01—Abstract
Summary
Summary of the 10-K filed February 27, 2009. Cited figures are marked; the original filing is the authoritative source.
W.W.
Grainger's 2008 10-K shows a company that grew sales and earnings through a difficult year, but with a sharply weaker outlook heading into 2009. Net sales rose 6.7% to $6.85 billiona, operating earnings climbed 16.7% to $782.7 million, and diluted EPS increased 22.3% to $6.04, helped by a 0.4-point gross margin improvement to 41.0% and share repurchases that reduced the share count. Management, however, said that sales turned negative in late 2008 as the economic downturn hit, that the fourth quarter showed a steep decline in the company's markets, and that it is difficult to project future results.
In response, Grainger froze executive and salaried pay, tied 2009 management bonuses to aggressive sales targets, and announced 300 to 400 job eliminations with $25 million to $35 millionb in annualized savings and roughly $15 million to $20 million in one-time severance charges. The balance sheet changed meaningfully during 2008. Grainger took on a $500 million four-year unsecured bank term loan, pushing long-term debt to $488 million and total debt to 20.7% of total capitalization, up from 5.0% a year earlier.
Cash rose to $396 million, working capital increased to $1.38 billionc, and the current ratio improved to 2.8. Operating cash flow was $530 million, but a $143 million working capital build, mainly inventory tied to the product line expansion, held back free cash flow, which was roughly $335 million after capital expenditures of $195 million. Treasury stock purchases totaled $394 million for 5.5 million shares, and about 7.4 million shares remained under the repurchase authorization.
Investors should weigh the strong 2008 earnings record against several risks: a likely sales decline in 2009 given macro indicators (the filing projects a 2.1%d U.S. GDP decline and a 7.2% drop in industrial production), a rising effective tax rate projected at 38.9%, an unresolved General Services Administration contract matter that could lead to a False Claims Act action with treble damages, and asbestos and silica litigation covering about 2,200 plaintiffs. Management said none of these legal matters is expected to have a material adverse effect, but the GSA issue carries the most uncertainty.
02—Key points
Key Highlights
- Net sales grew 6.7% to $6,850.0 million in 2008, with daily sales up 6.3%; about 5 points of growth came from price and volume and about 1 point from the product line expansion.
- Operating earnings rose 16.7% to $782.7 million and net earnings rose 13.1% to $475.4 million; gross margin improved 0.4 points to 41.0%.
- Diluted EPS was $6.04, up 22.3% from $4.94, aided by share repurchases of 5.5 million shares for $394.2 million; dividends rose to $1.55 per share from $1.34.
- Sales weakened in late 2008 and management says the fourth-quarter decline makes future results hard to project. Responses include a salary freeze, bonuses tied to aggressive sales targets, and 300 to 400 job cuts with $25 to $35 million in annualized savings.
- Total debt rose to 20.7% of total capitalization from 5.0%, driven by a $500 million four-year term loan obtained in May 2008; cash increased to $396.3 million and working capital to $1,382.4 million.
- 2009 capital expenditures are planned at $175 to $200 million, and the 2009 effective tax rate is projected at about 38.9%.
- Open legal matters include a GSA contract pricing and disclosure dispute with the DOJ, which could bring False Claims Act treble damages and penalties, and asbestos/silica suits involving roughly 2,200 plaintiffs.
03—One dollar
Follow one dollar
Of each $1.00 of revenue in FY2008, W.W. Grainger kept $0.07.
- Revenue$6.85B100.0%
- Cost of revenue−$4.04B59.0%
- Gross profit$2.81B41.0%
- Operating costs−$2.03B29.6%
- Operating income$782.7M11.4%
- Interest, other & tax−$307.3M4.5%
- Net income$475.4M6.9%
Where FY2008 revenue went
$6.85B- Cost of revenue: $4.04B, 59% of revenue
- SG&A: $2.03B, 30% of revenue
- Net income: $475.4M, 6.9% of revenue
- Interest, other & tax: $307.3M, 4.5% of revenue
Kept 6.9% as net incomeNet income $475.4M · 6.9%
Full revenue history →04—Financials
Financial Highlights
Figures from 10-KFY2008filed February 27, 2009Financial Statements
FY2008 against FY2007
| Line item | FY2008FY2007 | Change |
|---|---|---|
| Revenue | $6.85B$6.42B | +6.7% |
| Cost of Revenue | $4.04B$3.81B | +6.0% |
| Gross Profit | $2.81B$2.60B | +7.9% |
| SG&A Expenses | $2.03B$1.93B | +4.8% |
| Operating Income | $782.67M$670.65M | +16.7% |
| Interest Expense | $14.48M$2.97M | +387.1% |
| Net Income | $475.36M$420.12M | +13.1% |
| EPS (Basic) | $6.07$5.01 | +21.2% |
| EPS (Diluted) | $5.97$4.91 | +21.6% |
| Shares Outstanding (Basic) | 76.58M82.40M | −7.1% |
| Shares Outstanding (Diluted) | 77.89M84.17M | −7.5% |
05—Questions
Frequently Asked Questions
How did Grainger perform financially in 2008?
Grainger grew net sales 6.7% to $6.85 billion and operating earnings 16.7% to $782.7 million. Net earnings rose 13.1% to $475.4 million, and diluted EPS increased 22.3% to $6.04. Most of the growth came in the first part of the year, before the economic slowdown began to hurt sales in late 2008.
What is the outlook for 2009 and what steps is management taking?
The filing does not give specific 2009 sales guidance. It notes that sales declined in late 2008 and that the fourth-quarter drop in its markets makes projection difficult. The company froze salaries for executives and salaried employees, linked 2009 management incentive bonuses to aggressive sales targets, and announced 300 to 400 job eliminations expected to save $25 to $35 million annually, with $15 to $20 million in one-time severance costs. Management expects to add 50,000 products in 2009 and to fund capital spending of $175 to $200 million from operating cash flow.
Did Grainger's balance sheet and leverage change in 2008?
Yes. Grainger took on a $500 million unsecured four-year bank term loan in May 2008, raising long-term debt to $488.2 million. Total debt as a percentage of total capitalization rose to 20.7% from 5.0% in 2007. Liquidity remains solid, with $396.3 million in cash, a current ratio of 2.8, and a $250 million committed credit line that was undrawn. The company's S&P long-term debt rating is AA+, and its debt agreements contain no financial maintenance covenants.
What are the main legal and regulatory risks disclosed?
The most significant is a dispute with the Department of Justice over Grainger's General Services Administration contract, which the DOJ says may involve pricing non-compliance and overcharges. A settlement or civil suit under the False Claims Act could bring treble damages and penalties. Grainger says the matter is not expected to have a material adverse effect, but an unfavorable outcome could mean significant payments. The company also faces asbestos and silica injury suits involving about 2,200 plaintiffs, which it believes are largely insured or outside its liability.
Why did cash flow lag earnings growth in 2008?
Operating cash flow rose to $530.1 million, but working capital absorbed $143.1 million, mainly as inventory increased to support the product line expansion. After $195.0 million in capital spending, free cash flow was roughly $335 million. Grainger used cash to repurchase $394.2 million of stock and pay $121.5 million in dividends, funded partly by the $500 million term loan.
06—Continue