W.W. Grainger, Inc.
Q4 2009 Earnings Call Transcript

Published: 26 Jan 2010

[Ernest Duplessis:]

Hello, this is Ernest Duplessis, 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 and full-year 2009 results via this audio webcast. This recording is intended to provide you with more information related to our recent performance. Please also reference our 2009 fourth quarter and full-year earnings release issued January 26, in addition to other information on our Investor Relations web site 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 risk and uncertainty. Please see our Form 10-K for a discussion of factors that relate to forward-looking statements. Let’s begin by summarizing our full-year 2009 results. Sales of $6.2 billion were down 9% versus 2008. Net earnings decreased 9% and earnings per share decreased 6% to $5.62 versus $5.97 in 2008. Over the next 25 minutes, we want to explain in more detail how we achieved these results and give you some idea of what we’re seeing and expecting for 2010. Taking a closer look at the income statement for the year, gross profit margins increased about 80 basis points to 41.8%. Operating margins decreased approximately 70 basis points to 10.7%. The decrease in operating margins for the year were mainly driven by the 9% sales decline for the year and operating expenses, which declined at a slower rate than sales. For comparability, it is important to note that our earnings per share of $5.62 for the year 2009 included a non-cash gain of $0.37 in the third quarter from the step-up of our investment in our Japanese business, MonotaRO. If you exclude this one-time gain of $0.37, EPS for 2009 was $5.25. As mentioned in our earnings release, there were also some severance and impairment charges taken throughout the year. As we continue to examine ways to improve our cost structure and address underperforming assets, you may see charges like these continue in 2010. Let’s now focus on our 2009 fourth quarter results. Sales of $1.6 billion were up 3% versus last year’s fourth quarter. In a few moments, we will address some of the factors that contributed to our sales performance. Operating earnings, however, decreased 8% and net earnings decreased 10%. Bill will discuss some of the factors in the operating earnings performance shortly. Let’s take a look at what went into earnings per share for the quarter. Overall, EPS decreased by 7% to $1.27. This was impacted by a couple of significant items. First, during the quarter, the company closed 12 branches which, along with other asset write-downs, resulted in the company recognizing asset impairment charges of $9 million or $0.07 a share. Second, the company reduced headcount by more than 200 positions in the fourth quarter, incurring a $7.5 million or $0.05 per share charge for severance. Fourth quarter EPS were $1.39 excluding these items, versus $1.37 in the prior year. Let’s now focus on performance drivers during the quarter. In doing so, we’ll cover the following topics

[Bill Chapman:]

Thanks, Ernest. Fourth quarter operating earnings for the company decreased by 8% versus the 2008 fourth quarter. This decline was the result of an 80 basis point decrease in gross margins, primarily due to unfavorable mix of lower gross margins from the newly consolidated businesses in Japan and India. Operating expenses increased by 4% for the quarter. This was driven by a number of factors including $9 million in asset write-downs and $7.5 million in severance charges mentioned earlier. Company operating margin was 10.1%. Let’s now take a look at operating performance by segment. Operating earnings in the United States were down by 6% versus the 2008 fourth quarter. Operating margins declined by 60 basis points to 13.1%. Gross profit margins remained unchanged at 42.7%. In Canada, operating earnings were up 59% versus the 2008 fourth quarter. The improvement was the result of increased sales, a 90 basis point improvement in gross profit margins, and operating expenses which increased at a slower rate than sales. The improvement in gross margins was attributable to favorable inventory adjustments. The 2008 fourth quarter included a $2 million charge for the bankruptcy of a provider of freight payment services. Excluding these items, operating earnings were up 6% in U.S. dollars versus 2008. Operating losses for other business were $3 million in both 2009 and 2008 quarters. India, Panama and China were primary drivers of the losses, with Japan reporting net income. Lastly, let’s take a look at our operating cash flow. Operating cash flow for the quarter was $223 million versus $195 million in 2008. The full-year 2009 operating cash flow was $732 million, the strongest in company history. Cash allocated to capital expenditures was $53 million in the quarter and $142 million for the year. For the full year, the company returned $507 million in cash to shareholders in the form of dividends and share repurchases. The company bought back 2.5 million shares in the fourth quarter and 4.5 million shares for the year. As reported in our fourth quarter 2009 earnings release, we raised both sales and earnings guidance for 2010. We now expect sales growth in the range of 6% to 10% and EPS in the range of $5.40 to $5.90. Keep in mind that we expect about 3 percentage points of the top line growth to come from acquisitions and that the earnings drop-through in the initial year is less than company average. I won’t repeat what we said at the Analyst Meeting here, but 2010 is a transition year as we move from being a minority owner to a majority owner of the business in Japan. Also, let me emphasize that we now expect 100 to 200 basis points of top line growth coming from foreign exchange. The earnings drop-through for foreign exchange is about $0.01 to $0.02 of earnings per share, which is lower than what you would expect from a 1% to 2% increase in organic sales. The question you may be asking is, “so what has changed since mid-November when Grainger initially unveiled guidance for 2010?” First, we finished the year stronger than originally expected. Sales for the quarter were up 3%, versus our forecast of down 2% to up 1%. About 1 to 2 percentage points of that outperformance came from a larger contribution from foreign exchange. Second, the forecast for both Industrial Production and GDP has improved modestly. In November, 2010 IP was forecasted to be up 4.2%. Today, that forecast has moved to 4.4%. The same is true for GDP. In November, we were expecting 2010 GDP growth of 2.7%. Today, that has moved up to 2.9% growth. However, we remain cautious because job growth is expected to lag the recovery and we believe our growth is, in part, tied to non-farm payrolls. In terms of modeling 2010, here are a few things to consider