Laura Brown – SVP, Communications and IR
Bill Chapman – Senior Director, IR
W.W. Grainger Inc. (GWW) Q1 2012 Earnings Call April 17, 2012 8:00 AM ET
Hello, this is Laura Brown, Senior Vice President of Communications and Investor Relations. With me is Bill Chapman, Senior Director of Investor Relations. We are pleased to share with you some information regarding Grainger’s first quarter 2012 results via this audio webcast. Please also reference our 2012 first quarter earnings release issued today, April 17, in addition to other information available on our Investor Relations website to supplement this webcast.
Before we begin, please remember that certain statements and projections of future results made in the press release and in this webcast constitute forward-looking information. These statements are based on current market conditions and competitive and regulatory expectations and involve risk and uncertainty. Please see our Form 10-K for a discussion of factors that relate to forward-looking statements.
Strong sales growth and consistent execution was the story for the quarter. This performance was largely driven by continued enhancements to the foundation of our business and aggressive investment in our growth programs. As a result of the strong start to 2012, we have increased and narrowed the ranges for our sales and EPS guidance as referenced in today’s earnings release. We now expect sales to grow 12% to 14% and are forecasting EPS of $10.40 to $10.80 for the full year 2012. At the end of this recording, we’ll talk more about our revised guidance and our assumptions.
We’ll start with total company results, and then take a closer look at our segments. Company sales increased 16% versus the 2011 first quarter. We had 64 selling days in both quarters. Operating earnings increased 16%, while net earnings increased 19%. As highlighted in our release, earnings per share of $2.57 for the quarter is an all-time company record and represents an 18% increase versus 2011.
In a few moments we’ll take a closer look at sales results for the quarter; let’s now walk down the operating section of the income statement. Gross profit margins increased 40 basis points to 44.4%, as we successfully expanded gross margins across the business. Due to our size and scale, we were able to increase prices with the market and ahead of product cost inflation. We’ll provide more detail when we review the business by segment.
It is important to note that our gross profit margin follows a fairly consistent annual pattern, with generally highest gross margins in the first quarter. This is primarily driven by supplier funding for our annual customer trade shows in the quarter.
Company operating margins were essentially flat with the prior year at 13.9%. This was a function of strong sales growth and gross margin expansion offset by higher operating expenses driven by Fabory’s incremental expenses, growth-related spending, and higher corporate expenses, including stock-based compensation and expenses related to M&A activity and other corporate support expenses.
Let’s now focus on performance drivers during the quarter. In doing so, we’ll cover the following topics: first, sales by segment in the quarter and the month of March; second, operating performance by segment; third, cash generation and capital deployment; and finally, we’ll wrap up with a discussion of our revised 2012 guidance.
As mentioned earlier, company sales increased 16% for the quarter. Daily sales growth by month was as follows: 17% in January, 18% in February, and 15% in March. Of the 16% sales growth for the quarter, volume contributed 10 percentage points, acquisitions added 5 percentage points, and price added 3 percentage points. Foreign exchange and lower sales of seasonal products each represented a 1 percentage point drag on daily sales growth for the quarter.
Let’s move on to sales by segment. We report two segments: the United States and Canada. Our remaining operations in Asia, Europe, and Latin America are reported under a grouping titled Other Businesses.
Sales in the United States, which account for about 77% of total company revenue, increased 11% in the quarter, consisting of 9% volume growth and 3% from price, partially offset by a drag of 1 percentage point due to lower sales of seasonal products. By month, daily sales in the United States were up 11% in January, up 12% in February, and up 9% in March.
Now we’ll cover sales performance by customer end-market in the United States. We believe that increasing our product line, expanding customer sales coverage, and increasing our eCommerce capabilities is enabling the company to grow faster than the economy and gain additional market share.
As a result, sales to every customer end-market we serve in the United States, including Government, were positive in the quarter as follows. Natural Resources, formerly Agriculture and Mining, and Heavy Manufacturing were up in the mid-teens. Commercial, Retail, and Light Manufacturing were up in the low double-digits. Reseller was up in the high single-digits, and Government and Contractors were up in the mid-single-digits.
In the fourth quarter of 2010, we announced the possible divestiture of our Specialty Brands. Since that time, we have not received an acceptable offer. We plan to continue to operate the businesses and evaluate future options.
Now let’s turn our attention to the Canadian business. Sales in Canada represent about 12% of total company revenues. For the quarter, sales in Canada increased 13% in U.S. dollars and 14% in local currency. On a daily basis in Canadian dollars, sales were up 19% in January, up 14% in February, and up 11% in March. The 14% local currency sales growth in the quarter consisted of 13% volume growth and 1 percentage point from price.
From a customer standpoint, sales growth in Canada was driven by strength in the Construction, Agriculture and Mining, Transportation, Retail/Wholesale, and Heavy Manufacturing customer end-markets.
Let’s conclude our review of sales for the quarter by looking at the Other Businesses. Again, this group includes our operations in Asia, Europe, and Latin America, and currently represents about 11% of total company sales.
Sales for this group increased 104%, the result of strong growth in Japan and Mexico, coupled with the incremental sales from Fabory, our business in Europe acquired in August of 2011. Excluding Fabory, sales for our Other Businesses increased 33%.
Beginning in the second quarter, our Other Businesses will include the results of our newly acquired business in Brazil. This business, formerly known as AnFreixo S.A., is a leading broad line distributor of maintenance, repair, and operating (MRO) supplies and had 2011 sales of approximately US$37 million. The acquisition provides us with a solid entry point for physical operations in Brazil, the largest MRO market in Latin America.
Earlier in the quarter, we reported sales results for January and February and shared some information regarding sales performance in the month. Let’s now take a closer look at March. There were 22 selling days in March of 2012, one less than 2011. Total company sales were up 15% on a daily basis in March of 2012 versus March of 2011. The 15% growth consisted of 8% volume growth, 3 percentage points from price inflation, and 5 percentage points from acquisitions, partially offset by a 1 percentage point drag from foreign exchange.
In the United States, March daily sales were up 9%. This growth consisted of 6 percentage points of volume and 3 percentage points from price. Sales trends in March are more representative of our expectation for revenue growth going forward.
Conversely, sales growth in January and February was unusually strong due to the following factors: number one, customer pre-buying in advance of our February price increase, particularly in our lighting product line; number two, a higher advertising spend; and number three, easier comparisons in January and February versus March.
Consistent with the quarter, we saw positive daily sales growth in March to each of our U.S. customer end-markets as follows: Natural Resources increased in the low 20s; Heavy Manufacturing and Commercial increased in the low double-digits; Light Manufacturing, Reseller, and Retail were up in the high single-digits; Government was up in the mid-single-digits; and Contractor was up in the low single-digits.
Daily sales in Canada for March increased 10% in U.S. dollars, up 11% in local currency. The 11% local currency daily sales growth consisted of 11% volume and 1 percentage point from price, partially offset by a 1 percentage point decline attributable to lower sales of seasonal products.
Similar to the quarter, customers in the Construction, Agriculture and Mining, Transportation, Retail/Wholesale, and Heavy Manufacturing customer end-markets accounted for the largest increases in sales growth. The growth rate in March was influenced by difficult comparisons, particularly in the Government sector, where spending reached record levels in 2011.
Daily sales for our Other Businesses increased 110% in March, the result of strong growth in Japan and Mexico along with sales for our business in Europe. Excluding Fabory, sales for the Other Businesses increased 38% in March.
Sales growth in the month of April started a bit slowly, primarily due to the religious holidays, but is expected to be roughly in line with the growth in March.
Now I would like to turn the discussion over to Bill Chapman.
Thanks, Laura. Since we’ve already covered company operating performance, let’s jump right into performance by segment. Operating earnings in the United States increased 17% versus the 2011 first quarter, and operating margin increased 90 basis points to 17.6%. This performance was driven by 11% sales growth, higher gross margins, and positive expense leverage.
Gross profit margins for the quarter increased 10 basis points driven by price increases exceeding cost inflation, partially offset by higher freight costs and unfavorable mix, as lower sales of seasonal products slowed the sales growth of private label products. Expense leverage in the United States was positive despite higher growth-related spending on new sales representatives, eCommerce, and advertising.
Let’s move on to our business in Canada. Operating earnings increased 24% versus the prior year, 26% in local currency. Strong sales growth coupled with higher gross margins and effective cost management contributed to operating margins increasing 100 basis points to 10.9%. Gross margins increased 60 basis points, primarily driven by improved customer mix and higher prices.
Operating performance for our Other Businesses improved versus a year ago, the result of our focus on improving growth and operating results. This group posted operating earnings of $11 million for the quarter versus $6 million a year ago. Strong operating performance in Japan and Mexico, coupled with $1 million in operating earnings from Fabory, drove the improved results for this group.
Below the operating line, interest expense, net of interest income, was $2.5 million in the 2012 first quarter versus $1.4 million in the 2011 first quarter. The increase was primarily attributable to interest on the debt of €120 million used to finance a portion of the Fabory acquisition.
As mentioned at our November Analyst Meeting and in the 2011 Form 10-K, we were originally forecasting an effective tax rate of 37.9% for the full year 2012. In the 2012 first quarter, the effective tax rate was 37.4%, primarily due to higher earnings in foreign jurisdictions with lower tax rates and a lower blended state tax rate.
The difference between the actual effective tax rate and the forecasted rate resulted in a $0.02 per share benefit for the quarter. We are now expecting the full year 2012 effective tax rate to be in the range of 37.4% to 37.7%.
Lastly, let’s take a look at cash flow for the quarter. Operating cash flow was $106 million versus $118 million in 2011. The year-over-year reduction in cash flow was driven by lower trade accounts payable balances, due to the timing of inventory purchases, and a higher contribution to the company’s retirement plan tied to strong company performance and higher payroll expense in the prior year.
We used the cash generated during the quarter to invest in the business and return $109 million to shareholders through share repurchase and dividends. Capital expenditures for the quarter were $41 million. We paid dividends of $47 million and bought back 291,000 shares of stock. As of quarter-end, the company has approximately 6.8 million shares remaining on its share repurchase authorization.
As reported in our 2012 first quarter earnings release, we raised and narrowed both sales and earnings guidance for the full year 2012. We now expect sales growth in the range of 12% to 14% and earnings per share in the range of $10.40 to $10.80. While our sales guidance is below our first quarter 2012 performance, we expect EPS to expand over the prior year at an increasing rate for the remainder of 2012.
Let’s look more closely at the underlying elements of our revised expectations. First, sales growth in the first quarter, particularly January and February, was stronger than we had forecasted.
Second, unlike the first quarter, we are forecasting operating margin expansion over prior-year in each remaining quarter of 2012. This expansion should come from a more even contribution from both gross margin expansion and better expense leverage.
Gross profit margins in the second quarter should be higher than the prior year but below the 2012 first quarter, which includes supplier support provided for the annual customer trade shows. Year-over-year, gross profit margins for the remaining quarters should exceed 2011 but will remain relatively consistent with the second quarter of 2012. Again, better expense and earnings leverage should come in the back half of the year as we lap our growth investments, such as new sales representatives and eCommerce.
Third, our international business have posted improved performance, which we expect to continue. We believe Fabory will continue to deliver $0.03 to $0.06 of earnings accretion in 2012, while our newly acquired business in Brazil should be $0.03 to $0.05 dilutive this year.
Finally, the lower tax rate of 37.4% to 37.7% forecasted for 2012 should contribute $0.04 to $0.09 per share for the full year. As noted earlier, the first quarter included about a $0.02 benefit from the lower tax rate versus our original forecast.
Thank you for your interest in Grainger. Please mark your calendar for our Shareholders’ Meeting on Wednesday, April 25, and the release of April sales on Friday, May 11. If you have any questions, please do not hesitate to contact Laura Brown at 847-535-0409, or me at 847-535-0881. Thank you.
[No Q&A session for this event]