W.W. Grainger, Inc. — 2011 Form 10-K
Reporting period: Fiscal year ended December 31, 2011. The filing also reports unaudited quarterly results, including the fourth quarter. Grainger distributes maintenance, repair and operating supplies through branches, sales representatives, catalogs and eCommerce, primarily in the United States and Canada, with expanding international operations.
Key financial results
| Metric | 2011 | 2010 | Change |
|---|---|---|---|
| Net sales | $8.078 billion | $7.182 billion | +12.5% |
| Gross profit margin | 43.5% | 41.8% | +1.7 percentage points |
| Operating earnings | $1.052 billion | $860.5 million | +22.3% |
| Net earnings attributable to Grainger | $658.4 million | $510.9 million | +28.9% |
| Diluted earnings per share | $9.07 | $6.93 | +30.9% |
| Cash from operations | $746.1 million | $596.4 million | +$149.7 million |
Operating margin increased to 13.0% from 11.9%; net margin increased to 8.1% from 7.1%. Fourth-quarter sales were $2.077 billion versus $1.827 billion, operating earnings were $221.5 million versus $211.4 million, and diluted EPS was $2.04 versus $1.83.
Cash and cash equivalents were $335.5 million at year-end. Working capital was $1.307 billion, down from $1.369 billion, and the current ratio declined to 1.9 from 2.6. Total debt, including short-term debt and current maturities, was approximately $516.6 million; debt as a percentage of total capitalization was 15.9%, compared with 17.8% in 2010. Investing activities used $535.1 million, including $359.3 million for acquisitions and $196.9 million for capital expenditures. Financing activities used $177.4 million; dividends paid were $180.5 million and treasury-stock purchases were $151.1 million.
Business developments and changes
- U.S. sales increased 8.0%; operating earnings rose 15.9%. Canada sales increased 20.9% and operating earnings rose 129.7%. Other-business sales increased 66.2%, primarily reflecting Fabory and growth in international operations.
- Grainger acquired the Fabory Group, a European distributor, on August 31, 2011, for approximately $358 million net of acquired cash; it recorded about $257 million of goodwill and intangible assets. The purchase price allocation was not final. Acklands-Grainger acquired Fercomat in Canada.
- Gross-margin improvement reflected price increases exceeding product-cost increases, a lower share of low-margin sourced products, and lower excess and obsolete inventory requirements. Expense growth reflected volume, acquisitions and growth investments; U.S. branch closures also generated approximately $18 million of costs.
- Operating cash flow increased with earnings, partly offset by working-capital investment, particularly higher receivables and inventory. Capital expenditures were $196.9 million versus $127.1 million in 2010.
Outlook, risks and unusual items
As of January 25, 2012, management forecast 2012 sales growth of 10%–14%, including 5%–8% volume growth, 2%–3% price and approximately 3% from acquisitions. Forecast diluted EPS was $9.90–$10.65. Management expected gross-margin expansion and improved operating expenses as a percentage of sales, partly offset by growth investments and faster growth among lower-margin contract customers. Planned 2012 capital expenditures were $200–$225 million, expected to be funded from operating cash flow.
2011 EPS included a $0.16 expense for U.S. branch closures, a $0.12 tax-review settlement benefit and a $0.07 gain on sale of the MRO Korea joint venture, a net benefit of $0.03 per share. The 2010 comparison included a net $0.13-per-share benefit from a paid-time-off policy change and a healthcare-legislation tax item. A lower year-end discount rate for postretirement healthcare benefits was estimated to reduce 2012 pretax earnings by approximately $9.1 million.
Key risks include economic weakness, competitive and commodity-cost pressures, supply-chain or information-system disruptions, foreign-currency movements, acquisition integration and regulatory compliance. The company disclosed ongoing government inquiries into pricing under GSA and USPS contracts; possible settlements or litigation could involve significant payments, but loss estimates could not be determined. Grainger also began an internal investigation into alleged expense falsification and possible customer gift-card provision at its China subsidiary, voluntarily disclosed the matter to the DOJ and SEC, and agreed to cooperate. Asbestos and silica lawsuits were also pending; management did not expect them to have a material adverse effect.
Ernst & Young issued unqualified opinions on the financial statements and internal controls. Management and the auditor excluded Fabory’s internal controls from the 2011 control assessment; the acquired business represented $109 million of 2011 revenue and $183 million of year-end net assets.
Investor verification priorities
- Track whether 2012 sales and EPS guidance was achieved, and assess the contribution from volume, pricing and acquisitions.
- Review Fabory’s finalized purchase accounting, integration performance, margins and any goodwill or intangible-asset impairment indicators.
- Monitor working-capital conversion, inventory growth, cash generation, debt maturities and liquidity, especially the reported $221.5 million of current maturities.
- Follow the GSA and USPS pricing matters and the China investigation for outcomes, potential financial exposure and any control or compliance implications.
- Assess the effect of postretirement-benefit assumptions, commodity and currency movements, and growth investments on future margins and earnings.