W.W. Grainger, Inc.
Q3 2012 Earnings Call Transcript

Published: 16 Oct 2012

[Laura D. Brown:]

Hello. This is Laura Brown, Senior Vice President of Communications and Investor Relations. With me is Bill Chapman, Senior Director of Investor Relations. We will share with you some information regarding Grainger's Third Quarter 2012 Results via this audio webcast. Please also reference our 2012 third quarter earnings release issued today, October 16, 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. Before I discuss the quarter, I'd like to first highlight the $0.66 per share reserve for the expected settlement with the U.S. Department of Justice, which includes the following 2 parts

[William D. Chapman:]

Thanks, Laura. Since we've already analyzed company operating performance, let's jump right into performance by reporting segment. Again, we have excluded the $0.66 per share charge described at the beginning of this podcast. Operating earnings in the United States increased 7% versus the 2011 third quarter, and the U.S. operating increased 50 basis points to 18.2%. This performance was driven by 4% sales growth and higher gross margins. Gross profit margins for the quarter increased 50 basis points, driven by price increases exceeding cost inflation, partially offset by unfavorable customer mix. Operating expenses increased in line with the sales increase and were primarily driven by $19 million in incremental growth-related spending on areas such as new sales representatives, e-commerce and advertising. Let's move on to our business in Canada. Operating earnings increased 37% versus the prior year, up 38% in local currency. Strong sales growth, coupled with higher gross profit margins, and positive expense leverage, contributed to operating margins increasing 240 basis points to 12.5%. Gross margins increased 140 basis points, with roughly 2/3 of the expansion coming from the timing of supplier rebates and advertising credits. Operating performance for our Other Businesses declined versus a year ago, posting operating earnings of $9 million for the quarter versus $11 million in 2011. Strong performance improvement in Japan and Mexico was partially offset by losses from the acquired businesses in Europe and Brazil, along with losses at some of our startup businesses in developing markets. The operating loss in Europe was primarily driven by lower sales tied to the economy and lower gross margins related to unfavorable customer mix. Contributing to the loss in Europe were adjustments tied to the completion of the purchase price allocation. In Brazil, continued investments in expanding the sales force and product offering contributed to a small operating loss from this newly acquired business. Below the operating line, interest expense, net of interest income, was $4 million in the 2012 third quarter versus $2 million in the 2011 third quarter. This increase was primarily due to higher average debt outstanding and higher average interest rates in 2012 versus 2011. In addition, interest expense adjustments related to capital leases for the acquired business in Europe also contributed to the increase in 2012. The effective tax rate for the 2012 third quarter was 37.1% versus 38.7% in 2011. The lower rate was primarily due to higher earnings in foreign jurisdictions with lower tax rates and a lower blended state tax rate. As a reminder, we continue to expect the effective tax rate for the full year 2012 to be in the range of 37.4% to 37.7%. Lastly, let's take a look at cash flow for the quarter. Operating cash flow was $338 million versus $251 million in 2011. We used the cash generated during the quarter to invest in the business and return cash to shareholders through share repurchase and dividends. Capital expenditures for the quarter were $59 million versus $47 million in 2011. We paid dividends of $57 million in the quarter, reflecting the 21% increase in the quarterly dividend announced in April of this year. In addition, we bought back 421,000 shares of stock for $85 million and ended the quarter with 5.6 million shares remaining on our share repurchase authorization. In total, we returned $142 million to shareholders in the quarter. On July 18, 2012, in our second quarter earnings podcast, we indicated that if economic growth slows and/or the dollar continues to strengthen, the lower end of our sales range is more probable than the higher end. As reported in our 2012 third quarter earnings release, we slightly lowered and narrowed our 2012 sales guidance to a new range of 11% to 12% growth. At the same time, we reiterated our 2012 earnings per share guidance of $10.50 to $10.80. Let's look more closely at the underlying elements of our current expectations. First, we are forecasting daily sales growth of 6% to 9% in the fourth quarter. While we gain an extra selling day in the 2012 fourth quarter versus the 2011 quarter, the holiday calendar will be working against us in December. Both Christmas and New Year's Day fall on Tuesdays. So we will be open for business on Monday, December 24, and Monday, December 31, but are forecasting a minimal sales contribution on either day. Second, our gross profit margin for the fourth quarter should approximate the 43.6% reported for the 2012 third quarter. Third, we are forecasting strong operating margin expansion in the 2012 fourth quarter as we lap heavy investment spending in the prior year quarter. The absolute level of spending should be on par with growth spending in the 2012 third quarter and relatively small on an incremental basis versus the fourth quarter of 2011. Fourth, while our business in Canada posted strong performance in the 2012 third quarter, we are forecasting more moderate sales growth and margin expansion in the 2012 fourth quarter. Going forward, we will be investing in the foundational elements of the business, namely supply chain and information technology to support the impressive growth of this $1 billion business. In addition, we'll also begin to invest in growth drivers to accelerate market share gains primarily in Eastern Canada, which represents nearly 70% of the country's market opportunity. Fifth, the performance of our Other Businesses should continue to be driven primarily by Japan and Mexico. Conversely, we expect both Europe and Brazil to be slightly dilutive in the 2012 fourth quarter. Sixth, we expect foreign exchange to be a slight headwind on both the top and bottom lines in the fourth quarter. Finally, our 2012 guidance assumes an effective tax rate of 37.4% to 37.7% for the full year. In conclusion, we remain confident in our strategy to gain share and extend our leadership position in the large and fragmented MRO market. We will continue to invest in what matters to our customers, more products and services, more sales coverage and enhanced e-commerce capabilities, to provide outstanding customer service. At the same time, we will continue to drive margin expansion by growing our private label program and harvesting productivity through our continuous improvement programs, all with the objective of delivering solid returns to shareholders. Thank you for your interest in Grainger. Please mark your calendar for the release of October sales on Monday, November 12, and our Annual Analyst Meeting on November 14. If you have any questions, please do not hesitate to contact Laura Brown at [phone] or me at [phone]. Thank you.