W.W. Grainger, Inc. — 2011 Q2 Form 10-Q
Business and period: Grainger distributes maintenance, repair and operating supplies to businesses and institutions, primarily in the United States and Canada, with operations in Asia and Latin America. This unaudited report covers the three and six months ended June 30, 2011; comparisons are with the corresponding 2010 periods.
Financial performance
| Metric | Q2 2011 | Q2 2010 | Six months 2011 | Six months 2010 |
|---|---|---|---|---|
| Net sales | $2,003.0 million (+12.3%) | $1,783.7 million | $3,886.6 million (+12.5%) | $3,456.1 million |
| Gross profit | $862.4 million | $747.1 million | $1,692.0 million | $1,452.8 million |
| Gross margin | 43.1% | 41.9% | 43.5% | 42.0% |
| Operating earnings | $265.3 million (+23.4%) | $214.9 million | $527.9 million (+32.7%) | $397.8 million |
| Net earnings attributable to Grainger | $169.9 million (+31.6%) | $129.1 million | $327.8 million (+43.6%) | $228.3 million |
| Diluted EPS | $2.34 (+35%) | $1.73 | $4.52 (+49%) | $3.04 |
Cash flow and liquidity: First-half operating cash flow was $309.5 million, versus $286.3 million a year earlier. Investing cash outflow was $79.8 million, including $79.8 million of net capital additions, compared with $68.0 million and $26.9 million, respectively, in 2010. Financing cash outflow was $85.5 million, substantially below the prior-year $287.1 million, primarily because treasury-stock purchases fell to $50.8 million from $256.5 million. Cash increased to $465.7 million from $313.5 million at year-end 2010. Working capital was $1,427.5 million; the current ratio was 2.3, down from 2.6.
Debt: Total debt was approximately $486.2 million at June 30, 2011, including $236.5 million of current maturities, compared with approximately $494.3 million at December 31, 2010. Debt as a percentage of total capitalization was 15.9%, down from 17.8%. The filing attributes the increase in current maturities principally to the term loan becoming due within one year.
Material changes and management commentary
- Sales growth reflected stronger volume, price and foreign exchange; management attributed about 8 percentage points of second-quarter growth to volume. Gross-margin expansion was mainly due to selling-price increases exceeding product-cost increases.
- Second-quarter sales to heavy manufacturing and agriculture and mining customers rose in the high teens overall, though the U.S. agriculture and mining comparison was affected by prior-year Gulf oil-spill cleanup product sales. Canada and Other Businesses posted particularly strong growth.
- Operating expenses rose 12% in Q2, mainly from higher payroll, benefits and performance-related profit sharing. The 2010 quarter included a $10.3 million benefit from a paid-time-off policy change; excluding it, 2011 expense growth was 10%.
- Q2 effective tax rate was 35.0%, versus 39.1%; the 2011 rate benefited from settlements of tax examinations for 2007 and 2008. Diluted EPS included a $0.12-per-share benefit from those settlements. First-half 2010 included a net $0.02-per-share benefit from specified unusual items.
Guidance, risks and contingencies
On July 19, 2011, Grainger raised 2011 sales-growth guidance to 9%–10% and EPS guidance to $8.40–$8.70; the $0.12-per-share Q2 tax benefit is excluded. Management expected second-half gross margins to be similar to Q2, with some price erosion, and higher spending on sales representatives, eCommerce and advertising, plus costs for a Northern California distribution center opening in Q4. The filing cites tougher second-half sales comparisons and increased growth investment.
DOJ discussions regarding the GSA contract and DOJ/USPS investigations concerning pricing on USPS contracts remained ongoing. The company said it believes it complied in all material respects; outcomes and timing are uncertain, possible losses cannot be estimated, and unfavorable resolutions could involve significant payments, including potential False Claims Act damages and penalties. Management did not expect these matters to materially adversely affect financial position.
Other disclosed risks include economic and industry conditions, competition and pricing, product costs and supply disruptions, technology and data-security issues, litigation and regulatory proceedings, currency and commodity volatility, labor or transportation constraints, and natural or other catastrophes. The company reported effective disclosure controls and no material second-quarter change in internal control over financial reporting.
Important facts for investors to verify
- Whether sales growth, pricing and volume trends—and the expected second-half comparison—support the raised full-year guidance.
- How gross margins and operating costs develop as price erosion and growth investments affect earnings.
- The timing, resolution and financial exposure of the GSA and USPS investigations; potential loss is not estimable in the filing.
- Debt repayment and liquidity implications of the $236.5 million current maturity, and the return on elevated capital spending.
- The sustainability of EPS growth after excluding the Q2 tax-settlement benefit and comparing with 2010 unusual items.