Genuine Parts Company — Q2 2018 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2018. Genuine Parts distributes automotive replacement parts, industrial parts and business products through approximately 3,100 locations. The company reported three segments: Automotive, Industrial and Business Products.
Financial results
| Metric | Q2 2018 | Q2 2017 | Six months 2018 | Six months 2017 |
|---|---|---|---|---|
| Net sales | $4.822 billion | $4.100 billion | $9.408 billion | $8.006 billion |
| Operating profit | $390.2 million | $349.3 million | $708.7 million | $636.1 million |
| Net income | $227.0 million | $190.0 million | $403.5 million | $350.1 million |
| Diluted EPS | $1.54 | $1.29 | $2.74 | $2.36 |
- Sales increased 17.6% in Q2 and 17.5% in the first half. Management attributed most of the growth to acquisitions; organic sales growth was approximately 3% for Q2 and 2% for the first half, with favorable currency also contributing.
- Gross margin improved: cost of goods sold was 68.4% of sales in Q2 versus 69.8% a year earlier, and 68.6% versus 70.1% for the first half. However, operating expenses rose to 25.1% of sales in Q2 from 23.1%; operating margin consequently declined to 8.1% from 8.5% (first half: 7.5% versus 7.9%).
- Lower effective tax rates—24.4% in Q2 and 23.8% for the first half, versus 36.1% and 35.3%—supported net income growth. The company cited U.S. tax reform and the mix of U.S. and foreign earnings.
- Adjusted net income, a non-GAAP measure excluding transaction and other costs, was $233.6 million in Q2 and $420.0 million for the first half; adjusted diluted EPS was $1.59 and $2.85, respectively.
- Operating cash flow was $455.1 million for the first half, compared with $345.3 million in 2017. Capital expenditures were $65.1 million; acquisitions and other investing used $82.5 million; dividends paid were $204.6 million. Cash ended the period at $355.1 million, up from $314.9 million at year-end 2017.
- Total debt was approximately $3.177 billion, down $68 million from year-end. Average debt cost was 2.98%; the company reported compliance with debt covenants. The current ratio was 1.3, unchanged from year-end. Management said cash and available credit lines should fund anticipated operations.
- Dividends declared were $0.72 per share in Q2, versus $0.675 a year earlier. Total assets were $12.567 billion and total equity was $3.562 billion at June 30.
Segment performance and changes
- Automotive: Q2 sales rose 27.7%, including approximately 25% from acquisitions and 2% organic growth. Q2 operating profit rose 17.5%, but margin declined to 8.9% from 9.7%.
- Industrial: Q2 sales increased 8.7%, including 6.5% organic growth. Operating margin improved to 7.8% from 7.6%. The company combined EIS with Motion Industries into the Industrial segment effective January 1, 2018, with prior periods presented retrospectively.
- Business Products: Q2 sales were essentially unchanged; first-half sales declined 2.4%. Q2 operating profit fell 28.8%, and margin decreased to 4.4% from 6.2%, reflecting weaker organic sales, expense deleverage and lower volume incentives.
- Reported sales growth included the acquisition of European automotive distributor AAG, acquired in November 2017. Management said acquisition-related businesses generally have lower cost of goods sold and higher operating expenses, with operating margins described as consistent with other businesses.
Outlook, risks and unusual items
- No numerical earnings or sales guidance is provided. Management described long-term priorities including organic growth, disciplined acquisitions, digital capabilities, geographic expansion, margin improvement and cost control.
- The company expected to complete a proposed Business Products Group separation and combination with Essendant before year-end 2018, subject to regulatory and Essendant shareholder approvals and other conditions. The transaction was structured as a Reverse Morris Trust and contemplated approximately $347 million in cash payments to Genuine Parts, subject to closing adjustments. Staples separately expressed interest in acquiring Essendant for $11.50 per share; the FTC issued second requests relating to both proposals. Management said the outcome and any possible impairment at the spin-off date could not be predicted.
- Q2 and first-half results included after-tax transaction and other costs of $6.6 million and $16.5 million, respectively, related to AAG and the pending Essendant transaction. The filing cautions that the adjusted figures are non-GAAP and should not replace GAAP results.
- Notable exposures include AAG integration and European aftermarket conditions, the uncertain Essendant transaction, competition, weak comparable sales, labor and freight costs, potential tariffs, foreign exchange, litigation and information-system disruptions. A jury had awarded damages in an automotive product-liability matter; the company said it did not expect a material financial impact based on its defenses, insurance and reserves.
- The company said it was still refining its accounting for U.S. tax reform. It expected adoption of the new lease standard to significantly affect the balance sheet; disclosed operating lease minimum payments were approximately $1.14 billion at December 31, 2017.
Important facts for investors to verify
- Whether the Essendant transaction receives required regulatory and shareholder approvals, and how Staples’ proposal affects its timing or terms.
- Whether organic growth improves, particularly in U.S. Automotive and Business Products, and whether those segments regain operating-margin leverage.
- Whether AAG integration delivers anticipated benefits without further pressure on expenses, debt or cash generation.
- How lease-standard adoption, final tax-reform accounting and any spin-off-date impairment affect reported financial statements.
- Developments in the product-liability litigation and the company’s exposure under approximately $685.1 million of guaranteed borrowings of independents and affiliates.