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		October 7,			December 31,
Assets		2006			2005
Current assets:
Cash and cash equivalents		$	13,987		$	40,783
Receivables, net			83,733			94,689
Inventories, net			1,462,067			1,367,099
Other current assets			38,207			45,369
Total current assets			1,597,994			1,547,940
Property and equipment, net of accumulated depreciation of
$650,978 and $564,558			983,609			898,851
Assets held for sale			2,777			8,198
Goodwill			33,765			67,094
Intangible assets, net			27,920			-
Other assets, net			15,520			20,066
		$	2,661,585		$	2,542,149
Liabilities and Stockholders' Equity
Current liabilities:
Bank overdrafts		$	36,689		$	50,170
Current portion of long-term debt			67			32,760
Financed vendor accounts payable			140,736			119,351
Accounts payable			669,720			629,248
Accrued expenses			257,334			265,437
Other current liabilities			48,953			44,498
Total current liabilities			1,153,499			1,141,464
Long-term debt			450,859			406,040
Other long-term liabilities			66,773			74,874
Commitments and contingencies
Stockholders' equity:
Preferred stock, nonvoting, $0.0001 par value,
10,000 shares authorized; no shares issued or outstanding			-			-
Common stock, voting, $0.0001 par value, 200,000
shares authorized; 105,208 shares issued and outstanding
in 2006 and 109,637 issued and 108,198 outstanding in 2005			11			11
Additional paid-in capital			405,597			564,965
Treasury stock, at cost, 1,439 shares in 2005			-			(55,668	)
Accumulated other comprehensive income			662			3,090
Retained earnings			584,184			407,373
Total stockholders' equity			990,454			919,771
		$	2,661,585		$	2,542,149

 

		Twelve Week Periods Ended						Forty Week Periods Ended
		October 7,			October 8,			October 7,			October 8,
		2006			2005			2006			2005
Net sales		$	1,099,486		$	1,019,736		$	3,600,353		$	3,301,246
Cost of sales, including purchasing and warehousing costs			569,280			538,321			1,877,620			1,736,850
Gross profit			530,206			481,415			1,722,733			1,564,396
Selling, general and administrative expenses			427,685			375,999			1,383,468			1,226,246
Operating income			102,521			105,416			339,265			338,150
Other, net:
Interest expense			(9,232	)		(8,196	)		(28,147	)		(24,682	)
Gain on extinguishment of debt, net			986			-			986			-
Other income, net			154			933			753			2,298
Total other, net			(8,092	)		(7,263	)		(26,408	)		(22,384	)
Income before provision for income taxes			94,429			98,153			312,857			315,766
Provision for income taxes			35,482			37,360			116,893			120,397
Net income		$	58,947		$	60,793		$	195,964		$	195,369
Basic earnings per share		$	0.56		$	0.56		$	1.84		$	1.80
Diluted earnings per share		$	0.56		$	0.55		$	1.82		$	1.78
Average common shares outstanding			105,112			109,306			106,380			108,329
Dilutive effect of stock options			939			1,635			1,175			1,720
Average common shares outstanding - assuming dilution			106,051			110,941			107,555			110,049

 

		Forty Week Periods Ended
		October 7,			October 8,
		2006			2005
Cash flows from operating activities:
Net income		$	195,964		$	195,369
Adjustments to reconcile net income to net cash provided by
operating activities:
Depreciation and amortization			104,156			90,693
Amortization of deferred debt issuance costs			482			478
Share-based compensation			14,473			237
Loss on disposal of property and equipment, net			1,520			789
Benefit for deferred income taxes			(2,332	)		(190	)
Excess tax benefit from share-based compensation			(4,398	)		-
Tax benefit related to exercise of stock options			-			28,469
Loss on extinguishment of debt			1,887			-
Net decrease (increase) in:
Receivables, net			10,995			30,489
Inventories, net			(90,966	)		(138,193	)
Other assets			9,031			(13,737	)
Net increase (decrease) in:
Accounts payable			40,472			67,255
Accrued expenses			17,056			63,774
Other liabilities			(1,337	)		1,876
Net cash provided by operating activities			297,003			327,309
Cash flows from investing activities:
Purchases of property and equipment			(200,784	)		(159,391	)
Business acquisitions, net of cash acquired			(12,500	)		(99,300	)
Proceeds from sales of property and equipment			8,726			5,818
Net cash used in investing activities			(204,558	)		(252,873	)
Cash flows from financing activities:
(Decrease) increase in bank overdrafts			(13,481	)		4,042
Increase in financed vendor accounts payable			21,385			60,793
Early extinguishment of debt			(433,775	)		-
Dividends paid			(19,153	)		-
Payments on note payable			(49	)		-
Borrowings under credit facilities			580,575			1,500
Payments on credit facilities			(134,625	)		(25,275	)
Payment of debt related costs			(1,078	)		-
Proceeds from the issuance of common stock, primarily exercise
of stock options			14,100			30,155
Excess tax benefit from share-based compensation			4,398			-
Repurchase of common stock			(137,560	)		(62,552	)
Increase (decrease) in borrowings secured by trade receivables			22			(26,716	)
Net cash used in financing activities			(119,241	)		(18,053	)
Net (decrease) increase in cash and cash equivalents			(26,796	)		56,383
Cash and cash equivalents, beginning of period			40,783			56,321
Cash and cash equivalents, end of period		$	13,987		$	112,704
Supplemental cash flow information:
Interest paid		$	23,415		$	18,481
Income tax payments, net			101,322			68,087
Non-cash transactions:
Accrued purchases of property and equipment			31,958			34,403
Repurchases of common stock not settled			-			2,391
Retirement of common stock			192,339			193,185
Reclassification of net gain on hedges into earnings			(2,873	)		-
Unrealized gain on hedge arrangements			445			1,457

 

 

Management Overview 

During the third quarter of fiscal 2006, we recorded earnings per diluted share of $0.56 compared to $0.55 for the same quarter of fiscal 2005. These results were primarily driven by increased sales and higher gross margins offset by the loss of leverage on certain fixed operating expenses as a result of our lower than expected sales increase. Additionally, our operating results for the third quarter include the recognition of $0.03 of share-based compensation expense per diluted share required by the adoption of SFAS No. 123R on January 1, 2006.

 

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We believe the macroeconomic environment has continued to negatively impact our business throughout much of our third quarter and resulted in weakening trends in our 2006 results compared to the same periods of last year. We believe our customers have been adversely impacted by rising energy prices, higher insurance and interest rates, and larger required minimum payments on their credit card balances, which limit their current ability to spend.

 

We have established a high priority of examining our operating expenses, including both corporate and store-level, in light of our current sales trends. We believe we can continue to be more efficient in our corporate-level expenses by optimizing a number of job functions, being more selective in areas such as meetings and travel and re-evaluating all third party service providers. Second, we continue to examine our non-sales activities in our stores and the impact of those activities on our operating expenses. In addition to rolling out energy-management systems to a significant number of our stores, we are evaluating a number of administrative procedures performed by our store team members in an effort to better optimize their time.

More recent economic indicators suggest a more positive outlook including the moderation in energy prices, leveling of interest rates and absence of severe hurricanes. We also believe the factors that favorably impact our industry continue to remain strong. Customers can only defer necessary maintenance on their automobiles for so long, and we continue to educate customers about the value of performing certain types of maintenance and enhancements. We believe the combination of these favorable industry dynamics along with the execution of our business initiatives discussed in our fiscal 2005 annual report on Form 10-K and our more recent effort to examine operating expenses will continue to drive our earnings growth into the foreseeable future.

The following table highlights certain operating results and key metrics for the twelve and forty weeks ended October 7, 2006, and October 8, 2005.

 

			Twelve Weeks Ended						Forty Weeks Ended
			October 7, 2006			October 8, 2005			October 7, 2006			October 8, 2005
	Total net sales (in thousands)		$	1,099,486		$	1,019,736		$	3,600,353		$	3,301,246
	Total commercial net sales (in thousands)		$	277,894		$	227,081		$	900,483		$	700,790
	Comparable store net sales growth			1.4%			10.0%			2.3%			9.4%
	DIY comparable store net sales growth			(0.6%)			6.1%			(0.3%)			5.3%
	DIFM comparable store net sales growth			8.7%			26.5%			11.7%			27.0%
	Average net sales per store (in thousands)		$	1,561		$	1,525		$	1,561		$	1,525
	Inventory per store (in thousands)		$	483		$	486		$	483		$	486
	Selling, general and administrative expenses per store (in thousands)		$	141		$	133		$	457		$	433
	Inventory turnover			1.69			1.71			1.69			1.71
	Gross margin			48.2%			47.2%			47.8%			47.4%
	Operating margin			9.3%			10.3%			9.4%			10.2%

 

Note:

These metrics should be read along with the footnotes to the table setting forth our selected store data in Item 6. "Selected Financial Data" in our annual report on Form 10-K for the fiscal year ended December 31, 2005, which was filed with the SEC on March 16, 2006. The footnotes describe the calculation of the metrics. Average net sales per store and inventory turnover for the interim periods presented above were calculated using results of operations from the last 13 accounting periods.

Key 3^rd Quarter Events

The following key events occurred during our third quarter of 2006:

 

·  We opened our 3,000^th store

·  We completed the refinancing of our previous secured credit facility to an unsecured revolving credit facility

 

 

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Refinancing

On October 5, 2006, we entered into a new $750 million unsecured five-year revolving credit facility. This new facility replaced the term loans and revolver under our previous secured credit facility. Initial proceeds from this revolving loan were used to repay $434 million of principal outstanding on the term loans and revolver under our previous credit facility. As a result of the improved borrowing costs under the new facility, we anticipate pre-tax interest expense savings of more than $2.5 million annually. In conjunction with this refinancing, we wrote-off existing deferred financing costs related to our previous term loans and revolver. The write-off of these costs of $1.9 million was combined with a related gain on settlement of interest rate swaps of $2.9 million for a net gain on extinguishment of debt of $1.0 million.

Store Count

At October 7, 2006, we operated 3,029 stores within the United States, Puerto Rico and the Virgin Islands. We operated 2,912 stores throughout 40 states in the Northeastern, Southeastern and Midwestern regions of the United States. These stores operated under the “Advance Auto Parts” trade name except for certain stores in the state of Florida, which operated under the “Advance Discount Auto Parts” trade name. These stores offer automotive replacement parts, accessories and maintenance items, with no significant concentration in any specific product area. In addition, we operated 37 stores under the “Western Auto” and “Advance Auto Parts” trade names, located primarily in Puerto Rico and the Virgin Islands. The Western Auto stores offer automotive tires and service in addition to automotive parts, accessories and maintenance items. At October 7, 2006, we also operated 80 stores under the “Autopart International” trade name throughout the Northeastern region of the United States.

The following table sets forth information about our stores, including the number of new, closed and relocated stores, during the twelve and forty weeks ended October 7, 2006. We lease approximately 81% of our stores.

		Twelve Weeks Ended October 7, 2006			Forty Weeks Ended October 7, 2006
Number of stores at beginning of period			2,971			2,872
New stores			60			162
Closed stores			(2	)		(5	)
Number of stores, end of period			3,029			3,029
Relocated stores			10			31
Stores with commercial programs (a)			2,478			2,478

 

(a)	As of October 7, 2006, these commercial programs include the 80 AI stores.

We anticipate that we will add a total of approximately 205 to 215 new stores during 2006 primarily through new store openings, excluding any acquisitions.

Commercial Program

Our commercial program continued to produce favorable results during the twelve and forty weeks ended October 7, 2006 and continued to expand at an expected rate. We attribute this performance to the execution of our commercial plan as previously detailed in our fiscal 2005 annual report on Form 10-K.

Commercial sales represented approximately 25% of our total sales for both the twelve and forty weeks ended October 7, 2006 compared to approximately 22% and 21% for the twelve and forty weeks ended October 8, 2005, respectively. As of October 7, 2006, we operated commercial programs in 81% of our total stores, excluding the 80 AI stores, an increase from approximately 78% at the end of the prior year quarter. We continued to approach our goal of operating commercial programs in approximately 85% of our Advance Auto Parts store base. We believe we have the potential to grow profitably our share of the commercial business in each of our markets.

 

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Although our comparable store sales growth in commercial business was slightly lower than our target for the second and third quarters, we believe we have the opportunity to achieve double-digit comparable store sales growth in this business for the foreseeable future through the continued execution of our commercial plan and growth in our commercial programs. We believe the acquisition of AI supplements our commercial growth due to AI’s established delivery programs and knowledge of the commercial industry, particularly for foreign makes and models of vehicles.

Share-Based Payments

On January 1, 2006, we adopted the provisions of Statement of Financial Accounting Standard, or SFAS, No. 123 (revised 2004), "Share-Based Payment," or SFAS No. 123R. SFAS No. 123R replaces SFAS No. 123 and supersedes APB Opinion No. 25 and subsequently issued stock option related guidance. We elected to use the modified-prospective method of implementation. Under this transition method, share-based compensation expense for the twelve and forty weeks ended October 7, 2006 included compensation expense for all share-based awards granted subsequent to January 1, 2006 based on the grant-date fair value estimated in accordance with the provisions of SFAS No. 123R, and compensation expense for all share-based awards granted prior to but unvested as of January 1, 2006 based on the grant-date fair value estimated in accordance with original provisions of SFAS No. 123.

We use the Black-Scholes option-pricing model to value all options and straight-line method to amortize this fair value as compensation cost over the requisite service period. Total share-based compensation expense included in selling, general and administrative expenses in our statements of operations for the twelve and forty weeks ended October 7, 2006 was $4.6 million and $14.5 million, respectively. The related income tax benefit was $1.7 million and $5.4 million, respectively. We did not have any share-based compensation expense in accordance with APB No. 25 for the twelve weeks ended October 8, 2005. We recognized $0.2 million of share-based compensation expense in accordance with APB No. 25 for the forty weeks ended October 8, 2005. On a pro forma basis, share-based compensation was $.02 and $.07 per diluted share for the twelve and forty weeks ended October 8, 2005, respectively. In accordance with the modified-prospective transition method of SFAS No. 123R, we have not restated prior periods.

As a result of adopting SFAS No. 123R on January 1, 2006, our earnings before income tax expense and net earnings for the twelve weeks ended October 7, 2006, were $4.6 million and $2.9 million lower, respectively, than if we had continued to account for share-based compensation under APB No. 25. Our earnings before income tax expense and net earnings for the forty weeks ended October 7, 2006, were $14.2 million and $8.9 million lower, respectively, than if we had continued to account for share-based compensation under APB No. 25. The related impact in 2006 to basic and diluted earnings per share is $0.03 and $0.08 for the twelve and forty weeks ended October 7, 2006, respectively.

 

As of October 7, 2006, we have $30.9 million of unrecognized compensation expense related to non-vested fixed stock options we expect to recognize over a weighted average period of 2.0 years.

 

Critical Accounting Policies

Our financial statements have been prepared in accordance with accounting policies generally accepted in the United States of America. Our discussion and analysis of the financial condition and results of operations are based on these financial statements. The preparation of these financial statements requires the application of accounting policies in addition to certain estimates and judgments by our management. Our estimates and judgments are based on currently available information, historical results and other assumptions we believe are reasonable. Actual results could differ from these estimates. During the first, second and third quarters of fiscal 2006, we consistently applied the critical accounting policies discussed in our annual report on Form 10-K for the year ended December 31, 2005. For a complete discussion regarding these critical accounting policies, refer to this annual report on Form 10-K. In addition to these critical accounting policies, we have added “Share-Based Payments” as a critical accounting policy upon the adoption of SFAS No. 123R as of January 1, 2006.

Share-Based Payments

We account for our share-based compensation plans as prescribed by the fair value provisions of SFAS No. 123R. We use the Black-Scholes option-pricing model to determine the fair value of our stock options. This model

 

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requires the input of certain assumptions, including the expected life of stock options, expected stock price volatility and the estimate of stock option forfeitures. If actual results are different from these assumptions, the share-based compensation expense reported in our financial statements may not be representative of the actual economic cost of the share-based compensation. In addition, significant changes in these assumptions could materially impact our share-based compensation expense on future awards. 

Components of Statement of Operations

Net Sales

Net sales consist primarily of comparable store sales and new store net sales. We calculate comparable store sales based on the change in net sales starting once a store has been open for 13 complete accounting periods. We include relocations in comparable store sales from the original date of opening. We exclude net sales from the 37 Western Auto retail stores and 80 AI stores from our comparable store sales as a result of their unique product offerings.

Cost of Sales

Our cost of sales consists of merchandise costs, net of incentives under vendor programs, inventory shrinkage and warehouse and distribution expenses. Gross profit as a percentage of net sales may be affected by variations in our product mix, price changes in response to competitive factors and fluctuations in merchandise costs and vendor programs. We seek to avoid fluctuation in merchandise costs and instability of supply by entering into long-term purchase agreements with vendors when we believe it is advantageous.

Selling, General and Administrative Expenses

Selling, general and administrative expenses consist of store payroll, store occupancy (including rent), advertising expenses, other store expenses and general and administrative expenses, including salaries and related benefits of store support center team members, share-based compensation, store support center administrative expenses, data processing, professional expenses and other related expenses.

Results of Operations

The following table sets forth certain of our operating data expressed as a percentage of net sales for the periods indicated.

 

		Twelve Week Periods Ended (unaudited)						Forty Week Periods Ended (unaudited)
		October 7, 2006			October 8, 2005			October 7, 2006			October 8, 2005
Net sales			100.0	%		100.0	%		100.0	%		100.0	%
Cost of sales, including purchasing and warehousing costs			51.8			52.8			52.2			52.6
Gross profit			48.2			47.2			47.8			47.4
Selling, general and administrative expenses			38.9			36.9			38.4			37.2
Operating income			9.3			10.3			9.4			10.2
Interest expense			(0.8	)		(0.8	)		(0.8	)		(0.8	)
Gain on extinguishment of debt, net			0.1			0.0			0.0			0.0
Other income, net			0.0			0.1			0.0			0.1
Provision for income taxes			3.2			3.6			3.2			3.6
Net income			5.4	%		6.0	%		5.4	%		5.9	%

 

Twelve Weeks Ended October 7, 2006 Compared to Twelve Weeks Ended October 8, 2005

 

Net sales for the twelve weeks ended October 7, 2006 were $1,099.5 million, an increase of $79.8 million, or 7.8%, as compared to net sales for the twelve weeks ended October 8, 2005. The net sales increase was due to an increase in comparable store sales of 1.4%, contributions from new stores opened within the last year and sales from operations acquired during our third quarter of fiscal 2005. The comparable store sales increase resulted from an

 

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increase in average ticket sales and customer traffic in our do-it-for-me, or DIFM, business and an increase in average ticket sales by our do-it-yourself, or DIY, customers offset by a decrease in DIY customer count.

Gross profit for the twelve weeks ended October 7, 2006 was $530.2 million, or 48.2% of net sales, as compared to $481.4 million, or 47.2% of net sales, for the twelve weeks ended October 8, 2005. Gross profit increased as a percentage of net sales for the quarter due to the positive impact of ongoing category management initiatives, including improved procurement costs and a positive shift in sales mix, and logistics efficiencies.

Selling, general and administrative expenses increased to $427.7 million, or 38.9% of net sales, for the twelve weeks ended October 7, 2006, from $376.0 million, or 36.9% of net sales, for the twelve weeks ended October 8, 2005. Selling, general and administrative expenses increased as a percentage of sales as a result of:

 

·	recording share-based compensation expense of approximately 0.4% of net sales upon the implementation of SFAS 123R on January 1, 2006;
·	a 0.7% increase in certain fixed costs as a percentage of sales during the quarter, including rent and depreciation, as a result of low comparative sales growth; and
·	a 0.6% increase in expenses associated with higher costs for utilities and insurance programs.

 

Interest expense for the twelve weeks ended October 7, 2006 was $9.2 million, or 0.8% of net sales, as compared to $8.2 million, or 0.8% of net sales, for the twelve weeks ended October 8, 2005. In addition, interest income for the twelve weeks ended October 7, 2006 decreased as a result of overall lower cash balances during the period.

Income tax expense for the twelve weeks ended October 7, 2006 was $35.5 million, as compared to $37.4 million for the twelve weeks ended October 8, 2005. Our effective income tax rate was 37.6% for the twelve weeks ended October 7, 2006 compared to 38.1% for the same period ended October 8, 2005.

We produced net income of $58.9 million, or $0.56 per diluted share, for the twelve weeks ended October 7, 2006, as compared to $60.8 million, or $0.55 per diluted share, for the twelve weeks ended October 8, 2005. As a percentage of net sales, net income for the twelve weeks ended October 7, 2006 was 5.4%, as compared to 6.0% for the twelve weeks ended October 8, 2005. Our earnings per diluted share results reflect the impact on both earnings and the diluted share count of implementing SFAS 123R as further explained in this management’s discussion and analysis and in the notes to our financial statements contained elsewhere in this Form 10-Q.

Forty Weeks Ended October 7, 2006 Compared to Forty Weeks Ended October 8, 2005

Net sales for the forty weeks ended October 7, 2006 were $3,600.4 million, an increase of $299.1 million, or 9.1%, as compared to net sales for the forty weeks ended October 8, 2005. The net sales increase was due to an increase in comparable store sales of 2.3%, contributions from new stores opened within the last year and sales from operations acquired during our third quarter of fiscal 2005. The comparable store sales increase resulted from an increase in average ticket sales and customer traffic in our DIFM business and an increase in average ticket sales by our DIY customers offset by a decrease in DIY customer count.

Gross profit for the forty weeks ended October 7, 2006 was $1,722.7 million, or 47.8% of net sales, as compared to $1,564.4 million, or 47.4% of net sales, for the forty weeks ended October 8, 2005. Gross profit increased as a percentage of net sales for the forty weeks ended October 7, 2006 quarter due to the positive impact of category management.

Selling, general and administrative expenses increased to $1,383.5 million, or 38.4% of net sales, for the forty weeks ended October 7, 2006, from $1,226.2 million, or 37.2% of net sales, for the forty weeks ended October 8, 2005. Selling, general and administrative expenses increased as a percentage of sales as a result of a 0.4% increase in certain fixed costs as a percentage of sales during the forty weeks ended October 7, 2006, including rent and depreciation, reflective of lower than anticipated comparative sales growth. Additionally, as previously mentioned, we have recorded share-based compensation expense of approximately 0.4% of net sales upon the implementation of SFAS 123R on January 1, 2006.

 

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Interest expense for the forty weeks ended October 7, 2006 was $28.1 million, or 0.8% of net sales, as compared to $24.7 million, or 0.8% of net sales, for the forty weeks ended October 8, 2005. The increase in interest expense reflects overall higher interest rates, as compared to the forty weeks ended October 8, 2005. In addition, interest income for the forty weeks ended October 7, 2006 decreased as a result of overall lower cash balances during the period.

Income tax expense for the forty weeks ended October 7, 2006 was $116.9 million, as compared to $120.4 million for the forty weeks ended October 8, 2005. Our effective income tax rate was 37.4% for the forty weeks ended October 7, 2006 compared to 38.1% for the same period ended October 8, 2005.

We produced net income of $196.0 million, or $1.82 per diluted share, for the forty weeks ended October 7, 2006, as compared to $195.4 million, or $1.78 per diluted share, for the forty weeks ended October 8, 2005. As a percentage of net sales, net income for the forty weeks ended October 7, 2006 was 5.4%, as compared to 5.9% for the forty weeks ended October 8, 2005. Our earnings per diluted share results reflect the impact on both earnings and the diluted share count of implementing SFAS 123R as further explained in this management’s discussion and analysis and in the notes to our financial statements contained elsewhere in this Form 10-Q.

 

Liquidity and Capital Resources

 

Overview of Liquidity

Our primary cash requirements include the purchase of inventory, capital expenditures, payment of cash dividends and contractual obligations. In addition, we have used available funds to repurchase shares of common stock under our stock repurchase program. We have funded these requirements primarily through cash generated from operations supplemented by borrowings under our credit facilities as needed.

At October 7, 2006, our cash balance was $14.0 million, a decrease of $26.8 million compared to December 31, 2005. Our cash balance decreased primarily due to the repurchase of common stock, dividends paid to our shareholders partially and an overall net increase in working capital during the forty weeks ended October 7, 2006. At October 7, 2006, we had outstanding indebtedness consisting of borrowings of $450.9 million under our revolving credit facility. In addition, we had $66.8 million in letters of credit outstanding, which reduced our total availability under the revolving credit facility to $232.8 million.

On August 8, 2006, our Board of Directors declared a quarterly dividend of $0.06 per share to all common stockholders of record as of September 22, 2006. The dividend was paid on October 6, 2006. Subsequent to October 7, 2006, our Board of Directors declared a quarterly dividend of $0.06 per share to be paid on January 5, 2007 to all common stockholders of record as of December 22, 2006.

Capital Expenditures

Our primary capital requirements have been the funding of our continued store expansion program, including new store openings and store acquisitions, store relocations and remodels, inventory requirements, the construction and upgrading of distribution centers, the development and implementation of proprietary information systems and our acquisitions.

Our capital expenditures were $200.8 million for the forty weeks ended October 7, 2006. These amounts included costs related to new store openings, the upgrade of our information systems, remodels and relocations of existing stores. In addition, we also made a $12.5 million payment related to the acquisition of Autopart International. In 2006, we anticipate that our capital expenditures will be approximately $255.0 million.

Our future capital requirements will depend in large part on the number of and timing for new stores we open or acquire within a given year and the number of stores we relocate or remodel. We anticipate adding approximately 205 to 215 new stores during 2006 primarily through new store openings. As of October 7, 2006, 162 new stores had been added.

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Vendor Financing Program

Historically, we have negotiated extended payment terms from suppliers that help finance inventory growth, and we believe that we will be able to continue financing much of our inventory growth through such extended payment terms. We have a short-term financing program with a bank for certain merchandise purchases. The substance of the program is for us to borrow money from the bank to finance purchases from our vendors. This program allows us to further reduce our working capital invested in current inventory levels and finance future inventory growth. Our new credit facility does not restrict availability under this program. At October 7, 2006, $140.7 million was payable to the bank by us under this program.

Stock Repurchase Program

During the third quarter of fiscal 2005, our Board of Directors authorized a stock repurchase program of up to $300 million of our common stock plus related expenses. The program allows us to repurchase our common stock on the open market or in privately negotiated transactions from time to time in accordance with the requirements of the Securities and Exchange Commission. Under this program, we repurchased 3.7 million shares of common stock during the forty weeks ended October 7, 2006 at an aggregate cost of $136.6 million, or an average price of $37.12 per share, excluding related expenses. We did not repurchase any shares of common stock during the twelve weeks ended October 7, 2006. At October 7, 2006, we had repurchased a total of 5.2 million shares of common stock under this program at an aggregate cost of $196.0 million, or an average price of $37.63 per share, excluding related expenses.

During the twelve and forty weeks ended October 7, 2006, we retired 3.1 million and 5.1 million shares of common stock, respectively, which were previously repurchased under the $300 million stock repurchase program.

Analysis of Cash Flows

An analysis of our cash flows for the forty week period ended October 7, 2006 as compared to the forty week period ended October 8, 2005 is included below.

 

	Forty Week Periods Ended
	October 7, 2006			October 8, 2005
	(in millions)
Cash flows from operating activities	$	297.0		$	327.3
Cash flows from investing activities		(204.6	)		(252.9	)
Cash flows from financing activities		(119.2	)		(18.0	)
Net (decrease) increase in cash and
cash equivalents	$	(26.8	)	$	56.4

 

Operating Activities

For the forty weeks ended October 7, 2006, net cash provided by operating activities decreased $30.3 million to $297.0 million, as compared to the forty weeks ended October 8, 2005. Significant components of this increase consisted of:

 

·	$14.8 million increase in earnings exclusive of $14.2 million of non-cash, share-based compensation expense compared to the same period in fiscal 2005;
·	$13.5 million increase in depreciation and amortization;
·	$19.5 million decrease in cash inflows relating to the timing of receipts for normal collections of receivables;
·	$20.4 million reduction in cash outflows, net of accounts payable, as a result of reducing inventory growth rates in line with our current sales trend;

 

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·	$22.8 million increase in cash flows from other assets related to the timing of payments for normal operating expenses, primarily our monthly rent;
·	$46.7 million decrease in cash inflows relating to the timing of accrued operating expenses; and
·	$28.5 million decrease in cash flows from tax benefits related to exercise of stock options.

 

Investing Activities

For the forty weeks ended October 7, 2006, net cash used in investing activities decreased by $48.3 million to $204.6 million, as compared to the forty weeks ended October 8, 2005. Significant components of this increase consisted of:

 

·	increase in capital expenditures of $41.4 million used primarily to accelerate our square footage growth through adding new stores (including ownership of selected new stores) and remodeling existing stores; and
·	$99.3 million related to acquisitions in prior year.

 

Financing Activities

For the forty weeks ended October 7, 2006, net cash used in financing activities increased by $101.2 million to $119.2 million, as compared to the forty weeks ended October 8, 2005. Significant components of this increase consisted of:

 

 

·	a $39.4 million cash outflow under our vendor financing program;
·	a $433.8 million cash outflow used to extinguish debt in connection with our 3rd quarter refinancing;
·	a $469.7 million net cash inflow from borrowings on credit facilities primarily related to our refinancing;
·	a $19.2 million reduction in cash used to pay dividends;
·	$16.1 million less cash received from the issuance of common stock, primarily resulting from the exercise of stock options; and
·	a $75.0 million cash outflow resulting from the additional repurchase of common stock.

Contractual Obligations

Our future contractual obligations related to long-term debt, operating leases and other contractual obligations at October 7, 2006 were as follows:

Contractual Obligations		Total			Fiscal 2006			Fiscal 2007			Fiscal 2008			Fiscal 2009			Fiscal 2010			Thereafter
(in thousands)
Long-term debt		$	450,926		$	11		$	67		$	75		$	71		$	73		$	450,629
Interest payments		$	135,949		$	12,897		$	26,061		$	25,510		$	25,752		$	26,015		$	19,714
Letters of credit		$	66,768		$	1,859		$	59,909		$	5,000		$	-		$	-		$	-
Operating leases		$	1,970,635		$	41,547		$	240,262		$	215,385		$	197,872		$	178,010		$	1,097,559
Purchase obligations (1)		$	740		$	115		$	500		$	125		$	-		$	-		$	-
Other long-term liabilities(2)		$	66,773		$	-		$	-		$	-		$	-		$	-		$	-

 

	(1)	For the purposes of this table, purchase obligations are defined as agreements that are enforceable and legally binding and that specify all significant terms, including: fixed or minimum quantities to be purchased; fixed, minimum or variable price provisions; and the approximate timing of the transaction. Our open purchase orders are based on current inventory or operational needs and are fulfilled by our vendors within short periods of time. We currently do not have minimum purchase commitments under our vendor supply agreements nor are our open purchase orders for goods and services binding agreements. Accordingly, we have excluded open purchase orders from this table. The purchase obligation consists of certain commitments for training and development. This agreement expires in March 2008.
	(2)	Primarily includes employee benefit accruals, restructuring and closed store liabilities and deferred income

 

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taxes for which no contractual payment schedule exists.

 

Long Term Debt

 

On October 5, 2006, we entered into a new $750 million unsecured five-year revolving credit facility with our subsidiary, Advance Stores Company, Incorporated, serving as the borrower. This new facility replaced the term loans and revolver under our previous credit facility. Proceeds from this revolving loan were used to repay $434 million of principal outstanding on the term loans and revolver under our previous credit facility. In conjunction with this refinancing, we wrote-off existing deferred financing costs related to our previous term loans and revolver. The $1.9 million write-off of these costs was combined with a related gain on settlement of interest rate swaps of $2.9 million for a net gain on extinguishment of debt of $1.0 million.

Additionally, the new facility provides for the issuance of letters of credit with a sub limit of $300 million and swingline loans in an amount not to exceed $50 million. We may request that the total revolving commitment be increased by an amount not exceeding $250 million during the term of the credit agreement. Voluntary prepayments and voluntary reductions of the revolving balance are permitted in whole or in part, at our option, in minimum principal amounts as specified in the new credit facility.

As of October 7, 2006, we had borrowed $450.5 million under the revolver and had $66.8 million in letters of credit outstanding, which reduced availability under the revolver to $232.8 million. At October 7, 2006, we also have interest rate swaps in place that effectively fix our interest rate exposure on approximately 50% of our debt. These interest rate swaps are further discussed in our market risk analysis.

The interest rates on the borrowings under the new revolving credit facility will be based, at our option, on an adjusted LIBOR rate, plus a margin, or an alternate base rate, plus a margin. After an initial interest period, we may elect to convert a particular borrowing to a different type. The initial margin is 0.75% and 0.0% per annum for the adjusted LIBOR and alternate base rate borrowings, respectively. A commitment fee will be charged on the unused portion of the revolver, payable in arrears. The initial commitment fee rate is 0.150% per annum. Under the terms of the new credit facility, the interest rate spread and commitment fee will be based on our credit rating. The revolving facility terminates on October 5, 2011.

The new credit facility is fully and unconditionally guaranteed by Advance Auto Parts, Inc. The facility contains covenants restricting the ability of us and our subsidiaries to, among other things, (1) create, incur or assume additional debt (including hedging arrangements), (2) incur liens or engage in sale-leaseback transactions, (3) make loans and investments, (4) guarantee obligations, (5) engage in certain mergers, acquisitions and asset sales, (6) engage in transactions with affiliates, (7) change the nature of our business and the business conducted by its subsidiaries and (8) change our holding company status. We are required to comply with financial covenants with respect to a maximum leverage ratio and a minimum coverage ratio. The new credit facility also provides for customary events of default, including non-payment defaults, covenant defaults and cross-defaults to our other material indebtedness.

We are required to comply with financial covenants in the revolving credit facility with respect to (a) a maximum leverage ratio and (b) a minimum interest coverage ratio. We were in compliance with the above covenants under the revolving credit facility at October 7, 2006. For additional information regarding our revolving credit facility, refer to our Form 8-K filed on October 12, 2006.

Credit Ratings

At October 7, 2006, we had a credit rating from Standard & Poor’s of BB+ and a credit rating of Ba1 from Moody’s Investor Service. The current pricing grid used to determine our borrowing rates under our revolving credit facility is based on such credit ratings. If these credit ratings decline, our interest expense may increase. Conversely, if these credit ratings improve, our interest expense may decrease.

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Seasonality

Our business is somewhat seasonal in nature, with the highest sales occurring in the spring and summer months. In addition, our business can be affected by weather conditions. While unusually heavy precipitation tends to soften sales as elective maintenance is deferred during such periods, extremely hot or cold weather tends to enhance sales by causing automotive parts to fail at an accelerated rate.

New Accounting Pronouncements

In September 2006, the FASB issued SFAS No. 158, “Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans, an amendment of FASB Statements No. 87, 88, 106, and 132(R).” SFAS No. 158 requires recognition of the overfunded or underfunded status of defined benefit postretirement plans as an asset or liability in the statement of financial position and to recognize changes in that funded status in comprehensive income in the year in which the changes occur. SFAS No. 158 also requires measurement of the funded status of a plan as of the date of the statement of financial position. SFAS No. 158 is effective for recognition of the funded status of the benefit plans for fiscal years ending after December 15, 2006 and is effective for the measurement date provisions for fiscal years ending after December 15, 2008. We are currently evaluating the impact of SFAS No. 158.

In September 2006, the FASB issued SFAS No. 157, “Fair Value Measurements.” SFAS No. 157 clarifies the definition of fair value, establishes a framework for measuring fair value, and expands the disclosures on fair value measurements. SFAS No. 157 is effective for fiscal years beginning after November 15, 2007. We are currently evaluating the impact of SFAS No. 157.

In July 2006, the FASB issued FASB Interpretation No. 48, “Accounting for Uncertainty in Income Taxes,” or FIN 48.  FIN 48 clarifies the accounting and reporting for income taxes recognized in accordance with SFAS No. 109, “Accounting for Income Taxes.” The interpretation prescribes a recognition threshold and measurement attribute for the financial statement recognition, measurement, presentation and disclosure of uncertain tax positions taken or expected to be taken in income tax returns. FIN 48 is effective for fiscal years beginning after December 15, 2006. We are currently evaluating the impact of FIN 48.

In March 2006, the FASB’s Emerging Issues Task Force, or EITF, released Issue 06-3, “How Sales Taxes Collected From Customers and Remitted to Governmental Authorities Should Be Presented in the Income Statement,” or EITF 06-3. A tentative consensus was reached that entities may adopt a policy of presenting sales taxes in the income statement on either a gross or net basis. If taxes are significant, an entity should disclose its policy of presenting taxes and the amount of taxes if reflected on a gross basis in the income statement. EITF 06-3 is effective for periods beginning after December 15, 2006. We present sales net of sales taxes in our consolidated statement of operations and do not anticipate changing our policy as a result of EITF 06-3.

In March 2006, the FASB issued SFAS No. 156, “Accounting for Servicing of Financial Assets - an amendment of FASB Statement No. 140.” SFAS No. 156 amends SFAS No. 140, “Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities,” with respect to the accounting for separately recognized servicing assets and servicing liabilities. SFAS No. 156 is effective for fiscal years beginning after September 15, 2006. We do not expect the adoption of SFAS No. 156 to have a material impact on our financial condition, results of operations or cash flows.  

In February 2006, the FASB issued SFAS No. 155, “Accounting for Certain Hybrid Financial Instruments - an amendment of FASB Statements No. 133 and 140.” This statement simplifies accounting for certain hybrid instruments currently governed by SFAS No. 133, “Accounting for Derivative Instruments and Hedging Activities,” or SFAS No. 133, by allowing fair value remeasurement of hybrid instruments that contain an embedded derivative that otherwise would require bifurcation. SFAS No. 155 also eliminates the guidance in SFAS No. 133 Implementation Issue No. D1, “Application of Statement 133 to Beneficial Interests in Securitized Financial Assets,” which provides such beneficial interests are not subject to SFAS No. 133. SFAS No. 155 amends SFAS No. 140, “Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities - a Replacement of FASB Statement No. 125,” by eliminating the restriction on passive derivative instruments that a qualifying special-

 

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purpose entity may hold. SFAS No. 155 is effective for financial instruments acquired or issued after the beginning of our fiscal year 2007. We do not expect the adoption of SFAS No. 155 to have a material impact on our financial condition, results of operations or cash flows.

We are exposed to cash flow risk due to changes in interest rates with respect to our long-term debt. Our long-term debt currently consists of borrowings under a revolving credit facility and is primarily vulnerable to movements in the LIBOR rate. While we cannot predict the impact interest rate movements will have on our debt, exposure to rate changes is managed through the use of hedging activities. At October 7, 2006, $225 million of our bank debt was fixed in accordance with the interest rate swaps described below.

Our future exposure to interest rate risk is mitigated as a result of entering into four new interest rate swap agreements in October 2006 on an aggregate of $225 million of debt under our revolving credit facility. The first swap fixed our LIBOR rate at 4.9675% on $75 million of debt for a term of 60 months, expiring in October 2011. The second swap fixed our LIBOR rate at 4.968% on $50 million of debt for a term of 60 months, expiring in October 2011. The third swap fixed our LIBOR rate at 4.98% on $50 million of debt for a term of 60 months, expiring in October 2011. The fourth swap fixed our LIBOR rate at 4.965% on $50 million of debt for a term of 60 months, expiring in October 2011.

The table below presents principal cash flows and related weighted average interest rates on our long-term debt outstanding at October 7, 2006, by expected maturity dates. Additionally, the table includes the notional amounts of our hedged debt and the impact of the anticipated average pay and receive rates of our interest rate swaps through their maturity dates. Expected maturity dates approximate contract terms. Weighted average variable rates are based on implied forward rates in the yield curve at October 7, 2006. Implied forward rates should not be considered a predictor of actual future interest rates.

 

		Fiscal 2006			Fiscal 2007			Fiscal 2008			Fiscal 2009			Fiscal 2010			Thereafter			Total			Fair Market Value
Long-term debt:		(dollars in thousands)
Variable rate		$	-		$	-		$	-		$	-		$	-		$	450,475		$	450,475		$	450,475
Weighted average
interest rate			6.1%			5.8%			5.6%			5.7%			5.8%			5.9%			5.8%			-
Interest rate swaps:
Variable to fixed (1)		$	225,000		$	225,000		$	225,000		$	225,000		$	225,000		$	225,000		$	-		$	662
Weighted average pay rate			0.0%			0.0%			0.1%			0.0%			0.0%			0.0%			0.0%			-
Weighted average receive rate			0.4%			0.1%			0.0%			0.0%			0.1%			0.1%			1.1%			-

 

(1)

Amounts presented may not be outstanding for the entire year.

 

 

Our management evaluated, with the participation of our principal executive officer and principal financial officer, the effectiveness of our disclosure controls and procedures as of the end of the period covered by this report. Based on this evaluation, our principal executive officer and our principal financial officer have concluded that, as of the end of the period covered by this report, our disclosure controls and procedures were effective. Disclosure controls and procedures mean our controls and other procedures that are designed to ensure that information required to be disclosed by us in our reports that we file or submit 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. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by us in our reports that we file or submit under the Securities Exchange Act of 1934 is accumulated and communicated to our management, including our principal executive officer and principal financial officer, as appropriate to allow timely decisions regarding required disclosure.

 

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There have been no changes in our internal control over financial reporting that occurred during the quarter ended October 7, 2006 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.