Why did net sales decline while operating earnings grew?

Net sales fell 2.3% because of weak North American demand, the 2002 deconsolidation of Acklands' automotive aftermarket business into a 50% joint venture, and the elimination of the Digital segment. Operating earnings rose 16.1% because the company achieved higher gross margins from pricing actions and product mix, lower cost of merchandise sold, and reduced operating expenses. The comparison also benefited from the absence of the 2001 $39.1 million Material Logic restructuring charge.

How much of the 2002 earnings growth reflects underlying performance versus one-time items?

Reported net earnings rose 21.2% to $211.6 million, but this included a $23.9 million after-tax goodwill impairment charge at Acklands and a $4.5 million after-tax gain on securities sales. Excluding these items and the 2001 Material Logic and investment write-downs, net earnings grew 8.8% to $229.8 million and EPS grew 9.4% to $2.44, which is a more representative view of underlying growth.

Is Grainger's balance sheet and liquidity position strong?

Yes. Total debt was only 7.2% of total capitalization, the company held an AA+ S&P rating, and working capital was $898.7 million with a current ratio of 2.5. Most of its committed credit lines remained available, and it has no financial or performance covenants that restrict the business. Operating cash flow dropped to $303.5 million, but the decline was mainly a planned inventory build rather than a deterioration in profitability.

What are the main legal and risk exposures disclosed?

The company is a defendant in about 600 lawsuits involving roughly 1,110 plaintiffs alleging personal injury from asbestos-containing products it distributed. Management says it has been dismissed from many similar cases, that it would seek indemnification from manufacturers where a specific product is identified, and that a substantial portion of claims should be covered by insurance, though coverage discussions are ongoing. Management believes the ultimate outcome will not have a material adverse effect. Other risks include North American economic weakness, currency exposure to the Canadian dollar, and interest rate exposure on its variable-rate debt.

GWW 10-K FY2002 Annual Report — Revenue, Net Income, EPS

01—Abstract

Summary

Summary of the 10-K filed March 20, 2003. Cited figures are marked; the original filing is the authoritative source.

W.W.

Grainger's fiscal 2002 10-K shows a company that grew earnings despite a soft top line. Net sales fell 2.3% to $4.64 billion^a, driven by weak North American industrial demand, the Canadian automotive aftermarket joint venture with Uni-Select, and the wind-down of the Digital segment. Operating earnings rose 16.1% to $393.2 million, and the operating margin widened to 8.5% from 7.1%.

Excluding the Material Logic restructuring items and the 2002 cumulative accounting charge, earnings improved on a like-for-like basis, reflecting gross margin gains from pricing actions and mix, lower cost of merchandise sold, and tighter expense control. Diluted EPS was $2.24^b, including a $0.26 goodwill impairment charge at Acklands, and would have been $2.44 excluding these items. The balance sheet remains conservative.

Total assets were $2.44 billion^c, shareholders' equity was $1.67 billion, and total debt was only 7.2% of total capitalization. The company holds an AA+ S&P rating, and its committed credit lines were largely unused. Operating cash flow fell to $303.5 million from $509.2 million, mainly because of a $97 million inventory build intended to improve service levels and capture share in an anticipated economic recovery.

The company also repurchased 2.2 million shares for about $100 million^d and paid $66.5 million in dividends. Key risks include continued weakness in the North American economy, exposure to Canadian and Mexican currency and economic conditions, and a legal overhang from roughly 600 asbestos-related lawsuits, which management believes are largely insured and not material. Management also disclosed a pending $35 million acquisition of Gempler's by Lab Safety, expected to close in the second quarter of 2003.

02—Key points

Key Highlights

Net sales declined 2.3% to $4,643.9 million, reflecting softness in North American industrial demand, the Acklands automotive JV, and elimination of the Digital segment.
Operating earnings rose 16.1% to $393.2 million, and operating margin improved to 8.5% from 7.1%, supported by higher gross margins and lower cost of merchandise sold.
Diluted EPS of $2.24 included a $0.26 non-cash goodwill impairment at Acklands under SFAS 142; excluding that charge and prior-year Material Logic items, EPS grew about 9% to $2.44.
grainger.com processed about $420 million in sales in 2002, up 26% year over year, and the Industrial Supply division is rebuilding its distribution network with five new and four redesigned distribution centers.
The balance sheet is conservative, with total debt at 7.2% of capitalization, an AA+ S&P rating, and $264.7 million of available committed credit lines.
Operating cash flow fell to $303.5 million from $509.2 million, largely because of a $97 million inventory build, and the company repurchased about $100 million of stock and paid $66.5 million in dividends.
Management disclosed a pending acquisition of Gempler's for about $35 million in cash, expected to close in Q2 2003, and continues to face roughly 600 asbestos-related lawsuits that it believes are largely covered by insurance.

03—Questions

Frequently Asked Questions

Why did net sales decline while operating earnings grew?
Net sales fell 2.3% because of weak North American demand, the 2002 deconsolidation of Acklands' automotive aftermarket business into a 50% joint venture, and the elimination of the Digital segment. Operating earnings rose 16.1% because the company achieved higher gross margins from pricing actions and product mix, lower cost of merchandise sold, and reduced operating expenses. The comparison also benefited from the absence of the 2001 $39.1 million Material Logic restructuring charge.
How much of the 2002 earnings growth reflects underlying performance versus one-time items?
Reported net earnings rose 21.2% to $211.6 million, but this included a $23.9 million after-tax goodwill impairment charge at Acklands and a $4.5 million after-tax gain on securities sales. Excluding these items and the 2001 Material Logic and investment write-downs, net earnings grew 8.8% to $229.8 million and EPS grew 9.4% to $2.44, which is a more representative view of underlying growth.
Is Grainger's balance sheet and liquidity position strong?
Yes. Total debt was only 7.2% of total capitalization, the company held an AA+ S&P rating, and working capital was $898.7 million with a current ratio of 2.5. Most of its committed credit lines remained available, and it has no financial or performance covenants that restrict the business. Operating cash flow dropped to $303.5 million, but the decline was mainly a planned inventory build rather than a deterioration in profitability.
What are the main legal and risk exposures disclosed?
The company is a defendant in about 600 lawsuits involving roughly 1,110 plaintiffs alleging personal injury from asbestos-containing products it distributed. Management says it has been dismissed from many similar cases, that it would seek indemnification from manufacturers where a specific product is identified, and that a substantial portion of claims should be covered by insurance, though coverage discussions are ongoing. Management believes the ultimate outcome will not have a material adverse effect. Other risks include North American economic weakness, currency exposure to the Canadian dollar, and interest rate exposure on its variable-rate debt.

04—Continue

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