16 Pages Complete QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-Q [x] Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 For the period ended September 30, 1997 or [ ] Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 For the transition period from to Commission file number 1-5684 I.R.S. Employer Identification Number 36-1150280 W.W. Grainger, Inc. (An Illinois Corporation) 455 Knightsbridge Parkway Lincolnshire, Illinois 60069-3620 Telephone: (847)793-9030 Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes X No APPLICABLE ONLY TO CORPORATE ISSUERS: Indicate the number of shares outstanding of each of the issuers classes of common stock, as of the latest practicable date: 49,649,927 shares of the Company's Common Stock were outstanding as of October 31, 1997. (1)
Part I - FINANCIAL INFORMATION W.W. Grainger, Inc. and Subsidiaries CONSOLIDATED STATEMENTS OF EARNINGS (In thousands of dollars except for per share amounts) (Unaudited) Three Months Ended Nine Months Ended September 30, September 30, ---------------------- ---------------------- 1997 1996 1997 1996 ---------- ---------- ---------- ---------- Net sales ...................... $1,066,927 $ 901,858 $3,103,689 $2,633,129 Cost of merchandise sold ....... 693,775 582,324 2,006,228 1,703,490 ---------- ---------- ---------- ---------- Gross profit ................. 373,152 319,534 1,097,461 929,639 Warehousing, marketing, and administrative expenses ...... 277,338 233,737 811,687 677,388 ---------- ---------- ---------- ---------- Operating earnings ........... 95,814 85,797 285,774 252,251 Other income or (deductions) Interest income .............. 314 1,780 2,216 2,780 Interest expense ............. (1,436) (88) (4,012) (662) Unclassified-net ............. 233 (78) (536) (284) ---------- ---------- ---------- ---------- (889) 1,614 (2,332) 1,834 ---------- ---------- ---------- ---------- Earnings before income taxes ... 94,925 87,411 283,442 254,085 Income taxes ................... 38,445 35,139 114,794 102,142 ---------- ---------- ---------- ---------- Net earnings ................... $ 56,480 $ 52,272 $ 168,648 $ 151,943 ========== ========== ========== ========== Net earnings per common and common equivalent share ...... $ 1.12 $ 1.02 $ 3.28 $ 2.96 ========== ========== ========== ========== Average number of common and common equivalent shares outstanding ........... 50,334,582 51,454,355 51,472,222 51,417,826 ========== ========== ========== ========== Cash dividends paid per share .. $ 0.27 $ 0.25 $ 0.79 $ 0.73 ========== ========== ========== ========== The accompanying notes are an integral part of these financial statements. (2)
W.W. Grainger, Inc. and Subsidiaries CONSOLIDATED BALANCE SHEETS (In thousands of dollars) (Unaudited) Sept. 30, Dec. 31, ASSETS 1997 1996 - -------------------------------------------------------- ---------- ---------- CURRENT ASSETS Cash and cash equivalents ............................ $ 57,502 $ 126,935 Accounts receivable, less allowance for doubtful accounts of $17,869 in 1997 and $15,302 in 1996 .... 493,560 433,575 Inventories .......................................... 576,481 686,925 Prepaid expenses ..................................... 15,331 11,971 Deferred income tax benefits ......................... 59,943 60,837 ---------- ---------- Total current assets ............................... 1,202,817 1,320,243 PROPERTY, BUILDINGS, AND EQUIPMENT ..................... 1,053,855 985,712 Less accumulated depreciation and amortization ....... 479,566 434,728 ---------- ---------- Property, buildings, and equipment-net ............... 574,289 550,984 OTHER ASSETS ........................................... 231,496 247,794 ---------- ---------- TOTAL ASSETS ........................................... $2,008,602 $2,119,021 ========== ========== LIABILITIES AND SHAREHOLDERS' EQUITY - -------------------------------------------------------- CURRENT LIABILITIES Short-term debt ...................................... $ 132,941 $ 135,275 Current maturities of long-term debt ................. 24,324 24,753 Trade accounts payable ............................... 269,069 240,779 Accrued expenses ..................................... 186,575 187,457 Income taxes ......................................... 29,526 27,804 ---------- ---------- Total current liabilities .......................... 642,435 616,068 LONG-TERM DEBT (less current maturities) ............... 5,096 6,152 DEFERRED INCOME TAXES .................................. 3,669 2,207 ACCRUED EMPLOYMENT RELATED BENEFITS COSTS .............. 35,288 31,932 SHAREHOLDERS' EQUITY Cumulative Preferred Stock - $5 par value - authorized, 6,000,000 shares, issued and outstanding, none ....... -- -- Common Stock - $0.50 par value - authorized, 150,000,000 shares; issued, 53,476,419 shares, 1997, and 53,338,026 shares, 1996. ......................... 26,738 26,669 Additional contributed capital ........................ 264,972 262,318 Treasury stock, at cost - 3,790,186 shares, 1997, and 409,600 shares, 1996 ................................ (302,455) (32,090) Unearned restricted stock compensation ................ (16,996) (17,597) Cumulative translation adjustments .................... (3,830) (2,262) Retained earnings ..................................... 1,353,685 1,225,624 ---------- ---------- Total shareholders' equity ......................... 1,322,114 1,462,662 ---------- ---------- TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY ........... $2,008,602 $2,119,021 ========== ========== The accompanying notes are an integral part of these financial statements. (3)
W.W. Grainger, Inc. and Subsidiaries CONSOLIDATED STATEMENTS OF CASH FLOWS (In thousands of dollars) (Unaudited) Nine Months Ended September 30, ---------------------- 1997 1996 --------- ---------- Cash flows from operating activities: Net earnings ..................................... $ 168,648 $ 151,943 Provision for losses on accounts receivable ...... 9,290 7,986 Depreciation and amortization: Property, buildings, and equipment ............. 48,078 45,870 Intangibles and goodwill ....................... 12,339 9,427 Change in operating assets and liabilities: (Increase) in accounts receivable .............. (69,275) (57,401) Decrease in inventories ........................ 110,444 36,766 (Increase) in prepaid expenses ................. (3,360) (655) Decrease (increase) in deferred income taxes ... 2,356 (594) Increase in trade accounts payable ............. 28,290 28,968 (Decrease) in other accrued expenses ........... (882) (16,905) Increase in current income taxes payable ....... 1,722 1,137 Increase in accrued employment related benefits costs ............................... 3,356 2,880 Other - net ...................................... 1,277 2,304 ---------- ---------- Net cash provided by operating activities .......... 312,283 211,726 ---------- ---------- Cash flows from investing activities: Additions to property, buildings, and equipment - net of dispositions ................ (70,871) (34,325) Other - net ...................................... 2,006 (1,235) ---------- ---------- Net cash (used in) investing activities ............ (68,865) (35,560) ---------- ---------- Cash flows from financing activities: Net (decrease) in short-term debt ................ (2,334) (20,512) Proceeds from long-term debt ..................... -- 1,500 Long-term debt payments .......................... (1,485) (2,058) Stock options exercised .......................... 1,934 2,215 (Purchase)/issuance of treasury stock - net ...... (270,379) -- Cash dividends paid .............................. (40,587) (37,218) ---------- ---------- Net cash (used in) financing activities ............ (312,851) (56,073) ---------- ---------- Net (decrease) increase in cash and cash equivalents (69,433) 120,093 Cash and cash equivalents at beginning of year ..... 126,935 11,460 ---------- ---------- Cash and cash equivalents at end of period ......... $ 57,502 $ 131,553 ========== ========== The accompanying notes are an integral part of these financial statements. (4)
W.W. Grainger, Inc. and Subsidiaries NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) 1. BASIS OF STATEMENT PRESENTATION The financial statements and the related notes are condensed and should be read in conjunction with the consolidated financial statements and related notes for the year ended December 31, 1996, included in the Company's Annual Report on Form 10-K filed with the Securities and Exchange Commission. The consolidated financial statements include the accounts of the Company and its subsidiaries. All significant intercompany transactions are eliminated. Inventories are valued at the lower of cost or market. Cost is determined primarily by the last-in, first-out (LIFO) method. The unaudited financial information reflects all adjustments which are, in the opinion of management, necessary for a fair presentation of the statements contained herein. Checks outstanding of $32,831,709 and $35,366,000 were included in trade accounts payable at September 30, 1997 and December 31, 1996, respectively. 2. DIVIDEND On October 29, 1997, the Board of Directors declared a quarterly dividend of 27 cents per share, payable December 1, 1997 to shareholders of record on November 11, 1997. 3. SHARE REPURCHASE AUTHORIZATION On April 30, 1997, the Company's Board of Directors restored an existing share repurchase authorization to its original level of five million shares. The authorization continues to be adjustable to reflect stock splits and stock dividends. Repurchases are expected to be made from time to time in open market and privately negotiated transactions. The repurchased shares will be retained in the Company's treasury and be available for general corporate purposes (see the Liquidity and Capital Resources section). (5)
W.W. Grainger, Inc. and Subsidiaries NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) 4. EARNINGS PER SHARE (SFAS No. 128) The Statement of Financial Accounting Standards (SFAS) No. 128, "Earnings per Share," is effective for 1997 year end financial statements, and replaces Accounting Principles Board Opinion No. 15, "Earnings per Share," for calculating earnings per share. SFAS No. 128 eliminates the presentation of primary and fully diluted earnings per share and requires the dual presentation of earnings per share and earnings per share - assuming dilution. The calculation of earnings per share excludes any contingently returnable and any potential common shares (options, warrants, convertible securities, and contingent stock agreements). The calculation of earnings per share - assuming dilution includes common shares outstanding and the dilutive effect of potential common shares. The effect on the Company's earnings per share of adopting SFAS No. 128 is not expected to be material. 5. REPORTING COMPREHENSIVE INCOME (SFAS No. 130) SFAS No. 130, "Reporting Comprehensive Income," is effective for fiscal years beginning after December 15, 1997. The Company plans to adopt SFAS No. 130 in 1998. SFAS No. 130 requires disclosure of the components of and total comprehensive income in the period in which they are recognized in the financial statements. Comprehensive income is defined as the change in equity (net assets) of a business enterprise arising from transactions and other events and circumstances from nonowner sources. It includes all changes in equity during the reporting period except those resulting from investments by owners and distributions to owners. Adoption of SFAS No. 130 will require additional disclosures in the Company's financial statements. 6. DISCLOSURES ABOUT SEGMENTS OF AN ENTERPRISE AND RELATED INFORMATION (SFAS No. 131) SFAS No. 131, "Disclosures about Segments of an Enterprise and Related Information," is effective for fiscal years beginning after December 15, 1997. The Company plans to adopt SFAS No. 131 in 1998. SFAS No. 131 requires disclosure of certain information about operating segments in complete sets of financial statements of the enterprise and in condensed financial statements of interim periods issued to shareholders. It also requires disclosure of certain information about products and services, the geographic areas in which the enterprise operates, and major customers. The Company has not yet determined the effect that adoption of SFAS No. 131 will have on its financial reporting requirements. (6)
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND THE RESULTS OF OPERATIONS RESULTS OF OPERATIONS THREE MONTHS ENDED SEPTEMBER 30, 1997 COMPARED WITH THE THREE MONTHS ENDED SEPTEMBER 30, 1996: Net Sales Net sales of $1,066,927,000 in the 1997 third quarter increased 18.3% from net sales of $901,858,000 for the comparable 1996 period. There were 64 sales days both in the 1997 and 1996 third quarters. The year 1997 will have one less sales day than did the year 1996 (255 versus 256). The sales increase of 18.3% for the 1997 third quarter, as compared with the 1996 third quarter, was principally volume related. Excluding the incremental sales of Acklands - Grainger, Inc. (AGI), the Canadian industrial distribution business acquired on December 2, 1996, sales increased 8.5%. This 8.5% increase primarily represented the effects of the Company's marketing initiatives, which included new product additions, the expansion of branch facilities, and the National Accounts, Integrated Supply, and Direct Marketing programs. Sales in the 1997 third quarter were negatively affected by the United Parcel Service's (UPS) work stoppage which began on August 4, 1997 and lasted more than two weeks. The Company estimates that sales were approximately $14 million lower as a result of the UPS work stoppage. In addition, sales of seasonal products for the Company, excluding AGI, were flat in the 1997 third quarter as compared with the same 1996 period. Sales of non-seasonal products for the Company, excluding AGI, increased approximately 10% in the 1997 third quarter as compared with the same 1996 period. The Company's Grainger branch-based business experienced selling price increases of about 0.9% when comparing the third quarters of 1997 and 1996. Daily sales to National Account customers within the branch-based business increased an estimated 12%, on a comparable basis, over the 1996 third quarter. (7)
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND THE RESULTS OF OPERATIONS RESULTS OF OPERATIONS Net Earnings Net earnings of $56,480,000 in the 1997 third quarter increased 8.1% when compared to net earnings of $52,272,000 for the comparable 1996 period. The net earnings increase was lower than the net sales increase primarily due to lower gross profit margins, operating expenses increasing at a faster rate than net sales, higher interest expense, lower interest income, and a higher effective income tax rate. The Company's gross profit margin decreased by 0.46 percentage point when comparing the third quarters of 1997 and 1996. This decrease was partially the result of the incremental effect of Acklands - Grainger Inc. (AGI) which has lower average gross profit margins as compared with the average of all other business units. Excluding AGI, the Company's gross profit margin decreased 0.17 percentage point when comparing the third quarters of 1997 and 1996. Of note were the following factors affecting the gross profit margin for the Company, excluding AGI: 1. The change in selling price category mix was unfavorable primarily as a result of the growth in sales to the Company's larger volume customers. 2. Freight-in costs increased, partially as a result of special handling due to the UPS work stoppage. Partially offsetting the above factors was a favorable change in product mix as sales of seasonal products (generally lower than average profit margins) were flat. Operating expenses (warehousing, marketing, and administrative) for the Company increased 18.7% for the 1997 third quarter as compared with the same 1996 period. This rate of increase was greater than the rate of increase in net sales. Factors contributing to this rate of increase were the following: 1. Payroll and other operating expenses were higher as a result of the following initiatives: a) Continued expansion of the Company's integrated supply business; b) Continued development of the Company's full service capabilities on the Internet; c) Continued refocus and realignment of the Direct Sales force; d) Increased advertising expenses supporting the Company's marketing initiatives; e) Expansion of the Company's telesales capability; f) Continued enhancement of the Company's information systems, including Year 2000 compliance; and g) Continuation of business process improvement efforts. 2. The operating expenses of AGI, acquired in December 1996, were incremental and contributed to the increase. (8)
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND THE RESULTS OF OPERATIONS RESULTS OF OPERATIONS Interest income decreased $1,466,000 for the 1997 third quarter as compared with the same period in 1996. This decrease resulted from lower average daily invested balances. During the 1997 third quarter, average daily invested balances were lower primarily due to the purchase of over 3,300,000 shares of the Company's common stock since the beginning of the year, which was partially funded by the liquidation of marketable securities. The decrease in interest income was partially offset by higher average interest rates earned. Interest expense increased $1,348,000 for the third quarter of 1997 as compared with the same period in 1996. This increase resulted from higher average borrowings and lower capitalized interest, partially offset by lower average interest rates paid on all outstanding debt. Much of the increase in interest expense was related to approximately $135,000,000 in short-term debt added to finance the acquisition of Acklands - Grainger Inc. (AGI) in December 1996, and to the short-term debt added to partially fund the repurchase of shares of the Company's common stock. The Company's effective income tax rate for the third quarter of 1997 was 40.5% versus 40.2% for the comparable 1996 period. The increase in the effective income tax rate is attributable to proportionally higher income generated in Canada (AGI) which is taxed at a higher rate than domestic income. Net earnings for the third quarter of 1997 were negatively affected by the UPS work stoppage which occurred in August 1997. The gross profit margin lost on the estimated $14 million in lost sales, along with the incremental operating expenses incurred to serve customers during this period, resulted in an estimated negative effect on net earnings of about $0.06 per share. (9)
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND THE RESULTS OF OPERATIONS RESULTS OF OPERATIONS NINE MONTHS ENDED SEPTEMBER 30, 1997 COMPARED WITH THE NINE MONTHS ENDED SEPTEMBER 30, 1996: Net Sales: Net sales of $3,103,689,000 in the first nine months of 1997 increased 17.9% from net sales of $2,633,129,000 for the comparable 1996 period. There were 191 sales days in the 1997 nine month period and 192 sales days in the comparable 1996 period. The year 1997 will have one less sales day than did the year 1996 (255 versus 256). The sales increase of 17.9% for the first nine months of 1997 as compared with the same 1996 period was principally volume related. Excluding the incremental sales of Acklands - Grainger Inc. (AGI), sales increased 7.7%. This 7.7% increase can be explained primarily by the same factors discussed for the third quarter of 1997. (See the Third Quarter Net Sales discussion.) Sales of seasonal products for the Company, excluding AGI, declined approximately 4% in the first nine months of 1997 as compared with the same 1996 period. Many regions of the United States experienced milder weather during the first nine months of 1997 versus the comparable 1996 period. Sales of non-seasonal products for the Company, excluding AGI, increased approximately 10% in the first nine months of 1997 as compared with the same 1996 period. The Company's Grainger branch-based business experienced selling price increases of about 1.0% when comparing the first nine months of 1997 and 1996. Daily sales to National Account customers increased approximately 16%, on a comparable basis, over the same 1996 period. (10)
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND THE RESULTS OF OPERATIONS RESULTS OF OPERATIONS Net Earnings Net earnings of $168,648,000 in the first nine months of 1997 increased 11.0% when compared to net earnings of $151,943,000 for the comparable 1996 period. The net earnings increase was lower than the sales increase primarily due to operating expenses increasing at a faster rate than net sales, higher interest expense, lower interest income, and higher effective tax rates, partially offset by higher gross profit margins. The Company's gross profit margin increased by 0.05 percentage point when comparing the first nine months of 1997 and 1996. Excluding Acklands - Grainger Inc. (AGI), the Company's gross profit margin increased 0.41 percentage point when comparing the first nine months of 1997 and 1996. Of note were the following factors affecting the gross profit margin for the Company, excluding AGI: 1. The change in product mix was favorable as sales of seasonal products (generally lower than average gross profit margins) declined, and Lab Safety Supply sales (generally higher than average gross profit margins) increased as a percent of total sales. 2. Selling price increases exceeded the level of cost increases. Partially offsetting the above factors was an unfavorable change in selling price category mix, which primarily resulted from the growth in sales to the Company's larger volume customers. Operating expenses for the Company increased 19.8% for the first nine months of 1997 as compared with the same 1996 period. This rate of increase was higher than the rate of increase in net sales and was primarily related to the same factors discussed for the third quarter of 1997. (See the Third Quarter Net Earnings discussion.) Interest income decreased $564,000 for the first nine months of 1997 as compared with the same period in 1996. This decrease resulted from lower average daily invested balances, partially offset by higher average interest rates earned. During 1997, interest income was affected by the purchase of over 3,300,000 share of the Company's common stock, which was partially funded by the liquidation of marketable securities. Interest expense increased $3,350,000 for the first nine months of 1997 as compared with the same period in 1996. This increase resulted from higher average borrowings (see the Third Quarter Net Earnings discussion), partially offset by lower average interest rates paid on all outstanding debt and higher capitalized interest. (11)
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND THE RESULTS OF OPERATIONS RESULTS OF OPERATIONS The Company's effective income tax rate for the first nine months of 1997 was 40.5% versus 40.2% for the comparable 1996 period. The increase in the effective income tax rate is attributable to the same factor discussed for the third quarter 1997. (See the Third Quarter Net Earnings discussion.) Net earnings for the first nine months of 1997 were also negatively affected by the UPS work stoppage as discussed for the third quarter of 1997. (See the Third Quarter Net Earnings discussion.) OTHER DEVELOPMENTS Year 2000 The Company uses various software and technology which is affected by the Year 2000 issue. The Year 2000 issue is the inability of certain computer hardware and software to correctly process year information after December 31, 1999. The Company has put in place a project team dedicated to implementing a Year 2000 solution. In addition to internal systems, this team is addressing Year 2000 operational issues with suppliers, customers, and others with whom the Company does business. The Company is actively working to achieve the objective of properly functioning internal systems beyond the year 1999. This includes modifying certain existing systems as well as evaluating replacement of hardware and software for other systems, sooner than would otherwise be the case. Although total cost estimates have yet to be determined, the Company has incurred costs this year and expects to incur costs over the next two years to address the Year 2000 issue. Management believes that failure to address the Year 2000 issue on a timely basis could have a materially adverse effect on the Company and is committed to devoting the appropriate resources to ensure a Year 2000 solution. LIQUIDITY AND CAPITAL RESOURCES For the nine months ended September 30, 1997, working capital decreased by $143,793,000. The ratio of current assets to current liabilities was 1.9 at September 30, 1997 and 2.1 at December 31, 1996. The Consolidated Statements of Cash Flows, included in this report, detail the sources and uses of cash and cash equivalents. (12)
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND THE RESULTS OF OPERATIONS LIQUIDITY AND CAPITAL RESOURCES The Company continues to maintain a low debt ratio and strong liquidity position, which provides flexibility in funding working capital needs and long-term cash requirements. In addition to internally generated funds, the Company has various sources of financing available, including commercial paper sales and bank borrowings under lines of credit and otherwise. Total debt as a percent of Shareholders' Equity was 12.3% at September 30, 1997 and 11.4% at December 31, 1996. For the first nine months of 1997, $49,739,000 as expended for land, buildings, and facilities improvements, including the ongoing construction of a new office facility in Lake Forest, Illinois, and $20,561,000 for data processing, office, and other equipment, for a total of $70,300,000. For the first nine months of 1997, the Company repurchased approximately 3.3 million shares of its common stock. The Company used internally generated funds and short-term debt to fund 1997 share repurchases. As of September 30, 1997, approximately 2.9 million shares of common stock remain available under the repurchase authorization. (See Note 3 of the Notes to Consolidated Financial Statements.) W.W. Grainger, Inc. and Subsidiaries PART II - OTHER INFORMATION Items 1, 2, 3, 4, and 5 not applicable. Item 6 Exhibits (numbered in accordance with Item 601 of regulation S-K) and Reports on Form 8-K. EXHIBIT INDEX ---------------------- a) Exhibits (11) Computation of Earnings per Common and Common Equivalent Share 15 (27) Financial Data Schedule 16 b) Reports on Form 8-K - None. (13)
SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. W.W. Grainger, Inc. ----------------------------------------- (Registrant) Date: November 11, 1997 By: /s/ J.D. Fluno - ------------------------- ----------------------------------------- J.D. Fluno, Vice Chairman Date: November 11, 1997 By: /s/ P.O. Loux - ------------------------- ----------------------------------------- P.O. Loux, Senior Vice President, Finance and Chief Financial Officer Date: November 11, 1997 By: /s/ R.D. Pappano - ------------------------- ----------------------------------------- R.D. Pappano, Vice President, Financial Reporting and Investor Relations (14)