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 June 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: 93,356,200 shares of the
Company's Common Stock were outstanding as of July 30, 1999.
The Exhibit Index appears on page 24 in the sequential numbering system.
1
<PAGE>
<TABLE>
Part I - FINANCIAL INFORMATION
W.W. Grainger, Inc., and Subsidiaries
CONSOLIDATED STATEMENTS OF EARNINGS
(In thousands of dollars except for per share amounts)
(Unaudited)
<CAPTION>
Three Months Ended June 30, Six Months Ended June 30,
---------------------------- ----------------------------
1999 1998 1999 1998
------------ ------------ ------------ ------------
<S> <C> <C> <C> <C>
Net sales ........................................ $ 1,146,175 $ 1,118,970 $ 2,237,018 $ 2,176,077
Cost of merchandise sold ......................... 730,160 717,011 1,418,141 1,388,963
------------ ------------ ------------ ------------
Gross profit ................................... 416,015 401,959 818,877 787,114
Warehousing, marketing, and
administrative expenses ........................ 328,544 301,193 635,140 588,757
------------ ------------ ------------ ------------
Operating earnings ............................. 87,471 100,766 183,737 198,357
Other income or (deductions)
Interest income ................................ 319 142 729 480
Interest expense ............................... (2,943) (1,614) (4,676) (3,297)
Unclassified-net ............................... 117 286 (267) 127
------------ ------------ ------------ ------------
(2,507) (1,186) (4,214) (2,690)
------------ ------------ ------------ ------------
Earnings before income taxes ..................... 84,964 99,580 179,523 195,667
Income taxes ..................................... 34,411 40,330 72,707 79,245
------------ ------------ ------------ ------------
Net earnings ................................... $ 50,553 $ 59,250 $ 106,816 $ 116,422
============ ============ ============ ============
Earnings per share:
Basic .......................................... $ 0.54 $ 0.61 $ 1.15 $ 1.20
============ ============ ============ ============
Diluted ........................................ $ 0.53 $ 0.60 $ 1.13 $ 1.18
============ ============ ============ ============
Weighted average number of shares outstanding:
Basic .......................................... 92,820,417 97,246,552 92,827,072 97,235,431
============ ============ ============ ============
Diluted ........................................ 94,511 981 99,061,632 94,361,373 99,021,684
============ ============ ============ ============
Cash dividends paid per share .................... $ 0.16 $ 0.15 $ 0.31 $ 0.285
============ ============ ============ ============
<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 June 30, Six Months Ended June 30,
--------------------------- ---------------------------
1999 1998 1999 1998
------------ ------------ ------------ ------------
<S> <C> <C> <C> <C>
Net Earnings ..................................... $ 50,553 $ 59,250 $ 106,816 $ 116,422
Other comprehensive earnings:
Foreign currency translation
adjustments .................................. 2,973 (5,179) 5,510 (4,002)
------------ ------------ ------------ ------------
Comprehensive earnings ........................... $ 53,526 $ 54,071 $ 112,326 $ 112,420
============ ============ ============ ============
<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 June 30, 1999 Dec. 31, 1998
- --------------------------------------------------------------------------- ------------ ------------
<S> <C> <C>
CURRENT ASSETS
Cash and cash equivalents ............................................... $ 45,452 $ 43,107
Accounts receivable, less allowance for doubtful
accounts of $17,203 for 1999 and $15,951 for 1998 ..................... 562,630 463,377
Inventories ............................................................. 691,490 626,731
Prepaid expenses ........................................................ 21,944 11,950
Deferred income tax benefits ............................................ 63,241 61,200
------------ ------------
Total current assets .................................................. 1,384,757 1,206,365
PROPERTY, BUILDINGS, AND EQUIPMENT ........................................ 1,276,653 1,209,167
Less accumulated depreciation and amortization .......................... 583,163 548,639
------------ ------------
Property, buildings, and equipment-net .................................. 693,490 660,528
DEFERRED INCOME TAXES ..................................................... 6,237 3,187
OTHER ASSETS .............................................................. 256,936 233,822
------------ ------------
TOTAL ASSETS .............................................................. $ 2,341,420 $ 2,103,902
============ ============
LIABILITIES AND SHAREHOLDERS' EQUITY
- ---------------------------------------------------------------------------
CURRENT LIABILITIES
Short-term debt ......................................................... $ 247,337 $ 88,060
Current maturities of long-term debt .................................... 22,834 22,831
Trade accounts payable .................................................. 331,358 287,055
Accrued expenses ........................................................ 206,686 233,327
Income taxes ............................................................ 14,545 33,220
------------ ------------
Total current liabilities ............................................. 822,760 664,493
LONG-TERM DEBT (less current maturities) .................................. 127,434 122,883
ACCRUED EMPLOYMENT RELATED BENEFITS COSTS ................................. 39,779 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, 107,412,005 shares, 1999 and
107,233,771 shares, 1998 .............................................. 53,706 53,617
Additional contributed capital .......................................... 252,233 249,482
Treasury stock, at cost - 14,060,692 shares, 1999 and
13,728,672 shares, 1998 ............................................... (587,377) (572,900)
Unearned restricted stock compensation .................................. (16,287) (17,238)
Cumulative translation adjustments ...................................... (14,054) (19,564)
Retained earnings ....................................................... 1,663,226 1,585,344
------------ ------------
Total shareholders' equity .............................................. 1,351,447 1,278,741
------------ ------------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY .............................. $ 2,341,420 $ 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>
Six Months Ended June 30,
-------------------------------
1999 1998
------------ ------------
<S> <C> <C>
Cash flows from operating activities:
Net earnings ............................................................ $ 106,816 $ 116,422
Provision for losses on accounts receivable ............................. 6,737 6,482
Depreciation and amortization:
Property, buildings, and equipment .................................... 36,135 31,365
Intangibles and goodwill .............................................. 7,960 8,052
Capitalized software .................................................. 4,722 4,773
Change in operating assets and liabilities:
(Increase) in accounts receivable ..................................... (105,990) (66,785)
(Increase) decrease in inventories .................................... (64,759) 28,081
(Increase) in prepaid expenses ........................................ (9,994) (6,442)
(Increase) in deferred income taxes ................................... (5,091) (2,711)
Increase in trade accounts payable .................................... 44,303 21,065
(Decrease) in other current liabilities ............................... (26,641) (13,537)
(Decrease) in current income taxes payable ............................ (18,675) (8,320)
Increase in accrued employment related
benefits costs ...................................................... 1,994 2,921
Other - net ............................................................. 760 904
------------ ------------
Net cash (used in) provided by operating activities ....................... (21,723) 122,270
------------ ------------
Cash flows from investing activities:
Additions to property, buildings, and
equipment - net ....................................................... (69,097) (55,269)
Expenditures for capitalized software ................................... (12,374) (25,378)
Other - net ............................................................. (13,236) (3,170)
------------ ------------
Net cash (used in) investing activities ................................... (94,707) (83,817)
------------ ------------
Cash flows from financing activities:
Net increase in short-term debt ......................................... 159,277 3,064
Long-term debt payments ................................................. (32) (1,032)
Stock incentive plan .................................................... 2,941 2,031
Purchase of treasury stock - net ........................................ (14,477) (12,611)
Cash dividends paid ..................................................... (28,934) (27,845)
------------ ------------
Net cash provided by (used in) financing activities ....................... 118,775 (36,393)
------------ ------------
Net increase in cash and cash equivalents ................................. 2,345 2,060
Cash and cash equivalents at beginning of year ............................ 43,107 46,929
------------ ------------
Cash and cash equivalents at end of period ................................ $ 45,452 $ 48,989
============ ============
<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 $35,587,000 and $74,183,000 were included in trade
accounts payable at June 30, 1999 and December 31, 1998, respectively. These
amounts are immaterial to the consolidated financial statements.
2. DIVIDEND
On August 4, 1999, the Board of Directors declared a quarterly dividend of 16
cents per share, payable September 1, 1999 to shareholders of record on August
16, 1999.
6
<PAGE>
W.W. Grainger, Inc., and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Unaudited)
3. SEGMENT INFORMATION
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 June 30, 1999
(In thousands of dollars)
------------------------------------------------------------------------
Branch-based Other
Distribution Businesses Totals
--------------------- --------------------- ---------------------
<S> <C> <C> <C>
Total net sales $ 1,007,211 $ 198,376 $ 1,205,587
Intersegment net sales 57,187 2,225 59,412
Net sales from external customers 950,024 196,151 1,146,175
Segment operating earnings 97,779 349 98,128
</TABLE>
<TABLE>
<CAPTION>
Three Months ended June 30, 1998
(In thousands of dollars)
------------------------------------------------------------------------
Branch-based Other
Distribution Businesses Totals
--------------------- --------------------- ---------------------
<S> <C> <C> <C>
Total net sales $ 1,002,752 $ 183,250 $ 1,186,002
Intersegment net sales 64,471 2,561 67,032
Net sales from external customers 938,281 180,689 1,118,970
Segment operating earnings 104,258 4,596 108,854
</TABLE>
<TABLE>
<CAPTION>
Six Months ended June 30, 1999
(In thousands of dollars)
------------------------------------------------------------------------
Branch-based Other
Distribution Businesses Totals
--------------------- --------------------- ---------------------
<S> <C> <C> <C>
Total net sales $ 1,970,479 $ 393,244 $ 2,363,723
Intersegment net sales 122,865 3,840 126,705
Net sales from external customers 1,847,614 389,404 2,237,018
Segment operating earnings 203,015 1,050 204,065
</TABLE>
<TABLE>
<CAPTION>
Six Months ended June 30, 1998
(In thousands of dollars)
------------------------------------------------------------------------
Branch-based Other
Distribution Businesses Totals
--------------------- --------------------- ---------------------
<S> <C> <C> <C>
Total net sales $ 1,942,328 $ 369,563 $ 2,311,891
Intersegment net sales 132,063 3,751 135,814
Net sales from external customers 1,810,265 365,812 2,176,077
Segment operating earnings 202,561 13,010 215,571
</TABLE>
7
<PAGE>
W.W. Grainger, Inc., and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Unaudited)
3. SEGMENT INFORMATION (Continued)
There has been no material change in segment assets from the amounts reported at
December 31, 1998 in the Company's Annual Report on Form 10-K.
A reconciliation of segment operating earnings to consolidated operating
earnings is as follows:
<TABLE>
<CAPTION>
Three Months ended June 30
(In thousands of dollars)
-----------------------------------------------
1999 1998
---------------------- ---------------------
<S> <C> <C>
Total operating earnings for reportable segments $ 98,128 $ 108,854
Unallocated expenses (10,326) (8,088)
Elimination of intersegment profits (331) -
---------------------- ---------------------
Total consolidated operating earnings $ 87,471 $ 100,766
====================== =====================
</TABLE>
<TABLE>
<CAPTION>
Six Months ended June 30
(In thousands of dollars)
-----------------------------------------------
1999 1998
---------------------- ---------------------
<S> <C> <C>
Total operating earnings for reportable segments $ 204,065 $ 215,571
Unallocated expenses (20,312) (17,214)
Elimination of intersegment profits (16) -
---------------------- ---------------------
Total consolidated operating earnings $ 183,737 $ 198,357
====================== =====================
</TABLE>
8
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND THE RESULTS OF OPERATIONS
RESULTS OF OPERATIONS
THREE MONTHS ENDED JUNE 30, 1999 COMPARED WITH THE THREE MONTHS ENDED JUNE 30,
1998:
Net Sales
---------
The Company's net sales of $1,146,175,000 for the 1999 second quarter increased
2.4% from net sales of $1,118,970,000 for the comparable 1998 period. This
increase resulted from a 0.4% increase in the Branch-based Distribution segment
and an 8.3% 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
second quarters. The year 1999 will have one less sales day than did the year
1998 (254 vs. 255).
Despite a weak North American industrial economy, sales growth was positive for
the second quarter of 1999. Sales growth was constrained, however, by customer
service issues at Grainger Industrial Supply related to the field rollout of the
new business enterprise system. The Company estimates that it lost $10,000,000
of sales as a result of these service issues.
Sales growth for the second quarter of 1999 was primarily volume-driven,
reflecting favorable effects from the Company's customer-focused business unit
strategy, new marketing initiatives, and an increase in Internet transactions.
The overall sales increase reflects the Company's strategy to focus on
customer-specific business units. As noted above, negative sales influences
included a weaker industrial economy in both the U.S. and Canada, as well as
$10,000,000 in lost sales related to systems installation issues, as discussed
above. In addition, sales were negatively influenced by a decline in sales of
seasonal products due to the moderate weather experienced in many regions of the
country. On an average daily basis, sales of seasonal products decreased
approximately 10% in the 1999 quarter compared to the same quarter in 1998,
while sales of all other products increased about 3%.
Segment Net Sales
Branch-based Distribution Businesses
- ------------------------------------
Grainger Industrial Supply - Average daily sales were essentially flat for the
1999 second quarter compared to the 1998 second quarter. Sales were negatively
affected by the systems installation issue discussed above, which accounted for
$10,000,000 in lost sales, and by weak seasonal sales. Sales prices decreased
0.8% versus the second quarter of 1998.
9
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND THE RESULTS OF OPERATIONS
RESULTS OF OPERATIONS (Continued)
Sales were favorably affected by momentum in the Company's Internet strategy.
Online sales through Grainger.com reached $19,000,000 in the 1999 second
quarter, representing an 88% increase over Internet sales of $10,100,000 in the
first quarter of 1999, and a 526% increase over the second quarter of 1998.
Acklands - Grainger Inc. (Canada) - Average daily sales increased 2% for the
1999 second quarter compared to the 1998 second quarter. This increase was
driven by growth in Eastern Canada attributable to 10 new branches opened during
1998 and 1999, partially offset by continued sluggishness in Western Canada and
an unfavorable change in the Canadian exchange rate. In Canadian dollars,
average daily sales increased 3%. The Company is planning to open 7 more
branches in Eastern Canada during the remainder of 1999.
Grainger, S.A. de C.V. (Mexico) - Average daily sales increased 20% for the 1999
second quarter compared to the 1998 second 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 increased 1% for the 1999 second
quarter compared to the 1998 second quarter. Growth is in accordance with plans,
as the focus remains on transitioning customers to the new business platform.
The transition of customers 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 37% for the 1999
second quarter compared to the 1998 second quarter. Growth was driven by
contract renewals, scope expansion, and new engagements, 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 9% for the 1999 second quarter
compared to the 1998 second quarter. Strong sales growth reflects the continuing
success of the product line expansion program and higher circulation of targeted
catalogs.
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 second quarter increased by 0.38
percentage point compared to the same 1998 quarter. This increase was driven by
improvements at Grainger Industrial Supply and Grainger Custom Solutions.
Segment Gross Profit Margin
Branch-based Distribution Businesses
- ------------------------------------
Gross profit margin improvement was primarily attributable to Grainger
Industrial Supply. The improvement mostly related to favorable product mix,
reflecting net new products added to the Catalog and decreased sales of seasonal
products (which generally have lower-than-average gross profit margins).
This improvement was partially offset by an unfavorable selling price category
mix and by lower selling prices coinciding with the issuance of Grainger
Industrial Supply's Catalog in February 1999.
Other Businesses
- ----------------
The gross profit margin improved at Grainger Custom Solutions 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 9.1% for the 1999 second quarter compared to the 1998 second quarter.
The increase included higher data processing expenses, which exceeded the 1998
quarter by $8,500,000 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.
Annual data processing expenses are currently estimated to be a net $25,000,000
to $30,000,000 higher than 1998 annual data processing expenses, 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 5% for the 1999 second quarter versus the
comparable 1998 quarter. This rate of growth exceeded the growth in net sales
due to:
1. Increased expenses incurred to maintain customer service levels during the
installation of the new enterprise system;
2. Increased occupancy expenses;
3. Increased expenses relating to the development of the business in Mexico;
4. Increased data processing expenses as described on page 11 of this report,
and;
5. Increased training and education expenses relating to the new 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 data processing expenses, as described on page 11 of this report,
which included the continued development of the Company's full service
marketing capabilities on the Internet. (Expenses related to Internet
initiatives totaled $8,300,000 in the second quarter of 1999 versus
$4,700,000 in the second quarter of 1998.)
Grainger Integrated Supply reduced its operating expenses by about 13% while
achieving sales growth of 37%.
12
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND THE RESULTS OF OPERATIONS
RESULTS OF OPERATIONS (Continued)
Operating Earnings
------------------
Company operating earnings decreased 13.2% for the second quarter of 1999
compared to the same quarter in 1998. Operating earnings declined at both the
Branch-based Distribution Businesses 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 largely reflects the systems installation issues described
earlier in this document. The Company estimates that it lost $10,000,000 in
sales as a result of customer service issues at Grainger Industrial Supply
related to the field rollout of the new business enterprise system. It is
estimated that the combined 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.
The results for Internet Commerce reflect the continuing development of
OrderZone.com, the Company's one-stop, business-to-business on-line service
which became operational in the second quarter of 1999. Also, Internet Commerce
continued to invest in enhancements of Grainger.com, its award-winning Web site.
(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. The infrastructure investments are, in some
cases, redundant in that the majority of customers are still being served
through the Grainger Industrial Supply platform.
Progress being made in these new business ventures is in line with expectations.
Sales growth for these operations is consistent with management's overall
strategy.
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 increased $177,000 for the second quarter of 1999 compared with
the same period in 1998. This increase resulted from higher average daily
invested balances, partially offset by lower average interest rates earned.
Interest expense increased $1,329,000 for the second quarter 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.
The Company's effective income tax rate was 40.5% for the second quarter of both
1999 and 1998.
Net Earnings
------------
The Company's net earnings of $50,553,000 in the 1999 second quarter decreased
14.7% when compared to net earnings of $59,250,000 for the comparable 1998
period.
14
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND THE RESULTS OF OPERATIONS
RESULTS OF OPERATIONS (Continued)
SIX MONTHS ENDED JUNE 30, 1999 COMPARED WITH THE SIX MONTHS ENDED JUNE 30, 1998:
Net Sales
---------
The Company's net sales of $2,237,018,000 for the first six months of 1999
increased 2.8% from net sales of $2,176,077,000 for the comparable 1998 period.
This increase resulted from a 1.4% increase in the Branch-based Distribution
segment and a 6.4% 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 127 sales days in the first six 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 weak North American industrial economy, sales growth was positive for
the first six months of 1999 versus the comparable 1998 period. Sales growth was
constrained, however, by customer service issues at Grainger Industrial Supply
related to the field rollout of the new business enterprise system. The Company
estimates that it lost $10,000,000 of sales as a result of these service issues
which occurred during the latter part of the second quarter of 1999.
Sales growth for the first six months of 1999 was primarily volume-driven,
reflecting favorable effects from the Company's customer-focused business unit
strategy, new marketing initiatives, and an increase in Internet transactions.
The overall sales increase reflects the Company's strategy to focus on
customer-specific business units. As noted above, negative sales influences
included a weaker industrial economy in both the U.S. and Canada, as well as
$10,000,000 in lost sales related to systems installation issues, as discussed
above.
Segment Net Sales
Branch-based Distribution Businesses
- ------------------------------------
Grainger Industrial Supply - Average daily sales increased 1.8% for the first
six months of 1999 as compared to the 1998 period. Sales were negatively
affected by the systems installation issues experienced during the second
quarter of 1999, as discussed above. Sales prices decreased 0.1% for the first
six months 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)
Sales were favorably affected by momentum in the Company's Internet strategy.
Online sales through Grainger.com reached $29,183,000 in the first six months of
1999, representing a 443% increase over the comparable 1998 period.
Acklands - Grainger Inc. (Canada) - Average daily sales decreased 2% for the
first six months of 1999 as compared to the 1998 period. This decrease primarily
resulted from continued sluggishness in Western Canada and an unfavorable change
in the Canadian exchange rate, partially offset by growth in Eastern Canada
attributable to 10 new branches opened during 1998 and 1999. In Canadian
dollars, average daily sales increased 1%. The Company is planning to open 7
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 six 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 six
months of 1999 as compared to the 1998 period. Growth is in accordance with
plans, as the focus remains on transitioning customers to the new business
platform. The transition of customers 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 31% for the first six
months of 1999 as compared to the 1998 period. Growth was driven by contract
renewals, scope expansion, and new engagements, 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 9% for the first six months of
1999 as compared to the 1998 period. Strong sales growth reflects the continuing
success of the product line expansion program and higher circulation of targeted
catalogs.
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 six months of 1999 increased by
0.44 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
- ------------------------------------
Gross profit margin improvement was primarily attributable to Grainger
Industrial Supply. The improvement mostly related to favorable product mix,
including the effect of net new products added to the Catalog.
This improvement was partially offset by an unfavorable selling price category
mix and by lower selling prices coinciding with the issuance of Grainger
Industrial Supply's Catalog in February 1999.
Other Businesses
- ----------------
The gross profit margin improved at Grainger Custom Solutions 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 7.9% for the first six months of 1999 as compared to the same 1998
period. The increase included higher data processing expenses, which exceeded
the 1998 period by $10,500,000, 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.
Annual data processing expenses are currently estimated to be a net $25,000,000
to $30,000,000 higher than 1998 annual data processing expenses, 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 4% for the first six months of 1999 versus
the comparable 1998 period. This rate of growth exceeded the growth in net sales
due to:
1. Increased expenses incurred to maintain customer service levels during the
installation of the new enterprise system;
2. Increased occupancy expenses;
3. Increased expenses relating to the development of the business in Mexico;
4. Increased data processing expenses, as described on page 17 of this report,
and;
5. Increased training and education expenses relating to the new 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 data processing expenses, as described on page 17 of this report,
which included the continued development of the Company's full service
marketing capabilities on the Internet. (Expenses related to Internet
initiatives totaled $14,300,000 for the first six months of 1999 versus
$7,300,000 in 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
------------------
Company operating earnings decreased 7.4% for the first six months of 1999 as
compared to the same 1998 period. Operating earnings increased 0.2% at the
Branch-based Distribution Businesses. Operating earnings 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
- ------------------------------------
The reduced level of operating earnings is primarily attributable to Grainger
Industrial Supply and largely reflects the systems installation issues described
earlier in this document. The Company estimates that it lost $10,000,000 in
sales as a result of customer service issues at Grainger Industrial Supply
related to the field rollout of the new business enterprise system. It is
estimated that the combined 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.
Other Businesses
- ----------------
The decline in operating earnings primarily related to Internet Commerce and
Grainger Custom Solutions.
The results for Internet Commerce reflect the continuing development of
OrderZone.com, the Company's one-stop, business-to-business on-line service
which became operational in the second quarter of 1999. Also, Internet Commerce
continued to invest in enhancements of Grainger.com, its award-winning Web site.
(Sales processed through Grainger.com, which accelerated substantially during
the first six months of 1999, 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. The infrastructure investments are, in some
cases, redundant in that the majority of customers are still being served
through the Grainger Industrial Supply platform.
Progress being made in these new business ventures is in line with expectations.
Sales growth for these operations is consistent with management's overall
strategy.
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 increased $249,000 for the first six months of 1999 compared
with the same period in 1998. This increase resulted from higher average daily
invested balances, partially offset by lower average interest rates earned.
Interest expense increased $1,379,000 for the first six 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.
The Company's effective income tax rate was 40.5% for the first six months of
both 1999 and 1998.
Net Earnings
------------
The Company's net earnings of $106,816,000 in the first six months of 1999
decreased 8.3% when compared to net earnings of $116,422,000 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 is
scheduled for completion during the third quarter of 1999. 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 the planning of a
new line of credit from participating banks. This line of credit would be in
addition to an existing line of credit and be of short-term duration. The
creation of these contingency plans is essentially complete.
Phase III includes the remediation or replacement, and testing, of various
non-mission critical areas of the project. This activity is scheduled for
completion during the third 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. Remaining project expenses
for 1999 and beyond are estimated to be between $34,000,000 and $39,000,000.
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 a net $25,000,000 to $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 six months ended June 30, 1999, working capital increased by
$20,125,000. The ratio of current assets to current liabilities was 1.7 at June
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 low 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 29.4% at June 30, 1999 and 18.3% at
December 31, 1998. For the first six months of 1999, $68,463,000 were expended
for property, buildings, and equipment, and $12,374,000 were expended for
capitalized software, for a total of $80,837,000.
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: August 13, 1999 By: /s/ J.D. Fluno
- ------------------------------ -------------------------------------------
J.D. Fluno, Vice Chairman
Date: August 13, 1999 By: /s/ P.O. Loux
- ------------------------------ -------------------------------------------
P.O. Loux, Senior Vice President, Finance
and Chief Financial Officer
Date: August 13, 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>
Six Months Ended June 30,
-------------------------------
Basic: 1999 1998
-------------- --------------
<S> <C> <C>
Average number of shares outstanding during the period .................... 92,827,072 97,235,431
============== ==============
Net earnings .............................................................. $ 106,816,000 $ 116,422,000
============== ==============
Earnings per share ........................................................ $ 1.15 $ 1.20
============== ==============
Diluted:
Weighted average number of shares outstanding
during the period (basic) .............................................. 92,827,072 97,235,431
Common equivalents
Shares issuable under outstanding options .......................... 3,339,320 3,435,210
Shares which could have been purchased based
on the average market value for the period ....................... 2,382,966 2,192,246
-------------- --------------
956,354 1,242,964
Dilutive effect of exercised options prior to being
exercised .............................................................. 35,447 39,956
-------------- --------------
Shares for the portion of the period that the options
were outstanding ....................................................... 991,801 1,282,920
Contingently issuable shares .............................................. 542,500 503,333
-------------- --------------
1,534,301 1,786,253
-------------- --------------
Weighted average number of shares outstanding
during the period ..................................................... 94,361,373 99,021,684
============== ==============
Net earnings .............................................................. $ 106,816,000 $ 116,422,000
============== ==============
Earnings per share ........................................................ $ 1.13 $ 1.18
============== ==============
</TABLE>
26
<PAGE>
<TABLE>
Exhibit 11.2
W.W. Grainger, Inc., and Subsidiaries
COMPUTATION OF EARNINGS PER SHARE
<CAPTION>
Basic: 1999 1998
----------------- ------------------
<S> <C> <C>
Three months ended June 30:
Six months ended June 30, as reported in Exhibit 11.1 $ 1.15 $ 1.20
Three months ended March 31, as previously reported 0.61 0.59
----------------- ------------------
Earnings per share for the three months ended June 30 $ 0.54 $ 0.61
================= ==================
Diluted:
Three months ended June 30:
Six months ended June 30, as reported in Exhibit 11.1 $ 1.13 $ 1.18
Three months ended March 31, as previously reported 0.60 0.58
----------------- ------------------
Earnings per share for the three months ended June 30 $ 0.53 $ 0.60
================= ==================
</TABLE>
27
<PAGE>
<TABLE> <S> <C>
<ARTICLE> 5
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 6-mos
<FISCAL-YEAR-END> DEC-31-1999
<PERIOD-END> JUN-30-1999
<CASH> 45,452
<SECURITIES> 0
<RECEIVABLES> 579,833
<ALLOWANCES> 17,203
<INVENTORY> 691,490
<CURRENT-ASSETS> 1,384,757
<PP&E> 1,276,653
<DEPRECIATION> 583,163
<TOTAL-ASSETS> 2,341,420
<CURRENT-LIABILITIES> 822,760
<BONDS> 127,434
0
0
<COMMON> 53,706
<OTHER-SE> 1,297,741
<TOTAL-LIABILITY-AND-EQUITY> 2,341,420
<SALES> 2,237,018
<TOTAL-REVENUES> 2,237,018
<CGS> 1,418,141
<TOTAL-COSTS> 1,418,141
<OTHER-EXPENSES> 635,140
<LOSS-PROVISION> 6,737
<INTEREST-EXPENSE> 4,676
<INCOME-PRETAX> 179,523
<INCOME-TAX> 72,707
<INCOME-CONTINUING> 106,816
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 106,816
<EPS-BASIC> 1.15
<EPS-DILUTED> 1.13
</TABLE>
