W.W. Grainger, Inc. — Q1 2012 Form 10-Q
Business and period: Grainger distributes maintenance, repair and operating supplies and related services. This unaudited filing covers the three months ended March 31, 2012, compared with the three months ended March 31, 2011. Its operations are primarily in the United States and Canada, with other businesses in Asia, Europe and Latin America.
Financial performance
| Metric | Q1 2012 | Q1 2011 | Change |
|---|---|---|---|
| Net sales | $2,193.4 million | $1,883.6 million | +16.4% |
| Gross profit / margin | $974.3 million / 44.4% | $829.6 million / 44.0% | Profit +17.4%; margin +0.4 percentage point |
| Operating earnings / margin | $304.4 million / 13.9% | $262.6 million / 13.9% | +15.9%; margin essentially flat |
| Net earnings attributable to Grainger | $187.5 million | $157.9 million | +18.7% |
| Diluted earnings per share | $2.57 | $2.18 | +18% |
| Operating cash flow | $106.2 million | $118.4 million | Down $12.2 million |
| Capital expenditures | $40.6 million | $33.0 million | — |
Cash flow and liquidity: Cash and cash equivalents were $338.8 million at March 31, 2012, versus $335.5 million at December 31, 2011. Operating cash flow was pressured by a $130.4 million net use of cash from changes in operating assets and liabilities, mainly higher receivables, lower payables, and the timing of bonus and profit-sharing payments. Cash used in investing was $39.4 million; cash used in financing was $55.4 million, including $61.8 million of treasury-stock purchases and $47.0 million of dividends paid.
Working capital, as defined by the company, was $1,666.8 million, up $228.5 million from year-end; the working-capital assets-to-liabilities ratio rose to 2.9 from 2.4, primarily because of lower compensation and profit-sharing accruals after annual payments. Total debt was approximately $523.7 million, including short-term debt and current maturities; debt was 15.4% of total capitalization, down from 15.9% at December 31, 2011.
Material changes and management commentary
- Sales growth reflected approximately 10 percentage points from volume, 5 from acquisitions, and 3 from price, partly offset by 1 point each from lower seasonal-product sales amid unusually warm weather and foreign exchange.
- Gross margin improved mainly because price increases exceeded product-cost increases; higher freight costs partly offset the benefit. Operating expenses grew 18%, faster than sales, reflecting Fabory, growth initiatives, volume-related costs, and corporate support spending.
- U.S. segment sales increased 11%; Canada sales increased 13% (14% in local currency); Other Businesses sales increased 104%, mainly due to Fabory. Excluding Fabory, Other Businesses sales rose 33%.
- The effective tax rate declined to 37.4% from 39.1%, primarily due to a greater share of earnings in lower-tax foreign jurisdictions and a lower blended state tax rate. Management said lower taxes also benefited quarterly earnings and EPS.
- Management cited industrial production growth and strength in manufacturing and other customer end-markets, and attributed strong performance partly to investments in product expansion, sales force, eCommerce, inventory-management services, and international operations.
Outlook, risks and unusual items
- On April 17, 2012, Grainger raised 2012 sales-growth guidance to 12%–14% from 10%–14%, and EPS guidance to $10.40–$10.80 from $9.90–$10.65.
- On April 25, the board declared a quarterly dividend of $0.80 per share, payable June 1 to shareholders of record May 14. This was a 21% increase from the prior $0.66 quarterly rate.
- On April 2, after quarter-end, the company acquired all shares of Brazilian MRO distributor AnFreixo S.A.; its reported 2011 sales were approximately $37 million.
- Government investigations concerning pricing and contract compliance under the company’s GSA and USPS contracts remained ongoing. The company said possible loss could not be estimated; while it did not expect a material adverse effect on financial position, an unfavorable outcome could require significant payments, including potential treble damages and penalties.
- An internal investigation into alleged expense-report falsification and possible customer gift cards at Grainger China was ongoing. The company voluntarily notified the DOJ and SEC in January 2012 and said it could not predict regulatory action or other consequences.
- Management identified risks including product-cost and expense increases, competition, customer or supply disruption, technology and data-security issues, economic and currency conditions, commodity and fuel costs, litigation and regulatory proceedings, labor shortages, weather, and other disruptions.
Important facts for investors to verify
- Whether sales growth, pricing, and margin trends continue, and how growth spending affects expense leverage.
- Whether cash conversion improves as receivables and annual compensation-related payments affect working capital.
- Progress and financial impact of Fabory, AnFreixo, and other international operations.
- Developments, potential exposure, and any financial-statement updates relating to the government contract matters and China investigation.
- Performance against the revised 2012 sales and EPS guidance and the effect of the increased dividend and share repurchases.