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Executives

Carol Yancey - SVP, Finance & Corporate Secretary

Thomas Gallagher - President & CEO

Jerry Nix - EVP, Finance & CFO

Analysts

Scot Ciccarelli - RBC Capital Market

Mike Montani - ISI

Matthew Fassler - Goldman Sachs

Tony Cristello - BB&T Capital

John Murphy - Bank of America

Himanshu Patel - JPMorgan

Brian Sponheimer - Gabelli Company

Keith Hughes - SunTrust

Scott Stember - Sidoti

Genuine Parts Company (GPC) Q2 2010 Earnings Call July 16, 2010 11:00 AM ET

Operator

Good morning my name is Shawn and I will be your conference operator today. At this time I would like to welcome everyone to Genuine Parts Second Quarter Earning's Conference Call. (Operator Instructions). I will now turn the conference over to Ms. Carol Yancey, Senior Vice President of Finance and Corporate Secretary. Thank you, you may begin our conference.

Carol Yancey

Thank you, good morning and we thank you for joining us today for our second quarter earnings conference call to discuss our recent results and the outlook for the reminder of 2010. Before we begin this morning, please be advised that this call may involve forward-looking stalemates such as projections of revenue, earnings, capital structure and other financial items.

Statements on the plans and objectives of the company and its management, statements of future economic performance and assumptions underlining these statements regarding the company and its business. 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 obligations to update any forward-looking statements made during this call.

We will begin this morning with remarks from Thomas Gallagher our, Chairman, President and CEO, Tom.

Thomas Gallagher

Thank you Carol, I would like to add my welcome to each of you on the call today and to say that we appreciate you taking the time to be with us this morning. As we customarily do Jerry Nix, our Vice Chairman and Chief Financial Officer and I will split the duties on this call, and once we have concluded our remarks we will look forward to answering any questions that you may have.

Now early this morning we released our second quarter 2010 results and hopefully you've had an opportunity to review them. But for those who may not have seen the numbers as yet, a quick recap shows that the sales for the quarter were $2.847 billion, which was up 12%. Net income was a $124.5 million, which was up 20% and earnings per share were $0.78 this year compared to $0.65 in the second quarter of 2009 and the EPS increase was 20%.

After being up 6% in sales and 13% in earnings in the first quarter, we were pleased to show continued improvement and further strengthening in our results in the second quarter. That now puts us up 9% in sales for the 6 months and up 17% in both net income and earnings per share on a year-to-day basis and we feel that we are in a good position at the halfway point in the year.

And looking at the second quarter results by business segment; our two industrial related businesses continue to generate strong increases. Motion Industries, our Industrial Distribution segment was up 26% in sales in the quarter and EIS, our electrical distribution business was up 32%. Now a portion of the Motion increase is attributable to the BC Bearing acquisition that was completed on March 1st of this year. We mentioned this in our last call and the addition of the BC Bearing operations has strengthened our position in Western Canada and the Northwestern part of the U.S. We're pleased with the early results from this acquisition.

We're also pleased that the on-going or underlying business at Motion was up a very solid 18% in the quarter and then looking at the results in a bit more detail, we see a consistent pattern of sales improvement, both geographically and from a product and customer perspective as well.

Our top 12 product categories were up over 20% with every category showing a double digit improvement and our top 10 customer segments were also up over 20%. So we feel that we are seeing a broad and balanced performance within our industrial business which gives us reason for optimism as we look towards the remainder of the year.

Our results in the electrical segment were also up, netted by a small acquisition that was done at the beginning of the year as well as the increase in corporate pricing but the underlying business for EIS was up 22% in the quarter which we feel is a very strong performance. And as with our industrial business, the increase is broad based and fairly consistent across their product and customer categories, which is encouraging.

Both Motion and EIS sell into the manufacturing segment of the economy which continues to perform well right now. Industrial Production, Capacity Utilization and Purchasing Manager's Index all remained positive and encouraging, despite some recent moderation. As you will recall, these industries have historically been six to nine months leading indicators for industrial and electrical businesses and at the current levels, they present an encouraging picture throughout the remainder of the year.

Moving onto Automotive, we're pleased to see continued stability and improvement in this segment of our business. Our Automotive operations were up 7% in the second quarter, and this follows 6% improvements in the first quarter of this year and the fourth quarter of 2009. So we feel that our Automotive segment has firmed up and it is moving in the right direction.

Looking a little deeper into the results, we were pleased to see that both our company store group and our independently owned NAPA stores continued to grow at comparable rates in the quarter showing a good balance in our overall sales. Within our company store group, our commercial or wholesale business was up 9% in the quarter and our retail business was up 6%.

Both showed nice improvements over the first quarter results and within the commercial segment we had solid performances in our two largest wholesale initiatives, not to NAPA Auto Care and Major Accounts. Each of these programs was up 10% in the quarter and we continue to be pleased with the progress being made in these two important areas.

Additionally, our fleet business is starting to stabilize for us. You will recall that the fleet category consists of customers at range from small independent contractor or landscape-type companies owned up to the large over the road trucking companies. In total it represents approximately 20 to 25% of our business. The fleet category ran decreases throughout all of 2009 but then was essentially flat in the first quarter this year and it was up 4% in the second quarter. So we are encouraged by this and we hope to see further improvement as the year progresses.

Putting it all together, we feel we had a solid performance from our Automotive Group in the second quarter and we're encouraged by some of the trends that we are seeing and as a result, we look for continued good sales growth from Automotive over the second half of the year.

And finally, a few comments on office products which ended the quarter down 1%. We continue to encounter a sluggish end market and those of you who follow the industry know that this is fairly consistent across all industry participants. With that said however, we did see several bright spots in the quarter. And looking at the performance by customers segment, we were pleased to see that our independent customer base generated low single-digit growth after being down 5% in 2009. our independent business was flat in the first quarter and now up low single digits in the second quarter. So, we are encouraged by the positive trend that we see with our independent reseller group, but this was offset by a low double digit decrease in our major account segment in the quarter.

On the product side, we had a double digit increase in the furniture category, which we attribute largely to the repositioning of the line as mentioned in our last call, and we're pleased with the results thus far. In our remaining three product categories, we are basically flat in technology products and cleaning and breakroom supplies, and then down mid-single digits in our core office supplies.

As a point of information, the results in the cleaning and the breakroom supplies were impacted by the spike in demand last year from the H1N1 situation, and we will be up against this in the third and early fourth quarter as well, but the underlying cleaning and breakroom remains solid. Through mid-year, our Office Products Group is down 1%, and as mentioned earlier, the industry conditions remained challenging due to the significant contraction in office work and employment over the past two years.

However, we continue to feel that this business will turn slightly positive over the second half of the year. So, that's a quick overview of the revenue picture for the quarter, and at this time I'll turn it over to Jerry to comment on the financial side. Jerry?

Jerry Nix

Thank you, Tom. Good morning. We appreciate you joining us on the call today. We’ll first review the income statement and segment information, then touch on a few key balance sheet and other financial items. Tom will come back for a quick recap and guidance update and then we'll open the call up to your questions.

A review of the income statement shows the following; total sales were up 12% to $2.8 billion for the second quarter following a 6% sales increase in the first quarter. We are pleased expansion improved sales momentum this quarter with solid growth in automotive and especially strong results in our industrial and electrical businesses. For the six months ended in June, our sales stand at 5.4 billion up 9% from 2009.

Gross profit in the second quarter decreased 50 basis points to 28.9% of sales, compared to 29.4% in the second quarter last year. Although down, this decline is less than the 70 point decrease experienced in the first quarter and for the year, gross margin of 29.1% is now down approximately 60 basis points from 29.7 for the six months through June last year.

As we mentioned in our last quarter's call, that decrease thus far in 2010 primarily reflects the margin pressures in our automotive and office businesses. In automotive, the price and actions we took during the April to September timeframe last year has yet to fully annualize. And in office we continue to experienced competitive pricing pressures associated with the tough employment conditions affecting that industry.

We had anticipated these headwinds impacting our gross margins to the second and third quarter of 2010, and to a lesser degree each period. Clearly, we have more work to do here and our management teams are focused on improving this line. So, look into the fourth quarter and into 2011, we believe there is opportunity for gross margin expansion. In the meantime, we will continue to offset the decreases in gross margin line with cost savings and overall improvement in operating expenses. For the year through June, our cumulative pricing which represents supply increases to us was plus 3/10% in automotive, plus 9/10% in Industrial, plus 3/10% in Office Products and plus 2.3% in Electrical.

Now let's look at SG&A. For the second quarter, SG&A expense of 622 million were up 7.4% from 579 million for the same period of 2009. As a percent to sales this marked a 100 basis points improvement to 21.8%, versus 22.8% last year. For the six months in 2010, SG&A stands at $1.2 billion, a 5% increase from the same period in '09 and a 22.4% of the sales which is also a 100 basis point improvement from 23.4% last year. Decrease in expenses as a percentage of sales for the quarter and six months, is due to the benefit of greater leverage associated with our sales growth combined with our cost reduction efforts of the last few years.

We're especially pleased in our ability to show solid improvement on this line, given the comparison with the item such as the $9 million one time curtailment benefit associated with the company pension plan, which we recognized in the second quarter last year. Our management team remains focused on tightly managing our expenses.

Now let's discuss the results by segment. Automotive had revenue in the quarter $1.4597 billion, representing 51% of the total, up 7%, at operating profit in the quarter of $126 million, also up 7%. So, the operating profit margin remained virtually flat, going from 8.66% last year to 8.63% this year.

Net revenue for the six months $2750.1 million, up 7% had operating profit of $214.9 million, up 5%. For the quarter, the industrial group had revenue of $882.2 million, representing 31% of the total, up 26%. They had operating profit in the quarter of $60.1 million, up an outstanding 91%. Their operating margins showed a substantial rebound going from 4.5% to 6.8% of revenue.

For the six months, the industrial group had revenue $1.6855 billion, up17% and they had operating profit of $109 million, up 66%. For the quarter, office products had revenue of $402.0 million, representing 14% of the total, they were down 1% and they had operating profit of $30.5 million, down 9.5%. So, their operating margins continue to be under pressure, going from 8.3% to 7.6%.

And for the six months, they had revenue $812.5 million and that was down 1%, operating profits $67.0 million, down 7%. Moving onto the electrical group, they had revenue in the quarter of $106.6 million, representing 4% of the total, up 32%, with operating profits $6.9 million, up 36.5%. So, their margins continue to be strong and showed some improvement going from 6.3% to 6.5% of sales.

For the six months the electrical group had revenue of $206.9 million, that's up 24%, operating profit $13.8 million, up 28%. We thought it would be worth while to note again this quarter, that in an addition our segment results just discussed, total net sales benefited from the other sales line, which remains a much lower deduction from sales when compared to 2009.

This line represents a net effect of discounts, incentives and freight bills and as freight increases will improve sales volume, we have a lower deduction to sales. We view this as a more normal range for this line similar to our deductions in 2008 and 2007.

Total operating profit margin for the second quarter improved 50 basis points to 7.9% from 7.4% in the second quarter of '09. For the six months our 7.4% operating margins are up 30 basis points from last year. The improved expense leverage associated with our sales increase as well as our cost reduction efforts drove the increase in operating margins for both the quarter and the year.

We'd reminded you that in the recessionary period of 2009, we eliminated over $75 million in operating cost. We feel that we've done a pretty good job of keeping these costs out thus far in 2010, even with our strong sales growth. Add net interest expense of $6.7 million and 13.4 million for the quarter and six months respectively which is down slightly from the same period in 2009. We continue to expect our net interest to be approximately 26 to $28 million for the full year.

Other category which includes corporate expense, amortization of intangibles and minority of controlling interest was a $16.1 million expense in the second quarter, and is 28.3 million for the six months through June. Although up slightly in the quarter, we're down approximately $1 million on this line through June. For the full year, we continue to project that the total other category will be in the 40 to $50 million range.

For the quarter, our tax rate was approximately 38.0%, which is up from 37.6% in the second quarter last year. This is due to tax treatment of certainly retirement plan valuation adjustments. Currently we expect the tax rate for 2010 to remain at approximately 38.0%. Net income for the quarter, $124.5 million, was up 20% and EPS was $0.78 compared to 65 last year, also up 20%. And for the year, net income 225.1 million is up 17%, EPS $1.42 compared to $1.21 last year is also up 17%.

Now let's touch base on a few key balance sheet items. Cash at June 30th improved to $412 million from $239 million at June 30 last year and is up from 337 million, December 31, '09. As we will discuss in more detail later, we used our improved cash position to fund the dividend, capital expenditures, acquisitions and share repurchases. We expect to continue to generate consistently strong cash flows.

Accounts receivable of $1.4 billion increased 9% from last year, a 12% increase in sales for the second quarter. We continue to feel good about the level and quality of our receivables and remain diligent in monitoring the financial condition of our customers and their ability to pay, thus limiting our exposure to write offs and ensuring the adequacy of our reserve for bad debts. Our goal at GPC remains to grow receivables at a rate less than revenue growth.

Inventory at 6/30 was $2.2 billion and this includes $21 million from acquisitions but inventory is down 2%, approximately 50 million from both June 30 and December 31 of last year. We're extremely pleased with our improved level of inventories today and will continue to manage this key investment tightly. We see room for continued improvement in inventory over the balance of the year.

Also we were able to improve our accounts payable position again this quarter, with payables increasing to $1.3 billion, a 21% increase from this time last year and up 18% from December 31 '09. This progress this far into 2010 was primarily due to increased inventory purchases associated with our higher sales volume this year, especially when compared to the first half of 2009 when volume was down and purchase were especially due to the recessionary environment at that time.

In addition, we have improved this line through extended terms and other payable initiatives with our vendors such as the Procurement Car Purchasing Program and use of a vendor payable program. With the improvement in our accounts payable position, our days payable continue to improve and we remain pleased with the positive direction of this working capital category.

With our progress in the key areas of accounts receivable, inventory and payables, working capital of 2.6 billion at June 30, is up 5% from June 30 last year, and remain consistent with working capital at December 31 '09. We are encouraged with our progress in managing working capital and our balance sheet remains in excellent condition. We are continuing to generate solid cash flows and as mentioned earlier our strong cash position provides us with the financial flexibility to consider many investment opportunities.

After a record year for cash flows in 2009, we're looking for another strong year in 2010, and currently estimate cash from operations of approximately $750 million and free cash flow after deducting capital expenditures and dividends of approximately $400 million. We are pleased with the continued strength of our cash flows and we remain committed to the priorities for the use of the cash. These priorities are, first the dividend, which we have paid every year since going public in 1948, and raised for 54 consecutive years. At 2010 annual dividend, our $1.64 per share was increased from $1.60 per share in '09.

Additionally, we will continue to use our cash towards the ongoing reinvestment in each of our businesses, strategic acquisitions were appropriate and share repurchases. Capital expenditures are 18.1 million for the second quarter, that's down slightly from 22.9 million invested in the second quarter last year. For the six months in 2010 CapEx of 27.9 million compared to 37.0 in '09.

Currently we expect our CapEx spending to pickup over second half of the year, and be in the range of 85 to $95 million for the full-year. Vast majority of these investments relate to productivity enhancement projects primarily in technology.

Related depreciation and amortization were $23.2 million in the quarter, 45.3 for the six months, which are both up slightly from the same periods in '09. For the year, D&A will likely hold fairly steady with 2009 in 85 to $95 million range. Strategic acquisitions continue to be an ongoing and important use of cash, and are integral to our growth plans for the company. As you may know we made two acquisitions earlier this year, continued to evaluate additional acquisition opportunities as they present themselves.

We remain disciplined in our approach to this element of our growth strategy, and generally targeted bolt-on types of acquisitions with annual revenues in the 25 to $100 million range although there are certain exceptions. We intend to follow similar pattern, more strategic acquisitions into the future.

In the second quarter of this year, we used our cash to repurchase approximately 1.3 million shares of our company stock on our share repurchase program. Year-to-date, we've purchased approximately 1.6 million in shares, and today we have approximately 16.2 million shares authorized and are available for repurchase. We have no set pattern for this repurchases. We have no set pattern for these repurchases, but we expect to remain active in the program, as we continue to believe that our stock is an attractive investment and combined with a dividend provides the best return to out shareholders.

Total debt, January 30, of 2010 remains unchanged at $500 million, that includes $250 million which matures in November of 2011 and $250 million due in November of 2013. Total debt to total capital at June 30, 2010, 15.8% and we are comfortable with our capital structure this time.

The company is stable, our balance sheet is strong and that provides us with ability to take advantage of growth opportunities in any economic environment. In closing, we continue to operate in 2010 from the position of strength and have a great confidence in our growth strategies and the positive fundamentals in each of our businesses.

Second quarter was another period of solid growth for us and we look forward to reporting more progress over the second half of 2010. We will continue to support our growth with a strong and healthy balance sheet and sound cash flows, further maximizing our return to shareholders.

This concludes our financial review and I will conclude my comments by expressing our appreciating to all of our dedicated GPC associates. Their hard work is behind every aspect of our recovery and we are very proud of this group. We also want to thank our customers and our suppliers and we appreciate there continued. Tom, I'll turn it back to you.

Thomas Gallagher

Thank you, Jerry. So, that recaps our second quarter and first half 2010 results. With sales up 9% year-to-date and earnings up 17% we feel that we're well positioned to report a good performance for the full year. And we are proud of the job that the GPC team has done both on the operating side and on the balance sheet side through mid-year.

As far as the reminder of the year is concerned, we are mindful of the uncertainty that has been created by some of the mixed economic data that has recently been released. However, we are also influenced by the strength of our first half results and by what our management team anticipates in the months ahead.

With that said, we feel that an upward adjustment in our full year guidance is appropriate. As we see it now, we would say that a full year revenue expectation of plus 7% to plus 9% would be more in line with our current thinking up from our prior guidance of plus 3% to plus 5%. And then we would increase our prior EPS guidance from 255 to 270, to the current 270 to 280 and we look forward to refining this further in our third quarter conference call.

At this point we would to take your question and we will turn the call back over to Shawn to assemble the question for us, Shawn.

Question-and-Answer Session

Operator

(Operator Instructions) And your first question is from the line of Scot Ciccarelli with RBC Capital Markets.

Scot Ciccarelli - RBC Capital Market

Hey guys, how are you. I guess one of my questions is, now that we are starting to see improvements on the revenue growth, I know guys typically get vendor rebates, I know in auto and I believe industrial as well, is that going to be one of the supporters for gross margin going forward, number one and number two, when does that start to flow through? When do you actually know your purchasing levels are high enough, that you really start to benefit from that?

Jerry Nix

Scot, this is Jerry. I'll take that, it does effects us, it effects us more so in the office products and industrial business than it does in the automotive, but it does have an impact. But the automotive business and the office products business did not, they plan as much as the industrial business, so the fall off from there volume incentive was not as great. It was a significant last year in the industrial side of our business and they have been to evaluate in their incentive program with all the supplier, and then trying to renegotiate those, but I don't know how they have done with that, and I don't know how successful they've been, but it did have an impact on the margins in the industrial segment in the second quarter.

If you see the significant improvement in the margins there, probably a third of that was attributable to volume incentives and the rest of it is operating cost, they did a very good job taken out last year, and have not yet back entered the system, but I would also tell you that while we attribute to volume incentives, you wouldn't get those volume incentive if this wasn't the coverage because they are based on purchases so we wouldn't be making those purchases if we didn't have the business recovery, so the two of them tie together. We stay on that back to the sales volume level we had in 2007, even with a significant progress, so but it will help us on improve gross margin going forward.

Scot Ciccarelli - RBC Capital Market

Okay, that's helpful Jerry and then as you look at the total run rate, what you accomplished this quarter particularly industrial, I guess that's the one where I feel like it's the biggest one factor. Going forward in the balance of the year, do you think there is still a lot of inventory filling this past quarter, the second quarter, or is this kind of where the new run rate level is obviously counting per seasonality?

Thomas Gallagher

Scott, this is Tom. There may have been some inventory build-up or replenishment, but I think most of the revenue increase really came from normal plan in the quarter.

Scot Ciccarelli - RBC Capital Market

All right, that's very helpful. Thanks a lot guys.

Thomas Gallagher

All right, thank you.

Jerry Nix

Thank you.

Operator

Next one is from the line of Gregory Melich with ISI.

Mike Montani - ISI

Hi, good morning gentlemen, this is Mike Montani in from for Greg.

Thomas Gallagher

Good morning, Mike.

Jerry Nix

Good morning, Mike.

Mike Montani - ISI

I have actually probably two key questions for you. The first one was really related to sequential progress in demand, if you could talk about how that evolve over the course of the quarter and also just a feel for -- by geography especially in California if you're seeing anything noteworthy there in the Automotive?

Thomas Gallagher

I'll take that Mike. The quarter was very consistent sequentially, so we didn't see any significant fluctuations. Geographically, my guess is you're referring more to Automotive than any of the other businesses and here again our Western operations are performing in line with our expectations, and we think we are faring reasonably well in the marketplace out there.

Mike Montani - ISI

Great, and just with regard to the cost control you've done a strong job so far with keeping those under control, and if we were to remove the 9 million sort of boggy that you had in 2Q of last year, it seems that SG&A dollars would be up closer to 5.9. I guess as we look ahead now and with recovering volumes, can you talk about your outlook in terms of adding back headcount and to or any initiatives you have that might give us an indication of, is that 5.9 is now the new run rate, or how to think about that?

Jerry Nix

Mike, I don't think you can say that that's the new run rate. Last year, we took about $75 million in total out of our SG&A. Our expectation is that this year, we'll probably add about 20 million of that back in. The best we can tell is if we've added back in about 10 million of it through the first half of the year. Over the last couple of years, we reduced our headcount by about 12, 11 to 12%. If you just look at the first half of the year, we've added about a half of a percent back to headcount to support the sales growth. Certainly we -- lot of that were infrastructure changes we made last year that will not come back into the system, so I think we are still along solid ground saying now that 75 million SG&A reduction last year were probably had back in 20 million or so this year.

Mike Montani - ISI

And just the final point that I had and then I'll jump back in the queue. But on the cash side obviously continued to manage that very well, and now over 400 million as we move ahead should we think about potentially more activity from the M&A side or potentially more buy back, as you have a nice uptick there with the 50 million in repo this quarter. Thank you.

Jerry Nix

All right Mike, thank you. Yeah, you will see more activity and we did hold back, and we've not held back on acquisition because of the lack of cash. If we sure wanted, and we're working while it made sense and we could get to the proper valuation we do it, and in that position continues to be the same. We will -- active in the second quarter in our share purchase, and we will continue to be, and try to buy on weakness. It's easy to get rid of that cash. It's easy to spend it, but that's not our goal. Our goal is to spend it, so that we can maximize shareholder value. Shawn, you take the next call, please?

Operator

Question is from the line of Matthew Fassler with Goldman Sachs.

Matthew Fassler - Goldman Sachs

Thanks a lot, and good morning. My first question relates to the industrial business. If you look at your total revenue line, it was $882 million and two years ago in 2008, your revenue was $898 million. So with the strong recovery here you you're sort of -- and plus the acquisition of Bearings, you're almost back to 2008 levels. The profit dollars that you generated from industrial were 16 million light so and the margin is about 170 basis points lower. So I guess the question associated with that would be is the margin associated with the bearing business that much lower than the margin on the core Motion Industries business or is there some other element of impairment, either something structural or mix of business or perhaps vendor rebates not yet coming all the way back that would explain why the margin hasn't come back as much as the sales has recovered.

Thomas Gallagher

Matt, this is Tom. There are a couple of thoughts to that question. The margins at BC Bearing initially are just a bit lower than the Motion overall margins, but it's a company that's making terrific progress, and we're very confident in what they will do in terms of meeting the margin expectations. So, it's a good organization, good management and they will be accretive to us as we go forward. On the rebate side of it, all of that has not flowed through yet. We still have reduced inventories on the industrial side, and we'll continue to work to bring those down a bit over the remainder of the year.

So, well, Jerry mentioned that about a third of the improvement came from incentives. We still in our planning don't have all of the incentives added back that we were able to get back in 2008. And then the final thing I would just say is that the revenues have come back very nicely there. For planning purposes only, we're saying that our revenues will not get all the way back to the 2008 levels. This year we hope they do, but we're cautious as I mentioned in my comments based upon some of the recent economic data that's come out. We are saying, we just want to remain a little bit on the conservative side, in our expectations for the industrial business specifically, but all of our business is over all. But we are still looking for a nice double digit increase from the industrial business in the second half of the year.

Matthew Fassler - Goldman Sachs

Got it, second question, if you could just remind when the BC Bearing deal closed and what the parallel number was in the first quarter to the 18% that you talked about for Motion in Q2?

Thomas Gallagher

Sure, the deal closed at the end of February, so March 1st they became part of Motion Industries and they added about 7% to the overall Motion increase in the second quarter.

Matthew Fassler - Goldman Sachs

Great. And I guess the next question I will ask relates to gross margin, Jerry. You spoke about anticipated improvement in Q3 and in Q4. Now last year in Q4, you had some -- essentially one time factors drive a very big year on year increase in gross margin. You're up I think a 123 basis points year-on-year after having been down over the first nine months. And my sense was that, that was a very tough bogey for you at your end and that there was an expectation that even if the underlying trend was solid, that you would probably de-lever gross margin in the fourth quarter. Were your comments saying that you think you could actually surmount that fourth quarter bogey and have up gross margins in Q4?

Jerry Nix

No, I don't mean it that way. We will make a little progress each quarter; we will have less of a decreasing growth margin in the third quarter. We had significant LIFO gains last year because of the inventory reductions in the fourth quarter and that's what contributed to that gross margin improvement.

We are looking to reducing our inventories further this year, but it will not be to the level of last year as you can imagine with the recovery on the revenue side. Matt, I would be pleased if we could hold our gross margin in the fourth quarter this year compared to the fourth quarter last year.

Matthew Fassler - Goldman Sachs

Do you think it's actually feasible to get back to that 31% level though in the fourth quarter?

Jerry Nix

I think so, yes.

Matthew Fassler - Goldman Sachs

Got it, okay. Thank you very much.

Operator

Your next question is from Tony Cristello with BB&T Capital.

Tony Cristello - BB&T Capital

Thank you, gentlemen, good morning. Tom, if you look at the industrial business particularly this quarter, very, very strong organic growth and it appears that that level of growth is outpacing what we would think would be general industry levels.

Is there something going on as well with your ability as a market leader relative to some of the independents in the marketplace in terms of share gains that is also adding to what appears to be a very, very strong level of growth during the quarter.

Thomas Gallagher

Tony, I don't think we've got enough data to really give you an informed answer there. I do know that our industrial team, after suffering the way that they did in 2009, worked hard over the course of 2009 to better refine and develop their growth initiatives and that team is absolutely focused on building volume in a profitable way and I think their execution is awfully good. Where it's coming from, I wouldn't try to address, but we think that they have done a great job through the first half and they are going to give us a strong second half as well from our perspective.

Tony Cristello - BB&T Capital

And with respect to sort of categorizing the industrial segment as more of a late cycle recovery, are the growth rates you're seeing today and sort of how you're portraying what you anticipate for the second half consistent with your view right now of where you think this cycle currently may be?

Thomas Gallagher

Yes.

Tony Cristello - BB&T Capital

And do you think that some of the level of production and some of where the cycle and things are concerns in the macro, I should say, are they consistent also with this stage of the cycle?

Thomas Gallagher

That I don't know, Tony. I don't know that I can answer that. I'll come back may be and -- just to develop a little bit more the comments earlier. Right now, we know that regardless of where we are in the cycle, that we've got a terrific customer base that's producing product. And our team is focused on trying to maximize our penetration in each of these customers and trying to grow our presence in every customer that we service. And I think that we may be a little bit ahead of the overall growth rate but it's really coming from the focus and the intensity that the team has placed on maximizing our share of spend in our respective customer's places of business.

Tony Cristello - BB&T Capital

Okay, okay. And one last question, you've made significant changes in 2009, particularly in the Auto segment with some of the initiatives you had on price. Are there any initiatives new that you might have underway or do you think that everything you've done to date is about as much as you'd like or has been sufficient enough to get the business back where you wanted it to be?

Thomas Gallagher

Well, no. We don't think we're done by any stretch and we've got a number of things that our team is working on. We would not want to disclose some of those on the call but we don't think that we're finished. And frankly we think there's more upside yet in the Automotive business if we continue to stay focused on the things that we've identified as opportunities for us.

Tony Cristello - BB&T Capital

Do you think that the trends that the Automotive, sort of the aftermarket in and of itself has experienced right now, is there more of a cyclical nature to what we're seeing rather than, hey, once the economy recovers, the trends are not going to see 6, 7, 8% type organic growth, and it's going to come back to a much more normalized level? Or do you think some of the variables such as depressed vehicle sales and high unemployment and some of these other factors, average age, are truly going to allow for a longer sustainable tail of growth for the aftermarket?

Thomas Gallagher

I do, personally, Tony. If you look at a lot of the studies that have come out, what they would suggest is that while new car sales may rebound some over the next couple of years, we're not going back anytime soon to the historical levels, the 16.5, 17 million new car sales per year. The vehicle fleet is projected to continue to grow at a reasonable rate and the aging of the vehicles is projected to continue to persist. So what we see from a number of the studies is that the growth in the vehicles is actually going to come in the age category, six years and above, and we think that's a very, very good prospect for companies like ours because that's our target customer. Once the car gets to be six years or older, chances are the aftermarkets going to have an opportunity to do supply the parts that are needed to fix it. So, we think that the next couple of years could be reasonably good years for the aftermarket.

Tony Cristello - BB&T Capital

Okay, great, thank you guys.

Thomas Gallagher

Thank you.

Operator

Your next question is from the line of John Murphy with Bank of America.

John Murphy - Bank of America

Hey guys, John Murphy. How are you?

[Multiple Speakers]

Good John. How are you doing?

John Murphy - Bank of America

Good. Just kind of a follow-up on some of your highlights on inventory, you guys are doing a very good job of keeping your inventory lean, but I was just wondering as we look at the autos, the auto segment specifically, but your other segments as well, if you feel like the inventory in the channel across the board is very lean as well, even your competitors as well as your customers and as we hopefully see demand recover, there may be some real demand pull as well some potential restocking. I'm just trying to get a gauge of where we are in inventory in the channel in general for autos and your other segments.

Thomas Gallagher

John, I'll try to answer that and maybe will try to break it into pieces. If we look at inventory levels, at the installer level in the channel, I don't think there is going to be significant increase in demand going forward because they have historically kept their inventories fairly lean and rely on their serving part store to get them that part that they need within 20 or 30 minutes, so I don't think there is going to be much pull from that. I think that's going to be driven more by the increase in business that they experience. If we look at the store level at least within the NAPA channel, I think the inventories are in pretty good shape.

I don't think that they are extraordinarily lean, nor do I think that they are extraordinarily heavy. I think we are pretty well balanced, and that's one of the things that within NAPA we take some pride in is that we keep the inventories fairly responsive to what we see in the marketplace. So, there is not a lot of access that sits there at any time in the cycle. So, I think there we won't see huge inventory build-up on the part of our customer base giving us increased demand.

I think it's again going to be largely driven by the ultimate consumer demand, and then in our own case in our distribution centers, I think we do have some opportunity there to continue to work on what we would consider to be a little bit more investment than we absolutely have to have with enhanced technology and enhanced logistical capabilities that we're seeing some opportunities to do a better job with a little bit less. So, our inventories make them down just a little bit. Hopefully, it will come down a little bit and we will keep our service levels up as we have been, but I don't see that. I'm more concerned about inventory in the channel. Honestly, it's back a level or two from us and that's with maybe some of our vendors are important to them. Some of their raw material component suppliers and we have seen some recent examples where some of our good vendors historically are providing really, really good service have been impacted by some of there components suppliers who have not been able to keep up with the demand but, that's something that I think will be worked though over the next quarter or two. But I don't anticipate that inventory build up in the channel is going to give us any inflated demand.

John Murphy - Bank of America

Okay and then just second question, a last question, you raise your growth outlook for sales from a range of 3% to 5% to a range of 7% to 9%. Just wondering, if you can give us a break down by category, if you have it, where you receive the real strength there?

Thomas Gallagher

Well, we think, obviously the industrial related businesses will continue to perform well and I would say, from our planning perspective on the electrical side, we'd expect them to be up 14% to 16% over the second half of the year on the industrial side. We are thinking 13% to 15%, then again both of those numbers are a little bit tempered by some of the recent economic data that's come forth and we hope maybe there is a little bit of upside but at this point we don't want to count on it.

Automotive, we are seeing 5% to 7%, 6% to 7% over the remainder of the year and that office products we're seeing flat to up 1% to 2% over the reminder of the year

John Murphy - Bank of America

Great, thank you very much.

Operator

Your next question is from the line of Himanshu Patel with JPMorgan

Himanshu Patel - JPMorgan

Hi, could you guys talk just lastly about the cadence of sales throughout the second quarter in the Automotive division and also this particularly comment on how weather maybe impacting July.

Thomas Gallagher

The cadence has been studied through out the quarter. We didn't see any real difference as the quarter progressed and then our July results thus far are pretty consistent with what we saw in the second quarter.

Himanshu Patel - JPMorgan

Thank you.

Operator

Your next question is from the line of Brian Sponheimer with Gabelli Company

Brian Sponheimer - Gabelli Company

Hi, good morning. Just one question here, most of mine have been answered, regarding use of cash, you've clearly stated your intentions for the dividend for acquisitions and for repurchase. I was just curious, if there is any intent to further fund the obligations on the pension or is that something that might actually.

Jerry Nix

Brian, yeah we are looking at that. We don't need to make a contribution to the pension plan at this point for 2010. It does appear if you look at the projection, we'll make a contribution in 2011, but those are actuarially calculated. If you'll recall we went - we made a soft freeze on our pension plan effective 1/1/2009 and so if we continued to fund that pension plan and use the cash for that, it'll get to a point over a period of time that cash will be there and there is no way for the company to get any benefits from it. At this point, we'll let the actuaries do the calculations and certainly if we are required to make a contribution, we will. But it looks like now the first contribution that we will have to make will be in 2011.

Brian Sponheimer - Gabelli Company

Okay, great. And on the acquisition side, obviously evaluation is of the utmost importance. Has there been any movement from what you're seeing as far the realistic expectation from candidates that are looking to potentially be acquired?

Thomas Gallagher

The answer is kind of mixed, it's yes or no. We have some discussions where we think we got fair valuation for both the seller and buyer prospectively, and we continue to develop those discussions, we've had other discussion where we didn't find that common point and we've just deferred them for now.

One thing that may be happening is we may see private equity start to get back in the market, and if that happens and probably to move valuations up, and they would preclude us from some, but right now the discussions that we currently are having, we think are recently good possibilities over the second half of the year.

Brian Sponheimer - Gabelli Company

Okay, great, excellent, stuff. Thank you very much.

Thomas Gallagher

Thank you.

Jerry Nix

Thank you.

Operator

Your next question is from the line of Keith Hughes with SunTrust.

Keith Hughes - SunTrust

My question has been answered, thank you.

Thomas Gallagher

Thank you, Keith.

Operator

And we have time for one more question, and the question is from the line of Scott Stember with Sidoti.

Scott Stember - Sidoti

Hello, good morning.

Thomas Gallagher

Good morning.

Jerry Nix

Good morning, Scott.

Scott Stember - Sidoti

Yes, most of my questions have been answered. Could you just talk on the fleet side, you've shown some nice steady improvement there over the last couple of quarters. What's driving that? Is this sustainable and then maybe just dig into that a little bit?

Thomas Gallagher

Sure. First of all, keep in mind that we're coming off a very, very challenging period in 2009. So while we're up 4% in the quarter in 2009, we had four consecutive quarters of pretty significant decline, but what we saw happening -- beginning to happen in the early part of the year was we saw that the truck tonnage numbers were starting to firm up and improve some and the last report that we've seen takes us through the first quarter, and it looks like truck tonnage in the quarter was up about 4.5%.

So we just see vehicles starting to move again because there's a little bit more demand than -- at this point we do think it's sustainable, we're not looking for a dramatic improvement from where it is currently, but we do think what we see at the moment should carry through with the remainder of this year.

Scott Stember - Sidoti

Great, that's all I have. Thank you.

Thomas Gallagher

All right, thank you.

Jerry Nix

Shawn, thank you, we appreciate you joining us on the call today. We appreciate your continued interest and support of Genuine Parts Company. We look forward to talking to you in the future. Have a good day.

Operator

Thank you all for joining today's conference call. You may now disconnect.

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Source: Genuine Parts Company Q2 2010 Earnings Call Transcript
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