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GWW > SEC Filings for GWW > Form 10-K on 27-Feb-2014All Recent SEC Filings

Show all filings for GRAINGER W W INC

Form 10-K for GRAINGER W W INC


27-Feb-2014

Annual Report


Item 7: Management's Discussion and Analysis of Financial Condition and Results
of Operations
Overview
General. Grainger is a broad-line distributor of maintenance, repair and operating supplies, and other related products and services used by businesses and institutions. Grainger's operations are primarily in the United States and Canada, with a presence in Europe, Asia and Latin America. Grainger uses a multichannel business model to provide customers with a range of options for finding and purchasing products utilizing sales representatives, catalogs, direct marketing materials and eCommerce. Grainger serves more than 2 million customers worldwide through a network of highly integrated branches, distribution centers, multiple websites and export services.
Grainger's two reportable segments are the United States and Canada. The United States segment reflects the results of Grainger's U.S. operating segment. The Canada segment reflects the results for Acklands - Grainger Inc., Grainger's Canadian operating segment. Other Businesses include operations in Europe, Asia, Latin America and other U.S. operations, which are not material individually. Business Environment. Given Grainger's large number of customers and the diverse industries it serves, several economic factors and industry trends tend to shape Grainger's business environment. The overall economy and leading economic indicators provide general insight into projecting Grainger's growth. Grainger's sales in the United States and Canada tend to positively correlate with Gross Domestic Product (GDP), Industrial Production, Exports and Business Investment. In the United States, sales also tend to positively correlate with Business Inventory. The table below provides these estimated indicators for 2013 and 2014:
                                                United States                          Canada
                                       Estimated 2013   Forecasted 2014   Estimated 2013   Forecasted 2014
GDP                                         1.9%             2.7%              1.8%             2.4%
Industrial Production                       2.6%             3.2%              1.3%             2.5%
Exports                                     2.8%             4.9%              1.2%             2.9%
Business Investment                         2.9%             6.3%              1.2%             6.6%
Business Inventory                          4.2%             3.0%               -                 -
Source: Global Insight (February 2014)

The light and heavy manufacturing customer sectors, which comprised approximately 30% of Grainger's total 2013 sales, have historically correlated with manufacturing employment levels and manufacturing production. Manufacturing employment levels in the United States increased approximately 0.6% from December 2012 to December 2013, while manufacturing output increased 2.6%. These increases contributed to a high single-digit percent sales increase in the light manufacturing customer sector and a mid single-digit percent sales increase in the heavy manufacturing customer sector for Grainger in 2013. As oil production represents a large segment of the Canadian economy, fluctuations in crude oil prices can have a significant impact on the sales and business conditions in Grainger's Canadian business. According to the U.S. Energy Information Administration, crude oil prices increased from $88 to $98 per barrel, or an 11% increase from December 2012 to December 2013. Outlook. In 2014, Grainger plans to continue to make investments in its supply chain, eCommerce, sales force and inventory management services. These investments are expected to accelerate market share growth and increase Grainger's size and scale. Grainger is also taking appropriate steps to strengthen areas of the business that are not performing to expectations. On January 24, 2014, Grainger revised its 2014 earnings per share guidance from a range of $12.25 to $13.00 to a range of $12.10 to $12.85 and also revised its 2014 sales guidance from a range of 6 to 10 percent to a range of 5 to 9 percent. This change is primarily driven by unfavorable foreign exchange and the divestiture of the four direct marketing brands, which were sold on December 31, 2013.


Matters Affecting Comparability.
Grainger completed several acquisitions throughout 2013, 2012 and 2011, all of
which were immaterial individually and in the aggregate. Grainger's operating
results have included the results of each business acquired since the respective
acquisition dates.
Results of Operations
The following table is included as an aid to understanding changes in Grainger's
Consolidated Statements of Earnings:
                                               For the Years Ended December 31,
                                                                      Percent Increase/(Decrease) from
                                 As a Percent of Net Sales                       Prior Year
                            2013            2012           2011             2013               2012
Net sales                   100.0  %        100.0  %       100.0  %        5.4  %               10.8 %
Cost of merchandise
sold                         56.2            56.2           56.5           5.3                  10.2
Gross profit                 43.8            43.8           43.5           5.6                  11.5
Operating expenses           30.1            31.2           30.5           2.0                  13.3
Operating earnings           13.7            12.6           13.0          14.7                   7.5
Other income (expense)       (0.1 )          (0.1 )            -         (30.6 )                   -
Income taxes                  5.1             4.7            4.8          14.5                   8.8
Noncontrolling interest       0.1             0.1            0.1          19.5                  12.3
Net earnings
attributable to W.W.
Grainger, Inc.                8.4  %          7.7  %         8.1  %       15.5  %                4.8 %

2013 Compared to 2012
Grainger's net sales of $9,438 million for 2013 increased 5% when compared with
net sales of $8,950 million for 2012. The 5% increase for the year consisted of
the following contributors:
                      Percent Increase/ (Decrease)
Volume                             3
Business acquisitions              2
Price                              1
Foreign exchange                  (1)
Total                              5%

Net sales to most customer end markets increased for 2013. The increase in net sales was led by growth in sales to heavy and light manufacturing customers, followed by diversified commercial services customers. Refer to the Segment Analysis below for further details.

Gross profit of $4,136 million for 2013 increased 6%. The gross profit margin for 2013 was 43.8%, flat versus 2012, primarily driven by price increases exceeding product cost increases, offset by lower margins from the acquired businesses and faster growth with lower margin customers.

Operating expenses of $2,840 million for 2013 increased 2% from $2,785 million for 2012. Operating expenses in 2013 included a $26 million expense related to the impairment charges for the business in Brazil and Grainger Lighting Services in the United States. Also included was $10 million of expense related to restructuring charges for improving the long-term performance of the businesses in Europe and China. Operating expenses in 2012 included a $76 million expense related to the settlement of disputes involving the GSA and USPS contracts. Also included in 2012 was $24 million of expense related to branch closure costs, restructuring charges related to improving the long-term performance of the businesses in Europe, India and China and an impairment charge for Grainger Lighting Services. Excluding these expenses from both years, operating expenses increased 4%, primarily driven by the acquisitions and an incremental $132 million in growth-related spending on new sales representatives, eCommerce and inventory management solutions, primarily in the United States.


Operating earnings of $1,297 million for 2013 increased 15% from $1,131 million for 2012. Excluding the expenses mentioned above for both years, operating earnings increased 8%, primarily due to higher sales and operating expenses increasing at a slower rate than sales.

Net earnings attributable to Grainger for 2013 increased by 16% to $797 million from $690 million in 2012. The increase in net earnings primarily resulted from an increase in operating earnings. Diluted earnings per share of $11.13 in 2013 were 17% higher than $9.52 for 2012, due to increased net earnings and lower average shares outstanding.

The table below reconciles reported diluted earnings per share determined in accordance with generally accepted accounting principles in the United States to adjusted diluted earnings per share, a non-GAAP measure. Management believes adjusted diluted earnings per share is an important indicator of operations because it excludes items that may not be indicative of core operating results. Because non-GAAP financial measures are not standardized, it may not be possible to compare this financial measure with other companies' non-GAAP financial measures having the same or similar names.

                                     Twelve Months Ended December 31,
                                         2013                2012        %
Diluted earnings per share reported     $11.13               $9.52      17 %
GSA/USPS settlement                        -                 0.66
Goodwill impairment                      0.29                0.04
Restructuring                            0.10                0.18
Charge for U.S. branch closures            -                 0.03
Subtotal                                 0.39                0.91
Diluted earnings per share adjusted     $11.52              $10.43      10 %

Segment Analysis
The following comments at the reportable segment and other business unit level include external and intersegment net sales and operating earnings. See Note 16 to the Consolidated Financial Statements.

United States
Net sales were $7,414 million for 2013, an increase of $488 million, or 7%, when
compared with net sales of $6,926 million for 2012. The 7% increase for the year
consisted of the following contributors:
                      Percent Increase
Volume                       4
Business acquisitions        2
Price                        1
Total                        7%

Net sales to most customer end markets increased for 2013. The increase was led by high single digit growth to light manufacturing customers, followed by mid-single digit growth to heavy manufacturing, commercial services, contractors and natural resources customers. Government was up in the low single digits and net sales to resellers were down in the low single digits.

The segment gross profit margin decreased 0.3 percentage point in 2013 compared to 2012, primarily driven by lower margins from the acquired businesses and faster growth with lower margin customers, partially offset by price increases exceeding product cost increases.

Operating expenses were up 1% for 2013 versus 2012. Operating expenses in 2013 included a $13 million expense related to goodwill impairment charges for Grainger Lighting Services. The 2012 year included a $76 million expense related to the settlement of disputes involving the GSA and USPS contracts. Also included in 2012 was $10 million of expense primarily related to branch closure costs and a goodwill impairment charge for Grainger Lighting Services. Excluding these expenses from both years, operating expenses increased 5%, primarily driven by an incremental $118 million in growth-related spending on new sales representatives, eCommerce and inventory management solutions.


For the segment, operating earnings of $1,304 million for 2013 increased 15% over $1,133 million in 2012. Excluding the expenses mentioned above in both years, operating earnings were up 8%. The improvement in operating earnings for 2013 was due to an increase in net sales and operating expenses increasing at a slower rate than sales.

Canada
Net sales were $1,114 million for 2013, an increase of $8 million, or 1%, when
compared with $1,106 million for 2012. In local currency, sales increased 4% for
2013. The 1% increase for the year consisted of the following contributors:
                 Percent Increase/ (Decrease)
Volume                        4
Foreign exchange             (3)
Total                         1%

Sales performance in Canada was driven by double digit growth in the forestry market, followed by high single digit growth to the light manufacturing, commercial services and oil and gas end markets. Net sales to heavy manufacturing customers were down in the mid-single digits and the government end market was down in the low single digits.

The segment gross profit margin increased 0.4 percentage point in 2013 over 2012, primarily driven by price increases exceeding product cost increases and favorable freight rates, partially offset by the unfavorable effect of foreign exchange on purchases.

Operating expenses increased 2% in 2013. In local currency, operating expenses increased 5%, primarily due to higher volume-related payroll, occupancy and technology investments, partially offset by lower warehouse expenses.

Operating earnings of $129 million for 2013 were up $1 million, or 1%, versus 2012. In local currency, operating earnings increased 4%. The increase in earnings was due to sales growth and improved gross profit margins, partially offset by operating expenses increasing at a faster rate than sales.

Other Businesses
Net sales were $1,040 million for 2013, an increase of $33 million, or 3%, when
compared with $1,007 million for 2012. The net sales increase was primarily due
to incremental sales from Zoro Tools, Brazil and Mexico, partially offset by
lower sales in India due to a change in its business model. Higher sales in
Japan were offset by unfavorable foreign exchange. The 3% increase for the year
consisted of the following contributors:
                 Percent Increase/ (Decrease)
Volume/Price                  10
Foreign exchange             (7)
Total                         3%

Operating earnings for other businesses were $8 million for 2013 compared to $20 million for 2012. The year 2013 included $13 million of expense related to impairment charges for the business in Brazil and $10 million of expense in structural changes to the businesses in Europe and China. The year 2012 included $14 million of charges related to restructuring the businesses in Europe, India and China. Excluding these charges, operating earnings decreased $4 million, or 11%, primarily driven by lower earnings from the businesses in Latin America, partially offset by higher earnings at Zoro Tools and Japan.


Other Income and Expense
Other income and expense was $9 million of expense in 2013 compared with $13
million of expense in 2012. The following table summarizes the components of
other income and expense (in thousands of dollars):
                                   For the Years Ended December 31,
                                      2013                  2012
Interest income (expense) - net $       (9,991 )     $        (13,418 )
Other non-operating income               2,732                  1,866
Other non-operating expense             (1,996 )               (1,784 )
Total                           $       (9,255 )     $        (13,336 )

Net interest expense decreased in 2013 due to lower average interest rates, partially offset by higher average outstanding debt.

Income Taxes
Income taxes of $480 million in 2013 increased 15% as compared with $419 million in 2012. Grainger's effective tax rates were 37.3% and 37.5% in 2013 and 2012, respectively.

2012 Compared to 2011
Grainger's net sales of $8,950 million for 2012 increased 11% when compared with
net sales of $8,078 million for 2011. The 11% increase for the year consisted of
the following contributors:
                      Percent Increase/ (Decrease)
Volume                             6
Business acquisitions              3
Price                              3
Foreign exchange                  (1)
Total                             11%

Sales to all customer end markets increased for 2012. The increase in net sales was led by growth in sales to heavy and light manufacturing customers, followed by diversified commercial services customers. Refer to the Segment Analysis below for further details.

Gross profit of $3,916 million for 2012 increased 12%. The gross profit margin for 2012 was 43.8%, up 0.3 percentage point versus 2011, primarily driven by price increases exceeding product cost increases, partially offset by customer mix.

Operating expenses of $2,785 million for 2012 increased 13% from $2,458 million for 2011. Operating expenses in 2012 included a $76 million expense related to the settlement of disputes involving the GSA and USPS contracts. Also included was $24 million of expense related to branch closure costs, restructuring charges related to improving the long-term performance of the businesses in Europe, India and China and an impairment charge for Grainger Lighting Services. The year 2011 included $18 million of branch closure costs. Excluding these expenses from both years, operating expenses increased 10%, primarily driven by the Fabory and AnFreixo acquisitions and incremental growth-related spending on new sales representatives, eCommerce and advertising, primarily in the United States.

Operating earnings of $1,131 million for 2012 increased 7% from $1,052 million for 2011. Excluding the expenses mentioned above for both years, operating earnings increased 15%, primarily due to higher sales and gross profit margins, and operating expenses increasing at a slightly slower rate than sales.

Net earnings attributable to Grainger for 2012 increased by 5% to $690 million from $658 million in 2011. The increase in net earnings primarily resulted from an increase in operating earnings. Diluted earnings per share of $9.52 in 2012 were 5% higher than $9.07 for 2011, due to increased net earnings.


The table below reconciles reported diluted earnings per share determined in accordance with generally accepted accounting principles in the United States to adjusted diluted earnings per share, a non-GAAP measure. Management believes adjusted diluted earnings per share is an important indicator of operations because it excludes items that may not be indicative of core operating results. Because non-GAAP financial measures are not standardized, it may not be possible to compare this financial measure with other companies' non-GAAP financial measures having the same or similar names.

                                      Twelve Months Ended December 31,
                                          2012                2011        %
Diluted earnings per share reported       $9.52               $9.07       5 %
GSA/USPS settlement                       0.66                  -
Restructuring                             0.18                  -
Goodwill impairment                       0.04                  -
Charge for U.S. branch closures           0.03                0.16
Settlement of prior year tax reviews        -                (0.12)
Gain on sale of joint venture               -                (0.07)
Subtotal                                  0.91               (0.03)
Diluted earnings per share adjusted      $10.43               $9.04      15 %

Segment Analysis
The following comments at the reportable segment and other business unit level include external and intersegment net sales and operating earnings. See Note 16 to the Consolidated Financial Statements.

United States
Net sales were $6,926 million for 2012, an increase of $425 million, or 7%, when
compared with net sales of $6,501 million for 2011. The 7% increase for the year
consisted of the following contributors:
       Percent Increase
Volume        4
Price         3
Total         7%

Sales to all customer end markets increased for 2012. The increase was led by growth in sales to heavy and light manufacturing customers, followed by diversified commercial services customers.

The segment gross profit margin increased 0.3 percentage point in 2012 over 2011, primarily driven by price increases exceeding product cost increases, partially offset by customer mix.

Operating expenses were up 8% for 2012 versus 2011. The 2012 year included a $76 million expense related to the settlement of disputes involving the GSA and USPS contracts. Also included was $10 million of expense primarily related to branch closure costs and an impairment charge for Grainger Lighting Services. The 2011 year included costs for the closure of 35 branches of $18 million. Excluding these expenses from both years, operating expenses increased 4%, primarily driven by an incremental $70 million in growth-related spending on new sales representatives, eCommerce and advertising.

For the segment, operating earnings of $1,133 million for 2012 increased 6% over $1,066 million in 2011. Excluding the expenses mentioned above in both years, operating earnings were up 12%. The improvement in operating earnings for 2012 was due to an increase in net sales and gross profit margin, and operating expenses increasing at a slower rate than sales.


Canada
Net sales were $1,106 million for 2012, an increase of $113 million, or 11%,
when compared with $993 million for 2011. In local currency, sales increased 12%
for 2012. The 11% increase for the year consisted of the following contributors:
                 Percent Increase/ (Decrease)
Volume                        11
Price                         1
Foreign exchange             (1)
Total                        11%

The increase in net sales was led by growth to oil and gas, commercial and construction customers.
The segment gross profit margin increased 0.2 percentage point in 2012 over 2011, primarily driven by price increases exceeding product cost increases, partially offset by unfavorable customer and product mix.

Operating expenses increased 9% in 2012. In local currency, operating expenses increased 10% primarily due to higher volume-related payroll and travel costs, and higher advertising and depreciation expense, partially offset by lower occupancy costs.

Operating earnings of $127 million for 2012 were up $20 million, or 18%, versus 2011. In local currency, operating earnings increased 19%. The increase in earnings was due to strong sales growth, an improved gross profit margin and expense leverage.

Other Businesses
Net sales for other businesses, which include operations in Europe, Asia, Latin America and other U.S. operations were up 55% for 2012. The sales increase was due primarily to a full year of sales from Fabory, acquired in August 2011, and incremental sales from AnFreixo, acquired in April 2012, as well as strong growth from the businesses in Japan and Mexico.

Operating earnings for other businesses were $20 million for 2012 compared to $31 million for 2011. The decrease was primarily due to restructuring charges related to improving the long-term performance of the businesses in Europe, India and China. Excluding these charges, operating earnings were up $3 million, primarily driven by improved performance in Japan and Mexico, partially offset by losses from the acquired businesses in Europe and Brazil, along with losses in some start-up businesses in developing markets.

Other Income and Expense
Other income and expense was $13 million of expense in 2012 compared with $1
million of expense in 2011. The following table summarizes the components of
other income and expense (in thousands of dollars):

                                                         For the Years Ended December 31,
                                                           2012                    2011
Interest income (expense) - net                     $        (13,418 )       $        (7,023 )
Equity in net income of unconsolidated entity                      -                     314
Gain on sale of investment in unconsolidated entity                -                   7,639
Other non-operating income                                     1,866                     709
Other non-operating expense                                   (1,784 )                (2,541 )
Total                                               $        (13,336 )       $          (902 )

Net interest expense increased in 2012 due to higher average outstanding debt, higher average interest rates and interest expense related to capital leases for the acquired business in Europe.

In 2011, Grainger divested its 49% ownership in the MRO Korea Co., Ltd. joint venture, resulting in a gain of approximately $8 million.


Income Taxes
Income taxes of $419 million in 2012 increased 9% as compared with $385 million in 2011. Grainger's effective tax rates were 37.5% and 36.6% in 2012 and 2011, respectively. The 2011 rate benefited from a tax law change in Japan and the settlement of various tax reviews. Excluding these benefits in 2011, the effective tax rate was 38.1%. The effective tax rate in 2012 benefited primarily from a lower blended state tax rate.

Financial Condition
Grainger expects its strong working capital position, cash flows from operations and borrowing capacity to continue, allowing it to fund its operations, including growth initiatives, capital expenditures, acquisitions and repurchase of shares, as well as to pay cash dividends.

Cash Flow

Fiscal year 2013 compared with fiscal year 2012 Cash from operating activities continues to serve as Grainger's primary source of liquidity. Net cash flows from operations in 2013 were $986 million and increased $170 million from $816 million in 2012. The primary driver of the improvement was an increase in net earnings of $109 million. In addition, changes in operating assets and liabilities resulted in a net use of cash of $58 million for 2013 compared to $129 million for 2012. The lower use of cash for operating assets and liabilities was driven primarily by higher trade accounts payable due to higher inventory purchases at year-end in 2013 compared to 2012, partially offset by higher accounts receivable from increased sales.

Net cash used in investing activities was $399 million and $306 million in 2013 and 2012, respectively. The higher use of cash in 2013 compared to 2012 was primarily driven by the increased cash paid for acquisitions and cash expended for property, buildings, equipment and software.

Net cash used in financing activities of $591 million in 2013 increased $197 million from $394 million in 2012. The increase was primarily due to higher treasury share repurchases. Cash paid for treasury share purchases was $438 . . .

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