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