A host of macroeconomic factors continue to weigh on the U.S. economy, including rising interest rates, economic inflation, and supply chain and labor supply disruption. Geopolitical factors such as the War in Ukraine and now the Gaza war in Israel further complicate the picture. These various factors have serious ramifications for the operations of many businesses and for their financial performance. In some cases, the impact of these factors on companies can also translate into securities litigation. In the latest example of this phenomenon, the auto parts company Advance Auto Parts has been hit with a securities class action following a decline the price of the company’s share price after the company announced that its “strategic pricing initiative” was not sufficient to avert the impact of inflation and other macroeconomic factors on the company’s financial performance. A copy of the October 9, 2023, complaint filed against the company can be found here.
Advance Auto Parts (AAP) sells automobile parts and accessories through its various retail stores, serving both automobile professionals and non-professional consumers. On November 16, 2022, in its quarterly earnings call, the company announced its “strategic pricing initiatives” aimed to help grow margins in 2023. The company’s CEO said that “our goal overall is to cover cost increases.” The CEO said that these initiatives were based on the company’s research showing that in the professional category, availability rather than prices was the more important factor in sales.
On its quarterly earnings call on February 28, 2023, the company said that it was continuing to execute “disciplined inventory and pricing actions.” During the call, the company’s CEO dismissed the impact of the U.S. economy and other macroeconomic factors on sales and margins. While acknowledging that the company remains “cautious surrounding the macroeconomic backdrop, including with respect to the pressure on low-to-middle income consumers,” the CEO confirmed the company’s 2023 guidance.
However, in its quarterly earnings call on May 31, 2023, the CEO said that “our financial results in the first quarter were well below expectations, noting that the company’s pricing initiatives produced “less price realization than plans,” and that the company had been “unable to price to cover product costs in the quarter.” The company announced that it was revising its 2023 guidance on its operating margin from a previously announced 7.8% to 9.2% margin to 5% to 5.3%. According to the subsequently filed securities class action complaint, the company’s share price fell 35% on this news.
On October 9, 2023, a plaintiff shareholder filed a securities class action lawsuit in the Eastern District of North Carolina against AAP and certain of its directors and officers. The complaint purports to be filed on behalf of a class of investors who purchased AAP’s securities between November 16, 2022, and May 30, 2023.
The complaint alleges that during the class period, the defendants’ statements were false and misleading, because the defendants: “(1) misrepresented the efficacy of AAP’s strategic pricing initiative and the impact of pricing reductions; (2) omitted and/or concealed the negative impacts of the pricing initiative; (3) provided investors with an overly optimistic perception of AAP’s operations; and (4) created the false impression that inflation and macroeconomic factors had an insubstantial impact on the Company’s margins.”
The complaint alleges that the defendants violated Sections 10(b) and 20(a) of the Securities Exchange Act of 1934 and Rule 10b-5 thereunder. The complaint seeks to recover damages on behalf of the class.
The current economic conditions create a challenging operating environment for companies. In this case, the defendant company faced pressure on its margins due to its own rising costs. The complaint alleges that the company misrepresented the effectiveness of the company’s efforts to address its costs, and more to the point, misrepresented the impact that inflation and other macro factors were having on the company’s margins and financial performance. In essence, the complaint alleges that the defendants soft-pedaled the impact inflation and other macro factors were having on the company’s operations and financial performance.
This complaint has only just been filed and it remains to be seen how it will fare. One challenge the plaintiffs will face in response to the motion to dismiss will be demonstrating to the court that the defendants made the supposedly misleading statements with the requisite scienter. Faced with this issue, the court will struggle to find in this complaint allegations that show why the defendants would make the supposed misrepresentations that the plaintiffs allege. The defendants will seek to argue that over a relatively short period of two financial quarters, the company’s management simply underestimated the impact on the company’s operations of economic inflation and overestimated their own ability to be able to manage their pricing structures to deal with the impact of inflation. These allegations potentially might (at most) amount to negligence, but, the defendants will argue, they hardly amount to securities fraud.
In any event, and regardless of how this specific case fares, it seems likely that in the months ahead that businesses will continue to struggle in the current economic circumstances. Indeed, as I recently noted in a prior post (here), signs are that corporate bankruptcies are up sharply in 2023 compared to recent periods. The economic challenges will not only continue to affect companies’ financial performance, but in some instances, such as was the case here, the circumstances will translate into securities lawsuits. Among the current negative economic headwinds, rising interest and elevated economic inflation seem likely to cause the most difficulty.