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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, 2002
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)
100 Grainger Parkway
Lake Forest, Illinois 60045-5201
Telephone: (847) 535-1000
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: 91,438,002 shares of the Company's Common Stock were outstanding as of October 31, 2002.
1
| TABLE OF CONTENTS | ||
|---|---|---|
| Page No. | ||
| PART I | FINANCIAL INFORMATION | |
| Item 1. | Financial Statements (Unaudited) | |
| Condensed Consolidated Statements of Earnings at September 30, 2002 and September 30, 2001 |
3 - 4 | |
| Condensed Consolidated Statements of Comprehensive Earnings at September 30, 2002 and September 30, 2001 |
5 | |
| Condensed Consolidated Balance Sheets at September 30, 2002 and December 31, 2001 |
6 - 7 | |
| Condensed Consolidated Statements of Cash Flows at September 30, 2002 and September 30, 2001 |
8 - 9 | |
| Notes to Condensed Consolidated Financial Statements | 10 - 20 | |
| Item 2. | Management's Discussion and Analysis of Financial Condition and Results of Operations |
21 - 33 |
| Item 3. | Quantitative and Qualitative Disclosures about Market Risk | 34 |
| Item 4. | Controls and Procedures | 34 |
| PART II | OTHER INFORMATION | |
| Item 6. | Exhibits and Reports on Form 8-K | 35 |
| Signatures | 36 | |
| Certifications | 37 - 38 | |
2
Part I - FINANCIAL INFORMATION
Item 1. Financial Statements (Unaudited)
W.W. Grainger, Inc., and Subsidiaries
CONDENSED CONSOLIDATED STATEMENTS OF EARNINGS
(In thousands of dollars except for per share amounts)
(Unaudited)
| Three Months Ended September 30, |
Nine Months Ended September 30, |
||||||||
|---|---|---|---|---|---|---|---|---|---|
| 2002 | 2001 | 2002 | 2001 | ||||||
|
|
|
|
|
||||||
| Net sales | $ 1,203,400 | $ 1,199,358 | $ 3,523,457 | $ 3,643,818 | |||||
| Cost of merchandise sold | 800,840 | 803,507 | 2,338,306 | 2,458,140 | |||||
|
| |||||||||
| Gross profit | 402,560 | 395,851 | 1,185,151 | 1,185,678 | |||||
| Warehousing, marketing, and | |||||||||
| administrative expenses | 302,370 | 300,474 | 900,737 | 912,924 | |||||
| Restructuring charges | -- | -- | -- | 40,000 | |||||
|
| |||||||||
| Operating earnings | 100,190 | 95,377 | 284,414 | 232,754 | |||||
| Other income and (expense) | |||||||||
| Interest income | 1,112 | 713 | 3,008 | 1,813 | |||||
| Interest expense | (1,363 | ) | (2,169 | ) | (4,304 | ) | (9,137 | ) | |
| Equity in loss of | |||||||||
| unconsolidated entities | (779 | ) | (339 | ) | (2,040 | ) | (6,352 | ) | |
| Loss on liquidation of equity | |||||||||
| in unconsolidated entity | -- | -- | -- | (21,497 | ) | ||||
| Gain on sale of investment | |||||||||
| securities | -- | 138 | 7,308 | 138 | |||||
| Unclassified-net | 2,130 | 676 | 3,607 | (5,356 | ) | ||||
|
| |||||||||
| 1,100 | (981 | ) | 7,579 | (40,391 | ) | ||||
|
| |||||||||
| Earnings before income taxes | 101,290 | 94,396 | 291,993 | 192,363 | |||||
| Income taxes | 41,337 | 38,374 | 119,083 | 79,346 | |||||
|
| |||||||||
| Net earnings before cumulative | |||||||||
| effect of accounting change | $ 59,953 | $ 56,022 | $ 172,910 | $ 113,017 | |||||
| Cumulative effect of | |||||||||
| accounting change | -- | -- | (23,921 | ) | -- | ||||
|
| |||||||||
| Net earnings | $ 59,953 | $ 56,022 | $ 148,989 | $ 113,017 | |||||
|
| |||||||||
The accompanying notes are an integral part of these financial statements.
3
W.W. Grainger, Inc., and Subsidiaries
CONDENSED CONSOLIDATED STATEMENTS OF EARNINGS (Continued)
(In thousands of dollars except for per share amounts)
(Unaudited)
| Three Months Ended September 30, |
Nine Months Ended September 30, | ||||||||
|---|---|---|---|---|---|---|---|---|---|
|
|
|||||||||
| 2002 | 2001 | 2002 | 2001 | ||||||
|
|
|
|
|
||||||
| Earnings per share before | |||||||||
| cumulative effect of | |||||||||
| accounting change: | |||||||||
| Basic | $ 0.65 | $ 0.60 | $ 1.87 | $ 1.21 | |||||
|
| |||||||||
| Diluted | $ 0.64 | $ 0.59 | $ 1.82 | $ 1.19 | |||||
|
| |||||||||
| Cumulative effect of accounting | |||||||||
| change: | |||||||||
| Basic | $ -- | $ -- | $ (0.26) | $ -- | |||||
|
| |||||||||
| Diluted | $ -- | $ -- | $ (0.25) | $ -- | |||||
|
| |||||||||
| Earnings per share: | |||||||||
| Basic | $ 0.65 | $ 0.60 | $ 1.61 | $ 1.21 | |||||
|
| |||||||||
| Diluted | $ 0.64 | $ 0.59 | $ 1.57 | $ 1.19 | |||||
|
| |||||||||
| Weighted average number of shares | |||||||||
| outstanding: | |||||||||
| Basic | 91,871,851 | 93,360,391 | 92,414,235 | 93,381,350 | |||||
|
| |||||||||
| Diluted | 93,589,859 | 94,905,733 | 94,800,778 | 94,818,617 | |||||
|
| |||||||||
| Cash dividends paid per share | $ 0.180 | $ 0.175 | $ 0.535 | $ 0.520 | |||||
|
| |||||||||
The accompanying notes are an integral part of these financial statements.
4
W.W. Grainger, Inc., and Subsidiaries
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE EARNINGS
(In thousands of dollars)
(Unaudited)
| Three Months Ended September 30, |
Nine Months Ended September 30, |
||||||||
|---|---|---|---|---|---|---|---|---|---|
| 2002 | 2001 | 2002 | 2001 | ||||||
|
|
|
|
|
||||||
| Net earnings | $ 59,953 | $ 56,022 | $ 148,989 | $ 113,017 | |||||
| Other comprehensive earnings | |||||||||
| (loss): | |||||||||
| Foreign currency translation | |||||||||
| adjustments, net of tax benefit | |||||||||
| (expense) related to designated | |||||||||
| hedge of $(2,025), $(1,905), | |||||||||
| $164, and $(5,105), | |||||||||
| respectively | (9,369 | ) | (10,958 | ) | (1,832 | ) | (14,755 | ) | |
| Gain (loss) in investment | |||||||||
| securities: | |||||||||
| Unrealized holding (loss), | |||||||||
| net of tax benefit of $575, | |||||||||
| $886, $2,123, and $308, | |||||||||
| respectively | (900 | ) | (6,518 | ) | (3,321 | ) | (5,595 | ) | |
| Reclassification adjustments | |||||||||
| for realized gains included in | |||||||||
| net earnings, net of tax | |||||||||
| expense of $0, $54, $2,850 | |||||||||
| and $54, respectively | -- | (84 | ) | (4,458 | ) | (84 | ) | ||
|
|
|||||||||
| Comprehensive earnings | $ 49,684 | $ 38,462 | $ 139,378 | $ 92,583 | |||||
|
| |||||||||
The accompanying notes are an integral part of these financial statements.
5
W.W. Grainger, Inc., and Subsidiaries
CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands of dollars except for per share amounts)
|
ASSETS |
(Unaudited) Sept. 30, 2002 |
Dec. 31, 2001 | |||
|---|---|---|---|---|---|
|
|
|
|
|||
| CURRENT ASSETS | |||||
| Cash and cash equivalents | $ 218,470 | $ 168,846 | |||
| Accounts receivable (less allowances of | |||||
| $31,180 and $30,552, respectively) | 479,742 | 454,180 | |||
| Inventories | 646,452 | 634,654 | |||
| Prepaid expenses | 33,640 | 37,477 | |||
| Deferred income tax benefits | 100,982 | 97,454 | |||
|
| |||||
| Total current assets | 1,479,286 | 1,392,611 | |||
| PROPERTY, BUILDINGS, AND EQUIPMENT | 1,469,317 | 1,386,424 | |||
| Less accumulated depreciation and amortization | 745,487 | 696,706 | |||
|
| |||||
| Property, buildings, and equipment-net | 723,830 | 689,718 | |||
| DEFERRED INCOME TAXES | 11,500 | -- | |||
| INVESTMENTS IN UNCONSOLIDATED ENTITIES | 25,656 | 4,776 | |||
| GOODWILL AND OTHER INTANGIBLES, NET | 118,020 | 155,483 | |||
| OTHER ASSETS | 58,714 | 88,658 | |||
|
| |||||
| TOTAL ASSETS | $2,417,006 | $2,331,246 | |||
|
| |||||
The accompanying notes are an integral part of these financial statements.
6
W.W. Grainger, Inc., and Subsidiaries
CONDENSED CONSOLIDATED BALANCE SHEETS (Continued)
(In thousands of dollars except for per share amounts)
|
LIABILITIES AND SHAREHOLDERS' EQUITY |
(Unaudited) Sept. 30, 2002 |
Dec. 31, 2001 | |||
|---|---|---|---|---|---|
|
|
|
|
|||
| CURRENT LIABILITIES | |||||
| Short-term debt | $ 3,345 | $ 4,526 | |||
| Current maturities of long-term debt | 10,620 | 12,520 | |||
| Trade accounts payable | 333,210 | 275,893 | |||
| Accrued expenses | 250,700 | 251,760 | |||
| Income taxes | 25,830 | 9,112 | |||
|
| |||||
| Total current liabilities | 623,705 | 553,811 | |||
| LONG-TERM DEBT (less current maturities) | 118,641 | 118,219 | |||
| DEFERRED INCOME TAXES | -- | 1,239 | |||
| ACCRUED EMPLOYMENT RELATED BENEFITS COSTS | 63,190 | 54,649 | |||
| MINORITY INTEREST | -- | 139 | |||
| SHAREHOLDERS' EQUITY | |||||
| Cumulative Preferred Stock - $5 par value - authorized, | |||||
| 12,000,000 shares, issued and outstanding, none | -- | -- | |||
| Common Stock - $0.50 par value - authorized, | |||||
| 300,000,000 shares; issued 108,880,232 shares, 2002 and | |||||
| 108,473,703 shares, 2001 | 54,440 | 54,237 | |||
| Additional contributed capital | 374,107 | 289,201 | |||
| Retained earnings | 2,036,971 | 1,937,972 | |||
| Unearned restricted stock compensation | (18,240 | ) | (17,722 | ) | |
| Accumulated other comprehensive (loss) | (39,164 | ) | (29,553 | ) | |
| Treasury stock, at cost - 17,443,387 shares, 2002 and | |||||
| 15,129,062 shares, 2001 | (796,644 | ) | (630,946 | ) | |
|
| |||||
| Total shareholders' equity | 1,611,470 | 1,603,189 | |||
|
| |||||
| TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY | $ 2,417,006 | $ 2,331,246 | |||
|
| |||||
The accompanying notes are an integral part of these financial statements.
7
W.W. Grainger, Inc., and Subsidiaries
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands of dollars)
(Unaudited)
| Nine Months Ended Sept. 30,
|
|||||
|---|---|---|---|---|---|
| 2002 | 2001 | ||||
|
|
|
||||
| Cash flows from operating activities: | |||||
| Net earnings | $ 148,989 | $ 113,017 | |||
| Provision for losses on accounts receivable | 13,901 | 15,616 | |||
| (Increase) in deferred income taxes | (3,390 | ) | (10,576 | ) | |
| Depreciation and amortization: | |||||
| Property, buildings, and equipment | 57,576 | 59,440 | |||
| Intangibles and goodwill | 515 | 4,459 | |||
| Amortization of capitalized software | 12,875 | 12,200 | |||
| (Gain) on sales of investment securities | (7,308 | ) | (138 | ) | |
| Non-cash restructuring charge | -- | 10,638 | |||
| Asset write-downs | 1,844 | 6,000 | |||
| Loss on unconsolidated entities | 2,040 | 25,749 | |||
| Cumulative effect of accounting change | 23,921 | -- | |||
| Change in operating assets and liabilities- | |||||
| net of business acquisition, divestiture, and | |||||
| joint venture contributions: | |||||
| (Increase) decrease in accounts receivable | (42,762 | ) | 42,714 | ||
| (Increase) decrease in inventories | (21,861 | ) | 71,566 | ||
| Decrease (increase) in prepaid expenses | 2,965 | (22,238 | ) | ||
| Increase in trade accounts payable | 57,242 | 50,305 | |||
| (Decrease) increase in other current liabilities | (2,451 | ) | 16,488 | ||
| Increase (decrease) in current income taxes payable | 16,728 | (8,944 | ) | ||
| Increase in accrued employment related | |||||
| benefits costs | 6,527 | 4,064 | |||
| Other - net | 7,440 | 4,714 | |||
|
| |||||
| Net cash provided by operating activities | $ 274,791 | $ 395,074 | |||
|
| |||||
| Cash flows from investing activities: | |||||
| Additions to property, buildings, and | |||||
| equipment-net of dispositions | $ (92,649 | ) | $ (53,905 | ) | |
| Expenditures for capitalized software | (4,973 | ) | (5,463 | ) | |
| Proceeds from sales of investment securities | 15,957 | 473 | |||
| Net cash paid for business acquisition | -- | (14,407 | ) | ||
| Investments in unconsolidated entities | (3,211 | ) | (4,547 | ) | |
| Other-net | (15 | ) | (160 | ) | |
|
| |||||
| Net cash (used in) investing activities | $ (84,891 | ) | $ (78,009 | ) | |
|
| |||||
The accompanying notes are an integral part of these financial statements.
8
W.W. Grainger, Inc., and Subsidiaries
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (Continued)
(In thousands of dollars)
(Unaudited)
| Nine Months Ended Sept. 30,
|
|||||
|---|---|---|---|---|---|
| 2002 | 2001 | ||||
|
|
|
||||
| Cash flows from financing activities: | |||||
| Net (decrease) in short-term debt | $ (2,452 | ) | $(169,369 | ) | |
| Long-term debt issuance | 113,746 | -- | |||
| Long-term debt payments | (115,645 | ) | (15 | ) | |
| Stock incentive plan | 13,527 | 6,013 | |||
| Proceeds from sale of treasury stock | -- | 24,366 | |||
| Purchase of treasury stock-net | (99,573 | ) | (51,315 | ) | |
| Cash dividends paid | (49,990 | ) | (49,099 | ) | |
|
| |||||
| Net cash (used in) financing activities | $(140,387 | ) | $(239,419 | ) | |
|
| |||||
| Exchange rate effect on cash and cash equivalents | 111 | (2,514 | ) | ||
|
| |||||
| Net increase in cash and cash equivalents | 49,624 | 75,132 | |||
| Cash and cash equivalents at beginning of year | 168,846 | 63,384 | |||
|
| |||||
| Cash and cash equivalents at end of period | $ 218,470 | $ 138,516 | |||
|
| |||||
The accompanying notes are an integral part of these financial statements.
9
W.W. Grainger, Inc., and Subsidiaries
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
1. BACKGROUND AND BASIS OF STATEMENT PRESENTATION
W.W. Grainger, Inc., "the Company," is engaged in the distribution of maintenance, repair, and operating (MRO) supplies, services, and related information to businesses and institutions in North America.
The condensed consolidated financial statements of the Company and the related notes are unaudited and should be read in conjunction with the consolidated financial statements and related notes for the year ended December 31, 2001, included in the Company’s Annual Report on Form 10-K filed with the Securities and Exchange Commission.
The unaudited financial information reflects all adjustments which, in the opinion of management, are necessary for a fair presentation of the statements contained herein.
2. RECENT ACCOUNTING PRONOUNCEMENTS
On July 20, 2001, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards (SFAS) No. 141, "Business Combinations" and SFAS No. 142, "Goodwill and Other Intangible Assets." SFAS No. 141 was effective for all business combinations completed after June 30, 2001. SFAS No. 142 was effective for fiscal years beginning after December 15, 2001; however, certain provisions of this Statement applied to goodwill and other intangible assets acquired between July 1, 2001 and the effective date of SFAS No. 142.
As a result of adopting SFAS No. 141 and SFAS No. 142, the Company's accounting policies for goodwill and other intangibles changed effective January 1, 2002 as described below:
Intangibles subject to amortization: The Company recognizes an acquired intangible apart from goodwill whenever the intangible arises from contractual or other legal rights, or whenever it can be separated or divided from the acquired entity and sold, transferred, licensed, rented, or exchanged, either individually or in combination with a related contract, asset, or liability. Such intangible is amortized over its estimated useful life. Impairment losses are recognized if the carrying amount of an intangible subject to amortization is not recoverable from expected future cash flows and its carrying amount exceeds its fair value. Intangible amortization is expected to be $0.7 million for 2002 and $0.6 million per year for 2003 through 2006.
10
W.W. Grainger, Inc., and Subsidiaries
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Unaudited)
Goodwill and intangibles with indefinite lives: The Company recognizes as goodwill the excess cost of an acquired entity over the net amount assigned to assets acquired and liabilities assumed. Prior to January 1, 2002, goodwill was amortized over periods of up to 40 years. Beginning January 1, 2002, goodwill is no longer amortized. Goodwill will be tested for impairment on an annual basis and between annual tests whenever there is an impairment indicated. Impairment losses will be recognized whenever the implied fair value of goodwill is less than its carrying value. Beginning January 1, 2002, intangibles with indefinite lives are no longer amortized. They are tested for impairment by comparing their carrying value to fair value annually or whenever there is an impairment indicated. Impairment losses will be recognized whenever the fair value is less than the carrying value.
In the second quarter of 2002, the Company completed the process of evaluating goodwill for impairment under SFAS No. 142. Fair values of reporting units were estimated using a present value method that discounted future cash flows. When available and as appropriate, comparative market multiples were used to corroborate results of the discounted cash flows. As a result of application of the new impairment methodology introduced by SFAS No. 142, the Company recorded a non-cash charge to earnings of $32.3 million ($23.9 million after-tax, or $0.25 per diluted share) related to the write-down of goodwill of its Canadian subsidiary, Acklands-Grainger Inc. (AGI). Previous accounting rules incorporated a comparison of book value to undiscounted cash flows, whereas new rules require a comparison of book value to discounted cash flows, which are lower. Reported net earnings would have been as set forth below if SFAS No. 142 had been in effect for all periods presented. Earnings have been restated to exclude amortization expense (including any related tax effects) related to goodwill and intangible assets that are no longer being amortized. There were no material adjustments relating to the classification of the Company’s intangible assets or amortization periods.
Restatement per SFAS No. 142 Three Months Ended Nine Months Ended
- ---------------------------- ------------------ -------------------------
Sept. 30, Sept. 30,
--------- ---------
(In thousands of dollars except per share amounts)
2002 2001 2002 2001
-------- -------- -------- --------
Net earnings before accounting
changes, as reported $ 59,953 $ 56,022 $172,910 $113,017
Amortization, net of tax -- 825 -- 2,424
-------- -------- -------- --------
Adjusted net earnings
before accounting changes $ 59,953 $ 56,847 $172,910 $115,441
======== ======== ======== ========
Net earnings as reported $ 59,953 $ 56,022 $148,989 $113,017
Amortization, net of tax -- 825 -- 2,424
-------- -------- -------- --------
Adjusted net earnings $ 59,953 $ 56,847 $148,989 $115,441
======== ======== ======== ========
11
W.W. Grainger, Inc., and Subsidiaries
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Unaudited)
Three Months Ended Nine Months Ended
------------------ -----------------
Sept. 30, Sept. 30,
--------- ---------
(In thousands of dollars except per share amounts)
2002 2001 2002 2001
-------- -------- -------- --------
Before cumulative effect of accounting
- --------------------------------------
change:
-------
Basic earnings per share:
- -------------------------
As reported $ 0.65 $ 0.60 $ 1.87 $ 1.21
Change in amortization expense -- 0.01 -- 0.03
-------- -------- -------- --------
Adjusted basic earnings per share $ 0.65 $ 0.61 $ 1.87 $ 1.24
======== ======== ======== ========
Diluted earnings per share:
- ---------------------------
As reported $ 0.64 $ 0.59 $ 1.82 $ 1.19
Change in amortization expense -- 0.01 -- 0.03
-------- -------- -------- --------
Adjusted diluted earnings per share $ 0.64 $ 0.60 $ 1.82 $ 1.22
======== ======== ======== ========
After cumulative effect of accounting
- -------------------------------------
change:
-------
Basic earnings per share:
- -------------------------
As reported $ 0.65 $ 0.60 $ 1.61 $ 1.21
Change in amortization expense -- 0.01 -- 0.03
-------- -------- -------- --------
Adjusted basic earnings per share $ 0.65 $ 0.61 $ 1.61 $ 1.24
======== ======== ======== ========
Diluted earnings per share:
- ---------------------------
As reported $ 0.64 $ 0.59 $ 1.57 $ 1.19
Change in amortization expense -- 0.01 -- 0.03
-------- -------- -------- --------
Adjusted diluted earnings per share $ 0.64 $ 0.60 $ 1.57 $ 1.22
======== ======== ======== ========
12
W.W. Grainger, Inc., and Subsidiaries
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Unaudited)
The change in the carrying amount of goodwill by segment from December 31, 2001 to September 30, 2002 is as follows:
Goodwill, net by Segment
- ------------------------
Transfer to
Balance Transition Investment in Balance
Dec. 31, Impairment Joint Venture Translation Sept. 30,
2001 (Jan. 1, 2002) (Feb. 1, 2002) and other 2002
---------- ------------- -------------- ----------- ------------
(In thousands of dollars)
Branch-based
Distribution $ 125,443 $ (32,265) $ (5,063) $ 380 $ 88,495
Digital -- -- -- -- --
Lab Safety Supply 25,002 -- -- 103 25,105
Grainger
Integrated Supply -- -- -- -- --
---------- ------------- ------------- ---------- ------------
Total $ 150,445 $ (32,265) $ (5,063) $ 483 $ 113,600
========== ============= ============= ========== ============
As of September 30, 2002 and December 31, 2001, the Company’s balances of other intangibles were as follows:
Other Intangibles Sept. 30, 2002 Dec. 31, 2001
- ----------------- -------------- -------------
(In thousands of dollars)
Other amortizable intangibles, gross $ 91,970 $ 91,970
Accumulated amortization 88,365 87,744
----------- -----------
Other amortizable intangibles, net $ 3,605 $ 4,226
=========== ===========
Other intangibles with indefinite
lives, net $ 815 $ 812
=========== ===========
In August 2001, the FASB issued SFAS No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets.” SFAS No. 144, which is effective for fiscal years beginning after December 15, 2001, addresses financial accounting and reporting for the impairment or disposal of long-lived assets. It supercedes SFAS No. 121 “Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of,” and the accounting and reporting provisions of Accounting Principles Board Opinion No. 30, “Reporting the Results of Operations – Reporting the Effects of Disposal of a Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring Events and Transactions,” for the disposal of a segment of a business. The Company adopted SFAS No. 144 effective January 1, 2002. This adoption did not have a material effect on its results of operations or financial position.
13
W.W. Grainger, Inc., and Subsidiaries
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Unaudited)
In April 2002, the FASB issued SFAS No. 145, "Rescission of FASB Statements No. 4, 44, and 64, Amendment of FASB Statement No. 13, and Technical Corrections." SFAS No. 145 addresses a variety of accounting practices. The provisions of this statement related to the rescission of Statement No. 4 (Reporting Gains and Losses from Extinguishment of Debt) are effective for fiscal years beginning after May 15, 2002. The provisions of this statement related to Statement No. 13 (Accounting for Leases) are effective for transactions occurring after May 15, 2002. All other provisions of this statement are effective for financial statements issued on or after May 15, 2002. Statement No. 44 was entitled "Accounting for Intangible Assets of Motor Carriers" and Statement No. 64 was entitled "Extinguishments of Debt Made to Satisfy Sinking-Fund Requirements."
The Company adopted those provisions of SFAS No. 145 that were effective as of May 15, 2002. Adoption of those provisions did not have a material effect on the Company’s results of operations or financial position. For those provisions that are to be effective for fiscal years beginning after May 15, 2002, the Company does not expect that adoption of those provisions will have a material effect on its results of operations or financial position.
In June 2002, the FASB issued SFAS No. 146, “Accounting for Costs Associated with Exit or Disposal Activities.” This statement requires recognition of costs associated with exit or disposal activities when they are incurred rather than at the date of a commitment to an exit or disposal plan. This new statement is effective for exit or disposal activities that are initiated after December 31, 2002.
3. NONRECURRING CHARGES
On April 23, 2001, the Company announced plans to shut down the operations of Material Logic, with the exception of FindMRO, and write down its investment in other digital activities. The Company launched Material Logic in January 2001 as a utility for large customers to facilitate the purchase of MRO products over the Internet. Material Logic would have allowed large customers to access a single, networked catalog containing easily searchable and detailed product information, pre-negotiated prices, and availability information for indirect materials from major distributors. In order for Material Logic to grow, it needed broad industry support and funding from other equity participants. The Company closed Material Logic in April 2001 because economic and market conditions made it difficult to find funding partners and the market developed slower than anticipated. The Company shut down all of Material Logic’s branded e-commerce sites, except FindMRO, which remains an integrated sourcing service for the Company’s customers. Effective June 1, 2001, the results for FindMRO were added to the Branch-based Distribution Businesses segment.
In connection with the shut down of Material Logic operations, the Company took a nonrecurring, pretax charge against operating earnings of $40.0 million (after-tax $23.8 million) in the second quarter of 2001. The Company provided a comprehensive separation package, including outplacement services, to the employees whose jobs were eliminated. As part of the shut down, 166 employees were severed. Severance payments began in July 2001 and will continue until June 2004, when the last severance package expires. Other shut down costs include lease obligations which, if not settled earlier, will continue until 2004.
14
W.W. Grainger, Inc., and Subsidiaries
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Unaudited)
In addition, as part of other income and expense, the Company wrote down its investment in other digital enterprises and took a pretax charge of $26.5 million (after-tax $14.2 million) in the second quarter of 2001. This included a $21.5 million pretax loss on the divestiture of the Company’s 40% investment in Works.com, Inc., which was recorded as Loss on liquidation of equity in unconsolidated entity. The Company acquired its ownership in Works.com, Inc., an unrelated third party, on August 1, 2000, when the Company’s OrderZone.com business unit was combined with Works.com. Also included was a $5.0 million write-down of investments in certain closely held companies, which was recorded in Unclassified-net.
The total effect of these nonrecurring charges amounted to an after-tax cost of $38.0 million, or $0.40 per share, in the second quarter of 2001.
The following table displays the activity and balance of the Material Logic restructuring reserve from December 31, 2001 through September 30, 2002:
Balance Balance
Restructuring Reserve/ Dec. 31, Sept. 30,
(Operating expenses): 2001 Deductions Adjustments 2002
- ------------------------------ ---------- ---------- ---------- ----------
(In thousands of dollars)
Workforce reductions $ 4,880 $ (1,934) $ (623) $ 2,323
Asset and equipment
write-offs and
disposals 936 (936) -- --
Other shut down costs 3,661 (1,851) 623 2,433
---------- ---------- ---------- ----------
$ 9,477 $ (4,721) $ -- $ 4,756
========== ========== ========== ==========
Deductions reflect cash payments of $3.8 million and noncash charges of $0.9 million. The amounts in the adjustments column are reclassifications to reflect management’s current estimate of costs, by expense category.
4. JOINT VENTURE
On February 1, 2002, the Company finalized the creation of a joint venture named USI-AGI Prairies Inc. The joint venture was between Acklands - Grainger Inc. (AGI), its Canadian subsidiary, and Uni-Select Inc., a Canadian company. The joint venture combined Uni-Select’s Western Division with the automotive after-market parts division of AGI, which operated as Bumper to Bumper. AGI’s contribution of net assets was approximately U.S. $15 million. Additionally, AGI’s carrying value of its investment in this joint venture includes U.S. $5.1 million of allocated goodwill. The Company has a 50% stake in the new entity, which is managed by Uni-Select. Net sales for the automotive after-market parts division of AGI were approximately U.S. $33 million in 2001. Creation of this joint venture should have no material effect on 2002 net earnings.
No gain or loss was recognized when this transaction was finalized. Through February 1, 2002, the results of the automotive after-market parts division were consolidated with the Company. Beginning February 2, 2002, the Company has accounted for its joint venture investment using the equity method.
15
W.W. Grainger, Inc., and Subsidiaries
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Unaudited)
5. RELATED PARTY TRANSACTION
On February 28, 2002, the Company purchased substantially all of the assets, consisting of 4,801,600 shares of Company common stock and cash, of Mountain Capital Corporation, a Nevada corporation (“MCC”). In exchange, the Company transferred to MCC 4,695,725 shares of Company common stock. The number of shares transferred reflects a 1.5% discount (72,024 shares) from the number of shares received, and additionally reflects other adjustments designed to reimburse the Company for its direct transaction expenses of $0.6 million (10,549 shares) and for the Company’s payment of indebtedness of MCC of $1.3 million (23,302 shares). The effect on the Company of this transaction was to increase the number of shares held as Treasury stock, thereby reducing the number of shares outstanding by 105,875 shares. The shares received by MCC from the Company were subsequently distributed to the MCC shareholders pursuant to a plan of complete liquidation of MCC.
The transaction documentation includes:
(i) |
a Purchase Agreement containing the terms and conditions of the transaction, |
(ii) |
an Escrow Agreement providing for the pledge by MCC of 10% of the shares received in the transaction, and the pledge by the MCC shareholders of the escrowed shares, as security for the indemnification obligations and liabilities of MCC and the MCC shareholders, and |
(iii) |
a Share Transfer Restriction Agreement providing for certain restrictions on the transfer of Company common stock received by or otherwise held by the MCC shareholders and certain other parties to that agreement. |
Prior to the transaction, James D. Slavik, a Company director, was the president and a director of MCC. In addition, Mr. Slavik and certain members of his family owned all of the outstanding stock of MCC either directly or indirectly, including through family trusts of which Mr. Slavik served as trustee. Mr. Slavik was not present and did not participate in any of the deliberations of the Board of Directors nor any of its committees relating to the review, consideration, or approval of the transaction.
16
W.W. Grainger, Inc., and Subsidiaries
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Unaudited)
6. EXECUTIVE STOCK PURCHASE PROGRAM
On March 26, 2001, a group of 83 executive officers and other key managers bought 787,020 treasury shares from the Company at the then-current market price of the shares. Cash proceeds from the sale, which amounted to $24.4 million, were used by the Company to repurchase shares of the Company’s stock on the open market. Most employees financed their purchases through loans arranged with a local bank. The principal of each loan is payable by the employee on April 16, 2003, or earlier, upon termination of employment, sale by the borrower of shares under the program, or the occurrence of certain financial or other events affecting the employee or the Company. Among the financial and other events affecting the Company (triggering events), are a default on certain other indebtedness, a change in control, and a merger or sale of substantially all of the Company’s assets. The Company entered into a Note Purchase Agreement with the bank, agreeing to purchase the loan of any employee as a result of the employee’s failure to repay the loan when due or the occurrence of a triggering event. Should the Company be obliged to purchase any loan under the Note Purchase Agreement, the employee would be liable to the Company for the outstanding principal and accrued interest in accordance with the note’s terms. The Company has not recognized a liability for any potential defaults associated with this contingent credit risk under the program as of September 30, 2002. Nor has the Company been called upon to purchase any loan or make any payments as a result of any employee default or triggering event. As of September 30, 2002, 70 employees had loans outstanding to the bank aggregating $22.2 million, the largest of which was $4.4 million.
7. DERIVATIVE INSTRUMENT
During the third quarter of 2002, the Company refinanced a C$180.4 million bank loan that had been designated as a non-derivative hedge of the net investment in the Company’s Canadian subsidiary. The bank loan was replaced with a cross currency swap. This derivative instrument was designated as a hedge of the net investment in the Company’s Canadian subsidiary and is recognized on the balance sheet at its fair value.
The two-year cross currency swap matures on September 27, 2004. The cross currency swap is based on notional principal amounts of C$180.4 million and US$113.7 million, respectively. Initially the Company gave the counterparty US$113.7 million and received C$180.4 million. The Company will receive interest based upon the 90-day US commercial paper rate that was initially set at 1.78%. The Company will pay interest to the counterparty based upon the 90-day Canadian Bankers’ Acceptance rate plus 14 basis points which was initially set at 3.05%. At maturity of this cross currency swap, the Company will pay the counterparty C$180.4 million and will receive US$113.7 million.
17
W.W. Grainger, Inc., and Subsidiaries
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Unaudited)
The Company formally assesses whether the cross currency swap is effective at offsetting changes in the fair value of the underlying exposure quarterly. Because of the high degree of effectiveness between the hedging instrument and the underlying exposure being hedged, fluctuations in the value of the cross currency swap are generally offset by changes in the fair value of the underlying asset. Under Statement of Financial Accounting Standards No. 133, “Accounting for Derivative Instruments and Hedging Activities,” changes in the fair value of this instrument are recognized in foreign currency translation adjustment, a component of accumulated other comprehensive earnings, to offset the change in the value of the net investment of the Canadian investment being hedged. During the third quarter of 2002, the Company included a $0.1 million gain in the accumulated translation adjustment related to this hedge. Any ineffective portion of a financial instrument’s change in fair value is recognized in earnings. The ineffective portion of the hedge for the third quarter resulted in $3,000 of pretax income. The cross currency swap is an over-the-counter instrument with a liquid market. The Company does not enter into derivative financial instruments for trading purposes. The Company has established strict counterparty credit guidelines and entered into the transaction with an investment grade financial institution.
8. DIVIDEND
On October 30, 2002, the Board of Directors declared a quarterly dividend of 18 cents per share, payable December 1, 2002 to shareholders of record on November 11, 2002.
9. SEGMENT INFORMATION
After the shut down of Material Logic operations in the second quarter of 2001, FindMRO was included, on a prospective basis only, in the Branch-based Distribution segment. Separate books and records for FindMRO were not maintained prior to the shut down. Thus, extracting the operating results of FindMRO for restatement purposes was impracticable.
Three Months Ended September 30, 2002
--------------------------------------------------------------------
(In thousands of dollars)
Lab Grainger
Branch-based Safety Integrated
Distribution Digital Supply Supply Total
------------ ---------- ----------- ------------ -----------
Total net sales $ 1,075,450 $ -- $ 74,988 $ 57,092 $ 1,207,530
Intersegment net sales (3,757) -- (373) -- (4,130)
----------- ---------- ----------- ----------- -----------
Net sales to external customers $ 1,071,693 $ -- $ 74,615 $ 57,092 $ 1,203,400
=========== ========== =========== =========== ===========
Segment operating earnings $ 98,225 $ -- $ 13,014 $ 1,662 $ 112,901
=========== ========== =========== =========== ===========
18
W.W. Grainger, Inc., and Subsidiaries
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Unaudited)
Three Months Ended September 30, 2001
--------------------------------------------------------------------
(In thousands of dollars)
Lab Grainger
Branch-based Safety Integrated
Distribution Digital Supply Supply Total
----------- ---------- ----------- ----------- -----------
Total net sales $ 1,074,309 $ -- $ 79,012 $ 49,950 $ 1,203,271
Intersegment net sales (3,575) -- (338) -- (3,913)
----------- ---------- ----------- ----------- -----------
Net sales to external customers $ 1,070,734 $ -- $ 78,674 $ 49,950 $ 1,199,358
=========== ========== =========== =========== ===========
Segment operating earnings (loss) $ 95,488 $ -- $ 12,280 $ (880) $ 106,888
=========== ========== =========== =========== ===========
Nine Months Ended September 30, 2002
--------------------------------------------------------------------
(In thousands of dollars)
Lab Grainger
Branch-based Safety Integrated
Distribution Digital Supply Supply Total
------------ ---------- ----------- ------------ -----------
Total net sales $ 3,141,315 $ -- $ 221,879 $ 172,997 $ 3,536,191
Intersegment net sales (11,684) -- (1,050) -- (12,734)
----------- ---------- ----------- ----------- -----------
Net sales to external customers $ 3,129,631 $ -- $ 220,829 $ 172,997 $ 3,523,457
=========== ========== =========== =========== ===========
Segment operating earnings $ 285,177 $ -- $ 38,163 $ 4,562 $ 327,902
=========== ========== =========== =========== ===========
Nine Months Ended September 30, 2001
--------------------------------------------------------------------
(In thousands of dollars)
Lab Grainger
Branch-based Safety Integrated
Distribution Digital Supply Supply Total
------------ ----------- ----------- ----------- -----------
Total net sales $ 3,265,085 $ 29,979 $ 250,150 $ 138,277 $ 3,683,491
Intersegment net sales (10,571) (28,139) (963) -- (39,673)
----------- ---------- ----------- ----------- -----------
Net sales to external customers $ 3,254,514 $ 1,840 $ 249,187 $ 138,277 $ 3,643,818
=========== ========== =========== =========== ===========
Segment operating earnings (loss) $ 279,423 $ (50,157) $ 40,991 $ (39) $ 270,218
=========== ========== =========== =========== ===========
Lab Grainger
Branch-based Safety Integrated
Segment assets: Distribution Digital Supply Supply Total
- --------------- ---------- ---------- ----------- ----------- ----------
(In thousands of dollars)
At September 30, 2002 $ 1,848,919 $ -- $ 111,750 $ 35,953 $1,996,622
=========== ========== =========== =========== ==========
At December 31, 2001 $ 1,804,216 $ -- $ 114,030 $ 27,401 $1,945,647
=========== ========== =========== =========== ==========
19
W.W. Grainger, Inc., and Subsidiaries
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Unaudited)
A reconciliation of segment information to consolidated information is as follows:
Three Months Ended Nine Months Ended
September 30, September 30,
---------------------- ----------------------
2002 2001 2002 2001
--------- --------- --------- ---------
(In thousands of dollars)
Operating Earnings:
- -------------------
Total operating earnings for
reportable segments $ 112,901 $ 106,888 $ 327,902 $ 270,218
Unallocated expenses (12,709) (11,495) (43,472) (37,448)
Elimination of intersegment
profits (2) (16) (16) (16)
--------- --------- --------- ---------
Total consolidated operating
earnings $ 100,190 $ 95,377 $ 284,414 $ 232,754
========= ========= ========= =========
September 30, December 31,
2002 2001
----------- -----------
Assets:
- -------
Total assets for reportable segments $ 1,996,622 $ 1,945,647
Unallocated assets 420,384 385,599
----------- -----------
Total consolidated assets $ 2,417,006 $ 2,331,246
=========== ===========
Unallocated expenses and unallocated assets primarily relate to the Company headquarter’s support services, which are not part of any business segment. Unallocated expenses include payroll and benefits, depreciation, and other costs associated with these headquarter’s-related support services. Unallocated assets include non-operating cash and cash equivalents, prepaid expenses, and property, buildings and equipment, net.
20
Item 2.
W.W. Grainger, Inc., and Subsidiaries
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND THE RESULTS OF OPERATIONS
RESULTS OF OPERATIONS
THREE MONTHS ENDED SEPTEMBER 30, 2002 COMPARED WITH THE THREE MONTHS ENDED SEPTEMBER 30, 2001:
Company Net Sales
The Company’s net sales of $1,203.4 million in the 2002 third quarter were flat compared with sales of $1,199.4 million for the comparable 2001 period. Sales performance in the third quarter of 2002 was affected by the continuing general weakness in the North American economy and one more selling day.
There were 64 sales days in the 2002 third quarter and 63 sales days in the 2001 third quarter. The full year 2002 will have 255 sales days, the same number of sales days as the full year 2001.
Segment Net SalesThe following comments at the segment level refer to external and intersegment net sales; those comments at the business unit level include external and inter- and intrasegment net sales. For segment information, see Note 9 to the Condensed Consolidated Financial Statements included in this report.
Branch-based Distribution Businesses
Net sales of $1,075.5 million for the third quarter of 2002 were flat as compared to net sales of $1,074.3 million in the third quarter of 2001.
Daily net sales in the United States declined approximately 1% for the quarter versus 2001, primarily due to a slowdown in the U.S. economy. Sales to government accounts increased by 13% on a daily basis, while other customer segments declined.
Sales processed through the grainger.com website were $110 million for the third quarter 2002, a 29% increase over third quarter 2001 sales of $85 million.Daily net sales in Canada decreased 12% during the third quarter of 2002 due to the weakness in the Canadian economy, especially in the natural resources sector, and the elimination of automotive after-market parts sales. On February 1, 2002, Acklands - Grainger Inc. (AGI) and Uni-Select, Inc. created a new joint venture by combining AGI’s automotive after-market parts division and Uni-Select’s Western Division into a single company. Excluding the impact of the formation of this joint venture, daily net sales were down 4% for the quarter. For additional information concerning this joint venture, see Note 4 to the Condensed Consolidated Financial Statements included in this report.
21
W.W. Grainger, Inc., and Subsidiaries
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND THE RESULTS OF OPERATIONS
RESULTS OF OPERATIONS (Continued)
The operation in Mexico experienced a 1% decline in daily net sales in the third quarter of 2002 when compared with the same period of the prior year. This decrease was attributable to continued weakness in the automotive and electronics manufacturing industries and deterioration in the economy.
Digital Businesses
On April 23, 2001, the Company announced plans to shut down the operations of Material Logic, with the exception of FindMRO. The Company launched Material Logic in January 2001 as a utility for large customers to facilitate the purchase of MRO products over the Internet. Material Logic would have allowed large customers to access a single, networked catalog containing easily searchable and detailed product information, pre-negotiated prices, and availability information for indirect materials from major distributors. In order for Material Logic to grow, it needed broad industry support and funding from other equity participants. The Company closed Material Logic in April 2001 because economic and market conditions made it difficult to find funding partners and the market developed slower than anticipated. In connection with the shut down of Material Logic operations, the Company took a pretax nonrecurring charge against operating earnings of $40.0 million (after-tax of $23.8 million) in the second quarter of 2001. FindMRO was then established as an operating unit separate from Material Logic. Beginning with the 2001 third quarter, the Digital segment ceased operations.
Effective June 1, 2001, the results of FindMRO (on a prospective basis only) were moved to the Branch-based Distribution Businesses segment. Consequently, there were no reported sales in the third quarter of 2002 or the third quarter of 2001. The Company has not restated prior period segment information for this transfer, since restatement is impracticable.
Lab Safety Supply
Third quarter 2002 net sales for Lab Safety Supply were $75.0 million, a decrease of 5% when compared with $79.0 million for the same period in 2001. Daily net sales for the third quarter of 2002 declined 7% in this segment due to its heavy customer weighting in the manufacturing sector of the economy, which continues to be weak.
22
W.W. Grainger, Inc., and Subsidiaries
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND THE RESULTS OF OPERATIONS
RESULTS OF OPERATIONS (Continued)
Grainger Integrated Supply
Net sales for the third quarter of 2002 were $57.1 million, an increase of 14% when compared with $50.0 million for the same period in 2001. Daily sales increased 12% for the quarter due to additional penetration of existing customers by expansion of the number of their locations served. Sales for this business unit include product sales and management fees.
Company Net Earnings
The Company’s net earnings of $60.0 million in the third quarter of 2002 increased 7% compared with $56.0 million for the comparable 2001 period. The increase in net earnings resulted primarily from stronger operating earnings and higher other income. Earnings were also improved for the third quarter of 2002 due to the change in amortization of goodwill and other intangibles effective January 1, 2002. Reported net earnings for the third quarter of 2001 would have been $0.8 million higher if amortization expense relating to goodwill and intangible assets that are no longer being amortized was excluded. For information concerning amortization expense, see Note 2 to the Condensed Consolidated Financial Statements included in this report.
Operating earnings increased 5% for the third quarter of 2002 compared with the same 2001 period. The improvement in operating earnings was primarily attributable to improved performance at all three of the Company's business segments.Segment Operating Earnings
The following comments at the segment level include external and intersegment operating earnings; those comments at the business unit level include external and inter- and intrasegment operating earnings. For segment information, see Note 9 to the Condensed Consolidated Financial Statements included in this report.
23
W.W. Grainger, Inc., and Subsidiaries
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND THE RESULTS OF OPERATIONS
RESULTS OF OPERATIONS (Continued)
Branch-based Distribution Businesses
Operating earnings of $98.2 million for the third quarter increased 3% compared with operating earnings of $95.5 million in the third quarter of 2001. Improved operating performance in the U.S. and Mexico was partially offset by weak performance in Canada. Excluding Canada, operating earnings increased 4%.
Gross profit margins increased 0.6 percentage points from the comparable 2001 quarter. The improvement in gross profit margins was primarily attributable to selected pricing actions intended to cover freight and supplier cost increases, and favorable product mix. Partially offsetting this improvement was an unfavorable change in customer category mix.
Operating expenses were up 2% for the quarter as a result of start up and incremental costs related to the expansion and renovation of the U.S. distribution centers and increased healthcare-related benefits. These increased costs were partially offset by a reduction in other operating expenses.
Digital Businesses
On April 23, 2001, the Company announced plans to shut down the operations of Material Logic with the exception of FindMRO. In connection with the shut down, the Company took a nonrecurring pretax charge of $40.0 million (after-tax of $23.8 million) in the second quarter of 2001. Beginning with the 2001 third quarter, the Digital Businesses segment ceased operations.
Effective June 1, 2001, the results of FindMRO were added to the Branch-based Distribution Businesses. Consequently, no results are reported for this segment in 2002 nor in the third quarter of 2001.
Lab Safety Supply
Lab Safety Supply had operating earnings of $13.0 million for the third quarter of 2002, an increase of 6% compared with operating earnings of $12.3 million for the third quarter of 2001. The operating earnings increase was the result of improved gross margins and lower operating expenses. The operating expense decrease was the result of workforce reductions and other cost control measures.
24
W.W. Grainger, Inc., and Subsidiaries RESULTS OF OPERATIONS (Continued)
Grainger Integrated Supply Grainger Integrated Supply
had operating earnings of $1.7 million in the third quarter of 2002 compared
with operating losses of $0.9 million in the comparable period of 2001. The 2001
third quarter included a significant increase in the provision for uncollectable
accounts due to the bankruptcy filing of a large customer. Without this
incremental provision, operating earnings would have been $0.5 million for the
2001 third quarter. The additional improvement in operating performance for the
2002 quarter was the result of eliminating or restructuring unprofitable
contracts throughout 2001, productivity gains attained by leveraging the
existing cost structure, and increased volume. Other Income and Expense Other income and expense
was $1.1 million of income in the third quarter of 2002 compared with $1.0
million of expense in the third quarter of 2001. The improvement was primarily
attributable to incremental gains of $1.5 million in the third quarter of 2002
attributable to the liquidation of branch facilities and other assets. The
remaining improvement was due to higher interest income and lower interest
expense. Income Taxes The Company’s
effective income tax rate was 40.8% for the third quarter of 2002 and 40.7% for
the same period in 2001. 25
W.W. Grainger, Inc., and Subsidiaries RESULTS OF
OPERATIONS (Continued) NINE MONTHS ENDED
SEPTEMBER 30, 2002 COMPARED WITH THE NINE MONTHS ENDED SEPTEMBER 30, 2001: Company Net
Sales The Company’s net
sales of $3,523.5 million in the nine months of 2002 were down 3% compared with
sales of $3,643.8 million for the comparable 2001 period. Sales performance in
the first nine months of 2002 was affected by the continuing general weakness in
the North American economy. There were 191 sales days
in both the 2002 and 2001 first nine months. The full year 2002 will have 255
sales days, the same number of sales days as the full year 2001. Segment Net Sales The following comments at
the segment level include external and intersegment net sales; those comments at
the business unit level include external and inter- and intrasegment net sales.
For segment information see Note 9 to the Condensed Consolidated Financial
Statements included in this report.
Branch-based Distribution Businesses Net sales of $3,141.3
million for the first nine months of 2002 decreased 4% when compared with
net sales of $3,265.1 million in the first nine months of 2001. The sales
decline was primarily attributable to weakness in both the North American
economy and natural resources sector in Canada. Daily sales in the United
States declined approximately 3% primarily due to a slowdown in the U.S.
economy. Daily sales to government accounts increased 14%, while most other
customer segments declined. 26 W.W. Grainger, Inc., and Subsidiaries RESULTS OF
OPERATIONS (Continued) Daily sales in Canada
decreased 13% during the first nine months of 2002 due to the weakness in the
Canadian economy, especially in the natural resources sector, and the
elimination of automotive after-market parts sales. On February 1, 2002,
Acklands - Grainger Inc. (AGI) and Uni-Select, Inc. created a new joint venture
by combining AGI’s automotive after-market parts division and
Uni-Select’s Western Division into a single company. Excluding the impact
of the formation of this joint venture, daily sales were down 6% for the first
nine months. For additional information concerning the joint venture, see Note 4
to the Condensed Consolidated Financial Statements included in this report. The operation in Mexico
experienced an 8% decline in daily net sales during the first nine months of
2002 when compared with the same period in 2001. This decrease was attributable
to weakness in the automotive and electronics manufacturing industries, and
deterioration in the economy.
Digital Businesses On April 23, 2001, the
Company announced plans to shut down the operations of Material Logic with the
exception of FindMRO. In connection with the shut down, the Company took a
pretax, nonrecurring charge of $40.0 million (after-tax of $23.8 million) in the
first half of 2001. Beginning with the 2001 third quarter, the Digital segment
ceased operations. Effective June 1, 2001, the
results of FindMRO were added to the Branch-based Distribution Businesses.
Consequently, no sales are reported for this segment in the nine months of 2002,
but $30.0 million were reported for the same period in 2001.
Lab Safety Supply Net sales of $221.9 million
for the first nine months of 2002 decreased 11% compared with net sales of
$250.2 million for the same period in 2001. Net sales declined in this segment
due to its heavy customer weighting in the industrial sector of the economy,
which continues to be a weak market. Net sales are included for The Ben Meadows
Co. (Ben Meadows) since its acquisition on February 26, 2001. Ben Meadows was a
direct marketer specializing in equipment for the environmental and forestry
management markets. 27 W.W. Grainger, Inc., and Subsidiaries RESULTS OF
OPERATIONS (Continued)
Grainger Integrated Supply Net sales for the first
nine months of 2002 were $173.0 million, an increase of 25% compared with $138.3
million for the same period in 2001. Sales growth was primarily related to
additional penetration of existing customers by expansion of the number of their
locations served. Sales for this business unit include product sales and
management fees. Company Net Earnings The Company’s net
earnings of $149.0 million in the first nine months of 2002 increased 32%
compared with the net earnings of $113.0 million for the comparable 2001 period.
The first nine months of 2002 included the cumulative effect of an accounting
change as the result of the required assessment of the impact of SFAS No. 142,
“Goodwill and Other Intangible Assets.” The transitional impairment
charge resulted from application of the new impairment methodology introduced by
SFAS No. 142. Previous accounting rules incorporated a comparison of book value
to undiscounted cash flows, whereas new rules require a comparison of book value
to discounted cash flows, which are lower. The Company recorded a non-cash,
after-tax charge to earnings of $23.9 million ($0.25 per diluted share), related
to the write-down of goodwill for its Canadian subsidiary, Acklands - Grainger
Inc. This amount was recorded as a cumulative effect of an accounting change
effective January 1, 2002. For 2001, the nine months included the previously
announced nonrecurring, after-tax charges of $38.0 million, or $0.40 per diluted
share. The first nine months of 2002 included an after-tax gain related to
investment security sales of $4.5 million, or $0.04 per diluted share. Excluding
these nonrecurring items from both periods, net earnings before the cumulative
effect of an accounting change increased 12% to $168.5 million from $151.0
million; and earnings per diluted share, before the cumulative effect of an
accounting change, increased 12% to $1.78 from $1.59. The increase in net
earnings before cumulative effect of accounting change (excluding nonrecurring
items) resulted primarily from stronger operating earnings and higher other
income. In addition, the improvement in net earnings, before the cumulative
effect of accounting change, was due to the impact of the adoption of SFAS No.
142. Under this pronouncement, goodwill and other intangibles with indefinite
lives are not amortized beginning as of January 1, 2002. Reported net earnings
for the nine months ending on September 30, 2001, restated to exclude
amortization expense related to goodwill and intangible assets that are no
longer being amortized, would have been $2.4 million higher (or $0.03 per
diluted share). For additional information concerning amortization expense, see
Note 2 to the Condensed Consolidated Financial Statements included in this
report. Operating earnings
increased 22% for the first nine months of 2002 compared with the same 2001
period. The improvement in operating earnings was primarily attributable to the
elimination of losses of Material Logic of $50.2 million, and improved
performance at the Branch-based Distribution Businesses and at Grainger
Integrated Supply. Partially offsetting these improvements was a 7% decline for
Lab Safety Supply and an increase in corporate expenses. The Company recorded
severance and other costs of $5.8 million ($3.4 million after-tax) in the second
quarter of 2002 related to a consolidation of facilities and to workforce
reductions at the Company’s headquarters and at Lab Safety Supply. 28
W.W. Grainger, Inc., and Subsidiaries RESULTS OF
OPERATIONS (Continued) Segment Operating Earnings The following comments at
the segment level include external and intersegment operating earnings; those
comments at the business unit level include external and inter- and intrasegment
operating earnings. For segment information see Note 9 to the Condensed
Consolidated Financial Statements included in this report.
Branch-based Distribution Businesses
Operating earnings of
$285.2 million for the first nine months of 2002 increased 2% compared with
operating earnings of $279.4 million in the first nine months of 2001. Operating
earnings were impacted by weak performance in Canada. Excluding Canada,
operating earnings for the Branch-based Distribution Businesses increased 4%. Operating expenses were up
1% for the first nine months as a result of start up and incremental costs
related to the expansion and renovation of the U.S. distribution centers,
severance, and increased healthcare-related benefits.
Digital Businesses On April 23, 2001, the
Company announced plans to shut down the operations of Material Logic with the
exception of FindMRO. In connection with the shut down of Material Logic, the
Company took a nonrecurring, pretax charge of $40.0 million ($23.8 million
after-tax) in the first half of 2001. Beginning with the 2001 third quarter, the
Digital Businesses segment ceased operations. Effective June 1, 2001, the
results of FindMRO were added to the Branch-based Distribution Businesses.
Consequently, no results were reported for this segment in 2002. In the first
nine months of 2001, the Digital Businesses incurred operating losses of $50.2
million. 29
W.W. Grainger, Inc., and Subsidiaries RESULTS OF
OPERATIONS (Continued)
Lab Safety Supply Lab Safety Supply had
operating earnings of $38.2 million for the first nine months of 2002, a
decrease of 7% compared with operating earnings of $41.0 million for the first
nine months of 2001. The operating earnings decline was primarily volume
related. Through cost control, operating expenses decreased 10%. The operating
earnings decline was primarily volume related.
Grainger Integrated Supply Grainger Integrated Supply
had operating earnings of $4.6 million in the first nine months of 2002 compared
with operating losses of less than $0.1 million in the first nine months of
2001. A portion of the improvement in operating earnings was due to the 2001
period including a $1.4 million increase in the provision for uncollectable
accounts due to the bankruptcy filing of a large customer. The additional
improvement in operating earnings was the result of eliminating or restructuring
unprofitable contracts throughout 2001, productivity gains attained by
leveraging its existing cost structure, and increased volume. 30
W.W. Grainger, Inc., and Subsidiaries RESULTS OF
OPERATIONS (Continued)
Other Income and Expense Other income and expense was
$7.6 million of income in 2002 compared with $40.4 million of other expense in
2001. The following table provides an analysis of the components of other income and expense as of September 30, 2002
as compared with September 30, 2001: Income Taxes The Company’s
effective income tax rate was 40.8% for the first nine months of 2002 and 41.2%
for the same period in 2001. This rate decrease in 2002 compared with 2001 was
due primarily to the following two items: 1.
2. Capital losses in 2001 primarily related to investments in other digital enterprises, which are not
deductible in the absence of capital gains.
These items were partially offset by the impact of the write-off of
investment in unconsolidated entities in 2001 that resulted in tax benefits
disproportionate to the loss incurred. Excluding the effect of these items, the effective tax rate was 40.5% for
both 2002 and 2001. 31
W.W. Grainger, Inc., and Subsidiaries LIQUIDITY AND CAPITAL RESOURCES For the nine months ended September 30, 2002, working capital increased by
$16.8 million. The ratio of current assets to current liabilities was 2.4 at
September 30, 2002 and 2.5 at December 31, 2001. The Condensed Consolidated
Statements of Cash Flows, included in this report, detail the sources and uses
of cash and cash equivalents. The Company maintains a
debt ratio and liquidity position that provides flexibility in funding working
capital needs and long-term cash requirements. In addition to internally
generated funds, 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 total capitalization was 8% at both
September 30, 2002 and December 31, 2001. For the first nine
months of 2002, $99.7 million was expended for property, buildings, and
equipment, and $5.0 million was expended for capitalized software, for a total
of $104.7 million. In September 2002, the
Company received net proceeds of $113.7 million from the issuance of commercial
paper. The proceeds were used to repay outstanding long-term debt in the amount
of C$180.4 million. Since the Company has the ability to refinance the
commercial paper with debt having a longer maturity and the Company’s
intent is to keep the debt outstanding for greater than one year, the commercial
paper has been classified as long-term debt on the Company’s balance sheet
as of September 30, 2002. The long-term debt that was repaid with the proceeds
of the commercial paper issuance had been designated by the Company as a
non-derivative hedge of the Company’s net investment in its Canadian
subsidiary. The Company entered into a cross currency swap on September 25, 2002
which replaced the Canadian dollar long-term debt as a hedge of the net
investment in the Company’s Canadian subsidiary. The counterparty to the
financial instrument was an investment grade financial institution. The Company
does not expect any loss from nonperformance by this counterparty. For
additional information concerning the cross currency swap agreement, see Note 7
to the Condensed Consolidated Financial Statements included in this report. As of September 30, 2002,
1.3 million shares of common stock remained under the Company’s repurchase
authorization, after the repurchase of approximately 1.9 million shares in the
third quarter of 2002. On October 30, 2002, the Company’s repurchase
authorization was increased to 10 million shares. On April 23, 2001, the
Company announced that it would shut down the operations of Material Logic with
the exception of FindMRO. In connection with this announcement, the Company took
a pretax nonrecurring charge of $40.0 million in the second quarter of 2001. As
of December 31, 2001, $9.5 million of the reserve remained. During the nine
months ended September 30, 2002, the Company utilized $4.7 million of this
reserve, of which $3.8 million were cash payments. As of September 30, 2002,
$4.8 million of this reserve remains, which the Company anticipates will be
funded from internally generated cash. 32
W.W. Grainger, Inc., and Subsidiaries LIQUIDITY AND CAPITAL RESOURCES (Continued) The Company has a
contingent credit risk relating to certain guarantees of employee loans. As of
September 30, 2002, 70 employees had loans outstanding to a bank
aggregating $22.2 million, the largest of which was $4.4 million. For
additional information concerning this credit risk, see Note 6 to the Condensed
Consolidated Financial Statements included in this report. FORWARD-LOOKING
STATEMENTS Throughout this Form 10-Q
are forward-looking statements under the federal securities laws. The
forward-looking statements relate to the Company’s expected future
financial results and business plans, strategies, and objectives and are not
historical facts. They are often identified by qualifiers such as:
“will,” “expect,” “estimate,”
“continue,” “should,” “intend,” or similar
expressions. There are risks and uncertainties the outcome of which could cause
the Company’s results to differ materially from what is projected. Factors that may affect
forward-looking statements include the following: higher product costs or other
expenses; a major loss of customers; increased competitive pricing pressure on
the Company’s businesses; failure to develop or implement new technologies
or other business strategies; the outcome of pending and future litigation and
governmental proceedings; changes in laws and regulations; facilities
disruptions or shutdowns; disruption in transportation services; natural and
other catastrophes; unanticipated weather conditions; and other difficulties in
achieving or improving margins or financial performance. Trends and projections
could also be affected by general industry and market conditions, gross domestic
product growth rates, general economic conditions, including interest rate and
currency rate fluctuations, global and other conflicts, and other factors. 33
W.W. Grainger, Inc., and Subsidiaries 34
W.W. Grainger, Inc., and Subsidiaries Items 1, 2, 3, 4 and 5 not applicable. 35 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.
Date: November 11,
2002
By:
/s/ P.O. Loux
Date: November 11,
2002
By: /s/ J.E. Andringa 36
CERTIFICATION
I, R. L. Keyser, certify that: Date: November 11, 2002 By: /s/ R. L. Keyser 37
CERTIFICATION
I, P. O. Loux, certify that:
Date: November 11, 2002 By: /s/ P. O. Loux 38
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND THE RESULTS OF OPERATIONS
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND THE RESULTS OF OPERATIONS
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND THE RESULTS OF OPERATIONS
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND THE RESULTS OF OPERATIONS
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND THE RESULTS OF OPERATIONS
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND THE RESULTS OF OPERATIONS
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND THE RESULTS OF OPERATIONS
Nine months ended Nine months ended
Other income and (expense) Sept. 30, 2002 Sept. 30, 2001
- ------------------------- -------------- -------------
(In thousands of dollars)
Interest income/(expense), net $ (1,296) $ (7,324)
Equity in loss of unconsolidated entities (2,040) (6,352)
Loss on liquidation of equity in
unconsolidated entity -- (21,497)
Gain on sale of investment securities 7,308 138
Write-down of investments in other
digital enterprises (included in
Unclassified - net) -- (5,000)
Gain on sale of fixed assets (included in
Unclassified - net) 5,411 1,035
Other (included in Unclassified - net) (1,804) (1,391)
---------- ----------
$ 7,579 $ (40,391)
========== ==========
Higher losses in 2001 on equity interests in unconsolidated entities, which is a net of tax number.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND THE RESULTS OF OPERATIONS
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND THE RESULTS OF OPERATIONS
PART I - FINANCIAL INFORMATION
Item 3.
Quantitative and Qualitative Disclosures about Market Risk
For a description of additional market risks of the Company, see “Item 7A
– Quantitative and Qualitative Disclosures about Market Risk” in the
Company’s Annual Report on Form 10-K for the fiscal year ended December 31,
2001.
Item 4.
Controls and Procedures
(a)
Evaluation of disclosure controls and procedures
Within the 90 days prior to the filing date of this report, the Company carried out an
evaluation, under the supervision and with the participation of the
Company’s management, including the Chief Executive Officer and the Chief
Financial Officer, of the effectiveness of the design and operation of the
Company’s (including its consolidated subsidiaries) disclosure controls and
procedures pursuant to Exchange Act Rule 13a-14. Based
upon that evaluation, the Chief Executive Officer and the Chief Financial
Officer concluded that the Company’s disclosure controls and procedures are
effective.
(b)
Changes in internal controls
There were no significant changes in the Company’s internal controls or in other
factors that could significantly affect these controls subsequent to the date of
such evaluation.
PART II-OTHER INFORMATION
Item 6. Exhibits (numbered in accordance with Item 601 of regulation
S-K).
(a)
Exhibits
4.
Letter concerning the appointment of EquiServe
Trust Company, N.A., as successor rights agent,
effective August 1, 2002, under the agreement, dated as of April 28, 1999,
between the
Company and Fleet National Bank (formerly BankBoston, N.A.).
11.
Computations of Earnings per Share
99.
Additional Exhibits
1.
99.1
Chief Executive Officer certification pursuant to Section 906
of the Sarbanes-Oxley Act of 2002
2.
99.2
Chief Financial Officer certification pursuant to Section 906
of the Sarbanes-Oxley Act of 2002
(b)
Reports on Form 8-K
The Company filed a report on Form 8-K, dated August 13, 2002, reporting under Item 9
thereof information included as exhibits to the report, consisting of statements and
certifications furnished to the Securities and Exchange Commission pursuant to Securities
and Exchange Commission Order 4-460 and Section 906 of the Sarbanes-Oxley Act of 2002.
(Registrant)
P.O. Loux, Senior Vice President,
Finance and Chief Financial Officer
J.E. Andringa, Vice President
and Controller
1.
I have reviewed this quarterly report on Form 10-Q of W.W. Grainger, Inc.;
2.
Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to make
the statements made, in light of the circumstances under which such statements
were made, not misleading with respect to the period covered by this quarterly
report;
3.
Based on my knowledge, the financial statements, and other financial information
included in this quarterly report, fairly present in all material respects the
financial condition, results of operations and cash flows of the registrant as
of, and for, the periods presented in this quarterly report;
4.
The registrant’s other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
a)
designed such disclosure controls and procedures to ensure that material
information relating to the registrant, including its consolidated subsidiaries,
is made known to us by others within those entities, particularly during the
period in which this quarterly report is being prepared;
b)
evaluated the effectiveness of the registrant’s disclosure controls and
procedures as of a date within 90 days prior to the filing date of this
quarterly report (the “Evaluation Date”); and
c)
presented in this quarterly report our conclusions about the effectiveness of the disclosure controls
and procedures based on our evaluation as of the Evaluation Date;
5.
The registrant’s other certifying officer and I have disclosed, based on
our most recent evaluation, to the registrant’s auditors and the audit
committee of registrant’s board of directors (or persons performing the
equivalent function):
a)
all significant deficiencies in the design or operation of internal controls
which could adversely affect the registrant’s ability to record, process,
summarize and report financial data and have identified for the
registrant’s auditors any material weaknesses in internal controls; and
b)
any fraud, whether or not material, that involves management or other employees who have a significant
role in the registrant's internal controls; and
6.
The registrant’s other certifying officer and I have indicated in this
quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal controls
subsequent to the date of our most recent evaluation, including any corrective
actions with regard to significant deficiencies and material weaknesses.
Name: R. L. Keyser
Title: Chairman and Chief Executive Officer
1.
I have reviewed this quarterly report on Form 10-Q of W.W. Grainger, Inc.;
2.
Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to make
the statements made, in light of the circumstances under which such statements
were made, not misleading with respect to the period covered by this quarterly
report;
3.
Based on my knowledge, the financial statements, and other financial information
included in this quarterly report, fairly present in all material respects the
financial condition, results of operations and cash flows of the registrant as
of, and for, the periods presented in this quarterly report;
4.
The registrant’s other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
a)
designed such disclosure controls and procedures to ensure that material
information relating to the registrant, including its consolidated subsidiaries,
is made known to us by others within those entities, particularly during the
period in which this quarterly report is being prepared;
b)
evaluated the effectiveness of the registrant’s disclosure controls and
procedures as of a date within 90 days prior to the filing date of this
quarterly report (the “Evaluation Date”); and
c)
presented in this quarterly report our conclusions about the effectiveness of the disclosure controls
and procedures based on our evaluation as of the Evaluation Date;
5.
The registrant’s other certifying officer and I have disclosed, based on
our most recent evaluation, to the registrant’s auditors and the audit
committee of registrant’s board of directors (or persons performing the
equivalent function):
a)
all significant deficiencies in the design or operation of internal controls
which could adversely affect the registrant’s ability to record, process,
summarize and report financial data and have identified for the
registrant’s auditors any material weaknesses in internal controls; and
b)
any fraud, whether or not material, that involves management or other employees who have a significant
role in the registrant's internal controls; and
6.
The registrant’s other certifying officer and I have indicated in this
quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal controls
subsequent to the date of our most recent evaluation, including any corrective
actions with regard to significant deficiencies and material weaknesses.
Name: P. O. Loux
Title: Senior Vice President, Finance and
Chief Financial Officer
QuickLinks
TABLE OF CONTENTS
PART I - FINANCIAL INFORMATION
Item 1. Financial Statements (Unaudited)
Condensed Consolidated Statements of Earnings at September 30, 2002 and September 30, 2001
Condensed Consolidated Statements of Comprehensive Earnings at September 30, 2002 and September 30, 2001
Condensed Consolidated Balance Sheets at September 30, 2002 and December 31, 2001
Condensed Consolidated Statements of Cash Flows at September 30, 2002 and September 30, 2001
Notes to Condensed Consolidated Financial Statements
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations
Item 3. Quantitative and Qualitative Disclosures about Market Risk
Item 4. Controls and Procedures
PART II - OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K
Signatures
Certifications