W.W. Grainger, Inc.
Q4 2012 Earnings Call Transcript

Published: 24 Jan 2013

[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. The purpose of this podcast is to provide you with additional information regarding Grainger's fourth quarter 2012 results. Please also reference our 2012 fourth quarter earnings release issued today, January 24, 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. Today, we reported record results for the year 2012 and reiterated our earnings per share guidance for 2013. We'll discuss 2012 in more detail, as well as comment on January's strong sales start. At the very end of December, we experienced a dramatic slowdown in sales, contributing to quarterly performance that was below our guidance. In addition, there were 3 items included in our quarterly results that were not part of our November 14, 2012, earnings guidance

[William D. Chapman:]

Thanks, Laura. Since we've already analyzed company operating performance, let's jump right into performance by reporting segment. Operating earnings in the United States increased 17% versus the 2011 fourth quarter, and the U.S. operating margin increased 160 basis points to 16.2%. Excluding $10 million and $18 million in charges during the 2012 and 2011 quarters, operating earnings increased 12%,, and the U.S. operating margin increased 110 basis points to 16.8%. This performance was driven by the 5% sales growth, higher gross profit margins and positive expense leverage. 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 grew at a slower rate than sales and included $1 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 2% versus the prior year, down 2% in local currency. The increase in operating earnings was driven by favorable foreign exchange and modest expense leverage, partially offset by lower gross profit margins. Gross margins in Canada decreased 150 basis points versus the prior year. The decline was primarily due to unfavorable customer and product sales mix. Lower gross margins and higher operating expenses contributed to a 130 basis point decline in operating margins to 10.7%. Operating performance for our Other Businesses declined versus a year ago posting a loss of $10.4 million for the quarter versus operating earnings of $5 million in 2011. During the quarter, we decided to implement the following structural changes to the businesses in Europe, India and China to improve long-term performance, resulting in $13.7 million in restructuring charges. In Europe, we closed 6 underperforming shops and reduced headcount to better align the business with the weak economy in Western Europe. In India and China, we are streamlining these businesses by narrowing the product offering and by reducing headcount. Excluding these charges, the Other Businesses would have generated $3.3 million in operating earnings in the 2012 fourth quarter. This performance was primarily driven by the businesses in Japan and Mexico, partially offset by modest operating losses from the businesses in Brazil and Europe before the restructuring charges. Below the operating line, the 2012 fourth quarter had $5 million in other expense versus $5 million in other income for the 2011 fourth quarter. This rounds to a $9 million negative swing that was primarily due to an $8 million gain on the sale of our 49% ownership in MRO Korea that was recognized in the 2011 fourth quarter. In addition, interest expense net of interest income was $5 million in the 2012 fourth quarter versus $2 million in the 2011 quarter. The increase in interest expense was related to higher average borrowings, higher interest rates and capital leases for the acquired business in Europe. For the quarter the effective tax rate in 2012 was 37.6% versus 32.9% in 2011. The fourth quarter of 2011 included a benefit from the tax law change in Japan. For the year, the effective tax rate in 2012 was 37.5% versus 36.6% in 2011. In addition to the 2011 fourth quarter favorability, the company settled various tax reviews providing further benefit to the 2011 effective tax rate. Excluding these benefits in 2011, the effective tax rate was 38.1%. The effective tax rate in 2012 benefited primarily from a lower blended state tax rate. The company is currently projecting an effective tax rate of 37.3% to 37.7% for the year 2013. Lastly, let's take a look at cash flow for the quarter. Operating cash flow was $240 million versus $186 million in 2011. We used the cash generated during the quarter to invest in the business, fund an acquisition and return cash to shareholders through share repurchase and dividends. Capital expenditures for the quarter were $95 million versus $66 million in 2011. We paid dividends of $58 million in the quarter, reflecting the 21% increase in the quarterly dividend announced in April of 2012. In addition, we bought back 228,000 shares of stock for $44 million and ended the quarter with 5.3 million shares remaining on our share repurchase authorization. In total, we returned $102 million to shareholders in the quarter. At our Analyst Meeting in November, we issued sales and earnings guidance for 2013. Today, we reiterated that earnings per share guidance of $10.85 to $12 reflecting confidence in our strategy and industry-leading service. We also raised the 2013 sales guidance to a new range of 3% to 9% growth to reflect the increase in sales from the December 31, 2012, acquisition of Techni-Tool, Inc., which had sales in 2011 of $88 million. Here are a few additional considerations as you refine your models. For the first quarter 2013, the sales comparison in the 2013 first quarter is the most difficult of the year. We reported 16% sales growth in the 2012 first quarter. Second, we lose a selling day in the 2013 first quarter as we will have 63 selling days in 2013 versus 64 in 2012. Good Friday falls in the 2013 first quarter. In 2012, the Easter holiday fell in the second quarter. Business typically slows around the Easter holiday with Good Friday representing a very light day. Finally, the company's annual trade shows held in the first quarter typically result in gross profit margins and operating expenses that are about 100 basis points above the run rate for the full year. For the full year 2013, sales comparisons get easier as we move through the year. We also anniversary the acquisition in Brazil in May of 2013. Incremental growth spending in 2013 versus 2012 is still estimated to be $135 million, plus or minus $25 million, depending on sales volume. And finally in aggregate, we are expecting 10 to 60 basis points of operating margin expansion versus 13.8% for 2012 after adjustments. Cost leverage should be better than our original forecast, while gross margin expansion will be muted by the addition of Techni-Tool. In conclusion, we remain confident in our strategy to gain share and extend our leadership position in the large and fragmented MRO market. Thank you for your interest in Grainger. Please mark your calendar for the release of January sales on Tuesday, February 12. If you have any questions, please do not hesitate to contact Laura Brown at [phone]; or me, at [phone]. Thank you.