GENUINE PARTS CO annual report, FY2017

Business context and reporting period

Genuine Parts Company’s Form 10-K covers the fiscal year ended December 31, 2017. The company distributes automotive replacement parts, industrial parts, business products, and electrical/electronic materials through approximately 3,100 locations in North America, Australasia, and Europe.

Financial and operating performance

Sales growth comprised approximately 4.4% from acquisitions, 1.5% comparable-sales growth, and 0.4% favorable currency translation. Gross margin improved slightly, but selling, administrative and other expenses rose to 22.7% of sales from 22.0%. Interest expense increased to $41.5 million from $21.1 million, primarily due to acquisition-related borrowing and higher rates.

Management’s non-GAAP adjusted net income was $695.8 million, or $4.71 per diluted share, excluding after-tax acquisition transaction costs of $28.0 million and a $51.0 million tax-reform charge. Adjusted net income rose 1.2% and adjusted diluted EPS rose 2.6% year over year; these measures are supplemental, not GAAP results.

Business segments

• Automotive: Sales of $8.66 billion, up 7%; operating margin declined to 8.3% from 8.8%, reflecting modest comparable growth and rising costs.
• Industrial: Sales of $4.97 billion, up 7.2%; operating margin improved to 7.7% from 7.3% on stronger demand, supplier incentives, and better expense leverage.
• Business Products: Sales of $2.00 billion, up 1.5%, while comparable sales fell approximately 3.3%; operating margin declined to 4.9% from 5.9% amid core office-supply pressures.
• Electrical/Electronic Materials: Sales of $781 million, up 9.1%, largely from acquisitions; operating margin declined to 7.2% from 8.5%. In 2018, this business was combined with Motion Industries.

Material changes versus the prior year

• On November 2, 2017, the company acquired Alliance Automotive Group (AAG), a European distributor, for approximately $1.08 billion net cash consideration and repaid approximately $825 million of AAG debt. The transaction was funded primarily with new borrowings. AAG contributed $256.4 million in sales during the two months consolidated.
• Debt rose substantially to fund AAG and other acquisitions. Net cash used in investing activities increased to $1.63 billion, including $1.49 billion for acquisitions and other investing activities. Capital expenditures were $156.8 million.
• Operating cash flow fell by $131 million, which management attributed principally to less favorable cash movements in receivables, inventory, payables, and other short-term accounts.
• The Tax Cuts and Jobs Act resulted in a provisional $51.0 million tax expense, including a $37.1 million transition-tax estimate and $13.9 million deferred-tax remeasurement. The company had not completed its tax accounting and said estimates could change.
• Net sales increased after essentially flat sales in 2016; reported net income and diluted EPS declined despite the higher revenue.

Outlook, commentary, risks, and contingencies

No specific consolidated earnings or revenue guidance is provided. Management expects automotive fundamentals and sales initiatives to support 2018 growth, sees the Industrial business positioned for profitable growth and further margin expansion, and plans to pursue cost savings and diversification in Business Products. The company estimated 2018 capital expenditures of $200–$220 million and defined-benefit pension contributions of approximately $47 million. It expected increasing dividends to continue, while share repurchase amounts would vary.

Key risks include competitive and digital/e-commerce pressures; demand sensitivity to economic conditions, vehicle usage and age, industrial activity, and office-products digitization; vendor supply, pricing, and incentive risks; acquisition integration and execution; cyber and information-system disruption; foreign-exchange and trade-policy exposure; and increased debt, interest-rate exposure, and covenant restrictions. Management said cash and available financing were sufficient for expected operating and capital needs and reported compliance with debt covenants at year-end. The company had approximately $616.7 million of guaranteed borrowings for independent stores and affiliates; it reported no significant historical losses on these guarantees.

The company disclosed approximately 2,170 product-liability lawsuits. In one case, an $81.5 million jury award was reduced to $77.1 million after post-trial motions and offsets; the company appealed and did not expect a material financial-statement impact based on its defenses, insurance, and reserves. AAG’s purchase-price allocation remained preliminary. AAG, representing approximately 24% of year-end assets, was excluded from management’s and the auditor’s internal-control assessment for 2017; management and the auditor nevertheless concluded controls were effective for the assessed company.

Most important facts for investors to verify

• Whether AAG integration, synergies, and acquired-business performance justify the higher debt and goodwill/intangible-asset balances.
• Progress in reducing debt, servicing variable-rate borrowings, and maintaining covenant compliance.
• Whether underlying comparable-sales growth and operating margins improve, especially in Automotive, Business Products, and Electrical/Electronic.
• Final tax-reform accounting, including the provisional transition-tax and deferred-tax estimates, and the impact of subsequent tax guidance.
• Resolution, insurance coverage, and any ultimate cash or earnings effect of the $77.1 million product-liability verdict and other claims.
• Effects of AAG control integration, the planned segment combination, and adoption of revenue and lease accounting standards.