reviews
have been performed to ensure the accuracy of financial reporting
contained in this Quarterly Report.
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|
|
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|
Where the Company identified the existence of a material weakness, the
Company has performed extensive substantive procedures to ensure that
affected amounts are fairly stated for all periods presented in this
Quarterly Report.
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35
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|
The Company retained experienced accounting consultants, other than
the Companys independent registered public accounting firm, with
relevant accounting experience, skills and knowledge, working under
the supervision and direction of the Companys management, to assist
with the fiscal 2008 quarterly reporting process.
|
|
|
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|
The Company conducted a detailed and extensive review of account
reconciliations, non-routine transactions and agreements, and
financial statement classifications for accuracy and conformance with
GAAP.
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Control deficiencies not constituting material weaknesses
In addition to the material weaknesses described above, management has identified other
deficiencies in internal control over financial reporting that did not constitute material
weaknesses as of May 4, 2008. The Company implemented during fiscal 2007, first quarter of fiscal
2008, and plans to implement during the remainder of fiscal 2008, various measures to remediate
these control deficiencies and has undertaken other interim measures to address these control
deficiencies.
Managements conclusions
Management believes the remediation measures described above will strengthen the Companys
internal control over financial reporting and remediate the material weaknesses identified above.
Although management has not yet implemented all of these measures or tested all those that have
been implemented, management has concluded that the interim measures described above, provide
reasonable assurance regarding the reliability of financial reporting and the preparation of the
Companys financial statements included in this Quarterly Report and has discussed its conclusions
with the Companys Audit Committee.
The Company is committed to continuing to improve its internal control processes and will
continue to diligently and vigorously review its disclosure controls and procedures and its
internal control over financial reporting in order to ensure compliance with the requirements of
SOX 404. However, any control system, regardless of how well designed, operated and evaluated, can
provide only reasonable, not absolute, assurance that its objectives will be met. As management
continues to evaluate and improve the Companys internal control over financial reporting,
it may determine to take additional measures to address control deficiencies, and it may determine
not to complete certain of the measures described above.
CHANGES IN INTERNAL CONTROL OVER FINANCIAL REPORTING
During the quarter ended May 4, 2008, we implemented certain new internal controls
that have materially affected or are reasonably likely to materially
affect our internal control over financial reporting. We have refined
the process to improve the timeliness and quality of account reconciliations for certain
balance sheet accounts pertaining to our significant accounting
policies. We will continue to make additional enhancements in this
area. We believe these additional controls, in combination with our continued efforts to (i)
enhance previously existing controls, and (ii) provide internal training to remediate the material
weaknesses that continue to exist, will strengthen our internal control over
financial reporting.
36
PART II
OTHER INFORMATION
Item 1.
Legal Proceedings
Please refer to Note 12 Legal Matters in the notes to the unaudited consolidated financial
statements included in Item 1 of Part I above, which is incorporated herein by reference.
Item 1A.
Risk Factors
There have been no material changes to the risk factors disclosed in the 2007 10-K.
Item 6.
Exhibits
The Exhibit Index located at the end of this Quarterly Report is incorporated herein by
reference.
37
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.
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CSK Auto Corporation
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DATED: June 13, 2008
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By:
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/s/ Lawrence N. Mondry
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Lawrence N. Mondry
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President and Chief Executive Officer
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By:
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/s/ James D. Constantine
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James D. Constantine
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Executive Vice President of Finance and Chief Financial Officer
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38
EXHIBIT INDEX
|
|
|
Exhibit
|
|
|
Number
|
|
Description
|
|
2.01
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Agreement and Plan of Merger among OReilly Automotive, Inc., OC
Acquisition Company and CSK Auto Corporation, dated April 1, 2008,
incorporated herein by reference to Exhibit 2.1 to our Current
Report on Form 8-K, filed on April 7, 2008 (File No. 001-13927).
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3.01
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Restated Certificate of Incorporation of the Company, incorporated
herein by reference to Exhibit 3.01 to our Annual Report on Form
10-K, filed on May 4, 1998 (File No. 001-13927).
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3.02
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Certificate of Correction to the Restated Certificate of
Incorporation of the Company, incorporated herein by reference to
Exhibit 3.02 to our Annual Report on Form 10-K, filed on May 4,
1998 (File No. 001-13927).
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3.03
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Certificate of Amendment to the Restated Certificate of
Incorporation of CSK Auto Corporation, incorporated herein by
reference to Exhibit 3.2.1 to our Quarterly Report on Form 10-Q,
filed on September 18, 2002 (File No. 001-13927).
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3.04
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Second Certificate of Amendment of the Restated Certificate of
Incorporation of CSK Auto Corporation, incorporated herein by
reference to Exhibit 3.04 to our Quarterly Report on Form 10-Q,
filed on December 9, 2005 (File No. 001-13927).
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3.05
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Amended and Restated By-laws of the Company, incorporated herein
by reference to Exhibit 3.03 to our Annual Report on Form 10-K,
filed on April 28, 1999 (File No. 001-13927).
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3.06
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First Amendment to Amended and Restated By-laws of the Company,
incorporated herein by reference to Exhibit 3.03.1 to our annual
report on Form 10-K, filed on May 1, 2001 (File No 001-13927).
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3.07
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Second Amendment to Amended and Restated By-laws of the Company,
incorporated herein by reference to Exhibit 3.03.2 to our
Quarterly Report on Form 10-Q, filed on June 14, 2004 (File No.
001-13927).
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3.08
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Third Amendment to Amended and Restated By-Laws of CSK Auto
Corporation, incorporated herein by reference to Exhibit 3.1 to
our Current Report on Form 8-K, filed on August 16, 2007 (File No.
001-13927).
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3.09
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Fourth Amendment to Amended and Restated By-Laws of CSK Auto
Corporation, incorporated herein by reference to Exhibit 3.1 to
our Current Report on Form 8-K, filed on September 5, 2007 (File
No. 001-13927).
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4.01
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Rights Agreement, dated February 4, 2008, by and between CSK Auto
Corporation and Mellon Investor Services LLC, as Rights Agent,
incorporated herein by reference to Exhibit 1 to our Registration
Statement on Form 8-A, filed on
February 5, 2008 (File No.
001-13927).
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10.01
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First Amendment to the CSK Auto Corporation 1996 Associate Stock
Option Plan, effective as of March 31, 2008, incorporated herein
by reference to Exhibit 10.4.1 to our Annual Report on Form 10-K,
filed on April 18, 2008
(File
No. 001-13927).
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10.02
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First Amendment to the CSK Auto Corporation 1996 Executive Stock
Option Plan, effective as of March 31, 2008, incorporated herein
by reference to Exhibit 10.7.1 to our Annual Report on Form 10-K,
filed on April 18, 2008
(File
No. 001-13927).
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10.03
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First Amendment to the CSK Auto Corporation 1999 Employee Stock
Option Plan, effective as of March 31, 2008, incorporated herein
by reference to Exhibit 10.9.1 to our Annual Report on Form 10-K,
filed on April 18, 2008
(File
No. 001-13927).
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10.04
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First Amendment to the CSK Auto Corporation 2004 Stock and
Incentive Plan, effective as of March 31, 2008, incorporated
herein by reference to Exhibit 10.11.1 to our Annual Report on
Form 10-K, filed on April 18, 2008 (File No. 001-13927).
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10.05
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Form of Amended and Restated Severance and Retention Agreement
between CSK Auto, Inc. and each of its then senior executive
officers (other than Lawrence Mondry), incorporated herein by
reference to Exhibit 10.24 to our Annual Report on Form 10-K,
filed on April 18, 2008 (File No. 001-13927).
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10.06
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Second Amendment to Amended and Restated Outside Director
Compensation Policy, effective as of March 7, 2008, incorporated
herein by reference to Exhibit 10.29.2 to our
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39
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Exhibit
|
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Number
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Description
|
|
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|
Annual Report on
Form 10-K, filed on April 18, 2008
(File
No. 001-13927).
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10.07
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First Amendment to Employment Agreement, dated as of March 31,
2008, by and between CSK Auto, Inc., and Lawrence N. Mondry,
incorporated herein by reference to Exhibit 10.38.1 to our Annual
Report on Form 10-K, filed on April 18, 2008 (File No.
001-13927).
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10.08
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2008 Cash in Lieu Bonus Plan, dated March 18, 2008, incorporated
herein by reference to Exhibit 10.42 to our Annual Report on Form
10-K, filed on April 18, 2008 (File No. 001-13927).
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10.08.1
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Form of Notice of Participation in 2008 Cash in Lieu Bonus Plan,
incorporated herein by reference to Exhibit 10.42.1 to our Annual
Report on Form 10-K, filed on April 18, 2008 (File No.
001-13927).
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10.9
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Side Letter between CSK Auto, Inc., CSK Auto Corporation and
Michael Bryk, dated March 31, 2008, regarding reimbursement for
travel and temporary living expenses, incorporated herein by
reference to Exhibit 10.43 to our Annual Report on Form 10-K,
filed on April 18, 2008 (File No. 001-13927).
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10.10
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|
Side Letter between CSK Auto, Inc., CSK Auto Corporation and James
Constantine, dated March 31, 2008, regarding reimbursement for
travel and temporary living expenses, incorporated herein by
reference to Exhibit 10.44 to our Annual Report on Form 10-K,
filed on April 18, 2008 (File No. 001-13927).
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10.11
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Side Letter between CSK Auto, Inc., CSK Auto Corporation and Randi
Morrison, dated March 31, 2008, regarding reimbursement for travel
and temporary living expenses, incorporated herein by reference to
Exhibit 10.45 to our Annual Report on Form 10-K, filed on April
18, 2008 (File No. 001-13927).
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10.12
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Side Letter between CSK Auto, Inc., CSK Auto Corporation and Brian
Woods, dated March 31, 2008, regarding reimbursement for travel,
temporary living expenses, and relocation costs, incorporated
herein by reference to Exhibit 10.46 to our Annual Report on Form
10-K, filed on April 18, 2008 (File No. 001-13927).
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10.13
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|
2008 General and Administrative Staff Incentive Plan, incorporated
herein by reference to Exhibit 10.47 to our Annual Report on Form
10-K, filed on April 18, 2008 (File No. 001-13927).
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10.14
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|
2008 Executive Incentive Plan for Lawrence N. Mondry, incorporated
herein by reference to Exhibit 10.48 to our Annual Report on Form
10-K, filed on April 18, 2008 (File No. 001-13927).
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10.15
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|
Form of Restricted Stock Agreement between CSK Auto, Inc. and
Lawrence N. Mondry, incorporated herein by reference to Exhibit
(e)(17) of our Solicitation/Recommendation Statement on Schedule
14D-9, filed on June 11, 2008
(File No. 005-55039).
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31.01*
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Certification by the Chief Executive Officer pursuant to Section
302 of the Sarbanes-Oxley Act of 2002.
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31.02*
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Certification by the Chief Financial Officer pursuant to Section
302 of the Sarbanes-Oxley Act of 2002.
|
|
|
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32.01*
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|
Certification of the Chief Executive Officer and Chief Financial
Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002.
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*
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|
Filed herewith.
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|
Employment compensation plans or arrangements.
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40
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