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 quarterly period ended March 31, 2003
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
Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Act).
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: 91,631,529 shares of the Company’s Common Stock were outstanding as of April 30, 2003.
1
| TABLE OF CONTENTS | ||
|---|---|---|
| Page No. | ||
| PART I | FINANCIAL INFORMATION | |
| Item 1. | Financial Statements (Unaudited) | |
| Condensed Consolidated Statements of Earnings For the Three Months Ended March 31, 2003 and March 31, 2002 |
3 - 4 | |
| Condensed Consolidated Statements of Comprehensive Earnings For the Three Months Ended March 31, 2003 and March 31, 2002 |
5 | |
| Condensed Consolidated Balance Sheets at March 31, 2003 and December 31, 2002 |
6 - 7 | |
| Condensed Consolidated Statements of Cash Flows For the Three Months Ended March 31, 2003 and March 31, 2002 |
8 - 9 | |
| Notes to Condensed Consolidated Financial Statements | 10 - 16 | |
| Item 2. | Management's Discussion and Analysis of Financial Condition and Results of Operations |
17 - 22 |
| Item 3. | Quantitative and Qualitative Disclosures about Market Risk | 23 |
| Item 4. | Controls and Procedures | 23 |
| PART II | OTHER INFORMATION | |
| Item 4. | Submission of Matters to a Vote of Security Holders | 24 |
| Item 6. | Exhibits and Reports on Form 8-K | 25 |
| Signatures | 26 | |
| Certifications | 27 - 28 | |
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
March 31,
--------------------------
2003 2002
----------- -----------
Net sales $ 1,139,269 $ 1,125,265
Cost of merchandise sold 745,413 742,236
----------- -----------
Gross profit 393,856 383,029
Warehousing, marketing, and
administrative expenses 302,449 293,069
----------- -----------
Operating earnings 91,407 89,960
Other income and (expense)
Interest income 773 979
Interest expense (1,435) (1,534)
Equity in loss of unconsolidated entities (1,055) (720)
Gains on sales of investment securities -- 7,308
Unclassified-net (1,646) 2,745
----------- -----------
Net other income and (expense) (3,363) 8,778
----------- -----------
Earnings before income taxes and cumulative
effect of accounting change 88,044 98,738
Income taxes 35,640 40,280
----------- -----------
Earnings before cumulative effect of
accounting change 52,404 58,458
Cumulative effect of accounting change -- (23,921)
----------- -----------
Net earnings $ 52,404 $ 34,537
=========== ===========
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
Three Months Ended
March 31,
---------------------------------
2003 2002
-------------- ---------------
Earnings per share before cumulative
effect of accounting change:
Basic $ 0.58 $ 0.63
============== ===============
Diluted $ 0.57 $ 0.61
============== ===============
Cumulative effect of accounting change:
Basic $ -- $ (0.26)
============== ===============
Diluted $ -- $ (0.25)
============== ===============
Earnings per share:
Basic $ 0.58 $ 0.37
============== ===============
Diluted $ 0.57 $ 0.36
============== ===============
Weighted average number of shares
outstanding:
Basic 90,865,346 92,618,855
============== ===============
Diluted 92,584,753 95,428,131
============== ===============
Cash dividends paid per share $ 0.180 $ 0.175
============== ===============
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
March 31,
---------------------
2003 2002
-------- --------
Net earnings $ 52,404 $ 34,537
Other comprehensive earnings (losses):
Foreign currency translation adjustments, net
of tax benefit (expense) related to designated
hedge of $3,118 and $(101), respectively 12,349 157
(Losses) gains on investment securities:
Unrealized holding losses, net of tax benefit
of $795 and $1,189, respectively (1,243) (1,860)
Reclassifications for net losses (gains) included
in earnings, net of tax (benefit) expense of
$(629) and $2,850, respectively 985 (4,458)
-------- --------
Comprehensive earnings $ 64,495 $ 28,376
======== ========
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)
(Unaudited)
March 31, Dec. 31,
ASSETS 2003 2002
- -------------------------------------------------- ---------- ----------
CURRENT ASSETS
Cash and cash equivalents $ 218,585 $ 208,528
Accounts receivable (less allowances for
doubtful accounts of $28,616 and $26,868,
respectively) 454,981 423,240
Inventories 706,016 721,178
Prepaid expenses 52,779 36,665
Deferred income tax benefits 97,955 95,336
---------- ----------
Total current assets 1,530,316 1,484,947
PROPERTY, BUILDINGS, AND EQUIPMENT 1,515,626 1,492,858
Less accumulated depreciation and amortization 776,960 756,051
---------- ----------
Property, buildings, and equipment-net 738,666 736,807
DEFERRED INCOME TAXES 23,696 20,541
INVESTMENTS IN UNCONSOLIDATED ENTITIES 19,336 15,988
GOODWILL, NET 120,650 114,428
OTHER ASSETS AND INTANGIBLES, NET 60,079 64,737
---------- ----------
TOTAL ASSETS $2,492,743 $2,437,448
========== ==========
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)
(Unaudited)
March 31, Dec. 31,
LIABILITIES AND SHAREHOLDERS' EQUITY 2003 2002
- -------------------------------------------- ----------- -----------
CURRENT LIABILITIES
Short-term debt $ 2,793 $ 2,967
Current maturities of long-term debt 6,505 6,505
Trade accounts payable 301,276 290,807
Accrued expenses 204,138 248,085
Income taxes 65,273 37,902
----------- -----------
Total current liabilities 579,985 586,266
LONG-TERM DEBT (less current maturities) 127,564 119,693
ACCRUED EMPLOYMENT-RELATED BENEFITS COSTS 67,551 63,791
SHAREHOLDERS' EQUITY
Cumulative Preferred Stock - $5 par value -
12,000,000 shares authorized; none issued
nor outstanding -- --
Common Stock - $0.50 par value - 300,000,000
shares authorized; issued 109,034,253 and
109,017,642 shares, respectively 54,517 54,509
Additional contributed capital 380,464 379,942
Retained earnings 2,118,972 2,083,072
Unearned restricted stock compensation (15,354) (17,144)
Accumulated other comprehensive losses (23,651) (35,742)
Treasury stock, at cost - 17,458,587
and 17,449,587 shares, respectively (797,305) (796,939)
----------- -----------
Total shareholders' equity 1,717,643 1,667,698
----------- -----------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $ 2,492,743 $ 2,437,448
=========== ===========
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)
Three Months Ended
March 31,
--------------------
2003 2002
-------- --------
Cash flows from operating activities:
Net earnings $ 52,404 $ 34,537
Provision for losses on accounts receivable 3,901 4,629
Deferred income taxes (2,490) (143)
Depreciation and amortization:
Property, buildings, and equipment 19,823 19,688
Other intangibles 161 195
Amortization of capitalized software 4,912 4,301
Gains on sales of investment securities -- (7,308)
Net gains on sales of property, buildings and
equipment (137) (2,820)
Write-down of investments 1,614 --
Losses on unconsolidated entities 1,055 720
Cumulative effect of accounting change -- 23,921
Change in operating assets and liabilities-net
of joint venture contributions:
Increase in accounts receivable (32,318) (38,073)
Decrease (increase) in inventories 21,693 (25,384)
Increase in prepaid expenses (16,089) (5,456)
Increase in trade accounts payable 9,110 67,071
Decrease in other current liabilities (44,638) (40,304)
Increase in current income taxes payable 25,508 25,611
Increase in accrued employment-related
benefits costs 3,760 1,902
Other-net 1,385 4,383
-------- --------
Net cash provided by operating activities $ 49,654 $ 67,470
-------- --------
Cash flows from investing activities:
Additions to property, buildings, and
equipment-net of dispositions $(19,709) $(15,270)
Additions to capitalized software (2,004) (3,623)
Proceeds from sales of investment securities -- 15,957
Investments in unconsolidated entities (3,564) (3,210)
Other-net 179 1,341
-------- --------
Net cash used in investing activities $(25,098) $ (4,805)
-------- --------
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)
Three Months Ended
March 31,
------------------------
2003 2002
--------- ----------
Cash flows from financing activities:
Net decrease in short-term debt $ (174) $ (1,918)
Long-term debt payments (123) (1,900)
Stock options exercised 1,574 10,541
Purchase of treasury stock-net (502) --
Cash dividends paid (16,504) (16,372)
--------- ---------
Net cash used in financing activities $ (15,729) $ (9,649)
--------- ---------
Exchange rate effect on cash and cash equivalents 1,230 (272)
--------- ---------
Net increase in cash and cash equivalents 10,057 52,744
Cash and cash equivalents at beginning of year 208,528 168,846
--------- ---------
Cash and cash equivalents at end of period $ 218,585 $ 221,590
========= =========
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 facilities maintenance products, 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, 2002, included in the Company’s Annual Report on Form 10-K filed with the Securities and Exchange Commission.
The Condensed Consolidated Balance Sheet at December 31, 2002 has been derived from the audited financial statements at that date but does not include all of the disclosures required by accounting principles generally accepted in the United States of America for complete financial statements.
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
In November 2002, the Financial Accounting Standards Board (FASB) issued Interpretation No. 45 (FIN 45), “Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others.” It is an interpretation of FASB Statements No. 5, 57, and 107 and rescission of FASB Interpretation No. 34. FIN 45 elaborates on the disclosures to be made by a guarantor in its interim and annual financial statements about its obligations under certain guarantees that it has issued. It also clarifies that a guarantor is required to recognize at the inception of a guarantee a liability for the fair value of the obligation undertaken in issuing the guarantee. Initial recognition and measurement provisions of FIN 45 are applicable on a prospective basis to guarantees issued or modified after December 31, 2002, irrespective of the guarantor’s fiscal year-end. Disclosure requirements of FIN 45 are effective for financial statements of interim or annual periods ending after December 15, 2002. Adoption of this interpretation did not have a material effect on the Company’s results of operations or financial position. See Note 9 to the Condensed Consolidated Financial Statements for information regarding the Company’s warranty reserves. The Company has guaranteed certain bank loans of employees and has certain other guarantees as disclosed in Notes 7 and 9 to the Condensed Consolidated Financial Statements.
3. STOCK INCENTIVE PLANS
The Company maintains various stock incentive plans. The Company accounts for these plans under the recognition and measurement principles of Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees,” and related interpretations. The Company recognizes compensation cost for restricted shares and restricted stock units granted to employees. No compensation cost is recognized for stock option grants. All options granted under the Company’s plans had an exercise price equal to the market value of the underlying common stock on the date of grant.
10
W.W. Grainger, Inc., and Subsidiaries
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Unaudited)
The following table illustrates the effect on net earnings and earnings per share if the Company had applied the fair value recognition provisions of Statement of Financial Accounting Standards (SFAS) No. 123, “Accounting for Stock-based Compensation,” to stock-based compensation. The following table also provides the amount of stock-based compensation cost included in net earnings as reported.
Three Months Ended March 31,
----------------------------
(In thousands of dollars,
except for per share amounts)
2003 2002
---------- ------------
Net earnings as reported $ 52,404 $ 34,537
Deduct:
Total stock-based employee compensation
expense determined under the fair value
based method for all awards, net of
related tax (3,442) (3,342)
---------- ----------
Pro forma net earnings $ 48,962 $ 31,195
========== ==========
Earnings per share:
Basic - as reported $ 0.58 $ 0.37
Basic - pro forma $ 0.54 $ 0.34
Diluted - as reported $ 0.57 $ 0.36
Diluted - pro forma $ 0.53 $ 0.33
Stock-based employee compensation cost, net
of related tax, included in net earnings
as reported $ 1,075 $ 917
4. CUMULATIVE EFFECT OF ACCOUNTING CHANGE
Effective January 1, 2002, the Company adopted SFAS No. 142, "Goodwill and Other Intangible Assets." As a result of the application of the new impairment methodology introduced by SFAS No. 142, the Company recorded a noncash 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. (Acklands).11
W.W. Grainger, Inc., and Subsidiaries
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Unaudited)
5. SPECIAL CHARGES
In 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. In connection with this shut down, the Company took a pretax charge against operating earnings of $39.1 million (after-tax $23.2 million) in 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.
The following table displays the activity and balance of the Material Logic restructuring reserve from December 31, 2002 through March 31, 2003.
Restructuring Reserve Balance Balance
(operating expenses) Dec. 31, 2002 Deductions Mar. 31, 2003
- -------------------- ------------- ------------ -------------
(In thousands of dollars)
Workforce reductions $ 1,644 $ (437) $ 1,207
Other shutdown costs 850 (22) 828
------------ ------------ ------------
$ 2,494 $ (459) $ 2,035
============ ============ ============
Deductions reflect cash payments.
12
W.W. Grainger, Inc., and Subsidiaries
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Unaudited)
6. 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’s 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 Acklands, which operated as Bumper to Bumper. Acklands’ contribution of net assets was approximately U.S. $15 million. Additionally, Acklands’ 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.
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.
7. EXECUTIVE STOCK PURCHASE PROGRAMOn 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 was 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. Subsequent to March 31, 2003 all such loans had been paid. The Company did not recognize a liability for any potential defaults associated with this contingent credit risk under the program as of March 31, 2003. The Company was not called upon to purchase any loan or make any payments as a result of any employee default or triggering event.
8. DIVIDENDOn April 30, 2003, the Board of Directors declared a quarterly dividend of 18½ cents per share, payable June 1, 2003 to shareholders of record on May 12, 2003.
13
W.W. Grainger, Inc., and Subsidiaries
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Unaudited)
9. GUARANTEES
As discussed in Note 2 to the Condensed Consolidated Financial Statements, in November 2002, the FASB issued FIN 45, “Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others.” It also clarifies that a guarantor is required to recognize at the inception of a guarantee a liability for the fair value of the obligation undertaken in issuing the guarantee. Initial recognition and measurement provisions of FIN 45 are applicable on a prospective basis to guarantees issued or modified after December 31, 2002, irrespective of the guarantor’s fiscal year-end. As stated in Note 2 to the Condensed Consolidated Financial Statements, adoption of this interpretation did not have a material effect on the Company’s results of operations or financial position.
The Company has an outstanding guarantee related to an industrial revenue bond assumed by the buyer of one of the Company’s formerly owned facilities and has provided guarantees for loans to certain joint ventures. The maximum exposure under these guarantees was $9.0 million as of March 31, 2003. The Company has not recorded any liability relating to these guarantees and believes it is unlikely that material payments will be required.
As of March 31, 2003, the Company guaranteed $21.8 million of certain bank loans of employees. Subsequent to March 31, 2003 all such loans had been paid.
Warranty ReservesThe Company generally warrants the products it sells against defects for one year. For a significant portion of warranty claims, the manufacturer is responsible for the expenses associated with this warranty. For warranty expenses not covered by the manufacturer, the Company provides a reserve for costs based on historical experience. The reserve activity was as follows:
Three Months Ended March 31,
----------------------------
(In thousands of dollars)
2003 2002
------------ ------------
Beginning balance $ 3,000 $ 2,368
Returns (2,239) (2,279)
Provision 2,203 2,382
------------ ------------
Ending balance $ 2,964 $ 2,471
============ ============
14
W.W. Grainger, Inc., and Subsidiaries
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Unaudited)
10. SEGMENT INFORMATION
Three Months Ended March 31, 2003
---------------------------------------------------
(In thousands of dollars)
Branch-based Lab Integrated
Distribution Safety Supply Total
------------ -------- ----------- ----------
Total net sales $ 1,014,872 $ 71,489 $ 57,272 $1,143,633
Intersegment net sales (3,929) (435) - (4,364)
------------ -------- ----------- ----------
Net sales to external
customers $ 1,010,943 $ 71,054 $ 57,272 $1,139,269
============ ======== =========== ==========
Segment operating earnings $ 91,025 $ 10,853 $ 1,134 $ 103,012
============ ======== =========== ==========
Three Months Ended March 31, 2002
---------------------------------------------------
(In thousands of dollars)
Branch-based Lab Integrated
Distribution Safety Supply Total
------------ -------- ----------- ----------
Total net sales $ 999,311 $ 72,932 $ 57,214 $1,129,457
Intersegment net sales (3,851) (341) - (4,192)
------------ -------- ----------- ----------
Net sales to external
customers $ 995,460 $ 72,591 $ 57,214 $1,125,265
============ ======== =========== ==========
Segment operating earnings $ 89,235 $ 12,979 $ 1,567 $ 103,781
============ ======== =========== ==========
Branch-based Lab Integrated
Segment assets: Distribution Safety Supply Total
- --------------- ------------ -------- ----------- -----------
(In thousands of dollars)
At March 31, 2003 $ 1,911,517 $110,508 $ 35,292 $ 2,057,317
============ ======== =========== ===========
At December 31, 2002 $ 1,872,471 $104,372 $ 29,539 $ 2,006,382
============ ======== =========== ===========
15
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 March 31,
--------------------------------
2003 2002
----------- ------------
(In thousands of dollars)
Total operating earnings
for reportable segments $ 103,012 $ 103,781
Unallocated expenses (11,605) (13,815)
Elimination of intersegment profits -- (6)
----------- -----------
Total consolidated operating earnings $ 91,407 $ 89,960
=========== ===========
March 31, December 31,
2003 2002
----------- -----------
(In thousands of dollars)
Assets
- ------
Total assets for reportable segments $ 2,057,317 $ 2,006,382
Unallocated assets 435,426 431,066
----------- -----------
Total consolidated assets $ 2,492,743 $ 2,437,448
=========== ===========
Unallocated expenses and unallocated assets primarily relate to the Company headquarters’ support services, which are not part of any business segment. Unallocated expenses include payroll and benefits, depreciation, and other costs associated with headquarters-related support services. Unallocated assets include non-operating cash and cash equivalents, prepaid expenses, and property, buildings and equipment, net.
11. SUBSEQUENT EVENTOn April 14, 2003, the Company announced that its subsidiary, Lab Safety Supply, Inc. had completed the acquisition of Gempler’s, a direct marketing division of Gempler’s, Inc. Gempler’s had net sales in 2002 of approximately $32 million. Gempler’s, located in Wisconsin, serves the agricultural, horticultural, grounds maintenance and contractor markets with tools, safety supplies, clothing and other equipment. The purchase price was approximately $35 million in cash and assumption of certain liabilities. Allocation of the purchase price has not yet been finalized. No pro forma information has been provided due to the immaterial nature of this transaction.
16
Item 2.
W.W. Grainger, Inc., and Subsidiaries
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
CRITICAL ACCOUNTING POLICIES
The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues, and expenses in the financial statements. Management bases its estimates on historical experience and other assumptions, which it believes are reasonable. If actual amounts are ultimately different from these estimates, the revisions are included in the Company’s results of operations for the period in which the actual amounts become known.
Accounting policies are considered critical when they require management to make assumptions about matters that are highly uncertain at the time the estimate is made and when different estimates than management reasonably could have used have a material impact on the presentation of the Company’s financial condition, changes in financial condition, or results of operations. For a description of the Company’s critical accounting policies see the Company’s Annual Report on Form 10-K for the year ended December 31, 2002.
RESULTS OF OPERATIONS
THREE MONTHS ENDED MARCH 31, 2003 COMPARED WITH THE THREE MONTHS ENDED MARCH 31, 2002:
Company Net Sales
The Company’s net sales of $1,139.3 million in the 2003 first quarter increased 1% compared with sales of $1,125.3 million for the comparable 2002 period. Sales performance in the first quarter of 2003 reflected the continued weakness in the North American economy.
There were 63 sales days in both the 2003 and 2002 first quarters. The full year 2003 will have 255 sales days, the same number of sales days as the full year 2002.
Segment Net Sales
The following comments at the segment level refer to external and intersegment net sales. Comments at the business unit level include external and inter- and intrasegment net sales. For segment information, see Note 10 to the Condensed Consolidated Financial Statements included in this report.
17
W.W. Grainger, Inc., and Subsidiaries
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
RESULTS OF OPERATIONS (Continued)
Branch-based Distribution Businesses
Net sales of $1,014.9 million for the first quarter of 2003 were up 2% compared to net sales of $999.3 million in the first quarter of 2002.
Net sales in the United States were up 1% for the quarter versus 2002, primarily driven by sales to government accounts, up 11%, and national accounts, up 4%.
Sales processed through the grainger.com web site were $115 million for the first quarter 2003, a 21% increase over first quarter 2002 sales of $95 million.
Net sales in Canada increased 11% during the first quarter of 2003 including the effect of a favorable Canadian exchange rate. In local currency, this business experienced a 5% increase due primarily to higher sales to the government and the petroleum industry.
Sales in Mexico were flat for the first quarter of 2003 when compared with the same period of the prior year. This performance reflects the continuing softness of the Mexico economy.
Lab Safety
First quarter 2003 net sales for Lab Safety were $71.5 million, a decrease of 2% when compared with $72.9 million for the same period in 2002. The continuing weakness in the manufacturing sector of the U.S. economy contributed to this decrease.
Integrated Supply
Net sales for the first quarter of 2003 for Grainger’s Integrated Supply division were $57.3 million, up slightly when compared with $57.2 million for the same period in 2002. The fee revenue component was down due to fewer customer locations. Sales for this business unit include product sales and management fees.
18
W.W. Grainger, Inc., and Subsidiaries
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
RESULTS OF OPERATIONS (Continued)
Company Net Earnings
The Company’s net earnings of $52.4 million in the first quarter of 2003 increased 52% compared with $34.5 million for the comparable 2002 period. The results for 2002 included the cumulative effect of a change in accounting principle of $23.9 million and after-tax gains on the sales of investment securities of $4.5 million. Excluding those items, net earnings were $54.0 million for the first quarter of 2002 compared to $52.4 million for the first quarter of 2003, and diluted earnings per share were $0.57 for both periods. This decrease in net earnings resulted primarily from the negative change in other income and expense in the first quarter of 2003 compared with the same period in 2002. Partially offsetting this decline were stronger operating earnings and the impact of a lower effective income tax rate.
Operating earnings increased 2% for the first quarter of 2003 compared with the same 2002 period. The improvement in operating earnings was primarily attributable to improved performance at Branch-based Distribution Businesses and lower corporate expenses, partially offset by reduced operating earnings at Lab Safety and at Integrated Supply.
Segment Operating EarningsThe following comments at the segment level include external and intersegment operating earnings. Comments at the business unit level include external and inter- and intrasegment operating earnings. For segment information, see Note 10 to the Condensed Consolidated Financial Statements included in this report.
Branch-based Distribution Businesses
Operating earnings of $91.0 million for the first quarter of 2003 increased 2% compared with operating earnings of $89.2 million in the first quarter of 2002. The improved operating performance was driven by improvement in Canada and Mexico, while the United States was down 1%.
The gross profit margin increased 0.71 percentage point from the comparable 2002 quarter. The improvement in gross profit margin was primarily attributable to selected pricing actions intended to cover freight and supplier cost increases, and to favorable product mix. Partially offsetting these improvements were higher freight costs.
Operating expenses were up 4% for the quarter, primarily the result of incremental costs related to the logistics project and increases in other payroll and benefits costs including increased health care costs.
19
W.W. Grainger, Inc., and Subsidiaries
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
RESULTS OF OPERATIONS (Continued)
Lab Safety
Lab Safety had operating earnings of $10.9 million for the first quarter of 2003, a decrease of 16% compared with operating earnings of $13.0 million for the first quarter of 2002. The operating earnings decrease was the result of lower sales, lower gross profit margins, and higher operating expenses. Gross profit margins were affected by higher freight costs and product mix. The operating expense increase was primarily due to higher health care costs and increases in the distribution of catalog media.
Integrated Supply
Integrated Supply had operating earnings of $1.1 million in the first quarter of 2003, a decrease of 28% compared with operating income of $1.6 million in the comparable period of 2002. The reduction in operating earnings was due to lower gross profit margins, the result of lower fee revenue. Operating expenses were down slightly but not enough to offset the decline in fees.
Other Income and ExpenseOther income and expense was $3.4 million of expense in the first quarter of 2003 compared with $8.8 million of income in the first quarter of 2002. The following table provides an analysis of the components of other income and expense:
Three Months Ended March 31,
----------------------------
(In thousands of dollars)
Other income and (expense): 2003 2002
----------- ------------
Interest (expense), net of interest income $ (662) $ (555)
Equity in losses of unconsolidated entities (1,055) (720)
Gains on sales of investment securities - 7,308
Unclassified-net
Gains on sales of fixed assets, net 137 2,820
Write-down of investments (1,614) -
Other (169) (75)
----------- -----------
Net other income and (expense) $ (3,363) $ 8,778
=========== ===========
Income Taxes
The Company’s effective income tax rate was 40.5% for the first quarter of 2003 and 40.8% for the same period in 2002. Excluding the effect of equity losses in unconsolidated entities, which are recorded net of tax, the effective income tax rate was 40.0% for 2003 and 40.5% for 2002. This change in the effective tax rate was primarily driven by lower non-deductible losses in Mexico and a lower tax rate in Canada.
20
W.W. Grainger, Inc., and Subsidiaries
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
LIQUIDITY AND CAPITAL RESOURCES
For the three months ended March 31, 2003, working capital increased by $51.7 million. The ratio of current assets to current liabilities was 2.6 at March 31, 2003 and 2.5 at December 31, 2002. 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 7.4% and 7.2% at March 31, 2003 and December 31, 2002, respectively. For the first three months of 2003, $19.8 million was expended for property, buildings, and equipment, and $2.0 million was expended for capitalized software, for a total of $21.8 million.
As of March 31, 2003, approximately 10 million shares of common stock remained under the Company’s current repurchase authorization, after the repurchase of 12,000 shares in the first quarter of 2003.
The Company had a contingent credit risk relating to certain guarantees of employee loans. As of March 31, 2003, 66 employees had loans outstanding to a bank aggregating $21.8 million, the largest of which was $4.4 million. Subsequent to March 31, 2003 all such loans had been paid. For additional information see Note 7 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 RESULTS OF OPERATIONS
FORWARD-LOOKING STATEMENTS
This document may contain forward-looking statements under the federal securities laws. Any forward-looking statement relates to the Company’s expected future financial results and business plans, strategies, and objectives and are not historical facts. 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.
22
W.W. Grainger, Inc., and Subsidiaries
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, 2002. | ||
| 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. | ||
23
W.W. Grainger, Inc., and Subsidiaries
PART II-OTHER INFORMATION
Items 1, 2, 3, and 5 not applicable.
|
Item 4. Submission of Matters to a Vote of Security Holders. |
||
| An annual meeting of shareholders of the Company was held on April 30, 2003. At that meeting: | ||
| a) | Management's nominees listed in the proxy statement pertaining to the meeting were elected directors for the ensuing year. Of the 77,536,098 shares present in person or represented by proxy at the meeting, the number of shares voted for, and the number of shares as to which authority to vote in the election was withheld, were as follows with respect to each of the nominees: | |
Shares Voted Shares as to Which Voting
Name for Election Authority Withheld
-------------------- ------------ -------------------------
B. P. Anderson 73,108,550 4,427,548
W. M. Clark 76,442,292 1,093,806
W. H. Gantz 75,687,700 1,848,398
D. W. Grainger 76,507,333 1,028,765
R. L. Keyser 76,146,547 1,389,551
F. A. Krehbiel 75,693,976 1,842,122
J. W. McCarter, Jr. 73,932,949 3,603,149
N. S. Novich 73,933,013 3,603,085
J. D. Slavik 76,195,229 1,340,869
H. B. Smith 73,930,306 3,605,792
J. S. Webb 75,694,808 1,841,290
| A proposal to ratify the appointment of Grant Thornton LLP as independent auditors of the Company for the year ended December 31, 2003 was approved. Of the 77,536,098 shares present or represented by proxy at the meeting, 75,673,265 shares were voted for the proposal, 1,379,633 shares were voted against the proposal, and 483,200 shares abstained from voting with respect to the proposal. |
| A proposal to amend the 2001 Long Term Stock Incentive Plan was approved. Of the 77,536,098 shares present or represented by proxy at the meeting, 69,477,470 shares were voted for the proposal, 7,361,941 shares were voted against the proposal, and 696,687 shares abstained from voting with respect to the proposal. |
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| Item 6. | Exhibits and Reports on Form 8-K | |||
| (a) Exhibits (numbered in accordance with Item 601 of regulation S-K) | ||||
| (10) | (a) | Summary Description of 2003 Management Incentive Program | ||
| (b) | 2001 Long Term Stock Incentive Plan, as amended, incorporated by reference to Appendix A of the Company's Proxy Statement dated March 21, 2003. | |||
| (11) | Computations of Earnings per Share | |||
| (99) | Additional Exhibits | |||
| (i) | Chief Executive Officer certification pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 | |||
| (ii) | 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 April 16, 2003, reporting under Item 9 thereof information included as exhibits to the report, consisting of a press release announcing financial results for the quarter ended March 31, 2003, and supplemental financial information for the quarter ended March 31, 2003. | ||||
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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.
Date: May 13, 2003
By:
/s/ P.O. Loux
P.O. Loux, Senior Vice President,
Finance and Chief Financial Officer
Date: May 13, 2003
By: /s/ J.E. Andringa
J.E. Andringa, Vice President
and Controller
26
CERTIFICATION
I, R. L. Keyser, certify that:
| 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. | |
Date: May 13, 2003
By: /s/ R. L. Keyser
Name: R. L. Keyser
Title: Chairman and Chief Executive Officer
27
CERTIFICATION
I, P. O. Loux, certify that:
| 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. | |
Date: May 13, 2003
By: /s/ P. O. Loux
Name: P. O. Loux
Title: Senior Vice President, Finance and
Chief Financial Officer
28
Exhibit 11
W.W. Grainger, Inc., and Subsidiaries
COMPUTATIONS OF EARNINGS PER SHARE
Three Months Ended March 31,
--------------------------
BASIC:
- ------ 2003 2002
------------ ------------
Weighted average number of shares outstanding 90,865,346 92,618,855
============ ============
Earnings before cumulative effect of accounting
change $ 52,404,000 $ 58,458,000
Cumulative effect of accounting change -- (23,921,000)
------------ ------------
Net earnings $ 52,404,000 $ 34,537,000
============ ============
Earnings per share before cumulative effect of
accounting change $ 0.58 $ 0.63
Cumulative effect of accounting change per share -- (0.26)
------------ ------------
Earnings per share $ 0.58 $ 0.37
============ ============
DILUTED:
- -------
Weighted average number of shares outstanding 90,865,346 92,618,855
Potential Shares:
Shares issuable under outstanding options 5,633,934 7,968,595
Shares which could have been purchased using
the proceeds from the options exercised,
based on the average market value for the
period (4,735,676) (6,152,990)
------------ ------------
898,258 1,815,605
Dilutive effect of exercised options prior to
being exercised 5,929 77,276
------------ ------------
Shares for the portion of the period that the
options were outstanding 904,187 1,892,881
Contingently issuable shares 815,220 916,395
------------ ------------
1,719,407 2,809,276
------------ ------------
Adjusted weighted average number of shares
outstanding 92,584,753 95,428,131
============ ============
Earnings before cumulative effect of accounting
change $ 52,404,000 $ 58,458,000
Cumulative effect of accounting change -- (23,921,000)
------------ ------------
Net earnings $ 52,404,000 $ 34,537,000
============ ============
Earnings per share before cumulative effect of
accounting change $ 0.57 $ 0.61
Cumulative effect of accounting change per share -- (0.25)
------------ ------------
Earnings per share $ 0.57 $ 0.36
============ ============
29