Good day and welcome to the Genuine Parts Company Third Quarter 2017 Earnings Conference Call. Today's conference is being recorded. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. [Operator Instructions] At this time, I would like to turn the call over to Sid Jones, Senior Vice President, Investor Relations. Please go ahead Sir.

Good morning and thank you for joining us today for the Genuine Parts Company third quarter 2017 conference call to discuss our earnings results and current outlook for the full year. Before we begin this morning, please be advised that this call may involve forward-looking statements regarding the Company and its businesses. The Company's actual results could differ materially from any forward-looking statements due to several important factors described in the company's latest SEC filings. The Company assumes no obligation to update any forward-looking statements made during the call. We'll begin today with comments from our President and CEO, Paul Donahue. Paul?

Thank you Sid, and welcome to our third quarter conference call. As always we appreciate you taking the time to be with it. Earlier today we released our third quarter results. I’ll make a few remarks on our overall performance and then cover the highlights by business. Carol Yancey, our Executive Vice President and Chief Financial Officer will provide an update on our financial results and our current outlook for 2017. After that we will open the call to your question. To get us started, let's recap our third quarter sales and earnings performance across our global automotive, industrial, office and electrical operations. Total GPC sales were up 4% to $4.1 billion with net income at 158 million and earnings per share at $1.08. These results include approximately $18.5 million in pretax transaction cost primarily related to the previously announced acquisition of Alliance Automotive Group in Europe or AAG which we look to close in November. The $0.48 per share impact of these cost, adjusted earnings per share were $1.16 compared to $1.24 in the third quarter last year. As a diversified global distributor we continue to benefit from the balance of serving a broad range of geographies and end markets. While our US automotive, office and electrical businesses are operating in challenging end markets today, our industrial and international automotive businesses are operating in a more favorable market conditions and generating stronger growth. To that end, our investment in AAG, a leading European based automotive parts distributor, which we'll discuss later in our remarks underscores the growth opportunities we see internationally. In total, the diversity in our operations combined with an ongoing strategy to drive both organic and acquisitive growth enabled us to deliver a 4% total sales increase despite the challenging operating environment, one less billing day in…

Thank you Paul, we’ll begin with the review of our key financial information and then we will provide our updated outlook for 2017. Our total sales in the third quarter were at 3.9% including 1% increase in comparable revenues. Our gross margin for the quarter was 29.95% compared to 30.4% last year. The decrease is due primarily to lower supplier incentives recorded in the quarter associated with lower than expected purchasing volume. In addition, we experienced product mix shift in several of our businesses, US automotive, office and electric which also pressured our margins. For the nine months gross margin of 29.9% remains fairly steady with the prior year as the more favorable gross margin trends in the first six months mostly offset this quarter's decline. With that said we remain focused on enhancing our gross margin through several key initiatives including continued supplier negotiations, the ongoing investment in a more flexible and sophisticated pricing strategies as well as improved analytic capabilities around SKU profitability. We continue to see a somewhat inflationary pricing environment across our businesses in the third quarter with each of our businesses showing at least slight inflation through the nine months of the year. Our cumulative supplier price changes through September stand at 0.3% increase for automotive, 1.8% increase for industrial, 0.6% increase for our office and increase of 1.3% for electrical. Turning to our SG&A, our total expenses for the third quarter were 981 million or 962 million before the 18.5 million in transaction costs, primarily related to our pending European acquisition. On an adjusted basis, our total expenses were up 6% from last year and at 23.5% of sales and we continue to experience the de-leveraging of expenses associated with the slower organic sales environment in several of our businesses. In addition rising labor,…

Thank you, Carol. We enter the fourth quarter focused on generating stronger organic sales growth as well as maximizing the benefits of our acquisitions. Next month, we expect to close on the Alliance Automotive Group in Europe as well as the Apache and Monroe Motor Parts acquisitions announced earlier today. We believe in the long term benefits of our acquisition strategy and are excited to add these businesses to our operations. As mentioned before, we also move forward intensely focused on the plans and initiatives underway to reduce costs and improve our profitability, with the objective of enhancing gross margins and building a highly productive, cost effective infrastructure. While this has always been our focus, we understand we need to take steps now to be more nimble in challenging environments and ensuring we are positioned to capitalize on opportunities as the market begins to recover. We have consistently stated that our business is fit best under the GPC umbrella, we also continually assess the contribution of each business to our long term financial objectives for sustained revenue growth, cash flow generation and profitability. Although we are not satisfied with this quarter’s results, we are optimistic with the opportunities that lie ahead and we move forward with a heightened sense of urgency as we focus on maximizing shareholder value and positioning the company for long term success. So with that, we’ll turn it back to the operator and Carol and I will take your questions.

And we'll go first to Bret Jordan with Jefferies.

Could you talk a little about the cadence in auto as the quarter went, were there any particularly weak or strong months in the period?

Yeah. The good news, Bret, is that the month of September was, for the US group, was our best month of the quarter. August was a little softer, but as I said, September, we rebounded nicely on an average daily sales basis. If we look across our total automotive business, similar pattern. September was the strongest of the three months for global automotive business.

Okay. And how do you think you did relative to the underlying market, as you sort of look across the board and I guess it's hard to see everybody is POS, but do you think you’re relatively keeping pace or were there any supply issues?

No. Look, I would -- being the first one now, Bret, we haven't had the advantage of seeing our competitors’ numbers, but with flat comp numbers in the US, I'm guessing we're within range of most. I don't believe we're giving up market share as I mentioned in my prepared remarks. We saw nice growth in our DIY business. Again, I think that’s directly related to the things that we're doing and the initiatives we have in play. We saw a little bit of softness in the DIFM business, but again, we've got, I think, initiatives to get that turned as we head into the homestretch here.

Okay. On the margins in auto, you talked about the supplier incentive being down as well as the negative mix. Could you kind of bucket those and I guess from a supplier standpoint, I'm hearing a lot across the board, people trying to get their inventory levels down, have you taken within your total inventories, the auto content down and maybe if you could just sort of, within the margin, talk about how much is lower incentive versus lower margin mix?

Yeah. Bret, I’ll answer that in two ways. One is specifically to automotive margins, which were down 120 basis points in the quarter. I would say three predominant factors that have equal weight. One would be the lower rebates. The other would be the lower organic sales that we had planned for better organic sales. And then the other would be the SG&A, which is not only the leverage issue, but it’s some of the costs we pointed out, be it IT, digital, wage pressures. I mean, look, automotive headcount is flat, but when you layer in the wage pressures, the cost of insurance benefits, that’s weighing on there and the other thing in SG&A that we’ve called out is the delivery, the freight, the diesel feel. That really wasn't anticipated. There was definitely some spikes up related to some supply issues and the hurricanes and for us, the cost of delivery was a factor and so that’s the automotive margins. And then just when you look at the total gross profit in the quarter, we were down 46 basis points. 20 of that was related to the volume incentive in rebates and that's a combination of automotive and office.

Was there any AAG expense in the auto and the SG&A in the quarter?

No, the cost that we called out, the 18.5 million is all in the corporate expense, other line and none of it flowed through the operating margins.

Okay. And since you said the word hurricane, what do you think you lost to the hurricanes in the quarter?

Well, from a sales standpoint, it’s half a point. And that’s pretty representative across all four of our segments. It was a little bit higher in industrial and there is an impact on the profit side as well. So, we believe that was probably a penny or two in the quarter as it relates to that, but definitely a half a point on the sales.

But, Bret, we haven't been through these before our expectations and especially in the Southwest and our guys in the Southwest were obviously overwhelmed with Hurricane Harvey, the guys in the Southeast were -- we think we lost a couple of points in the Southeast with Irma. We do expect we'll see a snapback. Now, how quickly that comes, exactly when that comes, we think it will be in the fourth quarter, but we do expect there will be a little bit of a snapback. We sold a lot of generators, supplies, mops, brooms, buckets, bottled water, et cetera, but we would hope to see some hard parts bouncing back in Q4 as folks recover.

And Bret, I don’t think I answered your inventory question for automotive. Primarily, our industrial business has made the improvement in inventory, but I would tell you sequentially from Q2 to Q3, automotive did take some inventory out of the system. So, there is more work to be done there, but we are keeping a mindful eye on the level of inventory and as it relates to these volume incentives.

And we’ll go next to Scot Ciccarelli with RBC Capital Markets.

Another couple of auto margin questions actually. You guys just talked about roughly equal impacts from rebates and spending and deleverage, would you expect all those pressures to kind of continue on a go forward basis or why wouldn’t they continue, number one. Number two, are you guys starting to see a more competitive environment on the pricing front. Historically, this industry hasn’t experienced that, but just given the magnitude of margin swing, which is bigger than what we've seen in the last decade pretty much, just trying to figure out if there's something else that we need to be aware of. Thanks.

Yeah. I'll start with this and then I’ll let Paul comment on the pricing side. As it relates specifically to some of the things we’ve called out, factored into our guidance, the $0.15 lowering guidance, we have contemplated some similar numbers as it relates to the volume incentives for the rest of the year as well as some of this SG&A pressure, because I don't think that's going to alleviate too quickly. Having said that, and Paul mentioned this, we're now moving to some further steps that need to be taken. So, while we had made changes related on having a level of comparable sales, since we're not there, we're going to kind of the next set of changes. So it takes us a couple of quarters to come out, but I think the volume incentives, certainly that would be assumed to recur and that's what factored into our guidance adjustments.

Scot, relative to market pricing pressures, I can tell you that, as it has been in recent years, the pricing atmosphere across the automotive aftermarket is pretty stable and pretty famed fortunately. As we look at our primary competitors, there has not been folks out there trying to lead with price. With that said, I will tell you that internally, we are reviewing our pricing approach, our approach to pricing in the market. One of the things that we've -- our team has begun to implement is looking at zone pricing, which is not new for most retailers, but it is new perhaps for NAPA. So that is something that we are in the process of implementing and we believe will have a positive impact on our overall margins.

I appreciate that. I guess what I was just trying to think through is, one of the concerns industry, you guys are aware of this, is pricing transparency, given kind of the online competition. I know you guys effectively sell a private label product. Are there any concerns that pricing transparency where you do see stuff, margins maybe 15% to 20% less at an online competitor as opposed to an automotive specialist could wind up creating that price pressure, just broadly for the environment?

Yeah. Listen, I've Scot, am I -- are we concerned? Sure, we're concerned and it's something that we pay very, very close attention to. I will tell you I had the privilege of sitting through a session last week, we had eight of our largest and best NAPA auto care centers here in the building and so our folks coming in and talking to these folks about online pricing and what they see in the marketplace, sure, they are. Is it driving their decision making in terms of how they're pricing their job? They're not. And so, is it a concern? It is. But, do we believe that the pricing transparency is having a negative impact on our margins? We don't think so at this point.

And Scot, one other thing I’d mention that we didn’t really talk about, the product mix in the quarter for automotive, Paul mentioned the categories that performed well, be it tools and equipment, batteries, rotating electrical, those are typically at lower gross margin. The ones that didn't perform as well under car heating and cooling that relates to weather the mild winters or the mild summers, those are more the higher gross margins. So we did have some mix shift in our gross margin for automotive in the quarter. Hard to say what that’s going to be in Q4, but that's not necessarily indicative of online issues.

We'll go next to Chris Bottiglieri with Wolfe Research.

Just wanted to talk about the difference between DIFM and DIY, can you maybe just provide a little commentary on, because I know obviously a lot of it’s a self help, you’re kind of just low base, but you’re also kind of resetting the stores, so can you maybe talk about the DIY performance of the stores you aren’t resetting and kind of where you think industry trends are in DIY? And then I have a related follow-up.

Yeah. So you hit on it exactly, Chris. We certainly think that we are outpacing the rest of the industry and that's largely due to the initiatives that we've spoken to over the last number of quarters on these calls. Our team has improved the look in 350 stores. We have another 150 slated for the balance of the year. The stores that we have reset, we are seeing high single digit increases in our retail business. Those stores, we have not reset, we are seeing mid-single digit to lower single digit increases. But the good news in our DIY business, our ticket count is up, our traffic count, so the number of tickets is up and again, I give credit to our team and the good job that they're doing in the field. We’re getting folks into our stores today that perhaps were not our shoppers in previous years.

Got you. Okay. And then kind of like more of an industry question. I would think DIFM is selling a younger car, the DIY, so wondering just like air pockets and lapping troughs are, is there, I guess, what is there a chance, like we’re seeing this first in DIFM, maybe that’s one reason why DIFM is slowing down a little bit harder quicker and then two, is it just something about DIY that’s in general where some of the product sales are less tied to vehicle age, just any thoughts there would be appreciated.

Well, I think your point is accurate. Chris. I think that trough that we've seen is absolutely impacting the DIFM. So, going back through the recession, ’08, ’09 and even believe into a little bit of ’10, whereas we would normally be seeing 17 million, 18 million vehicle counts coming into our sweet spot. They're coming in at a much reduced rate. So I absolutely believe that is impacting the DIFM side. And then when you look at, as it relates to DIY, when you have an average vehicle now on the road at 11.7 years, we're seeing and a lot of cars coming in, 13, 14, 15 year old vehicles that to your point they’re ending up coming into our stores and taking the DIY route more so than the DIFM route. So I think your point is valid.

Okay. And so I’m being highly greedy here, but just one critical question. For the Poland [ph] acquisition, was that included in your original estimate or is that going to be left technically now that you’ve pulled with it?

You’re talking about the earnings per share number that we gave you for 2018?

Yeah.

That assumed the Poland acquisition.

The Poland acquisition is in that [indiscernible].

It was.

We’ll go next to Matt Fassler with Goldman Sachs.

A couple of follow-up questions. First on automotive margins. One relates to whether you're seeing any trend between private label, which I think is the bulk of your volume at NAPA relative to brands, so whether that’s having any impact on margin and mix? And then also we’ve heard a lot about vendor incentives in industrial over the years, we’ve heard less about it in auto. If you could just kind of talk to us, is this a new innovation or is it just frankly that delta in your sales versus expectations that's leading us to hear a bit more about it here in 2017?

Yeah. Matt, I'll take the first part of that. I’ll let Carol touch on vendor incentives. As it relates to private label versus brand and the impact on margin, 90% of what we sell in the US stores, Matt, is NAPA branded products. We do sell OE parts through our acquisition we did a number of years ago through our all term business, but 90% of what we sell is private brand and we haven't seen a significant shift away from private label, from our NAPA brand into the OE brand. And as it relates to the vendor incentives, I’ll let Carol touch on that.

Yeah. Look, I would say in general, it’s a -- you're right, we talk more about it on the industrial side because it is a little bigger component of their margins. It’s not as large of a component on the automotive margins, but having said that, it's something that we factor in to our profitability each year and we do it based on achieving certain volume levels and purchasing levels. And as we again contemplated through the first six months, we expected stronger comparable growth for the second half and as we got into third quarter, our purchases were actually down something like 6%. So -- and again, we could have made a decision to go out and buy that inventory regardless of needing it to get those volume levels, but we're working hard on keeping that inventory down. So we just felt it was appropriate to adjust our rebate assumptions. Having said that, that's not anything new. It's more of a function of the lower organic sales. Now, I’d point out on the motion side, look, having a core growth of 3% to 4% on the industrial side and we’ve talked about their incentives over the years, all the improvements they’ve done, and you see what it does with leverage and you’re saying the 20 basis point improvement and that's not all just incentives and volume rebates. That's just the core business.

Understood. If I could ask a quick follow-up, actually in the office business. It sounds like that business is somehow on a bit of a shorter leash at this point, are you – is this business still part of your long term plans, at what point do you think you'll decide on that question?

Yeah. So Matt, as we've talked before in these calls and one on one meeting, look, we review every one of our businesses and we have four different businesses we go to market auto and industrial and of course office and electrical. And we review them all and we review all of our geographical regions as well and all need to meet the expectations that we have, both on the volume -- top line and bottom line. And in the past, we have -- as I think we've talked, we have moved away from businesses that failed to meet those expectations. All that said Matt, there is no intention at this point to move away from our office products business. We're in the midst of a multi-year diversification strategy and honestly, the growth that we're seeing in facilities, breakroom and safety, which is now, gosh, it's 35 plus percent of our overall business, we're seeing good -- we're seeing good movement and we're seeing good trends. The challenge that we have, it’s that core -- the core office supply business. And unfortunately, the growth we’re seeing in FPS is not, right now, is not able to make up for the decline we're seeing in the core. But I will tell you, just like all of our businesses that we watch and monitor very closely and we certainly expect our office group to step up just like all of our businesses. The last thing I would say Matt on office is, there has been a bit of a change in customer dynamics. So, one of the big, well, there is only two. So, one of the big players that went private is making certain procurement decisions, which has had an impact on the wholesalers as well. So yeah, we've got a number of challenges, but our team I believe is addressing them and I still am positive about the outlook going forward.

And we'll take our next question from Seth Basham, Wedbush.

Sorry to return to the question around auto margins, but just a little bit more clarity. In terms of the 120 basis point decline in EBIT margins, can you give us a little bit more sense of how much of it was gross versus SG&A de-leverage.

It was slightly more on the gross margin side than the SG&A side, because again what I mentioned was the rebates for them and then the lower organic growth and then we had some product mix shift. So a little bit more so on gross margin than SG&A.

Got it. That's helpful. And in terms of the performance of independent versus company-owned stores in the US, was there much difference?

No, not really, Seth. Our flat comp that we saw across the business in the quarter was pretty consistent, both with our independence and our company-owned stores as well. So not a big variance there.

Got it. And then lastly, as it relates to your thought process around store and facility closures, how are you thinking about that if at all differently now in the auto segment based on the sluggishness that you've seen over a number of quarters?

So, Seth, let me take that in two parts. From a distribution center standpoint, we've got a vast distribution network, 47 DCs here in the US. We've got, I’m sorry, 57 DCs here in the US, sorry. I’m thinking about one of the other businesses. We've got a number in our other markets as well. So one of the things that we're evaluating is our distribution center infrastructure. We've added a third-party that we're working with to really help us evaluate whether our go to market strategy today is the absolute most efficient for our business. So that's under review. As it relates to our stores, Seth, there's nothing new there. We are, I mean, through our history, we are constantly opening and closing stores, underperforming stores in markets throughout the US and that hasn't changed any and I don't see that changing going forward, but we close, gosh, we’ll close 100 stores a year and we'll open 100 stores. Actually, this year, we’ll surpass that number. So that’s nothing new for us.

Got it. If I could sneak one last one in, just regarding service levels. So margins in auto were soft. You said, there wasn't any change in the pricing environment, but is there a change in the service level environment, in other words, are you adding more services, whether it be quicker deliveries, et cetera to try to drive sales in the past just leading to some SG&A pressure.

No. There's been no major shift in our service proposition that we provide our customers, Seth. We think that going back to our vast distribution center network with our 6000 stores, we deliver to our stores every night and we'll hotshot to our stores and our independent owners during the course of the day. So we have not -- we certainly have not pared back on any of our services that we provide our customers and we don't see that in the cards going forward either.

And with no additional questions, I'd like to turn the call back to management for additional comments or closing remarks.

We like to thank you for your participation in today's call. We appreciate your support and your interest in Genuine Parts Company and we look forward to reporting out at our next quarter Thank you.

That does conclude our call for today. Thank you for your participation. You may disconnect at this time.