W.W. Grainger, Inc. — Q2 2012 Form 10-Q
Business context and period. Grainger distributes maintenance, repair and operating supplies and related services, primarily in the United States and Canada, with operations also in Europe, Asia and Latin America. This unaudited quarterly report covers the three and six months ended June 30, 2012, compared with the same periods in 2011; balance-sheet comparisons are with December 31, 2011.
Key financial metrics
| Metric | Q2 2012 | Q2 2011 | First half 2012 | First half 2011 |
|---|---|---|---|---|
| Net sales | $2,249.3 million | $2,003.0 million | $4,442.7 million | $3,886.6 million |
| Gross profit / margin | $978.3 million / 43.5% | $862.4 million / 43.1% | $1,952.7 million / 43.9% | $1,692.0 million / 43.5% |
| Operating earnings / margin | $314.0 million / 14.0% | $265.3 million / 13.2% | $618.4 million / 13.9% | $527.9 million / 13.6% |
| Net earnings attributable to Grainger | $190.7 million | $169.9 million | $378.2 million | $327.8 million |
| Diluted EPS | $2.63 | $2.34 | $5.20 | $4.52 |
Performance and changes
- Q2 sales increased 12.3%; management attributed approximately 6 percentage points to volume, 5 to acquisitions and 3 to price, partly offset by a 2-point foreign-exchange impact. First-half sales rose 14.3%, with volume and acquisitions contributing most of the growth.
- Q2 operating earnings increased 18.4%, reflecting higher sales, improved gross margin and positive expense leverage. First-half operating earnings rose 17.1%; expenses grew slightly faster than sales over that period.
- Q2 diluted EPS increased 12% as reported. Q2 2011 included a $0.12-per-share tax-settlement benefit; excluding that benefit, management said Q2 EPS growth was 18%. First-half reported EPS rose 15%, or 18% excluding the same benefit.
- All customer end-markets grew. Heavy manufacturing led; U.S. and Canadian operating earnings each rose 15% in Q2. Other Businesses sales rose 84%, primarily from acquisitions and growth in Japan; excluding acquisitions, sales increased 21%. The newly acquired Brazilian business recorded a loss comparable to Fabory’s earnings.
- Price increases exceeding product-cost increases supported gross-margin expansion, partly offset by unfavorable customer and product mix. Acquisitions and spending on sales representatives, eCommerce and advertising increased operating expenses.
Cash flow, liquidity and debt
- First-half operating cash flow was $238.2 million, down from $309.5 million. Higher receivables associated with sales growth and lower current liabilities, including bonus and profit-sharing payments, contributed to cash use from working-capital changes.
- First-half investing cash outflow was $116.7 million, including $96.4 million of property, building and equipment additions and $24.3 million of net acquisition payments. Financing cash outflow was $208.4 million, including $211.0 million of treasury-stock purchases and $105.4 million of dividends.
- Cash and equivalents were $249.7 million at June 30, 2012, versus $335.5 million at year-end. Working capital, as defined by the company, was $1.672 billion, up $233.6 million; its working-capital assets-to-liabilities ratio was 2.9 versus 2.4.
- Total debt was approximately $548.5 million at June 30, including $72.5 million of short-term debt; total debt as a percentage of capitalization was 15.9%, unchanged from year-end. In May, Grainger borrowed $300 million through an unsecured term loan due November 2016, mainly to refinance existing debt and for general corporate purposes. The reported weighted-average rate while outstanding was 1.24%.
- The board declared a quarterly dividend of $0.80 per share on July 25, payable September 1, 2012.
Guidance, risks and contingencies
- On July 18, Grainger reiterated 2012 sales-growth guidance of 12%–14% and raised the low end of diluted EPS guidance to $10.50–$10.80 from $10.40–$10.80. Management expected second-half sales growth of 10%–13% and gross margins relatively consistent with Q2.
- DOJ discussions concerning GSA contract pricing and disclosure obligations, and USPS/DOJ discussions concerning two postal-service contracts, remained ongoing. Non-binding mediation was scheduled for Q3 2012. The company could not estimate possible losses; it did not expect a material adverse effect on financial position but said an unfavorable outcome could require significant payments, including possible treble damages and penalties. Grainger stated that it believed it had complied in all material respects.
- An internal investigation into alleged expense-form falsification and possible customer gift-card use at Grainger China was reported to the DOJ and SEC. The investigation did not substantiate initial information suggesting significant improper gift-card use; potential regulatory action or other consequences remained uncertain.
- Management identified risks including economic and market conditions, competition, product and other cost increases, supply or technology disruptions, currency and commodity volatility, litigation and regulatory matters, labor constraints, transportation disruption and natural catastrophes. The filing reported effective disclosure controls and no material second-quarter change in internal control over financial reporting.
Important facts for investors to verify
- Whether sales and EPS guidance was achieved, particularly given the projected slowdown in second-half sales growth.
- How acquisition-related growth, including Fabory and AnFreixo, and the Brazilian business’s performance affected future margins and earnings.
- Whether receivables and other working-capital movements continue to constrain operating cash flow relative to earnings.
- Developments and potential financial exposure in the GSA, USPS and China investigations; the filing provides no clear estimate of potential losses for the contract matters.
- The effect of the new term loan, share repurchases and dividends on debt, liquidity and capital allocation.