Genuine Parts Company (GPC) — Q4 2018 Earnings Call Transcript

Good morning, and thank you for joining us today for the Genuine Parts Company fourth quarter 2018 conference call to discuss our earnings results and outlook for 2019. I'm here with Paul Donahue, our President and Chief Executive Officer; and Carol Yancey, our EVP and Chief Financial Officer. Before we begin this morning, please be advised that this call may include certain non-GAAP financial measures, which may be referred to during today's discussion of our results as reported under Generally Accepted Accounting Principles. A reconciliation of these measures is provided in the earnings press release issued this morning, which is also posted in the Investors section of our website. Today's call also 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, including this morning's press release. The company assumes no obligation to update any forward-looking statements made during this call. Now let me turn the call over to Paul.

Thank you, Sid, and let me add my welcome to our fourth quarter 2018 conference call. We appreciate you taking the time to be with us this morning. Earlier today, we released our fourth quarter and full-year 2018 results. I will make a few remarks on our overall performance and then cover the highlights across our businesses. Carol Yancey, our Executive Vice President and Chief Financial Officer, will provide an update on our financial results and our current outlook for 2019. After that, we'll open the call to your questions. We were pleased to build on our prior progress in 2018 and report another solid quarter of improved results. For the second consecutive quarter, each of our three business segments grew their revenues with positive core sales comparisons, combined with the added benefit of our accretive acquisitions. We further improved our operating results with a 30 basis point increase in total operating margin. These results led our team to produce record sales and earnings for 2018 as well as improve our working capital position and generate strong cash flows. To recap, total GPC sales in the fourth quarter were $4.6 billion, a 9.4% increase from 2017, driven by a 0.6% comp sales increase and a 6% benefit from strategic acquisitions, net of a 1.2% negative impact from foreign currency translation. The 4.6% increase in comp sales reflects our strongest growth in 2018, up from the 4.3% increase in the third quarter, plus a 3.4% increase in the second quarter and a 2% increase in the first quarter. Net income in the fourth quarter was $187 million, and earnings per share were $1.27. Excluding the impact of transaction and other costs, as we covered in our press release, adjusted net income was $198 million or $1.35 per share, up 13% from the adjusted earnings per share in 2017. For the year, total sales were record $18.7 billion, a 14.9% increase compared to 2017. Net income was $810 million and EPS was $5.50. Before the impact of transaction and other costs, adjusted net income was $836 million and adjusted earnings per share, $5.68, a 21% increase on a comp basis to 2017. Turning to a review of our business segments, sales at our Global Automotive Group were up 11.4% in the fourth quarter, including a 3.8% comp sales increase and the benefit of acquisitions, less the unfavorable foreign currency translation of approximately 2%. We are encouraged by the sequential improvement in our Global Automotive comp sales growth, which was up from a 3.3% increase in the third quarter, a 2.1% increase in the second quarter, and a 1.5% increase in the first quarter of 2018. We would add that operations in each of our regions, including North America, Europe, and Australasia, contributed to the improved fourth quarter sales comp. In our U.S. Automotive division, sales were up 4% in the fourth quarter, with comp sales accounting for most of that at 3.3%. This was in line with our 3.2% comp sales increase in the third quarter and reflects solid execution of our sales initiatives, sound fundamentals for the aftermarket and generally favorable weather conditions which drove improved demand for much of the year. Following a cold winter in early 2018, the U.S. experienced a hot summer and warmer than average temperatures for most of the third quarter. This was followed by an early cold snap in October and November, producing the coldest November in over 27 years, while December was impacted by warmer than normal temperatures and heavy rainfall in many regions of the U.S. Our fourth quarter sales increase was driven by positive growth with both our commercial and retail customers. Sales to the commercial segment, which represents 75% to 80% of our total U.S. Automotive sales, outpaced our retail sales for the second consecutive quarter, as sales to our NAPA AutoCare customers were strong at plus 3.8% for the quarter. NAPA AutoCare, an industry-leading commercial program for our automotive business and a key sales driver for us, had over 18,000 members in 2018. To that end, we are pleased with the improved numbers our team is driving through our NAPA AutoCare segment and we remain confident that the improving trend will carry over into 2019. We're also pleased to report continued progress with our major account partners, as sales to this group improved in the fourth quarter. We expect to see this positive trend continue in the quarters ahead due to our ongoing and extensive efforts to meet and exceed both the product and service demands of these national and regional customers. In our retail business, we continue to deliver positive sales comps due to initiatives such as the NAPA Rewards Program, now 9.4 million members strong and growing, expanded store hours across our network and our retail impact store project. In 2018, we completed the rollout of the retail impact initiative in our company-owned stores and we're pleased that these stores continue to outpace the sales growth of our non-impact traditional stores. We also began implementing this initiative with our independently owned stores in 2018 and we'll continue this rollout over a multi-year process to drive additional retail sales across the NAPA network. In summary, our U.S. Automotive team delivered a solid fourth quarter, and for the year, this group produced 4% sales growth. We are pleased to see the momentum built throughout the year and expect this to continue into 2019. Turning to 2019, we entered the new year with Kevin Harrington as President of the U.S. Automotive Operations. Kevin is a 29-year NAPA veteran with significant leadership experience and a deep knowledge of the automotive aftermarket, and we're excited to have him lead the U.S. Automotive team into the future. We further bolstered our North American automotive business with the addition of Scott Sonnemaker, who joined the company earlier this month as Group President, North American Automotive. In this key role, he will streamline the automotive structure and further our global focus. Scott has responsibility for all aspects of the automotive business in the U.S., Canada, and Mexico. Scott is a seasoned executive in the distribution industry, having spent over 20 years in leadership roles at Sysco Foods. We're excited to have Scott on board and lead our efforts to maximize the future growth of this important segment of the company. Rounding out our North American automotive operations, total sales were up mid-single digits for both NAPA Canada and in Mexico before the negative impact of foreign currency translation. In Canada, we continue to drive our core sales growth with the solid execution of our sales initiatives and continue to benefit from our creative tuck-in acquisitions which have expanded our Canadian presence. Our leadership team in Canada is also doing a fine job of improving their operating results and we expect another solid year in Canada in 2019. In Mexico, we have operated for the last several years under two banners, Autototo, our legacy business model in Mexico, and NAPA Mexico. We launched our NAPA initiative in 2014 to operate in sync with our U.S. and Canadian NAPA operations. Our long-term strategy has been to move to one banner in Mexico. To that end, we have entered into an agreement to phase out the Autototo business effective March 1, 2019. Autototo represents approximately $100 million in annual automotive revenues and was not a significant contributor to our overall profitability. We're excited to move forward with a greater focus on NAPA Mexico and the growth opportunities we see to expand our sales, market share, and growing our NAPA footprint in Mexico. In Europe, we celebrated the one-year anniversary of the AAG acquisition in November of 2018, and in both the fourth quarter and full year, this business produced solid sales and operational results across its European footprint. This is especially encouraging in light of the unusually mild weather in many regions of Europe during the fourth quarter, as well as the continued political unrest in France and ongoing Brexit concerns in the UK. All in all, the AAG team remains focused on finishing the year strong, producing mid-single-digit comp sales increases driven by positive growth in each region. Additionally, AAG's ongoing acquisitions favorably impacted our sales in Europe, with TMS Motor Spares, acquired on August 31, and Platinum, acquired on October 2, having an especially positive impact in the UK. As you may recall, TMS is the leading automotive parts distributor based in Carlisle, England, with seven locations there and 17 locations in Scotland. Platinum International Group, based in Manchester, England, is a value-added battery distributor with nine UK locations and one location in the Netherlands. We see additional opportunities for acquisitions in Europe and we are pleased to begin the year with the closing of the Hennig Group acquisition on January 8. Previously announced in 2018, Hennig Group is one of Germany's leading suppliers of vehicle parts with 31 branches across Germany and estimated annual revenues of $190 million. The addition of Hennig Group further expands our presence and scale in the German marketplace, and we're excited to have them join the AAG team. We are quite pleased with AAG's 2018 performance and positive contribution to GPC. Our strategic expansion into Europe required the right partner with a history of proven success and a vision for the future, and with AAG, we have that team in place. We enter 2019 excited to begin our second full year with the AAG team and are encouraged by the growth opportunities we see for our European operations. In Australia and New Zealand, we had another solid quarter with both total sales and comp sales up mid-single digits in local currency. Additionally, the AAG team did a fine job of converting this strong growth to improved fourth quarter operating results. Overall, 2018 proved to be another year in a series of strong performances by the AAG team and we expect this to continue into 2019. The economic growth in Australia is fairly robust and projected to remain strong. The favorable economy and sound aftermarket fundamentals, combined with the ongoing execution of our growth plans bode well for the continued growth of our Australasian automotive business. In summary, our Global Automotive Group posted solid results in the fourth quarter, and we move forward into 2019 with plans for digital sales growth and operational improvement. Now let's turn to our Industrial Parts Group, which continues to post progressive sales growth and improved operating results. Total fourth quarter sales for Industrial were $1.6 billion, an increase of 8.7%, including a 7% comp sales growth plus the benefit of acquisitions. This represents the second straight quarter of 7% sales comp, our strongest since 2014. It also continues our two-year run of consistent sales increases driven by the effective execution of our growth initiatives and the favorable economic and industry-specific factors which continue to benefit the industrial marketplace. These factors include industrial indicators such as purchasing managers index, manufacturing industrial production, active rig counts, and U.S. exports. A broad strength in the industrial marketplace is also evident in our product and industry sector sales performance. Again, this quarter, 14 of our major product groups posted sales gains, with especially strong results in safety products and industrial supplies, pumps, and pneumatics. Likewise, sales to 10 of the top 12 industries we serve were up as well, highlighted by double-digit increases in the iron and steel, chemicals and allied products, oil and gas extraction, and rubber and plastic industries. Our growth initiatives for Industrial include ongoing strategic acquisitions. The addition of Hydraulic Supply Company in the fourth quarter performed well and was accretive to our results. Last week, we also announced the acquisition of Axis New England, which we expect to close next month. Axis is a leading automation and robotics business with locations in Danvers, MA, and Rochester, New York. It further expands our capabilities in the area of industrial plant floor automation. Axis highlights our ongoing strategy to participate in the fast-growing automation space and further builds on our previous acquisitions. We look forward to having Todd Clark and his talented team join us as part of the Motion Automation Solution Group. We expect this business to generate estimated annual revenues of $55 million. We are proud of the Industrial team and their tremendous operating performance in 2018, and as we look ahead to 2019, we expect to build on last year's success under the leadership of Randy Breaux, the recently appointed President of Motion Industries. Randy is a tremendous leader with significant experience in the industrial manufacturing and distribution markets. We're excited to have Randy lead our talented Motion team into the future. In addition to our future growth prospects in North America, we are planning to expand our industrial footprint into Australasia in 2019 with the full purchase of Inenco. As a reminder, this Australian-based distribution company has operations in New Zealand as well as a growing presence in Indonesia and Singapore. GPC originally made a 35% investment in Inenco in 2017, and they have performed extremely well while growing both top and bottom line the last two years. We expect to be in a position to complete this acquisition at some point in calendar year 2019. Inenco's annual sales are approximately $400 million and is a great strategic fit with Motion, aligning well with our strategic supplier base and providing for a market-leading presence in Australasia, Indonesia, and Singapore. Now, a few comments about S.P. Richards, our Business Products Group. This segment reported total sales of $457 million, up $1.6 million for the fourth quarter, driven by the growth in comp sales. This represents a third consecutive quarter of sequential sales improvement for this business and follows a positive sales comp reported in the third quarter of 2018, the first positive comps since the third quarter of 2015. In addition, sales were up in three of our four product categories for the second straight quarter. These include core office supplies, technology and our facilities break room and safety supply category. It's also important to highlight that the S.P. Richards teams significantly improved their operating results in the fourth quarter, hosting a 270 basis point improvement in operating margin. This was an excellent way to finish the year, and we want to thank all of our S.P. associates for their great efforts. Today, S.P. Richards represents the only independent national business products wholesaler in the U.S., and we continue to believe that there is opportunity for this business to grow and deepen its relationship with both independent dealers and other customer channels. We will continue to invest in these growth opportunities where and when appropriate. So that recaps are consolidated and business segment results for the fourth quarter of 2018. We were pleased to report sales growth in each of our business segments and also show progress in our overall operating performance. Our team finished 2018 with positive momentum, which we will carry with us into 2019. With that, I'll hand it over to Carol for her remarks.

Thank you, Paul. We'll begin with a review of our key financial information and then we will discuss our full-year outlook for 2019. Our total sales of $4.6 billion in the fourth quarter were up 9.4%, driving gross margin of 33.5% compared to 30.5% in 2017. For the full year, our sales of $18.7 billion increased by 15% and our gross margin improved to 32% from 30% in the prior year. These comparisons reflect significant improvement in our 2018 gross margin due to several reasons. The Automotive and Industrial businesses have benefited from effective margin initiatives including ongoing negotiations with our global suppliers, more flexible and sophisticated pricing and digital strategies as well as a more favorable product mix. In addition, the higher gross margin model at AAG and other acquisitions has positively impacted our gross margin throughout the year. Specific to the fourth quarter, all three of our segments earned additional supplier incentives due to improved volumes and we also had the benefit of year-end inventory gains net of LIFO, which further improved our gross margin relative to 2017. With the continued emphasis on our margin initiatives, we expect our 2019 gross margin rates to remain relatively in line with our full-year 2018 rate. The same is reasonable in place and have 1% to 2% consistent levels of volume incentives. We experienced an inflationary pricing environment across each of our segments in 2018 with more normal inflation in our industrial and business products and more pronounced in automotive in the fourth quarter. Overall, we attribute much of the fourth quarter present inflation to the direct and indirect impact of tariffs, but we also had steady price increases for raw materials, commodities and supplier freight spread throughout the year. While the impact of tariffs was not significant in 2018, we passed on the supplier increases to our customers to maintain our gross margin. We expect this to continue in 2019. Our cumulative supplier price increases for the 12 months of 2018 were up 1.8% in Automotive, up 3.8% in Industrial and up 1.8% in office. Our selling, administrative and other expenses in the fourth quarter were $1.2 billion, representing 26.4% of sales. For the year, these expenses were $4.6 billion or 24.6% of sales. These operating costs were up from 2017 in both the quarter and the year due to several factors, including the impact of a higher cost model at AAG and other acquisitions, as we discussed earlier. In addition, increased investments in facilities and people in 2018 as well as rising costs in areas such as payroll, freight, delivery, IT, and cybersecurity also impacted our operations. Additionally, in 2017, we benefited from lower than expected year-end expenses in areas such as incentive compensation, legal and professional, and insurance. This made for a more difficult comparison in the fourth quarter of 2018. Our selling, administration, and other expenses on the income statement also include $17 million and $30 million for the fourth quarter and full year of 2018, respectively, in transaction and other costs primarily related to AAG and the attempted transaction to spin off the business products group, net of a favorable termination fee we received. In 2017, transaction and other costs primarily related to AAG were $25 million and $44 million for the fourth quarter and the full year. We account for these items on the other net line in our segment information schedule in today's press release. To improve on our operating expenses, we continue to work toward a lower-cost but highly effective infrastructure. Our plans include steps to accelerate the integration of our acquisitions, investments to enhance our productivity and supply chains, and innovative strategies to unlock greater savings and efficiencies across our global operations. Now let's discuss the results by segment. Our Automotive revenue for the fourth quarter was $2.6 billion, up 11% from the prior year, and their operating profit of $199 million was up 9%, with an operating margin of 7.7% compared to 7.9% in the fourth quarter of 2017. While we continue to improve our leverage on solid sales growth, this was offset by the increased investments in our facilities and people as well as rising costs in areas such as payroll and freight. Our Industrial sales for $1.6 billion in the quarter were a strong 9% increase from the fourth quarter of the prior year. Our operating profit of $131 million was up 12%, and their operating margin improved to a solid 8.3% from 8.1% last year, with a 20 basis point increase due to gross margin expansion and the ability to leverage their expenses on the strong sales growth. The Industrial business has been operating well now for eight consecutive quarters. Our Business Products revenues were $457 million, a 2% increase from the prior year, and their operating profit of $26 million was up significantly, driving a 5.7% operating margin, which is up from 3% in 2017. There's a tremendous business turnaround for the business products team. Our total company operating profit in the fourth quarter was up 14% on a 9% sales increase, and our operating profit margin was 7.7% compared to 7.4% last year for a 30 basis point increase. This represents our second consecutive quarter of operating margin improvement. We had a net interest expense of $21 million in the fourth quarter, and for 2018, net interest was $93 million. In 2019, we expect net interest to hold fairly steady in the $91 million to $93 million range despite four rate increases in 2018 and another two expected for 2019. Our total amortization expense was $22 million for the quarter and $89 million for the full year. For 2019, we expect full year amortization to increase slightly to $90 million to $92 million. Our depreciation expense was $42 million for the fourth quarter and $153 million for the full year. We expect this to increase to $170 million to $180 million in 2019 due to the increase in capital expenditures in 2018 and our plans to further utilize our tax savings and strong cash flows for additional investments in 2019. On a combined basis, we expect depreciation and amortization of approximately $260 million to $270 million in 2019. Continuing with the segment information presented in our press release, the other line, which represents our corporate expense, was $58 million in the fourth quarter, and that includes $17 million in transaction and other costs discussed earlier. Excluding these costs, our corporate expense was $41 million, a $16 million comparable increase from 2017. For the full year, our corporate expense was $174 million, including $36 million in transaction and other costs, or $138 million excluding these costs. This is up $27 million from 2017 on a comparative basis. The primary increase in corporate expense for the fourth quarter and the full year reflects the incremental costs associated with our retirement plan valuation and other retirement benefits, as well as an increase in short and long-term incentives, IT and security, and costs related to minority interests. With these and other costs in mind, we expect our corporate expense to be in the $125 million to $135 million range for 2019. Our tax rate for the quarter was 26.6%. This compares to our fourth quarter 2017 rate at 51%, which included the required one-time unfavorable provisional adjustment related to tax reform. Our fourth quarter 2018 tax rate was higher than the first three quarters of 2018 due to the final transition tax expense adjustments, as well as the non-deductible retirement plan expense that we mentioned earlier. The effective tax rate was 24.6% in 2018 and we're planning for a full year tax rate of 25% in 2019. So, now, we'll discuss our balance sheet, which remains strong and in excellent condition. Our accounts receivable was $2.5 billion, up 3% from the prior year and well below our fourth quarter sales increase. We remain pleased with the quality of our receivables. Our inventory at December 31 was $3.6 billion, down 4% from 2017, so our teams made significant progress in 2018 and are doing an excellent job of managing this key investment. Our accounts payable of $4 billion is up 10% due mainly to the benefit of improved payment terms with our key global partners. Our accounts payable to inventory ratio improved to 111% at December 31 of 2018. We're very pleased with the improvement in our working capital position and its positive impact on our cash flows. Our total debt of $3.1 billion at December 31 is down slightly from the $3.2 billion in 2017. We're comfortable with our current debt structure and we have a strong balance sheet and the financial capacity to support our future growth initiatives as well as ongoing priorities for effective capital allocation. We generated strong cash flows in 2018 with $1.1 billion in cash from operations, up 41% from 2017. In addition, our free cash flow, which excludes capital expenditures and the dividend, improved to nearly $500 million from $263 million in 2017. We expect another solid year in 2019, and we're currently estimating $1.1 billion to $1.2 billion in cash from operations and free cash flow in the $400 million range. Strong cash flow continues to support our priorities for the use of cash, which we believe serves to maximize shareholder value. Our key priorities for cash remain the real investment in our businesses, share repurchases, strategic acquisitions, and the dividend. Regarding the dividend, yesterday, the board of directors approved a $3.05 per share annual dividend for 2019, marking our 63rd consecutive annual increase in the dividend paid to our shareholders; this represents the annual increase in the dividend paid to our shareholders, this represents the 6% increase from the $2.88 per share paid in 2018, and it's approximately 54% of our 2018 adjusted earnings per share, which is in line with our targeted payout ratio. We invested $232 million in capital expenditures in 2018, and this reflects the step-up investment related to the addition of AAG and our plans for incremental spending in areas such as technology and productivity in our facilities. For 2019, we will continue to reinvest our tax reform savings and our working capital improvement, and we're planning for capital expenditures in the range of $300 million. Regarding our share repurchase program, we purchased approximately 1 million shares of our common stock in 2018, and today we have 16.4 million shares authorized and available for repurchase. We expect to be active in the program over the long-term and we continue to believe that our stock is an attractive investment and combined with the dividend, provides the best return to our shareholders. So now let's discuss our guidance for 2019. In arriving at our 2019 full year guidance, we considered our performance in 2018, as well as our current risks, plans, and initiatives including the previously announced acquisitions. In addition, we took into account the impact of a strong U.S. dollar and the market conditions we see for the foreseeable future, which by most accounts indicate the potential for a global economic slowdown at some point in 2019. With these factors in mind, we expect total sales for 2019 to be in the range of a 3% to 4% increase, or a 4% to 5% increase before the approximate 1% headwinds from foreign currency translation. This guidance excludes the benefit of any unannounced or future acquisitions. By business, we are guiding to a 2.5% to 3.5% total sales growth for the automotive segment, or a 4.5% to 5.5% increase before the impact of an approximate 2% currency headwind. For the industrial segment, total sales growth of 5% to 6%, and flat total sales for the business products segment. On the earnings side, we currently expect earnings per share to be in the range of $5.75 to $5.90, or an adjusted $5.81 to $5.96, before the impact of an approximately 1% currency headwind. Our outlook reflects a cautiously optimistic view for 2019. We are being cautious due to the potential for economic slowdown, and in particular, a slowing industrial economy in the second half of the year. In addition, we expect to see a more challenging sales environment in Europe in 2019. Despite these conditions, though, we're optimistic that our management teams have the plans and initiatives in place to work through the issues and show progress in 2019. Likewise, we're very confident in the underlying fundamentals of our broad and growing business platform which provides us with sustained long-term growth opportunities. So that's our financial report for the fourth quarter and the full year of 2018, as well as our outlook for 2019. We were very pleased to finish the year with solid results and we look forward to reporting on our progress in the coming quarters. With that, I turn it back to Paul.

Thank you, Carol. Reflecting on 2018, our team was hard at work executing on their sales and cost initiatives to drive stronger pipeline topline growth, improve our operating results, and enhance our earnings growth. We were also focused on ensuring a successful year in our European operations and capturing the synergies planned for these acquisitions. Likewise, with the combination of VIS and Motion on January 1 of 2018, we focused this year on building on the synergies created by a larger and stronger industrial operation. Finally, we significantly improved our working capital position during the year, driving exceptional cash flows utilized for key investments in the company, as well as returning capital via share repurchases and dividends, which we just increased for the 63rd consecutive year as announced earlier today. With these things in mind, we're pleased to achieve record sales and earnings for the year, and we are encouraged by the operating improvement across our global distribution platform in North America, Europe, and Australasia. Our team had many accomplishments and we are proud of their efforts to create long-term value for our shareholders. Turning to the calendar, we are excited for the opportunities to build on the positive momentum generated in 2018. GPC is well positioned to capitalize on its many global prospects and further improve our operating results. With that said, we are also very aware of the potential for a slowdown in the global economy, as Carol mentioned, and that was a key factor in arriving at our outlook for 2019. Our growth plans, however, are solid; we remain committed to an organic and acquisitive growth strategy to drive long-term and sustained revenues while also focusing on the continued improvement in our gross margins and cost management. We are confident that our unwavering focus in these areas, combined with a continued emphasis on a strong balance sheet, excellent cash flows, and effective capital allocation, will serve to maximize your return to our shareholders. We're excited for the future and, as always, we look forward to updating you on our progress when we report again. With that, we'll turn it back to the operator, and Carol and I will take your questions.

On the AAG business, you've talked about some weather and political concerns. Could you sort of stack which was a bigger issue? And it sounds like you still picked up mid-single digits. Was that local currency?

That was local currency, Bret. And look, our team at AAG, despite some of the challenges they faced in the quarter, had a really good quarter. And I give them a lot of credit for executing on a number of their key initiatives. As you know, that market, Bret, is fragmented. There are lots of opportunities to continue to roll up bolt-on acquisitions as well as some good strategic ones. And again, I give our team a ton of credit because they had some real headwinds, but despite those headwinds, they posted a solid quarter.

What are you seeing over there as you look at the payable program both in the European business and maybe Australasia as well? Carol, maybe you could talk about what can be liberated out of working capital maybe?

Our working capital improvement that we had this year was not related to Europe, but having said that, we worked with the teams over there and our teams here to start putting in place a number of our similar programs. So, we do expect to see some working capital improvement starting in 2019. We have similar supply chain programs already in place for Europe and we have some of our global partners, some on and some coming on. So we would expect to see some working capital improvement from them in 2019.

And then I guess just one housekeeping. As you look at the fourth quarter in the U.S. business, the sort of the cadence of the quarter, I would imagine it's similar to what other people are saying: October, November, strong and December weak. But maybe you could talk a little about the cadence and regional performance.

That's exactly right, Bret. We're no different than many others who have reported: October and November were definitely the strongest two months, and then we saw our sales moderate in December. I think the moderation in December was really related just to how the holidays timed out, coupled with the warmer temperatures and a ton of rain across the U.S. As we look at the regionality of our business, I've got to give a call out to our Midwest team. They had a terrific Q4. You know, when you look at some of the temperatures in cities like Chicago in Q4 and on end of January, as the polar vortex rolled across, it really spiked our business and it continues to do well. So, the Midwest was definitely a top performer for us. The Northeast performed well again as they did all of 2018, and the Central Division. So again, you look across the Upper Midwest, and really from the Midwest all the way to the Northeast, it was solid business for us.

So, the business products segment made a pretty nice comeback here with solid comps through the last two quarters and some nice operating margin expansion. Since the spinoff plan fell through, has there been a reallocation of attention or resources to S.P. Richards? And then what do you view as the longer-term outlook for that business?

Well, Liz, great question. I would say a few things about our office team, led by Rick Top, and they had a really solid second half of the year. They were focused on the business and won some new business. In addition to driving some good core results out of our office supply business, I would also tell you that we saw good growth in our facilities and break room business. And that goes with the second part of your question about are we making an investment in the S.P. Richards business. We just brought on a key executive, an industry executive, Steve Shells, to run our FPS business. He is a well-qualified executive, and we expect to see continued growth out of that segment. Long-term, Liz, with S.P. Richards, we are head down operating the business, and I think what you saw with the much better performance in Q3 and Q4 when our team was solely focused on running the business and the changes that are happening in the industry, we'll see better results. Again, we're really proud of the team and the great job they did in the second half of the year.

And just a question on NAPA. I hear the automotive segment has had a split of about 75%. DIFM about 25% DIY for a long time. If we look at this business in 20 years, do you think the split is still going to be about 75%, 25%, or is there a plan to evolve that over time?

Well, you know, Liz, we have embarked on a longer-term plan to upgrade our stores, and we've now completed all of our company stores, and we saw a nice lift in our retail business. We're now embarking on a similar strategy with our independently-owned stores, and our goal is to help our independents lift their retail business as well. But even with those key initiatives, DIFM is going to be the larger segment. It's certainly the faster growing segment; the vehicle population today is only growing more and more complex. I don't see that changing anytime soon, so I would expect that our mix will stay relatively similar to what it is today.

So, the first question I got through the impact of tariffs. So to start with, it looks like your Automotive inflation year-to-date moved to 140 basis points relative to last quarter. That seems pretty massive. I would like to imply something, the order of 500 basis points of inflation to Q4 and actually have something wrong there. Just wanted an aiding comment on that.

So, first of all, the tariffs. As we talked about in our last quarter, the 10% tariff that went into effect relates to about 18% to 20% of our U.S. cost of goods sold coming from China. As it relates to that cost of goods sold, we worked with our Chinese suppliers; we took into account many factors with our teams, our cross-functional teams, we negotiated with the Chinese suppliers, we looked at the effect of currency, and ultimately, we had more of, say, a 4% to 5% increase that we took and that we also passed on to our customers. So what you saw in Q4 was definitely the impact of the tariffs coming through in the quarter that was pretty late in the year. We were able to pass that through, and obviously, you can see that in our gross margins. So as we look ahead, we're expecting about a 1% inflation for U.S. Auto for 2019. That does not contemplate any further changes to tariff.

I guess maybe two follow-ups there. So you would think, I mean, if it was 4% to 5% Q4 take several quarters for you to anniversary that. So why wouldn't the inflation impact, I guess be more in '19 and what percent? That's the first part.

So again, I think the 4% to 5%, it's not on all categories. There were only certain categories that this tariff applied to, so there were some key categories that it applied to. So when you blended it into the total automotive business and you look at it across the board, it waters itself down to say a 2% or 1%, and that's a cumulative number as it comes through. So we're not expecting a lot of those changes went in late Q4, so we're expecting some additional inflationary environment going into 2019, which is probably the best way to say that. We said in our prepared remarks that inflation would be 1% to 2%, and I would tell you right now, our best estimate is about 1% for U.S. Automotive, and about 1.5% to 2% for Business Products and Industrial. And again, more than anything, what's important is that our ability to take those price increases and pass them through to the customer.

And then I wanted to, kind of given your weaker economic outlook, or just — I guess preparing for that; I wanted to ask you a question on kind of downside risk. If you look at your automotive business in the U.S., can you tell us how the business performed on a same-store basis back in the economic downturn? The next one could be as bad as this, but I just want some context. And then similarly, I know you're new to the UK and to Germany, but those management teams are still obviously with the company, and I'm sure a lot of them are around with the downturn. Is there a way to contextualize how those businesses performed in the last economic downturn as well, just to understand the cyclicality of those businesses in Europe? Thank you.

Well, I think the first comment I want to just clarify: our U.S. business comps, you're coming off — I mean, obviously, the second half is stronger than the first half, but we had about 1.6% U.S. comps for 2018. We're implying in our guidance for U.S. comps to be up 3% to 4%; so we are not implying weakness in our U.S. comps. I think what you're speaking to more specifically is probably related to either Europe or the industrial business, but our North American automotive businesses and our Australasia automotive businesses going into 2019 are improved from 2018.

And Chris, I would just add to that: generally, what we see in the automotive aftermarket in a slower economy, which generally will result in fewer new cars sold, is that the automotive aftermarket generally performs pretty well. People hold onto their vehicles longer; they are conducting more repairs on those vehicles during the course of the year. So whether it be in Europe or the U.S., if there is a slowdown — and that's yet to be determined — I think our automotive aftermarket will be just fine, and as you mentioned, we've got a very experienced team on the ground in Europe that has worked their way through these economic cycles, and I think they'll be just fine.

My first question is on the U.S. auto business. You spoke to favorable weather trends for most of 2018. Based on what you've seen in 2019 to date, how do you think the weather situation is setting up for 2019?

Seth, I think that while we can't go into too many specifics about what we're seeing in Q1, anytime we're seeing that kind of extreme weather pattern, we're seeing again, and we're seeing actually this week across parts of the U.S.; that's going to bode well for the automotive parts business, and I think what we're now experiencing is really the back-to-back normalized winters. As we've said many times in these calls through the years, that's what this business needs, and our business, like our peer group, generally performs much better when we're in those kinds of normalized weather patterns.

Excellent, that's helpful perspective. Secondly, as we think about the gross margin outlook here; first, in terms of the fourth quarter performance for auto, you talked about a few drivers. Maybe you could help us tell, in terms of listing the biggest drivers in terms of degree of magnitude to the gross margin improvement between supplier negotiations and pricing and rebates?

Yes, so happy to answer that. As you may recall, through the nine months, our gross margin for AAG was up about 150 basis points, and we ended the year up 180 basis points. So, the strong fourth quarter was a combination of several factors. As we have said all year, the automotive and industrial had improved gross profit all year and that continued into the fourth quarter, as has AAG. So, AAG, including some of the synergies as we continue to integrate those businesses, as well as their acquisitions, have had a strong gross margin. In addition, as Paul mentioned, our favorable results in office products that grew; they had a more favorable product mix, and that helped with their gross margin conversion, and so you see that in their operating margin, and a lot of that flowed through to the gross margin line. Lastly, automotive, industrial, and office, all of them had better volumes which led to incremental supplier incentives that went into that number. Moreover, we also had, with some of this inflationary environment, favorable inventory gains, net of LIFO at automotive and industrial. So while we're not going to breakout any one of those, those factors were included in Q4. Having said that, we feel like this 32% rate, as we look ahead, is appropriate as we go forward.

Just one follow-up on that. Regarding the pricing and digital initiatives that you've undertaken in auto; can you give us some perspectives on how material they've been to your improvement in gross margin rate? And how you think those will benefit you going forward?

I guess we've factored that in. I mean, you've seen the gross margin improvements all year in auto, and we would say that it's not any one thing, but circling our investments in pricing and data analytics and some of the new strategies that we're doing has gone into that. But also, from a global sourcing and our global supplier partners, I mean, it's a buy-side and sell-side strategy that has gone into that. So, we've seen that throughout the year, and again, we would expect that to continue on into 2019. And then the great thing is, we had some inflation for the first time in many years, and as we look ahead to 2019, we expect to have a little bit of that as well.

I know you said that potential risk in the back half on a global economic slowdown. Is there anything that you're seeing now in the industrial business that's alerting you or causing you any concern, or is it more sort of speculative and what others are talking about that's just putting this in your guidance?

It's a great question, Chris, because what we're seeing in the industrial side, certainly with some of the key metrics that we follow very closely, like PMI and manufacturing output. The PMI number in January was up from the December number, so it actually, I think, was over 56 in the month of January, which we take as a real positive. And then you get a Federal Reserve number on industrial output and productivity that was a little bit slower in the month of January. So there are some mixed signals out there; I would tell you that we're not feeling in our business yet, but there is just a lot of noise out there that you kind of worry about avoiding; we worry all the time, right, if you don't know for sure. Our full year projection, we still feel good about where our industrial business is going and the team we have in place running that business.

Understood. And then, as you're following up on the winter question asked before, I mean, Canada I think was in polar vortex from the past 7 weeks or something like that, and obviously, the Midwest has been hit harder. Do you think the regional performance in the U.S. in 2019 could be different from what you've seen? I think the West was weaker earlier in '18 and really the Northeast and Midwest — Northeast led for most of the year, and now it seems like the Midwest has picked up. Any sort of — I'd love to hear your thoughts in terms of how the regional performance might change based on what we've seen so far.

I think that question, Chris, is a bit hard to say at this point. We have a number of initiatives that are going on in all of our geographical regions outside of weather impact that will influence our performance in those particular divisions, but as we sit here today and looking at another potential polar vortex coming across the U.S., it does appear that many of the same regions; the Midwest, the Northeast, the Central, will be the benefactors of that extreme weather. I would add one of our geographical regions that we've seen a nice spike in '19 as out in our mountain division, so that includes Seattle and Colorado and Wyoming, etc.; that business has gotten off to a good start in 2019. So it's good to see those folks stepping it up. So we'll wait and see, but again, we've got many key initiatives in the works that will certainly bolster all of our divisions in 2019.

Understood. And then in terms of the operating margin outlook, is there any difference in terms of how you're thinking about the three divisions? And then related to that, is your comp needed to drive expense leverage coming down in '19, or will it be relatively consistent with 2018?

Chris, I think as we think about our operating margin, and look, we were pretty excited to have a second half operating margin at 7.7% in total. Our Q4 improvement at 30 basis points was really great to see after a 10 basis point increase in Q3. We're anticipating 2019 probably something like 10 to 15 basis points in total operating margins. I would have to say, just given our growth outlook that that would come from primarily automotive and industrial. But I want to point out, there are a lot of investments in our business that — again, we've talked about our tax savings, we've talked about our CapEx, and we have been investing in our facilities and productivity, in people, in data analytics, supply chain, and a lot of investments for the future, and those investments will help us. I think those investments, as it flows through the SG&A line, also depreciation, we've got that — that we know will be beneficial long-term, but we're still fighting these headwinds as we've talked about with the tight labor market and wages and payroll. Additionally, freight and delivery, so those categories still grew greater than our sales, and while we think some of the freight in field will level up in 2019, this tight labor market we're in and with wages, we're not sure that that necessarily cycles out. So I don't think it's a lower comp number; we have the margin improvement, but again, we've implied some improved comp numbers for all of our businesses going forward. So again, on a long-term basis, we would expect to see operating margin improvement.

We'd like to thank you for participating in our fourth quarter and year-end conference call. We appreciate your support and interest in Genuine Parts Company, and we look forward to reporting on our first quarter results. Thank you.