There were 64 sales days in both the first quarter of 2005 and the first quarter of 2004.
Grainger’s net sales of $1,334.9 million in the first quarter of 2005 increased 8.7% compared with sales of $1,227.8 million for the comparable 2004 quarter. First quarter 2005 sales benefited from a stronger economy, market share gains, ongoing strategic initiatives and a favorable Canadian exchange rate. These growth factors were partially offset by the negative impact from the timing of the Easter holiday, which fell into the first quarter of 2005 versus the second quarter of 2004. The increase in net sales was realized in both segments of the business.
The gross profit margin improved a percentage point to 37.4% for the first three months of 2005 from 36.4% in the comparable period of 2004. Contributing to the gross profit margin improvement were positive inflation recovery and the positive effect of product mix. Operating earnings for the first quarter of 2005 totaled $108.7 million, an increase of 7.9% over the first quarter of 2004. The improvement in operating earnings was from both the Branch-based Distribution and Lab Safety segments, as well as from lower operating expenses at headquarters. Operating expenses of $390.2 million in 2005 increased 12.5% over the prior year, primarily driven by increased costs related to strategic initiatives and higher accruals for sales commissions and profit sharing.
Net earnings for the first quarter of 2005 increased by 16.4% to $72.8 million from $62.6 million in 2004. Diluted earnings per share of $0.79 in the first quarter 2005 was 14.5% higher than the $0.69 for the first quarter of 2004. The growth in net earnings for the quarter resulted from the improvement in operating earnings, higher other income and a reduced tax rate for the Company.
W.W. Grainger, Inc. and Subsidiaries
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
Segment Analysis
The following comments at the segment level refer to external and intersegment net sales. Comments at the business unit level include external and inter- and intrasegment net sales. See Note 7 to the Condensed Consolidated Financial Statements.
Branch-based Distribution
In the first quarter of 2005, net sales of $1,242.3 million increased by 8.7% compared to net sales of $1,143.1 million in the first quarter of 2004. Sales in the United States were up 8.2%, with growth in all customer end markets, led by the manufacturing and commercial sectors. National account sales within these customer segments were up 12% in the quarter and sales to government accounts were up 9%. Partially offsetting these improvements in sales was the negative impact from the timing of the Easter holiday, which fell into the first quarter of 2005 versus the second quarter of 2004.
Net sales in Canada in the first quarter of 2005 were 12.1% higher than the comparable quarter of 2004 due to a stronger economy and a favorable exchange rate. In local currency, sales increased 4.2%, resulting from improved sales in the natural resources sector. Sales in Mexico increased 15.2% in the first three months of 2005, driven by an improving economy, expanded telesales operation and incremental sales for one new and one expanded branch, both added in 2004.
The gross profit margin increased 0.8 percentage point in the 2005 quarter over the comparable quarter of 2004. Contributing to the improvement in gross profit margin were positive inflation recovery and the positive effect of product mix.
Operating expenses for the Branch-based Distribution businesses were up 14.7% in the quarter. Increased costs related to strategic initiatives, for both market expansion and the SAP system, were the primary drivers of the operating expense growth. Higher accruals for sales commissions and profit sharing also contributed to the increase. Partially offsetting these increases were lower bonus accruals and lower bad debt expense.
Operating earnings of $108.9 million for the first quarter of 2005 increased 1.6% over the $107.1 million for the first quarter of 2004. The earnings improvement resulted from higher sales and improved gross profits, partially offset by operating expenses, which grew at a faster rate than sales.
Lab Safety
Net sales at Lab Safety were $93.5 million for the first quarter of 2005, an increase of $7.7 million, or 9.0%, when compared with $85.8 million for the same period in 2004. The sales growth was attributable to incremental sales from the AW Direct business (AW Direct), acquired on January 14, 2005, as well as increased volume in core product lines. Excluding AW Direct, sales increased 1.1%. Excluding a one-time fulfillment program from prior year, sales were up 5.9%.
17
W.W. Grainger, Inc. and Subsidiaries
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
The gross profit margin of 43.3% for the first quarter of 2005 increased 2.1 percentage points over the first quarter of 2004. The margin improvement was primarily attributable to the elimination of the 2004 fulfillment program. The 2005 gross profit margin also benefited from inflation recovery. These margin increases were partially offset by incremental sales of AW Direct products, which generally have lower gross profit margins than the remainder of Lab Safety’s products.
Operating expenses at Lab Safety of $26.9 million were $3.3 million, or 14.2%, higher in the quarter due to incremental costs associated with the acquisition of AW Direct, as well as increased media spending.
Operating earnings of $13.6 million in the first quarter of 2005 were up 15.4% over 2004, resulting primarily from the increased gross profit margin, partially offset by increased operating expenses.
Other Income and Expense
Other income and expense was $6.6 million of income in the first quarter of 2005 compared with $0.4 million of income in the first quarter of 2004. The following table summarizes the components of other income and expense:
| Three Months Ended March 31,
|
|---|
| 2005
| 2004
|
|---|
| (In thousands of dollars) |
|---|
Other income and (expense): | | | | | | | | |
| Interest income (expense) – net | | | $ | 1,957 | | $ | (181 | ) |
| Equity in income (losses) of unconsolidated entities, net | | | | 420 | | | (345 | ) |
| Gain on sale of unconsolidated entity | | | | -- | | | 750 | |
| Unclassified – net: | | |
| Gains (losses) on sales of fixed assets, net | | | | 4,281 | | | (48 | ) |
| Other | | | | (38 | ) | | 189 | |
|
| |
| |
| Total other income and (expense) | | | $ | 6,620 | | $ | 365 | |
|
| |
| |
The improvement in other income and expense was primarily attributable to the gains realized on the sale of several facilities and the combination of higher interest income and lower interest expense versus the 2004 quarter. The gains resulting from the sales of fixed assets resulted principally from the sale of five facilities: four located in the United States that were related to the market expansion program and one located in Canada. The change to net interest income in 2005 from net interest expense in the prior year was primarily the result of higher average cash balances and higher interest rates and lower interest expense resulting from the payoff of debt.
Income Taxes
Grainger’s effective tax rate was 36.9% and 38.1% for the first quarter of 2005 and 2004, respectively. Excluding the effect of equity in unconsolidated entities, which is recorded net of tax, the effective income tax rate was 37.0% for 2005 and 38.0% for 2004. The one percentage point reduction in the effective tax rate was primarily the result of tax benefits related to the Medicare Act, the realization of tax benefits related to operations in Mexico and lower provisions related to uncertainties.
18
W.W. Grainger, Inc. and Subsidiaries
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
Financial Condition
For the three months ended March 31, 2005, working capital of $1,136.6 million increased by $44.3 million when compared to $1,092.3 million at December 31, 2004. The ratio of current assets to current liabilities was 2.8 at March 31, 2005, versus 2.6 at December 31, 2004.
Net cash provided by operating activities was $12.7 million in the first quarter of 2005 and $93.1 million in the first quarter of 2004. Net cash flows from operating activities serve as the Company’s primary source of funding its growth initiatives. Contributing to cash flows from operations were net earnings in the quarter of $72.8 million and the change in non-cash items such as deferred income taxes and depreciation and amortization. Nearly offsetting these amounts were Changes in operating assets and liabilities – net of business acquisition, which resulted in a net use of cash of $100.2 million for the 2005 quarter. The principal uses of cash were an increase in inventories and a reduction of other current liabilities. The increase in inventories was primarily in the Branch-based Distribution segment and was due to volume increases, greater availability of products and market expansion. Other current liabilities declined primarily due to the annual cash payments for profit sharing and bonuses.
Net cash used in investing activities was $52.4 million in the first quarter of 2005 and $10.3 million in the first quarter of 2004. In the first quarter of 2005, Grainger continued funding of the Company’s growth initiatives with the purchase of AW Direct and its ongoing investment in the market expansion program. The cash portion of the AW Direct purchase price was approximately $24.8 million. AW Direct is included as part of the Lab Safety segment. Cash expended for additions to property, buildings, equipment and capitalized software was $35.1 million in the 2005 quarter versus $14.6 million in the 2004 quarter.
Net cash used in financing activities was $19.9 million in the first quarter of 2005 and $50.4 million in the first quarter of 2004. Grainger’s purchases of treasury stock were $21.4 million lower in the first three months of 2005 as Grainger repurchased 239,400 shares compared with 785,300 shares in the first three months of 2004. As of March 31, 2005, approximately 6.8 million shares of common stock remained available under Grainger’s repurchase authorization. Dividends paid to shareholders were $18.2 million and $16.9 million for the first quarter of 2005 and 2004, respectively. Partially offsetting these financing cash outlays were proceeds from stock options exercised of $13.6 million in 2005 and $3.1 million in 2004.
Grainger maintains a debt ratio and liquidity position that provides flexibility in funding working capital needs and long-term cash requirements. In addition to internally generated funds, Grainger has various sources of financing available, including commercial paper sales and bank borrowings under lines of credit. Total debt as a percent of total capitalization was 0.4% and 0.5% at March 31, 2005 and December 31, 2004, respectively.
19
W.W. Grainger, Inc. and Subsidiaries
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
Critical Accounting Policies and Estimates
The preparation of financial statements, in conformity with accounting principles generally accepted in the United States of America, requires management to make judgments, estimates and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses in the financial statements. Management bases its estimates on historical experience and other assumptions, which it believes are reasonable. If actual amounts are ultimately different from these estimates, the revisions are included in Grainger’s results of operations for the period in which the actual amounts become known.
Accounting policies are considered critical when they require management to make assumptions about matters that are uncertain at the time the estimate is made and when different estimates than those management reasonably could have made have a material impact on the presentation of Grainger’s financial condition, changes in financial condition or results of operations. For a description of Grainger’s critical accounting policies see the Company’s Annual Report on Form 10-K for the year ended December 31, 2004.
Forward-Looking Statements
This document may contain forward-looking statements under the federal securities laws. The forward-looking statements relate to Grainger’s expected future financial results and business plans, strategies and objectives and are not historical facts. They are often identified by qualifiers such as “will,” “continue,” “believes,” “intends,” “expectations,” “expected,” “anticipate,” “estimate,” “assumption,” “may,” “potential,” “projection,” “depending” or similar expressions. There are risks and uncertainties the outcome of which could cause Grainger’s results to differ materially from what is projected.
Factors that may affect forward-looking statements include the following: higher product costs or other expenses; a major loss of customers; increased competitive pricing pressure on Grainger’s businesses; failure to develop or implement new technologies or other business strategies; the outcome of pending and future litigation and governmental proceedings; changes in laws and regulations; facilities disruptions or shutdowns; disruptions in transportation services; natural and other catastrophes; unanticipated weather conditions; and other difficulties in achieving or improving margins or financial performance.
Trends and projections could also be affected by general industry and market conditions, gross domestic product growth rates, general economic conditions, including industrial production, interest rate and currency rate fluctuations, global and other conflicts, job creation and employment levels in manufacturing, non-farm and other sectors, and other factors.
20
W.W. Grainger, Inc. and Subsidiaries
PART I — FINANCIAL INFORMATION
| Item 3. | | Quantitative and Qualitative Disclosures about Market Risk |
| | For quantitative and qualitative disclosures about market risk, see “Item 7A: Quantitative and Qualitative Disclosures About Market Risk” in the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2004. |
| Item 4. | | Controls and Procedures |
| | Disclosure Controls and Procedures |
| | | Grainger carried out an evaluation, under the supervision and with the participation of its management, including the Chief Executive Officer and the Chief Financial Officer, of the effectiveness of the design and operation of Grainger’s disclosure controls and procedures pursuant to Exchange Act Rule 13a-15. Based upon that evaluation, the Chief Executive Officer and the Chief Financial Officer concluded that Grainger’s disclosure controls and procedures were effective as of the end of the period covered by this report. |
| | Changes in Internal Control Over Financial Reporting |
| | | There were no changes in Grainger’s internal control over financial reporting that occurred during the period covered by this report that have materially affected, or are reasonably likely to materially affect, Grainger’s internal control over financial reporting. |
21
W.W. Grainger, Inc. and Subsidiaries
PART II — OTHER INFORMATION
Items 1, 3 and 5 not applicable.
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
Issuer Purchases of Equity Securities – First Quarter
Period
| Total Number of
Shares
Purchased (A)
| Average Price
Paid per Share
(B)
| Total Number of Shares
Purchased as Part of
Publicly Announced Plans
or Programs (C)
| Maximum Number of
Shares that May Yet be
Purchased Under the
Plans or Programs
|
| Jan. 1 — Jan. 31 | | | | 673 | | $ | -- | | | -- | | | 7,080,700 shares | |
Feb. 1 — Feb. 28 | | | | 18,504 | | $ | 62.13 | | | 17,000 | | | 7,063,700 shares | |
Mar. 1 — Mar. 31 | | | | 222,400 | | $ | 63.70 | | | 222,400 | | | 6,841,300 shares | |
|
|
|
|
|
| Total | | | | 241,577 | | $ | 63.58 | | | 239,400 | | | 6,841,300 shares | |
| | (A) | | The total number of shares purchased includes Grainger’s retention of 2,177 shares to satisfy tax withholding obligations in connection with the vesting of employee restricted stock awards. |
| | (B) | | Average price paid per share includes any commissions paid and includes only those amounts related to purchases as part of publicly announced plans or programs. Activity is reported on a settlement date basis. |
| | (C) | | Purchases were made pursuant to a share repurchase program approved by Grainger’s Board of Directors. As reported in Grainger’s Form 10-Q for the quarter ended September 30, 2002, which was filed on November 11, 2002, authority under the program was restored to 10 million shares on October 30, 2002. The program has no specified expiration date. No share repurchase plan or program expired or was terminated during the period covered by this report. |
Item 4. Submission of Matters to a Vote of Security Holders
| | | | An annual meeting of shareholders of Grainger was held on April 27, 2005. At that meeting: |
| | | | Management’s nominees were elected directors for the ensuing year. Of the 82,953,498 shares present in person or represented by proxy at the meeting, the number of shares voted for, and the number of shares as to which authority to vote in the election was withheld, were as follows with respect to each of the nominees: |
22
W.W. Grainger, Inc. and Subsidiaries
Name
| Shares Voted for
Election
| Shares as to Which
Voting Authority Withheld
|
B. P. Anderson
W. H. Gantz
D. W. Grainger
W. K. Hall
R. L. Keyser
J. W. McCarter, Jr.
N. S. Novich
G. L. Rogers
J. D. Slavik
H. B. Smith | 81,946,968
81,258,121
81,245,391
81,146,225
80,934,589
80,776,526
81,537,160
81,549,588
81,259,867
80,742,480 | 1,006,530
1,695,377
1,708,107
1,807,273
2,018,909
2,176,972
1,416,338
1,403,910
1,693,631
2,211,018 |
| | A proposal to ratify the appointment of Ernst & Young LLP as independent auditors of Grainger for the year ending December 31, 2005 was approved. Of the 82,953,498 shares present or represented by proxy at the meeting, 82,270,738 shares were voted for the proposal, 230,232 shares were voted against the proposal and 452,528 shares abstained from voting with respect to the proposal. |
| | A proposal to approve the 2005 Incentive Plan was approved. Of the 82,953,498 shares present in person or represented by proxy at the meeting, 61,711,482 shares were voted for the proposal, 14,137,417 shares were voted against the proposal, and 7,104,599 shares (including 6,239,157 shares represented by broker non-votes) abstained from voting with respect to the proposal. |
| | (a) | Exhibits (numbered in accordance with Item 601 of Regulation S-K) |
| | | | Compensatory Plans or Arrangements |
| | | | (i) | 2005 Incentive Plan, incorporated by reference to Appendix B of Grainger's Proxy Statement dated March 18, 2005. |
| | | (11) | Computations of Earnings per Share. |
| | | (31) | Rule 13a — 14(a)/15d — 14(a) Certifications |
| | | | (a) | Chief Executive Officer certification pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. |
| | | | (b) | Chief Financial Officer certification pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. |
| | | (32) | Section 1350 Certifications |
| | | | (a) | Chief Executive Officer certification pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. |
| | | | (b) | Chief Financial Officer certification pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. |
23
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
| | |
|---|
| | W.W. Grainger, Inc.
(Registrant) |
Date: May 2, 2005 |
By: |
/s/ P. O. Loux
P. O. Loux, Senior Vice President,
Finance and Chief Financial Officer |
Date: May 2, 2005 |
By: |
/s/ J. E. Andringa
J. E. Andringa, Vice President
and Controller |
24
