Business context and reporting period
W.W. Grainger, Inc. is a broad-line distributor of maintenance, repair and operating supplies, serving about 2 million customers through branches, distribution centers, sales representatives, catalogs and eCommerce. This Form 10-K covers the fiscal year ended December 31, 2012; quarterly figures are unaudited. The United States and Canada are reportable segments, with additional operations in Europe, Asia and Latin America.
Key financial metrics
| Metric | 2012 | 2011 | Change |
|---|---|---|---|
| Net sales | $8.950 billion | $8.078 billion | +10.8% |
| Gross profit / margin | $3.916 billion / 43.8% | $3.511 billion / 43.5% | Margin +0.3 percentage points |
| Operating earnings / margin | $1.131 billion / 12.6% | $1.052 billion / 13.0% | +7.5%; margin -0.4 points |
| Net earnings attributable to Grainger | $689.9 million | $658.4 million | +4.8% |
| Diluted EPS | $9.52 | $9.07 | +5.0% |
| Operating cash flow | $816.2 million | $746.1 million | +$70.1 million |
| Capital expenditures | $249.9 million | $196.9 million | +$53.0 million |
| Cash and cash equivalents | $452.1 million | $335.5 million | +$116.6 million |
| Total debt | $564.6 million | $516.6 million | Higher; debt / total capitalization was 15.3% versus 15.9% |
Working capital was $1.604 billion, versus $1.438 billion; the current ratio was 2.6, versus 2.4. Cash used in investing activities was $305.7 million, including $64.8 million for acquisitions. Cash used in financing activities was $394.4 million, including $340.5 million of share repurchases and $220.1 million of dividends. Management reported no material off-balance-sheet exposures.
Material changes versus the prior comparable period
- Sales growth reflected volume (+6%), acquisitions (+3%) and price (+3%), partly offset by foreign exchange (-1%). Gross margin improved as price increases exceeded product-cost increases, partly offset by customer mix.
- Operating expenses rose 13.3%, faster than sales, and operating margin declined. Expenses included a $76 million GSA/USPS settlement accrual and $24 million for branch closures, restructuring and impairment. Excluding identified charges in both years, operating earnings increased 15%.
- Adjusted diluted EPS, a non-GAAP measure, was $10.43, up 15%, versus reported EPS of $9.52. The 2012 adjustment was $0.91 per share, principally the GSA/USPS settlement, restructuring, goodwill impairment and U.S. branch closures.
- U.S. segment sales increased 7% and operating earnings 6%; Canada sales increased 11% and operating earnings 18%. Other Businesses sales rose 55%, substantially reflecting acquisitions, but operating earnings fell to $20 million from $31 million, with acquired operations in Europe and Brazil and some developing-market businesses reporting losses.
- Fourth-quarter sales were $2.226 billion, versus $2.077 billion; operating earnings were $258.4 million, versus $221.5 million; diluted EPS was $2.17, versus $2.04. Management reported that sales growth slowed sequentially through 2012, with a sudden sales decline in the final third of December.
Outlook, commentary, risks and contingencies
- On January 24, 2013, Grainger reiterated 2013 diluted EPS guidance of $10.85–$12.00 and raised sales-growth guidance to 3%–9% from 2%–8%, citing the Techni-Tool acquisition. Management anticipated a softer macroeconomic environment but expected to outperform economic indicators.
- Planned growth investments include sales capacity, product-line expansion, eCommerce, inventory-management services and international operations. 2013 capital expenditures were projected at $280–$350 million, funded from operating cash. The company projected a 37.3%–37.7% effective tax rate.
- The company paid the U.S. government $70 million plus interest under a settlement concerning GSA and USPS contract disclosure and pricing provisions. A $76 million liability had been recorded; the agreement contains no admission of wrongdoing and releases the company from the DOJ claims addressed by it. The recorded amount also included estimates for certain claims not covered by the agreement.
- Grainger was named in cases involving approximately 1,925 plaintiffs alleging asbestos and/or silica exposure. The company denied or intended to deny the allegations and stated it did not expect the cases to have a material adverse effect; outcomes remain uncertain.
- Principal risks include economic weakness, competitive pressure, commodity and fuel costs, supply interruptions, information-system or cybersecurity incidents, foreign-currency changes, acquisition integration, employee costs, and regulatory or legal matters. The company noted that cost pass-through depends on market conditions.
- Postretirement plan amendments and a Medicare-plan change reduced the benefit obligation by $84 million and $19 million, respectively. Management estimated these changes could increase 2013 pretax earnings by about $20 million and $5 million; a lower discount rate was estimated to reduce 2013 pretax earnings by about $5 million.
- Management and the auditor reported effective internal control over financial reporting; the auditor issued unqualified opinions on the financial statements and internal controls.
Important facts for investors to verify
- Whether the slower sales growth late in 2012 continued into 2013, and whether guidance assumptions were achieved.
- The recurring earnings and cash-flow impact of the GSA/USPS settlement, restructuring, impairment and other adjustments; compare GAAP results with management’s non-GAAP adjusted EPS.
- Profitability and integration progress in acquired and international businesses, particularly Fabory and AnFreixo, and the results of restructuring in Europe, India and China.
- Whether gross-margin gains can offset operating-cost growth, and how commodity prices, customer mix and competition affect margins.
- Debt maturities, liquidity and the company’s use of cash for capital spending, acquisitions, dividends and repurchases.
- Developments in asbestos/silica litigation, tax examinations and other governmental or regulatory proceedings.