W.W. GRAINGER, INC. annual report, FY2013

W.W. Grainger, Inc. — FY2013 Form 10-K

Reporting period: Fiscal year ended December 31, 2013. This is an annual filing, not a standalone Q4 report; selected quarterly figures are included. Grainger distributes maintenance, repair and operating supplies through branches, sales representatives, catalogs and eCommerce, primarily in the United States and Canada.

Financial results

MetricFY2013FY2012Change
Net sales$9.438 billion$8.950 billion+5.4%
Gross profit / margin$4.136 billion / 43.8%$3.916 billion / 43.8%Profit +5.6%; margin flat
Operating earnings / margin$1.297 billion / 13.7%$1.131 billion / 12.6%+14.7%
Net earnings attributable to Grainger$797 million$690 million+15.5%
Diluted EPS$11.13$9.52+16.9%
Cash from operating activities$986 million$816 million+$170 million
Capital expenditures$272 million$250 million+$22 million

Gross margin held steady as price increases exceeding product cost increases were offset by lower margins at acquired businesses and faster growth among lower-margin customers. Operating earnings benefited from sales growth and expense growth below the sales rate. Management’s adjusted diluted EPS, a non-GAAP measure, was $11.52 in 2013 versus $10.43 in 2012, excluding specified unusual items.

Cash, debt and liquidity

Year-end cash was $431 million, total debt was approximately $543 million, and working capital was $1.621 billion, versus $1.604 billion in 2012. The current ratio was 2.5, compared with 2.6. Debt was 14.0% of total capitalization, down from 15.3%. Operating cash flow less capital expenditures was approximately $714 million. Cash used in investing was $399 million, including $154 million net cash paid for acquisitions; cash used in financing was $591 million, including $438 million of treasury-share purchases and $255 million of dividends. The annual dividend paid per share rose to $3.59 from $3.06.

Material changes and Q4 performance

  • U.S. sales increased 7% to $7.414 billion; Canada sales rose 1% to $1.114 billion, or 4% in local currency; other-business sales rose 3% to $1.040 billion. Foreign exchange reduced reported growth in Canada and other businesses.
  • eCommerce revenue was $2.5 billion, up 16%, and represented 33% of consolidated revenue.
  • Grainger acquired E&R Industrial Sales and Safety Solutions in 2013 and divested four direct-marketing brands on December 31, 2013.
  • Q4 sales were $2.377 billion versus $2.226 billion a year earlier; operating earnings were $257 million versus $258 million; net earnings attributable to Grainger were $157 million versus $156 million; diluted EPS was $2.20 versus $2.17.
  • FY2013 included $26 million of impairment expense, principally for Grainger Lighting Services and Brazil, and $10 million of restructuring expense related mainly to Europe and China. The filing reports a combined $0.39-per-share impact. FY2012 included a $76 million GSA/USPS settlement expense and other charges, with a combined $0.91-per-share impact.

Outlook, risks and contingencies

On January 24, 2014, Grainger reduced its 2014 guidance to sales growth of 5%–9% (from 6%–10%) and EPS of $12.10–$12.85 (from $12.25–$13.00), primarily because of unfavorable foreign exchange and the brand divestitures. Planned 2014 capital expenditures were $375 million–$425 million, focused on supply chain, technology, eCommerce and sales initiatives.

Key risks cited include economic weakness, competition and pricing pressure, commodity and freight-cost volatility, product or supply-chain disruption, cybersecurity and information-system failures, foreign-exchange fluctuations, acquisition integration and impairment risk, and regulatory or litigation outcomes. Fabory’s $134 million goodwill balance had only a 17% fair-value cushion over carrying value, and the filing warns that continued weakness in Europe or changed assumptions could lead to impairment. Unresolved items include a $6 million reserve for certain GSA-related claims and approximately $44 million of tax uncertainty liabilities and interest; the timing of the latter cannot be reliably estimated. Asbestos and silica litigation involved approximately 1,929 plaintiffs as of January 23, 2014; management did not expect these matters to materially adversely affect consolidated results or financial position. The GSA/USPS settlement amounts were paid.

Management and the independent auditor concluded internal control over financial reporting was effective at year-end. Ernst & Young issued an unqualified opinion on the financial statements.

Investor verification priorities

  • Track whether 2014 sales and EPS meet the revised guidance, particularly after foreign-exchange effects and the divestitures.
  • Assess the durability of gross margins amid customer mix, acquisition-related margins, pricing and cost changes.
  • Monitor cash conversion and capital spending against the $375 million–$425 million 2014 plan, alongside buybacks and dividends.
  • Review impairment assumptions and performance at Grainger Lighting Services, Brazil and Fabory, including Fabory’s limited valuation headroom.
  • Follow the remaining GSA-related claims, tax examinations and uncertain tax positions, and asbestos/silica litigation developments.