W.W. Grainger, Inc.
Q4 2008 Earnings Call Transcript

Published: 26 Jan 2009

[Laura Brown:]

Hello, this is Laura Brown, Vice President of Investor Relations. Joining me is Bill Chapman, Director of Investor Relations. We are pleased to be sharing with you today Grainger's fourth quarter results as of December 31, 2008 via this audio webcast. This recording is intended to provide you with more information related to our recent performance. Please also reference our 2008 fourth quarter and full year earnings release issued January 26th in addition to other information on our Investor Relations website to supplement this webcast. Before we begin, please remember that certain statements and projections of future results made in the press release and in this webcast constitute forward-looking information. These statements are based on current market conditions and competitive and regulatory expectations and involve risks and uncertainty. Please see our Form 10-K for a discussion of factors that relate to forward-looking statements. Let's begin by taking a look at our full year 2008 results. Sales, net earnings and earnings per share were all records for Grainger. Sales of $6.9 billion were up 7% versus 2007. There was one extra selling day in the year versus 2007, so sales were up 6% on a daily basis. Net earnings increased 13% versus 2007 and earnings per share of $6.04 increased 22% versus $4.94 in 2007. Taking a closer look at the income statement for the year, gross profit margins increased about 40 basis points to 41%. Operating margins increased almost 100 basis points to 11.4%. Consistent with our guidance, the operating margin expansion was driven y a near equal mix of improved gross margins and operating expense leverage. For comparability, it is important to note that our record earnings per share of $6.04 for the year 2008 included the following items

[William D. Chapman:]

Thanks, Laura. Fourth quarter operating earnings for the company increased by 8% versus the 2007 fourth quarter. This improvement came entirely from the Grainger Branch-based segment. This increase was the result of improved gross margins through positive inflation recovery and operating expense leverage, despite the 1% decline in sales. Let's now take a look at operating performance by segment. Operating earnings for the Grainger Branch-based businesses increased 13% versus the 2007 fourth quarter. Operating margins increased 170 basis points to 14%. This operating margin expansion was primarily the result of a 120 basis point improvement in gross margins combined with operating expense leverage. Operating expenses as a percent of sales declined by about 50 basis points. Our expense leverage was aided by lower advertising, sales commissions, bonus, employee benefits and severance costs, along with a reduction in the company's bad debt reserve due to better collection efficiency. In addition, gains on the sale of real estate related to the market expansion program partially offset operating expenses for the quarter by $4.6 million versus $1.8 million in the 2007 fourth quarter. Pre-tax ROIC for the Grainger Branch-based segment increased 200 basis points for the year to 38.7% versus 36.7% in 2007, primarily reflecting the improvements in operating performance. Let's move on to the Acklands-Grainger Branch-based segment, where operating earnings decreased 14% for the quarter due to the negative effects of foreign currency. In Canadian dollars, operating earnings were up 5% versus last year's fourth quarter. This was the result of strong sales growth and higher gross profit margins, partially offset by higher operating expenses. In U.S. dollars, operating expenses included a $2 million reserve for a potential loss due to the bankruptcy of a freight payment processor. Also in U.S. dollars, operating margins in Canada decreased 80 basis points to 7.7% for the quarter versus 2007. For the full year, operating margins increased 50 basis points to 7.5% versus 7.0%. Pre-tax ROIC improved 140 basis points to 14.3% in 2008 versus 12.9% a year ago. We continue to be pleased with operational improvements in our Canadian business. Operating earnings for the Lab Safety segment decreased by 57% for the fourth quarter versus 2007. The decline in higher-margin core Lab Safety sales drove gross profit margins lower. Highsmith integration expenses also negatively affected performance. A combined leadership team with the Branch-based business in the United States was established in mid-December and integration efforts are just getting under way. Let's cover a few more items which affected results for the quarter. Higher interest expense represented a drag on earnings versus the prior year. In May of 2008 the company obtained a four-year term loan of $500 million. As a result of this loan, the company had $3.5 million in net interest expense in the quarter versus $200,000 in net interest expense in the 2007, representing a $3.3 million negative swing. The effective tax rate for the 2008 fourth quarter was 37.9% versus 38.1% in the 2007 quarter. Excluding transactions related to equity earnings in unconsolidated entities and the joint venture writedown, the effective tax rate was 36.7% and 38.5%, respectively. The lower effective tax rate for the 2008 fourth quarter was primarily the result of a lower weighted average state tax rate and increased deductibility of executive compensation expenses. For 2009 we are estimating the effective tax rate to be approximately 38.9% excluding the effect of equity in net income of unconsolidated entities. Lastly, let's take a look at cash flow. Operating cash flow was $195 million for the quarter and $530 million for the year. For 2008, we used our strong cash flow to fund growth initiatives through capital expenditures of $195 million. We also returned cash to shareholders through $394 million in share repurchases and $122 million in dividends. In November, we gave annual sales guidance of negative 5% to plus 5%, and since then macroeconomic trends have deteriorated. Based on our sales run rate in January, we are somewhat below the low end of the range, so we are implementing actions now for weaker sales. At this time we are not in a position to provide 2009 annual sales and earnings guidance due to economic uncertainty and a lack of visibility beyond mid-January. To conclude, we are pleased about the results for the quarter, particularly given the weakening economy, with operating earnings up 8% and earnings per share up 9% or up 15% excluding the $0.08 charge. Going forward we are encouraged about our opportunity to continue to serve customers and gain market share despite the challenging and uncertain times. Thank you for your interest in Grainger. Please mark your calendar for the release of January sales on Wednesday, February 11th. If you have any questions, please do not hesitate to contact Laura at 847535-0409, Nancy Hobor at 8475350065, or me at 847535-0881.