GWW

W.W. Grainger, Inc. - Q1 2003 Filing Summary

Business Context and Reporting Period

This Form 10-Q covers the quarterly period ended March 31, 2003. W.W. Grainger, Inc. is engaged in the distribution of facilities maintenance products, services, and related information to businesses and institutions in North America. The company operates through three primary segments: Branch-based Distribution, Lab Safety, and Integrated Supply.

Key Financial Metrics

Note: Q1 2002 Net Earnings included a $23.9 million after-tax cumulative effect of an accounting change (SFAS 142) and $4.5 million in after-tax gains on investment securities.

Material Changes vs. Prior Period

• Revenue Growth: Net sales increased 1% year-over-year, driven by a 2% increase in Branch-based Distribution (up 11% in Canada, up 1% in the U.S.) and flat performance in Mexico. Lab Safety sales declined 2% due to weakness in the U.S. manufacturing sector.
• Profitability: Reported Net Earnings increased 52% to $52.4 million. However, on an adjusted basis excluding the 2002 accounting change and investment gains, earnings were essentially flat ($52.4M in 2003 vs. $54.0M in 2002).
• Operating Performance: Operating earnings rose 2% to $91.4 million. Gross profit margins improved by 0.71 percentage points due to pricing actions and favorable mix, partially offset by higher freight costs.
• Other Income/Expense: This line item swung from $8.8 million of income in 2002 to $3.4 million of expense in 2003. The decline was primarily due to the absence of $7.3 million in gains on sales of investment securities recorded in 2002 and a $1.6 million write-down of investments in 2003.
• Cash Flow: Net cash provided by operating activities decreased 26% to $49.7 million, largely due to a smaller increase in trade accounts payable compared to the prior year and higher increases in accounts receivable.

Outlook, Risks, and Unusual Items

• Subsequent Acquisition: On April 14, 2003, the Lab Safety Supply subsidiary acquired Gempler's for approximately $35 million in cash. Gempler's serves agricultural and grounds maintenance markets with 2002 sales of ~$32 million.
• Restructuring: The company continues to incur costs related to the 2001 shutdown of Material Logic. As of March 31, 2003, the restructuring reserve balance was $2.0 million, with payments expected to continue until June 2004.
• Guarantees: The company has guaranteed $21.8 million in employee bank loans (all paid subsequent to March 31, 2003) and holds other guarantees with a maximum exposure of $9.0 million. Management believes material payments are unlikely.
• Risks: Management cites risks including higher product costs, competitive pricing pressure, failure to implement new technologies, and general economic conditions affecting the North American market.
• Capital Allocation: The company repurchased 12,000 shares of treasury stock in Q1 2003. Approximately 10 million shares remain under the current repurchase authorization. A quarterly dividend of $0.185 per share was declared on April 30, 2003.

Investor Verification Checklist

• Adjusted Earnings: Verify the "normalized" earnings comparison, as the reported 52% increase is heavily influenced by one-time items in the prior year (SFAS 142 charge and investment gains).
• Freight Costs: Monitor the impact of rising freight costs on gross margins, which management noted as an offset to pricing actions.
• Canada Performance: Confirm the sustainability of the 11% sales growth in Canada, which was aided by a favorable exchange rate.
• Investment Write-downs: Review the $1.6 million write-down of investments and the equity loss in unconsolidated entities ($1.1 million) for potential future impairments.
• Acquisition Integration: Assess the integration and performance of the newly acquired Gempler's business in subsequent quarters.