Tiresome and weary, Manny, Moe and Jack attempt to put some much needed 'pep' back into their business.
Pep Boys seemed fairly confident that an aggressive overhaul in late 2004 would help boost profits and give their name a fair shake on Wall Street. But in the course of the last year and a half, the media spotlight has continued to weigh heavy, and is still shedding some dismal light on their initiatives and turnaround strategy.
Bill Wade of Chicago-area Wade and Partners aftermarket consulting firm is worried about the state of fatigue they are in. "They have been through so many different strategies, if you look at any company that goes from one to another to another, that's what happened to Western Auto. Pretty soon there is just an organizational fatigue that takes over." He believes Pep Boys needs to settle on a rigid exercise strategy in order to successfully survive.
CEO Larry Stevenson was brought on board in 2003 to determine exactly what that rigid strategy would be. His past track record didn't look bad: He helped Chapters bookstores grow into the largest book retailer in Canada, so The Pep Boys' Board saw Stevenson as a good fit. In a corporate spotlight written by Red Coat Publishing, Stevenson said, "They saw me as someone who had gone into the retail sector and literally transformed it. I saw the same potential in Pep Boys. We were not using the large format in a way that was compelling to the customer. We had to rethink everything — product, pricing, advertising and what Pep Boys was going to be for the consumer."
Unfortunately, his efforts have brought forth lackluster results, according to some critics, including Barington Capital Group, an investment management agency that represents a group of investors that owns about 8 percent of the outstanding common stock of Pep Boys.
Jim Mitarotunda, chairman, president and CEO of Barington, believes that "the turnaround plan implemented under (Stevenson's) leadership has been poorly executed and unnecessarily disruptive to the company's two main businesses, leading to a significant decrease in shareholder value." They noted this in a letter to presiding director and now chairman William Leonard on Dec. 21, 2005.
But their harsh words didn't stop the Board from extending Stevenson's contract, originally scheduled to expire in April. Barington has repeatedly called for the Board to employ a new CEO as quickly as possible to stabilize the company's operations.
Labor pains?
From the beginning, part of Stevenson's problem involved labor management and the costs needed to maintain the stores and each of their 11 bays. In the last two years, new efforts were aimed at reducing expenses and eliminating an entire layer of field management in order to flatten the hierarchy. It also included the separation of management for its service and retail divisions, which required additional talent.
Liviu Dedes, director of training and organizational development for Pep Boys, said in an Executive Briefing with the Human Capital Institute, "It was a very painful growth spurt for us and as we looked at our internal talent pool it became evident very quickly that it was a shallow pool." To address this, they created an organizational competency model to help determine their core competencies, according to the report.RBC Capital Markets said in its March 3, 2006 research report that the company has made a concerted effort to increase the number of flat raters on the service side and that this should help drive productivity and volume as the company continues its shift toward higher volume, lighter maintenance jobs. RBC also noted that the company has reversed a seven-year trend of high turnover among flat raters by offering hiring bonuses and new guarantees.
But the industry is wondering if they've determined what's needed to ensure future success. Some analysts suggest the auto parts supplier has lost its way with some customers. The company has added everything from bikes, ATVs and work benches to portable DVD players and mobile electronics. While some items make sense, others don't fit, say some analysts.
"They brought these non-core products into the mix — If I'm a true parts guy, I don't want to see scooters, I want someone to get me the hard part for the engine I'm working on," says Tony Cristello, senior vice president of equity research for BB&T Capital Markets. "I think for them, they have to get back to their core customers." He points out that they've lost their identity a bit.
"Are you a destination parts store or a hybrid Target? That's part of the problem."
Slumping sales
From March to August 2005, Pep Boys' stock fell about 30 percent to a low of $12. When this issue closed at the beginning of May, stock was just shy of $15 per share.
Pep Boys posted an operating loss of $11.2 million in fiscal year 2005. For the 52 weeks ending Jan. 28, 2006, comparative sales decreased by 1.3 percent compared to an increase of 6.6 percent in fiscal year 2004. In its April 12, 2006 SEC filing, Pep Boys said sales were negatively impacted by the refurbishment program, a retail/service field reorganization and HR recruiting and training initiatives. They also suggest the economy is partly to blame, with higher gas prices affecting disposable income levels and miles driven.
In 2005, Pep Boys increased total debt by almost $75 million due to operating losses, inventory investments, refurbishments, the repurchase of common equity and costs to refinance company indebtedness. In addition, the filing noted that they refinanced $183 million of debt and associated costs, which had maturity dates in 2005 and 2006.
For the quarter ending Jan. 28, the company reported flat sales and an operating loss. Fourth-quarter sales were down to $549.82 million vs. $554 million year over year. Retail sales were up just over a half percent and service sales were down 1.3 percent.
RBC's report suggests that even though gross margins on the retail side came in at about 24 percent, on an adjusted basis the company reported both gross profit dollar and rate improvement year over year on sales that have remained flat. The report states, "The company cited ongoing category management, maturing merchandise categories and improved store operation initiatives." RBC analyst Scot Ciccarelli, CFA, says in his March 3, 2006 research comments that there is more room for improvement as Pep Boys continues its focus on inventory, store refurbishment and promotions.
The service business has been rougher, but numbers in the fourth quarter of '05 were a "marked improvement" from poor second- and third-quarter sales, says Ciccarelli, adding that Pep Boys' efforts to reduce service advisor staff and increase the number of flat raters may help increase profitability.
"We believe the company is making the necessary changes to right the business and that there are opportunities to adjust costs and spending levels in order to maintain its revenue run rate while controlling its fixed costs to get performance back on track in this segment."
Pep Boys reported in their SEC filing that they will likely exceed their expected cash requirements in fiscal 2006 and 2007 due to improved cash provided from operations, their existing line of credit and future access to capital markets.
Turning the corner?
RBC's report suggests that many changes Pep Boys made in the last several years have been necessary. "After initially revamping its support functions (i.e. marketing, human resources), The Pep Boys continues to realign its business segments in order to provide the operational structure with better organization and clarity. As the dust settles on these changes, we believe The Pep Boys will reap the benefits of this realignment as changes continue to take hold." RBC reports the company is, indeed, turning the corner.
But just what corner are they turning? Cristello clearly sees the partnership with Goldman, Sachs & Co. as a way of saying Pep Boys would like to sell part, if not all, of the company, though company executives remain mum on the subject. "The challenge is finding someone who wants the service business right now and someone who can then operate and manage the retail side," says Cristello. No company has the same model, and if the model no longer benefits Pep Boys, Cristello ponders how it will benefit another company. "The service side has 11 bays; most service shops have six to eight. That poses staffing and labor issues." He adds that on the retail side, their floor space is much bigger than a typical big box parts store, which could also be problematic for a potential buyer.
The Barington Group fully supported the Goldman partnership and believes "the company should be exploring alternatives to maximize value for each of Pep Boys' core assets," says Mitarotunda, who stresses, however, that he is concerned "that the Board lacks a sense of urgency.
"Barington is convinced that every day the Board continues on its current course, Pep Boys is being led in the wrong direction and the value of the company is deteriorating. In Barington's view, this can only have a negative impact on the prospects of the company and the value of any strategic alternatives that might be available for consideration by the Board."
Cristello also fears Pep Boys lacks density. Their presence "doesn't allow them to realize efficiencies in distribution and ad spend that they otherwise could if they were a little less clustered and had a larger presence geographically." Pep Boys currently operates in about 36 states; some have one or two stores while others have over 40.
Writer Stephen Simpson reports in the March 3 edition of The Motley Fool, "I can't, and won't rule out the possibility that this turnaround will work and/or that the company will attract a suitor willing to give investors a nice buyout premium. I'm also honest enough to point out that I didn't like the stock back in early November, and it's up about 15 percent since then. Maybe I'm still wrong about the stock, but at least I'll go down with a consistent story — there are other, better ideas out there today."
