EXHIBIT 13 ANNUAL REPORT TO SHAREHOLDERS FOR 2004 Exhibit 13 [Graybar logo] works to your advantage 2004 [photo] Annual Report Board of Directors [photo] Left to right: Dennis E. DeSousa Senior Vice President-Sales and Distribution Robert A. Reynolds, Jr. Chairman, President and Chief Executive Officer Juanita H. Hinshaw Senior Vice President and Chief Financial Officer Richard D. Offenbacher Senior Vice President-Sales and Marketing Lawrence R. Giglio Senior Vice President-Operations [photo] Left to right: Thomas S. Gurganous District Vice President-Richmond District Richard A. Cole District Vice President-Chicago District Kenneth B. Sparks District Vice President-Seattle District Frank H. Hughes President and Chief Executive Officer, Graybar Canada [photo] Left to right: D. Beatty D'Alessandro Vice President and Chief Information Officer Kathleen M. Mazzarella Vice President-Human Resources and Strategic Planning Gary D. Hodges District Vice President-Phoenix District Thomas F. Dowd Vice President, Secretary and General Counsel Company's Business Graybar Electric Company, Inc. is engaged internationally in the distribution of electrical, telecommunications and networking products and the provision of related supply chain management and logistics services, primarily to contractors, industrial plants, telephone companies, power utilities, and commercial users. All products sold by the Company are purchased by the Company from others. Classes of Customers Served Electrical Contractor Commercial & Industrial Voice & Data Communications Power Utility International Capital Stock Data Number of Equity Security Holders as of December 31, 2004: - ------------------------------------------------------------------- Title of Class Number of Security Holders - ------------------------------------------------------------------- Common Stock 128 Voting Trust Certificates for Common Stock 5,056 - ------------------------------------------------------------------- Dividend Data Common Stock, par value $1; stated value $20. Dividends declared for year: 2004 2003 2002 - ------------------------------------------------------------------- First Quarter $ .30 $ .30 $ .30 Second Quarter .30 .30 .30 Third Quarter .30 .30 .30 Fourth Quarter $1.10 $1.10 $1.10 - ------------------------------------------------------------------- Table of Contents Board of Directors .....................................Inside Front Cover Letter to Shareholders.................................................. 2 Business Review......................................................... 4 Financial Review ...................................................... 14 Management's Discussion and Analysis of Financial Condition and Results of Operations........................16 Consolidated Financial Statements...................................... 20 Report of Independent Registered Public Accounting Firm................................................. 30 District Management .................................................. 31 Locations.............................................................. 32 1 Letter To Shareholders Over the last few years, the one constant in our business has been rapid change - some from external forces and some of our own making. With change swirling around us, we have adjusted to keep our business on course for future success. Some of our changes have been so dramatic that our focus - by necessity - has often shifted to the internal. But as we closed 2004, we began to see the investments we have been making in our people and processes pay dividends. We also began to see the pace of both external and internal change moderating and giving way to a more stable environment. Now this moderating trend gives us the opportunity to focus outward more consistently and aggressively. With so much hard work behind us, we are ready to make this shift in focus with confidence. We know that we have revitalized our business and are pointed in the right direction. In 2005, therefore, our main focus will be on growth - profitable growth. We will do the things we need to do to boost sales and boost them with reasonable margins. By being who we are - reliable, resourceful team players - we will enjoy success. 2004 The signal achievement of 2004 was the completion of the rollout of our ERP (Enterprise Resource Planning) system. It is difficult to overstate either the size of this undertaking or the success that crowned our efforts. From start to finish, this was a nearly five-year effort that began in January 2000, with our first interview of consultants, and culminated in October 2004, when the final three districts went live on the SAP system. The new system links all of Graybar's branch, zone and district facilities and gives us an unprecedented ability to manage our assets - to improve both our customer service and the handling of our supply chain. Our new system has set the standard for our industry. We implemented more SAP functionality to a broader base of users in less time and with less cost than any other wholesale distributor in the United States. The effort that went into this conversion was immense. Every single employee of this company received classroom training - for a total of more than 300,000 hours of training. That's 37,500 eight-hour days - or 160 work-years. Yet in spite of this time away from their normal responsibilities, our employees managed to make the transition seamless for our customers. For that, our people deserve the greatest credit. Some of the credit also belongs to the framework and culture in which our people operate - the employee ownership whose 75th anniversary we celebrated in 2004. We honored that anniversary, in part, by changing our stock purchase program to enable employees to make purchases annually, instead of once every three years. This schedule also makes stock ownership available for employees earlier in their careers. I am pleased to note that at least some of the recognition due our employees and our Company has indeed come our way. For the second straight year, our Company was named to Information Week's list of the 500 top companies for innovative use of technology. We also received the 2004 Spirit of St. Louis Technology Award from the St. Louis Regional Chamber & Growth Association. Although ERP-related training will continue in 2005, most of the educational investment has now been made, and we expect the system to begin paying dividends this year. We expect the size of those dividends to expand significantly in 2006 and thereafter. The other major accomplishment of 2004 was the upturn in our financial results. After three consecutive years of decline, our sales turned higher, rising 7.3 percent. Our operating income increased 35 percent, and our net income increased 65 percent. These are solid results, especially in the context of a time-consuming ERP conversion. It is also encouraging that we completed the year with tangible indicators of increased business activity - order input exceeded sales in 2004, and our unfilled orders reached their highest point since 2001. Meanwhile, we continued in 2004 to earn accolades for the ways we do business. Selling Power magazine, citing our compensation, training and career mobility, named us as one of the "50 Best Companies to Sell For." NECA, the National Electrical Contractors Association, gave us their Industry Partner Award, the first time they had ever presented it to a distributor. And for the third consecutive year, Fortune magazine included us on its list of "Most Admired Companies." In fact, we moved up on the list, rising from fifth to second place in our industry category. The consistent message coming from both these hard, statistical metrics and reputation-related accolades is the same: We are operating our business well, and our financial statements reflect it. 2005 Looking ahead, we will of course face certain challenges. We must comply with new government regulations, such as Sarbanes-Oxley, which applies to all public-reporting companies. Like other companies, we must spend more and more time and money on legal issues, from employment to contracts to liability. And again like other companies, we expect to have to deal with higher interest rates and other costs, such as insurance. Each one percent increase in interest rates adds about $2.5 million to our interest expense. 2 We also have to manage rising employee costs. Sometimes these increases are not as clear as they might be, because compensation comes in multiple forms. Some employee costs have risen dramatically. For example, the 2004 cost to provide medical insurance and our defined-benefit pension plan was approximately $42 million higher than in 1999 -- a year in which we had similar sales volume, similar gross margin and more employees. In spite of all this, I do believe that, thanks to the hard work of the last several years and the improved national economy, the building blocks we have put in place will allow us to grow in 2005. I think the challenge for us now is to make that growth as profitable as possible. To meet that challenge, we will continue to place a strong emphasis on employee communications. I believe strongly that such initiatives as the Employee Advisory Teams, which consult with me directly about the Company's direction, and the teleconferences, are very useful in aligning us in the same direction. In early 2005 we added a new communications program with our first Branch Management Summit, where all branch and area managers met with the officers to discuss key company issues and apply solutions to the branch environment. And we will continue to communicate about the "Five Profitability Drivers" that, as I have said, will bring us the kind of profitable growth we need if we manage them properly. Those five drivers are: * Sales - The opportunities are there. We need to cultivate business opportunities with our current customers while pursuing new customers and diversifying into new markets. There is no substitute in business for a rising top line. With our focus again returning to the external, the time has come to make that happen. * Gross Margin - Sales alone will not produce profits. We need substantial improvement in our gross margin, especially on sales from our warehouses. This can be accomplished by selling products at the right price and by charging appropriately for our services. * Expenses - Our new SAP system will help us in this area, as will our redefined zone strategy. However, we don't want to be such zealous expense managers that we thwart future growth. * Accounts Receivable - Cutting the time it takes for us to get paid is not just the job of our financial people - it is everybody's job - because every interaction with the customer affects how promptly we get paid. * Inventory - Our challenge is to carry the right inventory in the right quantities and to place it closer to the customer. Significant progress in these five areas will result in dramatic improvements that will benefit our Company and our employees, and ultimately our customers. With our business now revitalized, with the pace of change now returned to a manageable level, and with our focus now restored to the opportunities around us, I am confident we can enjoy a year of profitable growth in 2005. /s/ Robert A. Reynolds, Jr. Robert A. Reynolds, Jr. Chairman, President and CEO St. Louis, Missouri March 2005 Only a few days after 2004 concluded, Graybar lost a distinguished and much- admired leader, Carl L. Hall. Carl was president and CEO of the Company from 1995 to 2000. He then served as chairman of the board until his retirement a year later. The embodiment of the self-made man, Carl started his career at Graybar in 1959 as a warehouseman in Cincinnati. He progressed through several positions there before becoming a district manager, first, in 1991, in Memphis, and later in Houston and Chicago. He became executive vice president in 1994. Carl led the Company during a period of significant growth. He managed with verve, taking advantage of the opportunities to invest aggressively in the business and its employees. Carl was also known for his sharp wit; for a competitive spirit that showed up everywhere; and for his friendly, optimistic spirit. We will miss him. 3 [photo] "Improving business conditions during 2004 resulted in a substantial increase in the Company's sales to electrical contractors compared to the prior year." page 9 4 Business Review -- 2004 Complementing the implementation of one of the most robust business systems in the wholesale distribution industry, Graybar continues to adapt its marketing programs, inventory strategy, customer service initiatives and sales assignments to meet market conditions and customer demands. Early in the year, our marketing functions at corporate headquarters, which had been structured based on electrical or comm/data focus, were combined into one organization. This change mirrored the reorganization of our field management, which was completed in the second half of 2003. With this corporate and field alignment we created more synergy within our management team while continuing to emphasize our well-developed sales and marketing specialization. In preparation for 2005, in December we strengthened this strategy by increasing the responsibility of our corporate vice presidents for electrical products and comm/data products and appointing them vice presidents of electrical business and comm/data business, respectively. Each is charged with implementing effective business plans that will enable the Company to achieve its market growth goals. Our field and corporate teams dedicated considerable time and resources to refining our go-to-market strategy, assuring that Graybar's inventory is positioned to work to our customers' advantage. Increased emphasis was placed on breadth and depth of inventory, and we began moving the inventory decision- making process closer to the customer. As a result, we now have more products positioned in our local branches. Supplier selectivity decisions made at corporate headquarters establish the guidelines used by local management to determine appropriate branch inventory selection and stocking levels. This process allows us to fill the needs of the local customer while maintaining the inventory positioning many customers demand nationally. We developed a new process to capture customer inventory needs from our vendor managed inventory (VMI) suppliers to assure all items purchased--not just those purchased through the VMI process--are reviewed and assessed for a potential stocking position. Our zone warehouses continue to provide an advantage to our customers and our suppliers. They provide a secondary support to our branch inventories and can be a low cost advantage for our suppliers. In our zone warehouses, we can aggregate products with long lead times and items not generally stocked in a local market and make them available next-day to our customers. In addition, when a supplier is introducing a new product, initial inventory in our zones positions us to meet customer demand during the rollout phase. Specific to the comm/data business, zones continue to enable efficient deployment of products that are subject to rapid technology changes, such as key systems, PBXs and electronic voice/data solutions. Structured cabling project jobs are typically handled through distributors' inventory on short notice; zones continue to provide Graybar a competitive advantage for this type of business. Our comprehensive offering of security and notification products was launched in January with the addition of several suppliers and lines. Training and promotional programs accompanied the introduction of the additional product lines, and the effort resulted in significant sales of new solutions to our existing customer base in both the Electrical and Comm/Data Markets. Graybar's commitment to having the best-trained sales and technical support people in the industry was reinforced by the Control, Automation and Networking (CAN-do) training completed in 2004. This five-day, hands-on course began with classes on introductory level industrial controls and progressed to the basics of automation and industrial networking. The training was available to Graybar customer service representatives, sales representatives and all technical specialists. In addition, more than 60 Graybar technical specialists were trained on the applications of Schneider's automation products as we deployed the first Schneider Electric Equity training course developed exclusively for Graybar. These successful technical training programs support our automation business growth strategy and will continue in 2005. Our commitment to employee training is further evidenced by our two annual training conferences--one for the electrical business and one for comm/data. Participants in these conferences learn [photo] 5 [photo] "Our comprehensive offering of security and notification products was launched in January with the addition of several suppliers and lines." page 5 6 [photo] how to meet the ever-changing demands of the market and deliver real cost- saving solutions designed specifically for our customers. In addition, attendees interact with more than 100 supplier representatives who review the benefits of the latest product innovations. Every attendee completes a series of rigorous training prerequisites in order to participate. The Company's sales strategy incorporates cultivating new opportunities and strengthening existing relationships with large, geographically diverse customers. This strategic focus, in conjunction with dedicated corporate resources and strong support from our districts, allowed the Company to expand incremental business opportunities with large industrial, commercial, utility and government entities in 2004. The Corporate Accounts group leads our initiatives with these important customers through coordinated efforts with our local branches. Our Corporate Accounts sales and service teams support our strategic customers by delivering unique, customer- specific services tailored to their particular needs. This platform includes dedicated sales management, centralized customer service, e- business, account administration, specialized reporting, quotations and financial coverage. The ability to engage these important customers, from the boardroom to plant sites, with fully integrated sales and service platforms remains a differentiator within the marketplace. In 2004 six of our strategic corporate accounts were renewed without bid because of our excellent service levels. Our government business experienced another year of significant growth in 2004. Servicing federal, state and local agencies through our Defense Logistics Agency contracts, and through General Services Administration (GSA) and U. S. Communities agreements, provides Graybar a long-term market growth opportunity. Accordingly, we continue to enhance our powerful sales and service capabilities while expanding our already broad non-core product offerings. A majority of this business is centrally processed in the Corporate Accounts Service Group. Our service expertise was rewarded with the renewal of all four of our Defense Logistics Agency contracts in 2004. Our targeted electronic communication strategy was enhanced with the development of several new market-focused electronic newsletters, which are e- mailed quarterly to customers. The e-newsletters provide information on emerging technologies, highlight key manufacturers and promote service solutions. They complement the specialized web sites for customers on Graybar.com. Graybar's customers continue to pursue e-business processes to drive cost out of their operations. As a result, we added several thousand new users to GraybarNet(R), our online order entry system, and we more than doubled the number of customers using our e-catalog through their procurement systems. In addition, the number of customers using electronic estimating increased by 60 percent, and we enabled transaction processing with many more customers using electronic data interchange (EDI) and extensible markup language (XML). Customers use Graybar's electronic catalog as the online source for many of their product needs. Features added to the catalog in 2004 included the ability to view expanded information such as material data safety sheets, technical specification sheets and supplier catalog pages. A new advanced search feature now allows customers to more easily locate items based on a product's attributes such as color, size, amperage, or connector type. This capability becomes especially important as we continue to expand the breadth and depth of our e-catalog product offering. Our GraybarNet application was redesigned to be more user friendly, and a new request for quotation feature was added. More search fields were added to the order status query to assist customers in locating orders online. These revisions make it easier for our customers to do business with Graybar online and are expected to generate increased usage of this application in 2005. The Graybar Technology Showcases have become a national customer-training event for comm/data, electrical, automation and security solutions. These events offer value to our customers on emerging technologies and product applications for all markets. Held in locations across the country, the showcases provided Graybar a venue to train more than 1,000 customers and highlight the capabilities of our automation specialists and network system specialists. Many of our electrical contractors and reseller customers are now enrolled in the Graybar ePoint program, which rewards members for purchases from participating suppliers. In 2004, we enhanced the program by improving web site navigation and including gift certificates and retail gift cards in the reward choices. In addition, members can now use their epoints for recruiting services from Monster.com(R). Graybar's counters continue to provide high quality service for walk-in and will-call customers. Our 200+ counters around the 7 [photo] "Our well-trained employees and our nationwide access to products from leading manufacturers position Graybar as a leading solutions provider for our industrial customers." page 11 8 country focus on having the right products in stock, providing quick, responsive service, and helping customers select the right electrical and communications products to meet their specific applications. While our merchandising strategy is focused on tools, test equipment and consumable products, our counters also provide a great opportunity to promote our many value-added services and the wide array of products available from our strategic suppliers. Supplier-of-the-month promotions throughout the year feature interactive counter days designed to educate our customers. Our marketing, operations, finance, human resources, and information systems groups continue to work together to develop ways to enhance productivity through the use of our new ERP system. During 2005 we plan to further improve transactional performance and related processes to take full advantage of this technology. Contractor Market Improving business conditions during 2004 resulted in a substantial increase in the Company's sales to electrical contractors compared to the prior year. The overall market conditions as well as significant price increases in copper and steel contributed to revenue growth. Continuous improvement in our service capabilities enabled us to capitalize on opportunities in the Contractor Market. Our service offering to electrical contractors provides us with a key competitive edge in the Contractor Market. In 2004 we increased our branch inventories to better serve contractors for their same-day requirements. In addition, we enhanced our project management capabilities with the complete rollout of the ERP system to every location. Our project management software is utilized by trained project specialists in the branches to manage projects more efficiently for our customers. Presentations at industry shows and regular customer visits by representatives of our eBusiness group have increased customer demand for electronic estimating through the NetPricer(TM) Service. With this third party, Internet-based service, customers can submit bids that are then automatically priced using their customer-specific pricing. This process saves time for both the customer and Graybar, and it allows us to provide faster turnaround on pricing quotes. In addition, we provide regular price files for many contractors who choose to load Graybar pricing into their own estimation packages. The Company continued to support the National Electrical Contractors Association (NECA) by participating in the 50th annual NECA show in Los Angeles in October. Graybar was honored at this event with NECA's Industry Partner Award for 50 years of support and participation in the NECA show. We are also members of the Electri21 Foundation, which provides valuable research and educational materials for the contractor industry. In September, we participated in the Independent Electrical Contractors (IEC) annual convention in Minneapolis. Graybar is the founding Platinum Partner with the IEC association. We also supported the Associated Builders and Contractors (ABC) by providing material for the National Craft Championship competition at their national convention. Industrial Market Throughout 2004, economic indicators showed positive trends in capacity utilization and new orders and high purchasing indices within the manufacturing sector, pointing to a rebound from the recession of the early 2000s in the Industrial Market. Graybar's sales in this market increased significantly in 2004. Industrial purchasing activity is expected to remain elevated through 2005. Graybar's strategy is to increase sales to industrial customers through our focus on their maintenance, repair and operations (MRO), original equipment manufacturing (OEM), security and automation needs. Two new [photo] Senior Vice President, Sales and Marketing Richard Offenbacher (left) accepts the Industry Partner Award on behalf of Graybar from NECA President Ben Cook. 9 [photo] "A significant amount of comm/data inventory was repositioned to branches-- closer to the customers." page 13 10 comprehensive internal training programs were implemented in 2004, furthering our commitment to providing highly knowledgeable sales coverage for our industrial customers. In addition, new focused marketing and sales tools are scheduled to be implemented to improve the Company's position within this market. Our specialized sales force, automation application specialists and network system specialists are well equipped to meet our customers' needs for networking, wireless and automation applications. Our well-trained employees and our nationwide access to products from leading manufacturers position Graybar as a leading solutions provider for our industrial customers. Our strategy is to leverage these strengths to grow market share. Commercial Market The Bureau of Economic Research forecasted three percent gains in the Commercial Market in 2004. Graybar realized modest growth in line with those expectations. Spending for maintenance, repair and operations (MRO) and communications products increased gradually throughout the year as many of our customers improved their facility infrastructures. This moderate growth trend is expected to continue in 2005. The healthcare, education and finance markets offer the largest business opportunities for Graybar. We support the MRO needs of these customers with our electrical sales force, and our specialized account managers/sales representatives cover the voice and data needs of these customers. The healthcare market continues to be handled primarily at our corporate accounts level as national healthcare buying groups solidify their positions with hospitals and clinics. We have been successful in developing relationships within the Group Purchasing Organizations (GPOs) and alliance organizations by promoting our services and developing programs that enhance sales opportunities for every Graybar branch. Spending by schools and universities, which began to decline in 2003 due to state and metropolitan budget issues, showed a rebound in 2004. Spending on communications infrastructure increased to accommodate the need for higher networking speeds and wireless technology. Growth in enrollment is expected to continue for the next three years leading to increased opportunity for Graybar in both MRO and communications infrastructure. We are pursuing additional electrical and communications sales opportunities in territories that include the corporate headquarters of financial institutions, retail chains, hospitality companies, and entertainment companies. In the service of our commercial customers our specialized comm/data account managers continued to gain traction in 2004. Their efforts have expanded Graybar's Project Pipeline, our proprietary software for tracking project bids and monitoring sales and order activity. Registered projects were up significantly, and Verified Independently for Performance (VIP) project registrations exceeded 2003 by more than 50 percent. Both of these measurements indicate Graybar's growing capability to position itself as a value-added supplier for our commercial customers. Comm/Data Market The economic slowdown that began in 1999 led to a significant decrease in business activity in the telecom sector, which only began to exhibit modest recovery last year. Early 2004 projections for information technology (IT) spending and network cabling were estimated to show mid single-digit growth. However, fourth quarter surveys of IT spending were mixed as more respondents indicated they would spend less than planned than those who indicated they would spend more. Supplier consolidations continued in the telecom sector, with several significant mergers and acquisitions taking place during 2004. Also significant was the number of major suppliers that introduced new product solutions outside of their traditional space and are now offering single- source, end-to-end cable and connectivity. The Construction Specifications Institute (CSI) late in the year released a major revision to Master Format(TM), the organizational standard for building specifications and instructions for nonresidential construction. The revisions created a significant industry change. Previously, communications was a subsystem in the electrical division; now communications is defined as a separate system. This will impact how communications systems for new buildings are designed, bid and awarded. With our focus on market specialization, Graybar anticipates additional business with consultants, integrators and comm/data contractors as these customers now have greater opportunity to bid the communications portion of large construction projects. In preparation for this change, we developed a new software package for designing and budgeting complex structured cabling projects, VIP Design Online(SM), which we introduced to communications industry consultants at the January 2005 Building Industry Consulting Service International (BICSI) conference. Graybar sales of comm/data products in 2004 were up slightly compared to 2003. Specialized sales and support continue to be key to our growth strategy in the Comm/Data Market. Determined to increase our share and position, several initiatives began in 2004: * Field management decisions were driven closer to the customer, improving Graybar's ability to coordinate specialized technical and sales resources into a converged solution for our customers. * Graybar's corporate marketing department developed major collaborative programs in areas such as commercial building and industrial automation. We are well positioned to capitalize on these opportunities as a result of our strengths in both the electrical and comm/data business. 11 [photo] Photo courtesy of Lineman College "In 2004 our initiatives to support the Utility Market included a new Utility Solutions Guide and a targeted utility section on our web site." page 13 12 * A significant amount of comm/data inventory was repositioned to branches--closer to the customers. * Fiber to the home initiatives with the leading manufacturers in the service provider sector began showing results. * Wireless demand in both the enterprise and service provider sectors brought us business from a leading supplier, and we continued to develop programs with additional suppliers to create opportunities to provide new wireless solutions to our customers. Utility Market Graybar's renewed commitment to the Utility Market in 2003 translated to sales and revenue growth in this market in 2004. Utility customers are an important market for Graybar due to their financial stability, sales and gross margin potential and their needs for the supply chain expertise that Graybar can provide. In 2004 our initiatives to support the Utility Market included a new Utility Solutions Guide and a targeted utility section on our web site. These tools focus on products, applications and value-added solutions for our customers. In addition, we formed an internal Utility Council, with representatives from each Graybar district, to provide feedback and guidance on our utility customers. We plan to continue these efforts and offer additional solutions, success stories, product specials and tools in 2005. We believe success in the Utility Market is important to our long-term growth, and we remain committed to being a leading solutions provider for our utility customers. We realize it will take sustained and persistent efforts as well as continued dedication of resources to gain share in this market. GRAYBAR FINANCIAL SERVICES In addition to providing financing for customers purchasing equipment for their own use, Graybar Financial Services (GFS), the Company's leasing and financing subsidiary, arranges financing for contractors that are selling communication, security and data systems as well as electrical projects. GFS is a profitable complement to Graybar's overall value proposition. GFS introduced attractive lease pricing on Voice Over Internet Protocol (VOIP) telecommunications equipment during the fourth quarter of 2004 in support of the Company's marketing efforts in the reseller market. In 2005, GFS is introducing a new advance funding product that enables qualified resellers to receive up to 65 percent of the total lease transaction amount prior to project completion. This up-front financing provides the reseller with needed working capital to acquire the equipment and resources necessary to complete the project with little or no cash outlay required on the part of the contractor. INTERNATIONAL MARKETS Canada Graybar Canada surpassed both its sales and net profit budgets for 2004. Strong focus on improved gross margin rate resulted in a substantial rise in profits for the year. [photo] Centralization of inventory maintenance, accounts payable, and financial reporting brought increased efficiencies and standardization of these business functions throughout the Canadian operation. An upgrade to computer software in Graybar Ontario and the launch of the Graybar Canada web site now enable customers to access their account information, check inventory availability and place orders via the Internet. The remainder of the Canadian branches are scheduled to make this upgrade in February 2005. Graybar Ontario's commitment to the automation control business led to its appointment as the exclusive Schneider Automation distributor for southwestern and central Ontario. The comm/data business continues to grow, and additional resources have been dedicated to expand customer opportunities in that market in 2005. Mexico Sales in Mexico improved in 2004 with increased momentum during the third and fourth quarters. Emphasis was placed on building end user sales and penetrating new territories, with special focus on Monterrey and Guadalajara, and results were encouraging. Increased sales coverage in key cities is planned for 2005. Puerto Rico Graybar Puerto Rico experienced double-digit sales growth in 2004. Two significant contracts to supply high voltage power cables and HPS lamps to the local power authority for the entire island contributed to the increased revenues. In the Contractor and Industrial Markets the team approach we established several years ago remains successful. We anticipate continued growth in 2005 by utilizing the team sales and service concept, and we expect to grow our market share in automation with focus on active component solutions. 13 Table of Contents Selected Consolidated Financial Data.............................. 15 Management's Discussion and Analysis of Financial Condition and Results of Operations........................................................ 16 Consolidated Financial Statements........................................................ 20 Report of Independent Registered Public Accounting Firm.............................................................. 30 14 Financial Review Selected Consolidated Financial Data (Stated in thousands except for per share data) 2004 2003 2002 2001 2000 - ----------------------------------------------------------------------------------------------------------------- Sales $4,093,462 $3,813,272 $3,986,954 $4,829,862 $5,231,901 Less--Cash discounts (13,909) (10,820) (12,062) (13,380) (13,564) - ----------------------------------------------------------------------------------------------------------------- Net Sales 4,079,553 3,802,452 3,974,892 4,816,482 5,218,337 Cost of Merchandise Sold (3,295,772) (3,067,986) (3,229,791) (3,934,719) (4,271,745) - ----------------------------------------------------------------------------------------------------------------- Interest Expense (23,453) (24,128) (26,301) (39,073) (46,681) - ----------------------------------------------------------------------------------------------------------------- Provision for Income Taxes Current (12,772) 7,690 (7,233) (22,915) (44,395) Deferred 2,843 (14,032) 14 3,302 1,196 - ----------------------------------------------------------------------------------------------------------------- Total provision for income taxes (9,929) (6,342) (7,219) (19,613) (43,199) - ----------------------------------------------------------------------------------------------------------------- Net Income 14,018 8,465 11,401 31,688 66,157 - ----------------------------------------------------------------------------------------------------------------- Income Applicable to Common Stock 14,017 8,463 11,399 31,685 66,154 - ----------------------------------------------------------------------------------------------------------------- Average Common Shares Outstanding (A) 5,709 5,993 6,245 5,846 6,101 - ----------------------------------------------------------------------------------------------------------------- Income per Share of Common Stock (A) 2.46 1.41 1.83 5.42 10.84 - ----------------------------------------------------------------------------------------------------------------- Cash dividends per share 2.00 2.00 2.00 2.00 2.00 - ----------------------------------------------------------------------------------------------------------------- Retained Earnings Balance, beginning of year 306,030 309,434 310,521 290,405 241,473 Add--Net income 14,018 8,465 11,401 31,688 66,157 - ----------------------------------------------------------------------------------------------------------------- 320,048 317,899 321,922 322,093 307,630 - ----------------------------------------------------------------------------------------------------------------- Less dividends Preferred ($1.00 per share) (1) (2) (2) (3) (3) Common (in cash) (11,267) (11,867) (12,486) (11,569) (11,583) Common (in stock) -- -- -- -- (5,639) - ----------------------------------------------------------------------------------------------------------------- (11,268) (11,869) (12,488) (11,572) (17,225) - ----------------------------------------------------------------------------------------------------------------- Balance, end of year 308,780 306,030 309,434 310,521 290,405 Proceeds on stock subscriptions, shares unissued -- 45 50 -- 49 Stock Outstanding Preferred -- 43 45 51 57 Common 110,967 117,427 123,272 114,424 119,828 - ----------------------------------------------------------------------------------------------------------------- $ 419,747 $ 423,545 $ 432,801 $ 424,996 $ 410,339 - ----------------------------------------------------------------------------------------------------------------- Accumulated other comprehensive income (loss) (27,383) (35,962) (44,958) (17,504) (542) - ----------------------------------------------------------------------------------------------------------------- Total Shareholders' Equity $ 392,364 $ 387,583 $ 387,843 $ 407,492 $ 409,797 - ----------------------------------------------------------------------------------------------------------------- Total Assets 1,451,372 1,422,130 1,400,171 1,535,998 1,843,438 Long-term Debt $ 205,603 $ 254,381 $ 266,710 $ 315,549 $ 238,349 - ----------------------------------------------------------------------------------------------------------------- <FN> (A) Adjusted for the declaration of a 5% stock dividend in 2000. This summary should be read in conjunction with the consolidated financial statements and related notes thereto included elsewhere in this annual report. 15 Financial Review Management's Discussion and Analysis of Financial Condition and Results of Operations (Stated in thousands except for share and per share data) OVERVIEW After declines in business in 2003 and 2002, the Company experienced significant sales growth and increased profits in 2004 as a result of the improved economic conditions experienced by the electrical and comm/data wholesale distribution industries and the customers they serve. The Company also completed the upgrade of its computer systems to an Enterprise Resource Planning system in the fourth quarter of 2004 after beginning the implementation in April 2003. With an improving economy and increased system capabilities that are expected to provide enhanced service capabilities, the Company believes it is positioned to grow profitably and expand its future business opportunities. Moderate, profitable sales growth is expected in 2005 as the electrical and communications markets continue to trend upward. RESULTS OF OPERATIONS Operating Results as a Percentage of Net Sales The following table sets forth certain information relating to the operations of the Company expressed as a percentage of net sales: Years Ended December 31: 2004 2003 2002 - --------------------------------------------------------------------------------- Net Sales 100.0% 100.0% 100.0% Cost of Merchandise Sold (80.8) (80.7) (81.3) - --------------------------------------------------------------------------------- Gross Margin 19.2 19.3 18.7 Selling, General and Administrative Expenses (16.3) (16.5) (15.8) Taxes, other than income taxes (1.0) (1.0) (1.0) Depreciation and amortization (.9) (1.0) (.8) - --------------------------------------------------------------------------------- Income from operations 1.0 .8 1.1 Other Income, net .1 .2 .1 Interest Expense (.5) (.6) (.7) - --------------------------------------------------------------------------------- Income Before Provision for Income Taxes .6 .4 .5 - --------------------------------------------------------------------------------- Provision for Income Taxes (.3) (.2) (.2) - --------------------------------------------------------------------------------- Net Income .3% .2% .3% - --------------------------------------------------------------------------------- 2004 Compared to 2003 Net sales in 2004 increased $277,101, or 7.3%, compared to 2003. The higher net sales resulted from the generally improved economic conditions that are prevalent on an industry-wide basis in the electrical and communications market sectors in which the Company operates. The Company's business in the electrical market improved significantly during 2004 as a result of the general increase in new construction projects along with increased spending by commercial and industrial customers. Communications market sales showed slight improvement in 2004. Activity in the communications market served by the Company continued to be impacted by the lingering effects of the excess of infrastructure and plant and network capacity in the communications marketplace. Electrical market sales increased 9.8% and communications market sales increased .1% when comparing 2004 to 2003. Gross margin increased $49,315, or 6.7%, in 2004 primarily due to the increased sales in the electrical and communications markets. Selling, general and administrative expenses increased $38,464, or 6.1%, when comparing 2004 to 2003 due largely to increases in employee compensation costs of approximately $9,800 and an increase in pension plan expense of approximately $18,200. The substantial increase in pension plan expense resulted primarily from increased payouts made under the standard terms of the Company's defined benefit pension plan during 2004. The balance of the increase in selling, general and administrative expenses resulted from increases in transportation and other general operating expenses due to higher sales and transaction volumes. The increase in taxes, other than income taxes of $639 resulted primarily from higher payroll tax expense due to the increase in the Company's employee compensation costs. Depreciation and amortization decreased $737 when comparing 2004 to 2003 due to lower depreciation expense on owned property. Other income, net includes gains on sale of property of $1,882 and $4,752 and accounts receivable interest charges to customers of $1,205 and $969 in 2004 and 2003, respectively. Interest expense decreased $675, or 2.8%, in 2004 primarily due to the decrease in long-term debt as a percentage of total debt and the overall decrease in long-term debt outstanding due to regularly scheduled principal payments. The Company's long-term debt carries higher interest rates on average when compared to current rates on short-term borrowings. The average amount of short-term borrowings outstanding during 2004 and 2003 amounted to approximately $146,000 and $109,000 at weighted average interest rates of 1.69% and 1.51%, respectively. The combined effect of the increase in gross margin and the decrease in other income, together with the increase in selling, general and administrative expenses and decreases in depreciation and amortization and interest expense, resulted in an increase in pretax earnings of $9,140 in 2004 compared to 2003. 16 Financial Review Management's Discussion and Analysis of Financial Condition and Results of Operations (Stated in thousands except for share and per share data) 2003 Compared to 2002 Net sales in 2003 decreased $172,440, or 4.3%, compared to 2002. The lower net sales resulted from the generally depressed economic conditions that have been prevalent on an industry-wide basis in the electrical and communications market sectors in which the Company operates. The general slowdown in new construction projects and the reduction in capital spending by commercial and industrial customers that began in 2001 continued throughout 2002 and the first half of 2003. Consolidated net sales in the second half of 2003 increased 1.5% when compared to the second half of 2002. Communications market activity continued to be more heavily impacted by the weak economic conditions compared to the Company's business in the electrical market due to the overall excess of infrastructure and plant and network capacity in the communications marketplace. Electrical market sales decreased 3.4% and communications market sales decreased 12.8% when comparing 2003 to 2002. Gross margin decreased $10,635, or 1.4%, in 2003 primarily due to the lower sales in the electrical and communications markets. Gross margin increased 2.1% when comparing the second half of 2003 to the second half of 2002. Selling, general and administrative expenses decreased slightly in 2003 due largely to current year and prior year reductions in the Company's employment levels which resulted in decreases in related employee compensation costs of approximately $10,700 in 2003. The decrease in these expenses was partially offset by an increase in expenses related to the implementation of the Enterprise Resource Planning (ERP) system of approximately $6,100. The Company expects that the decrease in employment levels will be sustainable until such time as there is a significant growth in sales. As a percentage of sales, selling, general and administrative expenses increased in 2003 compared to 2002, primarily because the rate at which expenses were reduced lagged the rate at which sales volume decreased. The reduction in taxes, other than income taxes of $1,178 in 2003 compared to 2002 resulted primarily from lower payroll tax expenses due to the reduction in the Company's employment levels. Depreciation and amortization increased $2,617 in 2003 primarily due to additional amortization expenses as a result of the implementation of the ERP system during the second quarter of 2003. Other income, net includes gains on sale of property of $4,753 and $0 and accounts receivable interest charges to customers of $969 and $1,552 in 2003 and 2002, respectively. Interest expense decreased $2,173, or 8.3%, in 2003 primarily due to lower interest rates on short-term borrowings. The average amount of short- term borrowings outstanding during 2003 and 2002 amounted to approximately $109,000 and $101,000 at weighted average interest rates of 1.51% and 2.11%, respectively. The combined effect of the decrease in gross margin and the increase in other income, together with the increase in depreciation and amortization and decreases in selling, general and administrative expenses and interest expense, resulted in a decrease in pretax earnings of $3,813 in 2003 compared to 2002. FINANCIAL CONDITION AND LIQUIDITY At December 31, 2004 current assets exceeded current liabilities by $396,589, down $20,023 from December 31, 2003. The increase in trade receivables from December 31, 2003 to December 31, 2004 resulted primarily from the increase in sales experienced by the Company and an increase in average days sales outstanding. Merchandise inventory levels were lower at December 31, 2004 when compared to December 31, 2003 inventory levels. Average inventory turnover for 2004 was generally unchanged from the average turnover for 2003. During 2003 and 2004 the Company converted its computer systems to an Enterprise Resource Planning (ERP) system. Implementation of the new system began in April 2003 and was completed in October 2004. The Company funded the project through a combination of equipment leases and working capital. Project costs through December 31, 2004 were approximately $100,000, of which $76,906 has been capitalized. The Company expects that conversion to the new ERP system will provide future benefits to its results of operations. The Company does not have any other plans or commitments that would require significant amounts of additional working capital. At December 31, 2004 the Company had available to it unused lines of credit amounting to $253,255. These lines are available to meet short-term cash requirements of the Company. Included in the Company's lines of credit is a Revolving Credit Loan Agreement with a group of banks at an interest rate based on the London Interbank Offered Rate (LIBOR) that had previously consisted of a $205,000, five-year facility. In October 2003 the Company elected to reduce the facility from $205,000 to $50,000. Upon expiration of the agreement in July 2004, the Company entered into a new unsecured credit agreement which consists of an $85,000, 364-day facility which expires in July 2005. There were no amounts outstanding under the Revolving Credit Loan Agreement at December 31, 2004. 17 Financial Review Management's Discussion and Analysis of Financial Condition and Results of Operations (Stated in thousands except for share and per share data) At December 31, 2004 the Company also had a $200 million accounts receivable securitization program that expires in October 2006. The securitization program provides for the sale of certain of the Company's trade receivables on a revolving basis to Graybar Commerce Corporation (GCC), a wholly owned, bankruptcy remote, special purpose subsidiary. GCC sells an undivided interest in the receivables to an unrelated multi-seller commercial paper conduit. The Company accounts for the securitization as an on-balance sheet financing arrangement because the Company has maintained effective control of the accounts receivable through a call option that gives GCC the unilateral right to repurchase the undivided interests. Accordingly, the accounts receivable and related debt are included in the accompanying consolidated balance sheets. GCC has granted a security interest in its trade receivables to the commercial paper conduit. Borrowings outstanding under the securitization program were $50,000 at December 31, 2004. Short-term borrowings outstanding during 2004 and 2003 varied from a minimum of $0 to a maximum of $192,223 and $188,281, respectively. The Revolving Credit Loan Agreement and certain other note agreements have various covenants that limit the Company's ability to make investments, pay dividends, incur debt, dispose of property, and issue equity securities. The Company is also required to maintain certain financial ratios as defined in the agreements. The Company has funded its capital requirements from operations, stock issuances to its employees and long-term debt. During 2004, cash used by operations amounted to $16,417 compared to $73,715 cash provided by operations in 2003. The decrease in cash provided by operations was predominantly attributable to the combined change in trade receivables, merchandise inventory and trade accounts payable, which in the aggregate resulted in cash used of $103,636 in 2004 compared to cash provided of $16,817 in 2003. Cash provided from the sale of common stock and proceeds received on stock subscriptions amounted to $361 and $506 in 2004 and 2003, respectively. Capital expenditures for property were $24,100, $50,824 and $55,532 for the years ended December 31, 2004, 2003 and 2002, respectively. Purchases of treasury stock were $6,909, $6,358 and $6,299 for the years ended December 31, 2004, 2003 and 2002, respectively. Dividends paid were $11,620, $12,202 and $11,984 for the years ended December 31, 2004, 2003 and 2002, respectively. Off-Balance Sheet Financing The Company has two operating lease arrangements with an independent lessor which have provided $63,684 of off-balance sheet financing for eight of the Company's zone distribution facilities. Each of the agreements carries a five-year term. The Company has the option, with the consent of the lenders to the lessor, to renew the leases for up to two additional five-year terms or to purchase the property for a price including the outstanding lease balance. If the Company elects not to renew the lease or purchase the property, or such lenders refuse to consent to a renewal, the Company may elect to remarket the property and arrange for its sale to a third party. At December 31, 2004 the Company has recorded a $756 liability for the estimated fair value of the residual value guarantee for these operating lease arrangements, one of which was renewed in 2003 and one of which was renewed in December 2004. The leasing structures used in these two lease arrangements qualify as variable interest entities under FASB Interpretation No. 46 and the Company's interests in the variable interest entities are required to be consolidated in the Company's financial statements beginning in the first quarter of 2005. As of December 31, 2004 the Company's maximum exposure to loss as a result of its involvement with the two lease arrangements is $54,131, the amount guaranteed by the Company as the residual fair value of the property in accordance with the lease arrangements. Contractual Obligations and Commitments The Company has the following contractual obligations as of December 31, 2004: Less More than 1 1-3 4-5 than 5 Total Year Years Years Years -------- -------- -------- ------- ------- Long-term Debt Obligations $306,770 $ 53,361 $128,757 $74,398 $50,254 Capital Lease Obligations 11,081 11,081 -- -- -- Operating Lease Obligations 137,437 35,142 59,905 15,785 26,605 Purchase Obligations 461,424 461,424 -- -- -- -------- -------- -------- ------- ------- Total $916,712 $561,008 $188,662 $90,183 $76,859 Long-term debt obligations consist of principal and interest payments. Purchase obligations consist primarily of open inventory purchase orders made in the normal course of business. Many of these obligations may be cancelled with limited or no financial penalties. The above table does not include $91,878 of accrued, unfunded employment-related benefit obligations, of which $77,470 is related to the Company's postretirement benefits plan, because it is not certain when the obligations will be paid. The Company also expects to make contributions totaling approximately $30,000 to its defined benefit pension plan during 2005 which are not included in the table. 18 Financial Review Management's Discussion and Analysis of Financial Condition and Results of Operations (Stated in thousands except for share and per share data) CRITICAL ACCOUNTING POLICIES The consolidated financial statements are prepared in accordance with accounting principles generally accepted in the United States, which require the Company to make estimates and assumptions (see Note 1 to the consolidated financial statements). The Company believes the following accounting policies have the potential to have a more significant impact on the financial statements either because of the significance of the financial statement item to which they relate or because they involve a higher degree of judgment and complexity. Allowance for Doubtful Accounts The Company performs ongoing credit evaluations of its customers, and a significant portion of trade receivables is secured by lien or bond rights. The Company maintains allowances to reflect the expected uncollectibility of accounts receivable based on past collection history, the economic environment and specific risks identified in the receivables portfolio. Although actual credit losses have historically been within management's expectations, additional allowances may be required if the financial condition of the Company's customers were to deteriorate. Income Taxes Deferred tax assets and liabilities are recorded based on the Company's assessment of future taxes to be paid in the jurisdictions in which the Company operates. These assessments involve temporary differences resulting from differing treatment of items for tax and accounting purposes, as well as estimates of the Company's current tax exposures. Based on the Company's evaluation of the tax positions it takes on the various tax returns it files, the Company believes it was adequately reserved for these issues at December 31, 2004. Inventory The Company values its inventories at the lower of cost or market. In assessing the ultimate realization of inventories, the Company makes judgments as to rights of return to suppliers and future demand requirements. If actual future demand, market conditions or supplier return provisions are less favorable than those projected by management, additional inventory write-downs may be required. Pension Plan The Company's pension plan expense and obligations are determined based on the selection of certain assumptions, the most significant of which are the expected long-term rate of return on plan assets and the discount rate used to discount plan liabilities. While management believes that the assumptions selected by the Company are appropriate, differences in actual experience or changes in assumptions may affect the Company's pension plan obligation and future pension expense. In 2004, the Company reduced the expected long-term rate of return on plan assets to 8.25%, down from 8.75% in 2003. The discount rate used to discount plan liabilities was changed from 6.00% at December 31, 2003 to 5.75% at December 31, 2004. The Company has elected to continue to use an expected long-term rate of return on plan assets of 8.25% for 2005. The change in assumptions and return on assets experienced by the plan are expected to result in 2005 pension expense of approximately $24,000. Supplier Volume Incentives The Company's agreements with many of its suppliers provide for the Company to earn incentives based on purchases during the agreement period. These agreements typically provide for the incentives to be paid in arrears, and the Company estimates amounts to be received from suppliers at the end of each reporting period based on the earnout level that the Company estimates is probable of being achieved. Amounts received have historically been within management's estimates. In the event that the operating performance of the Company's suppliers were to decline, however, there can be no assurance that amounts earned would be paid or that the incentives would continue to be included in future agreements. 19 Consolidated Financial Statements Consolidated Statements of Income and Retained Earnings (Stated in thousands except for share and per share data) For the Years Ended December 31, 2004 2003 2002 - -------------------------------------------------------------------------------------------------- Sales, net of returns and allowances $4,093,462 $3,813,272 $3,986,954 Less--Cash discounts (13,909) (10,820) (12,062) - -------------------------------------------------------------------------------------------------- Net Sales 4,079,553 3,802,452 3,974,892 - -------------------------------------------------------------------------------------------------- Cost of Merchandise Sold (3,295,772) (3,067,986) (3,229,791) - -------------------------------------------------------------------------------------------------- Gross Margin 783,781 734,466 745,101 Selling, General and Administrative expenses (664,663) (626,199) (627,015) Taxes, other than income taxes (40,758) (40,119) (41,297) Depreciation and amortization (36,516) (37,253) (34,636) - -------------------------------------------------------------------------------------------------- Income from operations 41,844 30,895 42,153 Other Income, net 5,556 8,040 3,313 Interest Expense (23,453) (24,128) (26,301) Loss on debt extinguishment -- -- (545) - -------------------------------------------------------------------------------------------------- Income Before Provision for Income Taxes 23,947 14,807 18,620 - -------------------------------------------------------------------------------------------------- Provision for Income Taxes Current (12,772) 7,690 (7,233) Deferred 2,843 (14,032) 14 - -------------------------------------------------------------------------------------------------- Total provision for income taxes (9,929) (6,342) (7,219) - -------------------------------------------------------------------------------------------------- Net Income 14,018 8,465 11,401 - -------------------------------------------------------------------------------------------------- Retained Earnings, beginning of year 306,030 309,434 310,521 Cash dividends- Preferred, $1.00 per share each year (1) (2) (2) Common, $2.00 per share each year (11,267) (11,867) (12,486) - -------------------------------------------------------------------------------------------------- Retained Earnings, end of year $ 308,780 $ 306,030 $ 309,434 - -------------------------------------------------------------------------------------------------- Net Income per share of Common Stock $ 2.46 $ 1.41 $ 1.83 - -------------------------------------------------------------------------------------------------- See accompanying Notes to Consolidated Financial Statements 20 Consolidated Financial Statements Consolidated Balance Sheets December 31, (Stated in thousands except for share and per share data) 2004 2003 - ----------------------------------------------------------------------------------------------------------------- ASSETS - ----------------------------------------------------------------------------------------------------------------- Current Assets Cash and cash equivalents $ 9,961 $ 19,161 Trade receivables (less allowances of $8,304 and $7,199, respectively) 624,728 556,967 Merchandise inventory 473,212 483,333 Other current assets 26,379 17,815 - ----------------------------------------------------------------------------------------------------------------- Total current assets 1,134,280 1,077,276 - ----------------------------------------------------------------------------------------------------------------- Property, at cost Land 29,944 27,092 Buildings 242,579 237,840 Furniture and fixtures 167,852 163,932 Software 76,906 76,339 Capital leases 22,936 23,987 - ----------------------------------------------------------------------------------------------------------------- 540,217 529,190 Less--Accumulated depreciation and amortization 248,711 223,585 - ----------------------------------------------------------------------------------------------------------------- 291,506 305,605 - ----------------------------------------------------------------------------------------------------------------- Other Assets 25,586 39,249 - ----------------------------------------------------------------------------------------------------------------- $1,451,372 $1,422,130 - ----------------------------------------------------------------------------------------------------------------- LIABILITIES AND SHAREHOLDERS' EQUITY - ----------------------------------------------------------------------------------------------------------------- Current Liabilities Short-term borrowings $ 67,757 $ - Current portion of long-term debt 49,019 22,872 Trade accounts payable 490,183 536,179 Accrued payroll and benefit costs 48,506 36,292 Other accrued taxes 10,147 13,684 Dividends payable 6,117 6,469 Other payables and accruals 65,962 45,168 - ----------------------------------------------------------------------------------------------------------------- Total current liabilities 737,691 660,664 - ----------------------------------------------------------------------------------------------------------------- Postretirement Benefits Liability 77,470 77,636 - ----------------------------------------------------------------------------------------------------------------- Pension Liability 37,488 40,895 - ----------------------------------------------------------------------------------------------------------------- Long-term Debt 205,603 254,381 - ----------------------------------------------------------------------------------------------------------------- Other Non-current Liabilities 756 971 - ----------------------------------------------------------------------------------------------------------------- Shares at December 31, 2004 2003 - ----------------------------------------------------------------------------------------------------------------- Shareholders' Equity Capital stock- Preferred, par value $.01 per share, Authorized 10,000,000 300,000 Issued to shareholders - 2,173 In treasury, at cost - (52) - ----------------------------------------------------------------------------------------------------------------- Outstanding - 2,121 - 43 - ----------------------------------------------------------------------------------------------------------------- Common, stated value $20 per share, Authorized 15,000,000 7,500,000 Issued to voting trustees 5,298,699 5,609,313 Issued to shareholders 276,641 290,389 In treasury, at cost (26,978) (28,343) - ----------------------------------------------------------------------------------------------------------------- Outstanding 5,548,362 5,871,359 110,967 117,427 - ----------------------------------------------------------------------------------------------------------------- Common shares subscribed 5,375 614 Retained earnings 308,780 306,030 Accumulated other comprehensive income (loss) (27,383) (35,962) - ----------------------------------------------------------------------------------------------------------------- 397,739 388,152 Less--Subscriptions receivable 5,375 569 - ----------------------------------------------------------------------------------------------------------------- Total Shareholders' Equity 392,364 387,583 - ----------------------------------------------------------------------------------------------------------------- $1,451,372 $1,422,130 - ----------------------------------------------------------------------------------------------------------------- See accompanying Notes to Consolidated Financial Statements 21 Consolidated Financial Statements Consolidated Statements of Cash Flows (Stated in thousands) For the Years Ended December 31, 2004 2003 2002 - ------------------------------------------------------------------------------------------------- Cash Flows From Operations Net Income $ 14,018 $ 8,465 $ 11,401 - ------------------------------------------------------------------------------------------------- Adjustments to reconcile net income to cash provided (used) by operations - Depreciation and amortization 36,516 37,253 34,636 Deferred income taxes (2,843) 14,032 (14) Gain on sale of property (1,882) (4,752) -- Changes in assets and liabilities: Trade receivables (67,761) (52,865) 88,650 Merchandise inventory 10,121 32,358 97,285 Other current assets (8,564) (545) (2,828) Other assets 12,869 (5,229) 3,655 Trade accounts payable (45,996) 37,324 (7,988) Accrued payroll and benefit costs 12,214 13,625 (4,149) Other accrued liabilities 24,891 (5,951) (7,269) - ------------------------------------------------------------------------------------------------- (30,435) 65,250 201,978 - ------------------------------------------------------------------------------------------------- Net cash flow provided (used) by operations (16,417) 73,715 213,379 - ------------------------------------------------------------------------------------------------- Cash Flows From Investing Activities Proceeds from sale of property 3,565 15,896 5,689 Capital expenditures for property (24,100) (50,824) (55,532) Investment in joint venture 794 987 360 - ------------------------------------------------------------------------------------------------- Net cash flow used by investing activities (19,741) (33,941) (49,483) - ------------------------------------------------------------------------------------------------- Cash Flows From Financing Activities Net increase (decrease) in short-term borrowings 67,757 -- (98,737) Repayment of long-term debt (20,176) (16,691) (46,430) Principal payments under capital leases (2,455) (6,694) (4,890) Sale of common stock 361 506 15,191 Purchases of treasury stock (6,909) (6,358) (6,299) Dividends paid (11,620) (12,202) (11,984) - ------------------------------------------------------------------------------------------------- Net cash flow provided (used) by financing activities 26,958 (41,439) (153,149) - ------------------------------------------------------------------------------------------------- Net Increase (Decrease) in Cash (9,200) (1,665) 10,747 - ------------------------------------------------------------------------------------------------- Cash, Beginning of Year 19,161 20,826 10,079 - ------------------------------------------------------------------------------------------------- Cash, End of Year $ 9,961 $ 19,161 $ 20,826 - ------------------------------------------------------------------------------------------------- See accompanying Notes to Consolidated Financial Statements 22 Consolidated Financial Statements Consolidated Statements of Changes in Shareholders' Equity for the Years Ended December 31, 2004, 2003 and 2002 (Stated in thousands) Common Accumulated Stock Other Common Preferred Subscribed, Retained Comprehensive Stock Stock Unissued Earnings Income (Loss) Total --------- --------- ---------- -------- ------------- ----- December 31, 2001 $ 114,424 $ 51 $ 0 $310,521 $ (17,504) $407,492 ========= ======== ======== ======== ========= ======== Net income 11,401 11,401 Currency translation adjustments (441) (441) Unrealized gain/(loss) from interest rate swap (net of tax of $1,536) (2,374) (2,374) Minimum pension liability (net of tax of $15,621) (24,639) (24,639) -------- Comprehensive income (loss) (16,053) -------- Stock issued 15,141 15,141 Stock redeemed (6,293) (6) (6,299) Advance payments 50 50 Dividends declared (12,488) (12,488) --------- -------- -------- -------- --------- -------- December 31, 2002 $ 123,272 $ 45 $ 50 $309,434 $ (44,958) $387,843 ========= ======== ======== ======== ========= ======== Net income 8,465 8,465 Currency translation adjustments 2,585 2,585 Unrealized gain/(loss) from interest rate swap (net of tax of $426) 673 673 Minimum pension liability (net of tax of $3,638) 5,738 5,738 -------- Comprehensive income 17,461 -------- Stock issued 511 511 Stock redeemed (6,356) (2) (6,358) Advance payments (5) (5) Dividends declared (11,869) (11,869) --------- -------- -------- -------- --------- -------- December 31, 2003 $ 117,427 $ 43 $ 45 $306,030 $ (35,962) $387,583 ========= ======== ======== ======== ========= ======== Net income 14,018 14,018 Currency translation adjustments 2,510 2,510 Unrealized gain/(loss) from interest rate swap (net of tax of $149) 233 233 Minimum pension liability (net of tax of $3,700) 5,836 5,836 -------- Comprehensive income 22,597 -------- Stock issued 406 406 Stock redeemed (6,866) (43) (6,909) Advance payments (45) (45) Dividends declared (11,268) (11,268) --------- -------- -------- -------- --------- -------- December 31, 2004 $ 110,967 $ 0 $ 0 $308,780 $ (27,383) $392,364 ========= ======== ======== ======== ========= ======== See accompanying Notes to Consolidated Financial Statements 23 Consolidated Financial Statements Notes to Consolidated Financial Statements for the Years Ended December 31, 2004, 2003 and 2002 (Stated in thousands except for share and per share data) 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES Description of Business Graybar Electric Company, Inc. is engaged internationally in the distribution of electrical, telecommunications and networking products and the provision of related supply chain management and logistics services, primarily to contractors, industrial plants, telephone companies, power utilities, and commercial users. All products sold by the Company are purchased by the Company from others. The Company's business activity is primarily with customers in the United States; however, the Company has limited sales activity in several international locations. Principles of Consolidation The consolidated financial statements include the accounts of Graybar Electric Company, Inc. and its subsidiary companies. All significant intercompany balances and transactions have been eliminated. Revenue Recognition Revenue is recognized when products are shipped and title transfers to the customer. Shipping and handling costs are primarily recorded in cost of merchandise sold, with the exception of costs totaling $36,791, $15,521 and $14,705 which are included in selling, general and administrative expenses in 2004, 2003 and 2002, respectively. Estimates The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses and the disclosure of contingent assets and liabilities. Actual results could differ from those estimates. Reclassifications Certain reclassifications of prior year presentations have been made to conform to the 2004 presentation. Cash and Cash Equivalents The Company classifies cash on hand, deposits in banks and other short- term, highly liquid investments with an original maturity of three months or less as cash and cash equivalents. Merchandise Inventory Inventory is stated at the lower of cost (determined using the last-in, first-out (LIFO) cost method) or market. LIFO accounting is a method of accounting that, compared with other inventory accounting methods, generally provides better matching of current costs with current revenues. Had the first-in, first-out (FIFO) method been used, inventory would have been approximately $24,822 and $0 greater than reported under the LIFO method at December 31, 2004 and 2003, respectively. The Company liquidated a portion of a previously created LIFO layer in 2004 and 2003, resulting in a (decrease) increase in cost of goods sold of $(473) and $2,081, respectively. Supplier Volume Incentives The Company's agreements with many of its suppliers provide for the Company to earn incentives based on purchases during the agreement period. The Company estimates the amount to be received from suppliers at the end of each reporting period based on the earnout level that the Company estimates is probable of being achieved. The Company records the incentive ratably over the year as a reduction of cost of sales as related inventory is sold. Changes in the estimated amount of incentives are treated as changes in estimate and are recognized using a cumulative catch-up adjustment. Property and Depreciation The Company provides for depreciation and amortization using the straight-line method over the following estimated useful lives of the assets: - ---------------------------------------------------------------------------------- Buildings 42 years - ---------------------------------------------------------------------------------- Permanent fixtures-- Over the shorter of the asset's life leased property or the lease term - ---------------------------------------------------------------------------------- Furniture, fixtures and equipment 4 to 14 years - ---------------------------------------------------------------------------------- Capital leases Over the shorter of the asset's life or the lease term - ---------------------------------------------------------------------------------- Depreciation expense was $23,746, $26,039 and $27,744 in 2004, 2003 and 2002, respectively. At the time property is retired, or otherwise disposed of, the asset and related accumulated depreciation are removed from the accounts, and any resulting gain or loss is credited or charged to other income. Property under capital leases is recorded in property with the corresponding obligations carried in long-term debt. The amount capitalized is the present value at the beginning of the lease term of the aggregate future minimum lease payments. Maintenance and repairs are expensed as incurred. Major renewals and betterments that extend the life of the property are capitalized. The Company capitalizes interest expense on major construction and development projects while in progress. Interest capitalized in 2004 and 2003 was $69 and $776, respectively. The Company capitalizes qualifying internal and external costs incurred to develop or obtain software for internal use during the application development stage. Costs incurred during the pre-application development and post-implementation stages are expensed as incurred. During 2004 and 2003, the Company capitalized $567 and $26,103, respectively. The estimated useful life of the software is eight years. 24 Consolidated Financial Statements Credit Risk Financial instruments that potentially expose the Company to concentrations of credit risk consist primarily of trade accounts receivable. The Company performs ongoing credit evaluations of its customers, and a significant portion of trade receivables is secured by lien or bond rights. The Company maintains allowances for potential credit losses, and such losses historically have been within management's expectations. Derivative Financial Instruments Statement of Financial Accounting Standards (SFAS) No. 133, as amended by SFAS No. 138 and SFAS No. 149, "Accounting for Derivative Instruments and Hedging Activities," requires the Company to recognize all derivative instruments on the balance sheet at fair value. The Company has entered into an interest rate swap agreement that effectively converts its floating rate payments to a fixed-rate basis. The Company manages interest rates on amounts due under certain operating leases through its swap agreement. The Company's interest rate swap agreement is designated as a cash flow hedge. On an ongoing basis, the Company reflects the current fair value of the interest rate swap on its balance sheet. At December 31, 2004 the Company has recorded a liability of $5,555 in other payables and accruals on the balance sheet for the fair value of the swap. The effective portion of the related gains or losses on the swap are deferred in accumulated other comprehensive income. Because the swap is completely effective, no ineffectiveness was recorded in the consolidated statements of income during 2004, 2003 and 2002. Unrealized net gains of $233 (net of tax) and $673 (net of tax) and an unrealized net loss of $2,374 (net of tax) related to the swap were recorded in accumulated other comprehensive income during the twelve-month periods ended December 31, 2004, 2003 and 2002, respectively. At December 31, 2004 an unrealized net loss of $3,400 (net of tax) is recorded in accumulated other comprehensive income. These deferred gains and losses are recognized in income in the period in which the related interest payments being hedged are recognized in expense. Goodwill The Company follows Statement of Financial Accounting Standards (SFAS) No. 142, "Goodwill and Other Intangible Assets," under which goodwill and indefinite-lived intangible assets are not amortized but rather tested annually for impairment. The effect of amortization expense related to goodwill on net income in periods prior to 2002 was not material. As of December 31, 2004 the Company has completed its annual impairment test and concluded that there is no impairment of the Company's goodwill. At December 31, 2004 the Company has $6,680 of goodwill included in other assets on the consolidated balance sheet. 2. INCOME TAXES The provisions for income taxes recorded in the consolidated statements of income and retained earnings are as follows: Years Ended December 31: 2004 2003 2002 - --------------------------------------------------------------------- Federal income tax Current $11,815 $(8,197) $ 6,724 Deferred (2,598) 13,115 693 State income tax Current 957 507 509 Deferred (245) 917 (707) - --------------------------------------------------------------------- Financial statement income tax provision $ 9,929 $ 6,342 $ 7,219 - --------------------------------------------------------------------- Deferred income taxes are provided based upon differences between the financial statement and tax bases of assets and liabilities. The following deferred tax assets (liabilities) are recorded at December 31: Assets/(Liabilities) 2004 2003 - --------------------------------------------------------------------- Postretirement benefits $30,136 $30,201 Payroll accruals 2,741 3,287 Bad debt reserves 2,933 2,651 Other deferred tax assets 11,750 11,748 Accrued (prepaid) pension 9,780 11,268 Inventory 7,354 (1,721) Fixed asset depreciation (15,798) (15,586) Fixed asset gains (9,542) (9,542) Computer software (16,895) (7,149) Other deferred tax liabilities (6,937) (8,588) - --------------------------------------------------------------------- $15,522 $16,569 - --------------------------------------------------------------------- Deferred tax assets included in other current assets were $16,161 and $6,167 in 2004 and 2003, respectively. Deferred tax assets included in other assets were $(639) and $10,402 in 2004 and 2003, respectively. The Company's deferred tax assets include state net operating loss carryforwards of $4,680 and $5,938 as of December 31, 2004 and 2003, respectively, that expire from 2006 to 2022. Valuation allowances of $1,022 and $2,191 have been established for a portion of these deferred tax assets as of December 31, 2004 and 2003, respectively. A reconciliation between the "statutory" federal income tax rate and the effective tax rate in the consolidated statements of income and retained earnings is as follows: Years Ended December 31: 2004 2003 2002 - --------------------------------------------------------------------- "Statutory" tax rate 35.0% 35.0% 35.0% State and local income taxes, net of federal benefit 2.1 2.4 (3.2) Other, net 4.4 5.4 7.0 - --------------------------------------------------------------------- Effective tax rate 41.5% 42.8% 38.8% - --------------------------------------------------------------------- 25 Consolidated Financial Statements 3. CAPITAL STOCK The Company's capital stock is owned by its employees and retirees. Common stock may not be sold by the holder thereof, except by first offering it to the Company. The Company may buy any common shares so offered at the price at which they were issued ($20) with appropriate adjustments for current dividends. During 2004 the Company offered to eligible employees the right to subscribe to 450,000 shares of common stock at $20 per share in accordance with the provisions of the Company's Common Stock Purchase Plan dated October 18, 2004. This resulted in the subscription of 268,772 shares ($5,375). Subscribers under the Plan elected to make payments under one of the following options: (i) all shares subscribed for prior to January 20, 2005; (ii) a portion of such shares prior to January 20, 2005, and the balance in monthly installments through payroll deductions (or in certain cases where a subscriber is no longer on the Company's payroll, through pension deductions or direct monthly payments) over an 11-month period; or (iii) all shares pursuant to the installment method. Shares were issued and Voting Trust Certificates were delivered to subscribers as of January 20, 2005, in the case of shares paid for prior to January 20, 2005. Shares will be issued and Voting Trust Certificates will be delivered to subscribers on a quarterly basis, as of the tenth day of March, June, September and December to the extent full payments of shares are made in the case of subscriptions under the installment method. Shown below is a summary of shares reacquired and retired by the Company in the three years ended December 31: Preferred Common Reacquired Retired Reacquired Retired - ------------------------------------------------------------ 2004 2,121 2,173 343,281 344,646 2003 129 164 317,774 316,811 2002 316 256 314,647 298,967 - ------------------------------------------------------------ 4. LONG-TERM DEBT AND BORROWINGS UNDER SHORT-TERM CREDIT AGREEMENTS December 31, Long-term debt was composed of: 2004 2003 - ------------------------------------------------------------------- 7.49% note, unsecured, due in annual installments of $14,286 in each of the years 2005 through 2011 $100,000 $100,000 6.59% note, unsecured, due in semiannual installments of $3,750 beginning in October 2003 through April 2013 63,750 71,250 7.36% note, unsecured, maturing May 2011, installments of $3,095 due semiannually in each of the years 2001 through 2010 with final payment of $3,094 due in 2011 40,238 46,428 6.65% note, unsecured, due in annual installments of $3,636 in each of the years 2003 through 2013 32,727 36,364 6.23% to 8.30% capital leases, various maturities 11,065 13,521 9.23% note secured by a first mortgage on various properties, maturing May 2005, installments of $2,725 due annually in each of the years 1995 through 2004 with final payment of $2,750 due in 2005 2,750 5,475 Variable rate mortgages, secured by facilities, various maturities 4,092 4,215 - ------------------------------------------------------------------- $254,622 $277,253 Less current portion 49,019 22,872 - ------------------------------------------------------------------- $205,603 $254,381 - ------------------------------------------------------------------- Long-term debt matures as follows: - ------------------------------------------------------------------- 2006 $ 31,798 2007 31,706 2008 31,696 2009 31,664 2010-2013 78,739 - ------------------------------------------------------------------- $ 205,603 - ------------------------------------------------------------------- 26 Consolidated Financial Statements The net book value of property securing various long-term debt instruments was $14,600 at December 31, 2004. The Company's borrowings under short-term credit agreements consist of issuances of commercial paper and borrowings under revolving credit agreements and bank lines of credit. The Company has a Revolving Credit Loan Agreement with a group of banks at an interest rate based on the London Interbank Offered Rate (LIBOR) that had previously consisted of a $205,000, five-year facility. In October 2003 the Company elected to reduce the facility from $205,000 to $50,000. Upon expiration of the agreement in July 2004, the Company entered into a new unsecured credit agreement which consists of an $85,000, 364-day facility which expires in July 2005. There were no amounts outstanding under the Revolving Credit Loan Agreement at December 31, 2004. At December 31, 2004 the Company had a $200 million accounts receivable securitization program that expires in October 2006. The securitization program provides for the sale of certain of the Company's trade receivables on a revolving basis to Graybar Commerce Corporation (GCC), a wholly owned, bankruptcy remote, special purpose subsidiary. GCC sells an undivided interest in the receivables to an unrelated multi-seller commercial paper conduit. The Company accounts for the securitization as an on-balance sheet financing arrangement because the Company has maintained effective control of the accounts receivable through a call option that gives GCC the unilateral right to repurchase the undivided interests. Accordingly, the accounts receivable and related debt are included in the accompanying consolidated balance sheets. GCC has granted a security interest in its trade receivables to the commercial paper conduit. Borrowings outstanding under the securitization program were $50,000 at December 31, 2004. Borrowings under short-term credit agreements varied from a minimum of $0 to a maximum of $192,223 and $188,281 in 2004 and 2003, respectively. The average amount of borrowings outstanding under short-term credit agreements during 2004 and 2003 amounted to approximately $146,000 and $109,000 at weighted average interest rates of 1.69% and 1.51%, respectively. The averages are based on the daily amounts outstanding during each year. The weighted average interest rate for amounts outstanding at December 31, 2004 was 2.74%. The Company had unused lines of credit of approximately $253,255 as of December 31, 2004. Certain committed lines of credit have annual fees of up to one hundred basis points of the committed lines of credit. The Revolving Credit Loan Agreement and certain other note agreements have various covenants that limit the Company's ability to make investments, pay dividends, incur debt, dispose of property, and issue equity securities. The Company is also required to maintain certain financial ratios as defined in the agreements. The Company is in compliance with all covenants as of December 31, 2004. The carrying amounts of the Company's outstanding long-term debt and short-term borrowings approximate their fair values at December 31, 2004. 5. PENSION AND OTHER POSTRETIREMENT BENEFITS The Company has a noncontributory defined benefit pension plan covering substantially all full-time employees. The plan provides retirement benefits based on an employee's final average earnings and years of service. Employees become 100% vested after five years of service, regardless of age. The Company's funding policy is to contribute the net periodic pension cost accrued each year, provided that the contribution will not be less than the ERISA minimum or greater than the maximum tax-deductible amount. The assets of the defined benefit pension plan are invested primarily in equity and fixed income securities and money market funds. The investment objective of the Company's defined benefit pension plan is to ensure that there are sufficient assets to fund regular pension benefits payable to employees over the long-term life of the plan. The Company's pension plan seeks to earn the highest possible long-term, total rate of return on assets consistent with prudent standards for preservation of capital, tolerance for investment risk and maintenance of liquidity. Asset allocation information for pension plan assets at December 31, 2004 is as follows: 2004 2003 Actual Actual Target Allocation Allocation Allocation ---------- ---------- ---------- Equity securities-U.S. 46% 46% 35% Equity securities-International 19 15 15 Fixed income investments 34 34 35 Other 1 5 15 ---------- ---------- ---------- 100% 100% 100% The Company and its subsidiaries provide certain health care and life insurance benefits for retired employees through the Retiree Welfare Plan (the Plan). Substantially all of the Company's employees may become eligible to participate in the Plan if they reach normal retirement age while working for the Company. Benefits are provided through insurance coverage with premiums based on the benefits paid during the year. The Company funds the Plan on a pay-as-you-go basis, and accordingly, the Plan has no assets at December 31, 2004 or 2003. 27 Consolidated Financial Statements The following table sets forth information regarding the Company's pension and other postretirement benefits as of December 31, 2004 and 2003 using a December 31 measurement date: Postretirement Pension Benefits Benefits ----------------------- --------------------- 2004 2003 2004 2003 -------------------------------------------------- Accumulated benefit obligation $188,673 $176,801 $ 126,449 $ 126,298 ------- ------- ------- ------- Projected benefit obligation 248,451 231,706 -- -- Fair value of plan assets 151,186 135,906 -- -- ------- ------- ------- ------- Funded status $(97,265) $(95,800) $(126,449) $(126,298) ------- ------- ------- ------- Amounts recognized in the consolidated balance sheet at December 31, 2004 consist of the following: Postretirement Pension Benefits Benefits ----------------------- --------------------- 2004 2003 2004 2003 -------------------------------------------------- Prepaid (accrued) benefit cost $(37,488) $(40,895) $(77,470) $(77,636) ------- ------- ------- ------- Intangible asset 11,110 12,392 -- -- Accumulated other comprehensive loss 27,828 33,664 -- -- ------- ------- ------- ------- Net amount recognized $ 1,450 $ 5,161 $(77,470) $(77,636) -------- -------- -------- -------- Weighted average assumptions as of December 31 are: Postretirement Pension Benefits Benefits ----------------------- --------------------- 2004 2003 2004 2003 -------------------------------------------------- Discount rate 5.75% 6.00% 5.75% 6.00% Expected return on plan assets 8.25% 8.75% -- -- Rate of compensation increase 4.00% 4.00% -- -- Health care cost trend on covered charges -- -- 9%/5% 10%/5% The expected return on plan assets assumption for the defined benefit pension plan is a long-term assumption and was determined after evaluating input from the plan's actuary and pension fund investment advisor, and also considering actual plan experience and historical and anticipated rates of return on the various classes of assets in which the plan invests. The Company anticipates that its investment managers will continue to generate long-term returns consistent with its assumed rate, despite temporary downturns in market performance. The following presents information regarding the plans for the years ended December 31, 2004 and 2003: Postretirement Pension Benefits Benefits ----------------------- --------------------- 2004 2003 2004 2003 -------------------------------------------------- Employer contributions $ 28,200 $ 21,300 $ 11,760 $ 11,148 Participant contributions -- -- 729 750 Benefits paid $(32,500) $(23,043) $(12,489) $(11,898) ------ ------ ------ ------ The Company expects to make contributions totaling $30,000 to its defined benefit pension plan during 2005. Estimated future defined benefit pension plan payments are as follows: 2005 $ 24,000 2006 26,000 2007 27,000 2008 27,000 2009 28,000 2010-2014 150,000 The net periodic cost recognized for the defined benefit pension plan was $35,610, $16,779 and $14,231 for each of the three years ended December 31, 2004, 2003 and 2002, respectively. Included in the Company's 2004 pension expense was approximately $15.1 million due to settlement of a portion of its defined benefit plan obligations as a result of increased election of lump sum payouts by retirees under the standard terms of the plan. The net periodic cost recognized for the postretirement benefit plan was $11,594, $11,198 and $9,533 for each of the three years ended December 31, 2004, 2003 and 2002, respectively. For measurement of the net periodic postretirement benefit obligation, a 9.0% annual rate of increase in per capita cost of covered health care benefits was assumed for 2005. The rate was assumed to gradually decrease to 5.0% for 2009 and to remain at that level thereafter. The Company has elected to defer accounting for the effects of the Medicare Prescription Drug, Improvement and Modernization Act of 2003 in accordance with FASB Staff Position (FSP) No. FAS 106-2. The accumulated postretirement benefit obligation and the net periodic postretirement benefit cost do not currently reflect the accounting impact of the Act since the Company is currently unable to determine whether the benefits provided by its plan are actuarially equivalent to Medicare Part D under the Act. The Company also provides a defined contribution profit sharing and savings plan covering substantially all of its full-time employees. Annual contributions by the Company to the plan are at the discretion of management and are generally determined based on the profitability of the Company. Employees may also contribute to the plan subject to limitations imposed by federal tax law and ERISA. 28 Consolidated Financial Statements 6. NET INCOME PER SHARE OF COMMON STOCK The computation of net income per share of common stock is based on the weighted average number of common shares outstanding during each year. The average numbers of shares used in computing net income per share of common stock were 5,708,968, 5,992,889 and 6,245,008 in 2004, 2003 and 2002, respectively. 7. COMMITMENTS The Company has two operating lease arrangements with an independent lessor which have provided $63,684 of off-balance sheet financing for eight of the Company's zone distribution facilities. Each of the agreements carries a five-year term. The Company has the option, with the consent of the lenders to the lessor, to renew the leases for up to two additional five-year terms or to purchase the property for a price including the outstanding lease balance. If the Company elects not to renew the lease or purchase the property, or such lenders refuse to consent to a renewal, the Company may elect to remarket the property and arrange for its sale to a third party. At December 31, 2004, the Company has recorded a $756 liability for the estimated fair value of the residual value guarantee for these operating lease agreements, one of which was renewed in 2003 and one of which was renewed in December 2004. The leasing structures used in these two lease arrangements qualify as variable interest entities under FASB Interpretation No. 46 and the Company's interests in the variable interest entities are required to be consolidated in the Company's financial statements beginning in the first quarter of 2005. As of December 31, 2004 the Company's maximum exposure to loss as a result of its involvement with the two lease arrangements is $54,131, the amount guaranteed by the Company as the residual fair value of the property in accordance with the lease arrangements. Rental expense was $40,916, $42,396 and $43,936 in 2004, 2003 and 2002, respectively. Future minimum rental payments required under operating leases that have either initial or remaining noncancellable lease terms in excess of one year as of December 31, 2004 are as follows: Years ending December 31: - -------------------------------------------------------------------- 2005 $35,142 2006 24,701 2007 18,866 2008 16,338 2009 10,608 Subsequent to 2009 31,782 - -------------------------------------------------------------------- In September 2000 the Company entered into a swap agreement to manage interest rates on amounts due under certain operating leases. The agreement, which expires in July 2013, is based on a notional amount of $28.7 million. The agreement calls for an exchange of interest payments with the Company receiving payments based on a London Interbank Offered Rate (LIBOR) floating rate, and making payments based on a fixed rate of 6.92%. There is no exchange of the notional amount upon which the payments are based. The fair value of the swap was $(5,555) at December 31, 2004 and is recorded in other payables and accruals in the consolidated balance sheet. 8. STATEMENTS OF CASH FLOWS During 2004, 2003 and 2002 income taxes paid (refunded) totaled $(4,057), $(1,684) and $12,484; interest paid totaled $23,548, $24,094 and $26,976; and liabilities assumed in connection with capitalized leases totaled $0, $9,793 and $0, respectively. 9. ACCUMULATED OTHER COMPREHENSIVE INCOME (LOSS) The components of accumulated other comprehensive income (loss) as of December 31, 2004 and 2003 are as follows: 2004 2003 - ---------------------------------------------------------------------------------- Currency translation adjustments $ 3,845 $ 1,335 Unrealized gain/(loss) from interest rate swap (3,400) (3,633) Minimum pension liability (27,828) (33,664) - ---------------------------------------------------------------------------------- $(27,383) $(35,962) - ---------------------------------------------------------------------------------- 10. QUARTERLY FINANCIAL INFORMATION (UNAUDITED) Quarterly financial data for 2004 and 2003 is as follows: For the quarters ended, 2004 3/31 6/30 9/30 12/31 - ------------------------------------------------------------------------------------ Net sales $939,309 $1,040,909 $1,072,482 $1,026,853 Gross margin 190,774 204,684 199,841 188,482 Net income 3,244 6,990 4,596 (812) Net income per share of common stock $ .56 $ 1.22 $ .81 $ (.13) - ------------------------------------------------------------------------------------ For the quarters ended, 2003 3/31 6/30 9/30 12/31 - ------------------------------------------------------------------------------------ Net sales $861,344 $949,982 $1,024,449 $ 966,677 Gross margin 172,813 180,813 190,971 189,869 Net income 158 1,697 4,609 2,001 Net income per share of common stock $ .03 $ .28 $ .77 $ .33 - ------------------------------------------------------------------------------------ 29 Report of Independent Registered Public Accounting Firm [Ernst & Young logo] Report of Independent Registered Public Accounting Firm The Board of Directors and Shareholders Graybar Electric Company, Inc. We have audited the accompanying consolidated balance sheets of Graybar Electric Company, Inc. as of December 31, 2004 and 2003, and the related consolidated statements of income and retained earnings, changes in shareholders' equity, and cash flows for each of the three years in the period ended December 31, 2004. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company's internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Graybar Electric Company, Inc. at December 31, 2004 and 2003, and the consolidated results of its operations and its cash flows for each of the three years in the period ended December 31, 2004, in conformity with U.S. generally accepted accounting principles. /s/ Ernst & Young LLP St. Louis, Missouri March 2, 2005 30 District Management as of December 31, 2004 NEW YORK DISTRICT Christopher O. Olsen District Vice President Ronald P. Segraves Director, Electrical Sales Stephen E. Thomas Director, Comm/Data Sales Joseph M. Sabatino Director, Operations Timothy D. Birky Director, Finance - -------------------------------------------------------------------- BOSTON DISTRICT Donald M. Block District Vice President Peter R. Elkas Director, Electrical Sales Gerald G. Pollick Director, Operations Joseph P. Peduto Director, Finance - -------------------------------------------------------------------- PITTSBURGH DISTRICT Steven M. Schooley District Vice President Wade V. Leidecker Director, Electrical Sales David A. Bender Director, Comm/Data Sales C. Robert Smith Director, Operations Peter M. Wingrove Director, Finance - -------------------------------------------------------------------- ATLANTA DISTRICT Joseph F. LaMotte District Vice President Donald W. Heitmeier Director, Electrical Sales Jeffrey W. Craig Director, Comm/Data Sales Keith E. (Kip) Davis Director, Operations Thomas G. Karrenbauer Director, Finance - -------------------------------------------------------------------- RICHMOND DISTRICT Thomas S. Gurganous District Vice President Lindsey G. Darnell Director, Electrical Sales Thomas R. Moore Director, Comm/Data Sales David K. Ange Director, Operations - -------------------------------------------------------------------- TAMPA DISTRICT Robert C. Lyons District Vice President Bruce E. Neilson Director, Electrical Sales Terrell L. Loveless Director, Comm/Data Sales Dale J. Thayer, Jr. Director, Operations Richard C. Hird Director, Finance - -------------------------------------------------------------------- CHICAGO DISTRICT Richard A. Cole District Vice President Michael N. Wall Director, Electrical Sales Richard H. Harvey Director, Comm/Data Sales John T. Roney Director, Operations Timothy E. Carpenter Director, Finance - -------------------------------------------------------------------- MINNEAPOLIS DISTRICT Robert L. Nowak District Vice President G. William Keller Director, Electrical Sales Paul D. Wise Director, Operations Ellen S. Rebne Director, Finance - -------------------------------------------------------------------- ST. LOUIS DISTRICT Michael W. Fowler District Vice President Thomas J. Spellacy Director, Electrical Sales John G. Smith Director, Comm/Data Sales Scott B. Neubauer Director, Operations Pete Rodriguez Director, Finance - -------------------------------------------------------------------- DALLAS DISTRICT Randall R. Harwood District Vice President John H. Hawfield Director, Electrical Sales Philip J. Harvatin Director, Comm/Data Sales Thomas T. Townsend Director, Operations Thomas E. Kinate Director, Finance - -------------------------------------------------------------------- SEATTLE DISTRICT Kenneth B. Sparks District Vice President Kirk A. Snure Director, Electrical Sales Christopher A. Borel Director, Comm/Data Sales John C. Fisher Director, Operations Paul A. Hansen Director, Finance - -------------------------------------------------------------------- PHOENIX DISTRICT Gary D. Hodges District Vice President Mick K. Upchurch Director, Electrical Sales Shayne P. Jones Director, Operations Kevin D. Cook Director, Finance - -------------------------------------------------------------------- CALIFORNIA DISTRICT David G. Maxwell District Vice President Ebbie R. Thigpen Director, Electrical Sales Jon D. Umene Director, Comm/Data Sales Kathy L. Edwards Director, Operations Richard T. Birkett Director, Finance 31 Locations as of December 31, 2004 CORPORATE OFFICE 34 North Meramec Avenue St. Louis, Missouri 63105 314 573-9200 - --------------------------------------------- New York District - --------------------------------------------- 1300 Livingston Avenue North Brunswick, New Jersey 08902 732 568-2500 BRANCHES New York: Albany, Hauppauge, Long Island City New Jersey: Newark, North Brunswick, Teterboro, Hackettstown, Parsippany, Wanamassa, Hamilton Pennsylvania: Philadelphia, Harrisburg, Allentown, Wilkes-Barre Delaware: New Castle - --------------------------------------------- Boston District - --------------------------------------------- 345 Harrison Avenue Boston, Massachusetts 02118 617 406-5000 BRANCHES Rhode Island: Cranston Massachusetts: Worcester, West Springfield, Somerville Maine: Portland New Hampshire: Manchester Vermont: Rutland, Burlington Connecticut: Hamden, Hartford Service Center Taunton, Massachusetts - --------------------------------------------- Pittsburgh District - --------------------------------------------- 900 Ridge Avenue Pittsburgh, Pennsylvania 15212 412 323-5200 BRANCHES Kentucky: Lexington, Louisville Ohio: Cincinnati, Columbus, Dayton, Lima, Toledo, Youngstown, Cleveland, Akron, Canton, Mansfield Pennsylvania: Greensburg, Erie West Virginia: Wheeling, Charleston New York: Buffalo, Rochester, Syracuse INFORMATION SYSTEMS 11885 Lackland Road St. Louis, Missouri 63146 314 573-5700 - --------------------------------------------- Atlanta District - --------------------------------------------- 2050 Nancy Hanks Drive Norcross, Georgia 30071 770 441-5580 BRANCHES Georgia: Atlanta Midtown, Marietta, Fayetteville, Savannah, Cartersville, Augusta Alabama: Birmingham, Huntsville, Mobile South Carolina: Columbia, Greenville, Spartanburg, Hilton Head, Beaufort Tennessee: Knoxville, Chattanooga, Nashville Florida: Pensacola Mississippi: Jackson - --------------------------------------------- Richmond District - --------------------------------------------- 1510 Tomlynn Street Richmond, Virginia 23230 804 354-1300 BRANCHES Virginia: Norfolk, Roanoke, Hampton, Chantilly, Commonwealth Controls-Richmond North Carolina: Asheville, Raleigh, Winston-Salem, Charlotte, Greensboro, Wilmington, Monroe South Carolina: Rock Hill Tennessee: Bristol Maryland: Baltimore, Lanham - --------------------------------------------- Tampa District - --------------------------------------------- 801 North Rome Avenue Tampa, Florida 33606 813 253-8881 BRANCHES Florida: Sarasota, Lakeland, Orlando, Pinellas, Melbourne, North Tampa, Tallahassee, Jacksonville, Daytona Beach, Miami, West Palm Beach, Fort Myers, Fort Pierce, Naples, Pompano Beach, Gainesville, Punta Gorda, Riviera Beach Service Center Riverview, Florida - --------------------------------------------- Chicago District - --------------------------------------------- 900 Regency Drive Glendale Heights, Illinois 60139 630 893-3600 BRANCHES Illinois: Naperville, Chicago Downtown, East Peoria, Springfield Indiana: Indianapolis, Hammond Fort Wayne, South Bend Michigan: Flint, Auburn Hills, East Livonia, Lansing, Grand Rapids, Belleville Iowa: Davenport, Cedar Rapids Wisconsin: West Allis, Racine, Madison - --------------------------------------------- Minneapolis District - --------------------------------------------- 2300 East 25th Street Minneapolis, Minnesota 55406 612 721-3545 BRANCHES Minnesota: St. Paul, Duluth, Burnsville, Plymouth, Rochester, Mankato, St. Cloud North Dakota: Fargo South Dakota: Sioux Falls, Brookings Wisconsin: Green Bay, Marinette, Manitowoc, Neenah, Stevens Point, Eau Claire Iowa: Des Moines - --------------------------------------------- St. Louis District - --------------------------------------------- 8170 Lackland Road Bel Ridge, Missouri 63114 314 573-2000 BRANCHES Missouri: Jefferson City, Kansas City, Springfield Kansas: Wichita Nebraska: Omaha Tennessee: Memphis, Jackson Arkansas: Little Rock, Springdale, Conway Indiana: Evansville Oklahoma: Oklahoma City, Tulsa - --------------------------------------------- Dallas District - --------------------------------------------- 4601 Cambridge Road Ft. Worth, Texas 76155 817 213-1200 BRANCHES Texas: Amarillo, Austin, Abilene, Dallas (Royal Lane Counter) Freeport, Houston, Beaumont, San Antonio, Corpus Christi, Dallas (Lewisville) Louisiana: Shreveport, Harahan, Baton Rouge, Lake Charles 32 Locations as of December 31, 2004 - --------------------------------------------- Seattle District - --------------------------------------------- 1919 Sixth Avenue South Seattle, Washington 98134 206 292-4848 BRANCHES Washington: Spokane, Tacoma, Everett Oregon: Portland, Eugene Idaho: Boise Alaska: Anchorage, Fairbanks Montana: Billings Hawaii: Honolulu - --------------------------------------------- Phoenix District - --------------------------------------------- 3350 West Earll Drive Phoenix, Arizona 85017 602 269-2131 BRANCHES Arizona: Mesa, Tucson, Scottsdale Colorado: Colorado Springs, Denver New Mexico: Albuquerque Texas: El Paso Nevada: Las Vegas Utah: Salt Lake City - --------------------------------------------- California District - --------------------------------------------- 383 South Cheryl Lane City of Industry, California 91789 909 451-4000 BRANCHES California: Anaheim (Counter), Long Beach (Counter), Van Nuys, Costa Mesa, Los Angeles (Counter), San Bernardino, Hayward, San Francisco (Downtown), Martinez, San Jose, Sacramento, San Diego, San Marcos (Counter), Santa Barbara, Santa Maria, Bakersfield, Fresno, Modesto, Rancho Cordova (Counter) Nevada: Sparks Regional Zones - --------------------------------------------- Atlanta Regional And National Zone - --------------------------------------------- Woodlands Business Park Building 100 8180 Troon Circle Austell, Georgia 30168 678 945-9970 - --------------------------------------------- Charlotte Regional Zone - --------------------------------------------- 1700 West Pointe Drive, Suite A Charlotte, North Carolina 28214 704 602-7000 - --------------------------------------------- Cincinnati Regional Zone - --------------------------------------------- 8814 Trade Port Drive Hamilton, Ohio 45011 513 874-8814 - --------------------------------------------- Cranbury Regional Zone - --------------------------------------------- 4 Aurora Drive Suite 401 Cranbury, New Jersey 08512 609 409-8100 - --------------------------------------------- Fresno Regional And National Zone - --------------------------------------------- 4401 East Central Avenue Fresno, California 93725 559 264-2393 - --------------------------------------------- Joliet Regional And National Zone - --------------------------------------------- 1700 Crossroad Drive Joliet, Illinois 60431 815 741-4660 - --------------------------------------------- Richmond Regional Zone - --------------------------------------------- 2501 Distribution Drive Richmond, Virginia 23231 804 521-6800 - --------------------------------------------- Rogers Regional Zone - --------------------------------------------- 13251 George Weber Drive Rogers, Minnesota 55374 763 428-1545 - --------------------------------------------- Seattle Regional Zone - --------------------------------------------- 1101 North Levee Road Puyallup, Washington 98371 253 848-3305 - --------------------------------------------- Springfield Regional Zone - --------------------------------------------- 1904 N. LeCompte, Building #12 Springfield, Missouri 65802 417 864-4955 - --------------------------------------------- Stafford Regional And National Zone - --------------------------------------------- 13131 North Promenade Boulevard Stafford, Texas 77477 281 340-5500 - --------------------------------------------- Youngstown Regional and National Zone - --------------------------------------------- 1100 Ohio Works Drive Youngstown, Ohio 44510 330 799-3220 International - --------------------------------------------- 34 North Meramec Avenue St. Louis, Missouri 63105 314 573-5210 LOCATIONS Carolina, Puerto Rico Mexico City, Mexico Kitchener, Ontario Hamilton, Ontario Guelph, Ontario Mississauga, Ontario Niagara Falls, Ontario Windsor, Ontario Halifax, Nova Scotia Dartmouth, Nova Scotia Bridgewater, Nova Scotia Kentville, Nova Scotia New Glasgow, Nova Scotia Sydney, Nova Scotia Truro, Nova Scotia Yarmouth, Nova Scotia Charlottetown, Prince Edward Island Bathurst, New Brunswick Florenceville, New Brunswick Fredericton, New Brunswick Moncton, New Brunswick Saint John, New Brunswick Corner Brook, Newfoundland Grand Falls-Windsor, Newfoundland St. John's, Newfoundland Wabush, Newfoundland Calgary, Alberta 33 Graybar Electric Company, Inc. 34 North Meramec Avenue St. Louis, Missouri 63105 www.graybar.com [photo]