27 Pages Complete
QUARTERLY REPORT UNDER SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
[x] Quarterly Report Pursuant to Section
13 or 15(d) of the Securities
Exchange Act of 1934
For the period ended September 30, 1999
or
[ ] 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
I.R.S. Employer Identification Number 36-1150280
W.W. Grainger, Inc.
(An Illinois Corporation)
100 Grainger Parkway
Lake Forest, Illinois 60045-5201
Telephone: (847) 535-1000
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
APPLICABLE ONLY TO CORPORATE ISSUERS:
Indicate the number of shares outstanding of each of the issuers classes of
common stock, as of the latest practicable date: 93,383,441 shares of the
Company's Common Stock were outstanding as of October 31, 1999.
The Exhibit Index appears on page 24 in the sequential numbering system.
1
<PAGE>
Part I - FINANCIAL INFORMATION
<TABLE>
W.W. Grainger, Inc., and Subsidiaries
CONSOLIDATED STATEMENTS OF EARNINGS
(In thousands of dollars except for per share amounts)
(Unaudited)
<CAPTION>
Three Months Ended Nine Months Ended
September 30, September 30,
---------------------------- ----------------------------
1999 1998 1999 1998
------------ ------------ ------------ ------------
<S> <C> <C> <C> <C>
Net sales ........................................ $ 1,175,393 $ 1,120,038 $ 3,412,411 $ 3,296,115
Cost of merchandise sold ......................... 752,657 714,727 2,170,798 2,103,690
------------ ------------ ------------ ------------
Gross profit ................................... 422,736 405,311 1,241,613 1,192,425
Warehousing, marketing, and
administrative expenses ........................ 342,354 309,068 977,494 897,825
------------ ------------ ------------ ------------
Operating earnings ............................. 80,382 96,243 264,119 294,600
Other income or (deductions)
Interest income ................................ 391 672 1,120 1,152
Interest expense ............................... (5,276) (1,550) (9,952) (4,847)
Unclassified-net ............................... 1,405 (1,097) 1,138 (970)
------------ ------------ ------------ ------------
(3,480) (1,975) (7,694) (4,665)
------------ ------------ ------------ ------------
Earnings before income taxes ..................... 76,902 94,268 256,425 289,935
Income taxes ..................................... 31,145 38,179 103,852 117,424
------------ ------------ ------------ ------------
Net earnings ................................... $ 45,757 $ 56,089 $ 152,573 $ 172,511
============ ============ ============ ============
Earnings per share:
Basic .......................................... $ 0.49 $ 0.58 $ 1.64 $ 1.78
============ ============ ============ ============
Diluted ........................................ $ 0.49 $ 0.57 $ 1.62 $ 1.75
============ ============ ============ ============
Weighted average number of shares outstanding:
Basic .......................................... 92,840,777 96,519,586 92,831,640 96,996,816
============ ============ ============ ============
Diluted ........................................ 94,352,612 98,010,294 94,358,453 98,684,554
============ ============ ============ ============
Cash dividends paid per share .................... $ 0.16 $ 0.15 $ 0.47 $ 0.435
============ ============ ============ ============
<FN>
The accompanying notes are an integral part of these financial statements.
</FN>
</TABLE>
2
<PAGE>
<TABLE>
W.W. Grainger, Inc., and Subsidiaries
CONSOLIDATED STATEMENTS OF COMPREHENSIVE EARNINGS
(In thousands of dollars)
(Unaudited)
<CAPTION>
Three Months Ended Nine Months Ended
September 30, September 30,
------------------------- -----------------------
1999 1998 1999 1998
--------- --------- --------- ---------
<S> <C> <C> <C> <C>
Net Earnings ..................................... $ 45,757 $ 56,089 $ 152,573 $ 172,511
Other comprehensive earnings:
Foreign currency translation
adjustments .................................. 1,539 (6,547) 7,049 (10,549)
--------- --------- --------- ---------
Comprehensive earnings ........................... $ 47,296 $ 49,542 $ 159,622 $ 161,962
========= ========= ========= =========
<FN>
The accompanying notes are an integral part of these financial statements.
</FN>
</TABLE>
3
<PAGE>
<TABLE>
W.W. Grainger, Inc., and Subsidiaries
CONSOLIDATED BALANCE SHEETS
(In thousands of dollars)
(Unaudited)
<CAPTION>
ASSETS Sept. 30, 1999 Dec. 31, 1998
- ------------------------------------------------------------ --------------- ---------------
<S> <C> <C>
CURRENT ASSETS
Cash and cash equivalents ................................ $ 47,609 $ 43,107
Accounts receivable, less allowance for doubtful
accounts of $18,009 for 1999 and $15,951 for 1998 ...... 565,499 463,377
Inventories .............................................. 699,290 626,731
Prepaid expenses ......................................... 16,198 11,950
Deferred income tax benefits ............................. 64,187 61,200
--------------- ---------------
Total current assets ................................... 1,392,783 1,206,365
PROPERTY, BUILDINGS, AND EQUIPMENT ......................... 1,270,784 1,209,167
Less accumulated depreciation and amortization ........... 585,312 548,639
--------------- ---------------
Property, buildings, and equipment-net ................... 685,472 660,528
DEFERRED INCOME TAXES ...................................... 9,167 3,187
OTHER ASSETS ............................................... 261,978 233,822
--------------- ---------------
TOTAL ASSETS ............................................... $ 2,349,400 $ 2,103,902
=============== ===============
LIABILITIES AND SHAREHOLDERS' EQUITY
- ------------------------------------------------------------
CURRENT LIABILITIES
Short-term debt .......................................... $ 221,911 $ 88,060
Current maturities of long-term debt ..................... 22,835 22,831
Trade accounts payable ................................... 306,136 287,055
Accrued expenses ......................................... 226,072 233,327
Income taxes ............................................. 17,681 33,220
--------------- ---------------
Total current liabilities .............................. 794,635 664,493
LONG-TERM DEBT (less current maturities) ................... 127,833 122,883
ACCRUED EMPLOYMENT RELATED BENEFITS COSTS .................. 41,376 37,785
SHAREHOLDERS' EQUITY
Cumulative Preferred Stock - $5 par value - authorized,
12,000,000 shares, issued and outstanding, none ........ -- --
Common Stock - $0.50 par value - authorized, 300,000,000
shares; issued, 107,455,033 shares, 1999 and
107,233,771 shares, 1998 ............................... 53,728 53,617
Additional contributed capital ........................... 255,302 249,482
Treasury stock, at cost - 14,069,892 shares, 1999 and
13,728,672 shares, 1998 ................................ (587,812) (572,900)
Unearned restricted stock compensation ................... (17,188) (17,238)
Cumulative translation adjustments ....................... (12,515) (19,564)
Retained earnings ........................................ 1,694,041 1,585,344
--------------- ---------------
Total shareholders' equity ............................... 1,385,556 1,278,741
--------------- ---------------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY ............... $ 2,349,400 $ 2,103,902
=============== ===============
<FN>
The accompanying notes are an integral part of these financial statements.
</FN>
</TABLE>
4
<PAGE>
<TABLE>
W.W. Grainger, Inc., and Subsidiaries
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands of dollars)
(Unaudited)
<CAPTION>
Nine Months Ended
September 30,
----------------------------------
1999 1998
--------------- ---------------
<S> <C> <C>
Cash flows from operating activities:
Net earnings ............................................. $ 152,573 $ 172,511
Provision for losses on accounts receivable .............. 10,316 9,771
Depreciation and amortization:
Property, buildings, and equipment ..................... 55,546 46,236
Intangibles and goodwill ............................... 11,945 12,020
Capitalized software ................................... 7,236 6,961
Change in operating assets and liabilities:
(Increase) in accounts receivable ...................... (112,438) (50,960)
(Increase) decrease in inventories ..................... (72,559) 41,802
(Increase) in prepaid expenses ......................... (4,248) (4,174)
(Increase) in deferred income taxes .................... (5,237) (3,671)
Increase in trade accounts payable ..................... 19,081 17,454
(Decrease) increase in other current liabilities ....... (7,256) 6,255
(Decrease) in current income taxes payable ............. (17,974) (11,689)
Increase in accrued employment related
benefits costs ....................................... 3,591 3,782
Other - net .............................................. 985 995
--------------- ---------------
Net cash provided by operating activities .................. 41,561 247,293
--------------- ---------------
Cash flows from investing activities:
Additions to property, buildings, and
equipment - net ........................................ (80,490) (87,913)
Expenditures for capitalized software .................... (19,606) (31,967)
Other - net .............................................. (15,093) (13,654)
--------------- ---------------
Net cash (used in) investing activities .................... (115,189) (133,534)
--------------- ---------------
Cash flows from financing activities:
Net increase in short-term debt .......................... 133,851 42,011
Long-term debt payments .................................. (49) (1,054)
Stock incentive plan ..................................... 3,116 4,201
Purchase of treasury stock - net ......................... (14,912) (117,292)
Cash dividends paid ...................................... (43,876) (42,483)
--------------- ---------------
Net cash provided by (used in) financing activities ........ 78,130 (114,617)
--------------- ---------------
Net increase (decrease) in cash and cash equivalents ....... 4,502 (858)
Cash and cash equivalents at beginning of year ............. 43,107 46,929
--------------- ---------------
Cash and cash equivalents at end of period ................. $ 47,609 $ 46,071
=============== ===============
<FN>
The accompanying notes are an integral part of these financial statements.
</FN>
</TABLE>
5
<PAGE>
W.W. Grainger, Inc., and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
1. BASIS OF STATEMENT PRESENTATION
The financial statements and the related notes are condensed and should be read
in conjunction with the consolidated financial statements and related notes for
the year ended December 31, 1998, included in the Company's Annual Report on
Form 10-K filed with the Securities and Exchange Commission.
The consolidated financial statements include the accounts of the Company and
its subsidiaries. All significant intercompany transactions are eliminated.
Inventories are valued at the lower of cost or market. Cost is primarily
determined by the last-in, first-out (LIFO) method.
The unaudited financial information reflects all adjustments which, in the
opinion of management, are necessary for a fair presentation of the statements
contained herein.
Checks outstanding of $57,688,000 and $74,183,000 were included in trade
accounts payable at September 30, 1999 and December 31, 1998, respectively.
These amounts are immaterial to the consolidated financial statements.
2. DIVIDEND
On October 27, 1999, the Board of Directors declared a quarterly dividend of 16
cents per share, payable December 1, 1999 to shareholders of record on November
8, 1999.
6
<PAGE>
W.W. Grainger, Inc., and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Unaudited)
3. SEGMENT INFORMATION (In thousands of dollars)
The following segment disclosures are condensed and should be read in
conjunction with the consolidated financial statements and related notes for the
year ended December 31, 1998, included in the Company's Annual Report on Form
10-K filed with the Securities and Exchange Commission.
<TABLE>
<CAPTION>
Three Months ended September 30, 1999
----------------------------------------------------
Branch-based Other
Distribution Businesses Totals
--------------- --------------- ---------------
<S> <C> <C> <C>
Total net sales ........................ $ 1,033,093 $ 196,023 $ 1,229,116
Intersegment net sales ................. 50,915 2,808 53,723
Net sales from external customers ...... 982,178 193,215 1,175,393
Segment operating earnings ............. 103,489 (10,781) 92,708
</TABLE>
<TABLE>
<CAPTION>
Three Months ended September 30, 1998
----------------------------------------------------
Branch-based Other
Distribution Businesses Totals
--------------- --------------- ---------------
<S> <C> <C> <C>
Total net sales ........................ $ 1,008,310 $ 179,991 $ 1,188,301
Intersegment net sales ................. 66,084 2,179 68,263
Net sales from external customers ...... 942,226 177,812 1,120,038
Segment operating earnings ............. 104,984 1,380 106,364
</TABLE>
<TABLE>
<CAPTION>
Nine Months ended September 30, 1999
----------------------------------------------------
Branch-based Other
Distribution Businesses Totals
--------------- --------------- ---------------
<S> <C> <C> <C>
Total net sales ........................ $ 3,003,572 $ 589,267 $ 3,592,839
Intersegment net sales ................. 173,780 6,648 180,428
Net sales from external customers ...... 2,829,792 582,619 3,412,411
Segment operating earnings ............. 306,504 (9,731) 296,773
</TABLE>
<TABLE>
<CAPTION>
Nine Months ended September 30, 1998
----------------------------------------------------
Branch-based Other
Distribution Businesses Totals
--------------- --------------- ---------------
<S> <C> <C> <C>
Total net sales ........................ $ 2,950,638 $ 549,554 $ 3,500,192
Intersegment net sales ................. 198,147 5,930 204,077
Net sales from external customers ...... 2,752,491 543,624 3,296,115
Segment operating earnings ............. 307,545 14,390 321,935
</TABLE>
7
<PAGE>
W.W. Grainger, Inc., and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Unaudited)
3. SEGMENT INFORMATION (In thousands of dollars)
<TABLE>
<CAPTION>
Branch-based Other
Distribution Businesses Totals
--------------- --------------- ---------------
<S> <C> <C> <C>
Segment Assets:
At September 30, 1999 .................. $ 1,789,304 $ 283,925 $ 2,073,229
At December 31, 1998 ................... $ 1,805,396 $ 189,298 $ 1,994,694
</TABLE>
A reconciliation of segment operating earnings to consolidated operating
earnings is as follows:
<TABLE>
<CAPTION>
Three Months ended September 30
1999 1998
--------------- ---------------
<S> <C> <C>
Total operating earnings for reportable segments . $ 92,708 $ 106,364
Unallocated expenses ............................. (12,326) (10,121)
Elimination of intersegment profits .............. -- --
--------------- ---------------
Total consolidated operating earnings .......... $ 80,382 $ 96,243
=============== ===============
</TABLE>
<TABLE>
<CAPTION>
Nine Months ended September 30
1999 1998
--------------- ---------------
<S> <C> <C>
Total operating earnings for reportable segments . $ 296,773 $ 321,935
Unallocated expenses ............................. (32,638) (27,335)
Elimination of intersegment profits .............. (16) --
--------------- ---------------
Total consolidated operating earnings .......... $ 264,119 $ 294,600
=============== ===============
</TABLE>
<TABLE>
<CAPTION>
September 30, December 31,
--------------- ---------------
1999 1998
--------------- ---------------
<S> <C> <C>
Assets:
Total assets for reportable segments ............. $ 2,073,229 $ 1,994,694
Unallocated assets ............................... 276,171 109,208
--------------- ---------------
Total Consolidated assets ...................... $ 2,349,400 $ 2,103,902
=============== ===============
</TABLE>
8
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND THE RESULTS OF OPERATIONS
RESULTS OF OPERATIONS
THREE MONTHS ENDED SEPTEMBER 30, 1999 COMPARED WITH THE THREE MONTHS ENDED
SEPTEMBER 30, 1998:
Net Sales
---------
The Company's net sales of $1,175,393,000 for the 1999 third quarter increased
4.9% from net sales of $1,120,038,000 for the comparable 1998 period. This
increase resulted from a 2.5% increase in the Branch-based Distribution segment
and an 8.9% increase in the Other Businesses of the Company (percentages
consider both external and intersegment sales). (For additional segment
information, see Note 3 of the Notes to Consolidated Financial Statements
included in this report.) There were 64 sales days in both the 1999 and 1998
third quarters. The year 1999 will have one less sales day than did the year
1998 (254 vs. 255).
Despite a soft industrial economy in the United States, sales growth was
positive for the third quarter of 1999 versus the comparable 1998 period. Sales
growth for the third quarter of 1999 was primarily volume-driven, reflecting
favorable effects from the Company's customer-focused business unit strategy,
new marketing initiatives, and the continuing acceleration in Internet
transactions. Sales growth was constrained, however, by customer service issues
at Grainger Industrial Supply and Grainger Parts related to the field rollout of
the new business enterprise system. The Company estimates that it lost
$9,000,000 of sales as a result of these service issues.
Segment Net Sales
Branch-based Distribution Businesses
- ------------------------------------
Grainger Industrial Supply - Average daily sales increased 1% for the 1999 third
quarter compared to the 1998 third quarter. Sales were favorably affected by
continued momentum in the Company's Internet strategy. Sales through the
Internet were $30,000,000 in the 1999 third quarter, representing a 740%
increase over the third quarter of 1998 and a 58% increase over Internet sales
of $19,000,000 in the second quarter of 1999. Sales were negatively affected by
the customer service issues discussed above. Grainger Industrial Supply
estimates that it lost $8,000,000 of sales as a result of these service issues.
Sales prices decreased 1.5% versus the third quarter of 1998.
9
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND THE RESULTS OF OPERATIONS
RESULTS OF OPERATIONS (Continued)
Acklands - Grainger Inc. (Canada) - Average daily sales increased 12% for the
1999 third quarter compared to the 1998 third quarter. This increase was driven
by growth in both Eastern and Western Canada. The growth in Eastern Canada was
attributable to 12 new branches opened during 1998 and 1999. The growth in
Western Canada was driven by an improvement in the oil and gas and industrial
sectors of the economy. In Canadian dollars, average daily sales increased 11%.
The Company is planning to open 3 more branches in Eastern Canada during the
remainder of 1999.
Grainger, S.A. de C.V. (Mexico) - Average daily sales increased 16% for the 1999
third quarter compared to the 1998 third quarter. This strong sales growth
reflects the continuing development of this new business. A key driver was
increased sales to customers located in Mexico's interior, who are served by the
Company's facility in Monterrey.
Other Businesses
- ----------------
Grainger Custom Solutions - Average daily sales decreased 4% for the 1999 third
quarter compared to the 1998 third quarter. This decrease was primarily the
result of reduced sales to several large customers who experienced slowdowns in
their business during the quarter. The transition of customers to Grainger
Custom Solutions from both Grainger Industrial Supply and Grainger Integrated
Supply is expected to continue through the end of 1999.
Grainger Integrated Supply - Average daily sales increased 84% for the 1999
third quarter compared to the 1998 third quarter. Sales for this business unit
includes product throughput and management fees. Growth was driven by new
engagements, contract renewals, and scope expansion reflecting the strong demand
for this new business, which provides fee-based, on-site indirect materials
management services to large businesses.
Lab Safety Supply - Average daily sales increased 7% for the 1999 third quarter
compared to the 1998 third quarter reflecting the continuing success of product
line expansion.
10
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND THE RESULTS OF OPERATIONS
RESULTS OF OPERATIONS (Continued)
Gross Profit Margin
-------------------
The Company's gross profit margin for the 1999 third quarter decreased by 0.22
percentage point compared to the same 1998 quarter. The decrease was driven by
lower gross profit margins within the Other Businesses partially offset by
higher gross profit margins within the Branch-based Distribution Business
segment.
Segment Gross Profit Margin
Branch-based Distribution Businesses
- ------------------------------------
Gross profit margins improved at Grainger Industrial Supply. The improvement
primarily related to a favorable product mix, reflecting net new products added
since the third quarter of 1998.
This improvement was partially offset by an unfavorable selling price category
mix and by lower selling prices on selected items, coinciding with the issuance
of Grainger Industrial Supply's Catalog in February 1999.
Other Businesses
- ----------------
Gross profit margins decreased at Grainger Integrated Supply and Grainger Custom
Solutions. The decrease at Grainger Integrated Supply related to product sales
throughput, which grew at a faster rate than related management fee income. The
decrease at Grainger Custom Solutions was primarily related to higher sales of
sourced product (not inventoried) which, in general, carry lower gross profit
margins.
Operating Expenses
------------------
Operating expenses (warehousing, marketing, and administrative expenses)
increased 10.8% for the 1999 third quarter compared to the 1998 third quarter.
The increase included higher data processing expenses, which exceeded the 1998
quarter by $8,800,000, as adjusted for 1999 volume increases. The higher data
processing expenses primarily related to Year 2000 compliance initiatives,
Internet commerce activities, and the ongoing installation of new business
enterprise systems. Data processing expenses for 1999 are estimated to be
approximately $30,000,000 higher than in 1998, as adjusted for 1999 volume
related increases.
11
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND THE RESULTS OF OPERATIONS
RESULTS OF OPERATIONS (Continued)
Segment Operating Expenses
Branch-based Distribution Businesses
- ------------------------------------
Operating expenses increased about 6% for the 1999 third quarter versus the
comparable 1998 quarter. This rate of growth exceeded the growth rate in net
sales due to:
1. Increased data processing expenses as described on page 11 of this report;
2. Increased expenses relating to the development of the business in Mexico;
3. Increased occupancy expenses;
4. Increased expenses incurred to maintain customer service levels during the
installation of the new business enterprise system, and;
5. Increased training and education expenses relating to the new business
enterprise system.
These factors were partially offset by decreased advertising expenses at
Grainger Industrial Supply resulting from increased cooperative programs.
Other Businesses
- ----------------
Operating expenses grew faster than net sales, reflecting continuing investments
to meet the diverse needs of segment-specific customers, to improve
accountability within the Company, and to take advantage of growth
opportunities. These investments included:
1. Continued development of the Grainger Custom Solutions business;
2. Expanded marketing programs at Lab Safety Supply, and;
3. Increased expenses, including data processing expenses related to Internet
initiatives totaling $12,200,000 in the third quarter of 1999 versus
$2,200,000 in the third quarter of 1998.
During the quarter, Grainger Integrated Supply reduced its operating expenses by
about 3% while achieving sales growth of 84%.
12
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND THE RESULTS OF OPERATIONS
RESULTS OF OPERATIONS (Continued)
Operating Earnings
------------------
The Company's operating earnings decreased 16.5% for the third quarter of 1999
compared to the same quarter in 1998. Operating earnings declined at both the
Branch-based Distribution segment and at the Other Businesses. (For segment
operating earnings, see Note 3 of the Notes to Consolidated Financial Statements
included in this report.)
Segment Operating Earnings
Branch-based Distribution Businesses
- ------------------------------------
The decline in operating earnings is primarily attributable to Grainger
Industrial Supply and Grainger Parts and largely reflects the systems
installation issues described earlier in this document. As previously noted, the
Company estimates that it lost $9,000,000 in sales as a result of customer
service issues at Grainger Industrial Supply and Grainger Parts. It is estimated
that the effect of the systems installation issues - including gross profit on
the lost sales, along with incremental operating expenses to maintain customer
service levels - was an $11,000,000 reduction in operating earnings for the
quarter.
Other Businesses
- ----------------
The decline in operating earnings primarily related to Internet Commerce and
Grainger Custom Solutions. Partially offsetting these declines were improved
results at Grainger Integrated Supply and Lab Safety Supply.
The results for Internet Commerce reflect incremental marketing expenses to
promote the Company's Web sites, Grainger.com and OrderZone.com. The marketing
programs were initiated in the fourth quarter of 1998 and grew substantially in
magnitude during the third quarter of 1999. Operating expenditures during the
quarter were also directed toward enhancing the functionality of Grainger.com.
Operating expenses also increased due to payroll expenses to support additional
transaction volume. (Sales processed through Grainger.com, which accelerated
substantially during the quarter, are recognized in Grainger Industrial Supply's
sales.)
Grainger Custom Solutions' results reflected increased investments for
developing the infrastructure for this business and the effect of eliminating
some less profitable business. During the transition, certain infrastructure
investments temporarily duplicate the Grainger Industrial Supply platform.
13
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND THE RESULTS OF OPERATIONS
RESULTS OF OPERATIONS (Continued)
Other Income Statement Data
---------------------------
Interest income decreased by $281,000 for the third quarter of 1999 compared
with the same period in 1998. This decrease resulted from lower average
daily-invested balances and lower average interest rates earned.
Interest expense increased by $3,726,000 for the third quarter of 1999 compared
to the same period in 1998. This increase resulted from higher average interest
rates paid on all outstanding debt, higher average borrowings, and lower
capitalized interest.
Unclassified-net had a positive effect on earnings before income taxes of
$2,502,000 for the third quarter of 1999 as compared with the same period in
1998. 1999 included a gain related to the disposal of facilities in the
Chicagoland area.
The Company's effective income tax rate was 40.5% for the third quarter of both
1999 and 1998.
Net Earnings
------------
The Company's net earnings of $45,757,000 in the 1999 third quarter decreased
18.4% as compared to net earnings of $56,089,000 for the comparable 1998 period.
14
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND THE RESULTS OF OPERATIONS
RESULTS OF OPERATIONS (Continued)
NINE MONTHS ENDED SEPTEMBER 30, 1999 COMPARED WITH THE NINE MONTHS ENDED
SEPTEMBER 30, 1998:
Net Sales
---------
The Company's net sales of $3,412,411,000 for the first nine months of 1999
increased 3.5% from net sales of $3,296,115,000 for the comparable 1998 period.
This increase resulted from a 1.8% increase in the Branch-based Distribution
segment and a 7.2% increase in the Other Businesses of the Company (percentages
consider both external and intersegment sales). (For additional segment
information, see Note 3 of the Notes to Consolidated Financial Statements
included in this report.) There were 191 sales days in the first nine months of
both 1999 and 1998. The year 1999 will have one less sales day than did the year
1998 (254 vs. 255).
Despite a soft North American industrial economy, sales growth was positive for
the first nine months of 1999 versus the comparable 1998 period. Sales growth
for the first nine months of 1999 was primarily volume-driven, reflecting
favorable effects from the Company's customer-focused business unit strategy,
new marketing initiatives, and the continuing acceleration in Internet
transactions. Sales growth was constrained, however, by customer service issues
at Grainger Industrial Supply and Grainger Parts related to the field rollout of
the new business enterprise system. The Company estimates that it lost
$19,000,000 of sales as a result of these service issues which occurred during
the latter part of the second quarter and the third quarter of 1999.
Segment Net Sales
Branch-based Distribution Businesses
- ------------------------------------
Grainger Industrial Supply - Average daily sales increased 2% for the first nine
months of 1999 as compared to the 1998 period. Sales were favorably affected by
momentum in the Company's Internet strategy. Online sales through the Internet
were $59,000,000 in the first nine months of 1999, representing a 555% increase
over the comparable 1998 period. Sales were negatively affected by the customer
service issues discussed above. Grainger Industrial Supply estimates that it
lost $18,000,000 of sales as a result of these service issues. Sales prices
decreased 0.6% for the first nine months of 1999 versus the comparable period of
1998.
15
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND THE RESULTS OF OPERATIONS
RESULTS OF OPERATIONS (Continued)
Acklands - Grainger Inc. (Canada) - Average daily sales increased 2% for the
first nine months of 1999 as compared to the 1998 period. This increase was
driven by growth in both Eastern and Western Canada during the third quarter of
1999 versus the comparable 1998 period. The growth in Eastern Canada was
attributable to 12 new branches opened during 1998 and 1999. The growth in
Western Canada was driven by an improvement in the oil and gas and industrial
sectors of the economy. In Canadian dollars, average daily sales increased 4%.
The Company is planning to open 3 more branches in Eastern Canada during the
remainder of 1999.
Grainger, S.A. de C.V. (Mexico) - Average daily sales increased 15% for the
first nine months of 1999 as compared to the 1998 period. This strong sales
growth reflects the continuing development of this new business. A key driver
was increased sales to customers located in Mexico's interior, who are served by
the Company's facility in Monterrey.
Other Businesses
- ----------------
Grainger Custom Solutions - Average daily sales decreased 2% for the first nine
months of 1999 as compared to the 1998 period. The focus remains on
transitioning customers to the new business platform. The transition of
customers to Grainger Custom Solutions from both Grainger Industrial Supply and
Grainger Integrated Supply is expected to continue through the end of 1999.
Grainger Integrated Supply - Average daily sales increased 46% for the first
nine months of 1999 as compared to the 1998 period. Sales for this business unit
includes product throughput and management fees. Growth was driven by new
engagements, contract renewals, and scope expansion reflecting the strong demand
for this new business, which provides fee-based, on-site indirect materials
management services to large businesses.
Lab Safety Supply - Average daily sales increased 8% for the first nine months
of 1999 as compared to the 1998 period. Strong sales growth reflects the
continuing success of the product line expansion program.
16
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND THE RESULTS OF OPERATIONS
RESULTS OF OPERATIONS (Continued)
Gross Profit Margin
-------------------
The Company's gross profit margin for the first nine months of 1999 increased by
0.21 percentage point compared to the same 1998 period. This increase was driven
by improvements at Grainger Industrial Supply and Grainger Custom Solutions.
Segment Gross Profit Margin
Branch-based Distribution Businesses
- ------------------------------------
The improvement in gross profit margins at Grainger Industrial Supply primarily
related to favorable product mix, reflecting net new products added since the
third quarter of 1998.
This improvement was partially offset by an unfavorable selling price category
mix and by lower selling prices on selected items, coinciding with the issuance
of Grainger Industrial Supply's Catalog in February 1999.
Other Businesses
- ----------------
The improvement in gross profit margins at Grainger Custom Solutions was
primarily due to the elimination of less profitable business and to lower
pricing received from suppliers.
Operating Expenses
------------------
Operating expenses (warehousing, marketing, and administrative expenses)
increased 8.9% for the first nine months of 1999 as compared to the same 1998
period. The increase included higher data processing expenses, which exceeded
the 1998 period by $19,300,000, as adjusted for 1999 volume increases. The
higher data processing expenses primarily related to Year 2000 compliance
initiatives, Internet commerce activities, and the ongoing installation of new
business enterprise systems. Data processing expenses for 1999 are estimated to
be approximately $30,000,000 higher than in 1998, as adjusted for 1999 volume
related increases.
17
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND THE RESULTS OF OPERATIONS
RESULTS OF OPERATIONS (Continued)
Segment Operating Expenses
Branch-based Distribution Businesses
- ------------------------------------
Operating expenses increased about 5% for the first nine months of 1999 versus
the comparable 1998 period. This rate of growth exceeded the growth in net sales
due to:
1. Increased data processing expenses, as described on page 17 of this report;
2. Increased expenses relating to the development of the business in Mexico;
3. Increased occupancy expenses;
4. Increased expenses incurred to maintain customer service levels during the
installation of the new business enterprise system, and;
5. Increased training and education expenses relating to the new business
enterprise system.
These factors were partially offset by decreased advertising expenses at
Grainger Industrial Supply resulting from increased cooperative programs.
Other Businesses
- ----------------
Operating expenses grew faster than net sales, reflecting continuing investments
to meet the diverse needs of segment-specific customers, to improve
accountability within the Company, and to take advantage of growth
opportunities. These investments included:
1. Continued development of the Grainger Custom Solutions business;
2. Expanded marketing programs at Lab Safety Supply, and;
3. Increased expenses, including data processing expenses, related to Internet
initiatives totaling $26,500,000 for the first nine months of 1999 versus
$9,500,000 for the comparable 1998 period.
18
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND THE RESULTS OF OPERATIONS
RESULTS OF OPERATIONS (Continued)
Operating Earnings
------------------
The Company's operating earnings decreased 10.3% for the first nine months of
1999 as compared to the same 1998 period. Operating earnings were relatively
flat at the Branch-based Distribution segment and declined at the Other
Businesses. (For segment operating earnings, see Note 3 of the Notes to
Consolidated Financial Statements included in this report.)
Segment Operating Earnings
Branch-based Distribution Businesses
- ------------------------------------
Operating earnings performance was affected by lower than expected sales growth,
largely due to weakness in the North American industrial economy and to service
issues at Grainger Industrial Supply and Grainger Parts. The Company estimates
that these service issues cost the Company $23,000,000 in operating earnings
year-to-date 1999, comprised of gross profit on lost sales and incremental
operating expenses.
Other Businesses
- ----------------
The decline in operating earnings primarily related to Internet Commerce and
Grainger Custom Solutions.
The results for Internet Commerce reflect the development and enhancement of
OrderZone.com, the Company's one-stop, business-to-business on-line service,
which became operational in the second quarter of 1999, and Grainger.com. (Sales
processed through Grainger.com are recognized in Grainger Industrial Supply's
sales.) Also reflected are continuing investments to market and promote these
two Web sites.
Grainger Custom Solutions' results reflected increased investments for
developing the infrastructure for this business and the effect of eliminating
some less profitable business. During the transition, certain infrastructure
investments temporarily duplicate the Grainger Industrial Supply platform.
19
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND THE RESULTS OF OPERATIONS
RESULTS OF OPERATIONS (Continued)
Other Income Statement Data
---------------------------
Interest income decreased by $32,000 for the first nine months of 1999 compared
with the same period in 1998. This decrease resulted from lower average
daily-invested balances and lower average interest rates earned.
Interest expense increased by $5,105,000 for the first nine months of 1999
compared to the same period in 1998. This increase resulted from higher average
interest rates paid on all outstanding debt and from higher average borrowings,
partially offset by higher capitalized interest.
Unclassified-net had a positive effect on earnings before income taxes of
$2,108,000 for the first nine months of 1999 as compared with the same period in
1998. During the third quarter of 1999 the Company recorded a gain related to
the disposal of facilities in the Chicagoland area.
The Company's effective income tax rate was 40.5% for the first nine months of
both 1999 and 1998.
Net Earnings
------------
The Company's net earnings of $152,573,000 in the first nine months of 1999
decreased 11.6% when compared to net earnings of $172,511,000 for the comparable
1998 period.
Year 2000
---------
The Company is using a standard methodology with three phases for the Year 2000
project.
Phase I includes conducting a complete inventory of potentially affected areas
of the business (including information technology and non-information
technology), assessing and prioritizing the information collected during the
inventory, and developing detailed plans to address all key areas of the
project. The Company has completed Phase I.
Phase II includes the remediation or replacement, and testing, of all mission
critical areas of the project, the surveying of key suppliers of goods and
services, and the creation of reasonable contingency plans to address
potentially serious Year 2000 related problems.
20
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND THE RESULTS OF OPERATIONS
RESULTS OF OPERATIONS (Continued)
The remediation of mission critical systems has been completed. The remediated
systems have been returned to production and final date testing of them has been
completed. The installation of replacement mission critical systems (as
distinguished from the remediation of existing mission critical systems) is
continuing and is scheduled for completion in the fourth quarter of 1999.
Remediation work required to make facilities Year 2000 ready has been completed.
The surveying of key suppliers is essentially complete. Of the key suppliers
surveyed, approximately 97% either have indicated that they are Year 2000 ready
or have provided a specific date by which they anticipate being ready.
Contingency plans reflect analyses of, among other things, risk levels to the
Company associated with Year 2000 related problems of key suppliers and
practical alternatives. In connection with these analyses, alternative sources
of various products and services have been identified. The possibility that
customers of the Company will have difficulty meeting their payment obligations
on a timely basis due to Year 2000 problems was a factor in establishing a new
line of credit from participating banks. This short-term line of credit is in
addition to an existing line of credit. The creation of contingency plans is
essentially complete.
Phase III includes the remediation or replacement, and testing, of non-mission
critical areas of the project. Substantially all of this non-mission critical
work has been completed with the remainder scheduled for completion during the
fourth quarter of 1999. Also included in Phase III is the implementation of
contingency plans as may be appropriate. Contingency plan implementation will
continue during the remainder of 1999.
Expenses associated with the Year 2000 project include both a reallocation of
existing internal resources and the use of outside services. Project expenses
for 1998 and 1997 totaled approximately $39,000,000. Project expenses for 1999
and beyond are estimated to be approximately $30,000,000.
Total data processing expenses for 1999, including those related to the Year
2000 project and the Company's new enterprise system, are currently estimated to
be approximately $30,000,000 higher than data processing expenses for 1998, as
adjusted for 1999 volume related increases.
21
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND THE RESULTS OF OPERATIONS
RESULTS OF OPERATIONS (Continued)
The estimated 1999 data processing expenses and the dates by which the Company
will complete the Year 2000 work are based on management's current assessment
and were derived utilizing numerous assumptions of future events, including the
continued availability of certain resources, third-party modification plans, and
other factors. However, there can be no guarantee that these estimates will be
achieved or that all components of Year 2000 compliance will be addressed as
planned. Uncertainties include, but are not limited to, the availability and
cost of personnel trained in this area, the ability to locate and correct all
relevant computer codes, and the sources and timeliness of various systems
replacements. There also can be no guarantee that the systems of other companies
will be Year 2000 ready on a timely basis or that the related changes will be
compatible with the Company's systems.
Management believes that failure to address the Year 2000 issue on a timely
basis could have a material adverse effect on the Company and continues to be
committed to devoting the appropriate resources to address that issue.
22
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND THE RESULTS OF OPERATIONS
LIQUIDITY AND CAPITAL RESOURCES
For the nine months ended September 30, 1999, working capital increased by
$56,276,000. The ratio of current assets to current liabilities was 1.8 at
September 30, 1999 and 1.8 at December 31, 1998. The Consolidated Statements of
Cash Flows, included in this report, detail the sources and uses of cash and
cash equivalents.
The Company continues to maintain a modest debt ratio and strong liquidity
position, which provides flexibility in funding working capital needs and
long-term cash requirements. In addition to internally generated funds, the
Company has various sources of financing available, including commercial paper
sales and bank borrowings under lines of credit and otherwise. Total debt, as a
percent of Shareholders' Equity, was 26.9% at September 30, 1999 and 18.3% at
December 31, 1998. For the first nine months of 1999, $83,107,000 were expended
for property, buildings, and equipment, and $19,606,000 were expended for
capitalized software, for a total of $102,713,000.
RISK FACTORS
This document contains statements that are not historical facts and are
forward-looking. The forward-looking statements are based on the Company's
current expectations and some of them are subject to risks and uncertainties the
outcome of which could result in actual future performance being materially
different from the performance indicated. Among the factors that could affect
indicated future performance are changes in, and the extent of implementation
and effectiveness of, Company strategies, market initiatives, business
development plans, and programs. Risk factors relating to the Company's Year
2000 compliance efforts are described elsewhere in this document. The
forward-looking statements should be read in conjunction with the discussion of
the Company's business and various factors that may affect it contained in the
Company's most recent Annual Report on Form 10-K, as well as in other Company
reports filed with the Securities and Exchange Commission.
23
<PAGE>
W.W. Grainger, Inc., and Subsidiaries
PART II - OTHER INFORMATION
Items 1, 2, 3, 4, and 5 not applicable.
Item 6: Exhibits (numbered in accordance with Item 601 of
regulation S-K) and Reports on Form 8-K.
EXHIBIT INDEX
-------------
(a) Exhibits
(11) Computation of Earnings Per Share. 26-27
(27) Financial Data Schedule.
(b) Reports on Form 8-K - None.
24
<PAGE>
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: November 12, 1999 By: /s/ J.D. Fluno
- ------------------------------ -------------------------------------------
J.D. Fluno, Vice Chairman
Date: November 12, 1999 By: /s/ P.O. Loux
- ------------------------------ -------------------------------------------
P.O. Loux, Senior Vice President, Finance
and Chief Financial Officer
Date: November 12, 1999 By: /s/ R.D. Pappano
- ------------------------------ -------------------------------------------
R.D. Pappano, Vice President,
Financial Reporting
25
<PAGE>
<TABLE>
Exhibit 11.1
W.W. Grainger, Inc., and Subsidiaries
COMPUTATION OF EARNINGS PER SHARE
<CAPTION>
Nine Months Ended September 30,
---------------------------------
1999 1998
--------------- ---------------
<S> <C> <C>
Basic:
Weighted average number of shares outstanding during the period
92,831,640 96,996,816
=============== ===============
Net earnings ......................................................... $ 152,573,000 $ 172,511,000
=============== ===============
Earnings per share ................................................... $ 1.64 $ 1.78
=============== ===============
Diluted:
Weighted average number of shares outstanding
during the period (basic) ......................................... 92,831,640 96,996,816
Common equivalents
Shares issuable under outstanding options ..................... 3,115,730 3,272,000
Shares which could have been purchased based
on the average market value for the period .................. 2,166,366 2,124,251
--------------- ---------------
949,364 1,147,749
Dilutive effect of exercised options prior to being
exercised ......................................................... 24,282 27,767
--------------- ---------------
Shares for the portion of the period that the options
were outstanding .................................................. 973,646 1,175,516
Contingently issuable shares ......................................... 553,166 512,222
--------------- ---------------
1,526,812 1,687,738
--------------- ---------------
Weighted average number of shares outstanding
during the period ................................................ 94,358,453 98,684,554
=============== ===============
Net earnings ......................................................... $ 152,573,000 $ 172,511,000
=============== ===============
Earnings per share ................................................... $ 1.62 $ 1.75
=============== ===============
</TABLE>
26
<PAGE>
<TABLE>
Exhibit 11.2
W.W. Grainger, Inc., and Subsidiaries
COMPUTATION OF EARNINGS PER SHARE
<CAPTION>
1999 1998
------------ ------------
<S> <C> <C>
Basic:
Three months ended September 30:
Nine months ended September 30, as reported in .................... $ 1.64 $ 1.78
Exhibit 11.1
Six months ended June 30, as previously reported .................. 1.15 1.20
------------- -------------
Earnings per share for the three months ended
September 30 .................................................... $ 0.49 $ 0.58
============= =============
Diluted:
Three months ended September 30:
Nine months ended September 30, as reported in .................... $ 1.62 $ 1.75
Exhibit 11.1
Six months ended June 30, as previously reported .................. 1.13 1.18
------------- -------------
Earnings per share for the three months ended
September 30 .................................................... $ 0.49 $ 0.57
============= =============
</TABLE>
27
<PAGE>
<TABLE> <S> <C>
<ARTICLE> 5
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 9-mos
<FISCAL-YEAR-END> DEC-31-1999
<PERIOD-END> SEP-30-1999
<CASH> 47,609
<SECURITIES> 0
<RECEIVABLES> 583,508
<ALLOWANCES> 18,009
<INVENTORY> 699,290
<CURRENT-ASSETS> 1,392,783
<PP&E> 1,270,784
<DEPRECIATION> 585,312
<TOTAL-ASSETS> 2,349,400
<CURRENT-LIABILITIES> 794,635
<BONDS> 127,833
0
0
<COMMON> 53,728
<OTHER-SE> 1,331,828
<TOTAL-LIABILITY-AND-EQUITY> 2,349,400
<SALES> 3,412,411
<TOTAL-REVENUES> 3,412,411
<CGS> 2,170,798
<TOTAL-COSTS> 2,170,798
<OTHER-EXPENSES> 977,494
<LOSS-PROVISION> 10,316
<INTEREST-EXPENSE> 9,952
<INCOME-PRETAX> 256,425
<INCOME-TAX> 103,852
<INCOME-CONTINUING> 152,573
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 152,573
<EPS-BASIC> 1.64
<EPS-DILUTED> 1.62
</TABLE>
