XNYS:PBY Pep Boys - Manny, Moe & Jack Annual Report 10-K Filing - 1/28/2012

Effective Date 1/28/2012

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TABLE OF CONTENTS
ITEM 15 EXHIBITS, FINANCIAL STATEMENT SCHEDULES

Table of Contents

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549

FORM 10K

(Mark One)    

ý

 

ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the fiscal year ended January 28, 2012

OR

o

 

TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from                to                

Commission file number 1-3381

The Pep Boys—Manny, Moe & Jack
(Exact name of registrant as specified in its charter)

Pennsylvania
(State or other jurisdiction of
incorporation or organization)
  23-0962915
(I.R.S. employer
identification no.)

3111 West Allegheny Avenue,

 

 
Philadelphia, PA
(Address of principal executive office)
  19132
(Zip code)

215-430-9000
(Registrant's telephone number, including area code)

Securities registered pursuant to Section 12(b) of the Act:

Title of each class   Name of each exchange on which registered
Common Stock, $1.00 par value   New York Stock Exchange

Securities registered pursuant to Section 12(g) of the Act:
None

         Indicate by check mark whether the Registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes o    No ý

         Indicate by check mark if the Registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes o    No ý

         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 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 ý    No o

         Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes ý    No o

         Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. ý

         Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definitions of "large accelerated filer," "accelerated filer," and "smaller reporting company" in Rule 12b-2 of the Exchange Act. (Check one):

Large accelerated filer o   Accelerated filer ý   Non-accelerated filer o
(Do not check if a
smaller reporting company)
  Smaller reporting company o

         Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act) Yes o    No ý

         As of the close of business on July 30, 2011 the aggregate market value of the voting stock held by non-affiliates of the registrant was approximately $507,481,000.

         As of March 30, 2012, there were 52,761,355 shares of the registrant's common stock outstanding.

   


Table of Contents


TABLE OF CONTENTS

 
   
  Page  

PART I

           

Item 1.

 

Business

    1  

Item 1A.

 

Risk Factors

    11  

Item 1B.

 

Unresolved Staff Comments

    15  

Item 2.

 

Properties

    15  

Item 3.

 

Legal Proceedings

    15  

Item 4.

 

(Removed and Reserved)

    16  

PART II

           

Item 5.

 

Market for Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities

    16  

Item 6.

 

Selected Financial Data

    19  

Item 7.

 

Management's Discussion and Analysis of Financial Condition and Results of Operations

    21  

Item 7A.

 

Quantitative and Qualitative Disclosures About Market Risk

    36  

Item 8.

 

Financial Statements and Supplementary Data

    38  

Item 9.

 

Changes in and Disagreements with Accountants on Accounting and Financial Disclosure

    85  

Item 9A.

 

Controls and Procedures

    85  

Item 9B.

 

Other Information

    88  

PART III

           

Item 10.

 

Directors, Executive Officers and Corporate Governance

    88  

Item 11.

 

Executive Compensation

    94  

Item 12.

 

Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters

    108  

Item 13.

 

Certain Relationships and Related Transactions and Director Independence

    110  

Item 14.

 

Principal Accounting Fees and Services

    111  

PART IV

           

Item 15.

 

Exhibits and Financial Statement Schedules

    112  

 

Signatures

    116  

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PART I

ITEM 1    BUSINESS

GENERAL

        The Pep Boys—Manny, Moe & Jack and subsidiaries (the "Company") began operations in 1921 and is the leading national chain offering automotive service, tires, parts and accessories. This positioning allows us to streamline the distribution channel and pass the savings on to our customers facilitating our vision to be the automotive solutions provider of choice for the value-oriented customer. The majority of our stores are in a Supercenter format (averaging 20,600 sq.ft.), which serves both "do-it-for-me" ("DIFM"), which includes service labor, installed merchandise and tires, and "do-it-yourself" ("DIY") customers with the highest quality service and merchandise offerings. Most of our Supercenters also have a commercial sales program that provides delivery of parts, tires and other products to automotive repair shops and dealers. In 2009, as part of our long-term strategy to lead with automotive service, we began complementing our existing Supercenter store base with Service & Tire Centers. The Service & Tire Centers (averaging 5,900 sq.ft.) are designed to capture market share and leverage our existing Supercenters and support infrastructure. This growth will occur both organically and through acquisitions. The growth is targeted at existing markets, but may include new markets opportunistically. The objective is to grow our market share and to leverage inventory, marketing, distribution and support costs. Acquisitions will be used to accelerate growth in markets where the Company is under-penetrated. In 2010, we introduced new, smaller format (14,000 sq.ft.) Supercenters. The new, smaller Supercenters are designed to provide our customers with our complete offering of automotive service, tires, parts and accessories in a more efficient and cost-effective footprint. In total, as of January 28, 2012, the Company operated approximately 12,640,000 of gross square feet of retail space, including over 7,100 service bays.

        In fiscal 2011, we opened 119 Service & Tire Centers, including 99 Service & Tire Centers acquired in three separate transactions, opened 1 new Supercenter, converted one Pep Express (retail only) store and one Service & Tire Center into Supercenters, and closed two Service & Tire Centers and one Supercenter. We are targeting a total of 75 new Service & Tire Centers and 10 Supercenters in fiscal 2012. We expect to lease new Service & Tire Center and Supercenter locations, as we believe that there are sufficient existing available locations in the marketplace with attractive lease terms to enable our expansion.

        On January 29, 2012, the Company entered into an Agreement and Plan of Merger (the "Merger Agreement") with Auto Acquisition Company, LLC and Auto Mergersub, Inc., affiliates of The Gores Group, LLC. On the terms and subject to the conditions set forth in the Merger Agreement, at the effective time of the merger (i) each share of the Company's common stock issued and outstanding immediately prior to such time shall be converted into the right to receive $15.00 in cash without interest, (ii) the Company's common stock shall no longer be publicly traded on the New York Stock Exchange and (iii) the Company will no longer file current nor periodic reports with the SEC (see Note 19 of the Notes to Consolidated Financial Statements in "Item 8 Financial Statements and Supplementary Data").

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        The following table sets forth the percentage of total revenues from continuing operations contributed by each class of similar products or services for the Company and should be read in conjunction with the Consolidated Financial Statements and Notes thereto included elsewhere herein:

 
  Year ended  
 
  January 28,
2012
  January 29,
2011
  January 30,
2010
 

Parts and accessories

    61.0 %   63.5 %   63.9 %

Tires

    18.6     16.9     16.4  
               

Total merchandise sales

    79.6     80.4     80.3  

Service labor

    20.4     19.6     19.7  
               

Total revenues

    100.0 %   100.0 %   100.0 %
               

        As of January 28, 2012, the Company operated 562 Supercenters, 169 Service & Tire Centers and 7 Pep Express stores located in 35 states and Puerto Rico. The following table indicates, by state, the

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number of stores the Company had in operation at the end of each of the last four fiscal years, and the number of stores opened and closed by the Company during each of the last three fiscal years:


NUMBER OF STORES AT END OF FISCAL YEARS 2008 THROUGH 2011

State
  2011
Year
End
  Opened   Closed   2010
Year
End
  Opened   Closed   2009
Year
End
  Opened   Closed   2008
Year
End
 

Alabama

    37     36         1             1             1  

Arizona

    22             22             22             22  

Arkansas

    1             1             1             1  

California

    130     4     3     129     6     1     124     6         118  

Colorado

    7             7             7             7  

Connecticut

    7             7             7             7  

Delaware

    8     1         7             7     1         6  

Florida

    90     30         60     7         53     10         43  

Georgia

    47     22         25     3         22             22  

Illinois

    32     3         29     4         25     3         22  

Indiana

    7             7             7             7  

Kentucky

    4             4             4             4  

Louisiana

    8             8             8             8  

Maine

    1             1             1             1  

Maryland

    20     1         19     1         18             18  

Massachusetts

    7             7     1         6             6  

Michigan

    5             5             5             5  

Minnesota

    3             3             3             3  

Missouri

    1             1             1             1  

Nevada

    12             12             12             12  

New Hampshire

    4             4             4             4  

New Jersey

    36     4         32     1         31     2         29  

New Mexico

    8             8             8             8  

New York

    33     2         31     2         29             29  

North Carolina

    8             8             8             8  

Ohio

    12             12     2         10             10  

Oklahoma

    5             5             5             5  

Pennsylvania

    53     2         51     6         45     3         42  

Puerto Rico

    27             27             27             27  

Rhode Island

    2             2             2             2  

South Carolina

    6             6             6             6  

Tennessee

    7             7             7             7  

Texas

    56     7         49     2         47             47  

Utah

    6             6             6             6  

Virginia

    17     1         16             16             16  

Washington

    9     7         2             2             2  
                                           

Total

    738     120     3     621     35     1     587     25         562  
                                           

INDUSTRY OVERVIEW

        The automotive aftermarket retail and service industry is in the mature stage of its life cycle and while the retail space is dominated by a small number of companies with large market shares, the automotive service business is highly fragmented. Over the past decade, consumers have moved away

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from DIY and toward DIFM due to increasing vehicle complexity and electronic content, and decreasing availability of diagnostic equipment and know-how. In addition, while this needs-based industry has a dedicated DIY customer base, the number of consumers who would prefer to have a professional fix their vehicle fluctuates with economic cycles. For example, a drop in disposable income during the most recent recession forced some former DIFM consumers to work on their own vehicles, slightly growing the DIY industry. Weak labor and credit markets, depressed new vehicles sales, and the increasing average length of vehicle ownership compounded this trend in 2009 and 2010. New car sales started to rebound in 2011 but remain significantly below historical levels. The broader economic recovery is expected to increase disposable income, which will likely result in the reversal of this recent trend.

        We expect the shift away from DIY and toward DIFM to increase as the economy recovers, and continue for the foreseeable future. In anticipation of the change in consumer behavior we have adopted a long-term strategy of leading with our automotive service offerings and expanding our commercial business, while maintaining our DIY customer base through our innovative marketing programs in order to capitalize on the forecasted long-term growth of the DIFM industry and decline of the DIY business.

BUSINESS STRATEGY

        Our vision for Pep Boys is to take our industry-leading position in automotive services and accessories and be the automotive solutions provider of choice for the value-oriented customer. Our brand positioning—"PEP BOYS DOES EVERYTHING. FOR LESS." is designed to convey to customers the breadth of the automotive services and merchandise that we offer and our value proposition. The four strategies to achieve our vision are to: (i) Earn the trust of our customers every day, (ii) Lead with our service business and grow through our Service & Tire Centers, (iii) Establish a differentiated DIY experience by leveraging our Automotive Superstore and (iv) Leverage our Automotive Superstore to provide the most complete offering for our commercial customers.

        Earn the TRUST of our Customers every day.    We do this by delivering a customer experience that is based on Speed, Expertise, Respect and Value. We start by utilizing customer analytics to understand the services and products our customers need or want in order to build long lasting relationships. Our rewards program provides us with information about our most loyal customers that assists us in meeting their needs and wants, while helping to add to customer count increases and repeat business by providing these customers with discounted towing, free services and rewards points for purchases. We have developed a tailored marketing plan for each of our markets to maximize our reach and efficiencies. These marketing programs include TV and radio promotions scheduled around traditional shopping holidays that focus on the most frequently needed services, complimented with digital media, direct marketing, grass-roots and print campaigns. In our stores, we strive to continuously improve the customer experience by providing better looking and easier to shop stores and more consistent execution of our simplified and streamlined operations. We strive to hire the best associates and our goal is to be the preferred employer in our industry by focusing on associate hiring practices, training and development, and rewarding associate performance through performance-based compensation plans. Online, we continue to develop innovative ways to make it easier for customers to do business with us, by providing our customers with the ability to use our website to research services and products, schedule service appointments and purchase products online for in store or (coming soon) home delivery.

        Lead with our Service business and grow through our Service & Tire Centers.    We do this by being a full service—tire, maintenance and repair—shop that DOES EVERYTHING. FOR LESS. Our full service capabilities, ASE (Automotive Service Excellence) certified technicians and continuous investment in training and equipment allow customers to rely on us for all of their automotive service and maintenance needs. We can provide these services at highly-competitive prices because our size

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and business model allow us to buy quality parts at lower prices and pass those savings onto our customers. We believe that offering a broad assortment of private label and branded tires at competitive prices provides a competitive advantage to the Company since many of our DIFM competitors do not sell tires and related services. In order to become the leading tire retailer, we developed key partnerships that expand our national branded tire offerings and launched a new interactive web application called TreadSmart which gives customers the ability to research, purchase and schedule tire installation online.

        Our store growth plans are centered on a "hub and spoke" model, which calls for adding smaller neighborhood Service & Tire Centers to our existing Supercenter store base in order to further leverage our existing inventories, distribution network, operations infrastructure and advertising spend. We acquired 99 Service & Tire Centers and opened 21 new stores in 2011—20 Service & Tire Centers and one Supercenter. Our plans call for 75 new Service & Tire and 10 Supercenter locations in 2012. The typical Service & Tire Center is full service with approximately six service bays and $1.0 million in expected annual sales. Our Service & Tire Centers offer customer convenience, allowing us to be close to our customers' home or work and generally serve a higher income demographic customer than our Supercenters. To further leverage our store investment, we are focused on expanding our vehicle fleet business by communicating our value offering to local and national fleet accounts through targeted marketing, improving store execution and expanding our dedicated fleet resources

        Establish a differentiated Retail experience by leveraging our Automotive Superstore.    The size of our stores allows us to provide the highest level of replacement parts coverage and the broadest range of maintenance, performance and appearance products and accessories in the industry. We are able to leverage our Superhub stores, which have a larger assortment of product than our normal Supercenter, to satisfy customer needs for slow-moving product by delivering this product to requesting Supercenters on demand. As part of our commitment to carry the best assortment of automotive aftermarket merchandise, we make assortment decisions by examining every merchandise category using market and demographic data to assure we have the best product in the right place. This category management process ensures our assortment includes the appropriate coverage for service, DIY and commercial consumers as well as allowing us to make good, sound decisions about price, product and promotions.

        Leverage our Automotive Superstore to provide the most complete offering for our Commercial customers.    To further leverage our inventory and automotive aftermarket expertise, we continue to expand our commercial operations. In addition to offering these customers parts and fluids, we enjoy a competitive advantage of also being able to offer tires, equipment, accessories and services.

STORE IMPROVEMENTS

        In fiscal 2011, the Company's capital expenditures totaled $74.7 million which, in addition to our regularly-scheduled facility improvements, included the addition of 21 stores and information technology enhancements. Our fiscal 2012 capital expenditures are expected to be approximately $80.0 million, which includes the addition of approximately 75 Service & Tire Centers, 10 Supercenters and the conversion of 15 Supercenters into Superhubs, which have a larger assortment of auto parts than our normal Supercenter. These expenditures are expected to be funded from cash on hand and net cash generated from operating activities. Additional capacity, if needed, exists under our revolving credit facility.

SERVICES AND PRODUCTS

        The Company operates a total of 7,182 service bays in 731 of its 738 locations. Each service location performs a full range of automotive maintenance and repair services (except body work) and installs tires, hard parts and accessories.

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        Each Pep Boys Supercenter and Pep Express store carries a similar product line, with variations based on the number and type of cars in the market where the store is located, while a Pep Boys Service & Tire Center carries tires and a limited selection of our products. A full complement of inventory at a typical Supercenter includes an average of approximately 27,000 items, while Service & Tire Centers average approximately 2,000 items. The Company's product lines include: tires (not stocked at Pep Express stores); batteries; new and remanufactured parts for domestic and import vehicles; chemicals and maintenance items; fashion, electronic, and performance accessories; and a limited amount of select non-automotive merchandise that appeals to automotive "Do-It-Yourself" customers, such as generators, power tools and personal transportation products.

        In addition to offering a wide variety of high quality name brand products, the Company sells an array of high quality products under various private label names. The Company sells tires under the names DEFINITY, FUTURA® and CORNELL®, and batteries under the name PROSTART®. The Company also sells wheel covers under the name FUTURA®; water pumps and cooling system parts under the name PROCOOL®; air filters, anti-freeze, chemicals, cv axles, hub assemblies, lubricants, oil, oil filters, oil treatments, transmission fluids, custom wheels and wiper blades under the name PROLINE®; alternators, battery booster packs, alkaline type batteries and starters under the name PROSTART®; power steering hoses, chassis parts and power steering pumps under the name PROSTEER®; brakes under the name PROSTOP® and brakes, batteries, starters, ignitions and chassis under the name VALUEGRADE. All products sold by the Company under various private label names were approximately 26% of the Company's merchandise sales in fiscal 2011, and 31% in both fiscal 2010 and 2009.

        The Company's commercial automotive parts delivery program, branded PEP EXPRESS PARTS®, is designed to increase the Company's market share with the professional installer and to leverage inventory investment. The program satisfies the commercial customer's automotive inventory needs by taking advantage of the breadth and quality of the Company's parts inventory as well as its experience supplying its own service bays and mechanics. As of January 28, 2012, approximately 81% or 459 of the Company's 569 Supercenters and Pep Express stores provided commercial parts delivery as compared to approximately 80% or 454 stores at the end of fiscal 2010.

        The Company also operates 15 Speed Shops, a store-in-a-store concept within existing Supercenters that creates a differentiated retail experience for automotive enthusiasts by stocking high-performance and specialty products, and has expert sales and installation technicians resident in 79 Supercenters to assist customers with automotive electronics products such as stereos, speakers, amplifiers, remote starters and alarm systems.

        The Company has a point-of-sale system in all of its stores, which gathers sales and inventory data by stock-keeping unit from each store on a daily basis. This information is then used by the Company to help formulate its pricing, inventory, marketing, and merchandising strategies. The Company has an electronic parts catalog that allows our employees to efficiently look up the parts that our customers need and to provide complete job solutions, advice and information for customer vehicles. The Company has an electronic work order system in all of its service centers. This system creates a service history for each vehicle, provides customers with a comprehensive sales document and enables the Company to maintain a service customer database.

        The Company primarily uses an "Everyday Low Price" (EDLP) strategy in establishing its selling prices. Management believes that EDLP provides better value to its customers on a day-to-day basis, helps level customer demand and allows more efficient management of inventories. On a periodic basis, the Company employs a promotional pricing strategy on select items and service offers to drive increased customer traffic.

        We believe that targeted advertising and promotions play important roles in succeeding in today's environment. We are constantly working to understand our customers' wants and needs so that we can

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build long-lasting, loyal relationships. We utilize promotions, advertising, and loyalty card programs to promote our service and repair capabilities, merchandise offerings and our commitment to customer service and satisfaction. The Company is committed to an effective promotional schedule with TV and radio promotions that focus on the most frequently needed services and are scheduled around periods of time when automotive repair and preventative maintenance are top of mind and relevant to our customers. These promotions will be supplemented by extensive direct marketing and grass-roots campaigns and occasional print campaigns. Finally, we utilize in-store signage, creative product placement and promotions to help educate customers about products that fit their needs.

        The Company maintains a web site located at www.pepboys.com. It serves as a portal to our Company, allowing consumers the freedom and convenience to access more information about the organization, our stores and our service, tires, parts and accessories offerings. Consumers can purchase and schedule installation of tires with our TreadSmart application, schedule a service appointment with our eServe application, keep track of all their maintenance and service records electronically through our online Glovebox application and are expected to be able to purchase products online from us for in-store or home delivery during 2012. The site also provides consumers with general and seasonal car care tips, do-it-yourself vehicle maintenance and light repair guidance, and safe driving pointers. Exclusive online coupons are available to site visitors who register their e-mail addresses with us. These coupons cover special discounts on services and products at Pep Boys.

STORE OPERATIONS AND MANAGEMENT

        Most Pep Boys stores are open seven days a week. Each Supercenter has a Retail Manager and Service Manager (Service & Tire Centers only have a Service Manager while Pep Express stores only have a Retail Manager) who report to geographic-specific Area Directors and Division Vice Presidents. (The Company is currently piloting a more customer-friendly and efficient store management model for its Supercenters that combines all associates within a store under the management of a General Manager.) The Division Vice Presidents report to the Executive Vice President of Stores who in turn reports to the President and Chief Executive Officer. As of January 28, 2012, a Retail Manager's and a Service Manager's average length of service with the Company is approximately 10.0 and 6.4 years, respectively.

        Supervision and control over individual stores is facilitated by Area Directors and Divisional Vice Presidents making regular visits to stores and utilizing the Company's computer system and operational handbooks. All of the Company's advertising, accounting, purchasing, information technology, and most of its administrative functions are conducted at its corporate headquarters in Philadelphia, Pennsylvania. Certain administrative functions for the Company's regional operations are performed at various regional offices of the Company. See "Item 2 Properties."

INVENTORY CONTROL AND DISTRIBUTION

        Most of the Company's merchandise is distributed to its stores from its warehouses by dedicated and contract carriers. Target levels of inventory for each product are established for each warehouse and store based upon prior shipment history, sales trends and seasonal demand. Inventory on hand is compared to the target levels on a weekly basis at each warehouse, potentially triggering re-ordering of merchandise from suppliers. In addition, each Pep Boys store has an automated inventory replenishment system that orders additional inventory, generally from a warehouse, when a store's inventory on-hand falls below the target levels. We also consolidated certain of our slow-moving hard parts inventory that had previously been stocked at each of our five warehouses into our centrally-located Indianapolis warehouse that can service each of our stores with overnight delivery of these parts, when necessary.

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        Implementation of the Superhub concept enables local expansion of our auto parts product assortment in a cost effective manner. We are now able to satisfy customer needs for slow-moving auto parts by carrying limited amounts of this product at Superhub locations. These Superhubs then deliver this product to requesting Supercenters to fulfill customer demand. Superhubs are generally replenished from distribution centers multiple times per week. As of January 28, 2012, the Company operated 38 Superhubs within existing Supercenters, with plans to convert an additional 15 Superhubs in fiscal 2012.

SUPPLIERS

        During fiscal 2011, the Company's ten largest suppliers accounted for approximately 52% of the merchandise purchased. No single supplier accounted for more than 21% of the Company's purchases. The Company has one long-term contract under which it is required to purchase merchandise. Management believes that the relationships the Company has established with its suppliers are generally good.

        In the past, the Company has not experienced difficulty in obtaining satisfactory sources of supply and believes that adequate alternative sources of supply exist, at similar cost, for the types of merchandise sold in its stores.

COMPETITION

        The Company operates in a highly competitive environment. The Company encounters competition from national and regional chains and from local independent service providers and merchants. The Company's competitors include general, full range, discount or traditional department stores which carry automotive parts and accessories and/or have automotive service centers, as well as specialized automotive retailers. Generally, the specialized automotive retailers focus on either the "do-it-yourself" or "do-it-for-me" areas of the business. The Company believes that its operation in both the "do-it-for-me" and "do-it-yourself" areas of the business positively differentiates it from most of its competitors. However, certain competitors are larger in terms of sales volume, store size, and/or number of stores. Therefore, these competitors have access to greater capital and management resources and have been operating longer or have more stores in particular geographic areas. The principal methods of competition in our industry include store location, customer service, product offerings, quality and price.

REGULATION

        The Company is subject to various federal, state and local laws and governmental regulations relating to the operation of its business, including those governing the handling, storage and disposal of hazardous substances contained in the products it sells and uses in its service bays, the recycling of batteries, tires and used lubricants, the sale of small engine merchandise and the ownership and operation of real property.

EMPLOYEES

        At January 28, 2012, the Company employed 19,123 persons as follows:

Description
  Full-time   %   Part-time   %   Total   %  

Retail

    3,964     29.5     3,722     65.6     7,686     40.2  

Service center

    8,104     60.3     1,831     32.2     9,935     52.0  
                           

Store total

    12,068     89.8     5,553     97.8     17,621     92.2  

Warehouses

    549     4.1     118     2.1     667     3.5  

Offices

    828     6.1     7     0.1     835     4.3  
                           

Total employees

    13,445     100.0     5,678     100.0     19,123     100.0  
                           

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        The Company had no union employees as of January 28, 2012. At January 29, 2011, the Company employed 12,441 full-time and 5,838 part-time employees.

SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS

        Certain statements contained herein, including in "Item 1 Business" and "Item 7 Management's Discussion and Analysis of Financial Condition and Results of Operations", constitute "forward-looking statements" within the meaning of The Private Securities Litigation Reform Act of 1995. The words "guidance," "expects," "anticipates," "estimates," "forecasts" and similar expressions are intended to identify these forward-looking statements. Forward-looking statements include management's expectations regarding implementation of its long-term strategic plan, 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 we believe that the expectations reflected in these forward-looking statements are based on reasonable assumptions, we can give no assurance that our expectations will be achieved. Our actual results may differ materially from the results discussed in the forward-looking statements due to factors beyond our control, 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 our stores, competitive pricing, the location and number of competitors' stores, product and labor costs and the additional factors described in our filings with the Securities and Exchange Commission ("SEC"). See "Item 1A Risk Factors." We assume no obligation to update or supplement forward-looking statements that become untrue because of subsequent events.

SEC REPORTING

        We electronically file certain documents with, or furnish such documents to, the SEC, including annual reports on Form 10-K, quarterly reports on Form 10-Q, and current reports on Form 8-K, along with any related amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Exchange Act. From time-to-time, we may also file registration and related statements pertaining to equity or debt offerings. The SEC maintains an Internet website at www.sec.gov that contains reports, proxy and information statements, and other information regarding issuers that file or furnish documents electronically with the SEC. All our filings can be accessed through the Securities and Exchange Commission website at www.sec.gov and searching with our ticker symbol "PBY".

        We provide free electronic access to our annual, quarterly and current reports (and all amendments to these reports) on our Internet website, www.pepboys.com, under the Investor Relations/Financial Information/SEC Filings link. These reports are available on our website as soon as reasonably practicable after we electronically file or furnish such materials with or to the SEC. Information on our website does not constitute part of this Annual Report, and any references to our website herein are intended as inactive textual references only.

        Copies of our SEC reports are also available free of charge. Please call our investor relations department at 215-430-9459 or write Pep Boys, Investor Relations, 3111 West Allegheny Avenue, Philadelphia, PA 19132 to request copies.

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EXECUTIVE OFFICERS OF THE COMPANY

        The following table indicates the name, age, tenure with the Company and position (together with the year of election to such position) of the executive officers of the Company:

Name
  Age   Tenure
with
Company
as of
April 2011
  Position with the Company and Date of Election to Position

Michael R. Odell

    48   5 years   President and Chief Executive Officer since June 2010

Raymond L. Arthur

    53   4 years   Executive Vice President—Chief Financial Officer since May 2008

William E. Shull III

    53   4 years   Executive Vice President—Stores since June 2010

Scott A. Webb

    48   5 years   Executive Vice President—Merchandising & Marketing since June 2010

Joseph A. Cirelli

    53   35 years   Senior Vice President—Business Development since November 2007

Troy E. Fee

    43   5 years   Senior Vice President—Human Resources since July 2007

Brian D. Zuckerman

    42   13 years   Senior Vice President—General Counsel & Secretary since March 2009

        Michael R. Odell was named Chief Executive Officer on September 22, 2008, after serving as Interim Chief Executive Officer since April 23, 2008. Mr. Odell received the additional title of President on June 17, 2010. Mr. Odell joined the Company in September 2007 as Executive Vice President—Chief Operating Officer, after having most recently served as the Executive Vice President and General Manager of Sears Retail & Specialty Stores. Mr. Odell joined Sears in its finance department in 1994 where he served until he joined Sears operations team in 1998. There he served in various executive operations positions of increasing seniority, including as Vice President, Stores—Sears Automotive Group.

        Raymond L. Arthur joined Pep Boys in May 2008 after serving as Executive Vice President and Chief Financial Officer of Toys "R" Us Inc., from 2004 to 2006, where he oversaw its strategic review and restructuring of company-wide operations, as well as managing the leveraged buy-out of the company. During his seven year tenure at Toys "R" Us, Mr. Arthur also served as President and Chief Financial Officer of toysrus.com from 2000 to 2003 and as Corporate Controller of Toys "R" Us from 1999 to 2000. Prior to that, he worked in a variety of roles of increasing responsibility for General Signal, American Home Products, American Cyanamid and in public accounting.

        William E. Shull III was named Executive Vice President—Stores on June 17, 2010 after having joined the Company in September 2008 as Senior Vice President—Stores. Over the last 25 years Mr. Shull has held several senior management positions with a variety of retailer and service companies where his focus was on building and integrating store management teams into successfully profitable and cohesive units. In his 13 years at AutoZone he was instrumental in building the foundation of the retail chain in 4 geographic regions and responsible for store communications, training, and served on several strategic initiative committees.

        Scott A. Webb was named Executive Vice President—Merchandising & Marketing on June 17, 2010 after having joined the Company in September 2007 as Senior Vice President—Merchandising & Marketing. Prior to joining Pep Boys, Mr. Webb served as the Vice President, Merchandising and Customer Satisfaction of AutoZone. Mr. Webb joined AutoZone in 1986 where he began his service in field management before transitioning, in 1992, to the Merchandising function.

        Joseph A. Cirelli was named Senior Vice President—Corporate Development in November 2007. Since March 1977, Mr. Cirelli has served the Company in positions of increasing seniority, including

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Senior Vice President—Service, Vice President—Real Estate and Development, Vice President—Operations Administration, and Vice President—Customer Satisfaction.

        Troy E. Fee, Senior Vice President—Human Resources, joined the Company in July 2007, after having most recently served as the Senior Vice President of Human Resources Shared Services for TBC Corporation, then the parent company of Big O Tires, Tire Kingdom and National Tire & Battery. Mr. Fee has over 20 years experience in operations and human resources in the tire and automotive service and repair business.

        Brian D. Zuckerman was named Senior Vice President—General Counsel & Secretary on March 1, 2009 after having most recently served as Vice President—General Counsel & Secretary since 2003. Mr. Zuckerman joined the Company as a staff attorney in 1999. Prior to joining Pep Boys, Mr. Zuckerman practiced corporate and securities law with two firms in Philadelphia.

        Each of the executive officers serves at the pleasure of the Board of Directors of the Company.

ITEM 1A    RISK FACTORS

        The following section discloses all known material risks that we face. However, it does not include risks that may arise in the future that are yet unknown nor existing risks that we do not judge material to the presentation of our financial statements. If any of the events or circumstances described as risk below actually occurs, our business, results of operations and/or financial condition could be materially and adversely affected.

Risks Related to Pep Boys

         Failure to complete the proposed Merger could adversely affect our business.

        On January 29, 2012, we entered into the Merger Agreement, pursuant to which we may be acquired for $15.00 per share in cash. There is no assurance that our shareholders will approve the Merger Agreement or that the other closing conditions to the merger will be satisfied. We are subject to several risks as a result of entering into the Merger Agreement, including the following:

    If the proposed merger is not completed, the share price of our common stock may change to the extent that the current market price of our common stock reflects an assumption that the proposed merger will be completed;

    Certain costs related to the proposed merger, including the fees and/or expenses of our legal, accounting and financial advisors, must be paid even if the proposed merger is not completed;

    Under circumstances as defined in the Merger Agreement, we may be required to pay a termination fee and/or reimburse expenses if the Merger Agreement is terminated;

    Shareholder lawsuits have been and may be filed against us in connection with the Merger Agreement;

    Our management and employees' attention may have been diverted from day-to-day operations; and

    A failed merger may result in negative publicity and/or a negative impression of us in the investment community or business community generally.

         We may not be able to successfully implement our business strategy, which could adversely affect our business, financial condition, results of operations and cash flows.

        Our long-term strategic plan, which we update annually, includes numerous initiatives to increase sales, enhance our margins and increase our return on invested capital in order to increase our

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earnings and cash flow. If these initiatives are unsuccessful, or if we are unable to implement the initiatives efficiently and effectively, our business, financial condition, results of operations and cash flows could be adversely affected.

        Successful implementation of our business strategy also depends on factors specific to the automotive aftermarket industry, many of which may be beyond our control (see "Risks Related to Our Industry").

         If we are unable to generate sufficient cash flows from our operations, our liquidity will suffer and we may be unable to satisfy our obligations.

        We require significant capital to fund our business. While we believe we have the ability to sufficiently fund our planned operations and capital expenditures for the next fiscal year, circumstances could arise that would materially affect our liquidity. For example, cash flows from our operations could be affected by changes in consumer spending habits or the failure to maintain favorable vendor payment terms or our inability to successfully implement sales growth initiatives. We may be unsuccessful in securing alternative financing when needed, on terms that we consider acceptable, or at all.

        The degree to which we are leveraged could have important consequences to investments in our securities, including the following risks:

    our ability to obtain additional financing for working capital, capital expenditures, acquisitions or general corporate purposes may be impaired in the future;

    a substantial portion of our cash flow from operations must be dedicated to the payment of rent and the principal and interest on our debt, thereby reducing the funds available for other purposes;

    our failure to comply with financial and operating restrictions placed on us and our subsidiaries by our credit facilities could result in an event of default that, if not cured or waived, could have a material adverse effect on our business or our prospects; and

    if we are substantially more leveraged than some of our competitors, we might be at a competitive disadvantage to those competitors that have lower debt service obligations and significantly greater operating and financial flexibility than we do.

         We depend on our relationships with our vendors and a disruption of these relationships or of our vendors' operations could have a material adverse effect on our business and results of operations.

        Our business depends on developing and maintaining productive relationships with our vendors. Many factors outside our control may harm these relationships. For example, financial difficulties that some of our vendors may face may increase the cost of the products we purchase from them or may interrupt our source of supply. In addition, our failure to promptly pay, or order sufficient quantities of inventory from our vendors may increase the cost of products we purchase or may lead to vendors refusing to sell products to us at all.

        A disruption of our vendor relationships or a disruption in our vendors' operations could have a material adverse effect on our business and results of operations.

         We depend on our senior management team and our other personnel, and we face substantial competition for qualified personnel.

        Our success depends in part on the efforts of our senior management team. Our continued success will also depend upon our ability to retain existing, and attract additional, qualified field personnel to meet our needs. We face substantial competition, both from within and outside of the automotive

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aftermarket to retain and attract qualified personnel. In addition, we believe that the number of qualified automotive service technicians in the industry is generally insufficient to meet demand.

         We are subject to environmental laws and may be subject to environmental liabilities that could have a material adverse effect on us in the future.

        We are subject to various federal, state and local environmental laws and governmental regulations relating to the operation of our business, including those governing the handling, storage and disposal of hazardous substances contained in the products we sell and use in our service bays, the recycling of batteries, tires and used lubricants, the ownership and operation of real property and the sale of small engine merchandise. When we acquire or dispose of real property or enter into financings secured by real property, we undertake investigations that may reveal soil and/or groundwater contamination at the subject real property. All such known contamination has either been remediated, or is in the process of being remediated. Any costs expected to be incurred related to such contamination are either covered by insurance or financial reserves provided for in the consolidated financial statements. However, there exists the possibility of additional soil and/or groundwater contamination on our real property where we have not undertaken an investigation. A failure by us to comply with environmental laws and regulations could have a material adverse effect on us.

Risks Related to Our Industry

         Our industry is highly competitive, and price competition in some segments of the automotive aftermarket or a loss of trust in our participation in the "do-it-for-me" market, could cause a material decline in our revenues and earnings.

        The automotive aftermarket retail and service industry is highly competitive and subjects us to a wide variety of competitors. We compete primarily with the following types of businesses in each segment of the automotive aftermarket:

Retail

    Do-It-Yourself

    automotive parts and accessories stores;

    automobile dealers that supply manufacturer replacement parts and accessories; and

    mass merchandisers and wholesale clubs that sell automotive products and select non-automotive merchandise that appeals to automotive "Do-It-Yourself" customers, such as generators, power tools and canopies.

    Commercial

    mass merchandisers, wholesalers and jobbers (some of which are associated with national parts distributors or associations).

Service

    Do-It-For-Me

    regional and local full service automotive repair shops;

    automobile dealers that provide repair and maintenance services;

    national and regional (including franchised) tire retailers that provide additional automotive repair and maintenance services; and

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    national and regional (including franchised) specialized automotive (such as oil change, brake and transmission) repair facilities that provide additional automotive repair and maintenance services.

    Tires

    national and regional (including franchised) tire retailers; and

    mass merchandisers and wholesale clubs that sell tires.

        A number of our competitors have more financial resources, are more geographically diverse, have a higher geographic market concentration or have better name recognition than we do, which might place us at a competitive disadvantage to those competitors. Because we seek to offer competitive prices, if our competitors reduce their prices we may also be forced to reduce our prices, which could cause a material decline in our revenues and earnings.

        With respect to the service labor category, the majorities of consumers are unfamiliar with their vehicle's mechanical operation and, as a result, often select a service provider based on trust. Potential occurrences of negative publicity associated with the Pep Boys brand, the products we sell or installation or repairs performed in our service bays, whether or not factually accurate, could cause consumers to lose confidence in our products and services in the short or long term, and cause them to choose our competitors for their automotive service needs.

         Vehicle miles driven may decrease, resulting in a decline of our revenues and negatively affecting our results of operations.

        Our industry is significantly influenced by the number of vehicle miles driven. Factors that may cause the number of vehicle miles and our revenues and our results of operations to decrease include:

    the weather—as vehicle maintenance may be deferred during periods of inclement weather;

    the economy—as during periods of poor economic conditions, customers may defer vehicle maintenance or repair, and during periods of good economic conditions, consumers may opt to purchase new vehicles rather than service the vehicles they currently own and replace worn or damaged parts;

    gas prices—as increases in gas prices may deter consumers from using their vehicles; and

    travel patterns—as changes in travel patterns may cause consumers to rely more heavily on mass transportation.

         Economic factors affecting consumer spending habits may continue, resulting in a decline in revenues and may negatively impact our business.

        Many economic and other factors outside our control, including consumer confidence, consumer spending levels, employment levels, consumer debt levels and inflation, as well as the availability of consumer credit, affect consumer spending habits. A significant deterioration in the global financial markets and economic environment, recessions or an uncertain economic outlook could adversely affect consumer spending habits and result in lower levels of economic activity. The domestic and international political situation also affects consumer confidence. Any of these events and factors could cause consumers to curtail spending, especially with respect to our more discretionary merchandise offerings, such as automotive accessories, tools and personal transportation products.

        During fiscal 2009, there was significant deterioration in the global financial markets and economic environment, which negatively impacted consumer spending and our revenues. While the economic climate improved somewhat in fiscal 2011, consumer spending has not returned to pre-recession levels.

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If the economy does not continue to strengthen, or if our efforts to counteract the impacts of these trends are not sufficiently effective, our revenues could decline, negatively affecting our results of operations.

         Consolidation among our competitors may negatively impact our business.

        Our industry has experienced consolidation over time. If this trend continues or if our competitors are able to achieve efficiencies in their mergers, the Company may face greater competitive pressures in the markets in which we operate.

ITEM 1B    UNRESOLVED STAFF COMMENTS

        None.

ITEM 2    PROPERTIES

        The Company owns its five-story, approximately 300,000 square foot corporate headquarters in Philadelphia, Pennsylvania and a 60,000 square foot office building in Los Angeles, California. The Company also owns the following administrative regional offices—approximately 4,000 square feet of space in each of Melrose Park, Illinois and Bayamon, Puerto Rico. The Company leases an administrative regional office of approximately 4,000 square feet in Carrollton, Texas.

        Of the 738 store locations operated by the Company at January 28, 2012, 232 are owned and 506 are leased. As of January 28, 2012, 126 of the 232 stores owned by the Company are currently used as collateral under our Senior Secured Term Loan, due October 2013.

        The following table sets forth certain information regarding the owned and leased warehouse space utilized by the Company to replenish its store locations at January 28, 2012:

Warehouse Locations
  Products
Warehoused
  Approximate
Square
Footage
  Owned
or
Leased
  Stores
Serviced
  States Serviced

San Bernardino, CA

  All     600,000   Leased     181   AZ, CA, NM, NV, UT, WA

McDonough, GA

  All     392,000   Owned     229   AL, FL, GA, LA, NC, PR, SC, TN

Mesquite, TX

  All     244,000   Owned     78   AR, CO, LA, MO, NM, OK, TX

Plainfield, IN

  All     403,000   Owned     73   IL, IN, KY, MI, MN, OH, PA

Chester, NY

  All     402,000   Owned     178   CT, DE, MA, MD, ME, NH, NJ, NY, PA, RI, VA

Philadelphia, PA

  Tires & Batteries     74,000   Leased     63   DE, NJ, PA, VA, MD
                       

Total

        2,115,000              
                       

        In addition to the distribution centers above, the Company leases one 20,000 square foot satellite warehouse. This satellite warehouse stocks approximately 40,000 Stock-Keeping Units (SKUs), serves 21 stores and has retail capabilities. The Company anticipates that its existing and future warehouse space and its access to outside storage will accommodate inventory necessary to support future store expansion and any increase in SKUs through the end of fiscal 2012.

ITEM 3    LEGAL PROCEEDINGS

        The Company is party to various actions and claims arising in the normal course of business. The Company believes that amounts accrued for awards or assessments in connection with all such matters

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are adequate and that the ultimate resolution of these matters will not have a material adverse effect on the Company's financial position. However, there exists a possibility of loss in excess of the amounts accrued, the amount of which cannot currently be estimated. While the Company does not believe that the amount of such excess loss could be material to the Company's financial position, any such loss could have a material adverse effect on the Company's results of operations in the period(s) during which the underlying matters are resolved.

ITEM 4    (REMOVED AND RESERVED)

PART II

ITEM 5    MARKET FOR THE REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES

        The common stock of The Pep Boys—Manny, Moe & Jack is listed on the New York Stock Exchange under the symbol "PBY." There were 4,399 registered shareholders as of March 30, 2012. The following table sets forth for the periods listed, the high and low sale prices and the cash dividends paid on the Company's common stock.

MARKET PRICE PER SHARE

 
  Market Price
Per Share
   
 
 
  Cash
Dividends
Per
Share
 
 
  High   Low  

Fiscal 2011

                   

Fourth quarter

  $ 12.08   $ 10.21   $ 0.03  

Third quarter

    12.04     8.18     0.03  

Second quarter

    14.28     10.27     0.03  

First quarter

    14.70     10.53     0.03  

Fiscal 2010

                   

Fourth quarter

  $ 15.96   $ 11.37   $ 0.03  

Third quarter

    12.00     8.82     0.03  

Second quarter

    13.26     7.86     0.03  

First quarter

    13.42     8.08     0.03  

        On March 12, 2009, the Board of Directors reduced the quarterly cash dividend to $0.03 per share. On January 29, 2012, the Board of Directors suspended all future dividend payments in anticipation of the Company's pending merger pursuant to the terms of the Merger Agreement. See Note 19 of the Notes to Consolidated Financial Statements in "Item 8 Financial Statements and Supplementary Data" for additional information.

        On January 26, 2010, the Company terminated the flexible employee benefits trust (the "Trust") that was established on April 29, 1994 to fund a portion of the Company's obligations arising from various employee compensation and benefit plans. In accordance with the terms of the Trust, upon its termination, the Trust's sole asset, consisting of 2,195,270 shares of the Company's common stock, was transferred to the Company in exchange for the full satisfaction and discharge of all intercompany indebtedness then owed by the Trust to the Company. The termination of the Trust had no impact on the Company's consolidated financial statements, except for the reclassification of the shares within the shareholders equity section of the Company's Consolidated Balance Sheets.

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EQUITY COMPENSATION PLANS

        The following table sets forth the Company's shares authorized for issuance under its equity compensation plans at January 28, 2012:

 
  Number of
securities to be
issued upon
exercise of
outstanding
options,
warrants and
rights (a)
  Weighted
average
exercise price
of outstanding
options,
warrants and
rights (b)
  Number of securities
remaining available
for future issuance
under equity
compensation plans
(excluding securities
reflected in the first
column (a))
 

Equity compensation plans approved by security holders

    2,952,304   $ 6.16     3,197,172  

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STOCK PRICE PERFORMANCE

        The following graph compares the cumulative total return on shares of Pep Boys stock over the past five years with the cumulative total return on shares of companies in (1) the Standard & Poor's SmallCap 600 Index, (2) the S&P 600 Automotive Retail Index and (3) an index of peer and comparable companies as determined by the Company. The comparison assumes that $100 was invested in January 2007 in Pep Boys Stock and in each of the indices and assumes reinvestment of dividends. The S&P 600 Automotive Retail Index consists of companies in the S&P SmallCap 600 index that meet the definition of the automotive retail classification, and is currently comprised of: Group 1 Automotive, Inc.; Lithia Motors, Inc.; Midas, Inc.; Monro Muffler Brake, Inc.; Sonic Automotive, Inc.; and The Pep Boys—Manny, Moe & Jack. The companies currently comprising the Peer Group are: Aaron's, Inc.; Advance Auto Parts, Inc.; AutoZone, Inc.; Big 5 Sporting Goods Corp.; Cabelas, Inc.; Conn's, Inc.; Dick's Sporting Goods, Inc.; HHGregg, Inc.; Midas, Inc.; Monro Muffler Brake, Inc.; O'Reilly Automotive, Inc.; PetSmart, Inc.; RadioShack Corp.; Rent-A-Center, Inc.; Tractor Supply Co.; West Marine, Inc.


Comparison of Cumulative Five Year Total Return

GRAPHIC

Company/Index
  Jan. 2007   Jan. 2008   Jan. 2009   Jan. 2010   Jan. 2011   Jan. 2012  

Pep Boys

  $ 100.00   $ 74.05   $ 19.23   $ 56.39   $ 95.48   $ 83.37  

S&P SmallCap 600 Index

  $ 100.00   $ 93.88   $ 57.94   $ 80.52   $ 104.73   $ 114.02  

Peer Group

  $ 100.00   $ 85.18   $ 72.19   $ 98.03   $ 146.69   $ 192.82  

S&P 600 Automotive Retail Index

  $ 100.00   $ 62.90   $ 17.23   $ 47.75   $ 68.24   $ 87.25  

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ITEM 6    SELECTED FINANCIAL DATA

        The following tables set forth the selected financial data for the Company and should be read in conjunction with the Consolidated Financial Statements and Notes thereto included elsewhere herein.

Fiscal Year Ended
  Jan. 28,
2012
  Jan. 29,
2011
  Jan. 30,
2010
  Jan. 31,
2009
  Feb. 2,
2008
 
 
  (dollar amounts are in thousands, except per share data)
 

STATEMENT OF OPERATIONS DATA

                               

Merchandise sales

  $ 1,642,757   $ 1,598,168   $ 1,533,619   $ 1,569,664   $ 1,749,578  

Service revenue

    420,870     390,473     377,319     358,124     388,497  

Total revenues

    2,063,627     1,988,641     1,910,938     1,927,788     2,138,075  

Gross profit from merchandise sales(8)

    488,435 (1)   487,788 (3)   448,815 (4)   440,502 (5)   443,626 (6)

Gross profit from service revenue(8)

    21,094 (1)   34,564 (3)   37,292 (4)   24,930 (5)   42,611 (6)

Total gross profit

    509,529 (1)   522,352 (3)   486,107 (4)   465,432 (5)   486,237 (6)

Selling, general and administrative expenses

    443,986     442,239     430,261     485,044     518,373  

Net gain from disposition of assets

    27     2,467     1,213     9,716     15,151  

Operating profit (loss)

    65,570     82,580     57,059     (9,896 )   (16,985 )

Non-operating income

    2,324     2,609     2,261     1,967     5,246  

Interest expense

    26,306     26,745     21,704 (7)   27,048 (7)   51,293  

Earnings (loss) from continuing operations before income taxes and discontinued operations

    41,588 (1)   58,444 (3)   37,616 (4)   (34,977 )(5)   (63,032 )(6)

Earnings (loss) from continuing operations before discontinued operations

    29,128 (2)   37,171     24,113     (28,838 )   (37,438 )

Discontinued operations, net of tax

    (225 )   (540 )   (1,077 )(4)   (1,591 )(5)   (3,601 )(6)

Net earnings (loss)

    28,903     36,631     23,036     (30,429 )   (41,039 )

BALANCE SHEET DATA

                               

Working capital

  $ 166,627   $ 203,367   $ 205,525   $ 179,233   $ 195,343  

Current ratio

    1.27 to 1     1.36 to 1     1.40 to 1     1.33 to 1     1.35 to 1  

Merchandise inventories

  $ 614,136   $ 564,402   $ 559,118   $ 564,931   $ 561,152  

Property and equipment-net

  $ 696,339   $ 700,981   $ 706,450   $ 740,331   $ 780,779  

Total assets

  $ 1,633,779   $ 1,556,672   $ 1,499,086   $ 1,552,389   $ 1,583,920  

Long-term debt, excluding current maturities

  $ 294,043   $ 295,122   $ 306,201   $ 352,382   $ 400,016  

Total stockholders' equity

  $ 504,329   $ 478,460   $ 443,295   $ 423,156   $ 470,712  

DATA PER COMMON SHARE

                               

Basic earnings (loss) from continuing operations before discontinued operations

  $ 0.55   $ 0.71   $ 0.46   $ (0.55 ) $ (0.72 )

Basic earnings (loss)

    0.54     0.70     0.44     (0.58 )   (0.79 )

Diluted earnings (loss) from continuing operations before discontinued operations

    0.54     0.70     0.46     (0.55 )   (0.72 )

Diluted earnings (loss)

    0.54     0.69     0.44     (0.58 )   (0.79 )

Cash dividends declared

    0.12     0.12     0.12     0.27     0.27  

Book value

    9.56     9.10     8.46     8.10     9.10  

Common share price range:

                               

High

    14.70     15.96     10.83     12.56     22.49  

Low

    8.18     7.86     2.76     2.62     8.25  

OTHER STATISTICS

                               

Return on average stockholders' equity(9)

    5.8 %   7.9 %   5.3 %   (6.8 )%   (7.9 )%

Common shares issued and outstanding

    52,753,719     52,585,131     52,392,967     52,237,750     51,752,677  

Capital expenditures

  $ 74,746   $ 70,252   $ 43,214   $ 151,883 (10) $ 43,116  

Number of stores

    738     621     587     562     562  

Number of service bays

    7,182     6,259     6,027     5,845     5,845  

(1)
Includes an aggregate pretax charge of $1.6 million for asset impairment, of which $0.6 million was charged to merchandise cost of sales, $1.0 million was charged to service cost of sales.

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(2)
Includes a tax benefit of $3.6 million due to the release of valuation allowances on state net operating loss carryforwards and credits.

(3)
Includes a pretax benefit of $5.9 million due to the reduction in reserve for excess inventory which reduced merchandise cost of sales and an aggregate pretax charge of $1.0 million for asset impairment, of which $0.8 million was charged to merchandise cost of sales and $0.2 million was charged to service cost of sales.

(4)
Includes an aggregate pretax charge of $3.1 million for asset impairment, of which $2.2 million was charged to merchandise cost of sales, $0.7 million was charged to service cost of sales and $0.2 million (pretax) was charged to discontinued operations.

(5)
Includes an aggregate pretax charge of $5.4 million for asset impairment, of which $2.8 million was charged to merchandise cost of sales, $0.6 million was charged to service cost of sales and $1.9 million (pretax) was charged to discontinued operations.

(6)
Includes an aggregate pretax charge of $11.0 million for the asset impairment and closure of 31 stores, of which $5.4 million was charged to merchandise cost of sales, $1.8 million was charged to service cost of sales and $3.8 million (pretax) was charged to discontinued operations. In addition, we recorded a pretax $32.8 million inventory impairment charge to cost of merchandise sales for the discontinuance of certain product offerings.

(7)
Fiscal 2009 includes a gain from debt retirement of $6.2 million. Fiscal 2008 includes a gain from debt retirement of $3.5 million, partially offset by a $1.2 million charge for deferred financing costs.

(8)
Gross profit from merchandise sales includes the cost of products sold, buying, warehousing and store occupancy costs. Gross profit from service revenue includes the cost of installed products sold, buying, warehousing, service payroll and related employee benefits and occupancy costs. Occupancy costs include utilities, rents, real estate and property taxes, repairs and maintenance and depreciation and amortization expenses. Our gross profit may not be comparable to those of our competitors due to differences in industry practice regarding the classification of certain costs.

(9)
Return on average stockholders' equity is calculated by taking the net earnings (loss) for the period divided by average stockholders' equity for the year.

(10)
Includes the purchase of master lease assets for $117.1 million.

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ITEM 7    MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

OVERVIEW

        The following discussion and analysis explains the results of our operations for fiscal 2011 and 2010 and developments affecting our financial condition as of January 28, 2012. This discussion and analysis below should be read in conjunction with Item 6 "Selected Consolidated Financial Data," and our consolidated financial statements and the notes included elsewhere in this report. The discussion and analysis contains "forward looking statements" within the meaning of The Private Securities Litigation Reform Act of 1995. Forward looking statements include management's expectations regarding implementation of its long-term strategic plan, 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. Actual results may differ materially from the results discussed in the forward looking statements due to a number of factors beyond our control, including those set forth under the section entitled "Item 1A Risk Factors" elsewhere in this report.

Introduction

        The Pep Boys-Manny, Moe & Jack is the leading national chain offering automotive service, tires, parts and accessories. This positioning allows us to streamline the distribution channel and pass the savings on to our customers facilitating our vision to be the automotive solutions provider of choice for the value-oriented customer. The majority of our stores are in a Supercenter format, which serves both "do-it-for-me" ("DIFM", which includes service labor, installed merchandise and tires) and "do-it-yourself" ("DIY") customers with the highest quality service offerings and merchandise. Most of our Supercenters also have a commercial sales program that provides delivery of tires, parts and other products to automotive repair shops and dealers. In 2009, as part of our long-term strategy to lead with automotive service, we began complementing our existing Supercenter store base with Service & Tire Centers. These Service & Tire Centers are designed to capture market share and leverage our existing Supercenter and support infrastructure. This growth will occur both organically and through acquisitions. The growth is targeted at existing markets, but may include new markets opportunistically. Acquisitions will be used to accelerate growth in markets where the Company is under-penetrated.

        During fiscal 2011, we acquired 99 Service & Tire Centers (see Note 2 of the Notes to Consolidated Financial Statements in "Item 8 Financial Statements and Supplementary Data"), opened 20 new Service & Tire Centers and one new Supercenter, converted one Pep Express (retail only) store and one Service & Tire Center to Supercenters, and closed three stores. We are targeting a total of 75 new Service & Tire Centers and 10 Supercenters in fiscal 2012. As of January 28, 2012, we operated 562 Supercenters and 169 Service & Tire Centers, as well as seven legacy Pep Express stores throughout 35 states and Puerto Rico.

EXECUTIVE SUMMARY

        Net earnings for fiscal 2011 were $28.9 million, a $7.7 million decrease from the $36.6 million reported for fiscal 2010. The decrease in profitability was primarily due to lower total gross profit margins, higher selling, general and administrative expenses, and lower net gains from disposition of assets. The current year net earnings also benefitted from a reduction in the effective tax rate which declined from 36.4% in fiscal year 2010 to 30.0% in the current year. Our diluted earnings per share for fiscal 2011 were $0.54, a decrease of $0.15 from the $0.69 recorded for fiscal 2010.

        Total revenue increased for fiscal 2011 by 3.8% as compared to fiscal 2010 as a result of our growth strategy. This increase in total revenues was comprised of a 7.8% increase in service revenue and a 2.8% increase in merchandise sales. For fiscal 2011, comparable store sales (sales generated by

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locations in operation during the same period of the prior year) decreased by 0.6%. This decrease in comparable store sales was comprised of a 0.6% increase in comparable store service revenue offset by a 0.9% decrease in comparable store merchandise sales.

        Sales of our services and non-discretionary products are impacted by miles driven. From March through December 2011, unleaded gasoline prices averaged $3.59 per gallon (national average) as compared to $2.80 in the corresponding period of the prior year. We believe the significant increase in gasoline prices led to the 1.8% decrease in miles driven from March through November 2011, after growing moderately over the previous 12 months. This change in trend combined with the financial burden of higher gasoline prices, continued high unemployment and negative consumer confidence in the overall U.S. economy depressed our fiscal 2011 sales. We believe these factors have also led customers to maintain their existing vehicles, rather than purchasing new ones which, in turn has partially offset the negative impact the reduction in miles driven has had on our sales of services and non-discretionary products. These same factors have negatively affected sales in our discretionary product categories like accessories and complementary merchandise. Given the nature of these macroeconomic factors, we cannot predict whether or for how long these trends will continue, nor can we predict to what degree these trends will affect us in the future. In addition, an unseasonably warm winter quarter in fiscal 2011 reduced sales in certain categories including wiper blades, batteries, antifreeze and winter goods.

        Our primary response to fluctuations in customer demand is to adjust our service and product assortment, store staffing and advertising messages. We believe that we are well positioned to help our customers save money and meet their needs in a challenging macroeconomic environment. In 2011, we have continued our "surround sound" media campaign that utilizes television, radio, digital and direct mail advertising to communicate our "DOES EVERYTHING. FOR LESS." brand message and have focused on "execution excellence" in our stores in order to earn the TRUST of our customers every day. We continue to develop innovative ways to make it more convenient for customers to do business with us and in the third quarter of 2011 we launched TreadSmart, which gives customers the ability to research, purchase and schedule the installation of tires online at a local Pep Boys location. We are currently piloting, and expect to roll-out nationally in 2012, eCommerce solutions that will allow retail customers to purchase products online for pick up at their local store or delivery to their home and commercial customers to order, pay and manage their accounts online.

RESULTS OF OPERATIONS

        The following discussion explains the material changes in our results of operations for the years ended January 28, 2012 and January 29, 2011 and January 30, 2010.

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Analysis of Statement 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  
Year ended
  Jan 28, 2012
(Fiscal 2011)
  Jan 29, 2011
(Fiscal 2010)
  Jan 30, 2010
(Fiscal 2009)
  Fiscal 2011 vs.
Fiscal 2010
  Fiscal 2010 vs.
Fiscal 2009
 

Merchandise sales

    79.6 %   80.4 %   80.3 %   2.8 %   4.2 %

Service revenue(1)

    20.4     19.6     19.7     7.8     3.5  
                           

Total revenues

    100.0     100.0     100.0     3.8     4.1  
                           

Costs of merchandise sales(2)

    70.3 (3)   69.5 (3)   70.7 (3)   (4.0 )   (2.4 )

Costs of service revenue(2)

    95.0 (3)   91.1 (3)   90.1 (3)   (12.3 )   (4.7 )

Total costs of revenues

    75.3     73.7     74.6     (6.0 )   (2.9 )

Gross profit from merchandise sales

    29.7 (3)   30.5 (3)   29.3 (3)   0.1     8.7  

Gross profit from service revenue

    5.0 (3)   8.9 (3)   9.9 (3)   (39.0 )   (7.3 )

Total gross profit

    24.7     26.3     25.4     (2.5 )   7.5  

Selling, general and administrative expenses

    21.5     22.2     22.5     (0.4 )   (2.8 )

Net gain from disposition of assets

        0.1     0.1     (98.9 )   103.4  

Operating profit (loss)

    3.2     4.2     3.0     (20.6 )   44.7  

Non-operating income

    0.1     0.1     0.1     (10.9 )   15.4  

Interest expense

    1.3     1.3     1.1     1.6     (23.2 )

Earnings (loss) from continuing operations before income taxes

    2.0     2.9     2.0     (28.8 )   55.4  

Income tax expense (benefit)

    30.0 (4)   36.4 (4)   35.9 (4)   41.4     (57.5 )

Earnings (loss) from continuing operations

    1.4     1.9     1.3     (21.6 )   54.2  

Discontinued operations, net of tax

            (0.1 )   58.3     49.9  
                           

Net earnings (loss)

    1.4     1.8     1.2     (21.1 )   59.0  
                           

(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 (loss) from continuing operations before income taxes.

Fiscal 2011 vs. Fiscal 2010

        Total revenue for fiscal 2011 increased by 3.8% or $75.0 million to $2,063.6 million from $1,988.6 million in fiscal 2010, while comparable store sales for fiscal 2011 decreased 0.6% as compared to the prior year. This decrease in comparable store sales consisted of an increase of 0.6% in comparable store service revenue offset by a decrease of 0.9% in comparable store merchandise sales. Total comparable store sales decreased due to lower customer counts in all three lines of business partially

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offset by an increase in the average transaction amount per customer. While our total revenue figures were favorably impacted by the opening or acquisition of new stores, a new store is not added to our comparable store sales until it reaches its 13th month of operation. Non-comparable stores contributed an additional $86.6 million of total revenue in fiscal 2011 as compared to the prior year.

        Total merchandise sales increased 2.8%, or $44.6 million, to $1,642.8 million in fiscal 2011, compared to $1,598.2 million in fiscal 2010. The increase in merchandise sales was due to our non-comparable stores which contributed an additional $58.4 million of sales during the year, partially offset by a decline in comparable store merchandise sales of 0.9%, or $13.8 million. The decrease in comparable store merchandise sales was comprised of a 2.3% decline in our retail business which was mostly offset by a 1.9% increase in merchandise sold through our service business as a result of increased tire and installed part sales. Total service revenue increased 7.8%, or $30.4 million, to $420.9 million in fiscal 2011 from $390.5 million in the prior year. The increase in service revenue was comprised of a $2.2 million, or 0.6%, increase in comparable store service revenue and $28.2 million of service revenue from our new non-comparable stores.

        We believe that comparable store customer counts decreased due to macroeconomic conditions, while the average transaction amount per customer increased due to selling price increases implemented to reflect the inflation in product acquisition costs. We believe the significant increase in gasoline prices led to a decline in miles driven, which combined with the financial burden of higher gasoline prices, continued high unemployment and negative consumer confidence in the overall U.S. economy depressed our fiscal 2011 sales. These negative economic conditions were somewhat mitigated by the continued aging of the U.S. light vehicle fleet as consumers spent more money on maintaining their vehicles as opposed to buying new vehicles. Over the long-term, we believe utilizing innovative marketing programs to communicate our value-priced, differentiated service and merchandise assortment will drive increased customer counts and our continued focus on delivering a better customer experience than our competitors will convert those increased customer counts into sales improvements consistently over all lines of business.

        Total gross profit decreased by $12.8 million, or 2.5%, to $509.5 million in fiscal 2011 from $522.4 million in fiscal 2010. Total gross profit margin decreased to 24.7% for fiscal 2011 from 26.3% for fiscal 2010. The decrease in total gross profit margin was primarily due to the opening or acquisition of new Service & Tire Centers. The 85 Big 10 locations acquired in the second quarter of 2011 lowered total gross profit margin for fiscal 2011 by 50 basis points. The Big 10 locations were dilutive to total gross profit margin primarily due to mix of sales being more highly concentrated in tires which have lower product margins combined with higher rent and payroll costs as a percent of total sales. The organic new stores opened by the Company, which are in their ramp up stage for sales while incurring their full amount of fixed expenses, including payroll and occupancy costs (rent, utilities and building maintenance), negatively affected total gross profit margin by 81 basis points and 42 basis points for fiscal 2011 and 2010, respectively. The current year also included a net charge of $0.5 million comprised of a $1.6 million asset impairment charge which was mostly offset by a $1.1 million reduction in the reserve for excess inventory. The prior year included a net benefit of $5.9 million comprised of a reduction in the reserve for excess inventory of $5.9 million and a $1.0 million reversal of an inventory accrual partially offset by an asset impairment charge of $1.0 million. Excluding the impact of both the acquired and the new organic Service & Tire Centers and the unusual items noted above, the total gross profit margin declined by 33 basis points to 26.1% from 26.4% in the prior year. This decline was mostly due to a shift in sales to lower margin tires and increased tire pricing pressure. While the acquired and new organic Service & Tire Centers have had a negative impact on total gross profit margin, these Service & Tire Centers positively contributed to total gross profit for the current fiscal year.

        Gross profit from merchandise sales increased by $0.6 million, or 0.1%, to $488.4 million for fiscal 2011 from $487.8 million in fiscal 2010. Gross profit margin from merchandise sales decreased to

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29.7% from 30.5% for the prior year. Gross profit from merchandise sales for fiscal 2011 included a $1.1 million reduction in our reserve for excess inventory and an asset impairment charge of $0.6 million. Gross profit from merchandise sales for fiscal 2010 included a net benefit of $6.2 million comprised of a $5.9 million reduction in our reserve for excess inventory and the reversal of an inventory related accrual of approximately $1.0 million partially offset by a $0.8 million asset impairment charge. Excluding these items from both years, gross profit margin from merchandise sales decreased by 44 basis points to 29.7% in fiscal 2011 from 30.1% in the prior year primarily due to a decrease in product gross margins of 50 basis points. The decrease in product gross margins was primarily due to a shift in sales to lower margin tires and increased tire pricing pressure.

        Gross profit from service revenue decreased by $13.5 million, or 39.0%, to $21.1 million for fiscal 2011 from $34.6 million in fiscal 2010. Gross profit margin from service revenue decreased to 5.0% from 8.9% for the prior year. In accordance with GAAP, service revenue is limited to labor sales (excludes any revenue from installed parts and materials) and costs of service revenue includes the fully loaded service center payroll, and related employee benefits, and service center occupancy costs. Gross profit from service revenue for fiscal 2011 and 2010 included a $1.0 million and $0.2 million asset impairment charge, respectively. Excluding the charge from both years, gross profit margin from service revenue decreased to 5.25% for fiscal 2011 from 8.9% in the prior year. The decrease in gross profit from service revenue was due to the opening or acquisition of new Service & Tire Centers. Excluding the impact of the acquired and new Service & Tire Centers, (which are in their ramp up stage for sales while incurring their full amount of fixed expenses, including payroll and occupancy costs) and the impairment charge, gross profit from service revenue increased to 11.3% for fiscal 2011 from 10.6% for fiscal 2010. The increase in gross profit was primarily due to increased service revenues which better leveraged fixed store occupancy costs, partially offset by an increase in payroll and occupancy costs.

        Selling, general and administrative expenses as a percentage of revenue decreased to 21.5% in fiscal 2011 from 22.2% in fiscal 2010. Selling, general and administrative expenses increased $1.7 million, or 0.4%, to $444.0 million. The increase was primarily due to higher general liability and workers compensation claims expense of $4.8 million related to a favorable actuarial based adjustment in the prior year, higher travel costs from increased gasoline prices related to our commercial fleet of $2.3 million, and acquisition, transition and merger related costs of $2.0 million. These were mostly offset by lower payroll and related expenses of $4.9 million, primarily due to lower short-term compensation accruals, and lower media expense of $2.6 million. The reduction as a percentage of sales reflects improved leverage of selling, general and administrative expenses achieved through increased sales in fiscal 2011.

        Net gains from the disposition of assets were not significant in fiscal 2011 and were $2.5 million in fiscal 2010. Fiscal 2010 includes $2.1 million in net settlement proceeds from the disposition of a previously closed property.

        Interest expense decreased by $0.4 million to $26.3 million in fiscal 2011 compared to $26.7 million in fiscal 2010.

        Income tax expense for fiscal 2011 was $12.5 million, or an effective rate of 30.0%, as compared to $21.3 million, or an effective rate of 36.4%, for fiscal 2010. The fiscal 2011 effective tax rate includes a $3.6 million benefit related to the release of valuation allowance on certain state net operating losses and credits. The fiscal 2010 effective tax rate includes a $2.2 million benefit related to the reduction of a valuation allowance on certain state net operating losses and credits.

        As a result of the foregoing, we reported net earnings of $28.9 million for fiscal 2011, a decrease of $7.7 million, or 21.1%, as compared to net earnings of $36.6 million for fiscal 2010. Our diluted earnings per share were $0.54 for fiscal 2011 as compared to $0.69 for fiscal 2010.

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Fiscal 2010 vs. Fiscal 2009

        Total revenue and comparable store sales for fiscal 2010 increased 4.1% and 2.7%, respectively, over the prior year. Total revenue for fiscal 2010 increased by $77.7 million to $1,988.6 million from $1,910.9 million in fiscal 2009. The 2.7% increase in comparable store revenues consisted of a 1.1% increase in comparable store service revenue and a 3.1% increase in comparable store merchandise sales. While our total revenue figures were favorably impacted by our opening of 35 new stores in fiscal 2010, a new store is not added to our comparable store sales base until it reaches its 13th month of operation. Non-comparable store sales contributed an additional $25.9 million of total revenues in fiscal 2010 as compared to fiscal 2009. Total comparable store sales increased due to growth in customer counts in all three lines of business combined with an increase in the total average transaction amount per customer.

        Total merchandise sales increased 4.2%, or $64.5 million, to $1,598.2 million in fiscal 2010 as compared to $1,533.6 million in fiscal 2009. Comparable store merchandise sales increased 3.1%, or $47.7 million, as compared to the prior year, driven primarily by increased customer counts across all lines of business as well as an increase in the average transaction amount per customer. The balance of the increase in merchandise sales was due to the contribution from our non-comparable stores. Total service revenue increased 3.5%, or $13.2 million, to $390.5 million in fiscal 2010 compared to $377.3 million in fiscal 2009. Comparable store service revenue increased 1.1%, or $4.2 million, as compared to the prior year, due to higher customer counts partially offset by a decrease in average transaction amount per customer. The balance of the increase in service revenue was primarily due to the contribution from our non-comparable store base which accounted for an additional $9.0 million of service revenue.

        In fiscal 2010, comparable customer count increased versus fiscal 2009 in all lines of business due to our traffic-driving promotional events and rewards program and our improved customer experience resulting from better store execution. Our core automotive parts and tires categories, which make up approximately 79% of our merchandise sales, experienced a 3.6% increase in comparable store sales.

        Gross profit from merchandise sales increased by $39.0 million, or 8.7%, to $487.8 million in fiscal 2010 from $448.8 million in fiscal 2009. Gross profit margin from merchandise sales increased to 30.5% for fiscal 2010 from 29.3% for fiscal 2009. Gross profit from merchandise sales for fiscal 2010 included a net benefit of $6.2 million comprised of a $5.9 million reduction in our reserve for excess inventory, which is discussed below, and the reversal of an inventory related accrual of approximately $1.0 million partially offset by an $0.8 million asset impairment charge. Gross profit from merchandise sales for fiscal 2009 included a net benefit of $0.4 million comprised of the reversal of inventory related accruals of approximately $2.0 million and a $0.6 million gain from an insurance settlement, largely offset by a $2.2 million asset impairment charge. Excluding these items from both years, gross profit margin from merchandise sales improved by 90 basis points to 30.1% in fiscal 2010 from 29.2% in the prior year. This improvement was primarily due to less inventory shrinkage, lower defective product expense and increased merchandise sales, which better leveraged fixed store occupancy costs such as rent and utilities and warehousing costs such as payroll and out bound freight-costs.

        In fiscal 2010 we reduced our reserve for excess inventory by $5.9 million, of which $4.6 million was recorded in the fourth quarter, as a result of significant improvements in the quality of our inventory, including: (i) improving inventory management, including timely return of excess product to vendors for full credit; (ii) maintaining relatively flat inventory levels despite the investment in new stores; (iii) reducing inventory lead times and safety stock requirements, including consolidating slow-moving hard parts inventory into one centrally located warehouse, which led to significant reductions in slower moving parts inventory at our distribution centers; and (iv) increasing our inventory turnover ratio, which is reflected in our increased comparable store sales.

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        Gross profit from service revenue decreased by $2.7 million, or 7.3%, to $34.6 million in fiscal 2010 from $37.3 million in the prior year. Gross profit margin from service revenue decreased to 8.9% for fiscal 2010 from 9.9% for fiscal 2009. Gross profit from service revenue for fiscal 2010 included a $0.2 million asset impairment charge related to previously closed stores. Gross profit from service revenue for fiscal 2009 included a $0.7 million asset impairment charge related to previously closed stores. Excluding these items from both years, gross profit margin from service revenue decreased to 8.9% for fiscal 2010 from 10.1% in the prior year. The decrease in gross profit from service revenue was due to the opening of new Service & Tire Centers, which while in their ramp up stage for sales incur their full amount of fixed expenses, including payroll and occupancy costs (rent, utilities and building maintenance). Our new Service & Tire Centers negatively impacted gross margins by 134 basis points in fiscal 2010. Excluding the impact of new Service & Tire Centers and the impairment charges described above, gross profit from service revenue increased to 10.7% for fiscal 2010 from 10.5% for fiscal 2009. The increase in gross profit, exclusive of new locations, was primarily due to increased service revenues which better leveraged fixed store occupancy costs and, to a lesser extent, labor costs.

        Selling, general and administrative expenses as a percentage of revenue decreased to 22.2% in fiscal 2010 from 22.5% in fiscal 2009. Selling, general and administrative expenses increased $12.0 million, or 2.8%, to $442.2 million. The increase was primarily due to higher payroll and related expenses of $5.6 million, higher media expense of $4.9 million and increased travel costs of $1.4 million. The reduction as a percentage of sales reflects improved leverage of selling, general and administrative expenses achieved through increased sales in fiscal 2010.

        Net gains from the disposition of assets increased by $1.3 million to $2.5 million in fiscal 2010 from $1.2 million in fiscal 2009. Fiscal 2010 includes $2.1 million in net settlement proceeds from the disposition of a previously closed property, while fiscal 2009 reflects an aggregate gain of $1.3 million from three store sale and leaseback transactions.

        Interest expense for fiscal 2010 was $26.7 million, an increase of $5.0 million, compared to $21.7 million in fiscal 2009. Interest expense for fiscal 2009 included a $6.2 million gain from the retirement of debt. Excluding this item, interest expense decreased by $1.2 million in fiscal 2010 compared to fiscal 2009 primarily due to reduced debt levels.

        Income tax expense for fiscal 2010 was $21.3 million, or an effective rate of 36.4%, as compared to $13.5 million, or an effective rate of 35.9%, for fiscal 2009. The fiscal 2010 effective tax rate includes a $2.1 million benefit related to the reduction of a valuation allowance on certain state net operating losses and credits. The fiscal 2009 effective tax rate includes a $1.2 million benefit due to the allocation of additional costs to certain jurisdictions thereby reducing past and future tax liabilities.

        As a result of the foregoing, we reported net earnings of $36.6 million for fiscal 2010, an increase of $13.6 million, or 59%, as compared to net earnings of $23.0 million for fiscal 2009. Our diluted earnings per share were $0.69 for fiscal 2010 as compared to $0.44 for fiscal 2009.

Discontinued Operations

        The analysis of our results of continuing operations excludes the operating results of closed stores, where the customer base could not be maintained, which have been classified as discontinued operations for all periods presented.

Industry Comparison

        We operate in the U.S. automotive aftermarket, which has two general lines of business: (1) the Service business, defined as Do-It-For-Me (service labor, installed merchandise and tires) and (2) the Retail business, defined as Do-It-Yourself (retail merchandise) and commercial. Generally, specialized automotive retailers focus on either the Service or Retail area of the business. We believe that

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operation in both the Service and Retail areas positively differentiates us from most of our competitors. Although we manage our performance at a store level in aggregation, we believe that the following presentation, which includes the reclassification of revenue from merchandise that we install in customer vehicles to service center revenue, shows an accurate comparison against competitors within the two sales arenas. We compete in the Retail area of the business through our retail sales floor and commercial sales business. Our Service Center business competes in the Service area of the industry. The following table presents the revenues and gross profit for each area of the business.

 
  Fiscal Year ended  
(dollar amounts in thousands)
  January 28,
2012
  January 29,
2011
  January 30,
2010
 

Service center revenue(1)

  $ 1,038,714   $ 941,869   $ 897,630  

Retail sales(2)

    1,024,913     1,046,772     1,013,308  
               

Total revenues

  $ 2,063,627   $ 1,988,641   $ 1,910,938  
               

Gross profit from service center revenue(3)

  $ 220,314   $ 216,176   $ 211,056  

Gross profit from retail sales(4)

    289,213     306,176     275,051  
               

Total gross profit

  $ 509,527   $ 522,352   $ 486,107  
               

(1)
Includes revenues from installed products.

(2)
Excludes revenues from installed products.

(3)
Gross profit from service center revenue includes the cost of installed products sold, buying, warehousing, 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.

(4)
Gross profit from retail sales includes the cost of products sold, buying, warehousing and store occupancy costs. Occupancy costs include utilities, rents, real estate and property taxes, repairs and maintenance and depreciation and amortization expenses.

CAPITAL & LIQUIDITY

Capital Resources and Needs

        Our cash requirements arise principally from (1) the purchase of inventory and capital expenditures related to existing and new stores, offices and distribution centers, (2) debt service and (3) contractual obligations. Cash flows realized through the sales of automotive services, tires, parts and accessories are our primary source of liquidity. Net cash provided by operating activities was $73.7 million for fiscal 2011, as compared to $117.2 million for fiscal 2010. The $43.5 million decrease was primarily due to an unfavorable change in operating assets and liabilities of $36.4 million, a decrease in net earnings net of non-cash adjustments of $8.4 million and a decrease in net cash used in discontinued operations of $1.2 million. The change in operating assets and liabilities was primarily due to unfavorable changes in inventory, net of accounts payable of $20.1 million, accrued expenses and other current assets of $15.0 million and other liabilities of $1.3 million.

        In fiscal year 2011, the increased investment in inventory of $42.8 million was principally funded by increased participation in our trade payable program and improvements in our trade vendor payment terms. Taking into consideration changes in our trade payable program liability (shown as cash flows from financing activities on the consolidated statements of cash flows), cash generated from accounts payable was $53.8 million and $29.7 million for fiscal years 2011 and 2010, respectively. The ratio of accounts payable, including our trade payable program, to inventory was 53.6% and 47.3% as of January 28, 2012 and January 29, 2011, respectively. The increase in inventory of $49.7 million since the

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end of fiscal 2010 year end, (including inventory acquired as part of store acquisitions which is shown in acquisition, net of cash acquired on the consolidated statement of cash flows) was due to (i) investment in our new or acquired stores of $11.0 million, (ii) higher inventory balances due to increase in commodity pricing including tires and oil based products of $14.4 million, and (iii) increased inventory coverage in certain tire and hard part categories.

        The change in accrued expenses and other current assets was primarily due to the reduction in 401(k) employer match, decrease in supplemental executive retirement plan pension accruals and lower short-term bonus compensation accruals of $11.1 million.

        Cash used in investing activities was $125.6 million in fiscal 2011 as compared to $72.1 million in the prior year, an increase of $53.5 million. During fiscal 2011, we acquired 99 Service & Tire Centers through three separate transactions, including 85 stores in Florida, Georgia and Alabama, seven stores in Houston and seven stores in the Seattle/Tacoma market for $42.6 million, net of cash acquired (see Note 2 of the Notes to Consolidated Financial Statements in "Item 8 Financial Statements and Supplementary Data"). Capital expenditures were $74.7 million and $70.3 million in fiscal 2011 and 2010, respectively. Capital expenditures for fiscal 2011 included the addition of 20 new Service & Tire Centers, one new Supercenter, the conversion of one Service & Tire Center and one Pep Express store to Supercenters, and the conversion of 19 Supercenters into Superhubs in addition to our regularly scheduled store and distribution center improvements and information technology enhancements. During fiscal 2011, we sold the last remaining store classified as held for disposal at its carrying value of $0.5 million. During fiscal 2010, we sold seven properties classified as held for disposal for net proceeds of $4.3 million, of which $0.6 million is included in discontinued operations, completed one sale leaseback transaction for net proceeds of $1.6 million and received $2.1 million in net settlement proceeds from the disposition of a previously closed property.

        Our targeted capital expenditures for fiscal 2012 are expected to be approximately $80.0 million. Our fiscal 2012 capital expenditures include the addition of approximately 75 Service & Tire Centers, 10 Supercenters and the conversion of 15 Supercenters into Superhubs. These expenditures are expected to be funded by cash on hand and net cash generated from operating activities. Additional capacity, if needed, exists under our existing line of credit.

        In fiscal 2011, cash provided by financing activities improved by $14.2 million to $20.0 million from $5.8 million in the prior year. In the prior year we repurchased $10.0 million of our outstanding 7.50% Senior Subordinated Notes for $10.2 million. The balance of the improvement was due to increased cash provided from our trade payable program of $6.7 million partially offset by the payment of $2.4 million in financing fees incurred to amend and restate our revolving credit agreement to reduce its interest rate by 75 basis points and to extend its maturity to July 2016. The trade payable program, which has an availability of $125.0 million, is funded by various bank participants who have the ability, but not the obligation, to purchase, directly from our vendors, account receivables owed by Pep Boys. As of January 28, 2012 and January 29, 2011, we had an outstanding balance (classified as trade payable program liability on the consolidated balance sheet) of $85.2 million and $56.3 million, respectively.

        We anticipate that cash on hand and cash generated by operating activities will exceed our expected cash requirements in fiscal year 2012. In addition, we expect to have excess availability under our existing revolving credit agreement during the entirety of fiscal year 2012. As of January 28, 2012, we had no borrowings on our revolving credit facility and undrawn availability of $194.9 million.

        Our working capital was $166.6 million and $203.4 million at January 28, 2012 and January 29, 2011, respectively. Our long-term debt less current maturities, as a percentage of our total capitalization, was 36.8% and 38.2% at January 28, 2012 and January 29, 2011, respectively.

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    Contractual Obligations

        The following chart represents our total contractual obligations and commercial commitments as of January 28, 2012:

Contractual Obligations
  Total   Within 1 year   From 1 to 3
years
  From 3 to 5
years
  After
5 years
 
 
  (dollars amounts in thousands)
 

Long-term debt(1)

  $ 295,122   $ 1,079   $ 294,043   $   $  

Operating leases

    812,988     98,479     183,929     158,457     372,123  

Expected scheduled interest payments on long-term debt

    50,279     21,767     28,512          

Other long-term obligations(2)

    25,089                  
                       

Total contractual obligations

  $ 1,183,478   $ 121,325   $ 506,484   $ 158,457   $ 372,123  
                       

(1)
Long-term debt includes current maturities.

(2)
Primarily includes defined benefit pension obligation of $10.4 million, deferred compensation items of $6.2 million, income tax liabilities of $2.6 million and asset retirement obligations of $5.9 million. We made voluntary contributions of $3.0 million and $5.0 million to our pension plan in fiscals 2011 and 2010, respectively, and none in fiscal 2009. Future plan contributions are dependent upon actual plan asset returns and interest rates. See Note 13 of the Notes to Consolidated Financial Statements in "Item 8 Financial Statements and Supplementary Data" for further discussion of our pension plans. The above table does not reflect the timing of projected settlements for our recorded asset retirement obligation costs, income tax liabilities and pension obligation because we cannot make a reliable estimate of the timing of the related cash payments.

Commercial Commitments
  Total   Within 1 year   From 1 to 3
years
  From 3 to 5
years
  After
5 years
 
 
  (dollar amounts in thousands)
 

Standby letters of credit

  $ 31,652   $ 31,652   $   $   $  

Surety bonds

    8,308     8,308              

Purchase obligations(1)(2)

    25,849     25,849              
                       

Total commercial commitments

  $ 65,809   $ 65,809   $   $   $  
                       

(1)
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 (other than(2) below) and generally, our open purchase orders (orders that have not been shipped) are not binding agreements. Those purchase obligations that are in transit from our vendors at January 29, 2012 that we do not have legal title to are considered commercial commitments.

(2)
In fiscal 2011, we entered into a commercial commitment to purchase 4.2 million units of oil products at various prices over a two-year period. Based on our present consumption rate, we expect to meet the cumulative minimum purchase requirements under this contract by the end of fiscal 2012.

    Long-term Debt

    7.50% Senior Subordinated Notes, due December 2014

        On December 14, 2004, we issued $200.0 million aggregate principal amount of 7.50% Senior Subordinated Notes (the "Notes") due December 15, 2014. The Company did not repurchase Notes in

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fiscal 2011. During fiscal 2010 the Company repurchased Notes in the principal amount of $10.0 million. On January 28, 2012, the outstanding balance of these Notes was $147.6 million.

    Senior Secured Term Loan Facility, due October 2013

        Our Senior Secured Term Loan (the "Term Loan") is due October, 2013. This facility is secured by a collateral pool consisting of real property and improvements associated with our stores, which is adjusted periodically based upon real estate values and borrowing levels. Interest accrues at the three month London Interbank Offered Rate (LIBOR) plus 2.0% on this facility.

        As of January 28, 2012, 126 stores collateralized the Senior Secured Term Loan. The outstanding balance under the Term Loan at the end of fiscal 2011 was $147.6 million. The $1.0 million decline in the outstanding balance was due to quarterly principal payments of $0.3 million.

    Revolving Credit Agreement, through July 2016

        On January 16, 2009, we entered into a Revolving Credit Agreement (the "Agreement") with available borrowings up to $300.0 million and a maturity of January 2014. Total incurred fees of $6.8 million were capitalized and are being amortized over the original five year life of the facility. On July 26, 2011, we amended and restated the Agreement to reduce its interest rate by 75 basis points and to extend its maturity to July 2016. The related refinancing fees of $2.4 million are being amortized over the new five year life. Our ability to borrow under the Agreement is based on a specific borrowing base consisting of inventory and accounts receivable. The interest rate on this credit line is daily LIBOR plus 2.00% to 2.50% based upon the then current availability under the Agreement. Fees based on the unused portion of the Agreement range from 37.5 to 75.0 basis points. As of January 28, 2012, there were no outstanding borrowings under the Agreement.

        The weighted average interest rate on all debt borrowings during fiscal 2011 and 2010 was 6.3%.

    Other Matters

        Several of our debt agreements require compliance with covenants. The most restrictive of these covenants, an earnings before interest, taxes, depreciation and amortization ("EBITDA") requirement, is triggered if the Company's availability under its credit agreement drops below $50.0 million. As of January 28, 2012, the Company had no borrowings outstanding under the Revolving Credit Agreement, additional availability of approximately $194.9 million and was in compliance with all financial covenants contained in its debt agreements.

        The failure to satisfy this covenant would constitute an event of default under the Revolving Credit Agreement, which would result in a cross-default under our 7.50% Senior Subordinated Notes and Senior Secured Term Loan.

    Other Contractual Obligations

        We have a vendor financing program which is funded by various bank participants who have the ability, but not the obligation, to purchase account receivables owed by us directly from our vendors. The total availability under the program was $125.0 million as of January 29, 2011. There was an outstanding balance of $85.2 million and $56.3 million under this program as of January 28, 2012 and January 29, 2011, respectively.

        We have letter of credit arrangements in connection with our risk management, import merchandising and vendor financing programs. We had no outstanding commercial letters of credit as of January 28, 2012 and were contingently liable for $0.3 million in outstanding commercial letters of credit as of January 29, 2011. We were contingently liable for $31.7 million and $107.6 million in outstanding standby letters of credit as of January 28, 2012 and January 29, 2011, respectively. The

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reduction in the outstanding balance was due to the expiration of letters of credit that were no longer required after we amended our Revolving Credit Agreement.

        We are also contingently liable for surety bonds in the amount of approximately $8.3 million and $10.3 million as of January 28, 2012 and January 29, 2011, respectively. The surety bonds guarantee certain of our payments (for example utilities, easement repairs, licensing requirements and customs fees).

    Off-balance Sheet Arrangements

        We lease certain property and equipment under operating leases and lease financings which contain renewal and escalation clauses, step rent provisions, capital improvements funding and other lease concessions. These provisions are considered in the calculation of our minimum lease payments which are recognized as expense on a straight-line basis over the applicable lease term. Any lease payments that are based upon an existing index or rate are included in our minimum lease payment calculations. Total operating lease commitments as of January 28, 2012 were $813.0 million.

    Pension and Retirement Plans

        The Company has a Supplemental Executive Retirement Plan (SERP). This unfunded plan had a defined benefit component that provided key employees designated by the Board of Directors with retirement and death benefits. Retirement benefits were based on salary and bonuses; death benefits were based on salary. Benefits paid to a participant under the defined benefit pension plan are deducted from the benefits otherwise payable under the defined benefit portion of the SERP. On January 31, 2004, we amended and restated our SERP. This amendment converted the defined benefit portion of the SERP to a defined contribution portion for certain unvested participants and all future participants. On December 31, 2008, the Company terminated the defined benefit portion of the SERP with a $14.4 million payment and recorded a charge of $6.0 million. The SERP currently consists of only the defined contribution plan which we refer to as our "Account Plan."

        The Company has a qualified 401(k) savings plan and a separate savings plan for employees residing in Puerto Rico, which cover all full-time employees who are at least 21 years of age with one or more years of service. The Company contributes the lesser of 50% of the first 6% of a participant's contributions or 3% of the participant's compensation. For fiscal 2011, 2010 and 2009, the Company's contributions were conditional upon the achievement of certain pre-established financial performance goals which were met in fiscal 2010 and 2009, but not in fiscal 2011. The Company's savings plans' contribution expense was $3.0 million and $3.1 million in fiscal 2010 and 2009, respectively.

        We also have a defined benefit pension plan (the "Plan") covering full-time employees hired on or before February 1, 1992. As of December 31, 1996, the Company froze the accrued benefits under the Plan and active participants became fully vested. The Plan's trustee will continue to maintain and invest plan assets and will administer benefits payments. Pension plan assets are stated at fair market value and are composed primarily of money market funds and collective trust funds primarily invested in equity and fixed income investments. While we had no minimum funding requirement during fiscal 2011 or fiscal 2010, we made a $3.0 million discretionary contribution to the Plan in April 2011 and a $5.0 million discretionary contribution to the Plan in October 2010. In fiscal 2011, the Company began the process of terminating the Plan. The termination of the Plan is expected to be completed by the end of fiscal 2012. In order to terminate the Plan, in accordance with Internal Revenue Service and Pension Benefit Guaranty Corporation requirements, the Company is required to fully fund the Plan on a termination basis and will commit to contribute the additional assets necessary to do so. Plan participants will not be adversely affected by the Plan termination, but rather will have their benefits either converted into a lump sum cash payment or an annuity contract placed with an insurance carrier.

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        The expense under these plans for fiscal 2011, 2010 and 2009 was $1.4 million, $6.3 million and $6.4 million, respectively. Pension expense for the Plan is calculated based upon a number of actuarial assumptions, including an expected return on plan assets of 6.8% and a discount rate of 5.7%. In developing the expected return on asset assumptions, we evaluated input from our actuaries, including their review of asset class return expectations. The discount rate utilized for the Plan is based on a model bond portfolio with durations that match the expected benefit payment pattern. We continue to evaluate our actuarial assumptions and make adjustments as necessary for the existing plans. See Note 13 of the Notes to Consolidated Financial Statements in "Item 8 Financial Statements and Supplementary Data" for further discussion of our pension plans.

CRITICAL ACCOUNTING POLICIES AND ESTIMATES

        Management's Discussion and Analysis of Financial Condition and Results of Operations discusses our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America. The preparation of these financial statements requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the 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, retirement benefits, share-based compensation, risk participation agreements, 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.

        We believe that the following represent our more critical estimates and assumptions used in the preparation of the consolidated financial statements:

    Inventory is stated at lower of cost, as determined under the last-in, first-out (LIFO) method, or market. Our inventory, consists primarily of automotive parts and accessories, is used on vehicles. Because of the relatively long lives of vehicles, along with our historical experience of returning most excess inventory to our vendors for full credit, the risk of obsolescence is minimal. We establish a reserve for excess inventory for instances where less than full credit will be received for such returns and where we anticipate items will be sold at retail prices that are less than recorded costs. The reserve is based on management's judgment, including estimates and assumptions regarding marketability of products, the market value of inventory to be sold in future periods and on historical experiences where we received less than full credit from vendors for product returns. If our estimates regarding excess inventory are inaccurate, we may incur losses or gains that could be material. A 10% difference in our inventory reserves as of January 28 2012, would have affected net income by approximately $0.3 million in fiscal 2011.

    We record reserves for future sales returns, customer incentives, warranty claims and inventory shrinkage. The reserves are based on expected returns of products and historical claims and inventory shrinkage experience. If actual experience differs from historical levels, revisions in our estimates may be required. A 10% change in these reserves at January 28, 2012 would have affected net earnings by approximately $0.9 million for fiscal 2011.

    We have risk participation arrangements with respect to workers' compensation, general liability, automobile liability, other casualty coverages and health care insurance, including stop loss coverage with third party insurers to limit our total exposure. A reserve for the liabilities associated with these agreements is established using generally accepted actuarial methods

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      followed in the insurance industry and our historical claims experience. The amounts included in our costs related to these arrangements are estimated and can vary based on changes in assumptions, claims experience or the providers included in the associated insurance programs. A 10% change in our self-insurance liabilities at January 28, 2012 would have affected net earnings by approximately $5.0 million for fiscal 2011.

    We have significant pension costs and liabilities that are developed from actuarial valuations. Inherent in these valuations are key assumptions including discount rates, expected return on plan assets and mortality rates. We are required to consider current market conditions, including changes in interest rates, in selecting these assumptions. Changes in the related pension costs or liabilities may occur in the future due to changes in the assumptions. The following table highlights the sensitivity of our pension obligation and expense to changes in these assumptions, assuming all other assumptions remain constant:

Change in Assumption (dollars in thousands)
  Impact on Annual
Pension Expense
  Impact on Projected
Benefit Obligation
 

0.50 percentage point decrease in discount rate

    Increase $413     Increase $3,425  

0.50 percentage point increase in discount rate

    Decrease $413     Decrease $3,425  

5.00 percentage point decrease in expected rate of return on assets

    Increase $148      

5.00 percentage point increase in expected rate of return on assets

    Decrease $148      
    We periodically evaluate our long-lived assets for indicators of impairment. Management's judgments, including judgments related to store cash flows, are based on market and operating conditions at the time of evaluation. Future events could cause management's conclusion on impairment to change, requiring an adjustment of these assets to their then current fair market value.

    We have a share-based compensation plan, which includes stock options and restricted stock units, or RSUs. We account for our share-based compensation plans on a fair value basis. We determine the fair value of our stock options at the date of the grant using the Black-Scholes option-pricing model. The RSUs are awarded at a price equal to the market price of our underlying stock on the date of the grant. In situations where we have granted stock options and RSUs with market conditions, we have used Monte Carlo simulations in estimating the fair value of the award. The pricing model and generally accepted valuation techniques require management to make assumptions and to apply judgment to determine the fair value of our awards. These assumptions and judgments include the expected life of stock options, expected stock price volatility, future employee stock option exercise behaviors and the estimate of award forfeitures. We do not believe there is a reasonable likelihood that there will be a material change in the future estimates or assumptions we use to determine stock-based compensation expense. However, 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. A 10% change in our share-based compensation expense for fiscal 2011 would have affected net earnings by approximately $0.2 million.

    We are required to estimate our income taxes in each of the jurisdictions in which we operate. This requires us to estimate our actual current tax exposure together with assessing temporary differences resulting from differing treatment of items, such as depreciation of property and equipment and valuation of inventories, for tax and accounting purposes. We determine our provision for income taxes based on federal and state tax laws and regulations currently in

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      effect. Legislation changes currently proposed by certain states in which we operate, if enacted, could increase our transactions or activities subject to tax. Any such legislation that becomes law could result in an increase in our state income tax expense and our state income taxes paid, which could have a material effect on our net earnings.

      At any one time our tax returns for many tax years are subject to examination by U.S. Federal, commonwealth, and state taxing jurisdictions. For income tax benefits related to uncertain tax positions to be recognized, a tax position must be more-likely-than-not to be sustained upon examination by taxing authorities. The amount recognized is measured as the largest amount of benefit that is greater than 50 percent likely of being realized upon ultimate settlement. An uncertain income tax position will not be recognized in the financial statements unless it is more-likely-than-not to be sustained. We adjust these tax liabilities, as well as the related interest and penalties, based on the latest facts and circumstances, including recently published rulings, court cases, and outcomes of tax audits. To the extent our actual tax liability differs from our established tax liabilities for unrecognized tax benefits, our effective tax rate may be materially impacted. While it is often difficult to predict the final outcome of, the timing of, or the tax treatment of any particular tax position or deduction, we believe that our tax balances reflect the more-likely-than-not outcome of known tax contingencies.

      The temporary differences between the book and tax treatment of income and expenses result in deferred tax assets and liabilities, which are included within our consolidated balance sheets. We must then assess the likelihood that our deferred tax assets will be recovered from future taxable income. To the extent we believe that recovery is not more-likely-than-not, we must establish a valuation allowance. To the extent we establish a valuation allowance or change the allowance in a future period, income tax expense will be impacted. Actual results could differ from this assessment if adequate taxable income is not generated in future periods from either operations or projected tax planning strategies.

RECENT ACCOUNTING STANDARDS

        In January 2010, the Financial Accounting Standards Board ("FASB") issued Accounting Standards Update ("ASU") 2010-06 "Fair Value Measurements—Improving Disclosures on Fair Value Measurements" ("ASU 2010-06"). This guidance requires new disclosures surrounding transfers in and out of level 1 or 2 in the fair value hierarchy and also requires that the reconciliation of level 3 inputs includes separately reported information on purchases, sales, issuances and settlements. The increased disclosures should be reported for each class of assets or liabilities. ASU 2010-06 also clarifies existing disclosures for the level of disaggregating, disclosures about valuation techniques and inputs used to determine level 2 or 3 fair value measurements and includes conforming amendments to the guidance on employers' disclosures about postretirement benefit plan assets. ASU 2010-06 was effective for interim and annual reporting periods beginning after December 15, 2009 except for the disclosures about purchases, sales, issuances or settlements in the roll forward activity for level 3 fair value measurements which are effective for interim and annual periods beginning after December 15, 2010. The adoption of ASU 2010-06 did not have a material impact on the Company's consolidated financial statements.

        In December 2010, the FASB issued ASU 2010-29 "Business Combinations (Topic 805)—Disclosure of Supplementary Pro Forma Information for Business Combinations" (ASU 2010-29). This accounting standard update clarifies that SEC registrants presenting comparative financial statements should disclose in their pro forma information revenue and earnings of the combined entity as though the current period business combinations had occurred as of the beginning of the comparable prior annual reporting period only. The update also expands the supplemental pro forma disclosures to include a description of the nature and amount of material, nonrecurring pro forma adjustments directly attributable to the business combination included in the reported pro forma revenue and

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earnings. ASU 2010-29 is effective prospectively for material (either on an individual or aggregate basis) business combinations entered into in fiscal years beginning on or after December 15, 2010 with early adoption permitted. The adoption of ASU 2010-29 did not have a material impact on the consolidated financial statements.

        In May 2011, the FASB issued ASU 2011-04, "Fair Value Measurement (Topic 820)—Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRSs" ("ASU 2011-04"), which is effective for annual reporting periods beginning after December 15, 2011. This guidance amends certain accounting and disclosure requirements related to fair value measurements. The Company does not believe the adoption of ASU 2011-04 will have a material impact on the consolidated results of operations and financial condition.

        In June of 2011, the FASB issued ASU No. 2011-05, "Presentation of Comprehensive Income" ("ASU 2011-05"). ASU 2011-05 was issued to improve the comparability of financial reporting between U.S. GAAP and International Financial Reporting Standards, and eliminates previous U.S. GAAP guidance that allowed an entity to present components of other comprehensive income ("OCI") as part of its statement of changes in shareholders' equity. With the issuance of ASU 2011-05, companies are now required to report all components of OCI either in a single continuous statement of total comprehensive income, which includes components of both OCI and net income, or in a separate statement appearing consecutively with the statement of income. ASU 2011-05 does not affect current guidance for the accounting of the components of OCI, or which items are included within total comprehensive income, and is effective for periods beginning after December 15, 2011, with early adoption permitted. On December 23, 2011, the FASB issued ASU 2011-12, which indefinitely defers the provision in ASU 2011-05 that required entities to present reclassification adjustments out of accumulated other comprehensive income by component in both the statements in which net income is presented and the statement in which OCI is presented. The other provisions in ASU 2011-05 are unaffected by the deferral. The application of this guidance affects presentation only and therefore is not expected to have an impact on the Company's consolidated financial condition, results of operations or cash flows.

        In September 2011, the FASB issued ASU 2011-08, "Intangibles—Goodwill and Other (Topic 350)—Testing Goodwill for Impairment" ("ASU 2011-08"). The new guidance provides entities with the option to perform a qualitative assessment of whether it is more likely than not that the fair value of a reporting unit is less than its carrying amount before applying the quantitative two-step goodwill impairment test. If an entity concludes that it is not more likely than not that the fair value of a reporting unit is less than its carrying amount, it would not be required to perform the quantitative two-step goodwill impairment test. Entities also have the option to bypass the assessment of qualitative factors for any reporting unit in any period and proceed directly to performing the first step of the quantitative two-step goodwill impairment test, as was required prior to the issuance of this new guidance. The new guidance is effective for fiscal years, and interim periods within those years, beginning after December 15, 2011, with early adoption permitted. The Company does not believe the adoption of ASU 2011-08 will have a material impact on the consolidated results of operations and financial condition.

ITEM 7A    QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

        The Company has market rate exposure in its financial instruments due to changes in interest rates and prices.

Variable and Fixed Rate Debt

        The Company's Revolving Credit Agreement bears interest at daily LIBOR plus 2.00% to 2.50% based upon the then current availability under the facility. At January 28, 2012, there were no

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outstanding borrowings under the agreement. Additionally, the Company has a Senior Secured Term Loan facility with a balance of $147.6 million at January 28, 2012, that bears interest at three month LIBOR plus 2.00%. Excluding our interest rate swap, a one percent change in the LIBOR rate would have affected net earnings by approximately $1.0 million for fiscal 2011. The risk related to changes in the three month LIBOR rate are substantially mitigated by our interest rate swap.

        The fair value of the Company's fixed rate debt instruments, principally the 7.50% Senior Subordinated Notes due December 15, 2014, was $149.0 million and $147.6 million at January 28, 2012 and January 29, 2011, respectively. The Company determines fair value on its fixed rate debt by using quoted market prices and current interest rates.

Interest Rate Swaps

        The Company entered into an interest rate swap for a notional amount of $145.0 million that is designated as a cash flow hedge on the first $145.0 million of the Company's Senior Secured Term Loan facility. The interest rate swap converts the variable LIBOR portion of the interest payments to a fixed rate of 5.036% and terminates in October 2013. As of January 28, 2012 and January 29, 2011, the fair value of the swap was a net $12.5 million and $16.4 million payable, respectively, recorded within other long-term liabilities on the balance sheet.

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ITEM 8    FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

To the Board of Directors and Stockholders of
The Pep Boys—Manny, Moe & Jack
Philadelphia, Pennsylvania

        We have audited the accompanying consolidated balance sheets of The Pep Boys—Manny, Moe & Jack and subsidiaries (the "Company") as of January 28, 2012 and January 29, 2011, and the related consolidated statements of operations, stockholders' equity, and cash flows for each of the three fiscal years in the period ended January 28, 2012. Our audits also included the financial statement schedule listed in the Index at Item 15. These consolidated financial statements and financial statement schedule are the responsibility of the Company's management. Our responsibility is to express an opinion on the consolidated financial statements and financial statement schedule based on our audits.

        We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

        In our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of The Pep Boys—Manny, Moe & Jack and subsidiaries as of January 28, 2012 and January 29, 2011, and the results of their operations and their cash flows for each of the three fiscal years in the period ended January 28, 2012, in conformity with accounting principles generally accepted in the United States of America. Also, in our opinion, such financial statement schedule, when considered in relation to the basic consolidated financial statements taken as a whole, presents fairly, in all material respects, the information set forth therein.

        We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the Company's internal control over financial reporting as of January 28, 2012, based on the criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated April 11, 2012 expressed an unqualified opinion on the Company's internal control over financial reporting.

DELOITTE & TOUCHE LLP

Philadelphia, Pennsylvania
April 11, 2012

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CONSOLIDATED BALANCE SHEETS

The Pep Boys—Manny, Moe & Jack and Subsidiaries

(dollar amounts in thousands, except share data)

 
  January 28,
2012
  January 29,
2011
 

ASSETS

             

Current assets:

             

Cash and cash equivalents

  $ 58,244   $ 90,240  

Accounts receivable, less allowance for uncollectible accounts of $1,303 and $1,551

    25,792     19,540  

Merchandise inventories

    614,136     564,402  

Prepaid expenses

    26,394     28,542  

Other current assets

    59,979     60,812  
           

Total current assets

    784,545     763,536  
           

Property and equipment—net

    696,339     700,981  

Goodwill

    46,917     2,549  

Deferred income taxes

    72,870     66,019  

Other long-term assets

    33,108     23,587  
           

Total assets

  $ 1,633,779   $ 1,556,672  
           

LIABILITIES AND STOCKHOLDERS' EQUITY

             

Current liabilities:

             

Accounts payable

  $ 243,712   $ 210,440  

Trade payable program liability

    85,214     56,287  

Accrued expenses

    221,705     236,028  

Deferred income taxes

    66,208     56,335  

Current maturities of long-term debt

    1,079     1,079  
           

Total current liabilities

    617,918     560,169  
           

Long-term debt less current maturities

    294,043     295,122  

Other long-term liabilities

    77,216     70,046  

Deferred gain from asset sales

    140,273     152,875  

Commitments and contingencies

             

Stockholders' equity:

             

Common stock, par value $1 per share: authorized 500,000,000 shares; issued 68,557,041 shares

    68,557     68,557  

Additional paid-in capital

    296,462     295,361  

Retained earnings

    423,437     402,600  

Accumulated other comprehensive loss

    (17,649 )   (17,028 )

Treasury stock, at cost—15,803,322 shares and 15,971,910 shares

    (266,478 )   (271,030 )
           

Total stockholders' equity

    504,329     478,460  
           

Total liabilities and stockholders' equity

  $ 1,633,779   $ 1,556,672  
           

   

See notes to the consolidated financial statements

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CONSOLIDATED STATEMENTS OF OPERATIONS

The Pep Boys—Manny, Moe & Jack and Subsidiaries

(dollar amounts in thousands, except per share data)

Year ended
  January 28,
2012
  January 29,
2011
  January 30,
2010
 

Merchandise sales

  $ 1,642,757   $ 1,598,168   $ 1,533,619  

Service revenue

    420,870     390,473     377,319  
               

Total revenues

    2,063,627     1,988,641     1,910,938  
               

Costs of merchandise sales

    1,154,322     1,110,380     1,084,804  

Costs of service revenue

    399,776     355,909     340,027  
               

Total costs of revenues

    1,554,098     1,466,289     1,424,831  
               

Gross profit from merchandise sales

    488,435     487,788     448,815  

Gross profit from service revenue

    21,094     34,564     37,292  
               

Total gross profit

    509,529     522,352     486,107  
               

Selling, general and administrative expenses

    443,986     442,239     430,261  

Net gain from disposition of assets

    27     2,467     1,213  
               

Operating profit

    65,570     82,580     57,059  

Non-operating income

    2,324     2,609     2,261  

Interest expense

    26,306     26,745     21,704  
               

Earnings from continuing operations before income taxes and discontinued operations

    41,588     58,444     37,616  

Income tax expense

    12,460     21,273     13,503  
               

Earnings from continuing operations before discontinued operations

    29,128     37,171     24,113  

Loss from discontinued operations, net of tax benefit of $(121), $(291) and $(580)

    (225 )   (540 )   (1,077 )
               

Net earnings

  $ 28,903   $ 36,631   $ 23,036  
               

Basic earnings per share:

                   

Earnings from continuing operations before discontinued operations

  $ 0.55   $ 0.71   $ 0.46  

Loss from discontinued operations, net of tax

    (0.01 )   (0.01 )   (0.02 )
               

Basic earnings per share

  $ 0.54   $ 0.70   $ 0.44  
               

Diluted earnings per share:

                   

Earnings from continuing operations before discontinued operations

  $ 0.54   $ 0.70   $ 0.46  

Loss from discontinued operations, net of tax

        (0.01 )   (0.02 )
               

Diluted earnings per share

  $ 0.54   $ 0.69   $ 0.44  
               

   

See notes to the consolidated financial statements

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CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY

The Pep Boys—Manny, Moe & Jack and Subsidiaries

(dollar amounts in thousands, except share data)

 
  Common Stock    
   
  Treasury Stock   Accumulated
Other
Comprehensive
Loss
   
   
 
 
  Additional
Paid-in
Capital
  Retained
Earnings
  Benefit
Trust
  Total
Stockholders'
Equity
 
 
  Shares   Amount   Shares   Amount  

Balance, January 31, 2009

    68,557,041     68,557     292,728     358,670     (14,124,021 )   (219,460 )   (18,075 )   (59,264 )   423,156  
                                       

Comprehensive income:

                                                       

Net earnings

                      23,036                             23,036  

Changes in net unrecognized other postretirement benefit costs, net of tax of $352

                                        595           595  

Fair market value adjustment on derivatives, net of tax of ($125)

                                        (211 )         (211 )
                                                       

Total comprehensive income

                                                    23,420  

Cash dividends ($.12 per share)

                      (6,286 )                           (6,286 )

Reclassification of Benefits Trust

                            (2,195,270 )   (59,264 )         59,264      

Effect of stock options and related tax benefits

                      (209 )   22,000     355                 146  

Effect of restricted stock unit conversions

                (1,493 )         81,726     1,321                 (172 )

Stock compensation expense

                2,575                                   2,575  

Dividend reinvestment plan

                      (375 )   51,491     831                 456  
                                       

Balance, January 30, 2010

    68,557,041     68,557     293,810     374,836     (16,164,074 )   (276,217 )   (17,691 )       443,295  
                                       

Comprehensive income:

                                                       

Net earnings

                      36,631                             36,631  

Changes in net unrecognized other postretirement benefit costs, net of tax of $344

                                        582           582  

Fair market value adjustment on derivatives, net of tax of $48

                                        81           81  
                                                       

Total comprehensive income

                                                    37,294  

Cash dividends ($.12 per share)

                      (6,323 )                           (6,323 )

Effect of stock options and related tax benefits

                      (2,023 )   96,590     2,608                 585  

Effect of restricted stock unit conversions

                (1,946 )         61,042     1,647                 (299 )

Stock compensation expense

                3,497                                   3,497  

Dividend reinvestment plan

                      (521 )   34,532     932                 411  
                                       

Balance, January 29, 2011

    68,557,041   $ 68,557   $ 295,361   $ 402,600     (15,971,910 ) $ (271,030 ) $ (17,028 ) $   $ 478,460  
                                       

Comprehensive income:

                                                       

Net earnings

                      28,903                             28,903  

Changes in net unrecognized other postretirement benefit costs, net of tax of $(1,872)

                                        (3,120 )         (3,120 )

Fair market value adjustment on derivatives, net of tax of $1,499

                                        2,499           2,499  
                                                       

Total comprehensive income

                                                    28,282  

Cash dividends ($.12 per share)

                      (6,344 )                           (6,344 )

Effect of stock options and related tax benefits

                      (900 )   45,321     1,223                 323  

Effect of employee stock purchase plan

                      (335 )   20,963     566                 231  

Effect of restricted stock unit conversions

                (2,136 )         70,228     1,897                 (239 )

Stock compensation expense

                3,237                                   3,237  

Dividend reinvestment plan

                      (487 )   32,076     866                 379  
                                       

Balance, January 28, 2012

    68,557,041   $ 68,557   $ 296,462   $ 423,437     (15,803,322 ) $ (266,478 ) $ (17,649 ) $   $ 504,329  
                                       

   

See notes to the consolidated financial statements

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CONSOLIDATED STATEMENTS OF CASH FLOWS

The Pep Boys—Manny, Moe & Jack and Subsidiaries

(dollar amounts in thousands)

 
  Year Ended  
 
  January 28,
2012
  January 29,
2011
  January 30,
2010
 

Cash flows from operating activities:

                   

Net earnings

  $ 28,903   $ 36,631   $ 23,036  

Adjustments to reconcile net earnings to net cash provided by continuing operations:

                   

Net loss from discontinued operations

    225     540     1,077  

Depreciation and amortization

    79,542     74,151     70,529  

Amortization of deferred gain from asset sales

    (12,602 )   (12,602 )   (12,325 )

Stock compensation expense

    3,237     3,497     2,575  

Loss (gain) from debt retirement

        200     (6,248 )

Deferred income taxes

    10,301     18,572     13,446  

Net gain from dispositions of assets

    (27 )   (2,467 )   (1,213 )

Loss from asset impairment

    1,619     970     2,884  

Other

    (573 )   (479 )   345  

Changes in operating assets and liabilities, net of the effects of acquisitions:

                   

Decrease in accounts receivable, prepaid expenses and other

    2,391     7,060     7,175  

(Increase) decrease in merchandise inventories

    (42,756 )   (5,284 )   7,039  

Increase (decrease) in accounts payable

    24,871     7,466     (9,640 )

Decrease in accrued expenses

    (18,745 )   (8,394 )   (13,238 )

(Decrease) increase in other long-term liabilities

    (2,463 )   (1,200 )   2,384  
               

Net cash provided by continuing operations

    73,923     118,661     87,826  

Net cash used in discontinued operations

    (273 )   (1,466 )   (603 )
               

Net cash provided by operating activities

    73,650     117,195     87,223  
               

Cash flows from investing activities:

                   

Capital expenditures

    (74,746 )   (70,252 )   (43,214 )

Proceeds from dispositions of assets

    515     7,515     14,776  

Collateral investment

    (7,638 )   (9,638 )    

Acquisitions, net of cash acquired. 

    (42,901 )   (288 )   (2,695 )

Other

    (837 )       (500 )
               

Net cash used in continuing operations

    (125,607 )   (72,663 )   (31,633 )

Net cash provided by discontinued operations

        569     1,762  
               

Net cash used in investing activities

    (125,607 )   (72,094 )   (29,871 )
               

Cash flows from financing activities:

                   

Borrowings under line of credit agreements

    5,721     21,795     249,704  

Payments under line of credit agreements

    (5,721 )   (21,795 )   (273,566 )

Borrowings on trade payable program liability

    144,180     121,824     102,042  

Payments on trade payable program liability

    (115,253 )   (99,636 )   (99,873 )

Payments for finance issuance cost

    (2,441 )        

Debt payments

    (1,079 )   (11,279 )   (11,990 )

Dividends paid

    (6,344 )   (6,323 )   (6,286 )

Other

    898     1,227     611  
               

Net cash provided by (used in) financing activities

    19,961     5,813     (39,358 )
               

Net (decrease) increase in cash and cash equivalents

    (31,996 )   50,914     17,994  

Cash and cash equivalents at beginning of year

    90,240     39,326     21,332  
               

Cash and cash equivalents at end of year

  $ 58,244   $ 90,240   $ 39,326  
               

Supplemental cash flow information:

                   

Cash paid for interest, net of amounts capitalized

  $ 23,097   $ 23,098   $ 24,509  

Cash received from income tax refunds

  $ 479   $ 195   $ 921  

Cash paid for income taxes

  $ 1,150   $ 890   $ 4,768  

Non-cash investing activities:

                   

Accrued purchases of property and equipment

  $ 1,400   $ 2,926   $ 1,738  

   

See notes to the consolidated financial statements

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THE PEP BOYS—MANNY, MOE & JACK AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Years ended January 29, 2011, January 30, 2010 and January 31, 2009

NOTE 1—SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

        The Pep Boys—Manny, Moe & Jack and subsidiaries (the "Company") consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America ("U.S. GAAP"). The preparation of the Company's financial statements requires the Company to make estimates and assumptions that affect the reported amounts of assets, liabilities, net sales, costs and expenses, as well as the disclosure of contingent assets and liabilities and other related disclosures. The Company bases its estimates on historical experience and on various other assumptions that management believes to be reasonable under the circumstances, the results of which form the basis for making judgments about carrying values of the Company's assets and liabilities that are not readily apparent from other sources. Actual results could differ from those estimates, and the Company includes any revisions to its estimates in the results for the period in which the actual amounts become known.

        The Company believes the significant accounting policies described below affect the more significant judgments and estimates used in the preparation of its consolidated financial statements. Accordingly, these are the policies the Company believes are the most critical to aid in fully understanding and evaluating the historical consolidated financial condition and results of operations.

        BUSINESS    The Company operates in the U.S. automotive aftermarket, which has two general lines of business: (1) the Service business, defined as Do-It-For-Me, or "DIFM" (service labor, installed merchandise and tires) and (2) the Retail business, defined as Do-It-Yourself, or "DIY" (retail merchandise) and commercial. The Company's primary store format is the Supercenter, which serves both "DIFM" and "DIY" customers with the highest quality service offerings and merchandise. In 2009, as part of the Company's long-term strategy to lead with automotive service, the Company began complementing the existing Supercenter store base with Service & Tire Centers. These Service & Tire Centers are designed to capture market share and leverage the existing Supercenter and support infrastructure. The Company currently operates stores in 35 states and Puerto Rico.

        FISCAL YEAR END    The Company's fiscal year ends on the Saturday nearest to January 31. Fiscal 2011, which ended January 28, 2012, fiscal 2010, which ended January 29, 2011, and fiscal 2009 which ended January 30, 2010 were all comprised of 52 weeks.

        PRINCIPLES OF CONSOLIDATION    The consolidated financial statements include the accounts of the Company and its wholly owned subsidiaries. All intercompany balances and transactions have been eliminated.

        CASH AND CASH EQUIVALENTS    Cash equivalents include all short-term, highly liquid investments with an initial maturity of three months or less when purchased. All credit and debit card transactions that settle in less than seven days are also classified as cash and cash equivalents.

        ACCOUNTS RECEIVABLE    Accounts receivable are primarily comprised of amounts due from commercial customers. The Company records an allowance for doubtful accounts based upon an evaluation of the credit worthiness of its customers. The allowance is reviewed for adequacy at least quarterly, and adjusted as necessary. Specific accounts are written off against the allowance when management determines the account is uncollectible.

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THE PEP BOYS—MANNY, MOE & JACK AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

Years ended January 29, 2011, January 30, 2010 and January 31, 2009

NOTE 1—SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)

        MERCHANDISE INVENTORIES    Merchandise inventories are valued at the lower of cost or market. Cost is determined by using the last-in, first-out (LIFO) method. If the first-in, first-out (FIFO) method of costing inventory had been used by the Company, inventory would have been $536.4 million and $486.0 million as of January 28, 2012 and January 29, 2011, respectively. During fiscal 2011, 2010 and 2009, the effect of LIFO layer liquidations on gross profit was immaterial.

        The Company's inventory consists primarily of automotive parts and accessories. Because of the relatively long lives of vehicles, along with the Company's historical experience of returning excess inventory to the Company's vendors for full credit, the risk of obsolescence is minimal. The Company establishes a reserve for excess inventory for instances where less than full credit will be received for such returns and where the Company anticipates items will be sold at retail prices that are less than recorded costs. The reserve is based on management's judgment, including estimates and assumptions regarding marketability of products, the market value of inventory to be sold in future periods and on historical experiences where the Company received less than full credit from vendors for product returns.

        The Company's reserve for excess inventory was $4.2 million and $5.4 million as of January 28, 2012 and January 29, 2011, respectively. In fiscal 2010, the Company reduced its reserve for excess inventory by $5.9 million to $5.4 million from $11.3 million primarily due to improved inventory management, including timely return of excess product to vendors for credit. However, in future periods the company may be exposed to material losses should the company's vendors alter their policy with regard to accepting excess inventory returns.

        PROPERTY AND EQUIPMENT    Property and equipment are recorded at cost. Depreciation and amortization are computed using the straight-line method over the following estimated useful lives: building and improvements, 5 to 40 years, and furniture, fixtures and equipment, 3 to 10 years. Maintenance and repairs are charged to expense as incurred. Upon retirement or sale, the cost and accumulated depreciation are eliminated and the gain or loss, if any, is included in the determination of net income. Property and equipment information follows:

(dollar amounts in thousands)
  January 28,
2012
  January 29,
2011
 

Land

  $ 204,023   $ 204,023  

Buildings and improvements

    875,999     848,268  

Furniture, fixtures and equipment

    723,938     685,481  

Construction in progress

    3,279     8,781  

Accumulated depreciation and amortization

    (1,110,900 )   (1,045,572 )
           

Property and equipment—net

  $ 696,339   $ 700,981  
           

        GOODWILL    The Company tests the recorded amount of goodwill for recovery on an annual basis in the fourth quarter of each fiscal year. Impairment reviews may also be triggered by any significant events or changes in circumstances affecting the Company's business.

        At fiscal year end 2011, the Company had six reporting units, of which three included goodwill. Goodwill impairment testing consists of a two-step process, if necessary. The first step is to compare

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THE PEP BOYS—MANNY, MOE & JACK AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

Years ended January 29, 2011, January 30, 2010 and January 31, 2009

NOTE 1—SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)

the fair value of a reporting unit with its carrying amount. If the carrying amount of a reporting unit exceeds its fair value, the second step of the impairment test must be performed in order to determine the amount of impairment loss, if any. The second step compares the implied fair value of reporting unit goodwill with the carrying amount of that goodwill. If the carrying amount of reporting unit goodwill exceeds the implied fair value of that goodwill, an impairment loss is recognized in an amount equal to the excess. The loss recognized cannot exceed the carrying amount of goodwill. The implied fair value of goodwill is determined in the same manner that the amount of goodwill recognized in a business combination is determined. The Company allocates the fair value of a reporting unit to all of the assets and liabilities of that unit, including intangible assets, as if the reporting unit had been acquired in a business combination. Any excess of the value of a reporting unit over the amounts assigned to its assets and liabilities is the implied fair value of goodwill.

        There were no impairments as a result of the Company's annual impairment tests in the fourth quarter of fiscal year 2011 or fiscal year 2010.

        LEASES    The Company amortizes leasehold improvements over the lesser of the lease term or the economic life of those assets. Generally, for stores the lease term is the base lease term and for distribution centers the lease term includes the base lease term plus certain renewal option periods for which renewal is reasonably assured and for which failure to exercise the renewal option would result in an economic penalty to the Company. The calculation of straight-line rent expense is based on the same lease term with consideration for step rent provisions, escalation clauses, rent holidays and other lease concessions. The Company begins expensing rent at the time the Company has the right to use the property.

        SOFTWARE CAPITALIZATION    The Company capitalizes certain direct development costs associated with internal-use software, including external direct costs of material and services, and payroll costs for employees devoting time to the software projects. These costs are amortized over a period not to exceed five years beginning when the asset is substantially ready for use. Costs incurred during the preliminary project stage, as well as maintenance and training costs are expensed as incurred.

        TRADE PAYABLE PROGRAM LIABILITY    The Company has a trade payable program which is funded by various bank participants who have the ability, but not the obligation, to purchase account receivables owed by the Company directly from its vendors. The Company, in turn, makes the regularly scheduled full vendor payments to the bank participants. In the first quarter of fiscal 2011 as a result of the Company's review, the Company determined that the gross amount of borrowings and payments on the trade payable program shown on the statement of cash flows under "Cash flows from financing activities" included certain vendors that had not participated in the trade payable program. As such, the Company made an equal and offsetting adjustment to reduce the trade payables borrowings and payments line items within financing activities by $225.2 million and $90.3 million for the years ended January 29, 2011 and January 30, 2010, respectively. These adjustments have no net impact on net cash used in financing activities or on any other cash flow line items.

        INCOME TAXES    The Company uses the asset and liability method of accounting for income taxes. Deferred income taxes are determined based upon enacted tax laws and rates applied to the differences between the financial statement and tax bases of assets and liabilities.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

Years ended January 29, 2011, January 30, 2010 and January 31, 2009

NOTE 1—SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)

        The Company recognizes taxes payable for the current year, as well as deferred tax assets and liabilities for the future tax consequences of events that have been recognized in the Company's financial statements or tax returns. The Company must assess the likelihood that any recorded deferred tax assets will be recovered against future taxable income. To the extent the Company believes it is more likely than not that the asset will not be recoverable, a valuation allowance must be established. To the extent the Company establishes a valuation allowance or changes the allowance in a future period, income tax expense will be impacted.

        In evaluating income tax positions, the Company records liabilities for potential exposures. These tax liabilities are adjusted in the period actual developments give rise to such change. Those developments could be, but are not limited to, settlement of tax audits, expiration of the statute of limitations, and changes in the tax code and regulations, along with varying application of tax policy and administration within those jurisdictions. Refer to Note 8, "Income Taxes," for further discussion of income taxes and changes in unrecognized tax benefit during fiscal 2011.

        SALES TAXES    The Company presents sales net of sales taxes in its consolidated statements of operations.

        REVENUE RECOGNITION    The Company recognizes revenue from the sale of merchandise at the time the merchandise is sold and the product is delivered to the customer. Service revenues are recognized upon completion of the service. Service revenue consists of the labor charged for installing merchandise or maintaining or repairing vehicles, excluding the sale of any installed parts or materials. The Company records revenue net of an allowance for estimated future returns. The Company establishes reserves for sales returns and allowances based on current sales levels and historical return rates. Revenue from gift card sales is recognized upon gift card redemption. The Company's gift cards do not have expiration dates. The Company recognizes breakage on gift cards when, among other things, sufficient gift card history is available to estimate potential breakage and the Company determines there are no legal obligations to remit the value of unredeemed gift cards to the relevant jurisdictions. Estimated gift card breakage revenue is immaterial for all periods presented.

        In the first quarter of fiscal 2009, the Company launched a Customer Loyalty program. The program allows members to earn points for each qualifying purchase. Points earned allow members to receive a certificate that may be redeemed on future purchases within 90 days of issuance. The retail value of points earned by loyalty program members is included in accrued liabilities as deferred income and recorded as a reduction of revenue at the time the points are earned, based on the historic and projected rate of redemption. The Company recognizes deferred revenue and the cost of the free products distributed to loyalty program members when the awards are redeemed. The cost of the free products distributed to program members is recorded within costs of revenues.

        A portion of the Company's transactions includes the sale of auto parts that contain a core component. These components represent the recyclable portion of the auto part. Customers are not charged for the core component of the new part if a used core is returned at the point of sale of the new part; otherwise the Company charges customers a specified amount for the core component. The Company refunds that same amount upon the customer returning a used core to the store at a later date. The Company does not recognize sales or cost of sales for the core component of these transactions when a used part is returned by the customer at the point of sale.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

Years ended January 29, 2011, January 30, 2010 and January 31, 2009

NOTE 1—SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)

        COSTS OF REVENUES    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, service center occupancy costs and cost of providing free or discounted towing services to customers. Occupancy costs include utilities, rents, real estate and property taxes, repairs, maintenance, depreciation and amortization expenses.

        VENDOR SUPPORT FUNDS    The Company receives various incentives in the form of discounts and allowances from its vendors based on purchases or for services that the Company provides to the vendors. These incentives received from vendors include rebates, allowances and promotional funds and are generally based upon a percentage of the gross amount purchased. Funds are recorded when title of goods purchased have transferred to the Company as the amount is known and not contingent on future events. The amount of funds to be received are subject to vendor agreements and ongoing negotiations that may be impacted in the future based on changes in market conditions, vendor marketing strategies and changes in the profitability or sell-through of the related merchandise for the Company.

        Generally vendor support funds are earned based on purchases or product sales. These incentives are treated as a reduction of inventories and are recognized as a reduction to cost of sales as the inventories are sold. Certain vendor allowances are used exclusively for promotions and to offset certain other direct expenses if the Company determines the allowances are for specific, identifiable incremental expenses. Vendor support funds, which reduced advertising expense, amounted to $2.5 million for the year ended January 28, 2012, and were immaterial for all other periods presented.

        WARRANTY RESERVE    The Company provides warranties for both its merchandise sales and service labor. Warranties for merchandise are generally covered by the respective vendors, with the Company covering any costs above the vendor's stipulated allowance. Service labor is warranted in full by the Company for a limited specific time period. The Company establishes its warranty reserves based on historical experience. These costs are included in either costs of merchandise sales or costs of service revenue in the consolidated statement of operations.

        The reserve for warranty activity for the years ended January 28, 2012 and January 29, 2011, respectively, are as follows:

(dollar amounts in thousands)
   
 

Balance, January 30, 2010

  $ 694  

Additions related to sales in the current year

    12,261  

Warranty costs incurred in the current year

    (12,282 )
       

Balance, January 29, 2011

    673  

Additions related to sales in the current year

    12,122  

Warranty costs incurred in the current year

    (12,122 )
       

Balance, January 28,2012

  $ 673  
       

        ADVERTISING    The Company expenses the costs of advertising the first time the advertising takes place. Gross advertising expense for fiscal 2011, 2010 and 2009 was $54.9 million, $57.5 million

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

Years ended January 29, 2011, January 30, 2010 and January 31, 2009

NOTE 1—SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)

and $52.6 million, respectively, and is recorded in selling, general and administrative expenses. No advertising costs were recorded as assets as of January 28, 2012 or January 29, 2011.

        STORE OPENING COSTS    The costs of opening new stores are expensed as incurred.

        IMPAIRMENT OF LONG-LIVED ASSETS    The Company evaluates the ability to recover long-lived assets whenever events or circumstances indicate that the carrying value of the asset may not be recoverable. In the event assets are impaired, losses are recognized to the extent the carrying value exceeds fair value. In addition, the Company reports assets to be disposed of at the lower of the carrying amount or the fair market value less selling costs. See discussion of current year impairments in Note 11, "Store Closures and Asset Impairments."

        EARNINGS PER SHARE    Basic earnings per share are computed by dividing earnings by the weighted average number of common shares outstanding during the year. Diluted earnings per share are computed by dividing earnings by the weighted average number of common shares outstanding during the year plus incremental shares that would have been outstanding upon the assumed exercise of dilutive stock based compensation awards.

        DISCONTINUED OPERATIONS    The Company's discontinued operations reflect the operating results for closed stores where the customer base could not be maintained. Loss from discontinued operations relates to expenses for previously closed stores and principally includes costs for rent, taxes, payroll, repairs and maintenance, asset impairments, and gains or losses on disposal.

        ACCOUNTING FOR STOCK-BASED COMPENSATION    At January 28, 2012, the Company has two stock-based employee compensation plans, which are described in Note 14, "Equity Compensation Plans." Compensation costs relating to share-based payment transactions are recognized in the financial statements. The cost is measured at the grant date, based on the calculated fair value of the award, and is recognized as an expense over the employee's requisite service period (generally the vesting period of the equity award).

        COMPREHENSIVE LOSS    Other comprehensive loss includes pension liability and fair market value of cash flow hedges.

        DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES    The Company may enter into interest rate swap agreements to hedge the exposure to increasing rates with respect to its certain variable rate debt agreements. The Company recognizes all derivatives as either assets or liabilities in the statement of financial position and measures those instruments at fair value.

        SEGMENT INFORMATION    The Company has six operating segments defined by geographic regions which are Northeast, Mid-Atlantic, Southeast, Central, West and Southern CA. Each segment

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

Years ended January 29, 2011, January 30, 2010 and January 31, 2009

NOTE 1—SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)

serves both DIY and DIFM lines of business. The Company aggregates all of its operating segments and has one reportable segment. Sales by major product categories are as follows:

 
  Year ended  
(dollar amounts in thousands)
  January 28,
2012
  January 29,
2011
  January 30,
2010
 

Parts and accessories

  $ 1,259,500   $ 1,261,678   $ 1,219,396  

Tires

    383,257     336,490     314,223  

Service labor

    420,870     390,473     377,319  
               

Total revenues

  $ 2,063,627   $ 1,988,641   $ 1,910,938  
               

        SIGNIFICANT SUPPLIERS    During fiscal 2011, the Company's ten largest suppliers accounted for approximately 52% of merchandise purchased. No single supplier accounted for more than 21% of the Company's purchases. Other than a commitment to purchase 4.2 million units of oil products at various prices over a two-year period, the Company has no long-term contracts or minimum purchase commitments under which the Company is required to purchase merchandise. Open purchase orders are based on current inventory or operational needs and are fulfilled by vendors within short periods of time and generally are not binding agreements.

        SELF INSURANCE    The Company has risk participation arrangements with respect to workers' compensation, general liability, automobile liability, and other casualty coverages. The Company has a wholly owned captive insurance subsidiary through which it reinsures this retained exposure. This subsidiary uses both risk sharing treaties and third party insurance to manage this exposure. In addition, the Company self insures certain employee-related health care benefit liabilities. The Company maintains stop loss coverage with third party insurers through which it reinsures certain of its casualty and health care benefit liabilities. The Company records both liabilities and reinsurance receivables using actuarial methods utilized in the insurance industry based upon historical claims experience.

        RECLASSIFICATION    Certain prior period amounts have been reclassified to conform to current period presentation. These reclassifications had no effect on reported totals for assets, liabilities, shareholders' equity, cash flows or net income.

RECENT ACCOUNTING STANDARDS

        In January 2010, the Financial Accounting Standards Board ("FASB") issued Accounting Standards Update ("ASU") 2010-06 "Fair Value Measurements—Improving Disclosures on Fair Value Measurements" ("ASU 2010-06"). This guidance requires new disclosures surrounding transfers in and out of level 1 or 2 in the fair value hierarchy and also requires that the reconciliation of level 3 inputs includes separately reported information on purchases, sales, issuances and settlements. The increased disclosures should be reported for each class of assets or liabilities. ASU 2010-06 also clarifies existing disclosures for the level of disaggregating, disclosures about valuation techniques and inputs used to determine level 2 or 3 fair value measurements and includes conforming amendments to the guidance on employers' disclosures about postretirement benefit plan assets. ASU 2010-06 was effective for interim and annual reporting periods beginning after December 15, 2009 except for the disclosures

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

Years ended January 29, 2011, January 30, 2010 and January 31, 2009

NOTE 1—SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)

about purchases, sales, issuances or settlements in the roll forward activity for level 3 fair value measurements which are effective for interim and annual periods beginning after December 15, 2010. The adoption of ASU 2010-06 did not have a material impact on the Company's consolidated financial statements.

        In December 2010, the FASB issued ASU 2010-29 "Business Combinations (Topic 805)—Disclosure of Supplementary Pro Forma Information for Business Combinations" (ASU 2010-29). This accounting standard update clarifies that SEC registrants presenting comparative financial statements should disclose in their pro forma information revenue and earnings of the combined entity as though the current period business combinations had occurred as of the beginning of the comparable prior annual reporting period only. The update also expands the supplemental pro forma disclosures to include a description of the nature and amount of material, nonrecurring pro forma adjustments directly attributable to the business combination included in the reported pro forma revenue and earnings. ASU 2010-29 is effective prospectively for material (either on an individual or aggregate basis) business combinations entered into in fiscal years beginning on or after December 15, 2010 with early adoption permitted. The adoption of ASU 2010-29 did not have a material impact on the consolidated financial statements.

        In May 2011, the FASB issued ASU 2011-04, "Fair Value Measurement (Topic 820)—Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRSs" ("ASU 2011-04"), which is effective for annual reporting periods beginning after December 15, 2011. This guidance amends certain accounting and disclosure requirements related to fair value measurements. The Company does not believe the adoption of ASU 2011-04 will have a material impact on the consolidated results of operations and financial condition.

        In June of 2011, the FASB issued ASU No. 2011-05, "Presentation of Comprehensive Income" ("ASU 2011-05"). ASU 2011-05 was issued to improve the comparability of financial reporting between U.S. GAAP and International Financial Reporting Standards, and eliminates previous U.S. GAAP guidance that allowed an entity to present components of other comprehensive income ("OCI") as part of its statement of changes in shareholders' equity. With the issuance of ASU 2011-05, companies are now required to report all components of OCI either in a single continuous statement of total comprehensive income, which includes components of both OCI and net income, or in a separate statement appearing consecutively with the statement of income. ASU 2011-05 does not affect current guidance for the accounting of the components of OCI, or which items are included within total comprehensive income, and is effective for periods beginning after December 15, 2011, with early adoption permitted. On December 23, 2011, the FASB issued ASU 2011-12, which indefinitely defers the provision in ASU 2011-05 that required entities to present reclassification adjustments out of accumulated other comprehensive income by component in both the statements in which net income is presented and the statement in which OCI is presented. The other provisions in ASU 2011-05 are unaffected by the deferral. The application of this guidance affects presentation only and therefore is not expected to have an impact on the Company's consolidated financial condition, results of operations or cash flows.

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THE PEP BOYS—MANNY, MOE & JACK AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

Years ended January 29, 2011, January 30, 2010 and January 31, 2009

NOTE 1—SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)

        In September 2011, the FASB issued ASU 2011-08, "Intangibles—Goodwill and Other (Topic 350)—Testing Goodwill for Impairment" ("ASU 2011-08"). The new guidance provides entities with the option to perform a qualitative assessment of whether it is more likely than not that the fair value of a reporting unit is less than its carrying amount before applying the quantitative two-step goodwill impairment test. If an entity concludes that it is not more likely than not that the fair value of a reporting unit is less than its carrying amount, it would not be required to perform the quantitative two-step goodwill impairment test. Entities also have the option to bypass the assessment of qualitative factors for any reporting unit in any period and proceed directly to performing the first step of the quantitative two-step goodwill impairment test, as was required prior to the issuance of this new guidance. The new guidance is effective for fiscal years, and interim periods within those years, beginning after December 15, 2011, with early adoption permitted. The Company does not believe the adoption of ASU 2011-08 will have a material impact on the consolidated results of operations and financial condition.

NOTE 2—ACQUISITIONS

        During fiscal 2011, the Company made three separate acquisitions. The Company acquired the assets related to seven service and tire centers located in the Seattle-Tacoma area, the assets related to seven service and tire centers located in the Houston, Texas area and all outstanding shares of capital stock of Tire Stores Group Holding Corporation which operated an 85-store chain in Florida, Georgia and Alabama under the name Big 10. Collectively, the acquired stores produced approximately $94.7 million (unaudited) in sales annually based on pre-acquisition historical information. The total purchase price of these stores was approximately $42.6 million in cash and the assumption of certain liabilities. The acquisitions were financed through cash flows provided by operations. The results of operations of these acquired stores are included in the Company's results from their respective acquisition dates.

        The Company has recorded its initial accounting for these acquisitions in accordance with accounting guidance on business combinations. The acquisitions resulted in goodwill related to, among other things, growth opportunities and assembled workforces. A portion of the goodwill is expected to be deductible for tax purposes. The Company has recorded finite-lived intangible assets at their estimated fair value related to trade name, favorable and unfavorable leases.

        The Company expensed all costs related to these acquisitions during fiscal 2011. The total costs related to these acquisitions were $1.5 million and are included in the consolidated statement of operations within selling, general and administrative expenses.

        The purchase price of the acquisitions has been allocated to the net tangible and intangible assets acquired, with the remainder recorded as goodwill on the basis of estimated fair values. In the fourth quarter of 2011, the Company revised its estimates, which resulted in an increase in goodwill of $0.7 million from our previous allocation of purchase price. The change related primarily to the

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

Years ended January 29, 2011, January 30, 2010 and January 31, 2009

NOTE 2—ACQUISITIONS (Continued)

establishment of a valuation allowance related to the deferred tax assets acquired which is included within other non-current assets. The allocation is a follows:

(dollar amounts in thousands)
  As of
Acquisition
Dates
 

Current assets

  $ 11,421  

Intangible assets

    950  

Other non-current assets

    9,149  

Current liabilities

    (13,817 )

Long-term liabilities

    (9,458 )
       

Total net identifiable assets acquired

  $ (1,755 )
       

Total consideration transferred, net of cash acquired

  $ 42,614  

Less: total net identifiable assets acquired

    (1,755 )
       

Goodwill

  $ 44,369  
       

        Intangible assets consist of trade names ($0.6 million) and favorable leases ($0.3 million). Long-term liabilities includes unfavorable leases ($9.1 million). The trade names are being amortized over their estimated useful life of 3 years. The favorable and unfavorable lease intangible assets and liabilities are being amortized to rent expense over their respective lease terms, ranging from 2 to 16 years. Amortization expense for the favorable and unfavorable leases over the next five years is approximately $0.6 million per year. Deferred tax assets in the amount of $6.8 million are primarily recorded in other non-current liabilities.

        Sales for the fiscal 2011 acquired stores totaled $63.9 million. The net loss for the acquired stores for the period from acquisition date through January 28, 2012 was $2.0 million, excluding transition related expenses.

        As the acquisitions (including Big 10) were immaterial to the operating results both individually and in aggregate for the thirteen and fifty-two week periods ended January 28, 2012 and January 29, 2011, pro forma results for the thirteen and fifty-two week periods ended January 28, 2012 are not presented.

        In 2011, the Company recorded a reduction to the contingent consideration of $0.7 million related to one of the Company's acquisitions. The reversal of contingent consideration was recorded to selling, general and administrative expenses in the consolidated statements of operations.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

Years ended January 29, 2011, January 30, 2010 and January 31, 2009

NOTE 3—OTHER CURRENT ASSETS

        The following are the components of other current assets:

(dollar amounts in thousands)
  January 28,
2012
  January 29,
2011
 

Reinsurance receivable

  $ 59,280   $ 57,532  

Income taxes receivable

    89     1,608  

Other

    610     1,672  
           

Total

  $ 59,979   $ 60,812  
           

NOTE 4—ACCRUED EXPENSES

        The following are the components of accrued expenses:

(dollar amounts in thousands)
  January 28,
2012
  January 29,
2011
 

Casualty and medical risk insurance

  $ 147,806   $ 146,667  

Accrued compensation and related taxes

    19,133     31,990  

Sales tax payable

    12,254     12,809  

Other

    42,512     44,562  
           

Total

  $ 221,705   $ 236,028  
           

NOTE 5—DEBT AND FINANCING ARRANGEMENTS

        The following are the components of debt and financing arrangements:

(dollar amounts in thousands)
  January 28,
2012
  January 29,
2011
 

7.50% Senior Subordinated Notes, due December 2014

  $ 147,565   $ 147,565  

Senior Secured Term Loan, due October 2013

    147,557     148,636  

Revolving Credit Agreement, through July 2016

         
           

Long-term debt

    295,122     296,201  

Current maturities

    (1,079 )   (1,079 )
           

Long-term debt less current maturities

  $ 294,043   $ 295,122  
           

7.50% Senior Subordinated Notes, due December 2014

        On December 14, 2004, the Company issued $200.0 million aggregate principal amount of 7.50% Senior Subordinated Notes (the "Notes") due December 2014. The Company did not repurchase Notes in fiscal 2011. During fiscal 2010, the Company repurchased Notes in the principal amount of $10.0 million, resulting in a loss from debt repurchases of $0.2 million.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

Years ended January 29, 2011, January 30, 2010 and January 31, 2009

NOTE 5—DEBT AND FINANCING ARRANGEMENTS (Continued)

    Senior Secured Term Loan Facility, due October 2013

        The Company has a Senior Secured Term Loan facility (the "Term Loan") due October 2013. This facility is secured by a collateral pool consisting of real property and improvements associated with stores, which is adjusted periodically based upon real estate values and borrowing levels. Interest accrues at the three month London Interbank Offered Rate (LIBOR) plus 2.0% on this facility. As of January 28, 2012, 126 stores collateralized the Term Loan.

    Revolving Credit Agreement, through July 2016

        On January 16, 2009, the Company entered into a Revolving Credit Agreement (the "Agreement") with available borrowings up to $300.0 million and a maturity of January 2014. Total incurred fees of $6.8 million were capitalized and are being amortized over the original five year life of the facility. On July 26, 2011, the Company amended and restated the Agreement to reduce its interest rate by 75 basis points and to extend its maturity to July 2016. The related refinancing fees of $2.4 million are being amortized over the new five year life. The Company's ability to borrow under the Agreement is based on a specific borrowing base consisting of inventory and accounts receivable. The interest rate on this credit line is daily LIBOR plus 2.00% to 2.50% based upon the then current availability under the Agreement. Fees based on the unused portion of the Agreement range from 37.5 to 75.0 basis points. As of January 28, 2012, there were no outstanding borrowings under the Agreement.

        The weighted average interest rate on all debt borrowings during fiscal 2011 and 2010 was 6.3%.

    Other Matters

        Several of the Company's debt agreements require compliance with covenants. The most restrictive of these covenants, an earnings before interest, taxes, depreciation and amortization ("EBITDA") requirement, is triggered if the Company's availability under its credit agreement drops below $50.0 million. The failure to satisfy this covenant would constitute an event of default under the Revolving Credit Agreement, which would result in a cross-default under the Notes and Term Loan.

        As of January 28, 2012, the Company had no borrowings outstanding under the Revolving Credit Agreement, additional availability of approximately $194.9 million and was in compliance with all financial covenants contained in its debt agreements.

    Other Contractual Obligations

        The Company has a vendor financing program with availability up to $125.0 million which is funded by various bank participants who have the ability, but not the obligation, to purchase account receivables owed by the Company directly from vendors. The Company, in turn, makes the regularly scheduled full vendor payments to the bank participants. There was an outstanding balance of $85.2 million and $56.3 million under the program as of January 28, 2012 and January 29, 2011, respectively.

        The Company has letter of credit arrangements in connection with its risk management, import merchandising and vendor financing programs. The Company had no outstanding commercial letters of credit as of January 28, 2012 and was contingently liable for $0.3 million in outstanding commercial

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

Years ended January 29, 2011, January 30, 2010 and January 31, 2009

NOTE 5—DEBT AND FINANCING ARRANGEMENTS (Continued)

letters of credit as of January 29, 2011. The Company was contingently liable for $31.7 million and $107.6 million in outstanding standby letters of credit as of January 28, 2012 and January 29, 2011, respectively.

        The Company is also contingently liable for surety bonds in the amount of approximately $8.3 million and $10.3 million as of January 28, 2012 and January 29, 2011, respectively. The surety bonds guarantee certain payments (for example utilities, easement repairs, licensing requirements and customs fees).

        The annual maturities of all long-term debt for the next five fiscal years are:

(dollar amounts in thousands)
Fiscal Year
  Long-Term Debt  

2012 Senior Secured Term Loan, due October 2013

  $ 1,079  

2013 Senior Secured Term Loan, due October 2013

    146,478  

2014 7.50% Senior Subordinated Notes, due December 2014

    147,565  

2015

     

Thereafter

     
       

Total

  $ 295,122  
       

        Interest rates that are currently available to the Company for issuance of debt with similar terms and remaining maturities are used to estimate fair value for debt issues that are not quoted on an exchange. The estimated fair value of long-term debt including current maturities was $293.6 million and $298.3 million as of January 28, 2012 and January 29, 2011.

NOTE 6—LEASE AND OTHER COMMITMENTS

        In fiscal 2010, the Company sold one property to an unrelated third party. Net proceeds from this sale were $1.6 million. Concurrent with this sale, the Company entered into an agreement to lease the property back from the purchaser over a minimum lease term of 15 years. The Company classified this lease as an operating lease. The Company actively uses this property and considers the lease as a normal leaseback. The Company recorded a deferred gain of $0.4 million.

        In fiscal 2009, the Company sold four properties to unrelated third parties. Net proceeds from these sales were $12.9 million. Concurrent with these sales, the Company entered into agreements to lease the properties back from the purchasers over minimum lease terms of 15 years. Each property has a separate lease with an initial term of 15 years and four five-year renewal options. Every five years, the leases have rent increases of an amount equal to the lesser of 8% of the monthly rent due in the immediately preceding lease year or the percentage of the CPI increase between five year anniversaries. The Company classified these leases as operating leases, actively uses these properties and considers the leases as normal leasebacks. The Company recognized a gain of $1.2 million on the sale of these properties and recorded a deferred gain of $6.4 million.

        In connection with the three acquisitions that occurred during fiscal 2011, the Company assumed additional lease obligations totaling $120.2 million over an average of 14 years.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

Years ended January 29, 2011, January 30, 2010 and January 31, 2009

NOTE 6—LEASE AND OTHER COMMITMENTS (Continued)

        The aggregate minimum rental payments for all leases having initial terms of more than one year are as follows:

(dollar amounts in thousands)
Fiscal Year
  Operating
Leases
 

2012

  $ 98,479  

2013

    94,176  

2014

    89,753  

2015

    82,831  

2016

    75,626  

Thereafter

    372,123  
       

Aggregate minimum lease payments

  $ 812,988  
       

        Rental expenses incurred for operating leases in fiscal 2011, 2010, and 2009 were $91.6 million, $79.7 million and $75.3 million, respectively, and are recorded primarily in cost of revenues. The deferred gain for all sale leaseback transactions is being recognized in costs of merchandise sales and costs of service revenues over the minimum term of these leases.

NOTE 7—ASSET RETIREMENT OBLIGATIONS

        The Company records asset retirement obligations as incurred and when reasonably estimable, including obligations for which the timing and/or method of settlement are conditional on a future event that may or may not be within the control of the Company. The obligation principally represents the removal of leasehold improvements from stores upon termination of store leases. The obligations are recorded as liabilities at fair value using discounted cash flows and are accreted over the lease term. Costs associated with the obligations are capitalized and amortized over the estimated remaining useful life of the asset.

        The Company has recorded a liability pertaining to the asset retirement obligation in other long-term liabilities on its consolidated balance sheet. Changes in assumptions reflect favorable experience with the rate of occurrence of obligations and expected settlement dates. The liability for asset retirement obligations activity from January 30, 2010 through January 28, 2012 is as follows:

(dollar amounts in thousands)
   
 

Asset retirement obligation at January 30, 2010

  $ 6,724  

Change in assumptions

    (1,192 )

Settlements

    (120 )

Accretion expense

    194  
       

Asset retirement obligation at January 29, 2011

    5,606  

Additions

    206  

Change in assumptions

    (199 )

Settlements

    (61 )

Accretion expense

    323  
       

Asset retirement obligation at January 28, 2012

  $ 5,875  
       

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THE PEP BOYS—MANNY, MOE & JACK AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

Years ended January 29, 2011, January 30, 2010 and January 31, 2009

NOTE 8—INCOME TAXES

        The components of income before income taxes are as follows:

 
  Year Ended  
(dollar amounts in thousands)
  January 28,
2012
  January 29,
2011
  January 30,
2010
 

Domestic

  $ 36,633   $ 52,319   $ 41,921  

Foreign

    4,954     6,125     (4,305 )

Total

  $ 41,588   $ 58,444   $ 37,616  

        The provision for income taxes includes the following:

 
  Year Ended  
(dollar amounts in thousands)
  January 28,
2012
  January 29,
2011
  January 30,
2010
 

Current:

                   

Federal

  $   $   $ 398  

State

    602     491     (511 )

Foreign

    1,557     2,210     149  

Deferred:

                   

Federal(a)

    14,743     20,309     13,820  

State

    (3,887 )   (1,818 )   42  

Foreign

    (555 )   81     (395 )
               

Total income tax expense from continuing operations(a)

  $ 12,460   $ 21,273   $ 13,503  
               

(a)
Excludes tax benefit recorded to discontinued operations of $0.1 million, $0.3 million and $0.6 million in fiscal 2011, 2010 and 2009, respectively.

        A reconciliation of the statutory federal income tax rate to the effective rate for income tax expense follows:

 
  Year Ended  
 
  January 28,
2012
  January 29,
2011
  January 30,
2010
 

Statutory tax rate

    35.0 %   35.0 %   35.0 %

State income taxes, net of federal tax

    3.2     2.4     2.4  

Job credits

    (1.5 )   (0.3 )   (0.9 )

Hire credits

    (2.1 )        

Tax uncertainty adjustment

    (0.1 )   0.2     (0.5 )

Valuation allowance

    (8.3 )   (3.5 )    

Non deductible expenses

    2.0     0.5     0.3  

Stock compensation

    0.1     0.2     0.8  

Foreign taxes, net of federal tax

    1.7     2.4     (0.7 )

Other, net

        (0.5 )   (0.5 )
               

    30.0 %   36.4 %   35.9 %
               

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THE PEP BOYS—MANNY, MOE & JACK AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

Years ended January 29, 2011, January 30, 2010 and January 31, 2009

NOTE 8—INCOME TAXES (Continued)

        Items that gave rise to the deferred tax accounts are as follows:

(dollar amounts in thousands)
  January 28,
2012
  January 29,
2011
 

Deferred tax assets:

             

Employee compensation

  $ 5,008   $ 3,060  

Store closing reserves

    1,365     1,064  

Legal reserve

    341     569  

Benefit accruals

    5,922     3,576  

Net operating loss carryforwards—Federal

    16,473     2,527  

Net operating loss carryforwards—State

    111,588     107,941  

Tax credit carryforwards

    17,877     17,086  

Accrued leases

    15,916     12,107  

Interest rate derivatives

    5,730     5,960  

Deferred gain on sale leaseback

    56,325     61,904  

Deferred revenue

    5,621     5,871  

Other

    1,951     2,570  
           

Gross deferred tax assets

    244,117     224,235  

Valuation allowance

    (103,915 )   (104,486 )
           

    140,202     119,749  
           

Deferred tax liabilities:

             

Depreciation

  $ 54,284   $ 44,634  

Inventories

    65,886     57,538  

Real estate tax

    3,307     3,132  

Insurance and other

    6,159     2,574  

Debt related liabilities

    3,903     2,187  
           

    133,539     110,065  
           

Net deferred tax asset

  $ 6,663   $ 9,684  
           

        As of January 28, 2012 and January 29, 2011, the Company had available tax net operating losses that can be carried forward to future years. The Company has $16.5 million of deferred tax assets related to federal net operating loss carryforwards which begin to expire in 2027. The Company has $2.7 million of deferred tax assets related to state tax net operating loss carryforwards related to unitary filings of which 2.4% will expire in the next five years for which a full valuation allowance has been recorded. The balance of $108.8 million of the Company's net operating loss carryforwards relate to separate company filing jurisdictions that will expire in various years beginning in 2012 of which $106.2 million have full valuation allowances recorded against them.

        The tax credit carryforward at January 28, 2012 consists of $7.3 million of alternative minimum tax credits, $4.0 million of work opportunity credits, $0.9 millions of hire tax credits and $5.7 million of state and Puerto Rico tax credits. The alternative minimum credits have an indefinite life and the other credits are scheduled to expire in various years starting from 2012 of which $0.9 million have full valuation allowances recorded against them. The tax credit carryforward at January 29, 2011 consists of

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THE PEP BOYS—MANNY, MOE & JACK AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

Years ended January 29, 2011, January 30, 2010 and January 31, 2009

NOTE 8—INCOME TAXES (Continued)

$7.3 million of alternative minimum tax credits, $3.4 million of work opportunity credits and $6.4 million of state and Puerto Rico tax credits of which $3.3 million have full valuation allowances recorded against them.

        The temporary differences between the book and tax treatment of income and expenses result in deferred tax assets and liabilities, which are included within the consolidated balance sheets. The Company must assess the likelihood that any recorded deferred tax assets will be recovered against future taxable income. To the extent the Company believes it is more likely than not that the asset will not be recoverable, a valuation allowance must be established. To the extent the Company establishes a valuation allowance or changes the allowance in a future period, income tax expense will be impacted. Based on the Company's improved performance and tax restructuring, the Company released $5.3 million of gross valuation allowances ($3.6 million net of federal benefit) on certain state net operating loss carryforwards and state credits during fiscal 2011.

        The Company and its subsidiaries file income tax returns in the U.S. federal, various states and Puerto Rico jurisdictions. The Company's U.S. federal returns for tax years 2004 and forward are subject to examination. State and local income tax returns are generally subject to examination for a period of three to five years after filing of the respective return. The Company has various state income tax returns in the process of examination.

        A reconciliation of the beginning and ending amount of unrecognized tax benefits is as follows:

(dollar amounts in thousands)
  January 28,
2012
  January 29,
2011
  January 30,
2010
 

Unrecognized tax benefit balance at the beginning of the year

  $ 4,131   $ 2,411   $ 2,458  

Gross increases for tax positions taken in prior years

        1,331     646  

Gross decreases for tax positions taken in prior years

            (526 )

Gross increases for tax positions taken in current year

    235     389     296  

Settlements taken in current year

            (271 )

Lapse of statute of limitations

    (1,002 )       (192 )
               

Unrecognized tax benefit balance at the end of the year

  $ 3,364   $ 4,131   $ 2,411  
               

        The Company recognizes potential interest and penalties for unrecognized tax benefits in income tax expense and, accordingly, the Company recognized $0.1 million in fiscal 2011 and no material income tax expense in fiscal 2010 related to potential interest and penalties associated with uncertain tax positions. At January 28, 2012, January 29, 2011, and January 30, 2010, the Company has recorded $0.3 million, $0.2 million, and $0.2 million, respectively, for the payment of interest and penalties which are excluded from the unrecognized tax benefit noted above.

        Unrecognized tax benefits include $1.3 million, $1.4 million, and $1.3 million, at January 28, 2012, January 29, 2011 and January 30, 2010, respectively, of tax benefits that, if recognized, would affect the

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THE PEP BOYS—MANNY, MOE & JACK AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

Years ended January 29, 2011, January 30, 2010 and January 31, 2009

NOTE 8—INCOME TAXES (Continued)

Company's annual effective tax rate. The Company believes it is reasonably possible that the amount will increase or decrease within the next twelve months; however, it is not currently possible to estimate the impact of the change.

NOTE 9—STOCKHOLDERS' EQUITY

        On January 26, 2010, the Company terminated the flexible employee benefits trust (the "Trust") that was established on April 29, 1994 to fund a portion of the Company's obligations arising from various employee compensation and benefit plans. In accordance with the terms of the Trust, upon its termination, the Trust's sole asset, consisting of 2,195,270 shares of the Company's common stock, was transferred to the Company in exchange for the full satisfaction and discharge of all intercompany indebtedness then owed by the Trust to the Company. The termination of the Trust had no impact on the Company's consolidated financial statements, except for the reclassification of the shares within the shareholders equity section of the Company's Consolidated Balance Sheets. The Company uses its treasury shares to satisfy share requirements to its employees under its compensation plans and dividend reinvestment program.

NOTE 10—ACCUMULATED OTHER COMPREHENSIVE INCOME (LOSS)

        The following are the components of other comprehensive income:

 
  Year Ended  
(dollar amounts in thousands)
  January 28,
2012
  January 29,
2011
  January 30,
2010
 

Net earnings

  $ 28,903   $ 36,631   $ 23,036  

Other comprehensive income (loss), net of tax:

                   

Defined benefit plan adjustment

    (3,120 )   582     595  

Derivative financial instrument adjustment

    2,499     81     (211 )
               

Comprehensive income

  $ 28,282   $ 37,294   $ 23,420  
               

        The components of accumulated other comprehensive loss are:

 
  Year Ended  
(dollar amounts in thousands)
  January 28,
2012
  January 29,
2011
  January 30,
2010
 

Defined benefit plan adjustment, net of tax

  $ (9,696 ) $ (6,576 ) $ (7,158 )

Derivative financial instrument adjustment, net of tax

    (7,953 )   (10,452 )   (10,533 )
               

Accumulated other comprehensive loss

  $ (17,649 ) $ (17,028 ) $ (17,691 )
               

NOTE 11—STORE CLOSURES AND ASSET IMPAIRMENTS

        During fiscal 2011, the Company recorded a $1.6 million impairment charge related to 12 stores classified as held and used. Of the $1.6 million impairment charge, $0.6 million was charged to merchandise cost of sales, and $1.0 million was charged to service cost of sales. In fiscal 2010, the

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THE PEP BOYS—MANNY, MOE & JACK AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

Years ended January 29, 2011, January 30, 2010 and January 31, 2009

NOTE 11—STORE CLOSURES AND ASSET IMPAIRMENTS (Continued)

Company recorded a $0.8 million impairment charge related to two stores classified as held and used. Of the $0.8 million impairment charge, $0.6 million was charged to merchandise cost of sales, and $0.2 million was charged to service cost of sales. In both years the Company used a probability-weighted approach and estimates of expected future cash flows to determine the fair value of these stores. Discount and growth rate assumptions were derived from current economic conditions, management's expectations and projected trends of current operating results. The fair market value estimates are classified as a Level 3 measure within the fair value hierarchy. The remaining fair value of impaired assets was $1.4 million at January 28, 2012.

        The following schedule details activity in the reserve for closed locations for the three years in the period ended January 28, 2012. The reserve balance includes remaining rent on leases net of sublease income.

(dollar amounts in thousands)
   
 

Balance, January 31, 2009

  $ 2,112  

Accretion of present value of liabilities

    111  

Change in assumptions about future sublease income, lease termination

    1,122  

Cash payments

    (1,095 )
       

Balance, January 30, 2010

    2,250  

Accretion of present value of liabilities

    81  

Change in assumptions about future sublease income, lease termination

    163  

Cash payments

    (1,253 )
       

Balance, January 29, 2011

    1,241  

Accretion of present value of liabilities

    53  

Provision for closed locations

    310  

Change in assumptions about future sublease income, lease termination

    674  

Cash payments

    (477 )
       

Balance, January 28, 2012

  $ 1,801  
       

        A store is classified as "held for disposal" when (i) the Company has committed to a plan to sell, (ii) the building is vacant and the property is available for sale, (iii) the Company is actively marketing the property for sale, (iv) the sale price is reasonable in relation to its current fair value and (v) the Company expects to complete the sale within one year. Assets held for disposal have been valued at the lower of their carrying amount or their estimated fair value, net of disposal costs. The fair value of these assets is estimated using readily available market data for comparable properties and is classified as a Level 2 (as described in Note 16, "Fair Value Measurements") measure within the fair value hierarchy. No depreciation expense is recognized during the period the asset is held for disposal. During fiscal 2011, the Company sold the last remaining store classified as an asset held for sale at the property's carrying value.

        During fiscal 2010, the Company sold seven stores classified as held for disposal for $4.3 million and recorded a net gain of $0.5 million in earnings from continuing operations. In addition, during fiscal 2010, the Company recorded a $0.2 million impairment charge related to a store classified as held for disposal. The Company lowered its selling price reflecting declines in the commercial real estate market. Substantially all of this impairment was charged to merchandise cost of sales.

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THE PEP BOYS—MANNY, MOE & JACK AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

Years ended January 29, 2011, January 30, 2010 and January 31, 2009

NOTE 11—STORE CLOSURES AND ASSET IMPAIRMENTS (Continued)

        During fiscal 2009, the Company sold four stores classified as held for disposal for $3.6 million and recorded a net gain of $0.2 million of which $0.1 million is reported in discontinued operations. The Company also decided to reopen one store and moved the carrying value of $1.7 million to property and equipment. During fiscal 2009 in response to a continuing weak real estate market, the Company reduced its prices for certain properties and recorded a $3.1 million impairment charge, of which $2.2 million was charged to merchandise cost of sales, $0.7 million was charged to service cost of sales and $0.2 million (pretax) was charged to discontinued operations.

NOTE 12—EARNINGS PER SHARE

        Basic earnings per share is based on net earnings divided by the weighted average number of shares outstanding during the period. The following schedule presents the calculation of basic and diluted earnings per share for earnings from continuing operations:

 
   
  Year Ended  
 
  (dollar amounts in thousands, except per share amounts)
  January 28,
2012
  January 29,
2011
  January 30,
2010
 

(a)

 

Earnings from continuing operations before discontinued operations

  $ 29,128   $ 37,171   $ 24,113  

 

Loss from discontinued operations, net of tax benefit of $(121), $(291) and $(580)

    (225 )   (540 )   (1,077 )
                   

 

Net earnings

  $ 28,903   $ 36,631   $ 23,036  
                   

(b)

 

Basic average number of common shares outstanding during period

    52,958     52,677     52,397  

 

Common shares assumed issued upon exercise of dilutive stock options, net of assumed repurchase, at the average market price

    673     485     270  
                   

(c)

 

Diluted average number of common shares assumed outstanding during period

    53,631     53,162     52,667  
                   

 

Basic earnings per share:

                   

 

Earnings from continuing operations (a/b)

  $ 0.55   $ 0.71   $ 0.46  

 

Discontinued operations, net of tax

    (0.01 )   (0.01 )   (0.02 )
                   

 

Basic earnings per share

  $ 0.54   $ 0.70   $ 0.44  
                   

 

Diluted earnings per share:

                   

 

Earnings from continuing operations (a/c)

  $ 0.54   $ 0.70   $ 0.46  

 

Discontinued operations, net of tax

        (0.01 )   (0.02 )