W.W. Grainger, Inc. — Q3 2012 Form 10-Q
Reporting period: Three and nine months ended September 30, 2012. The unaudited filing covers Grainger, a distributor of maintenance, repair and operating supplies, with operations primarily in the U.S. and Canada and growing international businesses.
Financial performance
| Metric | Q3 2012 | Q3 2011 | Nine months 2012 | Nine months 2011 |
|---|---|---|---|---|
| Net sales | $2,281.2 million | $2,114.6 million | $6,723.9 million | $6,001.3 million |
| Gross margin | 43.6% | 43.2% | 43.8% | 43.4% |
| Operating earnings | $254.3 million | $303.0 million | $872.7 million | $830.9 million |
| Operating margin | 11.2% | 14.3% | 13.0% | 13.8% |
| Net earnings attributable to Grainger | $155.4 million | $182.1 million | $533.6 million | $509.9 million |
| Diluted EPS | $2.15 | $2.51 | $7.35 | $7.03 |
- Q3 sales increased 8% reported and 10% per sales day; volume, acquisitions and pricing contributed, partly offset by foreign exchange. There were 63 sales days versus 64 a year earlier.
- Q3 gross margin improved 0.4 percentage point, mainly as price increases exceeded product-cost increases, partly offset by customer mix.
- Reported Q3 operating earnings fell 16% and diluted EPS fell 14%, primarily reflecting a $76 million government-contract liability. Excluding that item, management reported operating earnings growth of 9% and EPS growth of 12%.
- For the first nine months, sales rose 12% and diluted EPS rose 5%. Excluding the $0.66-per-share government-contract charge in 2012 and a $0.12-per-share tax-settlement benefit in 2011, management reported EPS growth of 16%.
- Q3 U.S. segment sales grew 4% and operating earnings declined 18% as reported; excluding the liability, U.S. operating earnings increased 7%. Canada sales grew 10% and operating earnings 37%. Other Businesses sales grew 51%, largely due to acquisitions, while segment operating earnings declined to $8.8 million from $10.6 million.
Cash flow, balance sheet and liquidity
- Nine-month operating cash flow was $576.1 million, versus $560.0 million. Investing activities used $174.1 million, including $155.2 million of capital expenditures and $24.4 million net cash paid for acquisitions. Financing activities used $322.5 million, including $296.5 million of treasury-stock purchases and $162.0 million of dividends.
- Cash and cash equivalents were $420.8 million at September 30, 2012, up from $335.5 million at year-end 2011. Current assets were $2,875.0 million and current liabilities $1,083.2 million.
- Total debt was approximately $562.1 million, comprising short-term debt, current maturities and long-term debt. Management reported debt at 15.9% of total capitalization, unchanged from December 31, 2011. The May 2012 $300 million unsecured term loan matures in November 2016; its weighted-average interest rate while outstanding was 1.24%.
- Management-defined working capital was $1,574.3 million, up from $1,438.4 million at year-end; its working-capital-assets-to-liabilities ratio increased to 2.6 from 2.4. The quarterly dividend was $0.80 per share; the board declared another $0.80 dividend payable December 1, 2012.
Outlook, contingencies and risks
- On October 16, 2012, Grainger reduced 2012 sales-growth guidance to 11%–12% from 12%–14%. EPS guidance remained $10.50–$10.80 and excludes the $0.66-per-share impact of the $76 million pre-tax government-contract expense. Management expected Q4 gross margins to remain relatively consistent with Q3.
- Following September mediation, the company reached a settlement in principle with the Department of Justice concerning disclosure and pricing provisions in GSA and USPS contracts. The proposed settlement includes a $70 million payment, plus an estimated $6 million liability for certain other alleged claims. The $76 million liability was recorded at quarter-end; the settlement remained subject to DOJ approval and a definitive agreement, and includes no admission of wrongdoing.
- The DOJ closed its inquiry into the company’s investigation of alleged expense-report falsification and possible customer gift-card practices at its China subsidiary. The company said its investigation did not substantiate initial information suggesting significant improper use of gift cards and reported cooperation with the DOJ and SEC.
- Management cited risks including economic and industry conditions, competition and pricing, product costs and supply disruptions, currency and commodity volatility, legal and regulatory proceedings, technology or data-security disruption, labor and transportation constraints, and natural or other catastrophes.
- The company planned early adoption of new indefinite-lived-asset impairment guidance and did not expect a material financial-statement effect.
Important facts for investors to verify
- Whether the proposed DOJ settlement received approval and was finalized, and the ultimate payments or additional liabilities.
- Whether 2012 sales and EPS guidance was achieved; note that EPS guidance excludes the government-contract charge.
- Underlying operating performance after separating the $76 million charge, acquisition effects, foreign exchange and the different number of sales days.
- Cash conversion and funding needs, including continued investment, dividends, share repurchases and debt service.
- Performance and profitability of acquired and developing-market businesses, including the Europe and Brazil operations noted as loss-making in Q3.