How much of the 2004 earnings growth came from one-time tax benefits rather than operations?

The effective tax rate fell to 35.5% (35.6% excluding equity-method effects) from 40.0%, which increased earnings by about $19.4 million, or $0.21 per diluted share. This is a notable portion of the 27.2% diluted EPS increase, so operating earnings growth of 13.5% is a better measure of underlying performance. Management also projects a 2005 tax rate of 37.0%, which implies a headwind relative to 2004.

What is driving Grainger's growth outlook for 2005?

Management cites the multiyear market expansion program in top metropolitan markets, a 3% to 4% GDP and industrial production forecast for 2005, and continued strength in light and heavy manufacturing, where output rose about 4.8% in 2004. The company plans $60 to $70 million for market expansion and $35 to $40 million for information technology, including the SAP rollout, with testing scheduled for the third quarter of 2005.

Is Grainger's balance sheet a source of risk for investors?

Not significantly. Long-term debt was eliminated in 2004 after the cross-currency swap matured, and the only remaining debt is $9.5 million of variable-rate industrial revenue bonds. Liquidity is strong, with $429.2 million of cash, a working capital position of $1.09 billion, a current ratio of 2.6, and $250 million of committed credit lines. The S&P long-term debt rating is AA+.

What legal and operational risks should investors monitor?

Grainger faces asbestos and silica lawsuits involving about 3,700 plaintiffs, plus 2,100 additional plaintiffs in cotton dust cases amended to include asbestos claims. Management believes most claims are insurance-covered and that outcomes will not be materially adverse, but insurance coverage discussions are ongoing. Separately, the EPA seeks a $0.4 million penalty over ozone-depleting substance sales. Operationally, the 2005 exit from on-site Integrated Supply services and the SAP system replacement carry execution risk.

How did the company's capital return policy look in 2004?

Grainger repurchased 2,001,000 shares for about $100.9 million in 2004, compared with 918,300 shares in 2003, and paid $71.2 million in dividends ($0.785 per share, up from $0.735). About 7.1 million shares remained available under the repurchase authorization at year-end. Stock option exercises brought in $72.3 million, partially offsetting these outflows.

GWW 10-K FY2004 Annual Report — Revenue, Net Income, EPS

01—Abstract

Summary

Summary of the 10-K filed February 28, 2005. Cited figures are marked; the original filing is the authoritative source.

W.W.

Grainger's fiscal 2004 10-K shows a strong rebound in profitability driven by a recovering U.S. economy and company-specific initiatives. Net sales rose 8.2% to $5,049.8 million^a, led by the Branch-based Distribution segment (up 8.5%) and Lab Safety (up 10.2%), while Integrated Supply was essentially flat. Gross margin expanded 1.6 percentage points to 37.8%, reflecting product cost reductions, global sourcing, selected price increases and favorable mix.

Operating earnings grew 13.5% to $439.5 million^b, and net earnings rose 26.4% to $286.9 million, or $3.13 per diluted share. Part of the earnings jump came from a lower effective tax rate (35.6% excluding equity-method items versus 40.0% in 2003), which added roughly $0.21 per diluted share, so investors should separate that one-time benefit from core operating growth. The balance sheet is conservative.

Debt was effectively eliminated after the $140.8 million^c cross-currency swap and related commercial paper matured in September 2004, leaving only $9.5 million of industrial revenue bonds, and total debt fell to 0.5% of capitalization. Operating cash flow was $406.5 million, capital expenditures were about $161 million, and the company repurchased 2.0 million shares while paying $71.2 million in dividends.

Management guided 2005 capital spending to $150 to $180 million^d and expects the market expansion program and SAP investments to drive growth. Key risks include the planned exit from on-site Integrated Supply services, ongoing asbestos/silica litigation involving about 3,700 plaintiffs, and the rising cost of the SAP and branch-network transition.

02—Key points

Key Highlights

Net sales of $5.05 billion, up 8.2% year over year, with growth across manufacturing and commercial customers and national accounts up 12%
Gross margin improved to 37.8% from 36.2%, driven by global sourcing, cost reduction programs and selected price increases
Operating earnings of $439.5 million, up 13.5%, with operating margin of 8.7%
Diluted EPS of $3.13, up 27.2%, aided by a lower effective tax rate that added about $0.21 per diluted share
Debt nearly eliminated: long-term debt fell to zero (from $4.9 million) after the $140.8 million cross-currency swap matured, and debt is 0.5% of total capitalization
Strong cash generation: operating cash flow of $406.5 million, funding $160.8 million of capex, $100.9 million of buybacks and $71.2 million of dividends
Integrated Supply is being folded into Industrial Supply and will no longer be reported as a separate segment from 2005; the company will report two segments going forward

03—Questions

Frequently Asked Questions

How much of the 2004 earnings growth came from one-time tax benefits rather than operations?
The effective tax rate fell to 35.5% (35.6% excluding equity-method effects) from 40.0%, which increased earnings by about $19.4 million, or $0.21 per diluted share. This is a notable portion of the 27.2% diluted EPS increase, so operating earnings growth of 13.5% is a better measure of underlying performance. Management also projects a 2005 tax rate of 37.0%, which implies a headwind relative to 2004.
What is driving Grainger's growth outlook for 2005?
Management cites the multiyear market expansion program in top metropolitan markets, a 3% to 4% GDP and industrial production forecast for 2005, and continued strength in light and heavy manufacturing, where output rose about 4.8% in 2004. The company plans $60 to $70 million for market expansion and $35 to $40 million for information technology, including the SAP rollout, with testing scheduled for the third quarter of 2005.
Is Grainger's balance sheet a source of risk for investors?
Not significantly. Long-term debt was eliminated in 2004 after the cross-currency swap matured, and the only remaining debt is $9.5 million of variable-rate industrial revenue bonds. Liquidity is strong, with $429.2 million of cash, a working capital position of $1.09 billion, a current ratio of 2.6, and $250 million of committed credit lines. The S&P long-term debt rating is AA+.
What legal and operational risks should investors monitor?
Grainger faces asbestos and silica lawsuits involving about 3,700 plaintiffs, plus 2,100 additional plaintiffs in cotton dust cases amended to include asbestos claims. Management believes most claims are insurance-covered and that outcomes will not be materially adverse, but insurance coverage discussions are ongoing. Separately, the EPA seeks a $0.4 million penalty over ozone-depleting substance sales. Operationally, the 2005 exit from on-site Integrated Supply services and the SAP system replacement carry execution risk.
How did the company's capital return policy look in 2004?
Grainger repurchased 2,001,000 shares for about $100.9 million in 2004, compared with 918,300 shares in 2003, and paid $71.2 million in dividends ($0.785 per share, up from $0.735). About 7.1 million shares remained available under the repurchase authorization at year-end. Stock option exercises brought in $72.3 million, partially offsetting these outflows.

04—Continue

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