W.W. Grainger, Inc.
Q2 2011 Earnings Call Transcript

Published: 19 Jul 2011

[Laura Brown:]

Hello, this is Laura Brown, senior vice president of communications and investor relations. With me is Bill Chapman, director of investor relations. We are pleased to share with you an update regarding Grainger's second quarter 2011 results via this audio webcast. Please also reference our 2011 second quarter earnings release issued July 19 in addition to other information available 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 risk and uncertainty. Please see our Form 10-K for a discussion of factors that relate to forward looking statements. Strong sales growth, consistent execution, and impressive gross margin expansion was the story for the quarter. We are very pleased with our continued ability to gain share due to expanding our product line, our sales force, ecommerce capabilities, onsite services, and our international operations. As a result of the strong year-to-date performance, we have raised our full year sales and EPS guidance. We now expect sales to grow 9% to 10% and are forecasting EPS in the range of $8.40 to $8.70 for the full year 2011, excluding unusual items. Please note that our guidance reflects tougher comparisons on the top line, continued strong gross profit margins, and higher growth-related spending in the back half of the year. At the end of this recording, we'll talk in more detail about our revised guidance and our assumptions. We'll start with total company results, then dig deeper into our segments. Company sales increased 12% versus the 2010 second quarter. We had the same number of selling days this quarter as 2010, so reported sales growth and daily sales growth were the same. Operating earnings increased 23% while net earnings increased 32%. As highlighted in our release, earnings per share of $2.34 for the quarter is an all-time company record and represents a 35% increase versus 2010. There was an unusual item in both the 2011 and the 2010 second quarters. The 2011 quarter included a $0.12 per share benefit, primarily from the settlement of tax examinations for 2007 and 2008. As mentioned previously, please note that this $0.12 per share tax benefit is not included in our guidance. The 2010 second quarter included an $0.08 per share benefit from the change in the company's paid time off, or PTO, policy. Additional details can be found in the second quarter earnings releases for 2011 and 2010. In a few moments, we'll take a closer look at sales results for the quarter. Let's now walk down the operating section of the income statement. Gross profit margins increased to 43.1%, up 120 basis points versus last year, as we were successful expanding gross margins in the United States, Canada, and our other businesses. Our size and scale gives us considerable advantage versus other distributors when it comes to effectively managing product cost inflation. Once again, this quarter, we were able to increase prices in line with the market and ahead of product cost inflation. We'll provide more detail when we review the business by segment. Gross profit margins generally follow a fairly consistent seasonal pattern with lower gross margins in the second and third quarters than in the first quarter. As a reminder, supplier funding for our annual customer trade shows was a major contributor to the 44% gross margin reported in the 2011 first quarter. Reported company operating earnings for the quarter increased 23%, while operating margins were 13.2%, up 120 basis points versus the prior year. If you exclude the $10 million benefit in 2010 from the PTO change, operating earnings were up 30% and operating margins were up 180 basis points. This strong performance was driven by the 12% sales growth, the 120 basis point improvement in gross profit margins, and positive expense leverage, excluding the PTO benefit. Strong execution across the board in the United States, Canada, and the other businesses contributed to this impressive performance. Let's now focus on performance drivers during the quarter. In doing so, we'll cover the following topics. First, sales by segment in the quarter and the month of June. Second, our operating performance by segment. Third, cash generation and capital deployment. And finally, we'll wrap up with a discussion of our revised 2011 guidance and other key items of interest. As mentioned earlier, sales for the company increased 12% for the quarter. Daily sales growth by month was as follows

[Bill Chapman:]

Thanks Laura. Since we have already covered company opening performance, let's jump right into performance by segment. Reported operating earnings in the United States increased 17% in the 2010 second quarter and operating margins increased 120 basis points to 16.6%. If you exclude the benefit from the PTO change in 2010, operating earnings in the United States increased 22% and operating margins expanded 180 basis points versus the prior year. This performance was driven by 9% sales growth and a higher gross profit margin. Gross profit margins in the United States increased 120 basis points. The gross margin expansion was primarily due to an effective product cost management and the ability to raise prices with the market and ahead of product cost increases. Operating expenses grew in line with sales for the quarter and were up 6% excluding the PTO benefit from the prior year. Let's move on to our business in Canada. At the end of the 2010 fourth quarter, we shared with you the plan for improving performance. We're happy to report that we continued to make substantial progress in the 2011 second quarter as operating earnings increased 130% versus the prior year. Strong sales growth, coupled with higher gross profit margins and tight cost controls contributed to operating margins jumping 530 basis points to 11.4%. The gross margin expansion in Canada was driven by a number of factors, including product cost deflation tied to the tailwind created by the strength of the Canadian dollar. A first quarter price increase, less price discounting and a more favorable customer mix also contributed to the growth in gross profit margins in the second quarter. Having reached the anniversary of actions taken last year to improve gross margins, we are expecting roughly 25 to 50 basis points of year over year in the back half of the year. In the second half of 2011, we will be filling a number of of open volume-related positions and will be opening a new distribution center in Saskatchewan. As a result, we expect to generate about 150 to 200 basis points of year over year operating expense leverage in the back half of the year in Canada. Operating performance in the quarter for our other businesses was impressive, the direct result of our focus on driving growth and improving profitability. This group posted operating earnings of $8.6 million for the quarter versus $1.9 million a year ago. Strong operating performance in Japan and Mexico led the improved results for this group. The effective tax rate for the quarter was 35.0% versus 39.1% in 2010, mainly due to the 12% per share benefit primarily related to the settlement of tax examinations for 2007 and 2008. Excluding this benefit, the effective tax rate is now expected to be 38.7% for the full year due to higher earnings forecasted in foreign jurisdictions with lower tax rates and a slightly lower overall effective state income tax rate. Lastly, let's take a look at cash flow for the quarter. Operating cash flow was $190 million versus $173 million in 2010. The growth in accounts receivable resulted in a slight drag on cash flow for the quarter. This increase was greater than the growth in sales due to a postal strike in Canada and the timing of quarter end, both temporarily influencing the timeliness of cash processing. We used the cash generated during the quarter to invest in the business and return capital to shareholders through dividends. Capital expenditures for the quarter were $52 million. Dividends paid to shareholders were $47 million, representing the 22% increase in the quarterly dividend rate announced in April. The company did not buy back any stock during the quarter, and has approximately 7.7 shares remaining on its share repurchase authorization. As reported in our second quarter earnings release, we raised both sales and earnings per share guidance for the full year 2011. We expect sales growth in the range of 9-10% and earnings per share in the range of $8.40 to $8.70. Company guidance does not include the $0.12 per share benefit, primarily from the settlement of tax examinations for 2007 and 2008. So let's take a look at the underlying elements of our expectations. First, as we have consistently communicated sales comparisons in the back half of the year are more difficult, in part due to sales related to the oil spill cleanup in 2010. Oil spill related sales added 3% to the 19% daily sales growth in the 2010 third quarter 2010 and 2% to the 14% daily sales growth in the fourth quarter of 2010. Additional detail can be found on the exhibits at the end of this podcast script. Second, we expect gross profit margins in the third and fourth quarters to be similar to the 2011 second quarter, with some slight price erosion as the year goes on, which is typical. As a reminder, supplier funding for our customer trade shows in March made the 44% gross profit margin it 2011 first quarter different for the rest of the year. Third, our investments in proven growth drivers, such as new sales representatives, ecommerce, and advertising will continue to accelerate throughout the year. In fact, we expect to add more than double the number of new sales representatives in 2011 than originally planned, going from 150 to 300 new hires. We're also stepping up the pace of our ecommerce and advertising investments. The opening of our new 800,000-square foot superregional distribution center in Northern California in the 2011 fourth quarter will also result in additional operating expense. For the full year about $60-70 million in growth related spending should spread as follows