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GRAINGER W W INC 10-Q 2008

Documents found in this filing:

  1. 10-Q
  2. Ex-3
  3. Ex-10
  4. Ex-11
  5. Ex-31
  6. Ex-31
  7. Ex-32
  8. Ex-32
  9. Ex-32

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-Q

 

(Mark One)

 

x

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF

THE SECURITIES EXCHANGE ACT OF 1934

 

For the quarterly period ended March 31, 2008

 

OR

 

o

TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF

THE SECURITIES EXCHANGE ACT OF 1934

 

 

For the transition period from

 

to

 

 

 

Commission file number 1-5684

 

 

 

 

 

 

 

 

 

 

W.W. Grainger, Inc.

(Exact name of registrant as specified in its charter)

 

Illinois

 

36-1150280

(State or other jurisdiction of incorporation or organization)

 

(I.R.S. Employer Identification No.)

 

 

 

100 Grainger Parkway, Lake Forest, Illinois

 

60045-5201

(Address of principal executive offices)

 

(Zip Code)

(847) 535-1000

(Registrant’s telephone number including area code)

 

Not Applicable

(Former name, former address and former fiscal year; if changed since last report)

 

 

 

 

 

 

 

 

 

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

 

 

Yes

X

 

No

 

 

 

 

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a

non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,”

“accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

 

Large accelerated filer x

Accelerated filer [ ]

Non-accelerated filer [ ]

Smaller reporting company [ ]

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the

Exchange Act).

 

Yes

 

 

No

X

 

 

 

There were 76,507,214 shares of the Company’s Common Stock outstanding as of March 31, 2008.

 

 

 

TABLE OF CONTENTS

 

Page No.

 

 

 

 

PART I

FINANCIAL INFORMATION

 

 

 

 

 

 

Item 1.

Financial Statements (Unaudited)

 

 

 

 

 

 

 

Condensed Consolidated Statements of Earnings 

for the Three Months Ended March 31, 2008 and 

March 31, 2007

 

3

 

 

 

 

 

Condensed Consolidated Statements of Comprehensive

Earnings for the Three Months Ended March 31, 2008 

and March 31, 2007

 

4

 

 

 

 

 

Condensed Consolidated Balance Sheets

as of March 31, 2008 and December 31, 2007

 

5 - 6

 

 

 

 

 

Condensed Consolidated Statements of Cash Flows

for the Three Months Ended March 31, 2008 and 

March 31, 2007

 

7 - 8

 

 

 

 

 

Notes to Condensed Consolidated Financial Statements

 

9 - 13

 

 

 

 

Item 2.

Management’s Discussion and Analysis of Financial

 

 

 

Condition and Results of Operations

 

14 – 20

 

 

 

 

Item 3.

Quantitative and Qualitative Disclosures About Market Risk

 

21

 

 

 

 

Item 4.

Controls and Procedures

 

21

 

 

 

 

PART II

OTHER INFORMATION

 

 

 

 

 

 

Item 1.

Legal Proceedings

 

21

 

 

 

 

Item 2.

Unregistered Sales of Equity Securities and Use of Proceeds

 

22

 

 

 

 

Item 4.

Submission of Matters to a Vote of Security Holders

 

23

 

 

 

 

Item 6.

Exhibits

 

24

 

 

 

 

Signatures

 

 

25

 

 

 

 

EXHIBITS

 

 

 

 

 

 

 

Exhibit 11

Computations of Earnings Per Share

 

 

 

 

 

 

Exhibits 31 & 32

Certifications

 

 

 

 

2

 

PART I – FINANCIAL INFORMATION

 

Item 1. Financial Statements (Unaudited)

 

W.W. Grainger, Inc. and Subsidiaries

CONDENSED CONSOLIDATED STATEMENTS OF EARNINGS

(In thousands of dollars, except for per share amounts)

(Unaudited)

 

 

 

Three Months Ended

March 31,

 

 

2008

 

2007

 

 

 

 

 

Net sales

 

$      1,661,046 

 

$      1,546,658 

 

 

 

 

 

Cost of merchandise sold

 

981,112 

 

914,570 

 

 

 

 

 

Gross profit

 

679,934 

 

632,088 

 

 

 

 

 

Warehousing, marketing and administrative expenses

 

494,111 

 

469,503 

 

 

 

 

 

Operating earnings

 

185,823 

 

162,585 

 

 

 

 

 

Other income and (expense):

 

 

 

 

Interest income

 

804 

 

4,022 

Interest expense

 

(1,433)

 

(577)

Equity in net income (loss) of unconsolidated entities

 

737 

 

(342)

Unclassified – net

 

569 

 

33 

Total other income and (expense)

 

677 

 

3,136 

 

 

 

 

 

Earnings before income taxes

 

186,500 

 

165,721 

 

 

 

 

 

Income taxes

 

72,262 

 

63,934 

 

 

 

 

 

Net earnings

 

$         114,238 

 

$         101,787 

 

 

 

 

 

 

 

 

 

 

Earnings per share:

 

 

 

 

Basic

 

$               1.47 

 

$               1.21 

 

 

 

 

 

Diluted

 

$               1.43 

 

$               1.17 

 

 

 

 

 

Weighted average number of shares outstanding:

 

 

 

 

Basic

 

77,933,996 

 

83,979,114 

 

 

 

 

 

Diluted

 

80,131,555 

 

86,758,949 

 

 

 

 

 

Cash dividends paid per share

 

$               0.35 

 

$               0.29 

 

 

The accompanying notes are an integral part of these financial statements.

 

3

 

W.W. Grainger, Inc. and Subsidiaries

CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE EARNINGS

(In thousands of dollars)

(Unaudited)

 

 

 

Three Months Ended

March 31,

 

 

2008

 

2007

 

 

 

 

 

Net earnings

 

$       114,238 

 

$       101,787

 

 

 

 

 

Other comprehensive earnings (losses):

 

 

 

 

 

 

 

 

 

Foreign currency translation adjustments, net of tax

benefit (expense) of $2,008 and $(528), respectively

 

(9,898)

 

2,583

 

 

 

 

 

Comprehensive earnings

 

$       104,340 

 

$       104,370

 

 

The accompanying notes are an integral part of these financial statements.

 

4

 

W.W. Grainger, Inc. and Subsidiaries

CONDENSED CONSOLIDATED BALANCE SHEETS

(In thousands of dollars, except for per share amounts)

(Unaudited)

 

 

ASSETS

 

March 31, 2008

 

Dec. 31, 2007

CURRENT ASSETS

 

 

 

 

Cash and cash equivalents

 

$                117,429 

 

$              113,437 

Marketable securities at cost,

 

 

 

 

which approximates market value

 

– 

 

20,074 

Accounts receivable (less allowances for doubtful

 

 

 

 

accounts of $28,326 and $25,830, respectively)

 

644,933 

 

602,650 

Inventories

 

966,326 

 

946,327 

Prepaid expenses and other assets

 

67,011 

 

61,666 

Deferred income taxes

 

58,822 

 

56,663 

Total current assets

 

1,854,521 

 

1,800,817 

 

 

 

 

 

PROPERTY, BUILDINGS AND EQUIPMENT

 

2,032,230 

 

2,004,276 

Less accumulated depreciation and amortization

 

1,146,667 

 

1,125,931 

Property, buildings and equipment – net

 

885,563 

 

878,345 

 

 

 

 

 

DEFERRED INCOME TAXES

 

61,592 

 

54,658 

 

 

 

 

 

INVESTMENT IN UNCONSOLIDATED ENTITIES

 

16,547 

 

14,759 

 

 

 

 

 

GOODWILL

 

228,485 

 

233,028 

 

 

 

 

 

OTHER ASSETS AND INTANGIBLES – NET

 

109,125 

 

112,421 

 

 

 

 

 

TOTAL ASSETS

 

$             3,155,833 

 

$           3,094,028 

 

 

5

 

W.W. Grainger, Inc. and Subsidiaries

CONDENSED CONSOLIDATED BALANCE SHEETS (Continued)

(In thousands of dollars, except for per share amounts)

(Unaudited)

 

 

LIABILITIES AND SHAREHOLDERS' EQUITY

 

March 31, 2008

 

Dec. 31, 2007

 

 

 

 

 

CURRENT LIABILITIES

 

 

 

 

Short-term debt

 

$                329,517 

 

$               102,060 

Current maturities of long-term debt

 

4,590 

 

4,590 

Trade accounts payable

 

339,544 

 

297,929 

Accrued compensation and benefits

 

124,399 

 

182,275 

Accrued contributions to employees’

 

 

 

 

profit sharing plans

 

39,980 

 

126,483 

Accrued expenses

 

84,226 

 

102,607 

Income taxes payable

 

71,253 

 

10,459 

Total current liabilities

 

993,509 

 

826,403 

 

 

 

 

 

LONG-TERM DEBT (less current maturities)

 

4,895 

 

4,895 

 

 

 

 

 

DEFERRED INCOME TAXES AND TAX UNCERTAINTIES

 

21,440 

 

20,727 

 

 

 

 

 

ACCRUED EMPLOYMENT-RELATED BENEFITS

 

145,762 

 

143,895 

 

 

 

 

 

SHAREHOLDERS' EQUITY

 

 

 

 

Cumulative Preferred Stock – $5 par value –

12,000,000 shares authorized; none issued nor outstanding

 

– 

 

– 

Common Stock – $0.50 par value –

300,000,000 shares authorized; issued

109,659,219 shares

 

54,830 

 

54,830 

Additional contributed capital

 

532,980 

 

475,350 

Retained earnings

 

3,403,049 

 

3,316,875 

Accumulated other comprehensive earnings

 

62,273 

 

72,171 

Treasury stock, at cost –

33,152,005 and 30,199,804 shares, respectively

 

(2,062,905)

 

(1,821,118)

 

 

 

 

 

Total shareholders' equity

 

1,990,227 

 

2,098,108 

 

 

 

 

 

TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY

 

$             3,155,833 

 

$            3,094,028 

 

 

The accompanying notes are an integral part of these financial statements.

 

6

 

W.W. Grainger, Inc. and Subsidiaries

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(In thousands of dollars)

(Unaudited)

 

 

 

Three Months Ended March 31,

 

 

2008

 

2007

CASH FLOWS FROM OPERATING ACTIVITIES:

 

 

 

 

Net earnings

 

$           114,238 

 

$           101,787 

Provision for losses on accounts receivable

 

4,706 

 

1,981 

Deferred income taxes and tax uncertainties

 

(6,370)

 

3,294 

Depreciation and amortization:

 

 

 

 

Property, buildings and equipment

 

25,333 

 

23,888 

Capitalized software and other intangibles

 

6,223 

 

6,035 

Stock-based compensation

 

8,084 

 

7,207 

Tax benefit of stock incentive plans

 

54 

 

888 

Net gains on sales of property, buildings and equipment

 

(1,316)

 

(1,300)

(Income) losses from unconsolidated entities

 

(737)

 

342 

Change in operating assets and liabilities:

 

 

 

 

(Increase) in accounts receivable

 

(48,937)

 

(46,013)

(Increase) decrease in inventories

 

(23,619)

 

12,342 

(Increase) in prepaid expenses

 

(5,355)

 

(7,733)

Increase in trade accounts payable

 

41,468 

 

44,004 

(Decrease) in other current liabilities

 

(162,485)

 

(111,123)

Increase in current income taxes payable

 

60,932 

 

44,171 

Increase in accrued employment-related benefits cost

 

1,867 

 

6,255 

Other – net

 

(778)

 

(3,612)

 

 

 

 

 

Net cash provided by operating activities

 

13,308 

 

82,413 

 

 

 

 

 

CASH FLOWS FROM INVESTING ACTIVITIES:

 

 

 

 

Additions to property, buildings and

equipment – net of dispositions

 

(31,062)

 

(32,246)

Additions to capitalized software

 

(2,313)

 

(727)

Other – net

 

19,871 

 

12,389 

 

 

 

 

 

Net cash used in investing activities

 

$            (13,504)

 

$            (20,584)

 

 

7

 

W.W. Grainger, Inc. and Subsidiaries

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (Continued)

(In thousands of dollars)

(Unaudited)

 

 

 

Three Months Ended March 31,

 

 

2008

 

2007

CASH FLOWS FROM FINANCING ACTIVITIES:

 

 

 

 

Net increase in commercial paper

 

$            223,913 

 

$                    – 

Borrowings under line of credit

 

3,921 

 

– 

Payments against line of credit

 

(54)

 

– 

Stock options exercised

 

3,559 

 

31,277 

Excess tax benefits from stock-based compensation

 

907 

 

6,784 

Purchase of treasury stock

 

(196,437)

 

(98,698)

Cash dividends paid

 

(28,064)

 

(24,519)

 

 

 

 

 

Net cash provided by (used in) financing activities

 

7,745 

 

(85,156)

 

 

 

 

 

Exchange rate effect on cash and cash equivalents

 

(3,557)

 

328 

 

 

 

 

 

NET INCREASE (DECREASE) IN CASH AND CASH

EQUIVALENTS

 

3,992 

 

(22,999)

 

 

 

 

 

Cash and cash equivalents at beginning of year

 

113,437 

 

348,471 

 

 

 

 

 

Cash and cash equivalents at end of period

 

$            117,429 

 

$          325,472 

 

 

The accompanying notes are an integral part of these financial statements.

 

8

 

W.W. Grainger, Inc. and Subsidiaries

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

1.

BACKGROUND AND BASIS OF STATEMENT PRESENTATION

 

W.W. Grainger, Inc. distributes facilities maintenance products and provides services and related information used by businesses and institutions in North America. In this report, the words “Company” or “Grainger” mean W.W. Grainger, Inc. and its subsidiaries.

 

The Condensed Consolidated Financial Statements of the Company and the related notes are unaudited and should be read in conjunction with the consolidated financial statements and related notes for the year ended December 31, 2007, included in the Company’s Annual Report on Form 10-K filed with the Securities and Exchange Commission (SEC).

 

The Condensed Consolidated Balance Sheet as of December 31, 2007, has been derived from the audited consolidated financial statements at that date, but does not include all of the disclosures required by accounting principles generally accepted in the United States of America for complete financial statements.

 

The unaudited financial information reflects all adjustments (consisting of normal recurring adjustments) which, in the opinion of management, are necessary for a fair presentation of the statements contained herein.

 

2.

SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

 

NEW ACCOUNTING STANDARD

 

In March 2008, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards No. 161, “Disclosures about Derivative Instruments and Hedging Activities – an amendment of FASB Statement No. 133” (SFAS No. 161). SFAS No. 161 amends and expands the disclosure requirements related to derivative instruments and hedging activities which will enable investors to better understand the effects on an entity’s financial statements, financial position and cash flows. The statement is effective for fiscal years beginning after November 15, 2008. The Company does not expect the adoption of SFAS No. 161 to have a material effect on its results of operations or financial position.

 

3.

DIVIDEND

 

On April 30, 2008, the Company’s Board of Directors declared a quarterly dividend of 40 cents per share, payable June 1, 2008, to shareholders of record on May 12, 2008. This represents a 14% increase from the prior quarterly rate of 35 cents per share.

 

 

9

 

W.W. Grainger, Inc. and Subsidiaries

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)

 

4.

WARRANTY RESERVES

 

The Company generally warrants the products it sells against defects for one year. For a significant portion of warranty claims, the manufacturer of the product is responsible for the expenses associated with this warranty program. For warranty expenses not covered by the manufacturer, the Company provides a reserve for future costs based on historical experience.

 

The warranty reserve activity was as follows:

 

 

Three Months Ended March 31,

 

 

 

2008

 

2007

 

(In thousands of dollars)

 

 

 

 

 

 

Beginning balance

 

$              3,443 

 

$              4,651 

Returns

 

(3,308)

 

(4,382)

Provision

 

3,112 

 

3,468 

Ending balance

 

$              3,247 

 

$              3,737 

 

5.

SHORT-TERM DEBT

 

At March 31, 2008, there was $319.9 million of commercial paper outstanding. The increase in the first quarter of 2008 was primarily due to the Company’s share repurchase program and annual cash payments for profit sharing and bonuses, and other operating needs.

 

In addition, at March 31, 2008, there was $9.6 million outstanding relating to the Grainger China LLC line of credit which has a maximum borrowing limit of US$21.0 million or the equivalent Chinese Renminbi. Grainger China LLC utilizes the line of credit to meet its business expansion and operating needs.

 

6.

EMPLOYEE BENEFITS

 

The Company has a postretirement healthcare benefits plan that provides coverage for a majority of its retired employees and their dependents should they elect to maintain such coverage. Covered employees become eligible for participation when they qualify for retirement. Participation in the plan is voluntary and requires participants to make contributions, as determined by the Company, toward the cost of the plan.

 

10

 

W.W. Grainger, Inc. and Subsidiaries

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)

 

 

The net periodic benefit costs charged to operating expenses, which are valued at the measurement date of January 1 and recognized evenly throughout the year, consisted of the following components:

 

 

Three Months Ended March 31,

 

2008

 

2007

 

(In thousands of dollars)

 

 

 

 

Service cost

$               2,425 

 

$             2,714 

Interest cost

2,373 

 

2,243 

Expected return on assets

(1,116)

 

(1,012)

Amortization of transition asset

(36)

 

(36)

Amortization of unrecognized losses

328 

 

523 

Amortization of prior service credits

(304)

 

(109)

Net periodic benefit costs

$               3,670 

 

$             4,323 

 

The Company has established a Group Benefit Trust to fund the plan and process benefit payments. The funding of the trust is an estimated amount, which is intended to allow the maximum deductible contribution under the Internal Revenue Code of 1986 (IRC), as amended. There are no minimum funding requirements and the Company intends to follow its practice of funding the maximum deductible contribution under the IRC. During the three months ended March 31, 2008 and 2007, the Company contributed $0.9 million and $0.5 million to the trust, respectively.

 

7.

SEGMENT INFORMATION

 

The three reportable segments are Grainger Branch-based, Acklands – Grainger Branch-based (Acklands – Grainger) and Lab Safety Supply, Inc. (Lab Safety). Grainger Branch-based is an aggregation including the following: Grainger Industrial Supply, Grainger, S.A. de C.V. (Mexico), Grainger Caribe Inc. (Puerto Rico) and Grainger China LLC (China). Acklands – Grainger is the Company’s Canadian branch-based distribution business. Lab Safety is a direct marketer of safety and other industrial products.

 

 

 

Three Months Ended March 31, 2008

 

Grainger Branch-based

 

Acklands - Grainger Branch-based

 

Lab Safety

Total

 

(In thousands of dollars)

Total net sales

$      1,372,501 

 

$                    177,303 

 

$            112,835 

 

$     1,662,639 

Intersegment net sales

(638)

 

– 

 

(955)

 

(1,593)

Net sales to external customers

$      1,371,863 

 

$                    177,303 

 

$            111,880 

 

$     1,661,046 

 

 

 

 

 

 

 

 

Segment operating earnings

$         175,853 

 

$                      11,675 

 

$              14,804 

 

$        202,332 

 

 

 

 

 

 

 

 

 

 

11

 

W.W. Grainger, Inc. and Subsidiaries

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)

 

 

 

 

Three Months Ended March 31, 2007

 

Grainger Branch-based

 

Acklands - Grainger Branch-based

 

Lab Safety

Total

 

(In thousands of dollars)

Total net sales

$      1,296,382 

 

$                    142,050 

 

$            109,100 

 

$     1,547,532 

Intersegment net sales

(233)

 

– 

 

(641)

 

(874)

Net sales to external customers

$      1,296,149 

 

$                    142,050 

 

$            108,459 

 

$     1,546,658 

 

 

 

 

 

 

 

 

Segment operating earnings

$         160,242 

 

$                        8,948 

 

$              14,610 

 

$        183,800 

 

 

 

 

 

 

 

 

 

 

Grainger Branch-based

 

Acklands – Grainger Branch-based

 

Lab Safety

Total

 

(In thousands of dollars)

Segment assets:

 

March 31, 2008

$       2,180,031 

 

$                     487,685 

 

$             213,329 

 

$     2,881,045 

 

 

 

 

 

 

 

 

December 31, 2007

$       2,107,408 

 

$                     502,414 

 

$             212,627 

 

$     2,822,449 

 

 

 

 

 

 

 

 

 

Following are reconciliations of segment information with the consolidated totals per the financial statements:

 

 

Three Months Ended March 31,

 

2008

 

2007

 

(In thousands of dollars)

Operating earnings:

 

Total operating earnings for reportable segments

$             202,332 

 

$             183,800 

Unallocated expenses and eliminations

(16,509)

 

(21,215)

Total consolidated operating earnings

$             185,823 

 

$             162,585 

 

 

 

March 31,

2008

 

December 31, 2007

 

(In thousands of dollars)

Assets:

 

Total assets for reportable segments

$          2,881,045 

 

$          2,822,449 

Unallocated assets

274,788 

 

271,579 

Total consolidated assets

$          3,155,833 

 

$          3,094,028 

 

 

12

 

W.W. Grainger, Inc. and Subsidiaries

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)

 

Unallocated expenses and unallocated assets primarily relate to the Company headquarters’ support services, which are not part of any business segment. Unallocated expenses include payroll and benefits, depreciation and other costs associated with headquarters-related support services. Unallocated assets include non-operating cash and cash equivalents, certain prepaid expenses, deferred income taxes and property, buildings and equipment – net.

 

8.

LEGAL PROCEEDINGS

 

As previously reported, the Company received a letter in December 2007 from the Commercial Litigation Branch of the Civil Division of the Department of Justice (the “DOJ”) regarding the Company’s contract with the United States General Services Administration (the “GSA”). The letter suggested that the Company had not complied with the contract’s disclosure obligations and pricing provisions, and had potentially overcharged government customers under the contract. As also reported, the DOJ subsequently intervened in a previously filed civil “qui tam” action alleging non-compliance with the contract and with the country of origin provisions of the Trade Agreement Act.

 

In March 2008, the Company began the process of meeting with the DOJ to discuss the DOJ’s allegations and damage estimates. The timing and outcome of these discussions are uncertain and could include settlement or civil litigation by the DOJ to recover, among other amounts, treble damages and penalties under the False Claims Act. While this matter is not expected to have a material adverse effect on the Company’s financial position, an unfavorable resolution could result in material payments by the Company. The Company continues to believe that it has complied with the GSA contract in all material respects.

 

9.

SUBSEQUENT EVENTS

 

On May 6, 2008, the Company entered into a four year term loan of $500 million. Proceeds are expected to be used primarily to pay down short-term debt, fund additional share repurchases and for general corporate purposes. The loan does not contain any financial covenants. There are non-financial covenants that are consistent with the Company’s size and credit quality.

 

13

 

W.W. Grainger, Inc. and Subsidiaries

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL

CONDITION AND RESULTS OF OPERATIONS

 

Item 2.

 

Overview

General

Grainger is the leading broad-line supplier of facilities maintenance and other related products in North America. Grainger distributes a wide range of products used by businesses and institutions to keep their facilities and equipment up and running. Grainger uses a multichannel business model to provide customers with a range of options for finding and purchasing products through a network of branches, sales representatives, direct marketing including catalogs, and a variety of electronic and Internet channels. Grainger serves customers through a network of more than 600 branches, 18 distribution centers and multiple Web sites.

 

Grainger’s three reportable segments are Grainger Branch-based, Acklands – Grainger Branch-based (Acklands – Grainger) and Lab Safety Supply, Inc. (Lab Safety). Grainger Branch-based is an aggregation including the following business units: Grainger Industrial Supply, Grainger, S.A. de C.V. (Mexico), Grainger Caribe Inc. (Puerto Rico) and Grainger China LLC (China). Acklands – Grainger is the Company’s Canadian branch-based distribution business. Lab Safety is a direct marketer of safety and other industrial products.

 

Business Environment

Several economic factors and industry trends shape Grainger’s business environment. Grainger’s sales tend to correlate positively with industrial production growth, particularly manufacturing output as well as employment growth, particularly non-farm payrolls. According to the Federal Reserve, overall industrial production increased 1.6% from March 2007 to March 2008. Manufacturing output increased 1.2% from March 2007 to March 2008, although manufacturing employment levels declined approximately 2%. Non-farm employment was essentially flat from March 2007 to March 2008. Grainger’s sales to manufacturing customers continue to show improvement, though at a slower rate than the first quarter of 2007. Current economic growth projections for 2008 industrial production and GDP are 0.7% and 1.3%, respectively.

 

For the first quarter of 2008, the Company had $37.2 million of capital expenditures, of which $15.0 million related to its U.S. market expansion program. The Company expects to complete its investments in the U.S. market expansion program in 2008.

 

Matters Affecting Comparability

Grainger’s operating results for the first quarter of 2008 include the operating results of the acquisition made by Lab Safety in May 2007. Since the acquisition date, those results have been included in the Lab Safety segment. See the Segment Analysis in the following Management’s Discussion and Analysis.

 

14

 

W.W. Grainger, Inc. and Subsidiaries

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL

CONDITION AND RESULTS OF OPERATIONS

 

Results of Operations – Three Months Ended March 31, 2008

The following table is included as an aid to understanding the changes in Grainger’s Condensed Consolidated Statements of Earnings:

 

 

Three Months Ended March 31,

 

Items in Condensed Consolidated

Statements of Earnings

 

 

 

 

 

As a Percent of Net Sales

 

Percent Increase (Decrease)

2008

 

2007

Net sales

100.0%

 

100.0%

 

7.4%

Cost of merchandise sold

59.1

 

59.1

 

7.3

Gross profit

40.9

 

40.9

 

7.6

Operating expenses

29.7

 

30.4

 

5.2

Operating earnings

11.2

 

10.5

 

14.3

Other income

0.0

 

0.2

 

(78.4)

Income taxes

4.3

 

4.1

 

13.0

Net earnings

6.9

 

6.6

 

12.2

 

Grainger’s net sales of $1,661.0 million for the first quarter of 2008 increased 7.4% compared with sales of $1,546.7 million for the comparable 2007 quarter. An increase in net sales was realized in all three segments of the business. The increase in net sales was led by mid single-digit sales growth in the government and commercial sectors. Approximately 2 percentage points of the sales growth came from Grainger’s ongoing strategic initiatives, market expansion and product line expansion, with another 1 percentage point from foreign exchange. As the Easter holiday fell in March during 2008 and in April during 2007, the sales growth for the first quarter of 2008 was negatively affected by approximately 1 percentage point. Refer to the Segment Analysis below for further detail of Grainger’s ongoing strategic initiatives.

 

Gross profit of $679.9 million for the first quarter of 2008 increased 7.6%. The gross profit margin during the first quarter of 2008 was essentially flat when compared to the same period in 2007 primarily due to positive inflation recovery offset by unfavorable selling price category mix.

 

Operating expenses of $494.1 million for the first quarter of 2008 increased 5.2%. Operating expenses grew at a slower rate than sales due to positive operating expense leverage primarily attributable to payroll and other operating expenses.

 

Operating earnings for the first quarter of 2008 totaled $185.8 million, an increase of 14.3% over the first quarter of 2007. This earnings improvement exceeded the sales growth rate primarily due to positive operating expense leverage.

 

15

 

W.W. Grainger, Inc. and Subsidiaries

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL

CONDITION AND RESULTS OF OPERATIONS

 

Net earnings for the first quarter of 2008 increased by 12.2% to $114.2 million from $101.8 million in 2007. The growth in net earnings for the quarter primarily resulted from the improvement in operating earnings, partially offset by lower interest income and a higher income tax rate versus 2007. Diluted earnings per share of $1.43 in the first quarter of 2008 were 22.2% higher than the $1.17 for the first quarter of 2007. This improvement was higher than the percentage increase for net earnings due to the effect of the Company’s share repurchase program.

 

Segment Analysis

The following comments at the segment level refer to external and intersegment net sales. Comments at the business unit level include external and inter- and intrasegment net sales. See Note 7 to the Condensed Consolidated Financial Statements.

 

Grainger Branch-based

Net sales were $1,372.5 million for the first quarter of 2008, an increase of $76.1 million, or 5.9%, when compared with net sales of $1,296.4 million for the same period in 2007.

 

Sales in the United States were up 5.6%, with growth in all customer end markets, except retail, which experienced a low single-digit decline. The increase in net sales was led by mid single-digit sales growth in the government and commercial sectors. Consistent with the Company’s results, sales growth in the segment was negatively affected by approximately 1 percentage point due to the timing of the Easter holiday. A decline in the sales of seasonal products also resulted in about a 1 percentage point reduction in the sales growth rate. Market expansion and product line expansion added approximately 3 percentage points to overall growth in the quarter, with most of the contribution coming from product line expansion.

 

Results for the market expansion program were as follows:

 

 

 

2008 First Quarter

 

 

Sales

Increase

 

Percent

Complete

Phase 1 (Atlanta, Denver, Seattle)

 

11%

 

100%

Phase 2 (Four markets in Southern California)

 

6%

 

100%

Phase 3 (Houston, St. Louis, Tampa)

 

11%

 

100%

Phase 4 (Baltimore, Cincinnati, Kansas City,

Miami, Philadelphia, Washington D.C.)

 

6%

 

100%

Phase 5 (Dallas, Detroit, Greater New York, Phoenix)

 

7%

 

85%

Phase 6 (Chicago, Minneapolis, Pittsburgh,

San Francisco),

 

5%

 

80%

 

The Company is on track to essentially complete phases 5 and 6 by mid-year and expects to see continued incremental sales growth from the program for another five years.

 

16

 

W.W. Grainger, Inc. and Subsidiaries

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL

CONDITION AND RESULTS OF OPERATIONS

 

The U.S. branch-based business added approximately 44,000 new products in the February 2008 catalog; these included fleet maintenance, power transmission and selected additions to existing product lines. The new catalog includes a total of 183,000 products. The Company expects to add more products throughout the year.

 

Sales in Mexico increased 17.4% in the first quarter of 2008 versus 2007, negatively affected by approximately 6 percentage points due to the timing of the Easter holiday. In local currency, sales were up 15.0% driven primarily by the ongoing branch expansion program.

 

The segment gross profit margin increased 0.1 percentage point in the 2008 first quarter over the comparable quarter of 2007, primarily driven by positive inflation recovery, partially offset by unfavorable selling price category mix.

 

Operating expenses in this segment were up 4.6% in the first quarter of 2008. Operating expenses grew at a slower rate than sales due to positive operating expense leverage primarily attributable to payroll and other operating expenses.

 

For the segment, operating earnings of $175.9 million for the first quarter of 2008 increased 9.7% over the $160.2 million for the first quarter of 2007. This earnings improvement exceeded the sales growth rate due to a slightly improved gross profit margin and positive operating expense leverage. Partially affecting this improvement were ongoing operating losses in China and more recent operating losses in Mexico primarily due to market expansion.

 

Acklands – Grainger Branch-based

Net sales at Acklands – Grainger were $177.3 million for the first quarter of 2008, an increase of $35.2 million, or 24.8%, when compared with $142.1 million for the same period in 2007. The timing of the Easter holiday had a negative impact of approximately 2 percentage points. In local currency, sales increased 7.0% due to stronger sales in the mining, petroleum and government sectors, partially offset by weakness in the forestry sector.

 

The gross profit margin increased 0.6 percentage point in the 2008 first quarter over the first quarter of 2007. The improvement in the gross profit margin was primarily due to lower freight costs partially offset by lower inflation recovery.

 

Operating expenses were up 26.0% in the first quarter of 2008. In local currency, operating expenses increased 8.1% in the 2008 first quarter over the first quarter of 2007. The increase in operating expenses was primarily due to payroll and benefits as a result of increased headcount and merit increases, partially offset by a reduction in contract labor services and incentive compensation.

 

Operating earnings of $11.7 million for the first quarter of 2008 were up $2.8 million or 30.5%. This earnings improvement exceeded the sales growth rate due to an improved gross profit margin partially offset by higher operating expenses.

 

17

 

W.W. Grainger, Inc. and Subsidiaries

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL

CONDITION AND RESULTS OF OPERATIONS

 

Lab Safety

Net sales at Lab Safety were $112.8 million for the first quarter of 2008, an increase of $3.7 million, or 3.4%, when compared with $109.1 million for the same period in 2007. Sales from an acquisition made during May 2007 contributed approximately 3 percentage points to the growth. Excluding this acquisition the rest of the business was essentially flat.

 

The gross profit margin decreased 0.2 percentage point in the first quarter of 2008 from the first quarter of 2007. Gross profit margin was down as a result of unfavorable selling price category mix and product mix, partially offset by positive inflation recovery.

 

Operating expenses were up 3.6% in the first quarter of 2008. Expenses grew at a faster rate than sales primarily due to higher benefit expenses related to increased medical claims.

 

Operating earnings of $14.8 million for the first quarter of 2008 increased 1.3% over the same period in 2007. This earnings improvement was less than the sales growth rate due to a lower gross profit margin and operating expenses which grew at a slightly faster rate than sales.

 

Other Income and Expense

Other income and expense was income of $0.7 million in the first quarter of 2008 compared with $3.1 million in the first quarter of 2007. This decrease was primarily attributable to lower interest income in 2008.

 

Income Taxes

Grainger’s effective tax rate was 38.7% and 38.6% for the first quarter of 2008 and 2007, respectively. Excluding the effect of equity in net income of unconsolidated entities, the effective income tax rate was 38.9% for the first quarter of 2008 and 38.5% for the first quarter of 2007.

 

Financial Condition

For the three months ended March 31, 2008, working capital of $861.0 million decreased by $113.4 million when compared to $974.4 million at December 31, 2007. The ratio of current assets to current liabilities was 1.9 at March 31, 2008, versus 2.2 at December 31, 2007. The decrease in working capital and reduction in the ratio of current assets to current liabilities primarily relates to the increase in short-term borrowing as a result of the Company’s share repurchase program and annual cash payments for profit sharing and bonuses.

 

18

 

W.W. Grainger, Inc. and Subsidiaries

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL

CONDITION AND RESULTS OF OPERATIONS

 

Net cash provided by operating activities was $13.3 million and $82.4 million for the three months ended March 31, 2008 and 2007, respectively. Net cash flows from operating activities serve as the Company’s primary source to fund its growth initiatives. Contributing to cash flows from operations were net earnings in the first three months ended March 31, 2008 of $114.2 million and the effect of non-cash expenses such as stock-based compensation, and depreciation and amortization. Partially offsetting these amounts were Changes in operating assets and liabilities, which resulted in a net use of cash of $136.1 million for the first three months of 2008. The principal operating uses of cash were increases in accounts receivable and inventory, as well as a reduction of other current liabilities. The increase in receivables was due to a higher sales volume. The increase in inventories was due to the product line expansion initiative and higher inventories to improve customer service through better product availability. Other current liabilities declined primarily due to the annual cash payments for profit sharing and bonuses. Partially offsetting these uses in cash was an increase in trade accounts payable and current income taxes payable.

 

Net cash used in investing activities was $13.5 million and $20.6 million for the three months ended March 31, 2008 and 2007, respectively. In the first three months of 2008, Grainger continued funding the Company’s market expansion initiative. Cash expended for additions to property, buildings, equipment and capitalized software was $35.9 million in the first three months of 2008 versus $35.8 million in the first three months of 2007.

 

Net cash provided by financing activities was $7.7 million for the three months ended March 31, 2008, versus net cash used of $85.2 million for the three months ended March 31, 2007. Grainger’s treasury stock purchases of $196.4 million were $97.7 million higher in the first three months of 2008 versus 2007, as Grainger repurchased 2.6 million shares compared to 1.2 million shares in the first three months of 2007. In addition, the Company completed the accelerated share repurchase program on January 4, 2008, and received an additional 0.4 million shares at that time. As of March 31, 2008, approximately 1.7 million shares of common stock remained available under Grainger’s repurchase authorization. Dividends paid to shareholders were $28.1 million and $24.5 million for the first three months of 2008 and 2007, respectively. Offsetting these financing cash outlays were proceeds from short-term borrowings of $227.8 million in 2008 versus no borrowing in 2007. Also offsetting the financing cash outlays were proceeds and excess tax benefits realized from stock options exercised of $4.5 million in 2008 versus $38.1 million in 2007.

 

Grainger maintains a debt ratio and liquidity position that provide flexibility in funding working capital needs and long-term cash requirements. In addition to internally generated funds, Grainger has various sources of financing available, including commercial paper sales and bank borrowings under lines of credit. Total debt as a percent of total capitalization was 14.6% at March 31, 2008, and 5.0% at December 31, 2007. The increase in total debt as a percent of total capitalization was primarily the result of short-term borrowings. See Note 9 to the Condensed Consolidated Financial Statements for additional borrowings detail.

 

19

 

W.W. Grainger, Inc. and Subsidiaries

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL

CONDITION AND RESULTS OF OPERATIONS

 

Critical Accounting Policies and Estimates

The preparation of financial statements, in conformity with accounting principles generally accepted in the United States of America, requires management to make judgments, estimates and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses in the financial statements. Management bases its estimates on historical experience and other assumptions, which it believes are reasonable. If actual amounts are ultimately different from these estimates, the revisions are included in Grainger’s results of operations for the period in which the actual amounts become known.

 

Accounting policies are considered critical when they require management to make assumptions about matters that are uncertain at the time the estimate is made and when different estimates than those management reasonably could have made have a material impact on the presentation of Grainger’s financial condition, changes in financial condition or results of operations. For a description of Grainger’s critical accounting policies see the Company’s Annual Report on Form 10-K for the year ended December 31, 2007.

 

Forward-Looking Statements

This Form 10-Q contains statements that are not historical in nature but concern future results and business plans, strategies and objectives and other matters that may be deemed to be “forward-looking statements” under the federal securities laws. Grainger has generally identified such forward-looking statements by using words such as "continues to believe, continues to show improvement, could, expect, expected, expects, intended, intends, on track, projections, and timing and outcome are uncertain" or similar expressions.

 

Grainger cannot guarantee that any forward-looking statement will be realized although Grainger does believe that its assumptions underlying its forward-looking statements are reasonable. Achievement of future results is subject to risks and uncertainties which could cause Grainger’s results to differ materially from those which are presented.

 

Factors that could cause actual results to differ materially from those presented or implied in a forward-looking statement include, without limitation: higher product costs or other expenses; a major loss of customers; increased competitive pricing pressures; failure to develop or implement new technologies or business strategies; the outcome of pending and future litigation or governmental or regulatory proceedings; changes in laws and regulations; disruption of information technology or data security systems; general industry or market conditions; general economic conditions; labor shortages; facilities disruptions or shutdowns; higher fuel costs or disruptions in transportation services; natural and other catastrophes; and unanticipated weather conditions.

 

Caution should be taken not to place undue reliance on Grainger’s forward-looking statements and Grainger undertakes no obligation to publicly update the forward-looking statements, whether as a result of new information, future events or otherwise.

 

20

 

W.W. Grainger, Inc. and Subsidiaries

 

PART I – FINANCIAL INFORMATION

 

Item 3.

Quantitative and Qualitative Disclosures About Market Risk

 

For quantitative and qualitative disclosures about market risk, see “Item 7A: Quantitative and Qualitative Disclosures About Market Risk” in the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2007.

 

Item 4.

Controls and Procedures

 

Disclosure Controls and Procedures

 

Grainger carried out an evaluation, under the supervision and with the participation of its management, including the Chief Executive Officer and the Chief Financial Officer, of the effectiveness of the design and operation of Grainger’s disclosure controls and procedures pursuant to Exchange Act Rule 13a-15. Based upon that evaluation, the Chief Executive Officer and the Chief Financial Officer concluded that Grainger’s disclosure controls and procedures were effective as of the end of the period covered by this report.

 

Changes in Internal Control Over Financial Reporting

 

There were no changes in Grainger’s internal control over financial reporting that occurred during the first quarter, that have materially affected, or are reasonably likely to materially affect, Grainger’s internal control over financial reporting.

 

PART II – OTHER INFORMATION

 

Items 1A, 3 and 5 not applicable.

 

Item 1.

Legal Proceedings

As previously reported, Grainger received a letter in December 2007 from the Commercial Litigation Branch of the Civil Division of the Department of Justice (the “DOJ”) regarding Grainger’s contract with the United States General Services Administration (the “GSA”). The letter suggested that Grainger had not complied with the contract’s disclosure obligations and pricing provisions, and had potentially overcharged government customers under the contract. As also reported, the DOJ subsequently intervened in a previously filed civil “qui tam” action alleging non-compliance with the contract and with the country of origin provisions of the Trade Agreement Act.

 

In March 2008, Grainger began the process of meeting with the DOJ to discuss the DOJ’s allegations and damage estimates. The timing and outcome of these discussions are uncertain and could include settlement or civil litigation by the DOJ to recover, among other amounts, treble damages and penalties under the False Claims Act. While this matter is not expected to have a material adverse effect on Grainger’s financial position, an unfavorable resolution could result in material payments by Grainger. Grainger continues to believe that it has complied with the GSA contract in all material respects.

 

21

 

W.W. Grainger, Inc. and Subsidiaries

 

Item 2.

Unregistered Sales of Equity Securities and Use of Proceeds

 

Issuer Purchases of Equity Securities – First Quarter

 

Period

Total Number of Shares Purchased (A)

Average Price Paid per Share (B)

Total Number of Shares Purchased as Part of Publicly Announced Plans

or Programs (C)

Maximum Number of

Shares that May Yet be

Purchased Under the

Plans or Programs (D)

 

 

 

 

 

 

Jan. 1 – Jan. 31 (E)

515,274

$78.41

515,274

4,168,719

shares

 

 

 

 

 

 

Feb. 1 – Feb. 29

1,924,999

75.50

1,923,500

2,245,219

shares

 

 

 

 

 

 

Mar. 1 – Mar. 31

589,800

73.45

589,800

1,655,419

shares

 

 

 

 

 

 

Total

3,030,073

$75.15

3,028,574

 

 

 

 

(A)

There were 1,499 shares withheld to satisfy tax withholding obligations in connection with the vesting of employee restricted stock awards.

 

(B)

Average price paid per share includes any commissions paid and includes only those amounts related to purchases as part of publicly announced plans or programs. Activity is reported on a trade date basis. The average price does not include 415,274 shares received as settlement of the accelerated share repurchase agreement which concluded on January 4, 2008.

 

(C)

Purchases were made pursuant to a share repurchase program approved by Grainger’s Board of Directors on August 17, 2007. This share repurchase program was rescinded by the Board of Directors on April 30, 2008.

 

(D)

On April 30, 2008, Grainger announced that its Board of Directors approved a share repurchase program and granted authority to repurchase up to 10 million shares. The program has no specified expiration date.

 

(E)

Includes 415,274 shares received as settlement of the Company’s accelerated share repurchase agreement with Goldman, Sachs & Co. which concluded on January 4, 2008.

 

22

 

W.W. Grainger, Inc. and Subsidiaries

 

Item 4.

Submission of Matters to a Vote of Security Holders

 

An annual meeting of shareholders of Grainger was held on April 30, 2008. At that meeting:

 

Management’s nominees were elected directors for the ensuing year. Of the 67,794,552 shares present in person or represented by proxy at the meeting, the number of shares voted for, and the number of shares as to which authority to vote in the election was withheld, were as follows with respect to each of the nominees:

Name

 

Shares Voted for

Election

 

Shares as to Which Voting

Authority Withheld

B. P. Anderson

 

66,336,071

 

1,458,481

W. H. Gantz

 

66,039,964

 

1,754,588

V. A. Hailey

 

66,342,733

 

1,451,819

W. K. Hall

 

66,204,212

 

1,590,340

R. L. Keyser

 

66,033,343

 

1,761,209

S. L. Levenick

 

66,342,337

 

1,452,215

J. W. McCarter, Jr.

 

66,065,965

 

1,728,587

N. S. Novich

 

66,415,583

 

1,378,969

M. J. Roberts

 

66,363,538

 

1,431,014

G. L. Rogers

 

66,411,023

 

1,383,529

J. T. Ryan

 

66,269,723

 

1,524,829

J. D. Slavik

 

66,120,852

 

1,673,700

H. B. Smith

 

63,265,855

 

4,528,697

 

A proposal to ratify the appointment of Ernst & Young LLP as independent auditors of Grainger for the year ending December 31, 2008, was approved. Of the 67,794,552 shares present or represented by proxy at the meeting, 67,150,808 shares were voted for the proposal, 164,939 shares were voted against the proposal and 478,805 shares abstained from voting with respect to the proposal.

 

23

 

W.W. Grainger, Inc. and Subsidiaries

 

 

Item 6.

Exhibits

 

(a)

Exhibits (numbered in accordance with Item 601 of Regulation S-K)

 

 

(3)

Bylaws, as amended.

 

 

(10)

A Credit Agreement with Wachovia Bank, National Association, as administrative agent, and other lenders.

 

 

(11)

Computations of Earnings per Share.

 

 

(31)

Rule 13a – 14(a)/15d – 14(a) Certifications

 

 

 

(a)  Chief Executive Officer certification pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

 

 

 

(b)  Chief Financial Officer certification pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

 

 

(32)

Section 1350 Certifications

 

 

 

(a)  Chief Executive Officer certification pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

 

 

 

(b)  Chief Financial Officer certification pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

 

 

24

 

SIGNATURES

 

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

 

 

 

W.W. Grainger, Inc.

 

 

(Registrant)

 

 

 

Date: May 6, 2008

 

 

 

By:

 

 

 

/s/ R. L. Jadin

 

 

R. L. Jadin, Senior Vice President

and Chief Financial Officer

 

 

 

Date: May 6, 2008

 

 

 

By:

 

 

 

/s/ G. S. Irving

 

 

G. S. Irving, Vice President

and Controller

 

 

25

 

 

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