W.W. Grainger, Inc.
Q1 2014 Earnings Call Transcript

Published: 16 Apr 2014

[Laura 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 2014 results. Please reference our 2014 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 record results for the 2014 first quarter and reiterated our sales and earnings per share guidance for 2014. In a quarter that experienced weather-related disruptions in North America and macroeconomic weakness outside of the United States, we delivered solid earnings and margins that were in line with the expectations we provided in the fourth quarter of 2013. At the end of this recording, we will talk in more detail about our guidance and assumptions. Let’s begin with an overview. Company sales for the quarter increased 5%. We had 63 selling days in the quarter, the same as the previous year. Operating earnings increased 3% and net earnings increased 2%. Earnings per share were $3.07 for the quarter, an increase of 4% versus the previous year. Let’s now walk down the operating section of the income statement in more detail. Reported gross profit margins decreased 10 basis points to 45.1% versus 45.2% in 2013 primarily due to the newly acquired businesses. Please reference Exhibit 5. Company operating earnings increased 3% versus the 2013 quarter. This increase was primarily driven by the 5% sales growth partially offset by lower gross profit margins. Operating expenses also increased 5% driven by $31 million in incremental growth and infrastructure spending as well as incremental expenses from the acquired businesses. Our reported company operating margin decreased 20 basis points to 14.9% versus 15.1% in 2013 primarily due to decline in gross margins. On an organic basis, excluding acquisitions and foreign exchange, company gross profit margins for the quarter increased 20 basis points to 45.5% versus 45.3% in 2013. The company operating margin decreased 20 basis points to 15.0% versus 15.2% in 2013, primarily due to lower performance in Canada. We took a cautious approach to growth and infrastructure spending in the 2014 first quarter given softer than expected sales growth in the first two months of the quarter. Given the pacing of projects and lower than expected spending in the first quarter, we are now anticipating full year incremental growth spending of approximately $115 million. We view our commitment to invest in growth as an example of our leadership in the MRO industry and the ability to continue gaining market share over the long-term. Let’s now focus on performance drivers during the quarter. In doing so, we will cover the following topics

[Bill Chapman:]

Thanks, Laura. Since we have already analyzed company operating performance, let’s jump right into results by reportable segment. Operating earnings in the United States increased 7% versus the 2013 first quarter, while operating margins were flat at 18.7%. Gross profit margins for the quarter decreased 30 basis points driven by lower gross margins from the newly acquired businesses and faster growth with lower margin customers. Operating expenses grew at a slower rate than sales, which included incremental expenses from the acquired businesses and $26 million in incremental growth and infrastructure-related spending on areas such as new sales representatives, e-commerce and advertising. For the U.S. business on an organic basis, excluding acquisitions, gross profit margins increased 40 basis points to 46.9% versus 46.5% in 2013 driven by price inflation exceeding cost inflation. Operating margin increased 30 basis points to 19.2% versus 18.9% in 2013 reflecting higher gross margins, partially offset by negative expense leverage. Let’s move on to our business in Canada. Operating earnings decreased 35% versus the prior year. The decrease was driven by the 10% sales decline, lower gross profit margins and negative expense leverage. Gross margins in Canada decreased 20 basis points versus the prior year, primarily due to higher freight costs, along with the effect of unfavorable foreign exchange from products sourced from the United States. Also contributing to the lower operating performance was increased payroll, benefits and severance, and approximately $2 million in incremental spending related to IT system investments. We continue to invest in the business in Canada through this tougher macroeconomic environment to strengthen our operations and better position the business for the long-term. The Other Businesses generated $8 million in operating earnings in the 2014 and 2013 first quarters. This performance included strong results from Zoro Tools partially offset by lower performance from the businesses in Latin America and costs to evaluate the new online business in other markets. Below the operating line, other income and expense was a net expense of $2.7 million in the 2014 first quarter versus $1.4 million in the 2013 first quarter. For the quarter, the effective tax rate in 2014 was 37.7% versus 37.3% in 2013. The increase was primarily due to more earnings in the United States relative to other jurisdictions with lower tax rates. We are still projecting an effective tax rate of 37.4% to 37.8% for the full year 2014. Lastly, let’s take a look at cash flow for the quarter. Operating cash flow was $168 million versus $176 million in 2013. The lower cash flow was driven primarily by lower trade accounts payable balances related to the timing of inventory purchases. We used the cash flow and cash flow on hand to invest in the business and return cash to shareholders through share repurchase and dividends. Capital expenditures for the quarter were $66 million versus $43 million in 2013. We paid dividends of $65 million, reflecting the 16% increase in the quarterly dividend announced in April of 2013. In addition, we bought back 615,000 shares of stock for $150 million and ended the quarter with 3 million shares remaining on our share repurchase authorization. In total, we returned $215 million to shareholders in the quarter. As reported in our 2014 first quarter earnings release, we reiterated our 2014 sales and earnings per share guidance. The sales guidance range remains at 5% to 9% growth. It’s important to note that we slightly revised the composition. The low end reflects more volume contribution and less price realization. Let’s look more closely at the underlying elements of our expectations. Let’s start with gross profit margins. For the full year, on an organic basis, we continue to expect gross margin expansion to reach 30 basis points at the high-end driven primarily by the United States. On a reported basis, we are forecasting minimal gross margin expansion versus 2013 due to lower gross margins from the acquired businesses. For the 2014 second quarter, we expect organic gross profit margins to be down approximately 15 basis points due primarily to one-time inventory transition costs in Canada in preparation for the relocation to the new distribution center in Toronto. On a reported basis, we are expecting gross profit margins to decrease by about 60 basis points due to the acquired businesses. Please keep in mind that as you model margins for the second quarter and the remainder of the year, our first quarter included supplier support provided for our annual customer tradeshows. As a result, both gross profit and operating expenses as a percent of sales are inflated by about 100 basis points. Let’s take a closer look at company operating margin expectations. In 2014, we anticipate operating margin contraction in the first half followed by operating margin expansion in the second half. This is due to the carryover effect of the 2013 second half growth and infrastructure spending and the acquisition of the lower margin businesses. For the full year, on an organic basis, we continue to expect 15 to 45 basis points of operating margin expansion. On a reported basis, we are forecasting full year operating margin expansion of 10 to 40 basis points, reflecting negative mix from the acquisitions. For the 2014 second quarter, on an organic basis, operating margins are forecasted to decline 40 to 80 basis points due to the incremental growth and infrastructure spending anticipated in the second quarter. Please see Exhibit 4 for more information. For the 2014 second quarter, on a reported basis, operating margins could decline 50 to 100 basis points. Please mark your calendar for the following upcoming events. On April 30, we will host our Annual Meeting of Shareholders. The script from the presentation will be available on our website following the event. On May 6, DG Macpherson, Senior Vice President and Group President, Global Supply Chain and International, 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 Tuesday, May 13. Overall, we are pleased with our start to 2014. We continue to invest in the business to gain share and deliver solid returns to shareholders. And we appreciate your support and thank you for your interest in Grainger. If you have any questions, please contact Laura Brown at 847-535-0409, Casey Darby at 847-535-0099 or me at 847-535-0881. Thank you. [No Q&A session for this event]