Car Insurance

While analysts seem to agree that the macro picture for aftermarket retailers is

brightening, CSK Auto, the nation’s fourth largest player, continues to struggle as a result

of costly acquisitions starting in 1999 that nearly doubled the company’s store base. As

aggressive and praiseworthy as this growth plan was at the time, it has now saddled the

Phoenix-based retailer with a financial burden that may prevent it from prospering in

today’s increasingly favorable market conditions.

While growing its market was top priority two years ago, CSK is now working to contain

itself as it looks to commercial sales to drive results. The company, which is the top auto

parts retailer in the West by store count, pledged at the outset of fiscal 2001 to cut debt

and lift profits–with inventory reduction a key component to its strategy. However, auto

parts retailing is seasonal and highly dependent on weather. High rainfall in California,

where the company has its largest share of stores, conspired with overall economic malaise

to drag first quarter comp sales down 1%. High energy costs in that state also harmed

results.

Then the inventory cuts and payout of legal settlements hurt second quarter profit margins

as vendor volume allowances and cash discounts were lost; net income before restructuring

charges fell 37.5% to $5.2 million year over year. For the first half of fiscal 2001, ended

Aug. 5, CSK’s revenue rose just 1% to $738 million; same store sales were flat.

The company has renewed liquidity thanks to its recent $30 million in financing secured

from Oppenheimer Funds. It is calling for income in the third quarter, which ends Nov. 4, to

rise 50% over the second. But some analysts worry about the company’s high borrowing levels,

the financial strain from the hefty price paid for its acquisitions and subsequent

integration costs and high product costs.

To conserve cash, CSK has halved its planned 2001 store openings from 50 to 25 and is

closing 36 underperforming stores. Management hopes these actions, along with eliminating

120 mostly corporate jobs and scuttling low-selling product lines such as clutch parts, will

help return it to the healthy profit growth it enjoyed before its rapid expansion-not to

mention boost the company’s ailing stock. CSK’s shares trade between $6 and $8, down sharply

from highs over $30 in 1999.

Charges for these second quarter restructuring moves totaled $44.6 million and led to a

reported loss of $21.6 million for the first half of the year. Before the charges, net

income was $9.5 million, or $0.34 per share, still far short of the $21.5 million, or $0.77

per share, earned in the first half of 2000. CSK expects the store closures to reduce

revenue by $23.6 million and gross profit by about $10.6 million over the next 12 months.

However, all the recent measures are expected to lower operating expenses by $9.3 million in

the second half of 2001 and $16.5 million in fiscal 2002. The job cuts are seen shaving $7

million from annual salary costs and the closures lifting annual profits by $4 million.

Another bright spot is that sales at the acquired Big Wheel/Rossi stores are growing in

double digits, although the business is still undercutting CSK’s earnings. The June 1999

purchase of the chain gave the retailer a presence in the upper Midwest, with 86 locations

in Minnesota, Wisconsin and North Dakota converted to Checker stores, and a distribution

center in Minnesota. CSK paid $62.7 million in cash for the company and assumed its debt,

which it funded by borrowing $125 million. Management has promised the stores will turn a

profit in 2002; Lehman Brothers analyst Alan Rifkin estimates they will add $0.05 to $0.07

per share to earnings next year.

Already contributing to CSK’s earnings are 194 former Al’s and Grand Auto Supply stores in

five Western states acquired in October 1999 for $143 million from PACCAR Inc. The purchase

solidified CSK’s dominance in the West. To strengthen its position in the Midwest, the

company purchased All-Car Distributors and its 22 stores in Wisconsin and Michigan, now

operating under the Checker banner, in April 2000.

The acquisitions left CSK with 84 auto service centers, which generated $7.6 million in

sales in fiscal 2000, but also lost $2.9 million that year. The company has ditched the

service business and closed or sublet most of the centers. Integration of all the 1999 and

2000 acquisitions cost CSK about $24 million in fiscal 2000, while capital expenses ate up

another $10.2 million.

In response to manufacturer marketing initiatives that have encouraged dealership care for a

longer period, CSK paid $10 million last year for Automotive Information Systems, a database

service whose “Identifix” diagnostics technology can be marketed to both professionals and

consumers through the Internet.

In fact, one of the few areas where CSK is doing well is its burgeoning commercial business.

In a recent conference call with the investment community, chairman and ceo Maynard Jenkins

noted the success of the CSK Proshop wholesale business, which has grown about 25% per year

since it began in the mid-1990s. Sales to commercial accounts rose 14.5% in fiscal 2000. In

its latest quarter, the commercial side totaled 19% of all sales at $71 million and rose

11.5% on a same store basis. By comparison, DIY same store sales were only slightly in

positive territory. Commercial comps were the chief driver of CSK’s 2% same store sales gain

in the second quarter.

“The diminished DIY business has been offset this year by growth in the professional and

corporate side, which generally improves the productivity of CSK’s stores,” said Moody’s

Investor Service analyst Marie Menendez. CSK has been so effective at marketing to

professional installers that it has been able to maintain its position against AutoZone’s

entry into its key markets, she added. AutoZone has about 400 stores in California.

CSK credits expansion of its parts depots, an on-line local warehouse network and increased

sku mix for growing sales to commercial accounts. “We have significantly increased our

marketing efforts to the commercial customer,” the company said in its most recent quarterly

filing. CSK operates commercial sales centers in about 554 of its stores.

According to several store managers, CSK is beginning to format some of its Midwestern

stores in what presumably will be the prototype for new stores going forward. At a Checker

Auto Parts outside Milwaukee that opened in March, the format is a marked contrast to a

former Big Wheel site in a nearby strip mall that has operated as a Checker for about two

years.

The newer store, a freestanding site, is smaller. It has lower ceilings, narrower aisles and

merchandise more easily within reach. Most notably, the parts counter, located in the rear

of the older store, is now positioned adjacent to the checkout registers near the entrance.

Motor oil, one of the most in-demand items in any auto parts store, is more prominently

displayed high up on the wall facing the entrance near the batteries, clearly visible to

anyone entering the store. In the older store, motor oil is hidden away in an aisle far from

the entrance. And on the wall above the display of FRAM air filters, banners carry all the

brand names found in the store. An electronic parts catalog in the same section, where

customers can key in their vehicle type and find the proper product, is also a new feature,

the manager said.

The overall effect is a more shopper-friendly store where any item a customer is looking for

can be easily spotted, with more accessible sales staff to answer questions. One manager

said that new stores will also trend toward free-standing sites.

“The company has invested heavily in systems and in-store improvements in recent years to

reduce future needs,” Moody’s Menendez wrote in a report, noting that CSK’s broad geographic

coverage, strong branding in its markets and seasoned management team are the retailer’s

primary strengths. “There is potential for sales to increase over the next few years as the

increase in auto production in 1994 and beyond translates into a larger number of cars

entering the sweet spot for repairs.

“But greater longevity of parts, changes in lease and warranty terms and [new] technology

could change the timing and venue of repairs, [which] have migrated toward professional

channels.”

Jenkins allowed during the recent call that the company’s comps have been spotty. “We can’t

draw any conclusion on the way comps are running. In areas where there’s no competition our

business has been tough, and in other areas with more competition, it’s been better.”