**UNITED STATES**

**SECURITIES AND EXCHANGECOMMISSION**

**WASHINGTON, D.C. 20549**

 

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**FORM 10-Q**

 
| **(Mark One)** |
|----------------|
| ** **     | ** ** |
| **x**          | **Quarterly Report Pursuant to  Section 13 or 15(d) of the Securities Exchange Act of 1934** |

 

**For thequarterly period ended May 3, 2008**

 

**OR**

 
| **o** | **Transition Report Pursuant to  Section 13 or 15(d) of the Securities Exchange Act of 1934** |
|-------|---------------------------------------------------------------------------------------------------------|

 

**For thetransition period from             to            **

 

**CommissionFile No. 1-3381**

 

**The Pep Boys - Manny, Moe &Jack**

(Exact name ofregistrant as specified in its charter)

 

| **Pennsylvania**                            | ** ** | **23-0962915**              |
|---------------------------------------------|------------|-----------------------------|
| (State or other jurisdiction of             |       | (I.R.S. Employer ID number) |
| incorporation or organization)              |       |                        |
|                                        |       |                        |
| **3111 W. Allegheny Ave. Philadelphia, PA** | ** ** | **19132**                   |
| (Address of principal executive offices)    |       | (Zip code)                  |

 

**215-430-9000**

(Registrant’s telephonenumber, including area code)

 

Indicate by check mark whether the registrant (1) hasfiled all reports required to be filed by Section 13 or 15(d) of theSecurities and Exchange Act of 1934 during the preceding 12 months (or for suchshorter period that the registrant was required to file such reports); and (2) hasbeen subject to such filing requirements for the past 90days.   Yes x   No o

 

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

 

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

 

Indicate by check mark whether the registrant isa shell company (as defined in Rule 12b-2 of the ExchangeAct).   Yes o   No x

 

As of May 30, 2008 there were 51,797,703shares of the registrant’s Common Stock outstanding.

 

 

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| **Index**                           | ** **                                                                                                                                      | **Page** |
|-------------------------------------|-------------------------------------------------------------------------------------------------------------------------------------------------|----------|
|                                |                                                                                                                                            |
| PART I - FINANCIAL INFORMATION |                                                                                                                                            |
|                                |                                                                                                                                            |     |
| Item 1.                             | Condensed Consolidated Financial Statements (Unaudited)                                                                                         |     |   |
|                                |                                                                                                                                            |     |
|                                | Condensed Consolidated Balance Sheets -  May 3, 2008 and February 2, 2008                                                             | 3        |
|                                |                                                                                                                                            |     |
|                                | Condensed Consolidated Statements of  Operations and Changes in Retained Earnings - Thirteen weeks ended  May 3, 2008 and May 5, 2007 | 4        |
|                                |                                                                                                                                            |     |
|                                | Condensed Consolidated Statements of Cash  Flows - Thirteen weeks ended May 3, 2008 and May 5, 2007                                   | 5        |
|                                |                                                                                                                                            |     |
|                                | Notes to Condensed Consolidated Financial  Statements                                                                                           | 6-22     |
|                                |                                                                                                                                            |     |
| Item 2.                             | Management’s Discussion and Analysis of  Financial Condition and Results of Operations                                                     | 23-27    |
|                                |                                                                                                                                            |     |
| Item 3.                             | Quantitative and Qualitative Disclosures  About Market Risk                                                                                     | 27       |
|                                |                                                                                                                                            |     |
| Item 4.                             | Controls and Procedures                                                                                                                         | 27       |
|                                |                                                                                                                                            |     |
| Item 5.                             | Other Information                                                                                                                               | 28       |
|                                |                                                                                                                                            |     |
| PART II - OTHER INFORMATION    |                                                                                                                                            |
|                                |                                                                                                                                            |     |
| Item 1.                             | Legal Proceedings                                                                                                                               | 29       |
|                                |                                                                                                                                            |     |
| Item 1A.                            | Risk Factors                                                                                                                                    | 29       |
|                                |                                                                                                                                            |     |
| Item 2.                             | Unregistered Sales of Equity Securities and  Use of Proceeds                                                                                    | 29       |
|                                |                                                                                                                                            |     |
| Item 3.                             | Defaults Upon Senior Securities                                                                                                                 | 29       |
|                                |                                                                                                                                            |     |
| Item 4.                             | Submission of Matters to a Vote of Security  Holders                                                                                            | 29       |
|                                |                                                                                                                                            |     |
| Item 5.                             | Other Information                                                                                                                               | 29       |
|                                |                                                                                                                                            |     |
| Item 6.                             | Exhibits                                                                                                                                        | 30       |
|                                |                                                                                                                                            |     |
| SIGNATURES                          | 31                                                                                                                                              |
|                                |                                                                                                                                            |
| INDEX TO EXHIBITS                   | 32                                                                                                                                              |
|                                     |                                                                                                                                                 |          |  |  |  |

 

2

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PART I - FINANCIALINFORMATION

 

Item 1. Condensed ConsolidatedFinancial Statements (Unaudited)

 

THEPEP BOYS - MANNY, MOE & JACK AND SUBSIDIARIES

CONDENSEDCONSOLIDATED BALANCE SHEETS

(dollar amounts inthousands, except share data)

 

UNAUDITED

 
| ** **                                                                           | ** ** | **May 3, 2008** | ** ** | **February 2, 2008** | ** ** |
|--------------------------------------------------------------------------------------|------------|---------------------------|------------|--------------------------------|------------|
| **ASSETS**                                                                           |       |                      |       |                           |       |
| Current Assets:                                                                      |       |                      |       |                           |       |
| Cash and cash equivalents                                                            |       | $                         | 87,277     |                           | $          | 20,926 |   |
| Accounts receivable, less allowance for  uncollectible accounts of $2,299 and $1,937 |       | 30,726                    |       | 29,450                         |       |
| Merchandise inventories                                                              |       | 561,439                   |       | 561,152                        |       |
| Prepaid expenses                                                                     |       | 39,601                    |       | 43,842                         |       |
| Other                                                                                |       | 65,411                    |       | 77,469                         |       |
| Assets held for disposal                                                             |       | 16,592                    |       | 16,918                         |       |
| Total Current Assets                                                                 |       | 801,046                   |       | 749,757                        |       |
|                                                                                 |       |                      |       |                           |       |
| Property and Equipment – Net                                                    |       | 705,557                   |       | 780,779                        |       |
| Deferred income taxes                                                                |       | 27,332                    |       | 20,775                         |       |
| Other                                                                                |       | 30,756                    |       | 32,609                         |       |
| Total Assets                                                                         |       | $                         | 1,564,691  |                           | $          | 1,583,920 |   |
|                                                                                 |       |                      |       |                           |       |
| **LIABILITIES AND STOCKHOLDERS’ EQUITY**                                        | ** ** | ** **                | ** ** | ** **                     | ** ** |
| Current Liabilities:                                                                 |       |                      |       |                           |       |
| Accounts payable                                                                     |       | $                         | 230,185    |                           | $          | 245,423 |   |
| Trade payable program liability                                                      |       | 19,020                    |       | 14,254                         |       |
| Accrued expenses                                                                     |       | 282,322                   |       | 292,623                        |       |
| Current maturities of long-term debt and  obligations under capital leases           |       | 2,278                     |       | 2,114                          |       |
| Total Current Liabilities                                                            |       | 533,805                   |       | 554,414                        |       |
|                                                                                 |       |                      |       |                           |       |
| Long-term debt and obligations under  capital leases, less current maturities        |       | 341,317                   |       | 400,016                        |       |
| Other long-term liabilities                                                          |       | 70,032                    |       | 72,183                         |       |
| Deferred gain from asset sales                                                       |       | 146,062                   |       | 86,595                         |       |
| Commitments and Contingencies                                                        |       |                      |       |                           |       |
| Stockholders’ Equity:                                                           |       |                      |       |                           |       |
| Common Stock, par value $1 per share:                                                |       |                      |       |                           |       |
| Authorized 500,000,000 shares; Issued  68,557,041 shares                             |       | 68,557                    |       | 68,557                         |       |
| Additional paid-in capital                                                           |       | 296,715                   |       | 296,074                        |       |
| Retained earnings                                                                    |       | 406,819                   |       | 406,819                        |       |
| Accumulated other comprehensive loss                                                 |       | (12,486                   | )          | (14,183                        | )          |
| Less cost of shares in treasury –  14,582,741 shares and 14,609,094 shares      |       | 226,866                   |       | 227,291                        |       |
| Less cost of shares in benefits trust -  2,195,270 shares                            |       | 59,264                    |       | 59,264                         |       |
| Total Stockholders’ Equity                                                      |       | 473,475                   |       | 470,712                        |       |
| Total Liabilities and Stockholders’ Equity                                      |       | $                         | 1,564,691  |                           | $          | 1,583,920 |   |

 

See notes tocondensed consolidated financial statements.

 

3

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THEPEP BOYS - MANNY, MOE & JACK AND SUBSIDIARIES

CONDENSEDCONSOLIDATED STATEMENTS OF OPERATIONS AND CHANGES IN RETAINED EARNINGS

(dollar amounts inthousands, except per share amounts)UNAUDITED

 
| **Thirteen weeks ended**                                   | ** ** | **May 3, 2008** | ** ** | **May 5, 2007** | ** ** |
|----------------------------------------------------------------------|------------|---------------------------|------------|---------------------------|------------|
| Merchandise Sales                                                    |       | $                         | 403,334    |                      | $          | 439,794 |   |
| Service Revenue                                                      |       | 94,709                    |       | 99,789                    |       |
| Total Revenues                                                       |       | 498,043                   |       | 539,583                   |       |
| Costs of Merchandise Sales                                           |       | 285,923                   |       | 311,530                   |       |
| Costs of Service Revenue                                             |       | 84,154                    |       | 87,464                    |       |
| Total Costs of Revenues                                              |       | 370,077                   |       | 398,994                   |       |
| Gross Profit from Merchandise Sales                                  |       | 117,411                   |       | 128,264                   |       |
| Gross Profit from Service Revenue                                    |       | 10,555                    |       | 12,325                    |       |
| Total Gross Profit                                                   |       | 127,966                   |       | 140,589                   |       |
| Selling, General and Administrative  Expenses                        |       | 119,015                   |       | 127,110                   |       |
| Net Gain from Dispositions of Assets                                 |       | 5,531                     |       | 2,359                     |       |
| **Operating Profit**                                                 | ** ** | **14,482**                | ** ** | **15,838**                | ** ** |
| Non-operating Income                                                 |       | 330                       |       | 1,905                     |       |
| Interest Expense                                                     |       | 5,427                     |       | 12,656                    |       |
| Earnings From Continuing Operations Before  Income Taxes             |       | 9,385                     |       | 5,087                     |       |
| Income Tax Expense                                                   |       | 4,094                     |       | 2,036                     |       |
| Net Earnings From Continuing Operations                              |       | 5,291                     |       | 3,051                     |       |
| (Loss) Gain From Discontinued Operations,  Net of Tax                |       | (619                      | )          | 124                       |       |
| **Net Earnings**                                                     | ** ** | **4,672**                 | ** ** | **3,175**                 | ** ** |
|                                                                 |       |                      |       |                      |       |
| Retained Earnings, beginning of period                               |       | 406,819                   |       | 463,797                   |       |
| Cumulative effect adjustment for adoption  of EITF 06-10, net of tax |       | (1,165                    | )          | —                    |       |
| Cumulative effect adjustment for adoption  of FIN 48                 |       | —                    |       | (155                      | )          |
| Cash Dividends                                                       |       | (3,495                    | )          | (3,581                    | )          |
| Effect of Stock Options                                              |       | (12                       | )          | (479                      | )          |
| Retained Earnings, end of period                                     |       | $                         | 406,819    |                      | $          | 462,757 |   |
|                                                                 |       |                      |       |                      |       |
| Basic Earnings Per Share:                                            |       |                      |       |                      |       |
|                                                                 |       |                      |       |                      |       |
| Net Earnings from Continuing Operations                              |       | $                         | 0.10       |                      | $          | 0.06 |   |
| Discontinued Operations, Net of Tax                                  |       | (0.01                     | )          | —                    |       |
| Basic Earnings Per Share                                             |       | $                         | 0.09       |                      | $          | 0.06 |   |
|                                                                 |       |                      |       |                      |       |
| Diluted Earnings Per Share:                                          |       |                      |       |                      |       |
|                                                                 |       |                      |       |                      |       |
| Net Earnings from Continuing Operations                              |       | $                         | 0.10       |                      | $          | 0.06 |   |
| Discontinued Operations, Net of Tax                                  |       | (0.01                     | )          | —                    |       |
| Diluted Earnings Per Share                                           |       | $                         | 0.09       |                      | $          | 0.06 |   |
|                                                                 |       |                      |       |                      |       |
| Cash Dividends Per Share                                             |       | $                         | 0.0675     |                      | $          | 0.0675 |   |

 

See notes to condensedconsolidated financial statements.

 

4

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THEPEP BOYS - MANNY, MOE & JACK AND SUBSIDIARIES

CONDENSEDCONSOLIDATED STATEMENTS OF CASH FLOWS

(dollar amounts inthousands)

UNAUDITED

 
| **Thirteen weeks ended**                                                | ** ** | **May 3, 2008** | ** ** | **May 5, 2007** | ** ** |
|-----------------------------------------------------------------------------------|------------|---------------------------|------------|---------------------------|------------|
| Cash Flows from Operating Activities:                                             |       |                      |       |                      |       |
| Net Earnings                                                                      |       | $                         | 4,672      |                      | $          | 3,175 |   |
| Adjustments to reconcile net earnings to  net cash used in continuing operations: |       |                      |       |                      |       |
| Net loss (earnings) from discontinued  operations                                 |       | 619                       |       | (124                      | )          |
| Depreciation and amortization                                                     |       | 19,019                    |       | 20,884                    |       |
| Amortization of deferred gain from asset  sales                                   |       | (1,825                    | )          | —                    |       |
| Accretion of asset disposal obligation                                            |       | 93                        |       | 64                        |       |
| Stock compensation expense                                                        |       | 1,322                     |       | 4,390                     |       |
| Gain on debt retirement                                                           |       | (2,883                    | )          | —                    |       |
| Deferred income taxes                                                             |       | 1,437                     |       | 1,642                     |       |
| Gain from dispositions of assets &  insurance recoveries                 |       | (5,531                    | )          | (3,719                    | )          |
| Loss from asset impairment                                                        |       | 370                       |       | —                    |       |
| Change in fair value of derivatives                                               |       | 69                        |       | 1,802                     |       |
| Excess tax benefits from stock based awards                                       |       | —                    |       | (301                      | )          |
| Increase (decrease) in cash surrender value  of life insurance policies           |       | 979                       |       | (534                      | )          |
| Changes in Operating Assets and  Liabilities:                                     |       |                      |       |                      |       |
| Decrease in accounts receivable, prepaid  expenses and other                      |       | 7,586                     |       | 10,178                    |       |
| Increase in merchandise inventories                                               |       | (287                      | )          | (11,772                   | )          |
| Decrease in accounts payable                                                      |       | (15,238                   | )          | (32,617                   | )          |
| Decrease in accrued expenses                                                      |       | (12,281                   | )          | (2,257                    | )          |
| (Decrease) increase in other long-term  liabilities                               |       | (2,394                    | )          | 1,075                     |       |
| Net cash used in continuing operations                                            |       | (4,273                    | )          | (8,114                    | )          |
| Net cash (used in) provided by discontinued  operations                           |       | (58                       | )          | 307                       |       |
| Net Cash Used in Operating Activities                                             |       | (4,331                    | )          | (7,807                    | )          |
|                                                                              |       |                      |       |                      |       |
| Cash Flows from Investing Activities:                                             |       |                      |       |                      |       |
| Cash paid for property and equipment                                              |       | (6,942                    | )          | (11,525                   | )          |
| Proceeds from dispositions of assets                                              |       | 132,090                   |       | —                    |       |
| Net cash provided by (used in) continuing  operations                             |       | 125,148                   |       | (11,525                   | )          |
| Net cash used in discontinued operations                                          |       | —                    |       | (85                       | )          |
| Net Cash Provided by (Used in) Investing  Activities                              |       | 125,148                   |       | (11,610                   | )          |
|                                                                              |       |                      |       |                      |       |
| Cash Flows from Financing Activities:                                             |       |                      |       |                      |       |
| Borrowings under line of credit agreements                                        |       | 97,909                    |       | 207,505                   |       |
| Payments under line of credit agreements                                          |       | (139,332                  | )          | (117,900                  | )          |
| Excess tax benefits from stock based awards                                       |       | —                    |       | 301                       |       |
| Borrowings on trade payable program liability                                     |       | 27,222                    |       | 17,461                    |       |
| Payments on trade payable program liability                                       |       | (22,456                   | )          | (17,405                   | )          |
| Payment for finance issuance cost                                                 |       | (93                       | )          | —                    |       |
| Proceeds from lease financing                                                     |       | 4,676                     |       | —                    |       |
| Reduction of long-term debt                                                       |       | (18,856                   | )          | (808                      | )          |
| Payments on capital lease obligations                                             |       | (49                       | )          | (83                       | )          |
| Dividends paid                                                                    |       | (3,495                    | )          | (3,581                    | )          |
| Repurchase of common stock                                                        |       | —                    |       | (58,152                   | )          |
| Proceeds from exercise of stock options                                           |       | 8                         |       | 773                       |       |
| Proceeds from dividend reinvestment plan                                          |       | —                    |       | 203                       |       |
| Net Cash (Used in) Provided by Financing  Activities                              |       | (54,466                   | )          | 28,314                    |       |
| Net Increase in Cash and Cash Equivalents                                         |       | 66,351                    |       | 8,897                     |       |
| Cash and Cash Equivalents at Beginning of  Period                                 |       | 20,926                    |       | 21,884                    |       |
| Cash and Cash Equivalents at End of Period                                        |       | $                         | 87,277     |                      | $          | 30,781 |   |
|                                                                              |       |                      |       |                      |       |
| Cash paid for interest, net of amounts  capitalized                               |       | $                         | 3,994      |                      | $          | 7,770 |   |
| Supplemental Disclosure of Cash Flow  Information:                                |       |                      |       |                      |       |   |   |
| Non-cash investing activities:                                                    |       |                      |       |                      |       |
| Accrued purchases of property and equipment                                       |       | $                         | 3,689      |                      | $          | 2,804 |   |

 

See notes to condensed consolidated financialstatements.

 

5

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THE PEP BOYS - MANNY,MOE & JACK AND SUBSIDIARIES

NOTES TO CONDENSEDCONSOLIDATED FINANCIAL STATEMENTS

(Dollar Amounts inThousands)

 

NOTE 1. Condensed Consolidated FinancialStatements

 

The condensed consolidated balance sheet as of May 3,2008, the condensed consolidated statements of operations and changes inretained earnings for the thirteen week periods ended May 3, 2008 and May 5,2007 and the condensed consolidated statements of cash flows for the thirteenweek periods ended May 3, 2008 and May 5, 2007 are unaudited. In theopinion of management, all adjustments necessary to present fairly thefinancial position, results of operations and cash flows at May 3, 2008and for all periods presented have been made.

 

Certain information and footnote disclosuresnormally included in financial statements prepared in accordance withaccounting principles generally accepted in the United States of America havebeen condensed or omitted, as permitted by Rule 10-01 of the Securitiesand Exchange Commission’s Regulation S-X, “Interim Financial Statements.” It issuggested that these condensed consolidated financial statements be read inconjunction with the financial statements and notes thereto included in theCompany’s Annual Report on Form 10-K for the fiscal year ended February 2,2008. The results of operations for the thirteen weeks ended May 3, 2008are not necessarily indicative of the operating results for the full year.

 

Our fiscal year ends on the Saturday nearest January 31.Accordingly, references to fiscal 2007, fiscal 2008 and fiscal 2009 refer tothe years ended February 2, 2008; January 31, 2009 and January 30,2010.

 

NOTE 2. New Accounting Standards

 

Adopted:

 

In September 2006, the Financial AccountingStandards Board (FASB) issued Statement of Financial Accounting Standards(SFAS) No. 157, “Fair Value Measurements” (SFAS 157). SFAS 157defines the term fair value, establishes a framework for measuring it withingenerally accepted accounting principles and expands disclosures about itsmeasurements. The Company adopted SFAS 157 on February 3, 2008.  This adoption did not have a material effecton the Company’s financial statements. Fair value disclosures are provided in Note 16.

 

InMarch 2007, the Emerging Issues Task Force (EITF) reached a consensus onIssue Number 06-10, “Accounting for Deferred Compensation andPostretirement Benefit Aspects of Collateral Assignment Split-Dollar LifeInsurance Arrangements” (EITF 06-10). EITF 06-10 provides guidance tohelp companies determine whether a liability for the postretirement benefitassociated with a collateral assignment split-dollar life insurance arrangementshould be recorded in accordance with either SFAS No. 106, “Employers’Accounting for Postretirement Benefits Other Than Pensions” (if, in substance,a postretirement benefit plan exists), or Accounting Principles Board Opinion No. 12(if the arrangement is, in substance, an individual deferred compensationcontract). EITF 06-10 also provides guidance on how a company shouldrecognize and measure the asset in a collateral assignment split-dollar lifeinsurance contract. EITF 06-10 is effective for fiscal years beginningafter December 15, 2007, although early adoption is permitted. On February 3,2008, the Company adopted EITF 06-10, which resulted in a $1,855 pretaxcharge to retained earnings for its only existing collateral assignmentsplit-dollar life insurance arrangement for a former CEO, who retired in fiscal2003.

 

InJune 2007, the FASB ratified EITF Issue Number 06-11, “Accounting forIncome Tax Benefits of Dividends on Share-Based Payment Awards”(EITF 06-11). EITF 06-11 applies to share-based payment arrangementswith dividend protection features that entitle employees to receive (a) dividendson equity-classified nonvested shares, (b) dividend equivalents onequity-classified nonvested share units, or (c) payments equal to thedividends paid on the underlying shares while an equity-classified share optionis outstanding, when those dividends or dividend equivalents are charged toretained earnings under SFAS No. 123(R), “Share-Based Payment,” and resultin an income tax deduction for the employer. A consensus was reached that arealized income tax benefit from dividends or dividend equivalents that arecharged to retained earnings and are paid to employees for equity-classifiednon-vested equity shares, non-vested equity share units, and outstanding equityshare options should be recognized as an increase in additional paid-incapital. EITF 06-11 is effective prospectively for the income tax benefitsthat result from dividends on equity-classified employee share-based paymentawards that are declared in fiscal years beginning after December 15,2007, and interim periods within those fiscal years. On February 3, 2008,the Company adopted EITF 06-11, which did not have a material impact on itsconsolidated financial statements.

 

To be adopted:

 

InDecember 2007, the FASB issued SFAS No. 141R, “Business Combinations,”which replaces SFAS No. 141, “Business Combinations.” SFAS No. 141R,among other things, establishes principles and requirements for how an acquirerentity recognizes 

 

6

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andmeasures in its financial statements the identifiable assets acquired, theliabilities assumed and any controlling interests in the acquired entity;recognizes and measures the goodwill acquired in the business combination or again from a bargain purchase; and determines what information to disclose toenable users of the financial statements to evaluate the nature and financialeffects of the business combination. Costs of the acquisition will berecognized separately from the business combination. SFAS No. 141R appliesprospectively, except for taxes, to business combinations for which theacquisition date is on or after the beginning of the first annual reportingperiod on or after December 15, 2008.

 

In December 2007, the FASB issued SFAS No. 160,“Noncontrolling Interests in Consolidated Financial Statements—an amendment ofARB No. 51.” SFAS No. 160, among other things, provides guidance andestablishes amended accounting and reporting standards for a parent company’snoncontrolling interest in a subsidiary. SFAS No. 160 is effective forfiscal years beginning on or after December 15, 2008. The Company does notexpect the adoption of SFAS No. 160 to have a material impact on itsfinancial condition, results of operations or cash flows.

 

In February 2008, the FASB issued StaffPosition No. FAS 157-2 (FSP No.157-2), “Effective Date of FASBStatement No. 157,” that defers the effective date of SFAS 157 forone year for certain nonfinancial assets and nonfinancial liabilities.  SFAS 157 is effective for certainnonfinancial assets and nonfinancial liabilities for financial statementsissued for fiscal years beginning after November 15, 2008. The Company iscurrently evaluating the impact SFAS No. 157 will have on its consolidatedfinancial statements beginning in fiscal 2009.

 

In March 2008, the FASB issued SFAS No. 161,“Disclosures about Derivative Instruments and Hedging Activities.” SFAS No. 161expands the disclosure requirements in SFAS No. 133, “Accounting forDerivative Instruments and Hedging Activities,” about an entity’s derivativeinstruments and hedging activities. SFAS No. 161 is effective for financialstatements issued for fiscal years and interim periods beginning after November 15,2008. The Company is currently evaluating the impact SFAS No. 161 willhave on its consolidated financial statements.

 

NOTE 3. Accounting for Stock-Based Compensation

 

The Company has stock-based compensation plans,under which it grants stock options and restricted stock units to key employeesand members of its Board of Directors.

 

In accordance with SFAS No. 123(R), theCompany recognizes compensation expense on a straight-line basis over thevesting period. A summary of total compensation expense and associated incomebenefit recognized related to stock-based compensation is as follows:

 
| ** **                                      | ** ** | **Thirteen Weeks Ended** | ** ** |
|-------------------------------------------------|------------|------------------------------------|------------|
| **(dollar amount in thousands)** | ** ** | **May 3, 2008**          | ** ** | **May 5, 2007** | ** ** |
| Compensation expense                            |       | $                                  | 1,322      |   | $ | 4,390 |   |
| Income tax benefit                              |       | $                                  | 491        |   | $ | 1,631 |   |

 

**Stock Options**

 

During the first quarter ended May 3, 2008,the Company granted 315,800 stock options with a weighted average grant datefair value of $3.55.  In the first quarterof fiscal 2007, the Company issued 1,052,367 stock options with a weightedaverage grant date fair value of $5.09. The following table summarizes the options under the Company’s plan:

 
| ** **                               | ** ** | **Number of Shares** | ** ** |
|------------------------------------------|------------|--------------------------------|------------|
| Outstanding — February 3, 2008 |       | 2,449,701                      |       |
| Granted                                  |       | 315,800                        |       |
| Exercised                                |       | (1,250                         | )          |
| Forfeited                                |       | (620,167                       | )          |
| Expired                                  |       | (339,300                       | )          |
| Outstanding — May 3, 2008      |       | 1,804,784                      |       |

 

7

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Expectedvolatility is based on historical volatilities for a time period similar tothat of the expected term. In estimating the expected term of the options, theCompany has utilized the “simplified method” allowable under the Securities andExchange Commission, or SEC, Staff Accounting Bulletin No. 107, “Share-BasedPayment,” for the quarter ended May 5, 2007 and changed to an actualexperience method during the quarter ended May 3, 2008.  The risk-free rate is based on the U.S.treasury yield curve for issues with a remaining term equal to the expectedterm. The fair value of each option granted during thirteen weeks ended May 3,2008 and May 5, 2007 is estimated on the date of grant using theBlack-Scholes option-pricing model with the following weighted-averageassumptions:

 
| ** **                        | ** ** | **May 3,  2008** | ** ** | **May 5,  2007** | ** ** |
|-----------------------------------|------------|-----------------------|------------|-----------------------|------------|
| Dividend yield                    |       | 2.90                  | %          | 1.80                  | %          |
| Expected volatility               |       | 45.43                 | %          | 39.41                 | %          |
| Risk-free interest rate range:    |       |                  |       |                  |       |
| High                              |       | 2.86                  | %          | 4.37                  | %          |
| Low                               |       | 2.69                  | %          | 4.27                  | %          |
| Ranges of expected lives in years |       | 4 - 5                 |       | 4 - 5                 |       |

 

**Restricted Stock Units**

 

During the first quarter ended May 3, 2008,the Company issued 237,021 restricted stock units with a weighted average grantdate fair value of $11.50.  In the firstquarter of fiscal 2007, the Company issued 630,300 restricted stock units witha weighted average grant date fair value of $15.26.   The following table summarizes the unitsunder the Company’s plan:

 
| ** **                             | ** ** | **Number of Shares** | ** ** |
|----------------------------------------|------------|--------------------------------|------------|
| Nonvested — February 3, 2008 |       | 710,945                        |       |
| Granted                                |       | 237,021                        |       |
| Forfeited                              |       | (348,291                       | )          |
| Vested                                 |       | (194,358                       | )          |
| Nonvested — May 3, 2008      |       | 405,317                        |       |

 

NOTE 4. Merchandise Inventories

 

Merchandise inventories are valued at the lowerof cost or market. Cost is determined by using the last-in, first-out (LIFO)method. An actual valuation of inventory under the LIFO method can be made onlyat the end of each fiscal year based on inventory and costs at that time.Accordingly, interim LIFO calculations must be based on management’s estimatesof expected fiscal year-end inventory levels and costs. If the first-in,first-out (FIFO) method of costing inventory had been used by the Company,inventory would have been  $554,920 and$555,188 as of May 3, 2008 and February 2, 2008, respectively.Inventory levels have shown immaterial decreases in the current quarter and theCompany anticipates no LIFO layer liquidations for the fiscal year ended January 31,2009.

 

The Company provides for estimated inventoryshrinkage based upon historical levels and the results of its cycle countingprogram.

 

The Company also provides for potentially excessand obsolete inventories based on current inventory levels, the historicalanalysis of product sales and current market conditions. The nature of theCompany’s inventory is such that the risk of obsolescence is minimal and excessinventory has historically been returned to the Company’s vendors for credit.The Company records a provision when less than full credit is expected from avendor or when market is lower than recorded costs. These provisions arerevised, if necessary, on a quarterly basis for adequacy. The Company’sinventory is recorded net of provisions for these matters which were $11,008 atMay 3, 2008 and $11,167 at February 2, 2008.

 

During the third quarter of fiscal 2007, theCompany recorded a $32,803 inventory write-down for the discontinuance andplanned exit of certain non-core merchandise adopted as one of the initialsteps in the Company’s five-year strategic plan. The write-down reduced thecarrying value of the discontinued merchandise from $74,080 to $41,277. Thecarrying value of the discontinued merchandise will be evaluated quarterly ascompared to the estimated sell through that was utilized in determining theimpairment. The inventory impairment was recorded in cost of merchandise saleson the consolidated statement of operations. The carrying value of thediscontinued merchandise was $1,992 at May 3, 2008 and $8,612 at February 2,2008.

 

8

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NOTE5. Property and Equipment

 

TheCompany’s property and equipment as of May 3, 2008 and February 2,2008, respectively, are as follows:

 
| **(dollar amounts in thousands)** | ** ** | **May 3, 2008** | ** ** | **February 2, 2008** | ** ** |
|--------------------------------------------------|------------|---------------------------|------------|--------------------------------|------------|
|                                             |       |                      |       |                           |       |
| Property and  Equipment - at cost:               |       |                      |       |                           |       |
| Land                                             |       | $                         | 186,072    |                           | $          | 213,962 |   |
| Buildings and  improvements                      |       | 799,456                   |       | 858,699                        |       |
| Furniture,  fixtures and equipment               |       | 676,115                   |       | 699,303                        |       |
| Construction in  progress                        |       | 2,516                     |       | 3,992                          |       |
|                                             |       | 1,664,159                 |       | 1,775,956                      |       |
| Less accumulated  depreciation and amortization  |       | 958,602                   |       | 995,177                        |       |
| Total Property  and Equipment - Net              |       | $                         | 705,557    |                           | $          | 780,779 |   |

 

NOTE6. Income Taxes

 

The Company adopted the provisions of FASBInterpretation No. 48, “Accounting for Uncertainty in Income Taxes,” (FIN48) on February 4, 2007. In connection with the adoption, the Companyrecorded a net decrease to retained earnings of $155 and reclassified certainpreviously recognized deferred tax attributes as FIN 48 liabilities. The amountof unrecognized tax benefits at February 4, 2007 was $7,126 of which$2,216 would impact the Company’s tax rate, if recognized. As of May 3,2008, included in the unrecognized tax benefits of $3,926 was $2,295 of taxbenefits that, if recognized, would affect our annual effective tax rate.  The Company is undergoing examinations of ourtax returns in certain jurisdictions. The Company has liabilities for uncertain tax positions of approximately$2,388 for which it is reasonably possible that the amount will increase ordecrease within the next twelve months. However, based on the uncertainties associated with settlements and thestatus of examination, it is not possible to estimate the impact of the change.

 

TheCompany recognizes potential interest and penalties for unrecognized taxbenefits in income tax expense and, accordingly, during the thirteen weeksended May 3, 2008 the Company recognized a benefit of approximately $98 inpotential interest and penalties associated with uncertain tax positions. At May 3,2008 and May 5, 2007, the Company has recorded approximately $1,074 and$760, respectively, for the payment of interest and penalties.

 

TheCompany files U.S., state and Puerto Rico income tax returns in jurisdictionswith varying statutes of limitations. The 2004 through 2007 tax years generally remain subject to examinationby federal and most state tax authorities. The Company and its subsidiaries have various state income tax returnsin the process of examination, appeals and settlement.  In Puerto Rico, the 2001 through 2007 taxyears generally remain subject to examination by their respective taxauthorities.

 

Thetemporary differences between the book and tax treatment of income and expensesresult in deferred tax assets and liabilities, which are included within theconsolidated balance sheets. The Company must then assess the likelihood thatthe deferred tax assets will be recovered from future taxable income. To theextent the Company believes that recovery is not more likely than not, avaluation allowance must be established. In this regard when determiningwhether or not a valuation allowance should be established, the Companyconsiders various tax planning strategies, including potential real estatetransactions, as future taxable income. As of May 3, 2008, the Company had valuation allowances for thesematters of $3,428 and at February 2, 2008 a valuation allowance of $4,077.

 

UnderFAS 109, the Company is required to project the deferred tax effects of expectedyear-end temporary differences.  Based onthe projections, as of January 31, 2009 the Company will not have anyfederal net operating loss carryforwards, and will have $71,728 of state netoperating loss carryforwards and $1,331 of Puerto Rico net operating losscarryforwards.  As of February 2,2008, the Company had $46,716 of federal net operating loss carryforwards,$180,411 of state net operating loss carryforwards and $768 of Puerto Rico netoperating loss carryforwards.  The statenet operating loss carryforwards will expire in various years beginning in 2008and the Puerto Rico net operating loss carryforwards will expire in variousyears beginning in 2014.

 

9

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NOTE 7. Discontinued Operations

 

In the third quarter of fiscal 2007, the Companyadopted its long-term strategic plan. One of the initial steps in this plan wasthe identification of 31 low-return stores for closure. The Company isaccounting for these store closures in accordance with the provisions of SFAS No. 146“Accounting for Costs Associated with Exit or Disposal Activities” and SFAS No. 144“Accounting for Impairment or Disposal of Long-Lived Assets.” In accordancewith SFAS No. 144, discontinued operations for all periods presented reflectthe operating results for 11 of the 31 closed stores because the Company doesnot believe that the customers of these stores are likely to become customersof other Pep Boys stores due to geographical considerations. The operatingresults for the other 20 closed stores are included in continuing operationsbecause the Company believes that the customers of these stores are likely tobecome customers of other Pep Boys stores that are in close proximity.  Below is a summary of these stores’operations for the thirteen weeks ended May 3, 2008 and May 5, 2007:

 
| ** **                                                     | ** ** | **Thirteen Weeks Ended** | ** ** |
|----------------------------------------------------------------|------------|------------------------------------|------------|
| **(dollar amounts in thousands)**               | ** ** | **May 3, 2008**          | ** ** | **May 5, 2007** | ** ** |
|                                                           |       |                               |       |   |   |
| Revenues in discontinued operations                            |       |                               |       |   |   |
| Merchandise Sales                                              |       | $                                  | —     |   | $ | 5,241 |   |
| Service Revenue                                                |       | —                             |       | 1,189 |   |
| Total revenues, discontinued operations                        |       | $                                  | —     |   | $ | 6,430 |   |
|                                                           |       |                               |       |   |   |
| (Loss) gain from discontinued operations, before  income taxes |       | $                                  | (988       | ) | $ | 177 |   |

 

Additionally, the Company has classified certainassets as assets held for disposal on its balance sheets.  As of May 3, 2008 and February 2,2008, the net book values of these assets were as follows:

 
| **(dollar amounts in thousands)** | ** ** | **May 3, 2008** | ** ** | **February 2, 2008** | ** ** |
|--------------------------------------------------|------------|---------------------------|------------|--------------------------------|------------|
|                                             |       |                      |       |                           |       |
| Land                                             |       | $                         | 9,976      |                           | $          | 9,976 |   |
| Buildings and  improvements                      |       | 15,479                    |       | 15,805                         |       |
|                                             |       | 25,455                    |       | 25,781                         |       |
| Less accumulated  depreciation and amortization  |       | (8,863                    | )          | (8,863                         | )          |
| Assets held for  disposal                        |       | $                         | 16,592     |                           | $          | 16,918 |   |

 

None of the stores closed during fiscal 2007have been sold as of May 3, 2008 and, accordingly, all remain in assetsheld for disposal.

 

The following details the reserve balances as ofMay 3, 2008.  The reserve includesremaining rent on leases net of sublease income, other contractual obligationsassociated with leased properties and employee severance.

 
| **(dollar amount in thousands)**                                                                | ** ** | **Severance** | ** ** | **Lease  Expenses** | ** ** | **Other Costs and  Contractual Obligations** | ** ** | **Total** | ** ** |
|----------------------------------------------------------------------------------------------------------------|------------|---------------|------------|---------------------|------------|-------------------------------------------------------------|------------|-----------|------------|
| Balance at  February 2, 2008                                                                              | ** ** | **$**         | **58**     | ** **          | **$**      | **3,574**                                                   | ** ** | **$**     | **109**    | ** ** | **$** | **3,741** | ** ** |
| Provision for  present value of liabilities                                                                    |       | —        |       | 191                 |       | —                                                      |       | 191       |       |
| Change in  assumptions about future sublease income, lease termination, contractual  obligations and severance |       | —        |       | 244                 |       | —                                                      |       | 244       |       |
| Cash payments                                                                                                  |       | (58           | )          | (756                | )          | —                                                      |       | (814      | )          |
| Balance at  May 3, 2008                                                                                   | ** ** | **$**         | **—** | ** **          | **$**      | **3,253**                                                   | ** ** | **$**     | **109**    | ** ** | **$** | **3,362** | ** ** |

 

10

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NOTE 8. Pension and Savings Plan

 

Pension expense includes the following:

 
| ** **                                       | ** ** | **Thirteen weeks ended** | ** ** |
|--------------------------------------------------|------------|------------------------------------|------------|
| **(dollar amounts in thousands)** | ** ** | **May 3, 2008**          | ** ** | **May 5, 2007** | ** ** |
|                                             |       |                               |       |   |   |
| Service cost                                     |       | $                                  | 43         |   | $ | 51 |   |
| Interest cost                                    |       | 885                                |       | 836 |   |
| Expected return on plan assets                   |       | (615                               | )          | (587 | ) |
| Amortization of transitional obligation          |       | 41                                 |       | 41 |   |
| Amortization of prior service cost               |       | 92                                 |       | 91 |   |
| Amortization of net loss                         |       | 303                                |       | 488 |   |
| Net periodic benefit cost                        |       | $                                  | 749        |   | $ | 920 |   |

 

The Company has a qualified defined benefitpension plan with accrued benefits frozen at December 31, 1996. TheCompany makes contributions to this plan in accordance with the requirements ofERISA. The Company does not anticipate making a contribution to this planduring fiscal 2008.

 

The Company has an unfunded, non-qualifiedExecutive Supplemental Retirement Plan (SERP) defined benefit plan that wasclosed to new participants on January 31, 2004. As of May 3, 2008,the Company contributed $654 of an anticipated $2,865 contribution duringfiscal 2008 to this plan.

 

The Company has a non-qualified SERP definedcontribution plan for key employees who were designated by the Board ofDirectors after January 31, 2004. The Company’s contribution expense forthe defined contribution portion of the plan was approximately $105 and $212for the thirteen weeks ended May 3, 2008, and May 5, 2007,respectively.

 

The Company has two 401(k) savings plans,which cover all full-time employees who are at least 21 years of age with oneor more years of service. The Company contributes the lesser of 50% of thefirst 6% of a participant’s contributions or 3% of the participant’scompensation. The Company’s savings plans’ contribution expense wasapproximately $1,052 and $976 for the thirteen weeks ended May 3, 2008 andMay 5, 2007, respectively.

 

NOTE 9. Sale-Leaseback

 

On March 25, 2008, the Company sold 18owned properties to an independent third party. Net proceeds from this salewere $62,542. Concurrent with the sale, the Company entered into agreements tolease the properties back from the purchaser over a minimum lease term of15 years. The Company classified these leases as operating leases. The twomaster leases have an initial term of 15 years with four five-year renewaloptions. The leases have yearly incremental rental increases that are 1.5% ofthe prior years rentals.  These leasesresult in approximately $82,000 in future minimum rental payments during theinitial non-cancelable lease term. The second through the fourth renewaloptions are at fair market rents. A $9 gain on the sale of these properties wasrecognized immediately upon execution of the sale and a $26,809 gain wasdeferred. The deferred gain is being recognized over 15 years.

 

On April 10, 2008, the Company sold 23owned properties to an independent third party. Net proceeds from this salewere $72,977. Concurrent with the sale, the Company entered into agreements tolease the properties back from the purchaser over a minimum lease term of15 years. The Company classified 22 of these leases as operating leases.The leases have an initial term of 15 years with four five-year renewaloptions. The leases have yearly incremental rental increases that are 1.5% ofthe prior years rentals. These leases result in approximately $92,000 in futureminimum rental payments during the initial non-cancelable lease term. Thesecond through the fourth renewal options are at fair market rents. A $5,522gain on the sale of these properties was recognized immediately upon executionof the sale and a $34,483 gain was deferred. The deferred gain is being recognizedover 15 years. The Company has continuing involvement in one property and hasrecorded the $4,583 proceeds, net of execution costs, included in the totalproceeds of $72,977, as a debt borrowing and as a financing activity in theStatement of Cash Flows. Accordingly, the Company continues to reflect theproperty on its balance sheet in accordance with Statement of FinancialAccounting Standards No. 13, “Accounting for Leases.”

 

During the first quarter of fiscal 2008, theCompany recognized $1,338 in Cost of Merchandise Sales and $487 in Costs ofService Revenue of the deferred gain generated from sale-leasebacktransactions.

 

Of the 562 store locations operated by theCompany at May 3, 2008, 234 are owned and 328 are leased.

 

11

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NOTE 10. Debt and Financing Arrangements

 
| **(dollar amounts in thousands)**                              | ** ** | **May 3, 2008** | ** ** | **February 2,  2008** | ** ** |
|-------------------------------------------------------------------------------|------------|---------------------------|------------|----------------------------|------------|
| 7.50% Senior Subordinated Notes, due  December 2014                      |       | $                         | 179,035    |                       | $          | 200,000 |   |
| Senior Secured Term Loan, due  October 2013                              |       | 154,261                   |       | 154,652                    |       |
| Other notes payable, 8.0%                                                     |       | —                    |       | 248                        |       |
| Lease financing obligations, payable  through October 2022               |       | 9,328                     |       | 4,786                      |       |
| Capital lease obligations payable through  October 2009                  |       | 349                       |       | 399                        |       |
| Line of credit agreement, through  December 2009                         |       | 622                       |       | 42,045                     |       |
|                                                                          |       | 343,595                   |       | 402,130                    |       |
| Less current maturities                                                       |       | 2,278                     |       | 2,114                      |       |
| Long-term debt and obligations under  capital leases, less current maturities |       | $                         | 341,317    |                       | $          | 400,016 |   |

 

On February 15, 2007, the Company amendedits Senior Secured Term Loan to reduce the interest rate from London InterbankOffered Rate (LIBOR) plus 2.75% to LIBOR plus 2.00%.

 

The Company used the proceeds from its March 25,2008 sale-leaseback transaction to repay $49,915 then drawn on the line ofcredit and to repurchase $20,965 principal amount of 7.50% Senior SubordinatedNotes for $18,082.  The gain onretirement of debt is included in interest expense.

 

The Company used the proceeds from its April 10,2008 sale-leaseback transaction to purchase $66,739 in short-term securities,classified as cash and cash equivalents.

 

As part of the April 10, 2008sale-leaseback transaction, the Company determined that it has continuinginvolvement in one property and has recorded the $4,583 proceeds, net ofexecution costs, as a debt borrowing and continues to reflect the property onits balance sheet in accordance with Statement of Financial AccountingStandards No. 13, “Accounting for Leases.”

 

The Company had $184,918 of availability underthe line of credit agreement on May 3, 2008.

 

On May 9, 2008, the Company repurchased$4,500 principal amount of its 7.50% Senior Subordinated Notes for $4,058.

 

NOTE 11. Warranty Reserve

 

The Company provides warranties for both itsmerchandise sales and service labor. Warranties for merchandise are generallycovered by the respective vendors, with the Company covering any costs abovethe vendor’s stipulated allowance. Service labor warranties are covered in fullby the Company on a limited lifetime basis. The Company establishes itswarranty reserves based on historical data of warranty transactions.

 

Components of the reserve for warranty costs forthe thirteen-week period ended May 3, 2008 and May 5, 2007 were asfollows:

 
| ** **                                       | ** ** | **13 Weeks Ended** | ** ** | **13 Weeks Ended** | ** ** |
|--------------------------------------------------|------------|------------------------------|------------|------------------------------|------------|
| **(dollar amounts in thousands)** | ** ** | **May 3, 2008**    | ** ** | **May 5, 2007**    | ** ** |
| Beginning Balance                                |       | $                            | 247        |                         | $          | 645 |   |
|                                             |       |                         |       |                         |       |
| Additions related to current period sales        |       | 2,230                        |       | 2,576                        |       |
|                                             |       |                         |       |                         |       |
| Warranty costs incurred in current period        |       | (2,013                       | )          | (2,750                       | )          |
|                                             |       |                         |       |                         |       |
| Ending Balance                                   |       | $                            | 464        |                         | $          | 471 |   |

 

12

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NOTE12.  Earnings Per Share

 
| ** **                                                  | ** **                                                                                                                     | ** **                  | **Thirteen Weeks Ended** | ** **                  |
|-------------------------------------------------------------|--------------------------------------------------------------------------------------------------------------------------------|-----------------------------|------------------------------------|-----------------------------|
| **(dollar amounts in thousands, except per share amounts)** | ** **                                                                                                                     | **May 3,********2008** | ** **                         | **May 5,********2007** | ** ** |
| *** ***                                                | *** ***                                                                                                                   | *** ***                | *** ***                       | *** ***                | *** *** | *** *** |
| (a)                                                         | Net Earnings From Continuing Operations                                                                                        |                        | $                                  | 5,291                       |   | $ | 3,051 |   |
|                                                        |                                                                                                                           |                        |                               |                        |   |   |
|                                                        | Discontinued Operations, Net of Tax                                                                                            |                        | (619                               | )                           | 124 |   |
|                                                        |                                                                                                                           |                        |                               |                        |   |   |
|                                                        | Net Income                                                                                                                     |                        | $                                  | 4,672                       |   | $ | 3,175 |   |
|                                                        |                                                                                                                           |                        |                               |                        |   |   |
| (b)                                                         | Basic average number of common shares  outstanding during period                                                               |                        | 52,063                             |                        | 53,122 |   |
|                                                        |                                                                                                                           |                        |                               |                        |   |   |
|                                                        | Common shares assumed issued upon exercise  of dilutive stock options, net of assumed repurchase, at the average market  price |                        | 107                                |                        | 512 |   |
|                                                        |                                                                                                                           |                        |                               |                        |   |   |
| (c)                                                         | Diluted average number of common shares  assumed outstanding during period                                                     |                        | 52,170                             |                        | 53,634 |   |
|                                                        |                                                                                                                           |                        |                               |                        |   |   |
| ** **                                                  | **Basic Earnings per Share:**                                                                                                  | ** **                  | ** **                         | ** **                  | ** ** | ** ** |
|                                                        | Net Earnings From Continuing Operations  (a/b)                                                                                 |                        | $                                  | 0.10                        |   | $ | 0.06 |   |
|                                                        | Discontinued Operations, Net of Tax                                                                                            |                        | (0.01                              | )                           | — |   |
|                                                        | Basic Earnings per Share                                                                                                       |                        | $                                  | 0.09                        |   | $ | 0.06 |   |
| ** **                                                  | ** **                                                                                                                     | ** **                  | ** **                         | ** **                  | ** ** | ** ** |
| ** **                                                  | **Diluted Earnings per Share:**                                                                                                | ** **                  | ** **                         | ** **                  | ** ** | ** ** |
|                                                        | Net Earnings From Continuing Operations  (a/c)                                                                                 |                        | $                                  | 0.10                        |   | $ | 0.06 |   |
|                                                        | Discontinued Operations, Net of Tax                                                                                            |                        | (0.01                              | )                           | — |   |
|                                                        | Diluted Earnings per Share                                                                                                     |                        | $                                  | 0.09                        |   | $ | 0.06 |   |

 

AtMay 3, 2008 and May 5, 2007, respectively, there were 2,210,000 and3,363,000 outstanding options and restricted stock units. Certain stock optionswere excluded from the calculation of diluted earnings per share because theirexercise prices were greater than the average market price of the common sharesfor the periods then ended and therefore would be anti-dilutive. The totalnumbers of such shares excluded from the diluted earnings per share calculationare 1,729,000 and 1,138,000 for the thirteen weeks ended May 3, 2008 and May 5,2007, respectively.

 

13

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NOTE13. Supplemental Guarantor Information

 

The Company’s 7.50% Senior Subordinated Notes (the “Notes”) are fullyand unconditionally and joint and severally guaranteed by certain of theCompany’s direct and indirectly wholly-owned subsidiaries - namely, The PepBoys Manny Moe & Jack of California, Pep Boys - Manny, Moe &Jack of Delaware, Inc., Pep Boys — Manny, Moe & Jack of PuertoRico, Inc. and PBY Corporation, (collectively, the “Subsidiary Guarantors”).The Notes are not guaranteed by the Company’s wholly owned subsidiary,Colchester Insurance Company.

 

 Thefollowing condensed consolidating information presents, in separate columns,the condensed consolidating balance sheets as of May 3, 2008 and February 2,2008 and the related condensed consolidating statements of operations and condensedconsolidating statements of cash flows for the thirteen weeks ended May 3,2008 and May 5, 2007 for (i) the Company (“Pep Boys”) on a parentonly basis, with its investment in subsidiaries recorded under the equitymethod, (ii) the Subsidiary Guarantors on a combined basis including theconsolidation by PBY Corporation of its wholly owned subsidiary, The Pep BoysManny Moe & Jack of California, (iii) the subsidiary of theCompany that does not guarantee the Notes, and (iv) the Company on aconsolidated basis.

 

14

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CONDENSED CONSOLIDATING BALANCE SHEET

(dollars in thousands)

(unaudited)

 
| **As of May 3, 2008**                                     | ** ** | **Pep Boys** | ** ** | **Subsidiary  Guarantors** | ** ** | **Subsidiary Non-  Guarantors** | ** ** | **Consolidation /  Elimination** | ** ** | **Consolidated** | ** ** |
|-------------------------------------------------------------------------------|------------|-------------------|------------|----------------------------|------------|--------------------------------------|------------|---------------------------------------|------------|------------------|------------|
| **ASSETS**                                                                    |       |              |       |                       |       |                                 |       |                                  |       |             |       |
| Current Assets:                                                               |       |              |       |                       |       |                                 |       |                                  |       |             |       |
| Cash and cash  equivalents                                                    |       | $                 | 77,568     |                       | $          | 7,411                                |       | $                                     | 2,298      |             | $          | — |   | $ | 87,277 |   |
| Accounts  receivable, net                                                     |       | 16,003            |       | 14,723                     |       | —                               |       | —                                |       | 30,726           |       |
| Merchandise  inventories                                                      |       | 191,345           |       | 370,094                    |       | —                               |       | —                                |       | 561,439          |       |
| Prepaid expenses                                                              |       | 25,807            |       | 13,013                     |       | 14,111                               |       | (13,330                               | )          | 39,601           |       |
| Other                                                                         |       | 12,829            |       | 10                         |       | 65,489                               |       | (12,917                               | )          | 65,411           |       |
| Assets held for  sale                                                         |       | 4,989             |       | 11,603                     |       | —                               |       | —                                |       | 16,592           |       |
| Total Current  Assets                                                         |       | 328,541           |       | 416,854                    |       | 81,898                               |       | (26,247                               | )          | 801,046          |       |
|                                                                          |       |              |       |                       |       |                                 |       |                                  |       |             |       |
| Property and  Equipment—Net of accumulated depreciation and amortization |       | 234,559           |       | 458,222                    |       | 32,737                               |       | (19,961                               | )          | 705,557          |       |
| Investment in  subsidiaries                                                   |       | 1,664,863         |       | —                     |       | —                               |       | (1,664,863                            | )          | —           |       |
| Intercompany  receivable                                                      |       | —            |       | 971,432                    |       | 77,305                               |       | (1,048,737                            | )          | —           |       |
| Deferred income  taxes                                                        |       | 3,605             |       | 23,727                     |       | —                               |       | —                                |       | 27,332           |       |
| Other                                                                         |       | 30,158            |       | 598                        |       | —                               |       | —                                |       | 30,756           |       |
| Total Assets                                                                  |       | $                 | 2,261,726  |                       | $          | 1,870,833                            |       | $                                     | 191,940    |             | $          | (2,759,808 | ) | $ | 1,564,691 |   |
| **LIABILITIES  AND STOCKHOLDERS’ EQUITY**                                | ** ** | ** **        | ** ** | ** **                 | ** ** | ** **                           | ** ** | ** **                            | ** ** | ** **       | ** ** |
| Current  Liabilities:                                                         |       |              |       |                       |       |                                 |       |                                  |       |             |       |
| Accounts payable                                                              |       | $                 | 230,176    |                       | $          | 9                                    |       | $                                     | —     |             | $          | — |   | $ | 230,185 |   |
| Trade payable  program liability                                              |       | 19,020            |       | —                     |       | —                               |       | —                                |       | 19,020           |       |
| Accrued expenses                                                              |       | 51,798            |       | 85,918                     |       | 170,853                              |       | (26,247                               | )          | 282,322          |       |
| Current  maturities of long-term debt and obligations under capital leases    |       | 2,039             |       | 239                        |       | —                               |       | —                                |       | 2,278            |       |
| Total Current  Liabilities                                                    |       | 303,033           |       | 86,166                     |       | 170,853                              |       | (26,247                               | )          | 533,805          |       |
| Long-term debt  and obligations under capital leases, less current maturities |       | 336,454           |       | 4,863                      |       | —                               |       | —                                |       | 341,317          |       |
| Other long-term  liabilities                                                  |       | 35,553            |       | 34,479                     |       | —                               |       | —                                |       | 70,032           |       |
| Deferred gain  from asset sales                                               |       | 64,474            |       | 101,549                    |       | —                               |       | (19,961                               | )          | 146,062          |       |
| Intercompany  liabilities                                                     |       | 1,048,737         |       | —                     |       | —                               |       | (1,048,737                            | )          | —           |       |
| Stockholders’  Equity                                                    |       | 473,475           |       | 1,643,776                  |       | 21,087                               |       | (1,664,863                            | )          | 473,475          |       |
| Total Liabilities  and Stockholders’ Equity                              |       | $                 | 2,261,726  |                       | $          | 1,870,833                            |       | $                                     | 191,940    |             | $          | (2,759,808 | ) | $ | 1,564,691 |   |

 

15

----

 

CONDENSED CONSOLIDATING BALANCE SHEET

(dollars in thousands)

 
| **As of February 2, 2008**                                | ** ** | **Pep Boys** | ** ** | **Subsidiary  Guarantors** | ** ** | **Subsidiary  Non-  Guarantors** | ** ** | **Consolidation /  Elimination** | ** ** | **Consolidated** | ** ** |
|-------------------------------------------------------------------------------|------------|-------------------|------------|----------------------------|------------|----------------------------------|------------|---------------------------------------|------------|------------------|------------|
| **ASSETS**                                                                    | ** ** | ** **        | ** ** | ** **                 | ** ** | ** **                       | ** ** | ** **                            | ** ** | ** **       | ** ** |
| Current Assets:                                                               |       |              |       |                       |       |                             |       |                                  |       |             |       |
| Cash and cash equivalents                                                     |       | $                 | 12,208     |                       | $          | 6,655                            |       | $                                     | 2,063      |             | $          | — |   | $ | 20,926 |   |
| Accounts receivable, net                                                      |       | 15,580            |       | 13,854                     |       | 16                               |       | —                                |       | 29,450           |       |
| Merchandise inventories                                                       |       | 198,975           |       | 362,177                    |       | —                           |       | —                                |       | 561,152          |       |
| Prepaid expenses                                                              |       | 21,368            |       | 17,938                     |       | 18,655                           |       | (14,119                               | )          | 43,842           |       |
| Other                                                                         |       | 21,272            |       | 15                         |       | 69,323                           |       | (13,141                               | )          | 77,469           |       |
| Assets held for disposal                                                      |       | 4,991             |       | 11,927                     |       | —                           |       | —                                |       | 16,918           |       |
| Total Current Assets                                                          |       | 274,394           |       | 412,566                    |       | 90,057                           |       | (27,260                               | )          | 749,757          |       |
|                                                                          |       |              |       |                       |       |                             |       |                                  |       |             |       |
| Property and Equipment—Net of accumulated  depreciation and amortization |       | 258,527           |       | 509,398                    |       | 32,908                           |       | (20,054                               | )          | 780,779          |       |
| Investment in subsidiaries                                                    |       | 1,646,349         |       | —                     |       | —                           |       | (1,646,349                            | )          | —           |       |
| Intercompany receivable                                                       |       | —            |       | 888,352                    |       | 81,833                           |       | (970,185                              | )          | —           |       |
| Deferred income taxes                                                         |       | 1,403             |       | 19,372                     |       | —                           |       | —                                |       | 20,775           |       |
| Other                                                                         |       | 31,638            |       | 971                        |       | —                           |       | —                                |       | 32,609           |       |
| Total Assets                                                                  |       | $                 | 2,212,311  |                       | $          | 1,830,659                        |       | $                                     | 204,798    |             | $          | (2,663,848 | ) | $ | 1,583,920 |   |
| **LIABILITIES AND STOCKHOLDERS’ EQUITY**                                 | ** ** | ** **        | ** ** | ** **                 | ** ** | ** **                       | ** ** | ** **                            | ** ** | ** **       | ** ** |
| Current Liabilities:                                                          |       |              |       |                       |       |                             |       |                                  |       |             |       |
| Accounts payable                                                              |       | $                 | 245,414    |                       | $          | 9                                |       | $                                     | —     |             | $          | — |   | $ | 245,423 |   |
| Trade payable program liability                                               |       | 14,254            |       | —                     |       | —                           |       | —                                |       | 14,254           |       |
| Accrued expenses                                                              |       | 57,320            |       | 70,486                     |       | 183,910                          |       | (19,093                               | )          | 292,623          |       |
| Deferred income taxes                                                         |       | —            |       | 8,167                      |       | —                           |       | (8,167                                | )          | —           |       |
| Current maturities of long-term debt and  obligations under capital leases    |       | 1,843             |       | 271                        |       | —                           |       | —                                |       | 2,114            |       |
| Total Current Liabilities                                                     |       | 318,831           |       | 78,933                     |       | 183,910                          |       | (27,260                               | )          | 554,414          |       |
| Long-term debt and obligations under  capital leases, less current maturities |       | 369,657           |       | 30,359                     |       | —                           |       | —                                |       | 400,016          |       |
| Other long-term liabilities                                                   |       | 38,109            |       | 34,074                     |       | —                           |       | —                                |       | 72,183           |       |
| Deferred gain on sale of assets                                               |       | 44,817            |       | 61,832                     |       | —                           |       | (20,054                               | )          | 86,595           |       |
| Intercompany liabilities                                                      |       | 970,185           |       | —                     |       | —                           |       | (970,185                              | )          | —           |       |
| Stockholders’ Equity                                                     |       | 470,712           |       | 1,625,461                  |       | 20,888                           |       | (1,646,349                            | )          | 470,712          |       |
| Total Liabilities and Stockholders’ Equity                               |       | $                 | 2,212,311  |                       | $          | 1,830,659                        |       | $                                     | 204,798    |             | $          | (2,663,848 | ) | $ | 1,583,920 |   |

 

16

----

 

CONDENSED CONSOLIDATING STATEMENT OF OPERATIONS

(dollars in thousands)

(unaudited)

 
| **Thirteen weeks ended May 3, 2008**             | ** ** | **Pep Boys** | ** ** | **Subsidiary  Guarantors** | ** ** | **Subsidiary  Non-Guarantors** | ** ** | **Consolidation /  Elimination** | ** ** | **Consolidated** | ** ** |
|-----------------------------------------------------------------|------------|-------------------|------------|----------------------------|------------|--------------------------------|------------|---------------------------------------|------------|------------------|------------|
|                                                            |       |              |       |                       |       |                           |       |                                  |       |             |       |
| Merchandise Sales                                               |       | $                 | 138,613    |                       | $          | 264,721                        |       | $                                     | —     |             | $          | — |   | $ | 403,334 |   |
| Service Revenue                                                 |       | 33,373            |       | 61,336                     |       | —                         |       | —                                |       | 94,709           |       |
| Other Revenue                                                   |       | —            |       | —                     |       | 5,667                          |       | (5,667                                | )          | —           |       |
| Total Revenues                                                  |       | 171,986           |       | 326,057                    |       | 5,667                          |       | (5,667                                | )          | 498,043          |       |
| Costs of Merchandise Sales                                      |       | 98,334            |       | 187,997                    |       | —                         |       | (408                                  | )          | 285,923          |       |
| Costs of Service Revenue                                        |       | 28,614            |       | 55,578                     |       | —                         |       | (38                                   | )          | 84,154           |       |
| Costs of Other Revenue                                          |       | —            |       | —                     |       | 5,806                          |       | (5,806                                | )          | —           |       |
| Total Costs of Revenues                                         |       | 126,948           |       | 243,575                    |       | 5,806                          |       | (6,252                                | )          | 370,077          |       |
| Gross Profit from Merchandise Sales                             |       | 40,279            |       | 76,724                     |       | —                         |       | 408                                   |       | 117,411          |       |
| Gross Profit from Service Revenue                               |       | 4,759             |       | 5,758                      |       | —                         |       | 38                                    |       | 10,555           |       |
| Gross Loss from Other Revenue                                   |       | —            |       | —                     |       | (139                           | )          | 139                                   |       | —           |       |
| Total Gross Profit (Loss)                                       |       | 45,038            |       | 82,482                     |       | (139                           | )          | 585                                   |       | 127,966          |       |
| Selling, General and Administrative  Expenses                   |       | 42,453            |       | 76,504                     |       | 90                             |       | (32                                   | )          | 119,015          |       |
| Net Gain from Dispositions of Assets                            |       | 556               |       | 4,975                      |       | —                         |       | —                                |       | 5,531            |       |
| Operating Profit (Loss)                                         |       | 3,141             |       | 10,953                     |       | (229                           | )          | 617                                   |       | 14,482           |       |
| Non-Operating (Expense) Income                                  |       | (4,104            | )          | 28,475                     |       | 648                            |       | (24,689                               | )          | 330              |       |
| Interest Expense (Income)                                       |       | 23,836            |       | 6,710                      |       | (1,047                         | )          | (24,072                               | )          | 5,427            |       |
| (Loss) Earnings from Continuing Operations  Before Income Taxes |       | (24,799           | )          | 32,718                     |       | 1,466                          |       | —                                |       | 9,385            |       |
| Income Tax (Benefit) Expense                                    |       | (10,473           | )          | 13,917                     |       | 650                            |       |                                  |       | 4,094            |       |
| Equity in Earnings of Subsidiaries                              |       | 19,131            |       | —                     |       | —                         |       | (19,131                               | )          | —           |       |
| Net Earnings from Continuing Operations                         |       | 4,805             |       | 18,801                     |       | 816                            |       | (19,131                               | )          | 5,291            |       |
| Loss From Discontinued Operations, Net of  Tax                  |       | (133              | )          | (486                       | )          | —                         |       | —                                |       | (619             | )          |
| Net Earnings                                                    |       | $                 | 4,672      |                       | $          | 18,315                         |       | $                                     | 816        |             | $          | (19,131 | ) | $ | 4,672 |   |

 

17

----

 

CONDENSED CONSOLIDATING STATEMENT OF OPERATIONS

(dollars in thousands)

(unaudited)

 
| **Thirteen weeks ended May 5, 2007**   | ** ** | **Pep Boys** | ** ** | **Subsidiary  Guarantors** | ** ** | **Subsidiary  Non-  Guarantors** | ** ** | **Consolidation /  Elimination** | ** ** | **Consolidated** | ** ** |
|-----------------------------------------------------------------|------------|-------------------|------------|----------------------------|------------|----------------------------------|------------|---------------------------------------|------------|------------------|------------|
|                                                            |       |              |       |                       |       |                             |       |                                  |       |             |       |
| Merchandise Sales                                               |       | $                 | 152,591    |                       | $          | 287,203                          |       | $                                     | —     |             | $          | — |   | $ | 439,794 |   |
| Service Revenue                                                 |       | 35,147            |       | 64,642                     |       | —                           |       | —                                |       | 99,789           |       |
| Other Revenue                                                   |       | —            |       | —                     |       | 6,260                            |       | (6,260                                | )          | —           |       |
| Total Revenues                                                  |       | 187,738           |       | 351,845                    |       | 6,260                            |       | (6,260                                | )          | 539,583          |       |
| Costs of Merchandise Sales                                      |       | 108,283           |       | 203,247                    |       | —                           |       | —                                |       | 311,530          |       |
| Costs of Service Revenue                                        |       | 29,681            |       | 57,783                     |       | —                           |       | —                                |       | 87,464           |       |
| Costs of Other Revenue                                          |       | —            |       | —                     |       | 5,566                            |       | (5,566                                | )          | —           |       |
| Total Costs of Revenues                                         |       | 137,964           |       | 261,030                    |       | 5,566                            |       | (5,566                                | )          | 398,994          |       |
| Gross Profit from Merchandise Sales                             |       | 44,308            |       | 83,956                     |       | —                           |       | —                                |       | 128,264          |       |
| Gross Profit from Service Revenue                               |       | 5,466             |       | 6,859                      |       | —                           |       | —                                |       | 12,325           |       |
| Gross Profit from Other Revenue                                 |       | —            |       | —                     |       | 694                              |       | (694                                  | )          | —           |       |
| Total Gross Profit                                              |       | 49,774            |       | 90,815                     |       | 694                              |       | (694                                  | )          | 140,589          |       |
| Selling, General and Administrative  Expenses                   |       | 41,974            |       | 85,982                     |       | 86                               |       | (932                                  | )          | 127,110          |       |
| Net Gain (Loss) from Dispositions of Assets                     |       | 2,367             |       | (8                         | )          | —                           |       | —                                |       | 2,359            |       |
| Operating Profit                                                |       | 10,167            |       | 4,825                      |       | 608                              |       | 238                                   |       | 15,838           |       |
| Non-Operating (Expense) Income                                  |       | (3,901            | )          | 33,719                     |       | 640                              |       | (28,553                               | )          | 1,905            |       |
| Interest Expense (Income)                                       |       | 31,913            |       | 10,383                     |       | (1,325                           | )          | (28,315                               | )          | 12,656           |       |
| (Loss) Earnings from Continuing Operations  Before Income Taxes |       | (25,647           | )          | 28,161                     |       | 2,573                            |       | —                                |       | 5,087            |       |
| Income Tax (Benefit) Expense                                    |       | (18,650           | )          | 19,665                     |       | 1,021                            |       | —                                |       | 2,036            |       |
| Equity in Earnings of Subsidiaries                              |       | 10,145            |       | —                     |       | —                           |       | (10,145                               | )          | —           |       |
| Net Earnings from Continuing Operations                         |       | 3,148             |       | 8,496                      |       | 1,552                            |       | (10,145                               | )          | 3,051            |       |
| Income From Discontinued Operations, Net of  Tax                |       | 27                |       | 97                         |       | —                           |       | —                                |       | 124              |       |
| Net Earnings                                                    |       | $                 | 3,175      |                       | $          | 8,593                            |       | $                                     | 1,552      |             | $          | (10,145 | ) | $ | 3,175 |   |

 

18

----

 

CONDENSED CONSOLIDATING STATEMENT OF CASH FLOWS

(dollars in thousands)

(unaudited)

 
| **Thirteen weeks ended May 3, 2008**                                         | ** ** | **Pep Boys** | ** ** | **Subsidiary  Guarantors** | ** ** | **Subsidiary  Non-  Guarantors** | ** ** | **Consolidation /  Elimination** | ** ** | **Consolidated** | ** ** |
|-------------------------------------------------------------------------------------------------------|------------|-------------------|------------|----------------------------|------------|----------------------------------|------------|---------------------------------------|------------|------------------|------------|
| **Cash  Flows from Operating Activities:**                                                            |       |              |       |                       |       |                             |       |                                  |       |             |       |
| Net Earnings                                                                                          |       | $                 | 4,672      |                       | $          | 18,315                           |       | $                                     | 816        |             | $          | (19,131 | ) | $ | 4,672 |   |
|                                                                                                  |       |              |       |                       |       |                             |       |                                  |       |             |       |   |   |   |   |   |
| Adjustments to  Reconcile Net Earnings to Net Cash (Used in) Provided by Continuing  Operations: |       | (12,417           | )          | 7,291                      |       | 281                              |       | 18,514                                |       | 13,669           |       |
| Changes in  operating assets and liabilities                                                          |       | (16,535           | )          | (1,306                     | )          | (4,773                           | )          | —                                |       | (22,614          | )          |
|                                                                                                  |       |              |       |                       |       |                             |       |                                  |       |             |       |
| Net cash (used  in) provided by continuing operations                                                 |       | (24,280           | )          | 24,300                     |       | (3,676                           | )          | (617                                  | )          | (4,273           | )          |
|                                                                                                  |       |              |       |                       |       |                             |       |                                  |       |             |       |
| Net cash (used  in) provided by discontinued operations                                               |       | (70               | )          | 12                         |       | —                           |       | —                                |       | (58              | )          |
|                                                                                                  |       |              |       |                       |       |                             |       |                                  |       |             |       |
| Net Cash (Used  in) Provided by Operating Activities                                                  |       | (24,350           | )          | 24,312                     |       | (3,676                           | )          | (617                                  | )          | (4,331           | )          |
|                                                                                                  |       |              |       |                       |       |                             |       |                                  |       |             |       |
| Net Cash Provided  by Investing Activities                                                            |       | 39,255            |       | 85,893                     |       | —                           |       | —                                |       | 125,148          |       |
|                                                                                                  |       |              |       |                       |       |                             |       |                                  |       |             |       |
| Net Cash Provided  by (Used in) Financing Activities                                                  |       | 50,455            |       | (109,449                   | )          | 3,911                            |       | 617                                   |       | (54,466          | )          |
| Net Increase in  Cash and Cash Equivalents                                                            |       | 65,360            |       | 756                        |       | 235                              |       | —                                |       | 66,351           |       |
| Cash and Cash  Equivalents at Beginning of Year                                                       |       | 12,208            |       | 6,655                      |       | 2,063                            |       | —                                |       | 20,926           |       |
| Cash and Cash  Equivalents at End of Year                                                             |       | $                 | 77,568     |                       | $          | 7,411                            |       | $                                     | 2,298      |             | $          | — |   | $ | 87,277 |   |

 

CONDENSED CONSOLIDATING STATEMENT OF CASH FLOWS

(dollars in thousands)

(unaudited)

 
| **Thirteen weeks ended May 5, 2007**                                         | ** ** | **Pep Boys** | ** ** | **Subsidiary  Guarantors** | ** ** | **Subsidiary  Non-Guarantors** | ** ** | **Consolidation /  Elimination** | ** ** | **Consolidated** | ** ** |
|-------------------------------------------------------------------------------------------------------|------------|-------------------|------------|----------------------------|------------|--------------------------------|------------|---------------------------------------|------------|------------------|------------|
| **Cash  Flows from Operating Activities:**                                                            |       |              |       |                       |       |                           |       |                                  |       |             |       |
| Net Earnings                                                                                          |       | $                 | 3,175      |                       | $          | 8,593                          |       | $                                     | 1,552      |             | $          | (10,145 | ) | $ | 3,175 |   |
| Adjustments to  Reconcile Net Earnings to Net Cash (Used in) Provided By Continuing  Operations: |       | 3,610             |       | 10,478                     |       | 539                            |       | 9,477                                 |       | 24,104           |       |
| Changes in  operating assets and liabilities                                                          |       | (59,878           | )          | 25,513                     |       | (1,079                         | )          | 51                                    |       | (35,393          | )          |
| Net cash (used  in) provided by continuing operations                                                 |       | (53,093           | )          | 44,584                     |       | 1,012                          |       | (617                                  | )          | (8,114           | )          |
| Net cash provided  by discontinued operations                                                         |       | 60                |       | 247                        |       | —                         |       | —                                |       | 307              |       |
| Net Cash (Used  in) Provided by Operating Activities                                                  |       | (53,033           | )          | 44,831                     |       | 1,012                          |       | (617                                  | )          | (7,807           | )          |
|                                                                                                  |       |              |       |                       |       |                           |       |                                  |       |             |       |
| Net Cash Used in  Investing Activities                                                                |       | (1,737            | )          | (9,788                     | )          | —                         |       | —                                |       | (11,525          | )          |
| Net cash used in  discontinued operations                                                             |       | (21               | )          | (64                        | )          | —                         |       | —                                |       | (85              | )          |
| Net Cash Used in  Investing Activities                                                                |       | (1,758            | )          | (9,852                     | )          | —                         |       | —                                |       | (11,610          | )          |
|                                                                                                  |       |              |       |                       |       |                           |       |                                  |       |             |       |
| Net Cash Provided  by (Used in) Financing Activities                                                  |       | 55,196            |       | (29,953                    | )          | 2,454                          |       | 617                                   |       | 28,314           |       |
| Net Increase in  Cash and Cash Equivalents                                                            |       | 405               |       | 5,026                      |       | 3,466                          |       | —                                |       | 8,897            |       |
| Cash and Cash  Equivalents at Beginning of Year                                                       |       | 13,581            |       | 7,946                      |       | 357                            |       | —                                |       | 21,884           |       |
| Cash and Cash  Equivalents at End of Year                                                             |       | $                 | 13,986     |                       | $          | 12,972                         |       | $                                     | 3,823      |             | $          | — |   | $ | 30,781 |   |

 

19

----

 

NOTE 14. Commitments and Contingencies

 

Duringthe fourth quarter of 2006 and the first quarter of 2007, the Company wasserved with four separate lawsuits brought by former associates employed inCalifornia, each of which lawsuits purports to be a class action on behalf ofall current and former California store associates. One or more of the lawsuitsclaim that the plaintiff was not paid for (i) overtime, (ii) accruedvacation time, (iii) all time worked (i.e. “off the clock” work) and/or (iv) lateor missed meal periods or rest breaks. The plaintiffs also allege that theCompany violated certain record keeping requirements arising out of theforegoing alleged violations. The lawsuits (i) claim these allegedpractices are unfair business practices, (ii) request back pay,restitution, penalties, interest and attorney fees and (iii) request thatthe Company be enjoined from committing further unfair business practices.  The initial accrued vacation time claims werefiled in California state court and subsequently removed by the Company toFederal court on jurisdictional grounds. During the third quarter of 2007, the Company reached a settlement inprinciple regarding the accrued vacation time claims, which was subject tocourt approval.  Following the Federalcourt approval hearing on May 5, 2008, the Federal court reversed itsearlier finding of proper Federal jurisdiction and remanded the case back toCalifornia state court.  While theCompany has appealed this ruling, it is also negotiating with the plaintiffs torestructure the previously agreed to settlement in principle for the purpose ofsubmitting such settlement to the California state court for approval.  On May 8, 2008, the Company reached asettlement in principle with respect to the remaining purported class actionclaims, which is subject to court approval.

 

TheCompany is also party to various other actions and claims arising in the normalcourse of business.

 

TheCompany believes that amounts accrued for awards or assessments in connectionwith all such matters, which amounts were increased by $1,900 in the firstquarter of fiscal 2008, are adequate and that the ultimate resolution of thesematters will not have a material adverse effect on the Company’s financialposition.  However, there exists areasonable possibility of loss in excess of the amounts accrued, the amount ofwhich cannot currently be estimated. While the Company does not believe that the amount of such excess losscould be material to the Company’s financial position, any such loss could havea material adverse effect on the Company’s results of operations in the period(s) duringwhich the underlying matters are resolved.

 

TheCompany has a contractual obligation to purchase, on or before August 1,2008, 29 properties that the Company currently rents under a master operatinglease.  The Company believes that the market value of these propertiesexceeds their $116,318 purchase price and is currently evaluating its optionsto fund such purchase through sale-leasebacks or other financing transactions.

 

NOTE 15. Other Comprehensive Income andAccumulated Other Comprehensive Loss

 

Following are the components of comprehensiveincome:

 
| ** **                                       | ** ** | **Thirteen weeks ended** | ** ** |
|--------------------------------------------------|------------|------------------------------------|------------|
| ** **                                       | ** ** | **May 3,**                    | ** ** | **May 5,** | ** ** |
| **(dollar amounts in thousands)** | ** ** | **2008**                           | ** ** | **2007** | ** ** |
|                                             |       |                               |       |   |   |
| Net earnings                                     |       | $                                  | 4,672      |   | $ | 3,175 |   |
|                                             |       |                               |       |   |   |
| Other comprehensive income (loss), net of  tax:  |       |                               |       |   |   |
| Defined benefit plan adjustment                  |       | 274                                |       | — |   |
| Derivative financial instrument adjustments  (1) |       | 1,423                              |       | (916 | ) |
|                                             |       |                               |       |   |   |
| Comprehensive income                             |       | $                                  | 6,369      |   | $ | 2,259 |   |

 

The components of Accumulated OtherComprehensive Loss are:

 
| ** **                                              | ** ** | **May 3,** | ** ** | **February 2,** | ** ** |
|---------------------------------------------------------|------------|-----------------|------------|----------------------|------------|
| **(dollar amounts in thousands)**        | ** ** | **2008**        | ** ** | **2008**             | ** ** |
|                                                    |       |            |       |                 |       |
| Derivative financial instrument adjustment,  net of tax |       | $               | 3,885      |                 | $          | 2,462 |   |
|                                                    |       |            |       |                 |       |
| Defined benefit plan adjustment, net of tax             |       | (16,371         | )          | (16,645              | )          |
|                                                    |       |            |       |                 |       |
| Accumulated Other Comprehensive Loss                    |       | $               | (12,486    | )                    | $          | (14,183 | ) |

 

----

(1)                                Of the net$2,196 increase in fair value during the thirteen weeks ended May 3, 2008,$2,265 ($1,423 net of tax) is included in Accumulated Other Comprehensive Losson the condensed consolidated balance sheet and a $69 expense was recordedthrough the condensed consolidated statement of operations.

 

20

----

 

NOTE 16.  Fair ValueMeasurements

 

The Company adopted SFAS No. 157,(as impacted by FSP Nos. 157-1 and 157-2) effective February 3, 2008, withrespect to fair value measurements of (a) nonfinancial assets andliabilities that are recognized or disclosed at fair value in the Company’sfinancial statements on a recurring basis (at least annually) and (b) allfinancial assets and liabilities.

 

Under SFAS No. 157,fair value is defined as the exit price, or the amount that would be receivedto sell an asset or paid to transfer a liability in an orderly transactionbetween market participants as of the measurement date. SFAS No. 157 alsoestablishes a hierarchy for inputs used in measuring fair value that maximizesthe use of observable inputs and minimizes the use of unobservable inputs byrequiring that the most observable inputs be used when available. Observableinputs are inputs market participants would use in valuing the asset orliability developed based on market data obtained from sources independent ofthe Company. Unobservable inputs are inputs that reflect the Company’sassumptions about the factors market participants would use in valuing theasset or liability developed based upon the best information available in thecircumstances. The hierarchy is broken down into three levels. Level 1 inputsare quoted prices (unadjusted) in active markets for identical assets orliabilities. Level 2 inputs include quoted prices for similar assets orliabilities in active markets, quoted prices for identical or similar assets orliabilities in markets that are not active, and inputs (other than quotedprices) that are observable for the asset or liability, either directly orindirectly. Level 3 inputs are unobservable inputs for the asset or liability.

 

Categorization within thevaluation hierarchy is based upon the lowest level of input that is significantto the fair value measurement.

 

*Assets andLiabilities that are Measured at Fair Value on a Recurring Basis:*

 

Effective February 3,2008, the application of fair value under SFAS No. 157 (as amended by FSPNos. 157-1 and 157-2) related to the Company’s long-term investments andinterest rate swap agreements. These items were previously, and will continueto be, recorded at fair value at each balance sheet date. The information inthe following paragraphs and tables primarily addresses matters relative tothese financial assets and liabilities.

 

Long-term investments:

 

Long-term investmentsconsist principally of U.S. Treasury securities which are valued at quotedmarket prices. The Company considers its long-term investments to be valuedusing Level 1 measurements.

 

Derivative liability:

 

The Company has interestrate swaps which are within the scope of SFAS No. 133, “Accounting forDerivative Instruments and Hedging Activities.” The Company values the swapsusing observable market data to discount projected cash flows and for creditrisk adjustments. The Company considers these to be Level 2 measurements.

 

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The following table providesinformation by level for assets and liabilities that are measured at fairvalue, as defined by SFAS No. 157, on a recurring basis.

 
| ** **                                       | ** ** | **Fair Value**       | ** ** | **Fair Value Measurements**         | ** ** |
|--------------------------------------------------|------------|---------------------------|------------|-----------------------------------------------|------------|
| **(dollar amounts in thousands)** | ** ** | **at**                    | ** ** | **Using Inputs Considered as** | ** ** |
| **Description**                                  | ** ** | **May 3, 2008** | ** ** | **Level 1**                              | ** ** | **Level 2** | ** ** | **Level 3** | ** ** |
| Assets:                                          |       |                      |       |                                          |       |   |   |   |   |
| Other long-term assets                           |       |                      |       |                                          |       |   |   |   |   |
| Long-term investments                            |       | $                         | 7,511      |                                          | $          | 7,511 |   |   |   |   |   |
|                                             |       |                      |       |                                          |       |   |   |   |   |
| Liabilities:                                     |       |                      |       |                                          |       |   |   |   |   |
| Other long-term liabilities                      |       |                      |       |                                          |       |   |   |   |   |
| Derivative liability                             |       | $                         | 8,767      |                                          |       |   | $ | 8,767 |   |   |   |
|                                                  |            |                           |            |                                               |            |  |  |  |  |  |  |  |

 

*Assets andLiabilities that are Measured at Fair Value on a Nonrecurring Basis:*

 

Duringthe quarter ended May 3, 2008, the Company had no significant measurementsof assets or liabilities at fair value (as defined in SFAS No. 157) on anonrecurring basis subsequent to their initial recognition. As indicated inNote 1, the aspects of SFAS No. 157 for which the effective date for theCompany was deferred under FSP No. 157-2 until January 1, 2009 relateto nonfinancial assets and liabilities that are measured at fair value, but arerecognized or disclosed at fair value on a nonrecurring basis. This deferralapplies to such items as nonfinancial assets and liabilities initially measuredat fair value in a business combination (but not measured at fair value insubsequent periods) or nonfinancial long-lived asset groups measured at fairvalue for an impairment assessment.

 

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Item 2. Management’sDiscussion and Analysis of Financial Condition and Results of Operations

 

The discussion and analysis below should be readin conjunction with (i) the condensed consolidated interim financialstatements and the notes to such financial statements included elsewhere inthis Form10-Q and (ii) the consolidated financial statements and the notesto such financial statements included in Item 8, “Financial Statements and SupplementaryData” of our Annual Report on Form 10-K for the fiscal year ended February 2,2008.

 

OVERVIEW

 

The Pep Boys - Manny, Moe & Jack is aleader in the automotive aftermarket with 562 stores located throughout 35states and Puerto Rico. All of our stores feature the nationally-recognized PepBoys brand name, established through more than 80 years of providinghigh-quality automotive merchandise and services, and are company-owned,ensuring chain-wide consistency for our customers. We are the only nationalchain offering automotive service, accessories, tires and parts under one roof,positioning us to achieve our goal of becoming the automotive solutionsprovider of choice for the value-oriented customer.

 

For the thirteen weeks ended May 3, 2008,our comparable sales (sales generated by locations in operation during the sameperiod) decreased by 5.6% compared to a decrease of 2.3% for the thirteen weeksended May 5, 2007. This decrease in comparable sales was comprised of a6.2% decrease in comparable merchandise sales and a 2.9% decrease in comparableservice revenue. Merchandise sales were negatively affected by thediscontinuance and planned exit of certain non-core automotive merchandiseadopted as one of the initial steps in the Company’s five-year strategic plan.In addition, both lines of revenue were affected by decreasing customer count.

 

Our net earnings for the first quarter of 2008were $4,672,000, $1,497,000 higher than the $3,175,000 of earnings reported inthe first quarter of 2007. This increase in profitability was the result of afocus on more profitable sales and service (higher gross margin), expensecontrol initiatives resulting in lower Selling, General and Administrativeexpenses, reduced interest expense and increased gains on sale of assetsresulting primarily from our sale-leaseback transactions and the use of thoseproceeds to reduce outstanding borrowings.

 

The following discussion explains thesignificant developments affecting our financial condition and material changesin our results of operations for the thirteen weeks ended May 3, 2008. Westrongly recommend that you read the audited consolidated financial statementsand footnotes and Management’s Discussion and Analysis of Financial Conditionand Results of Operations included in our Annual Report on Form 10-K forthe fiscal year ended February 2, 2008.

 

LIQUIDITY AND CAPITAL RESOURCES — May 3,2008

 

Our cash requirements arise principally from thepurchase of inventory, capital expenditures related to existing stores, officesand distribution centers, debt service and contractual obligations (includingreal estate leases).

 

Capital expenditures for the thirteen weeksended May 3, 2008 were primarily for store maintenance capitalexpenditures. During the thirteen weeks ended May 3, 2008, we investedapproximately $8,646,000 in property and equipment versus $10,453,000 investedin the first quarter of fiscal 2007. We estimate that capital expendituresrelated to existing stores, warehouses and offices during fiscal 2008 will beapproximately $50,000,000, including $35,000,000 of maintenance capitalexpenditures.

 

Our expectation during the remainder of fiscal2008 is for our inventory levels to remain comparable to the levels achieved inthe first quarter of 2008.

 

During the first quarter of fiscal 2008, theCompany completed two separate sale-leaseback transactions.  The proceeds from these transactions wereused to repay $49,915,000 of our then drawn revolving line of credit agreement,to repurchase $20,965,000 principal amount of our 7.50% Senior SubordinatedNotes for $18,082,000 and $783,000 for other transaction relatedobligations.  The remaining proceeds of$66,739,000 were invested in cash and cash equivalents.  During the remaining nine months of fiscal2008, the Company has $1,511,000 of debt service maturing.  As of May 3, 2008, there was excessavailability on its line of credit of $184,918,000.  The Company always looks to improve itsfinancing and will do so as opportunities become available.

 

On or before August 1, 2008, we areobligated to purchase 29 properties that we currently rent under a masteroperating lease.  We believe that themarket value of these properties exceeds their $116,318,000 purchase price.  The Company is currently evaluating itsfinancing options for this obligation including a sale-leaseback transaction orthe use of existing cash and credit facilities.

 

We anticipate that available cash balances, cashprovided by operating activities, our existing line of credit and future accessto the capital markets will exceed our expected cash requirements in fiscal2008.

 

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Working Capital increased from $195,343,000 at February 2,2008 to $267,241,000 at May 3, 2008. At May 3, 2008, we hadstockholders’ equity of $473,475,000 and long-term debt, net of currentmaturities, of $341,317,000. Our long-term debt was approximately 42% of ourtotal capitalization at May 3, 2008 and 46% at February 2, 2008.

 

DISCONTINUEDOPERATIONS

 

Inthe third quarter of fiscal 2007, we adopted our long-term strategic plan. Oneof the initial steps in this plan was the identification of 31 low-returnstores for closure. We are accounting for these store closures in accordancewith the provisions of SFAS No. 146 “Accounting for Costs Associated withExit or Disposal Activities” and SFAS No. 144, “Accounting for Impairmentor Disposal of Long-Lived Assets” (SFAS No. 144).  In accordance with SFAS No. 144, ourdiscontinued operations for all periods presented reflect the operating resultsfor 11 of the 31 closed stores because we do not believe that the customers ofthese stores are likely to become customers of other Pep Boys stores due togeographical considerations. The operating results for the other 20 closedstores are included in continuing operations because we believe that thecustomers of these stores are likely to become customers of other Pep Boysstores that are in close proximity.

 

RESULTS OF OPERATIONS

 

The following table presents for the periodsindicated certain items in the condensed consolidated statements of operationsas a percentage of total revenues (except as otherwise provided) and thepercentage change in dollar amounts of such items compared to the indicatedprior period.

 
|                                                     |   |                                            |   |                      |   | **Percentage**                |   |
|----------------------------------------------------------|--------|-------------------------------------------------|--------|---------------------------|--------|-------------------------------|--------|
|                                                     |   | **Percentage of Total Revenues** |   | **Change**                |   |
|                                                     |   | **May 3, 2008**                       |   | **May 5, 2007** |   | **Fiscal 2008 vs.** |   |
| **Thirteen weeks ended**                       |   | **(Fiscal 2008)**                          |   | **(Fiscal 2007)**    |   | **Fiscal 2007**          |   |
| Merchandise Sales                                        |   | 81.0                                            | %      | 81.5                      | %      | (8.3                          | )%     |
| Service Revenue (1)                                      |   | 19.0                                            |   | 18.5                      |   | (5.1                          | )      |
| Total Revenues                                           |   | 100.0                                           |   | 100.0                     |   | (7.7                          | )      |
| Costs of Merchandise Sales (2)                           |   | 70.9                                            | (3)    | 70.8                      | (3)    | (8.2                          | )      |
| Costs of Service Revenue (2)                             |   | 88.9                                            | (3)    | 87.6                      | (3)    | (3.8                          | )      |
| Total Costs of Revenues                                  |   | 74.3                                            |   | 73.9                      |   | (7.2                          | )      |
| Gross Profit from Merchandise Sales                      |   | 29.1                                            | (3)    | 29.2                      | (3)    | (8.5                          | )      |
| Gross Profit from Service Revenue                        |   | 11.1                                            | (3)    | 12.4                      | (3)    | (14.4                         | )      |
| Total Gross Profit                                       |   | 25.7                                            |   | 26.1                      |   | (9.0                          | )      |
| Selling, General and Administrative  Expenses            |   | 23.9                                            |   | 23.6                      |   | (6.4                          | )      |
| Net Gain from Dispositions of Assets                     |   | 1.1                                             |   | 0.4                       |   | NM                            |   |
| Operating Profit                                         |   | 2.9                                             |   | 2.9                       |   | (8.6                          | )      |
| Non-operating Income                                     |   | 0.1                                             |   | 0.4                       |   | NM                            |   |
| Interest Expense                                         |   | 1.1                                             |   | 2.3                       |   | (57.1                         | )      |
| Earnings from Continuing Operations Before  Income Taxes |   | 1.9                                             |   | 0.9                       |   | 84.5                          |   |
| Income Tax Expense                                       |   | 43.6                                            | (4)    | 40.0                      | (4)    | 101.1                         |   |
| Net Earnings from Continuing Operations                  |   | 1.1                                             |   | 0.6                       |   | 73.4                          |   |
| (Loss) Gain From Discontinued Operations,  Net of Tax    |   | (0.1                                            | )      | —                    |   | NM                            |   |
| Net Earnings                                             |   | 0.9                                             |   | 0.6                       |   | 47.1                          |   |

 

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| (1)    |   | Service revenue  consists of the labor charge for installing merchandise or maintaining or  repairing vehicles, excluding the sale of any installed parts or materials.                                                                                                                                                                                                                   |
|--------|--------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                                                                                                                                                                                                                                                                                      |
| (2)    |   | Costs of merchandise  sales include the cost of products sold, buying, warehousing and store  occupancy costs. Costs of service revenue include service center payroll and  related employee benefits and service center occupancy costs. Occupancy costs  include utilities, rents, real estate and property taxes, repairs and  maintenance and depreciation and amortization expenses. |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                      |
| (3)    |   | As a percentage of  Merchandise Sales or Service Revenue, as applicable.                                                                                                                                                                                                                                                                                                                  |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                      |
| (4)    |   | As a percentage of Earnings  from Continuing Operations Before Income Taxes and Cumulative Effect of  Change in Accounting Principle.                                                                                                                                                                                                                                                     |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                      |
| NM     |   | Not Meaningful                                                                                                                                                                                                                                                                                                                                                                            |

 

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Thirteen Weeks Ended May 3, 2008 vs.Thirteen Weeks Ended May 5, 2007

 

Total revenues for the first quarter decreased 7.7% and comparablestore revenues decreased 5.6% primarily due to reduced merchandise sales.Comparable merchandise sales decreased 6.2% and comparable service revenuedecreased 2.9%. Merchandise sales were affected by the discontinuance andplanned exit of certain non-core automotive merchandise and decreased customercount.  The decrease in service revenueresulted primarily from a decreased customer count and a reduction in ourmedium and heavy repair categories.

 

Gross profit from merchandise sales decreased slightly as a percentageof merchandise sales, to 29.1% in fiscal 2008 from 29.2% in fiscal 2007. Grossprofit from merchandise sales in dollars decreased 8.5% or $10,853,000 from thecomparative period in the prior year, primarily due to the merchandise salesdecline. Our product margin percentage decline was due to our discontinuanceand planned exit of certain non-core automotive merchandise which depressedmargins offset by reduced warehousing and distribution costs.

 

Gross profitfrom service revenue decreased as a percentage of service revenue to 11.1% infiscal 2008 from 12.4% in fiscal 2007. Gross profit from service revenue indollars decreased 14.4% or $1,770,000 from the comparative period in the prioryear. This decrease, as a percentage of service revenue, was due to decreasedproductivity as a result of lower revenue produced by a comparable payrollbase.   This lower productivity wasattributable to our reduced customer count and reduction in our medium andheavy repair categories.

 

Selling,general and administrative expenses, as a percentage of total revenues, were23.9% and 23.6% in fiscal 2008 and fiscal 2007, respectively. Selling, generaland administrative expenses decreased 6.4% or $8,095,000 from the comparativeperiod in the prior year. Fiscal year 2007 included a $3,900,000 CEO transitioncharge. Also contributing to the decrease in selling, general and administrativeexpense was lower retail payroll expenses of $2,880,000 and lower employeebenefits of $2,460,000.  Retail storepayroll and employee benefits were affected by an increase in our part timeversus full time employee mix along with a reduced work force due to theclosure of stores in the fourth quarter of fiscal 2007.

 

Net gain fromdispositions of assets increased from the prior year, primarily due to from the$5,531,000 gain recognized from two sale-leaseback transactions completedduring fiscal 2008. Fiscal 2007 included a $2,400,000 gain for the settlementof an insurance claim relating to stores impaired during Hurricane Katrina in2005.

 

Interestexpense decreased $7,229,000 primarily due to gain on debt repurchased of $2,883,000and lower debt balances.

 

Net earningsof  $4,672,000 for the first quarter offiscal 2008 improved $1,497,000 from the prior fiscal year as a result of lowerselling, general and administrative expenses, lower interest expense and highergains from dispositions of assets offset by lower gross profit caused bydecreased sales.

 

INDUSTRY COMPARISON

 

We operate inthe U.S. automotive aftermarket, which has two general competitive arenas:Do-It-For-Me (“DIFM”) (service labor, installed merchandise and tires) marketand the Do-It-Yourself (“DIY”) (retail merchandise) market. Generally, thespecialized automotive retailers focus on either the “DIY” or “DIFM” areas ofthe business. We believe that our operation in both the “DIY” and “DIFM” areasof the business positively differentiates us from most of our competitors.Although we manage our store performance at a store level in aggregation, webelieve that the following presentation shows a representative comparisonagainst competitors within the two sales arenas. We compete in the “DIY” areaof the business through our retail sales floor and commercial sales business(Retail Sales). Our Service Center Business (labor and installed merchandiseand tires) competes in the “DIFM” area of the industry.

 

The followingtable presents the revenues and gross profit for each area of the business.

 
| ** **                                       | ** ** | **Thirteen weeks ended** | ** ** |
|--------------------------------------------------|------------|------------------------------------|------------|
| ** **                                       | ** ** | **May 3,**                    | ** ** | **May 5,** | ** ** |
| **(dollar amounts in thousands)** | ** ** | **2008**                           | ** ** | **2007** | ** ** |
|                                             |       |                               |       |   |   |
| Retail Sales (1)                                 |       | $                                  | 273,325    |   | $ | 311,119 |   |
| Service Center Revenue (2)                       |       | 224,718                            |       | 228,464 |   |
| Total Revenues                                   |       | $                                  | 498,043    |   | $ | 539,583 |   |
|                                             |       |                               |       |   |   |
| Gross Profit from Retail Sales (3)               |       | $                                  | 73,404     |   | $ | 88,766 |   |
| Gross Profit from Service Center Revenue  (3)    |       | 54,562                             |       | 51,823 |   |
| Total Gross Profit                               |       | $                                  | 127,966    |   | $ | 140,589 |   |

 

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(1)                                Excludesrevenues from installed products.

 

(2)                                Includesrevenues from installed products.

 

(3)                                GrossProfit from Retail Sales includes the cost of products sold, buying,warehousing and store occupancy costs. Gross Profit from Service Center Revenueincludes the cost of installed products sold, buying, warehousing, servicecenter payroll and related employee benefits and service center occupancycosts. Occupancy costs include utilities, rents, real estate and propertytaxes, repairs and maintenance and depreciation and amortization expenses.

 

NEW ACCOUNTING STANDARDS TO BE ADOPTED

 

InDecember 2007, the Financial Accounting Standards Board (FASB) issued SFASNo. 141R, “Business Combinations,” which replaces SFAS No. 141, “BusinessCombinations.” SFAS No. 141R, among other things, establishes principlesand requirements for how an acquirer entity recognizes and measures in itsfinancial statements the identifiable assets acquired, the liabilities assumedand any controlling interests in the acquired entity; recognizes and measuresthe goodwill acquired in the business combination or a gain from a bargainpurchase; and determines what information to disclose to enable users of thefinancial statements to evaluate the nature and financial effects of thebusiness combination. Costs of the acquisition will be recognized separatelyfrom the business combination. SFAS No. 141R applies prospectively, exceptfor taxes, to business combinations for which the acquisition date is on orafter the beginning of the first annual reporting period on or after December 15,2008.

 

In December 2007, the FASB issued SFAS No. 160, “NoncontrollingInterests in Consolidated Financial Statements—an amendment of ARB No. 51.”SFAS No. 160, among other things, provides guidance and establishesamended accounting and reporting standards for a parent company’snoncontrolling interest in a subsidiary. SFAS No. 160 is effective forfiscal years beginning on or after December 15, 2008. The Company does notexpect the adoption of SFAS No. 160 to have a material impact on itsfinancial condition, results of operations or cash flows.

 

In February 2008, the FASB issued Staff Position No. FAS 157-2(FSP No.157-2), “Effective Date of FASB Statement No. 157,” that defersthe effective date of SFAS 157 for one year for certain nonfinancialassets and nonfinancial liabilities. SFAS 157 is effective for certain nonfinancial assets andnonfinancial liabilities for financial statements issued for fiscal yearsbeginning after November 15, 2008. The Company is currently evaluating theimpact SFAS No. 157 will have on its consolidated financial statementsbeginning in fiscal 2009.

 

In March 2008, the FASB issued SFAS No. 161, “Disclosuresabout Derivative Instruments and Hedging Activities.” SFAS No. 161 expandsthe disclosure requirements in SFAS No. 133, “Accounting for DerivativeInstruments and Hedging Activities,” about an entity’s derivative instrumentsand hedging activities. SFAS No. 161 is effective for financial statementsissued for fiscal years and interim periods beginning after November 15,2008. The Company is currently evaluating the impact SFAS No. 161 willhave on its consolidated financial statements.

 

CRITICALACCOUNTING POLICIES AND ESTIMATES

 

Management’s Discussion and Analysis of Financial Condition and Resultsof Operations discusses our condensed consolidated financial statements, whichhave been prepared in accordance with accounting principles generally acceptedin the United States of America. The preparation of these financial statementsrequires management to make estimates and assumptions that affect the reportedamounts of assets and liabilities and the disclosure of contingent assets andliabilities at the date of the consolidated financial statements and the reportedamounts of revenues and expenses during the reporting period. Additionally, theCompany estimates its interim product gross margins in accordance withAccounting Principles Bulletin No. 28, “Interim Financial Reporting.”

 

On an on-going basis, we evaluate our estimates and judgments,including those related to customer incentives, product returns and warrantyobligations, bad debts, inventories, income taxes, financing operations,restructuring costs, retirement benefits, risk participation agreements andcontingencies and litigation. We base our estimates and judgments on historicalexperience and on various other factors that are believed to be reasonableunder the circumstances, the results of which form the basis for makingjudgments about the carrying values of assets and liabilities that are notreadily apparent from other sources. Actual results may differ from theseestimates under different assumptions or conditions. For a detailed discussionof significant accounting policies that may involve a higher degree of judgmentor complexity, refer to “Critical Accounting Policies and Estimates” asreported in our Form 10-K for the year ended February 2, 2008, whichdisclosures are hereby incorporated by reference.

 

FORWARD-LOOKINGSTATEMENTS

 

Certain statements contained herein constitute “forward-lookingstatements” within the meaning of The Private Securities Litigation 

 

26

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Reform Act of 1995. The words “guidance,” “expect,” “anticipate,” “estimates,”“forecasts” and similar expressions are intended to identify suchforward-looking statements. Forward-looking statements include management’sexpectations regarding implementation of its long-term strategic plan, futurefinancial performance, automotive aftermarket trends, levels of competition,business development activities, future capital expenditures, financing sourcesand availability and the effects of regulation and litigation. Although webelieve that the expectations reflected in such forward-looking statements arebased on reasonable assumptions, we can give no assurance that our expectationswill be achieved. Our actual results may differ materially from the resultsdiscussed in the forward-looking statements due to factors beyond our control,including the strength of the national and regional economies, retail andcommercial consumers’ ability to spend, the health of the various sectors ofthe automotive aftermarket, the weather in geographical regions with a highconcentration of our stores, competitive pricing, the location and number ofcompetitors’ stores, product and labor costs and the additional factorsdescribed in our filings with the Securities and Exchange Commission (SEC). Weassume no obligation to update or supplement forward-looking statements thatbecome untrue because of subsequent events.

 

Item 3. Quantitative and QualitativeDisclosures About Market Risk

 

The Company’s primary market risk exposure with regard to financialinstruments is to changes in interest rates. Pursuant to the terms of itsrevolving credit agreement, changes in LIBOR could affect the rates at whichthe Company could borrow funds thereunder. At May 3, 2008, the Company hadborrowings of $621,000 under this facility. Additionally, the Company has a$154,261,000 Senior Secured Term Loan facility that bears interest at LIBORplus 2.0%, and approximately $116,318,000 of real estate operating leases whichvary based on changes in LIBOR.

 

The Company has an interest rate swap which it records the changes infair value through cost of merchandise sales. This swap will terminate on July 1,2008. During the thirteen weeks ended May 3, 2008 and May 5, 2007,cost of merchandise sales reflects a $69,000 and $828,000 expense for thechange in fair value of this swap.

 

The Company has a second interest rate swap for a notional amount of$145,000,000, which is designated as a cash flow hedge on its $154,261,000Senior Secured Term Loan. The Company documented that this swap met therequirements of SFAS No. 133 for hedge accounting on April 9, 2007,and has since recorded the effective portion of the change in fair valuethrough Accumulated Other Comprehensive Loss. Interest expense reflects a$974,000 expense for the change in fair value of this swap for the thirteenweeks ended May 5, 2007.

 

The fair value of the interest rate swaps was an $8,767,000 and$10,963,000 payable at May 3, 2008 and February 2, 2008. Of the net$2,196,000 increase in fair value during the thirteen weeks ended May 3,2008, $2,265,000 ($1,423,000 net of tax) was included in Accumulated OtherComprehensive Loss on the condensed consolidated balance sheet.

 

Item 4. Controls and Procedures

 

EVALUATION OF DISCLOSURE CONTROLS AND PROCEDURES

 

Our disclosure controls and procedures (as defined in Rule 13a -15 of the Securities Exchange Act of 1934 (the “Exchange Act”)) are designed toensure that information required to be disclosed is accumulated andcommunicated to our management, including our principal executive and principalfinancial officers, as appropriate to allow timely decisions regarding requireddisclosure. The Company’s management, with the participation of the Company’schief executive officer and chief financial officer, evaluated theeffectiveness of the Company’s disclosure controls and procedures as of the endof the period covered by this report. Based on that evaluation, the chiefexecutive officer and chief financial officer concluded that ourdisclosure controls and procedures as of the end of the period covered bythis report were not functioning effectively to provide reasonable assurancethat the information required to be disclosed by the Company in reports filedunder the Securities Exchange Act of 1934 is recorded, processed, summarizedand reported within the time periods specified in the SEC’s rules andforms, solely due to the fact that there was a material weakness in ourinternal control over financial reporting (which is a subset of disclosurecontrols and procedures) as described below.

 

CHANGES IN INTERNAL CONTROL OVER FINANCIAL REPORTING

 

Duringthe second quarter of fiscal 2007, the Company determined it had a materialweakness in its internal control over financial reporting related to itsfinancial close and reporting process. Since that time, the Company hascontinued to implement changes designed to enhance the effectiveness of itsfinancial close and reporting process including (i) hiring staff andproviding additional accounting research resources, (ii) improving processdocumentation and (iii) improving the review process by more senioraccounting personnel. However, as of May 3, 2008, the Company believesthat its ongoing efforts to hire and train additional staff are not yetcomplete. Accordingly, the Company cannot provide its constituents withreasonable assurance that the material weakness in the financial close andreporting process has been remediated. The Company has retained experiencedaccounting consultants, other than the Company’s independent registered publicaccounting firm, with relevant accounting experience, skills and knowledge, toprovide advice to the Company’s management in connection with the fiscal 2008financial reporting process.

 

During the first quarter of fiscal 2008, we transitioned our dataprocessing to a third party service provider. We are in the process of 

 

27

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modifying the design and documentation of certain of our internalcontrol processes and procedures relating to this change, as appropriate.

 

Other than described above, no change in the Company’s internal controlover financial reporting occurred during the fiscal quarter covered by thisreport that has materially affected, or is reasonably likely to materiallyaffect, the Company’s internal control over financial reporting.

 

Item 5. Other Information

 

None.

 

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PART II - OTHER INFORMATION

 

Item 1.  Legal Proceedings

 

During thefourth quarter of 2006 and the first quarter of 2007, the Company was servedwith four separate lawsuits brought by former associates employed inCalifornia, each of which lawsuits purports to be a class action on behalf ofall current and former California store associates. One or more of the lawsuitsclaim that the plaintiff was not paid for (i) overtime, (ii) accruedvacation time, (iii) all time worked (i.e. “off the clock” work) and/or (iv) lateor missed meal periods or rest breaks. The plaintiffs also allege that theCompany violated certain record keeping requirements arising out of theforegoing alleged violations. The lawsuits (i) claim these allegedpractices are unfair business practices, (ii) request back pay,restitution, penalties, interest and attorney fees and (iii) request thatthe Company be enjoined from committing further unfair business practices.  The initial accrued vacation time claims werefiled in California state court and subsequently removed by the Company toFederal court on jurisdictional grounds. During the third quarter of 2007, the Company reached a settlement inprinciple regarding the accrued vacation time claims, which was subject tocourt approval.  Following the Federalcourt approval hearing on May 5, 2008, the Federal court reversed itsearlier finding of proper Federal jurisdiction and remanded the case back toCalifornia state court.  While theCompany has appealed this ruling, it is also negotiating with the plaintiffs torestructure the previously agreed to settlement in principle for the purpose ofsubmitting such settlement to the California state court for approval.  On May 8, 2008, the Company reached asettlement in principle with respect to the remaining purported class actionclaims, which is subject to court approval.

 

The Company isalso party to various other actions and claims arising in the normal course ofbusiness.

 

The Companybelieves that amounts accrued for awards or assessments in connection with allsuch matters, which amounts were increased by $1,900,000 in the first quarterof fiscal 2008, are adequate and that the ultimate resolution of these matterswill not have a material adverse effect on the Company’s financialposition.  However, there exists areasonable possibility of loss in excess of the amounts accrued, the amount ofwhich cannot currently be estimated. While the Company does not believe that the amount of such excess losscould be material to the Company’s financial position, any such loss could havea material adverse effect on the Company’s results of operations in the period(s) duringwhich the underlying matters are resolved.

 

Item 1A.  Risk Factors

 

There have been no changes to the risks described in the Company’sAnnual Report on Form 10-K for the fiscal year ended February 2,2008.

 

Item 2.  Unregistered Sales of EquitySecurities and Use of Proceeds

 

None.

 

Item 3.  Defaults Upon Senior Securities

 

None.

 

Item 4.  Submission of Matters to a Voteof Security Holders

 

None.

 

Item 5.  Other Information

 

None.

 

29

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Item 6.  Exhibits and Reports on Form 8-K

 
| **(a)**

** **

**Exhibits** | ** ** | ** **                                                                                                                                                 |
|-----------------------------------|------------|------------------------------------------------------------------------------------------------------------------------------------------------------------|
|                              |       |                                                                                                                                                       |
| (31.1)**                          |       | Certification of Chief Executive Officer pursuant to Section 302  of the Sarbanes-Oxley Act of 2002                                                   |
|                              |       |                                                                                                                                                       |
| (31.2)**                          |       | Certification of Chief Financial Officer pursuant to Section 302  of the Sarbanes-Oxley Act of 2002                                                   |
|                              |       |                                                                                                                                                       |
| (32.1)**                          |       | Chief Executive Officer Certification pursuant to 18 U.S.C.  Section 1350, as adopted pursuant to Section 906 of the  Sarbanes-Oxley Act of 2002 |
|                              |       |                                                                                                                                                       |
| (32.2)**                          |       | Chief Financial Officer Certification pursuant to 18 U.S.C.  Section 1350, as adopted pursuant to Section 906 of the  Sarbanes-Oxley Act of 2002 |

 

----

** - Filed herewith

 

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SIGNATURES

 

Pursuant to the requirements of the Securities Exchange Act of 1934,the registrant has duly caused this Quarterly Report on Form 10-Q to be signedon its behalf by the undersigned thereunto duly authorized.

 
|                     | THE PEP BOYS - MANNY, MOE & JACK |
|--------------------------|-------------------------------------------|
|                     | (Registrant)                              |
|                     |                                      |   |
| Date: June 11, 2008 |                                      | by: | /s/ Raymond L. Arthur |
|                     |                                      | Raymond L. Arthur |
|                     |                                      | Executive Vice President and |
|                     |                                      | Chief Financial Officer |
|                          |                                           |  |  |

 

31

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INDEX TOEXHIBITS

 
| (31.1)** |   | Certification of Chief Executive Officer pursuant to Section 302  of the Sarbanes-Oxley Act of 2002                                                   |
|----------|--------|------------------------------------------------------------------------------------------------------------------------------------------------------------|
|     |   |                                                                                                                                                       |
| (31.2)** |   | Certification of Chief Financial Officer pursuant to Section 302  of the Sarbanes-Oxley Act of 2002                                                   |
|     |   |                                                                                                                                                       |
| (32.1)** |   | Chief Executive Officer Certification pursuant to 18 U.S.C.  Section 1350, as adopted pursuant to Section 906 of the  Sarbanes-Oxley Act of 2002 |
|     |   |                                                                                                                                                       |
| (32.2)** |   | Chief Financial Officer Certification pursuant to 18 U.S.C. Section 1350,  as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002  |

 

----

**   Filed herewith

 

32

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