W.W. Grainger, Inc. — Q3 2013 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2013. Grainger distributes maintenance, repair and operating supplies and related services, primarily in the United States and Canada. The financial statements are unaudited.
Financial performance
| Metric | Q3 2013 | Q3 2012 | Nine months 2013 | Nine months 2012 |
|---|---|---|---|---|
| Net sales | $2.399 billion | $2.281 billion | $7.061 billion | $6.724 billion |
| Gross profit | $1.051 billion | $994.0 million | $3.130 billion | $2.947 billion |
| Operating earnings | $346.7 million | $254.3 million | $1.040 billion | $872.7 million |
| Net earnings attributable to Grainger | $210.8 million | $155.4 million | $640.3 million | $533.6 million |
| Diluted EPS | $2.95 | $2.15 | $8.92 | $7.35 |
| Gross margin | 43.8% | 43.6% | 44.3% | 43.8% |
| Operating margin | 14.5% | 11.2% | 14.7% | 13.0% |
Q3 sales increased 5% year over year (4% on a per-sales-day basis); nine-month sales rose 5%. Q3 had 64 sales days versus 63 in 2012. Management attributed nine-month sales growth to volume, price and acquisitions, partly offset by foreign exchange.
Cash flow: Operating cash flow for the first nine months was $740.4 million, up from $576.1 million. Investing activities used $272.8 million, including $148.4 million of property and equipment additions and $128.0 million for acquisitions. Financing activities used $368.5 million, including $279.6 million of share repurchases and $188.7 million of dividends. Ending cash was $540.0 million.
Balance sheet and liquidity: At September 30, cash was $540.0 million; total debt was approximately $548.7 million, comprising short-term debt, current maturities and long-term debt. Total debt was 14.0% of total capitalization, versus 15.3% at year-end 2012. Working capital was $1.668 billion, and the working-capital assets-to-liabilities ratio was 2.7. Total assets were $5.252 billion. The company replaced its $400 million credit line with a $600 million facility; there were no borrowings under either facility.
Material changes and management commentary
- Q3 operating earnings increased 36%, but the prior-year quarter included $76 million of reserves relating to government contract issues. Excluding that item, Q3 operating earnings increased 5% and diluted EPS increased 5%; the reserve had reduced prior-year EPS by $0.66.
- Gross margin improved, supported by freight-consolidation savings and higher supplier rebates; customer mix, including stronger sales to lower-margin large customers, was a partial offset. Nine-month margin also benefited from price increases exceeding product-cost increases.
- Excluding the prior-year reserve, operating expenses rose 6% in Q3 and 5% for the nine months, reflecting growth and infrastructure investment. Management cited an additional $40 million of Q3 spending and $99 million for the nine-month period, including eCommerce, sales-force expansion and inventory management.
- The United States drove Q3 growth: segment sales rose 7%, while Canada sales declined 1% reported (up 2% in local currency). Other-business sales were flat per sales day, and operating earnings declined, particularly due to weaker results in Mexico, Colombia and Brazil.
- The effective tax rate was 37.3% for the nine months versus 37.5% in 2012; the 2013 rate included a benefit from resolving foreign tax matters. The company projected a full-year rate of 37.4%–37.8%.
Outlook, risks and other items
- On October 16, 2013, Grainger narrowed 2013 sales-growth guidance to 5%–6% from 5%–8%, and EPS guidance to $11.45–$11.65 from $11.40–$12.00. Management cited first-nine-month performance, continued growth and infrastructure investment, a softer global economy and unfavorable foreign exchange.
- Grainger acquired E&R Industrial on August 23, 2013; the distributor had approximately $180 million of 2012 sales. Its results were immaterial to Q3 and were to be included beginning in Q4. The purchase-price allocation remained subject to change.
- The board declared a quarterly dividend of $0.93 per share, payable December 1, 2013. The company repurchased 300,293 shares in Q3 at an average price of $255.59.
- Management listed risks including economic and market conditions, competition and pricing, product costs and supply disruption, foreign exchange and commodity volatility, litigation and regulatory matters, technology and data-security disruption, labor and transportation issues, and natural catastrophes. It did not expect pending legal and administrative matters, individually or in aggregate, to materially adversely affect consolidated financial position or results.
- Disclosure controls were judged effective at quarter-end; no material change in internal control over financial reporting was reported.
Important facts for investors to verify
- Whether revised full-year sales and EPS guidance was achieved, and how foreign exchange and economic softness affected results.
- How much reported earnings growth depended on the prior-year $76 million reserve, and whether margins and expense leverage were sustainable.
- Returns from growth and infrastructure spending, including eCommerce, sales-force expansion, inventory initiatives and Canada’s planned IT system.
- E&R Industrial’s final purchase-price allocation, subsequent contribution, and integration performance.
- Cash conversion, capital spending, acquisitions, repurchases and dividends relative to ongoing liquidity and investment needs.
- Exposure to the identified legal, regulatory, currency, supply-chain, technology and economic risks.