GENUINE PARTS CO (GPC) FY 2022 MD&A

ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.

The following discussion and analysis contains forward-looking statements, including, without limitation, statements relating to our plans, strategies, objectives, expectations, intentions and resources. Such forward-looking statements should be read in conjunction with our disclosures under “Item 1A. Risk Factors” of this Form 10-K.

OVERVIEW

Genuine Parts Company is a global service organization engaged in the distribution of automotive and industrial replacement parts. We have a long tradition of growth dating back to 1928, the year we were founded in Atlanta, Georgia.

In 2022, we conducted business in North America, Europe and Australasia from more than 10,600 locations. Our Automotive business operated in the U.S., Canada, Mexico, France, the U.K., Ireland, Germany, Poland, the Netherlands, Belgium, Spain, Portugal, Australia and New Zealand in 2022 and accounted for 62% of total revenues for the year. Our Industrial business operated in the U.S., Canada, Mexico, Australia, New Zealand, Indonesia and Singapore and accounted for 38% of total revenues.

Our mission is to be an employer of choice, supplier of choice, valued customer, good corporate citizen and investment of choice for all our shareholders. Additionally, we strive to be a respected community member that gives back to the communities in which we operate. Our strategic financial objectives are intended to align with our mission and drive value for all our stakeholders. Our strategic financial objectives include: (1) revenue growth in excess of market growth; (2) improved operating margins; (3) strong balance sheet and cash flows; and (4) effective capital allocation.

KEY PERFORMANCE INDICATORS

We consider a variety of performance and financial measures in assessing our business, and the key performance indicators used to measure our results are summarized below.

Comparable Sales

Comparable sales refer to period-over-period comparisons of our net sales excluding the impact of acquisitions, divestitures, foreign currency and other. We consider this metric useful to investors because it provides greater transparency into management’s view and assessment of our core ongoing operations. This metric is widely used by analysts, investors and competitors in our industry, although our calculation of the metric may not be comparable to similar measures disclosed by other companies, because not all companies and analysts calculate this metric in the same manner.

Gross Profit and Gross Margin

Gross profit represents net sales less cost of goods sold. Gross profit as a percentage of net sales is referred to as gross margin. Cost of goods sold primarily represents the cost of merchandise sold, including the cost of inbound freight from suppliers. It also includes the effects of supplier volume incentives and inventory adjustments. Our gross profit is variable in nature and generally follows changes in net sales. We believe that gross profit and gross margin are useful measures because they allow management, analysts, investors and others to evaluate the profit we generate from our sales, before operating and other expenses and income.

Selling, Administrative and Other Expenses ("SG&A")

SG&A includes all personnel and personnel-related costs at our segment headquarters, distribution centers, stores and branches, which accounts for more than 60% of total SG&A. Additional costs in SG&A include our facilities, freight and delivery, marketing, advertising, technology, digital, legal and professional costs. Freight and delivery costs are the shipping and handling costs incurred related to delivering merchandise to our customers.

Segment Profit and Segment Margin

Segment profit is calculated as net sales less costs of goods sold, operating expenses, and certain non-operating expenses attributable to the segment (e.g., foreign currency), excluding general corporate expenses, net interest expense, intangible asset amortization, and other unallocated amounts that are primarily driven by corporate initiatives. Operating expenses include SG&A at our segments. Segment profit as a percentage of segment net sales is referred to as segment margin.

We believe that segment profit and segment margin are useful measures because they allow management, analysts, investors, and other interested parties to evaluate the profitability of our segments, after the effects of

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operating and other expenses and income associated with those businesses. Refer to the Segment Data Footnote in the Notes to Consolidated Financial Statements for additional information.

Net Income and EBITDA

We believe that net income and EBITDA, along with their adjusted measures, are useful measures of operating performance. EBITDA helps us assess the underlying profitability of our company’s business operations before the effects of certain net expenses that directly arise from our capital investment decisions (depreciation, amortization), financing decisions (interest), and tax strategies (income taxes). Net Income represents our profitability after the effects of all operating and other expenses and income.

The adjusted measures of EBITDA and net income eliminate certain non-recurring charges and other items that we do not believe are reflective of our ongoing business performance. These adjusted measures help us evaluate our operating performance on a comparable basis from period-to-period so that we can better understand the ongoing factors and trends affecting our business operations. We also use adjusted EBITDA, together with net income and segment profit, to forecast our performance, evaluate our actual results against our forecasts and compare our results to others in the industries that we serve. Adjusted EBITDA is also a measure of performance included in our executive incentive compensation plans. See “Non-GAAP Financial Measures” below for a discussion of how we define adjusted net income and adjusted EBITDA and a reconciliation of adjusted net income, EBITDA and adjusted EBITDA to net income, the most directly comparable financial measure calculated and presented in accordance with accounting principles generally accepted in the United States (“GAAP”).

CONSOLIDATED RESULTS OF OPERATIONS

Our discussion of our results focuses on 2022 and 2021 and year-to-year comparisons between those periods. Discussions of 2020 results and year-to-year comparisons between 2021 and 2020 results are not included in this Form 10-K and can be found in “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in Part II, Item 7 of our Annual Report on Form 10-K for the fiscal year ended December 31, 2021.

In 2022, we experienced strong and consistent customer demand and a favorable pricing environment for our services. These factors, combined with our Industrial segment's $1.3 billion acquisition of Kaman Distribution Group ("KDG"), contributed to 17.1% revenue growth over 2021. Our strong revenue growth, expense leverage and strategic initiatives drove a 60 basis point improvement in segment margin and provided $1.5 billion in cash from operations, a 16.6% increase from 2021. These results allowed us to continue investing in our businesses through strategic acquisitions and capital expenditures.

Our results of operations are summarized below for the years ended December 31, 2022 and 2021.

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Net Sales

Our net sales increase of 17.1% includes an 11.8% comparable sales increase and an 8.6% positive impact from acquisitions, slightly offset by an unfavorable impact of foreign currency of 3.3%.

Strong customer demand, which was consistent throughout 2022, and a favorable pricing environment were the primary drivers of our comparable sales growth. We deployed strategic pricing increases throughout 2022 to offset the dynamic product cost increases we faced across our businesses from elevated inflationary pressure, particularly in Automotive. Separately, we continued to invest in strategic acquisitions in both segments, with the KDG acquisition in particular providing a significant sales benefit in 2022. Our sales growth was negatively impacted by the U.S. dollar strengthening relative to other foreign currencies during the year, most significantly against the Euro.

Automotive

Net sales for Automotive were $13.7 billion in 2022, an 8.9% increase from 2021. The increase includes 9.0% growth in comparable sales and a 4.5% contribution from acquisitions, partially offset by a 4.6% unfavorable impact from foreign currency and other.

Our growth in sales was driven by continued solid demand for automotive parts, a strong pricing environment due to elevated inflation in product costs, and footprint expansion through acquisitions, such as our entry into new markets in Spain and Portugal. Several underlying factors driving customer demand for automotive parts in the markets we serve include increases in the average age of cars on the road and miles driven, and the lack of availability of new cars due to supply chain constraints.

Industrial

Net sales for Industrial were $8.4 billion in 2022, a 33.2% increase from 2021. The increase includes 17.3% growth in comparable sales and a 16.8% contribution from acquisitions primarily driven by the addition of KDG. This was slightly offset by a 0.9% unfavorable impact of currency translation.

Our growth in comparable sales reflects the positive impact of our ongoing sales initiatives and strength in numerous industry segments in North America throughout much of 2022. We experienced double-digit sales growth across all 14 customer sectors we served, with the largest percent increases in oil and gas, mining, and aggregate and cement. The increase in sales volume drove the majority of our growth, in addition to a contribution of low single-digit product cost inflation. Our acquisition of KDG contributed significantly to our sales growth, and it enhanced our position as a market leader in the industrial supply chain for MRO and OEM customer support and advanced engineering and automation solutions.

Gross Profit & Gross Margin

Gross profit increased $1.1 billion, or approximately 16.7% from 2021, primarily driven by the increase in net sales, and gross margin decreased slightly to 35.0% from 35.2% in 2021. The positive contributions to gross margin from our pricing and sourcing initiatives, among others, were more than offset by the negative impact of lower supplier incentives as a percentage of sales; the relative sales growth of Industrial as a component of total sales, which generates lower gross margins than Automotive; and the unfavorable impact of foreign currency.

Operating Expenses

SG&A expenses represent 26.1% of net sales in 2022 compared to 27.4% of net sales in 2021. The decrease in SG&A expense as a percent of net sales was primarily driven by leveraging strong core sales growth, cost

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reduction and productivity initiatives, as well as a one-time benefit of $103 million on the sale of real estate that had been previously leased to S.P. Richards Company ("SPR"). These benefits were partially offset by higher personnel and freight and delivery costs in 2022, and costs of $67 million associated with the acquisition and integration of KDG, which includes an impairment of $17 million from the retirement of certain legacy trade names. Additionally we had a remeasurement to increase our product liability by $29 million due to a revision of our estimate of the number of claims to be incurred in future periods, among other assumptions.

The increase in depreciation and amortization expense of $57 million was due to higher amortization from intangible assets associated with the acquisition of KDG and higher depreciation from increased capital investments to improve our distribution facilities, streamline our supply chain and invest in enhanced technology solutions.

Non-Operating Expenses and Income

We incurred $42 million in net non-operating expenses in 2022, a $79 million change from $37 million in net non-operating income in 2021. This category primarily includes net interest expense, pension and investment income, foreign currency gains and losses, and Accounts Receivable Sales Agreement ("A/R Sales Agreement") fees. The $79 million change includes the effects of a $12 million increase in net interest expense in 2022 due to increased borrowing to fund the acquisition of KDG. It also includes the effects of a $67 million decrease in other non-operating income. The decrease primarily resulted from a $32 million year-over-year net decline in income on certain investments, a $17 million increase in A/R Sales Agreement fees, and the net change of $12 million as foreign currency moved from gains in the prior year to losses in the current year.

Segment Profit

Automotive

Automotive segment profit increased 11.0% and its segment margin improved 10 basis points from 2021. The increased segment profit reflects the benefits of strong sales growth due to solid customer demand, a favorable pricing environment and footprint expansion into new markets, such as in Europe. We were able to improve segment margin in Automotive, despite elevated inflationary product cost pressures, primarily through our strategic pricing initiatives and our ability to leverage operating costs through strong core sales growth and the benefits of our strategic supply chain initiatives.

Industrial

Industrial segment profit increased 49.0% and its segment margin improved 110 basis points from 2021. The improvement in Industrial segment profit and margin primarily reflects the benefits of leveraging expenses through double-digit core sales growth, the acquisition of KDG and our strategic supply chain and other operating initiatives.

Income Taxes

Our effective income tax rate was 24.8% as of December 31, 2022, compared to 25.1% in 2021. For the year ended December 31, 2022, the rate decrease is primarily due to the inclusion in the prior year results of the impact of a United Kingdom rate change that required deferred tax asset and liability remeasurement, partially offset by other one time adjustments.

On August 16, 2022, the Inflation Reduction Act of 2022 ("IRA") was signed into law, and is effective beginning January 1, 2023. The IRA contains tax provisions primarily focused on implementing a 15% minimum tax on global adjusted financial statement income and a 1% excise tax on share repurchases which we do not expect to have material impacts to our financial statements.

Net Income

Net income was $1.2 billion in 2022, a significant increase compared to $899 million in 2021. Diluted earnings per share ("EPS") was $8.31 in 2022, up 33.4% compared to $6.23 in 2021. Adjusted net income was $1.2 billion in 2022, an increase of 19.1% from $997 million in 2021. Adjusted diluted EPS was $8.34, a 20.7% increase compared to $6.91 in 2021. EBITDA was $2.0 billion in 2022, an increase of 28.4% from $1.6 billion in 2021. Adjusted EBITDA was $2.0 billion in 2022, an increase of 18.9% from $1.7 billion in 2021.

The growth in net income, adjusted net income, EBITDA and adjusted EBITDA in all periods presented reflects strong operating results in both of our segments, driven primarily by strong sales growth, the benefits of key acquisitions (including KDG), and the continued execution of our strategic pricing and other initiatives, as discussed more fully in the commentary above.

Adjusted net income, adjusted diluted EPS, EBITDA and adjusted EBITDA are non-GAAP measures (see table below for reconciliations to the most directly comparable GAAP measures).

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Non-GAAP Financial Measures

The following tables sets forth reconciliations of net income, diluted EPS to adjusted net income and adjusted diluted EPS to account for the impact of adjustments. We also include adjusted EBITDA with a reconciliation to pretax earnings. We believe that the presentation of adjusted net income, adjusted diluted EPS and adjusted EBITDA, which are not calculated in accordance with GAAP, when considered together with the corresponding GAAP financial measures and the reconciliations to those measures, provide meaningful supplemental information to both management and investors that is indicative of our core operations. We consider these metrics useful to investors because they provide greater transparency into management’s view and assessment of our ongoing operating performance by removing items management believes are not representative of our continuing operations and may distort our longer-term operating trends. We believe these measures to be useful to enhance the comparability of our results from period to period and with our competitors, as well as to show ongoing results from operations distinct from items that are infrequent or not associated with our core operations. We do not, nor do we suggest investors should, consider such non-GAAP financial measures in isolation from, or as a substitute for, GAAP financial information.

The table below represents amounts per common share assuming dilution:

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(1)Adjustment reflects a gain on the sale of real estate that had been leased to S.P. Richards.

(2)Adjustment reflects insurance recoveries in excess of losses incurred on inventory, property, plant and equipment and other fire-related costs.

(3)Adjustment to remeasure product liability for a revised estimate of the number of claims to be incurred in future periods, among other assumptions.

(4)Adjustment reflects damages reinstated by the Washington Supreme Court order on July 8, 2021 in connection with a 2017 automotive product liability claim.

(5)Adjustment reflects a loss on an internally developed software project that was disposed of due to a change in management strategy related to advances in alternative technologies.

(6)Adjustment relates to gains recognized upon remeasurement of certain equity investments to fair value upon acquiring the remaining equity of those entities.

(7)Adjustment for 2022 primarily includes costs of $67 million associated with the January 3, 2022 acquisition and integration of KDG which includes a $17 million impairment charge. The impairment charge was driven by a decision to retire certain legacy trade names, classified as other intangible assets, prior to the end of their estimated useful lives as part of executing our KDG integration and rebranding strategy. Separately, this adjustment includes an $11 million loss related to an investment. Adjustment for 2021 includes transaction and other non-recurring costs related to acquisitions.

(8) Adjustments are the same as adjustments included within the adjusted net income table above.

The table below clarifies where the adjusted items are presented in the consolidated statement of income:

OUTLOOK

We expect continued revenue and earnings growth in 2023 despite uncertain economic conditions. We anticipate revenue growth in 2023, as positive trends related to miles driven, aging vehicles and limited new car inventory remain supportive of sustained demand for our Automotive business. In addition, we believe the strong performance in our Industrial business reflects the diversity of our product and service offerings. We expect our growing capabilities in industrial solutions, including automation, fluid power and conveyance to be differentiators for our business.

We continue to execute our strategic pricing and sourcing initiatives to mitigate product and other inflationary cost pressures which we expect to drive improvement in gross margins and earnings. With our global growth initiatives and strong industry fundamentals, we believe we are well positioned for both near-term and sustainable long-term sales and earnings growth.

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FINANCIAL CONDITION

Our cash balance at December 31, 2022 was $653 million compared to cash of $715 million a year ago. Accounts receivable increased $391 million, or 21.7%, from December 31, 2021 primarily due to higher net sales inclusive of the KDG acquisition. Inventory increased $552 million, or 14.2% from December 31, 2021 in association with higher product demand and increased net sales, and acquisitions (including KDG). Accounts payable increased $652 million, or 13.6% from December 31, 2021 due to increased purchases to support higher net sales and extended payment terms with certain suppliers. Total debt of $3.3 billion at December 31, 2022 increased $919 million from December 31, 2021 primarily due to the Senior Notes offering (as discussed below) to fund the acquisition of KDG.

Supply Chain Finance Programs

We have negotiated extended payment dates with our suppliers through supply chain finance programs. Several global financial institutions offer voluntary supply chain finance ("SCF") programs which enable our suppliers (generally those that grant extended terms), at their sole discretion, to sell their receivables from us to these financial institutions on a non-recourse basis at a rate that takes advantage of our credit rating and may be beneficial to them. The SCF program is primarily available to suppliers of goods and services included in cost of goods sold in our consolidated statements of income. We and our suppliers agree on commercial terms for the goods and services we procure, including prices, quantities and payment terms, regardless of whether the supplier elects to participate in the SCF program. Our current payment terms with the majority of our suppliers range from 30 to 360 days. The suppliers sell goods or services, as applicable, to us and they issue the associated invoices to us based on the agreed-upon contractual terms. Then, if they are participating in the SCF program, our suppliers, at their sole discretion, determine which invoices, if any, they want to sell to the financial institutions. In turn, we direct payment to the financial institutions, rather than the suppliers, for the invoices sold to the financial institutions. No guarantees are provided by us or any of our subsidiaries on third-party performance under the SCF program; however, we guarantee the payment by our subsidiaries to the financial institutions participating in the SCF program for the applicable invoices. We have no economic interest in a supplier’s decision to participate in the SCF program, and we have no direct financial relationship with the financial institutions, as it relates to the SCF program. Accordingly, amounts due to our suppliers that elected to participate in the SCF program are included in the line item accounts payable in our consolidated balance sheets. All activity related to amounts due to suppliers that elected to participate in the SCF program is reflected in cash flows from operating activities in our consolidated statement of cash flows. We have been informed by the financial institutions that as of December 31, 2022 and 2021, suppliers elected to sell $3.1 billion and $2.7 billion, respectively, of our outstanding payment obligations to the financial institutions. The amount settled through the SCF program was $3.7 billion for the year ended December 31, 2022.

LIQUIDITY AND CAPITAL RESOURCES

Our strong financial position and cash flow performance have provided us with the capacity to invest in acquisitions, capital expenditures and technology to support our global growth strategy, as well as return value to our shareholders through dividends and share repurchases. Our sources of capital consist primarily of cash flows from operations, supplemented as necessary by private and public issuances of debt and bank borrowings. Currently, we believe that our cash on hand and available short-term and long-term sources of capital are sufficient to fund our operations in both the short and long term, including working capital requirements, strategic acquisitions, dividends, share repurchases, capital expenditures, scheduled debt and interest payments, and income tax obligations.

Our total debt outstanding at December 31, 2022 increased by $919 million from December 31, 2021, as discussed above.

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Sources and Uses of Cash

A summary of our consolidated statements of cash flows is as follows:

Operating Activities

We generated strong positive cash flow in 2022 with the increase in cash provided by operating activities primarily driven by higher earnings and the effective management of our working capital, including a $200 million benefit related to increasing the amount of receivables sold under our A/R Sales Agreement.

Investing Activities

We continue to invest in our business through strategic acquisitions and capital expenditures to broaden our product and service offerings, improve our business operations and expand our global footprint. In 2022, net cash used in investing activities included $1.7 billion used for acquisitions of businesses and other investing activities primarily in connection with the acquisition of KDG and a $158 million benefit from the settlement of a net investment hedge. Additionally, we invested $340 million in capital expenditures to improve our supply chain, facilities, and technology environment. These items were partially offset by $145 million in proceeds from the sale of property, plant and equipment (primarily real estate that had been previously leased to SPR) and $34 million in proceeds from divestitures of store operations in Automotive.

Financing Activities

Cash provided by financing activities reflects $919 million of net proceeds from debt primarily from the Senior Notes offering, which was mostly offset by dividends paid to shareholders of $496 million and repurchases of our common stock of $223 million. In 2022, we announced a 10% increase in our regular quarterly cash dividend and we expect this trend of increasing dividends to continue in the foreseeable future. We also expect to remain active in our share repurchase program, but the amount and value of shares repurchased will vary and is subject to authorization of our Board of Directors.

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Notes and Other Borrowings

On January 3, 2022, we amended our A/R Sales Agreement to increase the facility limit by an additional $200 million, bringing the total to $1 billion. The terms of the A/R Sales Agreement limit the balance of receivables sold to approximately $1 billion at any point in time. Refer to the A/R Sales Agreement Footnote in the Notes to Consolidated Financial Statements for more information.

On January 6, 2022, we issued $500 million of unsecured 1.750% Senior Notes due 2025. Simultaneously, we issued $500 million of unsecured 2.750% Senior Notes due 2032. For both offerings, interest is payable semi-annually on February 1 and August 1 of each year, beginning on August 1, 2022.

At December 31, 2022, we had $3.4 billion of unsecured Senior Notes outstanding. Approximately $1.8 billion of these borrowings contain covenants related to a maximum debt to EBITDA ratio and certain limitations on additional borrowings. At December 31, 2022, we were in compliance with the covenants under our Unsecured Revolving Credit Facility and our outstanding unsecured Senior Notes. Any failure to comply with our debt covenants or restrictions could result in a default under our financing arrangements or require us to obtain waivers from our lenders for failure to comply with these restrictions. The occurrence of a default that remains uncured or the inability to secure a necessary consent or waiver could create cross defaults under other debt arrangements and have a material adverse effect on our business, financial condition, results of operations and cash flows.

We ended the year with $2.2 billion of total liquidity (comprising $1.5 billion availability on the revolving credit facility and $653 million of cash and cash equivalents). Due to the workers’ compensation and insurance reserve requirements in certain states, we also had unused letters of credit of approximately $71 million outstanding at December 31, 2022. Our unused letters of credit expire within one year, but have automatic renewal clauses. From time to time, we may enter into other credit facilities or financing arrangements to provide additional liquidity and to manage against foreign currency risk. We currently believe that the existing lines of credit and cash generated from operations will be sufficient to fund anticipated operations for the foreseeable future.

Our total average cost of debt was 2.33% at December 31, 2022 and 2.35% at December 31, 2021. Total interest expense, net of interest income, for all borrowings was $74 million and $62 million in 2022 and 2021, respectively. Refer to the Debt Footnote in the Notes to Consolidated Financial Statements for more information.

Contractual and Other Obligations

The following table summarizes our material cash requirements at December 31, 2022 that we expect to be paid in cash. The table does not include amounts that are contingent on events or other factors that are uncertain or unknown at this time, including legal contingencies and uncertain tax positions. The amounts presented are based on various estimates and actual results may vary from the amounts presented.

Purchase orders or contracts for the purchase of inventory and other goods and services are not included in our estimates. We are not able to determine the aggregate amount of such purchase orders that represent contractual cash requirement, as purchase orders may represent authorizations to purchase rather than binding agreements. Our purchase orders are based on our current distribution needs and are fulfilled by our vendors within short time horizons. We do not have significant agreements for the purchase of inventory or other goods specifying minimum quantities or set prices that exceed our expected requirements.

Additionally, we guarantee the borrowings of certain independently owned automotive parts stores (independents) and certain other affiliates in which we have a noncontrolling equity ownership interest (affiliates). Our maximum exposure to loss as a result of our involvement with these independents and affiliates is generally equal to the total borrowings subject to our guarantee. At December 31, 2022, the total borrowings of the independents and affiliates subject to guarantee by the company were approximately $916 million. These loans generally mature over periods from one to six years. Our amount of commitment expiring in 2023 is approximately $401 million. To date, we have had no significant losses in connection with guarantees of independents’ and affiliates’ borrowings.

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Share Repurchases

In 2022, we repurchased approximately 1.6 million shares of our common stock for an aggregate $223 million, and we had remaining authority to purchase approximately 10.3 million shares of our common stock at December 31, 2022. We expect to remain active in our share repurchase program and continue to return capital to our shareholders. There were no other repurchase plans announced as of December 31, 2022.

CRITICAL ACCOUNTING POLICIES

Management’s Discussion and Analysis of Financial Condition and Results of Operations is based upon our consolidated financial statements, which have been prepared in accordance with U.S. GAAP. The preparation of our consolidated financial statements requires management to make estimates, assumptions and judgments that affect the reported amounts of assets, liabilities, net sales and expenses and related disclosure of contingent assets and liabilities. Management bases its estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions.

We describe in this section certain critical accounting policies that require us to make significant estimates, assumptions and judgments. An accounting policy is deemed to be critical if it requires an accounting estimate to be made based on assumptions about matters that are uncertain at the time the estimate is made and if different estimates that reasonably could have been used, or changes in the accounting estimates that are reasonably likely to occur periodically, could materially impact the consolidated financial statements. Management believes the following critical accounting policies reflect its most significant estimates and assumptions used in the preparation of the consolidated financial statements. For further information on the critical accounting policies, see the Summary of Significant Accounting Policies Footnote in the Notes to Consolidated Financial Statements.

Consideration Received from Vendors

We may enter into agreements at the beginning of each year with many of our vendors that provide for inventory purchase incentives. Generally, we earn inventory purchase incentives upon achieving specified volume purchasing levels or other criteria. We accrue for the receipt of these incentives as part of our inventory cost based on cumulative purchases of inventory to date and projected inventory purchases through the end of the year. While management believes we will continue to receive consideration from vendors in 2023 and beyond, there can be no assurance that vendors will continue to provide comparable amounts of incentives in the future or that we will be able to achieve the specified volumes necessary to take advantage of such incentives.

Impairment of Goodwill and Other Intangible Assets

At least annually, we evaluate property, plant and equipment, goodwill and other intangible assets for potential impairment indicators. Our judgments regarding the existence of impairment indicators are based on market conditions and operational performance, among other factors. Future events could cause us to conclude that impairment indicators exist and that assets associated with a particular operation are impaired. Evaluating for impairment also requires us to estimate future operating results and cash flows which requires judgment by management. Any resulting impairment loss could have a material adverse impact on our financial condition and results of operations. Refer to the Goodwill and Other Intangible Assets Footnote of the Notes to Consolidated Financial Statements for further information on the results of our annual goodwill impairment testing.

Employee Benefit Plans

Our benefit plan committees in the U.S. and Canada establish investment policies and strategies and regularly monitor the performance of our pension plan assets. Our U.S. plan, our largest pension plan, is well-funded, with a fund status of 127% at December 31, 2022. The plans in Europe are unfunded and therefore there are no plan assets. Our pension plan investment strategy implemented by our management is to achieve long-term objectives and invest the pension assets in accordance with the applicable pension legislation in the U.S. and Canada, as well as fiduciary standards. The long-term primary objectives for the pension plan funds are to provide for a reasonable amount of long-term growth of capital without undue exposure to risk, protect the assets from erosion of purchasing power and provide investment results that meet or exceed the pension plans’ actuarially assumed long-term rates of return. Our investment strategy with respect to pension plan assets is to generate a return in excess of the passive portfolio benchmark (38% U.S. Large-cap stocks, 9% U.S. Mid-cap stocks, 10% International stocks, 3% Emerging Market stocks and 40% Barclays U.S. Gov/Credit Index).

We make several critical assumptions in determining our pension plan assets and liabilities and related pension income. We believe the most critical of these assumptions are the expected rate of return on plan assets and the discount rate. Other assumptions we make relate to employee demographic factors such as rate of

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compensation increases, mortality rates, retirement patterns and turnover rates. Refer to the Employee Benefit Plans Footnote of the Notes to Consolidated Financial Statements for more information regarding these assumptions.

Based on the investment policy for the pension plans, as well as an asset study that was performed based on our asset allocations and future expectations, our expected rate of return on plan assets for measuring 2023 pension income is 7.09% for the plans. The asset study forecasted expected rates of return for the approximate duration of our benefit obligations, using capital market data and historical relationships.

The discount rate is chosen as the rate at which pension obligations could be effectively settled and is based on capital market conditions as of the measurement date. We have matched the timing and duration of the expected cash flows of our pension obligations to a yield curve generated from a broad portfolio of high-quality fixed income debt instruments to select our discount rate. Based upon this cash flow matching analysis, we selected a weighted average discount rate for the plans of 5.61% at December 31, 2022.

Our pension income for 2022 is determined at the December 31, 2021 measurement date. A 25 basis point increase in discount rate would result in an approximate $46 million decrease on our projected benefit obligation. A 25 basis point decrease in discount rate would result in approximate $48 million increase on our projected benefit obligation. A 25 basis point change in discount rate would have an immaterial impact on our pension income. A 25 basis point change in expected return on asset would have an approximate $6 million impact on our pension income. These sensitivities reflect the effect of changing one assumption at a time and assume no changes to the design of the pension plans.

Effective December 31, 2013, our defined benefit pension plans were amended to freeze benefit plan accruals for participants and provide for immediate vesting of accrued benefits. Net periodic benefit income for our defined benefit pension plans was $27 million, $19 million, and $18 million for the years ended December 31, 2022, 2021 and 2020, respectively. The income associated with the pension plans in 2022, 2021 and 2020 reflects the impact of the freeze. Refer to the Employee Benefit Plans Footnote of the Notes to Consolidated Financial Statements for more information regarding employee benefit plans.

Business Combinations

When we acquire businesses, we apply the acquisition method of accounting and recognize the identifiable assets acquired, the liabilities assumed, and any noncontrolling interests in an acquiree at their fair values on the acquisition date, which requires significant estimates and assumptions. Goodwill is measured as the excess of the fair value of the consideration transferred over the net of the acquisition date fair values of the identifiable assets acquired and liabilities assumed. The acquisition method requires us to record provisional amounts for any items for which the accounting is not complete at the end of a reporting period. We must complete the accounting during the measurement period, which cannot exceed one year. Adjustments made during the measurement period could have a material impact on our financial condition and results of operations.

We typically measure customer relationships and other intangible assets using an income approach. Significant estimates and assumptions used in this approach include discount rates and certain assumptions that form the basis of the forecasted cash flows expected to be generated from the asset (e.g., future revenue growth rates and EBITDA margins). If the subsequent actual results and updated projections of the underlying business activity change compared with the assumptions and projections used to develop these values, we could record impairment charges. In addition, we have estimated the economic lives of certain acquired tangible and intangible assets and these lives are used to calculate depreciation and amortization expense. If our estimates of the economic lives change, depreciation or amortization expenses could be increased or decreased, or the acquired asset could be impaired.

Legal and Product Liabilities

We accrue for potential losses related to legal disputes, litigation, product liabilities, and regulatory matters when it is probable (the future event or events are likely to occur) that we will incur a loss and the amount of the loss can be reasonably estimated.

To calculate product liabilities, we estimate potential losses relating to pending claims and also estimate the likelihood of additional, similar claims being filed against us in the future. To estimate potential losses on claims that could be filed in the future, we consider claims pending against us, claim filing rates, the number of codefendants and the extent to which they share in settlements, and the amount of loss by claim type. The estimated losses for pending and potential future claims are calculated on a discounted basis using risk-free interest rates derived from market data about monetary assets with maturities comparable to those of the projected product liabilities. We use an actuarial specialist to assist with measuring our product liabilities. While we believe our legal and product liability estimates are reasonable in light of all available information, if one or more legal claims were to greatly exceed our

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estimates, our results of operations and cash flows could be materially and adversely affected. Refer to the Commitments and Contingencies Footnote of the Notes to Consolidated Financial Statements for additional information regarding product liabilities.

Self Insurance

We are self-insured for the majority of our group health insurance costs. A reserve for claims incurred but not reported is developed by analyzing historical claims data provided by our claims administrators. These reserves are included in accrued expenses in the accompanying consolidated balance sheets as the expenses are expected to be paid within one year.

Long-term insurance liabilities consist primarily of reserves for our workers’ compensation program. In addition, we carry various large risk deductible workers’ compensation policies for the majority of workers’ compensation liabilities. We record the workers’ compensation reserves based on an analysis performed by an independent actuary. The analysis calculates development factors, which are applied to total reserves as provided by the various insurance companies who underwrite the program. While we believe that the assumptions used to calculate these liabilities are appropriate, significant differences in actual experience or significant changes in these assumptions may materially affect workers’ compensation costs.

RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS

Refer to the Summary of Significant Accounting Policies Footnote in the Notes to Consolidated Financial Statements for information on recent accounting pronouncements.