Edgar Filing: ADVANCE AUTO PARTS INC

AAP 10-K

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

Form 10-K

(Mark One)

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

For the fiscal year ended December 30, 2006

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 001-16797

ADVANCE AUTO PARTS, INC.

(Exact name of registrant as specified in its charter)

Delaware (State or other jurisdiction of incorporation or organization)	54-2049910 (I.R.S. Employer Identification No.)
5008 Airport Road Roanoke, Virginia (Address of Principal Executive Offices)	24012 (Zip Code)

(540) 362-4911

(Registrant’s telephone number, including area code)

Securities Registered Pursuant to Section 12(b) of the Act:

Title of each class

Common Stock

($0.0001 par value)

Name of each exchange on which registered

New York

Stock Exchange

Securities Registered Pursuant to Section 12(g) of the Act: None

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

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 x

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 x No o

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§229.405 of this chapter) 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. o

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

Large accelerated filer x

Accelerated filer o

Non-accelerated filer o

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

Yes o No x

As of July 14, 2006, the last business day of the registrant’s most recently completed second fiscal quarter, the aggregate market value of the 104,791,059 shares of Common Stock held by non-affiliates of the registrant was $3,043,132,353, based on the last sales price of the Common Stock on July 14, 2006, as reported by the New York Stock Exchange.

As of February 26, 2007, the registrant had outstanding 105,667,492 shares of Common Stock, par value $0.0001 per share (the only class of common equity of the registrant outstanding).

Documents Incorporated by Reference:

Portions of the definitive proxy statement of the registrant to be filed within 120 days of December 30, 2006, pursuant to Regulation 14A under the Securities Exchange Act of 1934, for the 2007 Annual Meeting of Stockholders to be held on May 16, 2007, are incorporated by reference into Part III.

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TABLE OF CONTENTS
			Page

Part I.

	Item 1.	Business	2

	Item 1A.	Risk Factors	10

	Item 1B.	Unresolved Staff Comments	13

	Item 2.	Properties	14

	Item 3.	Legal Proceedings	15

	Item 4.	Submission of Matters to a Vote of Security Holders	15

Part II.

	Item 5.	Market for the Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities	16

	Item 6.	Selected Financial Data	17

	Item 7.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	20

	Item 7A.	Quantitative and Qualitative Disclosures About Market Risks	37

	Item 8.	Financial Statements and Supplementary Data	37

	Item 9.	Changes in and Disagreements with Accountants on Accounting and Financial Disclosure	37

	Item 9A.	Controls and Procedures	37

	Item 9B.	Other Information	38

Part III.

	Item 10.	Directors, Executive Officers and Corporate Governance	39

	Item 11.	Executive Compensation	39

	Item 12.	Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters	39

	Item 13.	Certain Relationships and Related Transactions, and Director Independence	39

	Item 14.	Principal Accountant Fees and Services	39

Part IV.

	Item 15.	Exhibits, Financial Statement Schedules	40

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FORWARD-LOOKING STATEMENTS

Certain statements in this report are "forward-looking statements" within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934, which are usually identified by the use of words such as "will," "anticipates," "believes," "estimates," "expects," "projects," "forecasts," "plans," "intends," "should" or similar expressions. We intend those forward-looking statements to be covered by the safe harbor provisions for forward-looking statements contained in the Private Securities Litigation Reform Act of 1995 and are included in this statement for purposes of complying with these safe harbor provisions.

These forward-looking statements reflect current views about our plans, strategies and prospects, which are based on the information currently available and on current assumptions.

Although we believe that our plans, intentions and expectations as reflected in or suggested by those forward-looking statements are reasonable, we can give no assurance that the plans, intentions or expectations will be achieved. Listed below and discussed elsewhere in this report are some important risks, uncertainties and contingencies which could cause our actual results, performance or achievements to be materially different from the forward-looking statements made in this report. These risks, uncertainties and contingencies include, but are not limited to, the following:

·	the implementation of our business strategies and goals;
·	our ability to expand our business;
·	competitive pricing and other competitive pressures;
·	a decrease in demand for our products;
·	the occurrence of natural disasters and/or extended periods of unfavorable weather;
·	our ability to obtain affordable insurance against the financial impacts of natural disasters;
·	the availability of suitable real estate locations;
·	our overall credit rating;
·	deterioration in general economic conditions;
·	our ability to attract and retain qualified team members;
·	integration of acquisitions;
·	our relationship with our vendors;
·	our involvement as a defendant in litigation or incurrence of judgments, fines or legal costs;
·	adherence to the restrictions and covenants imposed under our revolving credit facility;
·	acts of terrorism; and
·	other statements that are not of historical fact made throughout this report, including in the sections entitled “Business,” "Management's Discussion and Analysis of Financial Condition and Results of Operations" and "Risk Factors."

We assume no obligations to update publicly any forward-looking statements, whether as a result of new information, future events or otherwise. In evaluating forward-looking statements, you should consider these risks and uncertainties, together with the other risks described from time to time in our other reports and documents filed with the Securities and Exchange Commission, or SEC, and you should not place undue reliance on those statements.

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PART I

Item 1. Business.

Unless the context otherwise requires, “Advance,” “we,” “us,” “our,” and similar terms refer to Advance Auto Parts, Inc., its predecessor, its subsidiaries and their respective operations. Our fiscal year consists of 52 or 53 weeks ending on the Saturday closest to December 31 of each year. Fiscal 2003 included 53 weeks of operations. All other fiscal years presented included 52 weeks of operations.

Overview

We primarily operate within the United States automotive aftermarket industry, which includes replacement parts (excluding tires), accessories, maintenance items, batteries and automotive chemicals for cars and light trucks (pickup trucks, vans, minivans and sport utility vehicles). We currently are the second largest specialty retailer of automotive parts, accessories and maintenance items to "do-it-yourself," or DIY, and “do-it-for-me”, or DIFM, customers in the United States, based on store count and sales.

We were formed in 1929 as Advance Stores Company, Incorporated and operated as a retailer of general merchandise until the 1980s. During the 1980s, we sharpened our focus to target sales of automotive parts and accessories to DIY customers. From the 1980s to the present, we have grown significantly as a result of strong comparable store sales growth, new store openings and strategic acquisitions. Since 1996, we have aggressively expanded our sales to DIFM customers through our commercial delivery program. The Company was incorporated in 2001 in conjunction with the acquisition of Discount Auto Parts, Inc., or Discount. More recently in 2005, we acquired Autopart International, Inc., or AI.

Our Internet address is www.AdvanceAutoParts.com. We make available free of charge through our Internet website our annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and amendments to those reports filed or furnished pursuant to the Securities Exchange Act of 1934 as soon as reasonably practicable after we electronically file such material with, or furnish it to, the SEC.

Operating Segments

We conduct our operations in two reportable segments: Advance Auto Parts, or AAP, and AI. The AAP segment is comprised of our store operations within the United States, Puerto Rico and the Virgin Islands which operate under the trade names “Advance Auto Parts,” “Advance Discount Auto Parts” and “Western Auto.” The AI segment consists solely of the operations of Autopart International, which continues to operate as an independent, wholly-owned subsidiary.

Financial information on our segments is included in Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations, of this Annual Report on Form 10-K. In addition, selected financial data for our segments is available in Note 20, Segment and Related Information, of the Notes to Consolidated Financial Statements, included in Item 15. Exhibits, Financial Statement Schedules, of this Annual Report on Form 10-K.

AAP Segment

At December 30, 2006, we operated 2,995 stores within the United States, Puerto Rico and the Virgin Islands. We operated 2,958 stores throughout 40 states in the Northeastern, Southeastern and Midwestern regions of the United States. These stores operated under the “Advance Auto Parts” trade name except for certain stores in the state of Florida, which operated under the “Advance Discount Auto Parts” trade name. These stores offer a broad selection of brand name and proprietary automotive replacement parts, accessories and maintenance items for domestic and imported cars and light trucks, with no significant concentration in any specific product area. In addition, we operated 37 stores under the “Western Auto” and “Advance Auto Parts” trade names, located primarily in Puerto Rico and the Virgin Islands. The Western Auto stores offer automotive tires and service in addition to automotive parts, accessories and maintenance items.

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We also provide our customers online shopping and access to over one million stock keeping units, or SKUs. Our online site allows our customers to pick up merchandise at a conveniently located store or have their purchase shipped directly to their home or business.

AAP Store Operations

Our stores generally are located in freestanding buildings in areas with high vehicle traffic counts, good visibility and easy access to major roadways. Our stores typically range in size from 5,000 to 10,000 square feet. The size of our new stores is generally 7,000 square feet. All stores have a base SKU offering while certain stores may have a more expansive SKU offering as follows:

Type of Store	Description	SKU Offering
Base	· Includes base SKU offering	16,000
Hub / Undercar	· Provides customized assortment of merchandise in a centralized market location specifically identified based on the demand within an individual market · Benefits all our DIY and DIFM customer within the market	16,600 - 18,000
Local Area Warehouse (LAW)	· LAW concept utilizes existing space in selected stores to ensure the availability of a customized assortment in addition to hub and undercar assortments to other stores served by LAW · Product is available on a same day basis to stores served by LAW	24,600 - 28,000

To ensure our stores have the right product at the right time, we also utilize a network of Parts Delivered Quickly, or PDQ®, facilities and one Master PDQ® facility. Our PDQ® and Master PDQ® network of facilities provide our customers an additional assortment of over 80,000 harder-to-find parts and accessories on a same-day or overnight basis. In addition, we launched our Special Order Center in 2006, an in-store kiosk providing customers with access to more than one million incremental SKUs.

Store team members utilize our proprietary point-of-sale system, including a fully integrated electronic parts catalog to identify and suggest the appropriate quality and price options for the SKUs that we carry, as well as the related products, tools or additional information that is required by our customers to complete their automotive repair projects properly and safely.

Replacement parts sold at our stores include an extensive number of applications of those parts including:

Automotive filters	Starters	CV shafts	Suspension parts
Radiators	Alternators	Spark splugs	Engines
Brake pads	Batteries	Transmission parts	Transmissions
Fan belts	Shock absorbers	Clutches
Radiator hoses	Struts	Electronic ignition components

In addition to parts and accessories, we also provide a variety of services free of charge to our customers including:

Battery installation	“How-To” Project Kiosks	Electrical system testing
Wiper installation	“How-To” Video Clinics	Oil and battery recycling

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Our retail stores are 100% company operated and are divided into geographic areas. A senior vice president, who is supported by five to six regional vice presidents, manages each area of retail stores. Division managers report to the regional vice presidents and have direct responsibility for store operations in a specific division, which typically consists of 10 to 14 stores. Depending on store size and sales volume, each store is staffed by 10 to 20 team members under the leadership of a store manager. Our stores generally are open from 7:30 a.m. to 9:00 p.m. six days a week and 9:00 a.m. to 9:00 p.m. on Sundays and most holidays to meet the needs of our DIY and DIFM customers. We continue to increase the number of our stores which remain open until midnight or in some cases 24 hours per day.

Commercial Sales

In addition to the in-store customer service provided to our DIY customers, we also maintain a commercial sales team dedicated to the development of our commercial business and the support of our DIFM customers. Since 1996, we have aggressively expanded our sales to DIFM customers through our commercial delivery program. Sales to DIFM customers represented approximately 23% of our AAP sales in 2006 and consisted of sales to both walk-in commercial customers and sales delivered to our commercial customers’ place of business, including independent garages, service stations and auto dealers. At December 30, 2006, we had 2,439 AAP stores with commercial delivery programs, or 81% of total AAP stores.

A vice president has the responsibility of the strategic growth of the commercial program through the development of commercial programs and commercial marketing and merchandising initiatives with the continued focus on getting our DIFM customers to use us as their “first call” supplier. Additionally, each of our four area senior vice presidents has a director of commercial sales that concentrates solely on strategic and tactical commercial sales growth opportunities. Each director leads four to five area commercial sales managers. Division commercial sales managers report directly to our area commercial sales managers and, similar to our retail division managers, they are directly responsible for commercial sales and operations in each division. We also target DIFM customers through our commercial marketing efforts in all our retail stores, including those that do not offer a delivery service.

Total AAP Stores

Our 2,995 AAP stores were located in the following states and territories at December 30, 2006:

Location	Number of Stores	Location	Number of Stores	Location	Number of Stores

Alabama	114	Maryland	72	Oklahoma	18
Arkansas	35	Massachusetts	46	Pennsylvania	153
California	1	Michigan	71	Puerto Rico	34
Colorado	33	Minnesota	16	Rhode Island	6
Connecticut	30	Mississippi	54	South Carolina	119
Delaware	5	Missouri	39	South Dakota	7
Florida	441	Nebraska	18	Tennessee	142
Georgia	213	New Hampshire	9	Texas	125
Illinois	73	New Mexico	1	Vermont	7
Iowa	26	New Jersey	44	Virgin Islands	2
Indiana	90	New York	111	Virginia	163
Kansas	26	North Carolina	213	West Virginia	64
Kentucky	86	North Dakota	4	Wisconsin	43
Louisiana	58	Ohio	170	Wyoming	2
Maine	11

The following table sets forth information concerning increases in the total number of our AAP stores during the past five years:

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	2006			2005					2004			2003			2002
Beginning Stores		2,810			2,652					2,539			2,435			2,484
New Stores⁽¹⁾		190			169					125			125			110		⁽³	⁾
Stores Closed		(5	)		(11	)				(12	)		(21	)		(159	)	⁽⁴	⁾
Ending Stores		2,995			2,810		⁽²	⁾		2,652			2,539			2,435

⁽¹⁾	Does not include stores that opened as relocations of previously existing stores within the same general market area or substantial renovations of stores.

⁽²⁾	Includes 2 and 7 stores not operating at December 30, 2006 and December 31, 2005, respectively, primarily due to hurricane damage.

⁽³⁾	Includes 57 stores acquired during the third and fourth quarters of fiscal 2002 as a result of our Trak Auto Parts acquisition.

⁽⁴⁾	Includes 133 stores closed as a result of our integration of the Discount operations.

Store Systems

Our store based information systems, which are designed to improve the efficiency of our operations and enhance customer service, are comprised of proprietary point-of-sale, or POS, electronic parts catalog, or EPC, store-level inventory management and standard operating procedure, or SOP, systems. Additionally, we support our store-level operations with a proprietary labor scheduling system known as management planning and training, or MPT. These systems are tightly integrated and together provide real-time, comprehensive information to store and merchandising personnel, resulting in improved customer service levels, team member productivity and in-stock availability.

Point-of-Sale. Our POS system, or APAL, is in all of our stores operating under the “Advance Auto Parts”, "Advance Discount Auto Parts” and “Western Auto” trade names. Information maintained by APAL is used to formulate pricing, marketing and merchandising strategies and to replenish inventory accurately and rapidly. APAL is designed to improve customer checkout time and decrease the time required to train newly hired team members. In addition, APAL provides additional customer purchase history, which may be used for customer demographic analysis.

Electronic Parts Catalog. Our enhanced EPC system, which is fully integrated with APAL, is a software system that enables our store team members to identify millions of application uses for automotive parts and accessories. The EPC system enables store team members to assist our customers in their parts selection and ordering based on year, make, model and engine type of their vehicles. Our centrally based EPC data management system enables us to reduce the time needed to exchange data with our vendors and ultimately catalog and deliver updated, accurate product information. If a hard-to-find part or accessory is not available at one of our stores, the EPC system can determine whether the part is carried and in-stock through our PDQ^Ò system. Available parts and accessories are then ordered electronically from another store, LAW, PDQ^Ò or Master PDQ^Ò with immediate confirmation of price, availability and estimated delivery time.

Our EPC system also contains enhanced search engines and user-friendly navigation tools that enhance our team members’ ability to look up any needed parts as well as additional products the customer needs to complete their automotive repair project. While we believe this generally leads to an increase in average sales per transaction, we believe these components will enhance our customers’ shopping experience with us and help them accurately complete the repair job the first time, saving them time and money. Additionally, information about a customer's automobile can be entered into a permanent customer database that can be accessed immediately whenever the customer visits or telephones one of our stores.

Store-Level Inventory Management System. Our store-level inventory management system provides real-time inventory tracking at the store level. With the store-level system, store team members can check the quantity of on-hand inventory for any SKU, adjust stock levels for select items for store specific events, automatically process returns and defective merchandise, designate SKUs for cycle counts and track merchandise transfers. Our stores use

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radio frequency hand-held devices to help ensure the accuracy of our inventory.

Standard Operating Procedures. Our SOP system is a web-based, electronic data management system that allows our team members instant and quick access to any of our standard operating procedures through a comprehensive on-line search function.

Store Support Center

Merchandising

Virtually all of our merchandise is selected and purchased for our stores by team members at our centralized store support center in Roanoke, Virginia. In 2006, we purchased merchandise from over 400 vendors, with no single vendor accounting for more than 6% of purchases. Our purchasing strategy involves negotiating multi-year agreements with certain vendors, which allows us to achieve more favorable terms and pricing.

Our merchandising team is currently led by a group of seven senior professionals, who have an average of 22 years of automotive purchasing experience and 27 years in retail. The merchandising team is skilled in sourcing high quality products globally and maintaining consistent inventory levels. The merchandising team has developed strong vendor relationships in the industry and, in a collaborative effort with our vendor partners, utilizes a highly effective category management process. We believe this process, which develops a customer focused business plan for each merchandise category, improves comparable store sales, gross margin and inventory turns.

Our merchandising strategy is to carry a broad selection of high quality brand name automotive parts and accessories such as Bosch^®, Castrol^®, STP^®, Prestone^®, Monroe^®, Bendix^®, Purolator^®, Dayco^® and Trico^®, which generates DIY customer traffic and also appeals to commercial customers. In addition to these branded products, we stock a wide selection of high quality proprietary products that appeal to value conscious customers. These lines of merchandise include everything from chemical and wash-and-wax products to tools, batteries, parts and interior automotive accessories under the names of Professional’s Favorite^TM, Joe’s Garage^TM, Mechanic’s Choice^TM, Auto Xpress^TM, Autocraft^TM, Endurance^TMand Wearever^TM.

Sales of replacement parts account for a majority of our net sales and typically generate higher gross margins than maintenance items or general accessories. We customize our replacement part mix based on a merchandising program designed to optimize inventory mix at each individual store. The custom assortment is based on that store's historical and projected sales mix coupled with regionally specific customer needs.

Supply Chain

Our supply chain consists of centralized inventory management and transportation functions which support a logistics network of distribution centers, PDQ^® warehouses and stores. Our inventory management team utilizes a replenishment system, or E-3, to monitor the distribution center, PDQ^® warehouse and store inventory levels and order additional product when appropriate while streamlining costs associated with the handling of that product. E-3 utilizes the most up-to-date information from our point-of-sale system as well as inventory movement forecasting based upon history, sales trends by SKU, seasonality and demographic shifts in demand. E-3 combines these factors with service level goals, vendor lead times and cost of inventory assumptions to determine the timing and size of purchase orders. A significant portion of our purchase orders are sent via electronic data interchange, with the remainder being sent by computer generated e-mail or facsimile.

Our transportation team utilizes a transportation management system for efficiently managing incoming shipments to the distribution centers and stores. Benefits from this system include reduced vendor to distribution center freight costs, visibility of purchase orders and shipments for the entire supply chain, a reduction in distribution center inventory, or safety stock, due to consistent transit times, decreased third party freight and billing service costs, decreased distribution center to store freight costs and higher store in-stock position.

We currently operate eight distribution centers. All of these distribution centers are equipped with our distribution management system, or DCMS. Our DCMS provides real-time inventory tracking through the processes of receiving, picking, shipping and replenishing at our distribution centers. The DCMS, integrated with

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technologically advanced material handling equipment, significantly reduces warehouse and distribution costs, while improving efficiency. This equipment includes carousels, “pick-to light” systems, robotic picking, radio frequency technology, voice technology and automated sorting systems. Through the continued implementation of our supply chain initiatives we expect to further increase the efficient utilization of our distribution capacity. We believe our current capacity will allow us to support in excess of 3,400 stores. Subsequent to December 30, 2006, the Company announced its plan to build a new distribution center in Indiana scheduled to open in mid-2008.

We currently offer over 58,000 SKUs to substantially support all of our retail stores via our 13 stand-alone PDQ® warehouses and/or our eight distribution centers (all of which stock PDQ^® items). Stores have visibility to inventory in their respective facilities and can place orders to these facilities, or as an alternative, through an online ordering system to virtually any of the other facilities. Ordered parts are delivered to substantially all stores on a same day or next day basis through our dedicated PDQ^® trucking fleet and third party carriers. Store inventories are replenished from our eight distribution centers. In addition, we operate a PDQ^® warehouse that stocks over 50,000 incremental SKUs of harder-to-find automotive parts and accessories. This facility is known as the "Master PDQ^®" warehouse and utilizes existing PDQ^® distribution infrastructure and/or third party arrangements to provide next day service to substantially all of our stores.

Advertising

We have an extensive advertising program designed to communicate our merchandise offerings, product assortment, competitive prices, free services and commitment to customer service. The program is focused on establishing Advance Auto Parts as the solution for a customer's automotive needs. We utilize a mix of media that reinforces our brand image, including television, radio, print, promotional signage and outdoor media, plus our proprietary in-store television network and internet site.

Our advertising plan is a brand-building program built around television and radio advertising. The plan is supported by print and in-store signage. Our television advertising is a combination of national and regional media in both sports and entertainment programming. Radio advertising, which is used as a supplementary medium, generally airs during peak drive times. We also sponsor sporting events, racing teams and other events at all levels in a grass-roots effort to positively impact individual communities, including Hispanic and other ethnic communities, to create awareness and drive traffic for our stores.

Since early 2003, we supported our new advertising campaign, “We’re ready in Advance” throughout all of our media. We believe this advertising campaign differentiates Advance Auto Parts in the customer’s mind by positioning us as both a source for brand name auto parts and accessories at low prices and as a resource for expert advice and useful tips to help customers keep their vehicles running smoothly. The campaign includes creative and compelling television and radio commercials designed to drive sales and build an enduring, positive image of Advance Auto Parts as a special place to shop.

Since 2004, we have built upon the campaign through an integrated consumer education program. This program is intended to build our image as not only the source for product, but also the best resource for vehicle maintenance information. Our free brochure kiosk displaying "We're ready with answers" and our free monthly video clinic broadcasts on Advance TV, our exclusive in-store how-to network, are just two elements of this growing program. We believe we will differentiate our stores from our competitors' by providing our customers valuable information regarding "why-to" and "how-to" perform regular maintenance on their vehicles, in order to enhance their vehicles' performance, reliability, safety and appearance. Our goal with this initiative is to continue our long-term brand building success, increase customer loyalty and expand our customer base.

AI Segment

We acquired AI in September 2005. The acquisition, which included 61 stores throughout New England and New York, a distribution center and AI’s wholesale distribution business, complements our growing presence in the DIFM market in the Northeast.

AI’s business primarily serves the commercial market from its store locations. In addition, its North American Sales Division services warehouse distributors and jobbers throughout North America. We believe AI provides a

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high level of service to its commercial customers by providing quality parts, unsurpassed customer service and efficient parts delivery. As a result of its extensive sourcing network, AI is able to serve its customers in search of replacement parts for both domestic and imported cars and light trucks with a greater focus on imported parts. The vast majority of AI’s product is sold under it proprietary brand. The AI stores offer an average of 9,500 SKUs with access to an additional 14,000 unique SKUs through its logistics network.

At December 30, 2006, we operated 87 stores under the “Autopart International” trade name in the following states throughout the Northeast:

Location	Number of Stores	Location	Number of Stores	Location	Number of Stores

Connecticut	17	New Hampshire	8	Rhode Island	4
Maine	5	New York	19	Vermont	1
Massachusetts	33

The following table sets forth information concerning increases in the total number of our AI stores:

	2006		2005
Beginning Stores		62		-
New Stores		25		62	⁽¹	⁾
Stores Closed		-		-
Ending Stores		87		62

⁽¹⁾	Of the 62 new stores in 2005, 61 stores were acquired in September 2005 as a result of our AI acquisition.

Seasonality

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

Team Members

At February 26, 2007, we employed 25,489 full-time team members and 18,283 part-time team members. Our workforce consisted of 87% of our team members employed in store-level operations, 9% employed in distribution and 4% employed in our corporate offices. We have never experienced any labor disruption and are not party to any collective bargaining agreements. We believe that our team member relations are good.

We allocate substantial resources to the recruiting, training and retention of team members. Our performance management process allows us to align each team member’s goals with our corporate strategic goals. We believe this program provides us with a well-trained, productive workforce that is committed to high levels of customer service and assures a qualified team to support future growth.

Trade Names, Service Marks and Trademarks

We own a number of trade names and own and have federally registered several service marks and trademarks, including “Advance Auto Parts,” “Western Auto,” “Parts America,” “Autopart International” and “PDQ” for use in connection with the automotive parts retailing business. In addition, we own and have registered a number of trademarks for our proprietary products. We believe that these trade names, service marks and trademarks are important to our merchandising strategy. We do not know of any infringing uses that would materially affect the use of these trade names and marks, and we actively defend and enforce them.

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Competition

Our primary competitors are both national and regional retail chains of automotive parts stores, including AutoZone, Inc., O'Reilly Automotive, Inc., CSK Auto Corporation and The Pep Boys-Manny, Moe & Jack, discount stores and mass merchandisers that carry automotive products, wholesalers or jobber stores, including those associated with national parts distributors or associations, such as NAPA and Carquest, independent operators and automobile dealers that supply parts. We believe that chains of automotive parts stores that, like us, have multiple locations in one or more markets, have competitive advantages in customer service, marketing, inventory selection, purchasing and distribution as compared to independent retailers and jobbers that are not part of a chain or associated with other retailers or jobbers. The principal competitive factors that affect our business include store location, availability, customer service and product offerings, quality and price.

Environmental Matters

We are subject to various federal, state and local laws and governmental regulations relating to the operation of our business, including those governing recycling of batteries and used lubricants, and regarding ownership and operation of real property. We handle hazardous materials as part of our operations, and our customers may also use hazardous materials on our properties or bring hazardous materials or used oil onto our properties. We currently provide collection and recycling programs for used automotive batteries and used lubricants at all of our stores as a service to our customers. Pursuant to agreements with third party vendors, used batteries and lubricants are collected by our team members, deposited into vendor supplied containers or pallets and stored by us until collected by the third party vendors for recycling or proper disposal. Persons who arrange for the disposal, treatment or other handling of hazardous or toxic substances may be liable for the costs of removal or remediation at any affected disposal, treatment or other site affected by such substances.

We own and lease real property. Under various environmental laws and regulations, a current or previous owner or operator of real property may be liable for the cost of removal or remediation of hazardous or toxic substances on, under or in such property. These laws often impose joint and several liability and may be imposed without regard to whether the owner or operator knew of, or was responsible for, the release of such hazardous or toxic substances. Other environmental laws and common law principles also could be used to impose liability for releases of hazardous materials into the environment or work place, and third parties may seek recovery from owners or operators of real properties for personal injury or property damage associated with exposure to released hazardous substances. From time to time, we receive notices from the Environmental Protection Agency and state environmental authorities indicating that there may be contamination on properties we own, lease or operate or may have owned, leased or operated in the past or on adjacent properties for which we may be responsible. Compliance with these laws and regulations has not had a material impact on our operations to date.

Growth Strategy

Our growth strategies consist of the following:

Increase Our Average Sales per Store. In 2006, our average sales per AAP store reached an industry leading level of $1.55 million per store. We plan to continue increasing our average sales per store by, among other things: (1) improving store execution with a focus on customer service; (2) execution of our category management program; (3) continued maturation of our sales initiatives for our DIY customers including local purchase ordering, factory direct ordering, salvage body parts and our custom mix (store specific merchandise assortment); (4) the implementation of our 2010 store remodeling program, with now more than 65% of our chain remodeled and targeting a total of 150 AAP stores to be remodeled annually; (5) consistent growth and execution of our commercial program, including optimization of delivery vehicles; (6) enhanced merchandising and marketing programs and (7) focus on making our supply chain more responsive.

Expand Our Operating Margin. In addition to driving operating margin expansion through increased average sales per store and continued comparable store sales growth, we will continue to focus on increasing margins by: (1) improving our purchasing efficiencies with vendors; (2) utilizing our supply chain infrastructure and existing distribution network to optimize our inventory mix and maximize distribution capacity; (3) controlling our operating

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expenses, including an examination of both corporate and store-level and (4) continuing to implement our category management and custom mix initiatives and increase direct importing, including the expansion of our private label and proprietary brands in our AAP stores.

Increase Free Cash Flow. We have generated free cash flow over the last five years. Our strategy is to invest back into our business to drive further progress towards our four financial goals. We look to deploy additional cash in the most optimal way to increase shareholder value, which has included stock repurchases and selective acquisitions and more recently cash dividends.

Increase Return on Invested Capital. We believe we can increase our return on invested capital by increasing our average sales per store and our margins. We believe we can also increase our return on invested capital by leveraging our supply chain initiatives to increase sales faster than inventory growth, implementing a lower cost store remodel program and selectively expanding our store base primarily in existing markets. Based on our experience, such in-market openings provide higher returns on our invested capital by enabling us to leverage our distribution infrastructure, marketing expenditures and local management resources. We intend to open 200 to 210 AAP and AI stores primarily in existing markets in 2007.

Industry

The United States automotive aftermarket industry is generally grouped into two major categories: DIY and DIFM. According to the Automotive Aftermarket Industry Association, or AAIA, the DIY category represents an approximate $35 billion market with sales to consumers who maintain and repair vehicles themselves. Per the AAIA, the DIFM category represents an approximate $75 billion market with sales to professional installers, such as independent garages, service stations and auto dealers. DIFM parts and services are typically offered to vehicle owners who are less inclined to repair their vehicles themselves. The DIFM category includes an approximate $36 billion market which includes dealer purchases directly from the original equipment manufacturers.

We believe the United States automotive aftermarket industry will benefit from several favorable trends, including the:

·	increasing number and age of vehicles in the United States, increasing number of miles driven annually, and increasing number of cars coming off of warranty, particularly previously leased vehicles;
·	higher cost of replacement parts as a result of technological changes in recent models of vehicles and increasing number of light trucks and sport utility vehicles that require more expensive parts, resulting in higher average sales per customer;
·	continued consolidation of automotive aftermarket retailers;
·	move to higher priced premium parts, which offer enhanced features, benefits and/or warranties; and
·	market share growth opportunities for specialty retailers relative to other channels selling similar merchandise.

Item 1A. Risk Factors.

Risks Relating to Our Business

We may not be able to successfully implement our business strategy, including increasing comparable store sales, enhancing our margins and increasing our return on invested capital, which could adversely affect our business, financial condition and results of operations.

We have implemented numerous initiatives to increase comparable store sales, enhance our margins and increase our return on invested capital in order to increase our 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 and results of operations could be adversely affected.

Successful implementation of our business strategy also depends on factors specific to the retail automotive parts industry and numerous other factors that may be beyond our control. Adverse changes in the following factors

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could undermine our business strategy:

·	general economic conditions and conditions in our local markets, which could reduce our sales;

·	the competitive environment in the automotive aftermarket parts and accessories retail sector that may force us to reduce prices beyond our normal control or increase promotional spending;
·	changes in the automotive aftermarket parts manufacturing industry, such as consolidation, which may disrupt or sever one or more of our vendor relationships;
·	our ability to anticipate and meet changes in consumer preferences for automotive products, accessories and services in a timely manner; and
·	our continued ability to hire and retain qualified personnel, which depends in part on the types of recruiting, training, compensation and benefit programs we adopt or maintain.

We will not be able to expand our business if our growth strategy is not successful, which could negatively impact our financial results.

We have increased our store count significantly from 1,567 stores at the end of 1998 to 3,082 stores at December 30, 2006. We intend to continue to expand our base of stores as part of our growth strategy, primarily by opening new stores. There can be no assurance that the implementation of this strategy will be successful. The actual number of new stores to be opened and their success will depend on a number of factors, including, among other things:

·	our ability to manage the expansion and hire, train and retain qualified sales associates;
·	the availability of potential store locations in highly visible, well-trafficked areas; and
·	the negotiation of acceptable lease or purchase terms for new locations.

There can be no assurance that we will be able to open and operate new stores on a timely or sufficiently profitable basis or that opening new stores in markets we already serve will not harm existing store profitability or comparable store sales. The newly opened and existing stores' profitability will depend on our ability to properly merchandise, market and price the products required in their respective markets.

Furthermore, we may acquire stores or businesses from, make investments in, or enter into strategic alliances with, companies that have stores or distribution networks in our current markets or in areas into which we intend to expand our presence. Any future acquisitions, investments, strategic alliances or related efforts will be accompanied by risks, including:

·	the difficulty of identifying appropriate strategic partners or acquisition candidates;
·	the difficulty of assimilating and integrating the operations of the respective entities;
·	the potential disruption to our ongoing business and diversion of our management's attention;
·	the inability to maintain uniform standards, controls, procedures and policies; and
·	the impairment of relationships with team members and customers as a result of changes in management.

We cannot assure you that we will be successful in overcoming these risks or any other problems encountered with these acquisitions, investments, strategic alliances or related efforts.

If overall demand for products sold by our stores slows, our business, financial condition and results of operations will suffer.

Overall demand for products sold by our stores depends on many factors and may slow for any number of reasons, including:

·	the weather, as vehicle maintenance may be deferred during periods of unfavorable weather;
·	the economy, as during periods of good economic conditions, more of our DIY customers may pay others to repair and maintain their cars instead of working on their own cars. In periods of declining economic conditions, both DIY and DIFM customers may defer vehicle maintenance or repair; and
·	the decline of the average age of vehicles, miles driven or number of cars on the road may result in a

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reduction in the demand for our product offerings.

If any of these factors cause overall demand for the products we sell to decline, our business, financial condition and results of operations will suffer.

We depend on the services of many qualified team members and may not be able to attract and retain such qualified team members.

Our success depends to a significant extent on the continued services and experience of our many team members. At February 26, 2007, we employed 43,772 team members. We cannot assure you that we will be able to retain our current qualified team members as well as attract and retain additional qualified team members that may be needed in the future. Our ability to maintain an adequate number of qualified team members is highly dependent on an attractive and competitive compensation and benefits package. If we fail to maintain such a package, our customer service and execution levels could suffer by reason of a declining quality of our workforce, which could adversely affect our financial condition and results of operations.

If we are unable to compete successfully against other companies in the automotive aftermarket industry, we could lose customers and our revenues may decline.

The sale of automotive parts, accessories and maintenance items is highly competitive in many ways, including location, price, name recognition and customer service. We compete in both the DIY and DIFM categories of the automotive aftermarket industry, and primarily with national and regional retail automotive parts chains, discount stores and mass merchandisers that carry automotive products, wholesalers or jobber stores, independent operators and automobile dealers that supply parts. These competitors and the level of competition vary by market. Some of our competitors may possess advantages over us in certain markets we share, including a greater amount of marketing activities, a larger number of stores, longer operating histories, greater name recognition or larger and more established customer bases. Our response to these competitive disadvantages may require us to reduce our prices beyond our normal control or increase our promotional spending, which would lower revenue and profitability. Competitive disadvantages may also prevent us from introducing new product lines or require us to discontinue current product offerings or change some of our current operating strategies. If we do not have the resources or expertise or otherwise fail to develop successful strategies to address these competitive disadvantages, we could lose customers and our revenues may decline.

Disruptions in our relationships with vendors or in our vendors' operations could increase our cost of goods sold.

Our business depends on developing and maintaining close relationships with our vendors and upon the vendors' ability or willingness to sell quality products to us at favorable prices and terms. Many factors outside of our control may harm these relationships and the ability or willingness of these vendors to sell us products on favorable terms. For example, financial or operational difficulties that some of our vendors may face may increase the cost of the products we purchase from them or the ability for us to source product from them. In addition, the trend towards consolidation among automotive parts suppliers may disrupt or end our relationship with some vendors, and could lead to less competition and, consequently, higher prices.

Because we are involved in litigation from time to time, and are subject to numerous laws and governmental regulations, we could incur substantial judgments, fines, legal fees and other costs.

We are sometimes the subject of complaints or litigation from customers, employees or other third parties for various actions. From time to time, we are involved in litigation involving claims related to, among other things, breach of contract, tortious conduct, employment discrimination, asbestos exposure, real estate matters and product defects. The damages sought against us in some of these litigation proceedings are substantial. Although we maintain liability insurance for some litigation claims, if one or more of the claims greatly exceeds our coverage limits or our insurance policies do not cover a claim, it could have a material adverse affect on our business and operating results.

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Additionally, we are subject to numerous federal, state and local laws and governmental regulations relating to employment matters, environmental protection and building and zoning requirements. If we fail to comply with existing or future laws or regulations, we may be subject to governmental or judicial fines or sanctions. In addition, our capital expenses could increase due to remediation measures that may be required if we are found to be noncompliant with any existing or future laws or regulations.

Risks Relating to Our Financial Condition

The covenants governing our revolving credit facility impose restrictions on us.

The terms of our revolving credit facility impose operating and financial restrictions on us and our subsidiaries and require us to meet certain financial tests. These restrictions may also have a negative impact on our business, financial condition and results of operations by significantly limiting or prohibiting us from engaging in certain transactions, including:

·	incurring or guaranteeing additional indebtedness;
·	making capital expenditures and other investments;
·	incurring liens on our assets and engaging in sale-leaseback transactions;
·	issuing or selling capital stock of our subsidiaries;
·	transferring or selling assets currently held by us;
·	engaging in transactions with affiliates;
·	entering into any agreements that restrict dividends from our subsidiaries; and
·	engaging in mergers or acquisitions.

The failure to comply with any of these covenants would cause a default under our revolving credit facility. Furthermore, our revolving credit facility contains certain financial covenants, including a maximum leverage ratio and a minimum coverage ratio, which, if not maintained by us, will cause us to be in default under our revolving credit facility. Any of these defaults, if not waived, could result in the acceleration of all of our debt, in which case the debt would become immediately due and payable. If this occurs, we may not be able to repay our debt or borrow sufficient funds to refinance it. Even if new financing were available, it may be on terms that are less favorable or otherwise not acceptable to us.

Item 1B. Unresolved Staff Comments.

None.

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Item 2. Properties.

The following table sets forth certain information relating to our distribution and other principal facilities:

Facility		Opening Date	Area Served	Size (Sq. ft.)⁽¹⁾	Nature of Occupancy

Main Distribution Centers:
	Roanoke, Virginia	1988	Mid-Atlantic	433,681	Leased
	Lehigh, Pennsylvania	2004	Northeast	635,487	Owned
	Lakeland, Florida	1982	Florida	552,796	Owned
	Gastonia, North Carolina	1969	South	634,472	Owned
	Gallman, Mississippi	2001	South	388,168	Owned
	Salina, Kansas	1971	West, Midwest	413,500	Owned
	Delaware, Ohio	1972	Northeast	480,100	Owned
	Thomson, Georgia	1999	Southeast	374,400	Owned

Master PDQ® Warehouse:
	Andersonville, Tennessee	1998	All	115,019	Leased

PDQ® Warehouses:
	Youngwood, Pennsylvania	1999	East	39,878	Leased
	Riverside, Missouri	1999	West	43,912	Leased
	Guilderland Center, New York	1999	Northeast	40,950	Leased
	Temple, Texas	1999	Southwest	61,343	Leased
	Altamonte Springs, Florida	1996	Central Florida	10,000	Owned
	Jacksonville, Florida	1997	Northern Florida and Southern	12,712	Owned
			Georgia
	Tampa, Florida	1997	West Central Florida	10,000	Owned
	Hialeah, Florida	1997	South Florida	12,500	Owned
	West Palm Beach, Florida	1998	Southeast Florida	13,300	Leased
	Mobile, Alabama	1998	Alabama and Mississippi	10,000	Owned
	Atlanta, Georgia	1999	Georgia and South Carolina	16,786	Leased
	Tallahassee, Florida	1999	South Georgia and Northwest	10,000	Owned
			Florida
	Fort Myers, Florida	1999	Southwest Florida	14,330	Owned

Corporate/Administrative Offices:
	Roanoke, Virginia	1995	All	49,000	Leased
	Roanoke, Virginia	2002	All	144,000	Leased

AI Properties:
	Sharon, Massachusetts	1974	AI corporate office	20,000	Leased
	Norton, Massachusetts⁽²⁾	2006	AI corporate office	30,000	Leased
	Sharon, Massachusetts	1974	New England, New York - AI	102,644	Leased
	Foxboro, Massachusetts	2004	New England, New York - AI	84,875	Leased
	Norton, Massachusetts⁽²⁾	2006	New England, New York - AI	317,500	Leased

⁽¹⁾	Square footage amounts exclude adjacent office space.

⁽²⁾	This facility began servicing AI stores in January 2007. This facility will replace the two existing AI distribution centers. The AI corporate offices will relocate to office space within the Norton distribution center in 2007.

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At December 30, 2006, we owned 588 of our stores and leased 2,494 stores. The expiration dates, including the exercise of renewal options, of the store leases are summarized as follows:

Years	AAP Stores	AI Stores	Total
2006-2007	25	8	33
2008-2012	173	37	210
2013-2017	602	28	630
2018-2027	924	14	938
2028-2037	554	-	554
2038-2051	129	-	129
	2,407	87	2,494

Item 3. Legal Proceedings.

We currently and from time to time are involved in litigation incidental to the conduct of our business, including litigation arising from claims of employment discrimination or other types of employment matters as a result of claims by current and former employees. Although we diligently defend against these claims, we may enter into discussions regarding settlement of these and other lawsuits, and may enter into settlement agreements, if we believe settlement is in the best interests of our shareholders. The damages claimed against us in some of these proceedings are substantial. Although the amount of liability that may result from these matters cannot be ascertained, we do not currently believe that, in the aggregate, they will result in liabilities material to our consolidated financial condition, future results of operations or cash flow.

Our Western Auto subsidiary, together with other defendants including automobile manufacturers, automotive parts manufacturers and other retailers, has been named as a defendant in lawsuits alleging injury as a result of exposure to asbestos-containing products. We and some of our other subsidiaries also have been named as defendants in many of these lawsuits. The plaintiffs have alleged that these products were manufactured, distributed and/or sold by the various defendants. To date, these products have included brake and clutch parts and roofing materials. Many of the cases pending against us or our subsidiaries are in the early stages of litigation. The damages claimed against the defendants in some of these proceedings are substantial. Additionally, some of the automotive parts manufacturers named as defendants in these lawsuits have declared bankruptcy, which will limit plaintiffs’ ability to recover monetary damages from those defendants. Although we diligently defend against these claims, we may enter into discussions regarding settlement of these and other lawsuits, and may enter into settlement agreements, if we believe settlement is in the best interests of our shareholders. We also believe that most of these claims are at least partially covered by insurance. Based on discovery to date, we do not believe the cases currently pending will have a material adverse effect on us. However, if we were to incur an adverse verdict in one or more of these claims and were ordered to pay damages that were not covered by insurance, these claims could have a material adverse effect on our operating results, financial position and liquidity. If the number of claims filed against us or any of our subsidiaries alleging injury as a result of exposure to asbestos-containing products increases substantially, the costs associated with concluding these claims, including damages resulting from any adverse verdicts, could have a material adverse effect on our operating results, financial position and liquidity in future periods.

Item 4. Submission of Matters to a Vote of Security Holders.

None.

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PART II

Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities.

Our common stock is listed on the New York Stock Exchange, or NYSE, under the symbol "AAP." The table below sets forth, for the fiscal periods indicated, the high and low sale prices per share for our common stock, as reported by the NYSE.

	High		Low
Fiscal Year Ended December 30, 2006
Fourth Quarter	$	38.58	$	34.01
Third Quarter	$	35.31	$	27.65
Second Quarter	$	42.30	$	28.40
First Quarter	$	45.50	$	38.35
Fiscal Year Ended December 31, 2005
Fourth Quarter	$	44.88	$	35.40
Third Quarter	$	47.73	$	37.45
Second Quarter	$	44.17	$	34.10
First Quarter	$	35.10	$	28.13

The closing price of our common stock on February 26, 2007 was $38.73. The table gives effect to our three-for-two stock split effectuated in the form of a 50% stock dividend distributed on September 23, 2005, as trading began on a post-split basis on September 26, 2005. At February 26, 2007, there were 420 holders of record of our common stock.

On February 15, 2006, our Board of Directors declared a quarterly cash dividend, the first in our history. The $0.06 per share quarterly cash dividend has been declared in each quarter of fiscal 2006. Any payments of dividends in the future will be at the discretion of our Board of Directors and will depend upon our results of operations, earnings, capital requirements and other factors deemed relevant by our Board of Directors.

Equity Compensation Plan Information

The following table sets forth our shares authorized for issuance under our equity compensation plans at December 30, 2006.

	Number of shares to be issued upon exercise of outstanding options, warrants, and rights ⁽¹⁾		Weighted-average exercise price of outstanding options, warrants, and rights		Number of securities remaining available for future issuance under equity compensation plans⁽¹⁾⁽²⁾

Equity compensation plans
approved by stockholders		7,269	$	29.31		4,565

Equity compensation plans
not approved by stockholders		-		-		-
Total		7,269	$	29.31		4,565

⁽¹⁾	Number of shares presented is in thousands.
⁽²⁾	Excludes shares reflected in the first column.

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Stock Price Performance

The following graph shows a comparison of our cumulative total return on our common stock, Standard & Poor’s 500 Index and the Standard & Poor’s 500 Specialty Retail Index. The graph assumes that the value of an investment in our common stock and in each such index was $100 on December 29, 2001, and that any dividends have been reinvested. The comparison in the graph below is based solely on historical data and is not intended to forecast the possible future performance of our common stock.

COMPARISON OF CUMULATIVE TOTAL RETURN AMONG

ADVANCE AUTO PARTS, INC., S&P 500 INDEX

AND S&P 500 SPECIALTY INDEX

Company / Index	Dec 29 2001		Dec 28 2002		Jan 3 2004		Jan 1 2005		Dec 31 2005		Dec 30 2006
ADVANCE AUTO PARTS, INC.	$	100	$	104.44	$	173.05	$	185.67	$	277.11	$	228.22
S&P 500 INDEX	$	100	$	76.65	$	98.83	$	109.92	$	115.32	$	133.53
S&P 500 SPECIALTY RETAIL INDEX	$	100	$	64.84	$	94.06	$	107.82	$	110.90	$	118.26

Item 6. Selected Consolidated Financial Data.

The following table sets forth our selected historical consolidated statement of operations, balance sheet and other operating data. The selected historical consolidated financial and other data at December 30, 2006 and December 31, 2005 and for the three years ended December 30, 2006 have been derived from our audited consolidated financial statements and the related notes included elsewhere in this report. The historical consolidated financial and other data at January 1, 2005, January 3, 2004 and December 28, 2002 and for the years ended January 3, 2004 and December 28, 2002 have been derived from our audited consolidated financial statements and the related notes that have not been included in this report. You should read this data along with "Management's Discussion and Analysis of Financial

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Condition and Results of Operations," and our consolidated financial statements and the related notes included elsewhere in this report.

	Fiscal Year ⁽¹⁾⁽²⁾

	2006			2005			2004			2003			2002
	(in thousands, except per share data)

Statement of Operations Data:
Net sales	$	4,616,503		$	4,264,971		$	3,770,297		$	3,493,696		$	3,204,140
Cost of sales		2,415,339			2,250,493			2,016,926			1,889,178			1,769,733
Gross profit		2,201,164			2,014,478			1,753,371			1,604,518			1,434,407
Selling, general and administrative expenses ⁽³⁾		1,797,814			1,605,986			1,424,613			1,305,867			1,202,524
Expenses associated with merger related restructuring⁽⁴⁾		-			-			-			-			597
Expenses associated with merger and integration ⁽⁵⁾		-			-			-			10,417			34,935
Operating income		403,350			408,492			328,758			288,234			196,351
Interest expense		(35,992	)		(32,384	)		(20,069	)		(37,576	)		(77,081	)
Gain (loss) on extinguishment of debt		986			-			(3,230	)		(47,288	)		(16,822	)
Expenses associated with secondary offering		-			-			-			-			(1,733	)
Other income, net		1,571			2,815			289			341			963
Income from continuing operations before
income taxes and (loss) income on
discontinued operations		369,915			378,923			305,748			203,711			101,678
Income tax expense		138,597			144,198			117,721			78,424			39,530
Income from continuing operations before
(loss) income on discontinued operations		231,318			234,725			188,027			125,287			62,148
Discontinued operations:
(Loss) income from operations of discontinued
Wholesale Distribution Network (including loss on
disposal of $2,693 in 2003)		-			-			(63	)		(572	)		4,691
(Benefit) provision for income taxes		-			-			(24	)		(220	)		1,820
(Loss) income on discontinued operations		-			-			(39	)		(352	)		2,871
Net income	$	231,318		$	234,725		$	187,988		$	124,935		$	65,019


Per Share Data ⁽⁶⁾:
Income from continuing operations before
(loss) income on discontinued operations
per basic share	$	2.18		$	2.17		$	1.70		$	1.15		$	0.59
Income from continuing operations before
(loss) income on discontinued operations
per diluted share	$	2.16		$	2.13		$	1.66		$	1.12		$	0.57
Net income per basic share	$	2.18		$	2.17		$	1.70		$	1.14		$	0.62
Net income per diluted share	$	2.16		$	2.13		$	1.66		$	1.11		$	0.60
Cash dividends declared per basic share	$	0.24		$	-		$	-		$	-		$	-
Weighted average basic shares outstanding		106,129			108,318			110,846			109,499			105,147
Weighted average diluted shares outstanding		107,124			109,987			113,222			112,115			108,564

Cash flows provided by (used in):

Operating activities	$	333,604		$	321,632		$	260,397		$	355,921		$	242,996
Investing activities		(258,642	)		(302,780	)		(166,822	)		(85,474	)		(78,005	)
Financing activities		(104,617	)		(34,390	)		(48,741	)		(272,845	)		(169,223	)

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	Fiscal Year ⁽¹⁾⁽²⁾

	2006			2005			2004			2003			2002
	(in thousands, except per share data and ratios)
Balance Sheet and Other Financial Data:

Cash and cash equivalents	$	11,128		$	40,783		$	56,321		$	11,487		$	13,885
Inventory	$	1,463,340		$	1,367,099		$	1,201,450		$	1,113,781		$	1,048,803
Inventory turnover⁽⁷⁾		1.71			1.75			1.74			1.72			1.75
Inventory per store⁽⁸⁾	$	475		$	476		$	453		$	439		$	429
Accounts payable to inventory ratio⁽⁹⁾		53.2%			54.8%			53.7%			51.0%			44.9%
Net working capital⁽¹⁰⁾	$	498,553		$	406,476		$	416,302		$	372,509		$	462,896
Capital expenditures	$	258,586		$	216,214		$	179,766		$	101,177		$	98,186
Total assets	$	2,682,681		$	2,542,149		$	2,201,962		$	1,983,071		$	1,965,225
Total debt	$	477,240		$	438,800		$	470,000		$	445,000		$	735,522
Total net debt⁽¹¹⁾	$	500,318		$	448,187		$	433,863		$	464,598		$	722,506
Total stockholders' equity	$	1,030,854		$	919,771		$	722,315		$	631,244		$	468,356


Selected Store Data:

Comparable store sales growth ⁽¹²⁾		2.1%			8.7%			6.1%			3.1%			5.5%
Number of stores at beginning of year		2,872			2,652			2,539			2,435			2,484
New stores		215			231			125			125			110
Closed stores⁽¹³⁾		(5	)		(11	)		(12	)		(21	)		(159	)
Number of stores, end of period		3,082			2,872			2,652			2,539			2,435
Relocated stores		47			54			34			32			39
Stores with commercial delivery program, end of period		2,526			2,254			1,945			1,625			1,411
Total commercial sales, as a percentage of total sales		25.0%			21.8%			18.4%			15.8%			15.0%
Total store square footage, end of period⁽¹⁴⁾		22,235			20,899			19,734			18,875			18,108
Average net sales per store⁽¹⁵⁾	$	1,552		$	1,551		$	1,453		$	1,379		$	1,303
Average net sales per square foot ⁽¹⁶⁾	$	209		$	208		$	195		$	186		$	174

⁽¹⁾	Our fiscal year consists of 52 or 53 weeks ending on the Saturday nearest to December 31. All fiscal years presented are 52 weeks, with the exception of 2003, which consists of 53 weeks.
⁽²⁾	The statement of operations data for each of the years presented reflects the operating results of the wholesale distribution segment as discontinued operations.
⁽³⁾	Selling, general and administrative expenses exclude certain charges disclosed separately and discussed in notes (4) and (5) below.
⁽⁴⁾	Represents expenses related primarily to lease costs associated with 27 Advance Auto Parts stores identified to be closed at December 29, 2001 as a result of the Discount acquisition.
⁽⁵⁾	Represents certain expenses related to, among other things, overlapping administrative functions and store conversions as a result of the Discount acquisition.
⁽⁶⁾	Basic and diluted shares outstanding for each of the years presented gives effect to a 3-for-2 stock split effectuated by us in the form of a 50% stock dividend distributed on September 23, 2005 and a 2-for-1 stock split effectuated by us in the form of a 100% stock dividend distributed on January 2, 2004.
⁽⁷⁾	Inventory turnover is calculated as cost of sales divided by the average of beginning and ending inventories. The fiscal 2003 cost of sales excludes the effect of the 53^rd week in the amount of $34.3 million.
⁽⁸⁾	Inventory per store is calculated as ending inventory divided by ending store count. For fiscal 2003, ending inventory used in this calculation excludes certain inventory related to the wholesale distribution segment. The wholesales distribution segment, which was discontinued in fiscal 2003, consisted of independently owned and operated dealer locations, for which the Company supplied merchandise inventory.
⁽⁹⁾	Accounts payable to inventory ratio is calculated as ending accounts payable divided by ending inventory. Beginning in fiscal 2004, as a result of our new vendor financing program, we aggregate financed vendor accounts payable with accounts payable to calculate our accounts payable to inventory ratio.
⁽¹⁰⁾	Net working capital is calculated by subtracting current liabilities from current assets.
⁽¹¹⁾	Net debt includes total debt and bank overdrafts, less cash and cash equivalents.
⁽¹²⁾	Comparable store sales is calculated based on the change in net sales starting once a store has been open for 13 complete accounting periods (each period represents four weeks). Relocations are included in comparable

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	store sales from the original date of opening. We do not include net sales from the 37 Western Auto retail stores in our comparable store calculation as a result of their unique product offerings, including automotive service and tires. We also exclude the net sales from the AI stores from our comparable store sales. In 2003, the comparable store sales calculation included sales from our 53^rd week compared to our first week of operation in 2003 (the comparable calendar week). In 2004, as a result of the 53^rd week in 2003, the comparable store sales calculation excluded week one of sales from 2003.
⁽¹³⁾	Closed stores in 2002 include 133 stores closed as part of the integration of the Discount operations.
⁽¹⁴⁾	Total store square footage excludes the square footage of the stores in the AI segment.
⁽¹⁵⁾	Average net sales per store is calculated as net sales divided by the average of beginning and ending number of stores for the respective period. The fiscal 2006 and 2005 calculation excludes the net sales and stores from the AI segment. The fiscal 2003 net sales exclude the effect of the 53^rd week in the amount of $63.0 million.
⁽¹⁶⁾	Average net sales per square foot is calculated as net sales divided by the average of the beginning and ending total store square footage for the respective period. The fiscal 2006 and 2005 calculation excludes the net sales and square footage from the AI segment. The fiscal 2003 net sales exclude the effect of the 53^rd week in the amount of $63.0 million.

Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations.

The following discussion and analysis of financial condition and results of operations should be read in conjunction with "Selected Financial Data," our consolidated historical financial statements and the notes to those statements that appear elsewhere in this report. Our discussion contains forward-looking statements based upon current expectations that involve risks and uncertainties, such as our plans, objectives, expectations and intentions. Actual results and the timing of events could differ materially from those anticipated in these forward-looking statements as a result of a number of factors, including those set forth under “Forward Looking Statements” and "Risk Factors" elsewhere in this report.

Our fiscal year ends on the Saturday nearest December 31 of each year, which results in an extra week every six years (our next 53-week fiscal year is 2009). Our first quarter consists of 16 weeks, and the other three quarters consist of 12 weeks.

Introduction

We primarily operate within the United States automotive aftermarket industry, which includes replacement parts (excluding tires), accessories, maintenance items, batteries and automotive chemicals for cars and light trucks (pickup trucks, vans, minivans and sport utility vehicles). We currently are the second largest specialty retailer of automotive parts, accessories and maintenance items to “do-it-yourself,” or DIY, customers in the United States, based on store count and sales. At December 30, 2006, we operated 3,082 stores throughout 40 states.

We operate in two reportable segments: Advance Auto Parts, or AAP, and Autopart International, or AI. The AAP segment is comprised of our store operations within the United States, Puerto Rico and the Virgin Islands which operate under the trade names “Advance Auto Parts,” “Discount Advance Auto Parts” and “Western Auto.” At December 30, 2006, we operated 2,995 stores in the AAP segment, of which 2,958 stores operated under the trade names “Advance Auto Parts” and “Discount Advance Auto Parts” throughout 40 states in the Northeastern, Southeastern and Midwestern regions of the United States. These stores offer automotive replacement parts, accessories and maintenance items, with no significant concentration in any specific product area. In addition, we operated 37 stores under the “Western Auto” and “Advance Auto Parts” trade names, located primarily in Puerto Rico and the Virgin Islands. The Western Auto stores offer automotive tires and service in addition to automotive parts, accessories and maintenance items.

At December 30, 2006, we operated 87 stores in the AI segment under the “Autopart International” trade name. We acquired AI in September 2005, and AI operates as an independent, wholly-owned subsidiary. AI’s business primarily serves the commercial market from its store locations. In addition, its North American Sales Division services warehouse distributors and jobbers throughout North America.

The following table sets forth the total number of new, closed and relocated stores and stores with commercial delivery programs during fiscal 2006, 2005 and 2004. We lease approximately 80% of our stores.

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AAP
	Fiscal Year
	2006			2005			2004
Number of stores at beginning of year		2,810			2,652			2,539
New stores		190			169			125
Closed stores		(5	)		(11	)		(12	)
Number of stores, end of period^(a)		2,995			2,810			2,652
Relocated stores		47			54			34
Stores with commercial delivery programs		2,439			2,192			1,945

AI
	Fiscal Year
		2006			2005
Number of stores at beginning of year		62			-
New stores^(b)		25			62
Closed stores		-			-
Number of stores, end of period		87			62
Relocated stores		-			-
Stores with commercial delivery programs		87			62

^(a)	Includes 2 and 7 stores not operating at December 30, 2006 and December 31, 2005, respectively, primarily due to hurricane damage.

^(b)	Of the 62 new stores in 2005, 61 stores were acquired in September 2005 as a result of our AI acquisition.

We anticipate adding approximately 200 to 210 AAP and AI stores during 2007.

Management Overview

We recorded earnings per diluted share of $2.16 in fiscal 2006 compared to $2.13 for fiscal 2005. These results were primarily driven by increased sales and higher gross margin dollars offset by an increase in certain fixed operating expenses. Although sales did not meet our expectation for 2006, our average sales per store did reach the industry leading level of $1.55 million per store. Additionally, our operating results for fiscal 2006 include the recognition of $0.11 of share-based compensation expense per diluted share required by the adoption of Statement of Financial Accounting Standard, or SFAS, No. 123 (revised 2004), "Share-Based Payment," or SFAS No. 123R, on January 1, 2006.

We believe the macroeconomic environment negatively impacted our business throughout much of 2006 and resulted in weakening trends in our 2006 results compared to 2005. We believe our customers have been adversely impacted by rising energy prices, higher insurance and interest rates, and larger required minimum payments on their credit card balances, which limit their current ability to spend.

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

We believe our 2006 results do reflect the progress made on the following key initiatives that focus specifically on driving higher sales per store:

·	Improving store execution with a focus on customer service;

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·	Continued execution of our category management program, including direct importing;

·	Continued implementation of our 2010 store remodeling program at a more selective pace now that more than 65% of our chain has been remodeled;
·	Our focus on making our supply chain more responsive and improving our in-stock position;
·	Consistent growth and execution of our commercial program, including the optimization of delivery vehicles;
·	Our focus on recruiting, training and retaining high-performing team members, especially those who are ASE certified and/or bilingual; and
·	Enhanced merchandising and marketing programs.

Additionally, we believe the factors that favorably impact our industry continue to remain strong. Customers can only defer necessary maintenance on their automobiles for so long, and we continue to educate customers about the value of performing certain types of maintenance and enhancements. Government data recently revealed that consumers are driving their automobiles more, which leads to a greater need for maintenance. The growing population of light trucks and sport utility vehicles are also beginning to hit the average age where we believe they will need certain repairs, including overall more expensive, replacement parts.

We believe the combination of these favorable industry dynamics along with the continued execution of our key business initiatives along with our more recent effort to examine operating expenses will allow us to achieve each of the following goals:

1.	Raising average sales per store;
2.	Expanding operating margin;
3.	Increasing free cash flow; and
4.	Increasing return on invested capital.

The following table highlights certain consolidated operating results and key metrics for 2006, 2005 and 2004:

	Fiscal Year
	2006			2005			2004

Total net sales (in thousands)	$	4,616,503		$	4,264,971		$	3,770,297
Total commercial net sales (in thousands)	$	1,155,953		$	931,320		$	693,449
Comparable store net sales growth		2.1	%		8.7	%		6.1	%
DIY comparable store net sales growth		(0.3	)%		4.8	%		2.8	%
DIFM comparable store net sales growth		10.8	%		25.2	%		22.9	%
Average net sales per store (in thousands)	$	1,552		$	1,551		$	1,453
Inventory per store (in thousands)	$	475		$	476		$	453
Selling, general and administrative expenses
per store (in thousands)	$	583		$	559		$	537
Inventory turnover		1.71			1.75			1.74
Gross margin		47.7	%		47.2	%		46.5	%
Operating margin		8.7	%		9.6	%		8.7	%

Note: These metrics should be reviewed along with the footnotes to the table setting forth our selected store data in Item 6 “Selected Financial Data” located elsewhere in this report. The footnotes contain descriptions regarding the calculation of these metrics.

Key 2006 Milestones

The following key milestones occurred during 2006:

·	We opened our 3,000^th store;
·	In the AAP segment, we surpassed the $1 billion mark in commercial sales;

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·	We completed the refinancing of our previous secured credit facility to an unsecured revolving credit facility; and
·	On February 15, 2006, our Board of Directors declared a quarterly cash dividend, the first in our history.

Refinancing

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

Stock Repurchase Program

During fiscal 2006, we repurchased 3.7 million shares of common stock at an aggregate cost of $136.6 million, or an average price of $37.12 per share, excluding related expenses. Our stock repurchase program, as authorized by our Board of Directors in fiscal 2005, authorizes us to repurchase up to $300 million of our common stock plus related expenses. The program allows us to repurchase our common stock on the open market or in privately negotiated transactions from time to time in accordance with the requirements of the Securities and Exchange Commission. As of December 30, 2006, we had $104.0 million, excluding related expenses, remaining for future stock repurchases under the stock repurchase program.

Commercial Program

As indicated in the preceding operating results table, our commercial program produced solid revenues in our AAP stores during fiscal 2006. We attribute this performance to the execution of our commercial plan, which consists of:

·	Targeting commercial customers with a hard parts focus;
·	Targeting commercial customers who need access to a wide selection of inventory;
·	Moving inventory closer to our commercial customers to ensure quicker deliveries;
·	Growing our market share of the commercial market through internal growth and selected acquisitions;
·	Providing trained parts experts to assist commercial customers’ merchandise selections;
·	Shifting commercial delivery vehicles or other commercial resources to store locations where they can be most productive; and
·	Providing credit solutions to our commercial customers through our commercial credit program.

Commercial sales represented approximately 25% of our consolidated total sales for the fiscal year compared to almost 22% in fiscal 2005, including AI. At December 30, 2006, we operated commercial programs in 82% of our stores, including the 87 AI stores, up from approximately 78% at the end of the prior fiscal year. We continued to approach our goal of operating commercial programs in approximately 85% of our AAP store base. Due to AI’s sole focus on the commercial business, virtually all of their sales are to commercial customers.

We believe we have the opportunity to grow our commercial business for the foreseeable future through the continued execution of our commercial plan and growth in our commercial programs. We believe the acquisition of AI supplements our commercial growth due to AI’s established delivery programs and knowledge of the commercial industry, particularly for foreign makes and models of vehicles.

Share-Based Payments

On January 1, 2006, we adopted the provisions of SFAS No. 123R. SFAS No. 123R replaces SFAS No. 123 and supersedes APB Opinion No. 25 and subsequently issued stock option related guidance. We elected to use the modified-prospective method of implementation. Under this transition method, share-based compensation expense

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for fiscal year ended 2006 included compensation expense for all share-based awards granted subsequent to January 1, 2006 based on the grant-date fair value estimated in accordance with the provisions of SFAS No. 123R, and compensation expense for all share-based awards granted prior to but unvested as of January 1, 2006 based on the grant-date fair value estimated in accordance with original provisions of SFAS No. 123.

We use the Black-Scholes option-pricing model to value all options and straight-line method to amortize this fair value as compensation cost over the requisite service period. Total share-based compensation expense included in selling, general and administrative expenses in our statements of operations for the fiscal years ended 2006 was $19.1 million. The related income tax benefit was $7.1 million. We recognized $0.4 and $0.5 million of share-based compensation expense in accordance with APB No. 25 for the fiscal years ended December 31, 2005 and January 1, 2005. On a pro forma basis, share-based compensation was $0.09 and $0.05 per diluted share for the fiscal years ended December 31, 2005 and January 1, 2005, respectively. In accordance with the modified-prospective transition method of SFAS No. 123R, we have not restated prior periods.

As a result of adopting SFAS No. 123R on January 1, 2006, our earnings before income tax expense and net earnings for the fiscal year ended December 30, 2006, were $18.8 million and $11.7 million lower, respectively, than if we had continued to account for share-based compensation under APB No. 25. The related impact in 2006 to basic and diluted earnings per share is $0.11 for the fiscal year ended December 30, 2006.

As of December 30, 2006, we have $26.3 million of unrecognized compensation expense related to non-vested fixed stock options we expect to recognize over a weighted average period of 1.8 years.

AI Acquisition

The Company finalized the allocation of the purchase price of the assets acquired and liabilities assumed of Autopart International during the third quarter of fiscal 2006. We acquired AI in September 2005. The acquisition, which included 61 stores throughout New England and New York, a distribution center and AI’s wholesale distribution business, complements our growing presence in the Northeast. AI serves the growing commercial market in addition to warehouse distributors and jobbers. The acquisition was accounted for under the purchase method of accounting. Accordingly, AI’s results of operations have been included in our consolidated statement of operations since the acquisition date. The total purchase price of $87.6 million primarily consisted of $74.9 million paid upon closing and an additional $12.5 million of contingent consideration paid in March 2006 based upon AI satisfying certain earnings before interest, taxes, depreciation and amortization targets met through December 31, 2005. The completion of the purchase price allocation resulted in the recognition of $17.6 million in goodwill and $29.0 million of identifiable intangible assets. Furthermore, an additional $12.5 million is contingently payable based upon the achievement of certain synergies through fiscal 2008, which will be reflected in the statement of operations as earned. We recognized additional cost of sales of $3.1 million in fiscal 2006 due to such synergies.

Hurricane and Fire Impact

During the second half of fiscal 2005, Hurricanes Katrina, Rita and Wilma impacted our operations throughout the states of Alabama, Florida, Louisiana, Mississippi and Texas. At the time these storms hit, we operated approximately 750 stores throughout these states. Over 70% of these locations experienced some kind of physical damage and even more suffered sales disruptions. Additionally, we believe we experienced sales disruptions resulting from the economic impact of increased fuel prices on our customer base throughout all of our markets immediately following these hurricanes. We also incurred and recognized incremental expenses associated with compensating our team members for scheduled work hours for which stores were closed and food and supplies provided to our team members and their families. While these sales disruptions and related incremental expenses are not recoverable from our insurance carrier, the insurance coverage provides for the recovery of physical damage at cost, damaged merchandise at retail values and damaged capital assets at replacement cost. Additionally, during fiscal 2005 we lost two store locations due to fire.

For fiscal 2005, we estimated and reflected in earnings $0.1 million of insurance recoveries, net of deductibles, for the fixed costs of all damage. A portion of these recoveries included the settlement with our insurance carrier for the retail value of certain damaged inventory. In fiscal 2006, we lost one store location due to fire and received additional recoveries as we settled additional hurricane claims for

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damaged inventory at retail value and for damaged capital assets at replacement value. Accordingly, earnings for fiscal 2006 reflected $1.4 million of insurance recoveries, net of deductibles.

Critical Accounting Policies

Our financial statements have been prepared in accordance with accounting policies generally accepted in the United States of America. Our discussion and analysis of the financial condition and results of operations are based on these financial statements. The preparation of these financial statements requires the application of accounting policies in addition to certain estimates and judgments by our management. Our estimates and judgments are based on currently available information, historical results and other assumptions we believe are reasonable. Actual results could differ from these estimates.

The preparation of our financial statements included the following significant estimates.

Vendor Incentives

We receive incentives from vendors as a result of purchasing and promoting their products through a variety of programs, including cooperative advertising allowances, volume rebates and other promotional incentives. We account for vendor incentives in accordance with Emerging Issues Task Force, or EITF, No. 02-16, “Accounting by a Customer (Including a Reseller) for Certain Consideration Received from a Vendor.” Many of the incentives are under long-term agreements (terms in excess of one year), while others are negotiated on an annual basis. Cooperative advertising allowances and volume rebates are earned based on inventory purchases and initially recorded as a reduction to inventory. The deferred amounts are included as a reduction to cost of sales as the inventory is sold.

We recognize other promotional incentives earned under long-term agreements as a reduction to cost of sales. These incentives are recognized based on the cumulative net purchases as a percentage of total estimated net purchases over the life of the agreement. Our margins could be impacted positively or negatively if actual purchases or results from any one year differ from our estimates; however, the impact over the life of the agreement would be the same. Short-term incentives (terms less than one year) are recognized as a reduction to cost of sales over the course of the agreements.

Amounts received or receivable from vendors that are not yet earned are reflected as deferred revenue. Management's estimate of the portion of deferred revenue that will be realized within one year of the balance sheet date is included in other current liabilities. Earned amounts that are receivable from vendors are included in receivables except for that portion expected to be received after one year, which is included in other assets.

Inventory Reserves

We establish reserves for inventory shrink, as an increase to our cost of sales, for our stores and distribution centers based on our extensive and frequent cycle counting program. Our estimates of these shrink reserves depend on the accuracy of the program, which is dependent on compliance rates of our facilities and the execution of the required procedures. We evaluate the accuracy of this program on an ongoing basis and believe it provides reasonable assurance for the established reserves. If estimates regarding our cycle counting program are inaccurate, we may be exposed to losses or gains that could be material.

We have recorded reserves for potentially excess and obsolete inventories based on current inventory levels and historical analysis of product sales and current market conditions. The nature of our inventory is such that the risk of obsolescence is minimal and excess inventory has historically been returned to our vendors for credit. We provide reserves where less than full credit is expected from a vendor or where we anticipate that items will be sold at retail prices that are less than recorded cost. We develop these estimates based on the determination of return privileges with vendors, the level of credit provided by the vendor and management’s estimate of the discounts to recorded cost, if any, required by market conditions. Future changes by vendors in their policies or willingness to accept returns of excess inventory could require us to revise our estimates of required reserves for excess and obsolete inventory and result in a negative impact on our consolidated statement of operations. A 10% difference in actual inventory reserves at December 30, 2006 would have affected net income by approximately $1.9 million.

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Warranty Reserves

Our vendors are primarily responsible for warranty claims. We are responsible for merchandise sold under warranty which is not covered by vendor warranties (primarily batteries). We record a reserve for future warranty claims as an increase in our cost of sales based on current sales of the warranted products and historical claim experience. If claims experience differs from historical levels, revisions in our estimates may be required, which could have an impact on our consolidated statement of operations. A 10% change in the warranty reserves at December 30, 2006 would have affected net income by approximately $0.8 million for the fiscal year ended December 30, 2006.

Self-Insured Reserves

We are self-insured for general and automobile liability, workers' compensation and the health care claims of our team members, although we maintain stop-loss coverage with third-party insurers to limit our total liability exposure. A reserve for liabilities associated with these losses is established for claims filed and claims incurred but not yet reported using actuarial methods followed in the insurance industry and our historical claims experience. While we do not expect the amounts ultimately paid to differ significantly from our estimates, our self-insurance reserves and corresponding selling, general and administrative expenses could be affected if future claim experience differs significantly from historical trends and actuarial assumptions. A 10% change in our self-insurance liabilities at December 30, 2006 would have affected net income by approximately $4.4 million for the fiscal year ended December 30, 2006.

Leases and Leasehold Improvements

We lease certain store locations, distribution centers, office space, equipment and vehicles. We account for our leases under the provisions of SFAS No. 13, “Accounting for Leases,” and subsequent amendments which require that leases be evaluated and classified as operating leases or capital leases for financial reporting purposes. Certain leases contain rent escalation clauses, which are recorded on a straight-line basis over the initial term of the lease with the difference between the rent paid and the straight-line rent recorded as a deferred rent liability. Lease incentive payments received from landlords are recorded as deferred rent liabilities and are amortized on a straight-line basis over the lease term as a reduction in rent. In addition, leasehold improvements associated with these operating leases are amortized over the shorter of their economic lives or the respective lease terms. The term of each lease is generally the initial term of the lease unless external economic factors were to exist such that renewals potentially provided for in the lease are reasonably assured to be exercised. In those instances the renewal period would be included in the lease term for purposes of establishing an amortization period and determining if such lease qualified as a capital or operating lease.

Impairment of Long-Lived Assets

We primarily invest in property and equipment in connection with the opening and remodeling of stores and in computer software and hardware. We periodically review our store locations and estimate the recoverability of our assets, recording an impairment charge, if necessary, when we decide to close the store or otherwise determine that future undiscounted cash flows associated with those assets will not be sufficient to recover the carrying value. This determination is based on a number of factors, including the store’s historical operating results and cash flows, estimated future sales growth, real estate development in the area and perceived local market conditions that can be difficult to predict and may be subject to change. In addition, we regularly evaluate our computer-related and other long-lived assets and may accelerate depreciation over the revised useful life if the asset is expected to be replaced or has limited future value. When assets are retired or otherwise disposed of, the cost and related accumulated depreciation or amortization are removed from the accounts, and any resulting gain or loss is reflected in income for that period. Our impairment loss calculations require management to apply judgment in estimating future cash flows and asset fair values, including forecasting useful lives of the assets and selecting the discount rate that reflects the risk inherent in future cash flows. If actual results are not consistent with our assumptions and judgments used in estimating future cash flows and asset fair values, we may be exposed to additional impairment losses that could be material to our results of operations.

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Tax Reserves

The determination of our income tax liabilities is based upon the tax code, regulations and pronouncements of the taxing jurisdictions in which we do business. Our income tax returns are periodically examined by those jurisdictions. These examinations include, among other things, auditing our filing positions, the timing of deductions and allocation of income among the various jurisdictions. At any particular time, multiple years are subject to examination by various taxing authorities.

In evaluating our income tax positions, we record reserves for potential exposures. These contingency reserves 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 the evolution of tax code and regulations, along with varying application of tax policy and administration within those jurisdictions.

These contingency reserves contain uncertainties because management is required to make assumptions and apply judgment to estimate exposures associated with our various filing positions. Although management believes that the judgments and estimates are reasonable, actual results could differ and the company may be exposed to gains or losses that could be material. To the extent that actual results differ from our estimates, the effective tax rate in any particular period could be materially affected. Favorable tax developments would be recognized as a reduction in our effective tax rate in the period of resolution. Unfavorable tax developments would require an increase in our effective tax rate and a possible use of cash in the period of resolution.

Share-Based Payments

We have a share-based compensation plan, which includes fixed stock options and deferred stock units, or DSUs. We account for our share-based compensation plans as prescribed by the fair value provisions of SFAS No. 123R. We determine the fair value of our stock options at the date of the grant using the Black-Scholes option-pricing model. The DSUs are awarded at a price equal to the market price of our underlying stock on the date of the grant. The option-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 stock option forfeitures. We do not believe there is a reasonable likelihood 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 the fiscal year ended December 30, 2006 would have affected net income by approximately $1.2 million for the fiscal year ended December 30, 2006.

Components of Statement of Operations

Net Sales

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

Our fiscal year ends on the Saturday closest to December 31 and consists of 52 or 53 weeks. Our 2004 fiscal year began on January 4, 2004 and consisted of 52 weeks, while our 2003 fiscal year began on December 29, 2002 and consisted of 53 weeks. The extra week of operations in fiscal 2003 resulted in our fiscal 2004 consisting of non-comparable calendar weeks to fiscal 2003. To create a meaningful comparable store sales measure for fiscal 2004, we have compared the calendar weeks of 2004 to the corresponding calendar weeks of fiscal 2003. Accordingly, our calculation of comparable stores sales for fiscal 2004 excludes week one of operations from fiscal 2003.

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Cost of Sales

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

Selling, General and Administrative Expenses

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

Consolidated Results of Operations

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

	Fiscal Year Ended
	December 30,			December 31,			January 1,
	2006			2005			2005

Net sales		100.0	%		100.0	%		100.0	%
Cost of sales		52.3			52.8			53.5
Gross profit		47.7			47.2			46.5
Selling, general and administrative expenses		39.0			37.6			37.8
Operating income		8.7			9.6			8.7
Interest expense		(0.8	)		(0.7	)		(0.5	)
Loss on extinguishment of debt		0.0			-			(0.1	)
Other income, net		0.1			(0.0	)		0.0
Income tax expense		3.0			3.4			3.1
Income from continuing operations before discontinued operations		5.0			5.5			5.0
Discontinued operations:
(Loss) income from operations of discontinued wholesale
distribution network		-			-			(0.0	)
(Benefit) provision for income taxes		-			-			(0.0	)
(Loss) income on discontinued operations		-			-			(0.0	)
Net income		5.0	%		5.5	%		5.0	%

Fiscal 2006 Compared to Fiscal 2005

Net sales for 2006 were $4,616.5 million, an increase of $351.5 million, or 8.2%, over net sales for 2005. The net sales increase was due to an increase in comparable store sales of 2.1%, contributions from the 190 AAP stores opened within the last year and sales from AI. AI, which was acquired in September 2005, produced sales of $111.1 million in 2006 compared to $30.3 million for the partial period in 2005. The comparable store sales increase was driven by an increase in average ticket sales and customer traffic in our DIFM business and an increase in average ticket sales by our DIY customers offset by a decrease in DIY customer count. In addition, we believe our DIFM sales have increased as a result of the continued execution of our commercial plan as discussed previously in the Commercial Program.

Gross profit for 2006 was $2,201.2 million, or 47.7% of net sales, as compared to $2,014.5 million, or 47.2% of net sales, in 2005. The increase in gross profit as a percentage of sales reflects the positive impact of our ongoing category management initiatives, including improved procurement costs and a positive shift in sales mix, and logistics efficiencies.

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Selling, general and administrative expenses were $1,797.8 million, or 39.0% of net sales, for 2006, as compared to $1,606.0 million, or 37.6% of net sales, for 2005. Selling, general and administrative expenses increased as a percentage of sales as a result of:

·	recording share-based compensation expense of approximately 0.4% of net sales upon the implementation of SFAS 123R on January 1, 2006;
·	a 0.5% increase in certain fixed costs as a percentage of sales during the year, including rent and depreciation, as a result of low comparative sales growth; and
·	a 0.3% increase in expenses associated with higher costs for insurance programs, including workers’ compensation, auto liability and general liability.

Additionally, AI contributed approximately 0.2% of selling, general and administrative expenses as a result of the reinvestment of working capital to accelerate their new store growth.

Interest expense for 2006 was $36.0 million, or 0.8% of net sales, as compared to $32.4 million, or 0.7% of net sales, in 2005. The increase in interest expense is a result of both higher average outstanding debt levels and borrowing rates as compared to fiscal 2005. In addition, other income for fiscal 2006 decreased as a result of less interest income associated with lower cash balances throughout the year.

Income tax expense for 2006 was $138.6 million, as compared to $144.2 million for 2005. Our effective income tax rate was 37.5% and 38.1% for 2006 and 2005, respectively.

We generated net income of $231.3 million, or $2.16 per diluted share, for 2006, as compared to $234.7 million, or $2.13 per diluted share, for 2005. As a percentage of sales, net income for 2006 was 5.0%, as compared to 5.5% for 2005. Our earnings per diluted share results reflect the impact on both earnings and the diluted share count of implementing FAS 123R as further explained in this management’s discussion and analysis and in the notes to our financial statements contained elsewhere in this Form 10-K.

Fiscal 2005 Compared to Fiscal 2004

Net sales for 2005 were $4,265.0 million, an increase of $494.7 million, or 13.1%, over net sales for 2004. The net sales increase was due to an increase in comparable store sales of 8.7%, contributions from the 151 new stores opened within the last year and sales from acquired operations. The comparable store sales increase was driven by an increase in average ticket sales and a slight increase in customer traffic.

Gross profit for 2005 was $2,014.5 million, or 47.2% of net sales, as compared to $1,753.4 million, or 46.5% of net sales, in 2004. The increase in gross profit as a percentage of sales reflects continued benefits realized from our category management program in the form of better margins on key product categories and increased incentives under our vendor programs and supply chain efficiencies.

Selling, general and administrative expenses were $1,606.0 million, or 37.6% of net sales, for 2005, as compared to $1,424.6 million, or 37.8% of net sales, for 2004. For fiscal 2005, we experienced a decrease in selling, general and administrative expenses as a percentage of net sales resulting from our ability to leverage our strong comparable store sales and lower self-insurance expense partially offset by higher fuel and energy costs.

Interest expense for 2005 was $32.4 million, or 0.7% of net sales, as compared to $20.1 million, or 0.5% of net sales, in 2004. The increase in interest expense is a result of both higher average outstanding debt levels and borrowing rates as compared to fiscal 2004.

Income tax expense for 2005 was $144.2 million, as compared to $117.7 million for 2004. This increase in income tax expense primarily reflects our higher earnings. Our effective income tax rate was 38.1% and 38.5% for 2005 and 2004, respectively.

We generated net income of $234.7 million, or $2.13 per diluted share, for 2005, as compared to $188.0 million, or $1.66 per diluted share, for 2004. As a percentage of sales, net income for 2005 was 5.5%, as compared to 5.0% for 2004.

Table of Contents

Quarterly Consolidated Financial Results (in thousands, except per share data)

	16-Weeks Ended 4/23/2005		12-Weeks Ended 7/16/2005		12-Weeks Ended 10/8/2005		12-Weeks Ended 12/31/2005		16-Weeks Ended 4/22/2006		12-Weeks Ended 7/15/2006		12-Weeks Ended 10/7/2006		12-Weeks Ended 12/30/2006
Net sales	$	1,258,364	$	1,023,146	$	1,019,736	$	963,725	$	1,393,010	$	1,107,857	$	1,099,486	$	1,016,150
Gross profit		600,931		482,050		481,415		450,082		665,168		527,359		530,206		478,431
Net income	$	68,647	$	65,929	$	60,793	$	39,356	$	74,081	$	62,936	$	58,947	$	35,354

Net income per share:
Basic⁽¹⁾	$	0.64	$	0.61	$	0.56	$	0.36	$	0.69	$	0.60	$	0.56	$	0.34
Diluted⁽¹⁾	$	0.63	$	0.60	$	0.55	$	0.36	$	0.68	$	0.59	$	0.56	$	0.33