ITEM 1 BUSINESS
GENERAL
The Pep Boys - Manny, Moe & Jack and Subsidiaries (the "Company") is engaged principally in the retail sale of automotive parts and accessories, automotive maintenance and service and the installation of parts sold by it through its chain of 604 stores (as of February 1, 1997) which consists of 528 SUPERCENTERS, having an aggregate of 5,398 service bays, and 76 PARTS USA stores. The Company operates approximately 11,761,000 gross square feet of retail space, including the service bays. The SUPERCENTERS average approximately 20,800 square feet and the PARTS USA stores average approximately 10,300 square feet.
As of February 1, 1997, the Company operated its stores in 33 states, the District of Columbia and Puerto Rico. The following table indicates by state the number of stores of the Company in operation at the end of fiscal 1993, 1994, 1995 and 1996 and the number of stores opened and closed by the Company during each of the last three fiscal years:
NEW STORES AND EXPANSION STRATEGY
During fiscal 1996, the Company opened 56 SUPERCENTERS, all of which include service bays, and 44 PARTS USA stores. Two outmoded units were closed, one of which was replaced by a SUPERCENTER.
The Company's typical SUPERCENTER is a free standing, "one-stop" shopping automotive warehouse that features approximately 12 state-of-the-art service bays. Each SUPERCENTER carries an average of approximately 27,000 stock-keeping units and serves the automotive aftermarket needs of the "do-it-yourself", the "do-it-for-me" and the "buy-for-resale" customer segments. Late in 1996, a new SUPERCENTER prototype was introduced that averages approximately 18,200 square feet. The Company intends to continue to utilize this new prototype in 1997. While the overall size of the SUPERCENTER will be reduced, the number of stock-keeping units offered will not decrease.
PARTS USA stores operate in locations that the Company believes will be better served by stores with an extensive selection of parts and accessories (an average of approximately 26,000 stock-keeping units per store) but without tires or service bays. These stores are generally located in certain urban areas and areas located between SUPERCENTERS. PARTS USA stores primairly serve the automotive aftermarket needs of the "do-it-yourself" and the "buy-for- resale" customer segments. New PARTS USA stores will average approximately 8,100 square feet. The Company believes the utilization of this supplemental format will enable it to grow at a faster rate and achieve greater economies of scale by providing more retail outlets as well as increase its market penetration and share over time.
The Company expects to open approximately 120 new stores in 1997, most of which are expected to be in existing markets. If all 120 stores are opened, the Company anticipates spending approximately $188,000,000 in addition to the $14,194,000 it has already spent as of February 1, 1997 in connection with certain of these locations. Funds required to finance this expansion are expected to come primarily from operating activities with the remainder provided by unused lines of credit or from accessing traditional lending sources which may include the public capital markets.
The Company is positioning certain SUPERCENTERS and PARTS USA stores to deliver high quality parts to the professional installer. This will strengthen the Company's position in the "buy-for-resale" category by allowing the Company to further penetrate its markets while providing a valuable service to the professional mechanic. As of the end of 1996, the Company operated the Auto Parts Delivery program in 57 of its stores.
The most important factors considered by the Company when deciding to open new stores are vehicle and population demographics, competitive positioning and site development costs. The most important factors considered by the Company when deciding whether to close a store are profitability and whether the store is outmoded by virtue of store size, location and surroundings, number of service bays, number of other stores within the same market area and the cost/benefit of establishing a replacement store rather than expanding or otherwise upgrading an older store.
The Company's ability to meet its expansion goals will depend, in large measure, upon the availability of suitable sites, prevailing economic conditions, its success in completing negotiations to purchase or lease properties, and its ability to obtain governmental approvals and meet construction deadlines.
MERCHANDISING
Each Pep Boys' SUPERCENTER and PARTS USA store carries the same basic product line, with variations based on the number and type of cars registered in the different markets. A full complement of a SUPERCENTER and a PARTS USA stores' inventory currently includes an average of approximately 27,000 and 26,000 items, respectively. The Company's automotive product line includes: tires (not included in PARTS USA stores); batteries; new and rebuilt parts for domestic and imported cars, including suspension parts, ignition parts, mufflers, engines and engine parts, oil and air filters, belts, hoses, air conditioning parts, and brake parts; chemicals, including oil, antifreeze, polishes, additives, cleansers and paints; mobile electronics, including sound systems and alarms; car accessories, including seat covers, floor mats, gauges, mirrors and booster cables; and a large selection of truck and van accessories.
In addition to offering a wide variety of high quality, branded products, the Company sells an array of high quality products under the Pep Boys and various other private label names. The Company sells oil, transmission fluid and chemicals under the Pep Boys name. The Company also sells oil treatments and lubricants under the name PROLINE(tm) and paints under the name VARSITY (R). The Company sells starters and alternators under the name PROSTART(R), water pumps under the name PROCOOL(R) and batteries under the names PRO-START(R), MASTER START(tm) and RIGHT START(tm). Brakes are sold under the names SHUR GRIP(R), PROSTOP(R) and ELITE (tm) and tires under the names CORNELL(R) and FUTURA(R). The Company also sells shock absorbers under the name PRO RYDER(R), and trunk and hatchback lift supports under the name PROLIFT(R). All products sold by the Company under the Pep Boys and various other private label names accounted for approximately 25% of the Company's merchandise sales in fiscal 1996. The remaining merchandise is sold under the brand names of others. Except for revenues from maintaining or repairing automobiles and installing products, which accounted for approximately 15.0%, 15.0% and 13.9% of the Company's total revenues in fiscal years 1996, 1995 and 1994, respectively, no class of products or services accounted for as much as 10% of the Company's total revenues.
The Company has a point-of-sale system in all of its stores which gathers sales and gross profit data by stock-keeping-unit from each store on a daily basis. This information is then used by the Company to help formulate its pricing, marketing and merchandising strategies.
The Company has an electronic work order system in all of its service centers. This system creates a service history for each vehicle, provides customers with a comprehensive, professional sales document and has enabled the Company to establish a service customer database.
The Company uses an "Everyday Low Price" (EDLP) strategy in establishing its selling prices. Management believes that EDLP provides better value to its customers on a day-to-day basis, helps level customer demand and allows more efficient management of inventories.
The Company uses various forms of advertising to promote its category dominant product offering, its state-of-the-art automotive service and repair capabilities and its commitment to customer service and satisfaction. The Company's advertising vehicles include, but are not limited to, multipage catalogs, television and radio commercials and in-store promotions. Most of the gross cost of the advertising directed by the Company is customarily borne by the suppliers of the products advertised.
In fiscal 1996, approximately 66% of the Company's total revenues were cash transactions (including personal checks), and the remainder were credit and charge card sales.
The Company does not experience significant seasonal fluctuation in the generation of its revenues.
STORE OPERATIONS AND MANAGEMENT
All Pep Boys' stores are open seven days a week. Each SUPERCENTER has a manager, a service manager, a parts manager and two or more assistant managers. Each PARTS USA store has a manager, a parts manager and two or more assistant managers. A store manager's average length of service with the Company is approximately six years.
The Company has service bays in 528 of its 604 locations. Each service department can perform a variety of services which include: engine diagnosis and tune-ups, wheel alignments, state inspections, air conditioning service, coolant system service; the repair and installation of parts and accessories including brake parts, suspension parts, exhaust systems, front end parts, ignition parts, belts, hoses, clutches, filters, radios, alarms, sun roofs, cruise controls, and various other merchandise sold in Pep Boys' stores; installation and balancing of tires, and oil and lubrication services.
The Company coordinates the operation and merchandising of each store through a network of district and regional managers. The regional managers report to one of three divisional Vice Presidents - Store Operations and one Vice President - Service Operations, who report to the Company's Senior Vice President - Store Operations who reports to the Company's Executive Vice President and Chief Operating Officer. Supervision and control over the individual stores are facilitated by means of the Company's computer system, operational handbooks and regular visits to the individual stores by the district operations managers and loss prevention personnel.
All of the Company's advertising, accounting, management information systems, purchasing and most administrative functions are conducted at its corporate headquarters in Philadelphia, Pennsylvania. Certain administrative functions for the Company's western, southwestern, southeastern, midwest and Puerto Rico operations are performed at various regional offices of the Company. See "Properties."
INVENTORY CONTROL AND DISTRIBUTION
Almost all of the Company's merchandise is distributed to its stores from its warehouses by Company-owned or leased trucks. Target levels of inventory for each product have been established for each of the Company's warehouses and stores and are based upon prior shipment history, sales trends and seasonal demand. Inventory on hand is compared to the target levels on a weekly basis at each warehouse. If the inventory on hand at a warehouse is below the target levels, the Company's buyers order merchandise from its suppliers.
Each Pep Boys store has an automatic inventory replenishment system that automatically orders additional inventory when a store's inventory on hand falls below the target level. In addition, the Company's centralized buying system, coupled with continued advancement in its warehouse and distribution systems has greatly enhanced the Company's ability to control its inventory.
SUPPLIERS
During fiscal 1996, the Company's ten largest suppliers accounted for approximately 38% of the merchandise purchased by the Company. No single supplier accounted for more than 10% of the Company's purchases. The Company has no long-term contracts for the purchase of merchandise. Management believes that the relationships the Company has established with its suppliers are generally good.
In the past, the Company has not experienced difficulty in obtaining satisfactory sources of supply and believes that adequate alternative sources of supply exist, at substantially similar cost, for virtually all types of merchandise sold in its stores.
COMPETITION
The business of the Company is generally highly competitive. The Company encounters competition from nationwide and regional chains and from local independent merchants. Some of the Company's competitors are general, full range, discount or traditional department stores which carry automotive parts and accessories and/or have automotive service centers, and others, similar to the Company, are specialized automotive service retailers. Certain of its competitors are larger in terms of sales volume, store size, and/or number of stores, have access to greater capital and management resources and have been operating longer in particular geographic areas than the Company.
Although the Company's competition varies by geographical area, the Company believes that it generally has a favorable competitive position in terms of depth and breadth of product line, price, quality of personnel and customer service.
In addition, the Company believes that its operation of service bays in its SUPERCENTERS positively differentiates it from most of its competitors by providing its customers with the ability to purchase parts and have them installed at the same location. The Company believes that the warranty policies in connection with the higher priced items it sells, such as tires, batteries, brake linings and other major automotive parts and accessories, are comparable or superior to those of its competitors.
EMPLOYEES
At February 1, 1997, the Company employed 20,489 persons as follows:
Of the 1,277 full-time and part-time warehouse employees referred to above, 340 employees at the Company's New Jersey warehouse facilities are members of a union. The Company believes employee relations are generally good. At the end of fiscal 1995, the Company employed approximately 13,186 full-time and 4,405 part-time employees and at the end of fiscal 1994, the Company employed approximately 11,804 full-time and 4,070 part-time employees.
EXECUTIVE OFFICERS OF THE COMPANY
The following table indicates the names, ages, years with the Company and positions (together with the year of election to such positions) of the executive officers of the Company:
Years with Position with the Company and Name Age Company Date of Election to Position - --------------------- --- ---------- -----------------------------
Mitchell G. Leibovitz 51 18 Chairman of the Board since March 1994; Chief Executive Officer since March 1990; President since 1986
Wendel H. Province 49 7 Executive Vice President since November 1994; Chief Operating Officer since March 1993
Michael J. Holden 45 17 Executive Vice President since March 1996; Senior Vice President & Chief Financial Officer since March 1987
Frederick A. Stampone 41 14 Senior Vice President since March 1987; Chief Administrative Officer since March 1993; Secretary since December 1988
Mark L. Page 40 21 Senior Vice President - Store Operations since March 1993
Messrs. Leibovitz, Province, Holden and Stampone have been executive officers of the Company for more than the past five years. Mr. Page has been an executive officer of the Company for less than the past five years. Mr. Page was a regional manager for the Company from February 1987 until February 1991 when he was elected Vice President - Western Store Operations. On March 14, 1993, Mr. Page became Senior Vice President - Store Operations. Each of the officers serves at the pleasure of the Board of Directors of the Company. There are no arrangements or understandings pursuant to which any officer was elected to office.
ITEM 2
ITEM 2 PROPERTIES
The Company's headquarters in Philadelphia, Pennsylvania, which also serves as an administrative regional office for its eastern operations, occupies a five-story structure owned by the Company with approximately 300,000 square feet of floor space. The Company occupies approximately 30,000 square feet of a 60,000 square foot, three-story structure which the Company owns located in Los Angeles, California which serves as an administrative regional office for its western operations. The Company leases approximately 4,000 square feet of office space in each of Decatur, Georgia; Richardson, Texas; and owns approximately 4,000 square feet of office space in each of Melrose Park, Chicago; and Bayamon, Puerto Rico, all of which serve as administrative regional offices.
Of the 604 store locations operated by the Company at February 1, 1997, 346 are owned and 258 are leased. Of the 258 leased store locations, 114 are fully leased and 144 are ground leases only.
The following table sets forth certain information regarding the owned and leased warehouse space utilized by the Company for its 604 store locations at February 1, 1997.
To meet its current expansion requirements the Company plans to open a 400,000 square foot, leased warehouse facility in Plainfield, Indiana in June 1997. Additionally, the Company plans to open a 240,000 square foot, leased warehouse facility in Northern California in late 1997.
The Company anticipates that its existing and planned warehouse space will accommodate inventory necessary to support store expansion and any increase in stock-keeping units through the end of fiscal 1997.
The Company is subject to federal, state and local provisions relating to the protection of the environment, including provisions with respect to the disposal of oil at its store locations. Estimated capital expenditures relating to compliance with such environmental provisions are not deemed material.
ITEM 3
ITEM 3 LEGAL PROCEEDINGS The Company is a defendant in a purported class action entitled "Brian Lee, Anthony Baxton, and Harry Schlein v. The Pep Boys - Manny, Moe & Jack," United States District Court for the Southern District of Alabama, Southern Division. The action was originally filed on or about May 21, 1996 in the Circuit Court of Mobile County, Alabama. The Company has since removed the case to Federal Court, and the plaintiffs have filed a motion to remand the case back to Alabama State Court. The Company has also moved to dismiss the case for failure to state a claim. The plaintiffs' motion to remand and the Company's motion to dismiss are pending before the Federal District Court. In their complaint, the plaintiffs allege that the Company sold old or used automotive batteries to consumers as if those batteries were new. The complaint purports to state causes of action for fraud and deceit, negligent misrepresentation, breach of contract and violation of state consumer protection statutes. The plaintiffs are seeking compensatory and punitive damages, as well as injunctive and equitable relief. The Company believes the claims are without merit and intends to vigorously defend this action. The Company is also party to various other lawsuits and claims arising in the normal course of business. In the opinion of management, these lawsuits and claims, including the case above, are not singularly or in the aggregate, material to the Company's financial position or results of operations.
ITEM 4
ITEM 4 SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS No matters were submitted to a vote of security holders, through the solicitation of proxies or otherwise, during the fourth quarter of the fiscal year ended February 1, 1997.
PART II ITEM 5
ITEM 5 MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
The common stock of The Pep Boys - Manny, Moe & Jack is listed on the New York Stock Exchange under the symbol "PBY". There were 4,336 registered shareholders as of February 1, 1997. The following table sets forth for the periods listed, the high and low sale prices and the cash dividends paid on the Company's common stock.
It is the present intention of the Company's Board of Directors to continue to pay regular quarterly cash dividends; however, the declaration and payment of future dividends will be determined by the Board of Directors in its sole discretion and will depend upon the earnings, financial condition and capital needs of the Company and other factors which the Board of Directors deems relevant.
FISCAL 1996 vs. FISCAL 1995
Total revenues for fiscal 1996, which included 52 weeks, increased 15% over fiscal 1995, which included 53 weeks, due to a higher store count (604 at February 1, 1997 compared with 506 at February 3, 1996) coupled with a 4% increase in comparable store revenues (revenues generated by stores in operation during the same months of each period). Comparable store merchandise sales increased 4% while comparable store service revenue increased 6%.
The increase in gross profit from merchandise sales, as a percentage of merchandise sales, was due primarily to significantly higher merchandise margins and a decrease in warehousing costs, offset, in part, by an increase in store occupancy costs.
The increase in gross profit from service revenue, as a percentage of service revenue, was due primarily to a decrease in service center employee benefits expense.
The increase in selling, general and administrative expenses, as a percentage of total revenues, was due primarily to increases in store expenses and general office costs.
Interest expense decreased, as a percentage of total revenues, due primarily to lower interest rates, partially offset by higher debt levels incurred to fund the Company's store expansion program.
The 24% increase in net earnings in fiscal 1996, as compared with fiscal 1995, was due primarily to increases in total and comparable store revenues, a substantial increase in gross profit from merchandise sales, as a percentage of merchandise sales, an increase in gross profit from service revenue, as a percentage of service revenue and lower interest expense, as a percentage of total revenues, offset, in part, by higher selling, general and administrative expenses, as a percentage of total revenues.
FISCAL 1995 vs. FISCAL 1994
Total revenues for fiscal 1995, which included 53 weeks, increased 13% over fiscal 1994 due to a higher store count (506 at February 3, 1996 compared with 435 at January 28, 1995). Comparable store revenues (revenues generated by stores in operation during the same months of each period) increased 1%. Comparable store merchandise sales decreased 1% while comparable store service revenue increased 7%.
The increase in gross profit from merchandise sales, as a percentage of merchandise sales, was due primarily to higher merchandise margins, offset, in part, by increases in store occupancy and warehousing costs.
The increase in gross profit from service revenue, as a percentage of service revenue, was due primarily to decreases in service payroll and service center occupancy costs.
The increase in selling, general and administrative expenses, as a percentage of total revenues, was due primarily to increases in store, general office and employee benefits expenses, offset, in part, by a decrease in media costs.
The 24% increase in interest expense was due to higher debt levels incurred during the year to fund the Company's store expansion program coupled with higher interest rates.
The 2% increase in net earnings before the cumulative effect of a change in accounting principle in fiscal 1995, as compared with fiscal 1994, was due primarily to increases in gross profit from merchandise sales, as a percentage of merchandise sales, and gross profit from service revenue, as a percentage of service revenue, offset, in part, by increases in selling, general and administrative expenses and interest expense, as a percentage of total revenues.
EFFECTS OF INFLATION
The Company uses the LIFO method of inventory valuation. Thus, the cost of merchandise sold approximates current cost. Although the Company cannot accurately determine the precise effect of inflation on its operations, it does not believe inflation has had a material effect on revenues or results of operations during fiscal 1996, fiscal 1995 or fiscal 1994.
LIQUIDITY AND CAPITAL RESOURCES
The Company's cash requirements arise principally from the need to finance the acquisition, construction and equipping of new stores and to purchase inventory. The Company opened 100 stores in fiscal 1996, 75 stores in fiscal 1995 and 51 stores in fiscal 1994. In fiscal 1996, with increased levels of capital expenditures, the Company increased its debt by $43,550,000. In fiscal 1995, with an increase in cash from operating activities, the Company decreased its debt by $22,507,000. In fiscal 1994, with increased levels of capital expenditures coupled with cash utilized to purchase its stock for transfer to the Flexitrust, a flexible employee benefits trust (established April 29, 1994 to fund a portion of the Company's obligations arising from various employee compensation and benefit plans and holding 2,232,500 shares of Common Stock as of February 1, 1997), the Company increased its debt by $182,859,000.
Inventories have increased in the past three years as the Company added a net of 218 stores while the average number of stock-keeping units per store rose during the period from approximately 24,000 to approximately 27,000, many of which are higher cost hard parts.
The Company currently plans to open approximately 120 new stores in fiscal 1997. Management estimates that the cost to open all 120 stores, coupled with capital expenditures relating to existing stores, warehouses and offices during fiscal 1997, will be approximately $250,000,000. The funds required to finance the store expansion, including related inventory requirements, are expected to come primarily from operating activities, with the remainder provided by unused lines of credit, which totaled $266,000,000 at February 1, 1997, or from accessing traditional lending sources which may include the public capital markets.
On August 25, 1994, the Company sold $86,250,000 of 4% convertible subordinated notes due September 1, 1999. Proceeds were used to repay portions of the Company's short-term variable-rate bank debt.
On April 21, 1995, the Company amended and restated a revolving credit agreement it had with several major banks to increase the amount of borrowings provided from up to $100,000,000 to up to $200,000,000. At the Company's option, the interest rate on any loan may be based on (i) the higher of the Federal funds rate plus 1/4% or the prime rate, (ii) LIBOR plus up to .63% or (iii) a negotiated rate based upon market conditions.
On June 12, 1995, the Company sold $100,000,000 of 7% Notes due June 1, 2005. Proceeds were used to repay portions of the Company's long-term variable-rate bank debt, and for general corporate purposes.
On September 20, 1996, the Company received net proceeds of $146,250,000 from the sale of zero coupon subordinated Liquid Yield Option Notes due 2011 which have an aggregate principal amount at maturity of $271,704,000. The notes were issued at a discount representing a yield to maturity of 4%. Proceeds from the notes were used to repay the Company's short-term variable-rate bank debt and portions of the Company's long-term variable-rate bank debt and for general corporate purposes.
The Company's working capital was $70,691,000 at February 1, 1997, $39,868,000 at February 3, 1996 and $121,858,000 at January 28, 1995. The Company's long-term debt, as a percentage of its total capitalization, was 37% at February 1, 1997, 36% at February 3, 1996 and 39% at January 28, 1995.
FUTURE ACCOUNTING STANDARD
In February 1997, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards (SFAS) No. 128, "Earnings per Share." This new standard requires dual presentation of basic and diluted earnings per share (EPS) on the face of the statement of earnings and requires reconciliation of the numerators and denominators of the basic and diluted EPS calculations. This statement will be effective for the fourth quarter of the Company's 1997 fiscal year. Assuming the Company had adopted the provisions of SFAS No. 128, the pro forma effect on the Company's EPS calculations for the last three fiscal years are as follows: 1996 - as reported: $1.62, basic: $1.67; 1995 - as reported: $1.34, basic: $1.37; and 1994 - as reported: $1.25, basic: $1.28. For the fiscal year ended January 28, 1995, both as reported and pro forma basic EPS information include a $.07 per share charge from the cumulative effect of an accounting change for postemployment benefits. The Company's reported EPS calculations are the same as pro forma diluted EPS.
ITEM 8
ITEM 8 FINANCIAL STATEMENT AND SUPPLEMENTARY DATA
INDEPENDENT AUDITORS' REPORT Board of Directors and Stockholders The Pep Boys - Manny, Moe & Jack
We have audited the accompanying consolidated balance sheets of The Pep Boys - Manny, Moe & Jack and subsidiaries as of February 1, 1997 and February 3, 1996, and the related consolidated statements of earnings, stockholders' equity, and cash flows for each of the three years in the period ended February 1, 1997. Our audits also included the financial statement schedule listed in the Index at Item 14.