UNITED STATESSECURITIES AND EXCHANGE COMMISSIONWashington, D.C. 20549
FORM 10-Q
GENUINE PARTS COMPANY
Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No o
Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). Yes x No o
Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of June 30, 2004.
174,992,788
PART 1 — FINANCIAL INFORMATION
Item 1 — Financial Statements
GENUINE PARTS COMPANY and SUBSIDIARIESCONDENSED CONSOLIDATED BALANCE SHEETS
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GENUINE PARTS COMPANY AND SUBSIDIARIESCONSOLIDATED STATEMENTS OF INCOME(Unaudited)
See notes to condensed consolidated financial statements.
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GENUINE PARTS COMPANY AND SUBSIDIARIESCONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS(Unaudited)
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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
Note A — Basis of Presentation
The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with the instructions to Form 10-Q and therefore do not include all information and footnotes necessary for a fair presentation of financial position, results of operations and cash flows in conformity with accounting principles generally accepted in the United States. Except as disclosed herein, there has been no material change in the information disclosed in the notes to the consolidated financial statements included in the Annual Report on Form 10-K of Genuine Parts Company (the “Company”) for the year ended December 31, 2003. Accordingly, the quarterly condensed consolidated financial statements and related disclosures should be read in conjunction with the 2003 Annual Report on Form 10-K.
The preparation of interim financial statements requires management to make estimates and assumptions for the amounts reported in the condensed consolidated financial statements. Specifically, the Company makes estimates in its interim financial statements for the accrual of bad debts, certain inventory adjustments and volume rebates earned. Bad debts are accrued based on a percentage of sales and volume rebates are estimated based upon cumulative and projected purchasing levels. Inventory adjustments are estimated on an interim basis and adjusted in the fourth quarter to reflect year-end valuation and book to physical results. The estimates for interim reporting may change upon final determination at year-end, and such changes may be significant.
In the opinion of management, all adjustments necessary for a fair statement of income for the interim period have been made. These adjustments are of a normal recurring nature. The results of operations for the quarter and six months ended June 30, 2004 are not necessarily indicative of results for the entire year.
Note B — Segment Information
Net sales by segment exclude the effect of certain discounts, incentives and freight billed to customers. The line item “other” represents the net effect of the discounts, incentives and freight billed to customers, which is reported as a component of net sales in the Company’s consolidated statements of income.
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Note C — Comprehensive Income
Total comprehensive income was $192,555,000 and $207,214,000 for the six month periods ended June 30, 2004 and 2003, respectively. The difference between total comprehensive income and net income was due to foreign currency translation adjustments and adjustments to the fair value of derivative instruments, as summarized below (in thousands):
Comprehensive income for the three months ended June 30, 2004 and 2003 totaled $97,160,000 and $118,567,000, respectively.
Note D — New Accounting Pronouncements
In January 2003, the Emerging Issues Task Force (“EITF”) of the Financial Accounting Standards Board (“FASB”) issued EITF Issue No. 02-16, Accounting by a Customer (Including a Reseller) for Certain Consideration Received from a Vendor (“EITF 02-16”). EITF 02-16 addresses accounting and reporting issues related to how a reseller should account for cash consideration received from vendors. Generally, cash consideration received from vendors is presumed to be a reduction of the prices of the vendor’s products or services and should, therefore, be characterized as a reduction of cost of sales when recognized in the customer’s income statement. However, under certain circumstances, this presumption may be overcome and recognition as revenue or as a reduction of other costs in the income statement may be appropriate. The Company, in certain circumstances, included funds of this type in SG&A. Under the new method, vendor allowances for advertising and catalog related programs are generally considered a reduction in cost of goods sold. On January 1, 2003, the Company adopted EITF No. 02-16 and recorded a non-cash charge of $19.5 million, net of a $13.6 million tax benefit ($.12 and $.11 per basic and diluted share, respectively) related to the capitalization of certain vendor consideration as part of inventory cost.
In January 2003, the FASB issued Interpretation No. 46 (“FIN 46”), Consolidation of Variable Interest Entities, an Interpretation of ARB No. 51. FIN 46, as revised in December 2003, requires certain variable interest entities to be consolidated by the primary beneficiary of the entity if the equity investors in the entity do not have the characteristics of a controlling financial interest or do not have sufficient equity at risk for the entity to finance its activities without additional subordinated financial support from other parties. FIN 46 is effective for all new variable interest entities created or acquired after January 31, 2003. For variable interest entities created or acquired prior to February 1, 2003, the provisions of FIN 46 must be applied no later than December 31, 2003 for entities meeting the definition of special-purpose entities, and no later than fiscal periods ending after March 15, 2004 for all other entities under consideration.
In connection with the adoption of FIN 46, in June 2003, the Company’s construction and lease facility was amended. Subject to the amendment, FIN 46 did not change the Company’s accounting for the construction and lease facility. This construction and lease facility, expiring in 2008, contains residual value guarantee provisions and other guarantees which would become due in the event of a default under the operating lease agreement or at the expiration of the operating lease agreement if the fair value of the leased properties is less than the guaranteed residual value. The maximum amount of the Company’s potential guarantee obligation at June 30, 2004 is approximately $84,970,000. The Company believes the likelihood of funding the guarantee obligation under any provision of the operating lease agreement is remote. In addition to the construction and lease facility, the Company has relationships with entities that are required to be considered for consolidation under FIN 46. Specifically, the Company guarantees the borrowings of certain independently controlled automotive parts stores (“independents”) and certain other affiliates in which the Company has a minority equity ownership interest (“affiliates”). Presently, the independents are generally consolidated by an unaffiliated enterprise that has a
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controlling financial interest through ownership of a majority voting interest in the entity. The Company has no voting interest or other equity conversion rights in any of the independents. The Company does not control the independents or the affiliates, but receives a fee for the guarantee. The Company has concluded that it is not the primary beneficiary with respect to any of the independents and that the affiliates are not variable interest entities. The Company’s maximum exposure to loss as a result of its involvement with these independents and affiliates is equal to the total borrowings subject to the Company’s guarantee. At June 30, 2004, the total borrowings of the independents and affiliates subject to guarantee by the Company were approximately $170,000,000. These loans generally mature over periods from one to ten years. In the event that the Company is required to make payments in connection with guaranteed obligations of the independents or the affiliates, the Company would obtain and liquidate certain collateral (e.g. accounts receivable and inventory) to recover all or a portion of the amounts paid under the guarantee. To date, the Company has had no significant losses in connection with guarantees of independents’ and affiliates’ borrowings.
Note E — Stock Options
As more fully disclosed in Note 7 of the Company’s notes to the consolidated financial statements in the 2003 Annual Report on Form 10-K, the following table illustrates the effect on net income and earnings per share if the fair value based method had been applied to all outstanding and unvested awards in each period (in thousands, except per share amounts):
Beginning on January 1, 2003, the Company began prospectively accounting for all future stock compensation awards in accordance with the fair value method of SFAS 123, Accounting for Stock-Based Compensation (“SFAS 123”). The adoption of the preferred recognition provisions of SFAS 123 is not expected to have a material impact on the Company’s financial position or results of operations in 2004, and the effect on periods thereafter, while entirely dependent on the terms of future stock compensation awards, is not expected to be significant.
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Note F — Employee Benefit Plans
Net periodic pension cost included the following components for the three months ended June 30:
Net periodic pension cost included the following components for the six months ended June 30:
Pension benefits also include amounts related to a supplemental retirement plan.
The Medicare Prescription Drug Improvement and Modernization Act of 2003 (the “Act”) was signed December 8, 2003 to make additional voluntary benefits available through Medicare. As permitted by Financial Staff Position No. FAS 106-1, the Company has not yet recognized the effects of the Act in the financial statements and accompanying notes. The Company is evaluating the implications of the Act and will recognize the expected financial effects in the quarter ending September 30, 2004, as prescribed by Financial Staff Position No. FAS 106-2.
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Item 2.
Management’s Discussion and Analysis of Financial Condition and Results of Operations
The following discussion should be read in conjunction with the December 31, 2003 consolidated financial statements, accompanying notes, related information and Management’s Discussion and Analysis of Financial Condition and Results of Operations included in our Form 10-K filed for the year ended December 31, 2003, and the June 30, 2004 consolidated financial statements and accompanying notes.
Overview
Genuine Parts Company is a service organization engaged in the distribution of automotive replacement parts, industrial replacement parts, office products and electrical/electronic materials. The Company has a long tradition of growth dating back to 1928, the year we were founded in Atlanta, Georgia. In the second quarter of 2004, business was conducted throughout the United States, in Canada, and in Mexico from approximately 1,800 locations.
The Company recorded consolidated net income of $101 million for the three months ended June 30, 2004, compared to a net income of $90 million in the same period last year, an increase of 12%. For the six months ended June 30, 2004, we recorded consolidated net income of $201 million, a 13% increase compared to $179 million recorded in the previous year before the cumulative effect adjustment relating to accounting for vendor cash consideration in 2003 as discussed below. After the cumulative effect adjustment in 2003, net income for the six months ended June 30, 2004 was up 27% from $159 million in the same period of 2003.
On January 1, 2003, the Company adopted the provisions of Financial Accounting Standards Board Emerging Issues Task Force’s Issue No. 02-16 (“EITF 02-16”), related to the accounting treatment of cash consideration received from vendors, resulting in a non-cash charge of $19.5 million recorded as a cumulative effect of a change in accounting principle. This encompasses certain advertising and promotional allowances, catalog support and other cash support arrangements that normally exist among retailers and distributors with their vendors. The Company historically classified certain advertising vendor monies received as a component of SG&A. Under the new method, these vendor monies must be classified as cost of goods sold and a portion of the amounts must be capitalized into ending inventory.
The results in all of our industry groups for each of the last three years ending in 2003 had been affected by the slow economy, with the impact being greatest for Motion Industries and EIS due to the conditions in the manufacturing sectors of the economy. The Company has countered this impact with the introduction of new product lines, sales to new markets and cost savings initiatives, among other things. For the three and six month periods ended June 30, 2004, we believe the market conditions showed signs of improvement and we continued to focus on our marketing plans and sales initiatives. As a result, we were able to report improved performance for these periods in 2004.
Critical Accounting Estimates
The preparation of the financial statement information contained herein requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenue and expenses, and related disclosure of contingent assets and liabilities. Management bases its estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions.
An accounting policy is deemed to be critical if it requires an accounting estimate to be made based on assumptions about matters that are highly uncertain at the time the estimate is made, and if different estimates that reasonably could have been used, or changes in the accounting estimates that are reasonably likely to occur periodically, could materially impact the financial statements. Information with respect to the Company’s critical accounting policies which the Company believes could have the most significant effect on the Company’s reported results and require subjective or complex judgments by management is contained in Item 7, Management’s Discussion and Analysis of Financial Condition and Results of Operations, of the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2003. Management believes that as of June 30, 2004, there have been no material changes to this information.
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Sales
Sales for the second quarter of 2004 were $2.30 billion, up 7% over the same period in 2003. Each of our four business units recorded sales increases for the period and sales at Motion Industries, the Industrial Products Group, and EIS, the Electrical/Electronic Materials Group, were especially strong. For the six months ended June 30, 2004, sales were $4.49 billion compared to $4.17 billion for the same period last year, an increase of 8%. The Company’s sales growth is attributed to our internal growth initiatives across all our businesses, as well as by improving economic conditions.
Sales for the Automotive Group increased 4% in the second quarter of 2004 and for the six months ended June 30, 2004 sales increased 7% compared to last year. In addition to our internal efforts, we believe that improved demographics and the improving economy have favorably affected the automotive aftermarket. The Industrial Products Group increased sales by 11% in the second quarter and for the year sales are up 9% compared to 2003. Likewise, sales for the Electrical/Electronics Group were up 17% in the second quarter compared to last year and up 14% through the six months ended June 30, 2004. Both of these groups serve the manufacturing sector, which is currently experiencing a strong recovery from earlier periods. Sales for the Office Products Group were up 5% in the second quarter of 2004 and year to date are up 6% compared to sales for the six months ended June 30, 2003. We attribute this group’s consistent revenue growth to their continued enhancement of product offerings and an increased demand for core business products.
Cost of Goods Sold/Expenses
Cost of goods sold for the second quarter of 2004 was $1.60 billion compared to $1.50 billion for the same period in 2003. As a percent of sales, cost of goods sold increased slightly from 69.74% to 69.84% for the three months ended June 30, 2004. For the six months ended June 30, 2004, cost of goods sold was $3.11 billion compared to $2.88 billion last year and as a percent of sales increased from 69.11% to 69.30%. The increases for the three and six month periods ended June 30, 2004 reflect the impact of shifts in product and customer mix, and pricing pressures.
Selling, administrative and other expenses of $529.1 million improved to 23.03% of sales for the second quarter of 2004 compared to 23.38% for the same period last year. For the six months ended June 30, 2004, these expenses totaled $1.05 billion and improved to 23.44% of sales compared to 23.87% for the same period in 2003. The decrease in SG&A expenses reflects the measures taken to control costs in each of our businesses.
Operating Profit
Operating profit as a percentage of sales was 8.0% for the second quarter of 2004 compared to 7.9% for the same period in 2003. For the six months ended June 30, 2004, operating profit as a percentage of sales was 8.3% compared to 8.1% for the same period of the previous year. The overall improvement in operating profit margin for the quarter and six months can be attributed to the increase in revenues in each of our business segments as well as improvements in selling, administrative and other expenses.
The Automotive Group’s operating profit increased 5% compared to the second quarter last year, and their operating profit margin of 9.0% was up slightly compared to the second quarter of 2003. For the six months ended June 30, 2004, the group’s operating profit increased 8% and their operating profit margin improved to 8.6% from 8.5% for the same period last year. The Industrial Group had a 15% increase in operating profit compared to the second quarter of 2003, and the operating profit margin for this group improved to 6.1% for the second quarter. Operating profit increased 10% for the six months ended June 30, 2004 compared to 2003 and their operating profit margin was up slightly from last year to 6.8%. For the three and six month periods ended June 30, 2004, the Office Products Group’s operating profit increased 4% and 5%, respectively. Their operating profit margins were 8.8% in the second quarter and 10.1% for the six months ended June 30, 2004, reflecting no change from the same periods in 2003. The Electrical /Electronic Materials Group increased their operating profit for the second quarter to $4.3 million from $1.9 million in the second quarter of 2003, and their operating profit margin improved to 5.0% compared to 2.6% in the same period in 2003. For the six months ended June 30, 2004, the group increased their operating profit to $7.5 million from $3.5 million for the same period last year, and their operating profit margin improved to 4.5% from 2.4% for the six months ended June 30, 2003.
Net Income
Net income was $101 million and $201 million for the three and six month periods ended June 30, 2004, respectively, compared to a net income of $90 million and $179 million in the same periods last year, before the cumulative effect adjustment in 2003 previously discussed above. Earnings per share, assuming dilution, were $.58 for the second quarter of 2004 compared to $.52 for the same period of the previous year, and for the six months were $1.15 in 2004 compared
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to $1.02 in 2003 before the accounting change. After the cumulative effect adjustment in 2003, net income for the six months ended June 30, 2004 was up 27% from $159 million and diluted earnings per share were up 26% from $.91 in the same period of 2003.
Income Taxes
The effective income tax rate was 38.3% for the current quarter and the six months ended June 30, 2004, and the effective income tax rate was 39.1% for the same periods in 2003. The decrease in 2004 is primarily due to lower state income taxes and the utilization of foreign tax credits.
Financial Condition
The major balance sheet categories were relatively consistent with the December 31, 2003 condensed consolidated balance sheet. Cash balances increased $112.3 million from December 31, 2003, due primarily to increased revenues and collections, stock option exercises, and better inventory management. Accounts receivable increased $88.9 million and remains consistent with the Company’s overall sales increase. Prepaid expenses declined approximately $65.6 million, primarily due to the collection of accrued receivables in 2004. Other assets increased $21.9 million from December 31, 2003, due primarily to the Company’s increased annual pension contribution. Accounts payable increased by $66 million due to the Company’s increased purchases associated with increased sales volume, as well as increases in payment terms with certain vendors. The Company’s long-term debt is discussed in detail below.
Liquidity and Capital Resources
The Company’s total debt decreased $50 million from December 31, 2003 to June 30, 2004 primarily due to cash generated from increased revenues and collections, stock option exercises and better inventory management. The Company reclassified a $125 million note due in 2010 to current as the Company intends to pay the amount in full during 2004. This reclassification resulted in an increase in current debt and an offsetting reduction in long-term debt.
The Company manages its exposure to changes in short-term interest rates, particularly to reduce the impact on its floating-rate term notes, by entering into interest rate swap agreements. The Company has interest rate swaps with fair values of approximately $11.6 million and $5.8 million outstanding as of December 31, 2003 and June 30, 2004, respectively. The decrease in fair values since December 31, 2003 is primarily due to the termination of one $50 million notional interest swap and the normal settlement of monthly payments due on swaps during the six months ended June 30, 2004. At June 30, 2004, the Company had one $50 million notional interest rate swap agreement outstanding with a maturity date of 2008. In addition, at June 30, 2004, approximately $500 million of the Company’s total borrowings, of which $250 million matures November 2008 and $250 million matures November 2011, are at fixed rates of interest.
The ratio of current assets to current liabilities is 3.0 to 1 and the Company’s cash position is excellent. The Company believes existing lines of credit and cash generated from operations will be sufficient to fund future operations.
Contractual Obligations
There have been no material changes to obligations and/or commitments since year-end. Purchase orders or contracts for the purchase of inventory and other goods and services are not included in our estimates. We are not able to determine the aggregate amount of such purchase orders that represent contractual obligations, as purchase orders may represent authorizations to purchase rather than binding agreements. Our purchase orders are based on our current distribution needs and are fulfilled by our vendors within short time horizons. The Company does not have significant agreements for the purchase of inventory or other goods specifying minimum quantities or set prices that exceed our expected requirements.
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Item 3.
Quantitative and Qualitative Disclosure of Market Risk
The information called for by this item is provided elsewhere herein and under Item 7A in the Company’s Form 10-K for the year ended December 31, 2003. There have been no material changes in market risk from the information provided under Item 7A in the Company’s 10-K for the year ended December 31, 2003.
Forward-Looking Statements:
Statements in this report constitute forward-looking statements that are subject to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. The Company cautions that its forward-looking statements involve risks and uncertainties. The Company undertakes no duty to update its forward-looking statements, which reflect the Company’s beliefs, expectations, and plans as of the present. Actual results or events may differ materially from those indicated as a result of various important factors. Such factors include, but are not limited to, changes in general economic conditions, the growth rate of the market for the Company’s products and services, the ability to maintain favorable supplier arrangements and relationships, competitive product and pricing pressures, including internet related initiatives, the effectiveness of the Company’s promotional, marketing and advertising programs, changes in laws and regulations, including changes in accounting and taxation guidance, the uncertainties of litigation, as well as other risks and uncertainties discussed from time to time in the Company’s filings with the Securities and Exchange Commission. Readers are cautioned that other factors not listed here could materially impact the Company’s future earnings, financial position and cash flows. You should not place undue reliance upon forward-looking statements contained herein, and should carefully read other reports that the Company will, from time to time, file with the Securities and Exchange Commission.
Item 4.
Controls and Procedures
As of the end of the period covered by this report, an evaluation was performed under the supervision and with the participation of the Company’s management, including the Chief Executive Officer (CEO) and Chief Financial Officer (CFO), of the effectiveness of the design and operation of the Company’s disclosure controls and procedures. Based on that evaluation, the Company’s management, including the CEO and CFO, concluded that the Company’s disclosure controls and procedures were effective to provide reasonable assurance that information required to be disclosed in the Company’s reports under the Securities Exchange Act of 1934 (Exchange Act) is recorded, processed, summarized, and reported within the time periods specified in the SEC’s rules and forms, and that such information is accumulated and communicated to the Company’s management, including the CEO and CFO, as appropriate, to allow timely decisions regarding disclosure. There have been no significant changes in the Company’s internal controls over financial reporting or in other factors during or subsequent to the end of the period covered by this report that have materially affected, or are reasonably likely to materially affect, the Company’s internal controls over financial reporting.
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PART II — OTHER INFORMATION
Item 2. Changes in Securities, Use of Proceeds and Issuer Purchases of Equity Securities
The following table provides information about the purchases of shares of the Company’s common stock during the three month period ended June 30, 2004:
On April 19, 1999, the Board of Directors authorized the repurchase of 15 million shares, and such repurchase plan was announced April 20, 1999. The authorization for this repurchase plan continues until all such shares have been repurchased, or the repurchase plan is terminated by action of the Board of Directors. There were no other publicly announced plans outstanding as of June 30, 2004.
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Submission Of Matters To A Vote Of Security Holders
Item 6. Exhibits and Reports on Form 8-K
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
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