W.W. Grainger, Inc.
Q1 2013 Earnings Call Transcript

Published: 16 Apr 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 first quarter 2013 results. Please also reference our 2013 first quarter earnings release issued today, April 16, in addition to other information available on our Investor Relations website to supplement this podcast. Before we begin, please remember that certain statements and projections of future results made in the press release and in this podcast 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 results for the 2013 first quarter and raised our 2013 sales and earnings guidance. We raised the low end of the guidance ranges to reflect the solid start to the year and account for an increase in growth spending. We now expect sales to grow 5% to 9% and are forecasting EPS of $11.30 to $12 for the full year 2013. At the end of this recording, we'll talk more about our revised guidance and assumptions. Company sales for the quarter increased 4% versus the 2012 first quarter, 6% on a daily basis. We had 63 selling days in the quarter, 1 less than the previous year. Operating earnings and net earnings increased 13%. Earnings per share were $2.94 for the quarter, an increase of 14% versus the 2012 first quarter. Let's now walk down the operating section of the income statement in more detail. Gross profit margins increased 80 basis points to 45.2% versus 44.4% in 2012, primarily driven by the United States segment. Company operating margin increased 120 basis points to 15.1% versus 13.9% a year ago. The earnings growth was driven by the 4% sales increase and operating expenses growing at a slower rate than sales. Operating expenses increased 3%, including $22 million in incremental growth-related spending versus the 2012 first quarter. These growth investments include additional sales coverage, eCommerce, advertising, IT systems and expansion of the company's distribution center network. We took a cautious approach to spending in the 2013 first quarter given the uncertainties surrounding the threat of the fiscal cliff at the end of December. Given a modestly improving economic backdrop and solid performance in the quarter, we are increasing the estimated amount of incremental growth-related spending to $160 million for the year. We had originally forecasted $135 million in incremental growth-related investment in 2013, but also bracketed this number with $25 million on either side based on sales growth. We view our commitment to a higher growth spending as an example of our leadership in the MRO industry and an attractive opportunity to gain market share over the long term. Let's now focus on performance drivers during the quarter. In doing so, we'll cover the following topics

[William D. Chapman:]

Thanks, Laura. Since we've already analyzed company operating performance, let's jump right into performance by reportable segment. Operating earnings in the United States increased 11% versus the 2012 first quarter, while the operating margin increased 110 basis points to 18.7%. This performance was driven by the 4% sales growth, higher gross profit margins and positive operating expense leverage. Gross profit margins for the quarter increased 80 basis points driven by price increases exceeding cost inflation and growth of private label products, partially offset by unfavorable selling mix. Operating expenses grew at a slower rate than sales and included $20 million in incremental growth-related spending on areas such as new sales representatives, eCommerce and advertising. Let's move on to our business in Canada. Operating earnings increased 11% versus the prior year in both U.S. dollars and local currency. The improvement in operating performance was driven by higher sales and positive operating expense leverage, despite an incremental $2 million in growth-related spending. Gross margins in Canada were essentially flat versus the prior year. The 4% growth in sales and lower operating expenses contributed to a 70 basis point increase in the operating margin to 11.6%. The Other Businesses generated $8 million in operating earnings in the 2013 first quarter versus $11 million in the 2012 first quarter. The decline in earnings performance for the quarter versus the prior year was primarily driven by operating losses for the acquired business in Brazil and lower earnings for some of the smaller businesses in Asia and Latin America. The earnings decline was partially offset by strong earnings growth in Japan and operating earnings growth in Europe, related to lower expenses from restructuring actions taken in the 2012 fourth quarter. Below the operating line, interest expense, net of interest income, was $2.3 million in the 2013 first quarter versus $2.5 million in the 2012 first quarter. For the quarter, the effective tax rate in 2013 was 37.3% versus 37.4% in 2012. The company is currently projecting an effective tax rate of 37.3% to 37.7% for the full year 2013. Lastly, let's take a look at cash flow for the quarter. Operating cash flow was $176 million, up 66% versus $106 million in 2012. Cash flow in the 2013 quarter benefited from higher earnings, lower inventory purchases and a lower management incentive payout versus the prior year. We used the cash to invest in the business and return cash to shareholders, share repurchase and dividends. Capital expenditures for the quarter were $43 million versus $41 million in 2012. We paid dividends of $57 million reflecting the 21% increase in the quarterly dividend announced in April of 2012. In addition, we bought back 315,000 shares of stock for $70 million and ended the quarter with 5.0 million shares remaining on our share repurchase authorization. In total, we returned $127 million to shareholders in the quarter. As reported in our 2013 first quarter earnings release, we raised the low end of our 2013 sales guidance by 2 percentage points, and we increased the low end of our 2013 earnings per share guidance by $0.45. We now expect 5% to 9% sales growth and earnings per share of $11.30 to $12. Let's look more closely at the underlying elements of our current expectations. Let's begin with sales. The new guidance range for daily sales growth implies roughly 5% to 10% daily sales growth for the remainder of the year. In the absence of any material changes in the economy, we expect reported daily sales growth to accelerate slightly through the year, driven by contributions from our growth programs and easier comparisons. We anniversary-ed the Brazil acquisition in May of 2013. We have 1 additional selling day in the 2013 third quarter, although selling days for the full year are equal to 2012. And we are now forecasting a range of negative 1 to 0 percentage points related to foreign exchange. Moving on to gross profit margins. We are forecasting gross margin expansion of 20 to 30 basis points for the full year. Gross profit margins in the second quarter should be above last year's second quarter, but below the 2013 first quarter. Consistent with prior years, the first quarter included supplier support provided for our annual customer trade shows. As a result, both gross profit and operating expenses, as a percent of sales, are inflated by about 100 basis points. Unlike 2012, we are not expecting any interim price increases for the remainder of the year given the low inflation environment for commodities. We're also expecting that stronger sales growth to large customers with lower pricing will create headwinds, particularly in the back half of the year. Operating expenses should generate 20 to 30 basis points of cost leverage for the full year. Incremental growth-related spending of $160 million for the year will accelerate and will drive sequential increases in operating expenses for the remaining 3 quarters. Roughly 40% of the incremental growth spending will occur in the front half of the year with the remaining 60% hitting in the second half. Work is underway to build out a new enterprise system for the businesses in Canada and Mexico. Costs for the project are back-end loaded, but could affect 2013 operating margins in Canada by 50 to 100 basis points, depending on the pace of spending. We expect 40 to 60 basis points of operating margin expansion for the full year versus 2012 through the combination of gross margin expansion and better cost leverage. Finally, we are now forecasting foreign exchange, primarily related to the Japanese yen, to be a headwind of $0.05 to $0.07 per share for the full year. Please mark your calendar for the following events scheduled during the next 4 weeks. On April 24, we will host our Annual Meeting of Shareholders. The script from that presentation will be available on our website following this event. On May 7, Court Carruthers, Senior Vice President and President of Grainger United States, will present at the Robert W. Baird Growth Stock Conference in Chicago. The event will be webcast. And finally, we will release April sales on Friday, May 10. Thank you for your interest in Grainger. If you have any questions, please do not hesitate to contact Laura Brown at [phone]; Casey Darby at [phone]; or me, at [phone]. Thank you.