UNITED STATES
SECURITIES AND
EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
[ ] 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
W.W. Grainger, Inc.
(Exact name of
registrant as specified in its charter)
| Illinois (State or other jurisdiction of incorporation or organization) |
36-1150280 (I.R.S. Employer Identification No.) |
|
100 Grainger Parkway, Lake Forest, Illinois (Address of principal executive offices) |
60045-5201 (Zip Code) |
|
(847)
535-1000 |
|
Title of each class Common Stock $0.50 par value, and accompanying Preferred Share Purchase Rights |
Name of each exchange on which registered New York Stock Exchange Chicago Stock Exchange |
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 _______
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy of information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. (X)
Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Act).
Yes ___X____ No _______
The aggregate market value of the voting common equity held by non-affiliates of the registrant was $3,640,546,466 as of the close of trading reported on the Consolidated Transaction Reporting System on June 30, 2003. The Company does not have non-voting common equity.
Indicate the number of shares outstanding of each of the registrant’s classes of common stock, as of the latest practicable date.
Common Stock $0.50 par value 90,946,878 shares outstanding as of March 1, 2004Portions of the proxy statement relating to the annual meeting of shareholders of the registrant to be held on April 28, 2004, are incorporated by reference into Part III hereof.
1
|
TABLE OF CONTENTS |
| Page(s) | ||
|
PART I |
||
| Item 1: | BUSINESS | 3-5 |
| THE COMPANY | 3 | |
| BRANCH-BASED DISTRIBUTION | 3-4 | |
| INDUSTRIAL SUPPLY | 3-4 | |
| ACKLANDS-GRAINGER INC. | 4 | |
| FINDMRO | 4 | |
| GLOBAL SOURCING | 4 | |
| PARTS | 4 | |
| MEXICO | 4 | |
| LAB SAFETY | 5 | |
| INTEGRATED SUPPLY | 5 | |
| DIGITAL | 5 | |
| INDUSTRY SEGMENTS | 5 | |
|
COMPETITION |
5 | |
|
EMPLOYEES |
5 | |
|
WEB SITE ACCESS TO COMPANY REPORTS |
5 | |
| Item 2: |
PROPERTIES |
6 |
| Item 3: | LEGAL PROCEEDINGS | 6 |
| Item 4: | SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS | 6 |
| Executive Officers | 6-7 | |
| PART II | ||
| Item 5: | MARKET FOR
REGISTRANT’S COMMON
EQUITY, RELATED SHAREHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES |
7 |
| Item 6: | SELECTED FINANCIAL DATA | 8 |
| Item 7: | MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS |
8-18 |
| Item 7A: | QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK | 18 |
| Item 8: | FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA | 18 |
| Item 9: | CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE |
19 |
| Item 9A: | CONTROLS AND PROCEDURES | 19 |
| PART III | ||
| Item 10: | DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT | 19 |
| Item 11: | EXECUTIVE COMPENSATION | 19 |
| Item 12: | SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED SHAREHOLDER MATTERS |
19 |
| Item 13: | CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS | 19 |
| Item 14: | PRINCIPAL ACCOUNTANT FEES AND SERVICES | 19 |
| PART IV | ||
| Item 15: | EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K |
20-21 |
| Signatures | 22 | |
| Certifications | 23-25 | |
PART I
The Company
W.W. Grainger, Inc., incorporated in the State of Illinois in 1928, is in the service
business. It distributes products used by businesses and institutions across
North America to keep their facilities and equipment running. The words
“Grainger” or “Company” mean W.W. Grainger, Inc., and its
subsidiaries in this report.
Grainger uses a multichannel business model to serve more than 1.6 million customers of all sizes with multiple ways to find and purchase products through a network of branches, field sales forces, direct marketing through catalogs and Internet channels. Orders can be placed via telephone, fax, Internet or in person. Products are available for immediate pick-up or for shipment.
Grainger reports its operating results in three segments: Branch-based Distribution, Lab Safety and Integrated Supply. The Branch-based Distribution businesses primarily serve the needs of North American businesses for facility maintenance products. Lab Safety Supply, Inc. (Lab Safety), a direct marketing company, serves customers who purchase safety, industrial and other products. Integrated Supply serves customers seeking to outsource some or all of their indirect materials management processes.
Grainger also has internal business support functions which provide coordination and guidance in the areas of accounting, administrative services, business development, communications, compensation and benefits, employee development, enterprise systems, finance, human resources, insurance and risk management, internal audit, investor relations, legal, real estate and construction services, security and safety, taxes and treasury services. These services are provided in varying degrees to all business units.
Grainger does not engage in basic or substantive product research and development activities. Items are regularly added to and deleted from Grainger’s product lines on the basis of market information, recommendations of customers and suppliers and other factors.
Branch-based Distribution
The Branch-based Distribution
businesses provide North American customers with product solutions for their facility
maintenance and other product needs through logistics networks which are configured for
rapid product availability. Grainger offers a broad selection of facility maintenance and
other products through local branches, catalogs and the Internet. The Branch-based
Distribution businesses consist of the following Grainger divisions: Industrial Supply,
Acklands-Grainger Inc. (Canada), FindMRO, Export, Global Sourcing, Parts, Grainger, S.A.
de C.V. (Mexico) and Grainger Caribe Inc. (Puerto Rico). The more significant of these
businesses are described below.
Industrial Supply
Industrial Supply offers U.S.
businesses and institutions a combination of product breadth, local availability, speed of
delivery, simplicity of ordering and competitively priced products. Industrial Supply
distributes tools, lighting products, test instruments, cleaning supplies, material
handling equipment, pumps and plumbing supplies, motors and many other items. Its
customers range from small and medium-sized businesses to large corporations and
governmental organizations. During 2003, Industrial Supply completed an average of 88,000
sales transactions daily.
Industrial Supply operates 394 branches located in all 50 states. These branches are generally located within 20 minutes of the majority of U.S. businesses and serve the immediate needs of their local markets allowing customers to pick up items directly from the branches.
Industrial Supply’s branches range in size from small branches to large master branches. Branches are used to fulfill will-call needs and customer service. Master branches handle a higher volume of counter/will-call customers daily, in addition to shipping to customers for other branches in their area. On average, a branch is 20,000 square feet in size, has 10 employees and handles about 220 transactions per day. Also in 2003, Industrial Supply invested approximately $1.4 million in plant and equipment related to one new branch, three branch relocations and several branch additions and remodelings. No branches were closed in 2003.
In 2000, Industrial Supply began the process of reconfiguring its distribution network to remove a warehousing step from its distribution system. When completed, the new network will comprise nine distribution centers (DCs) – five new and four redesigned facilities – that will take over most of the shipping previously handled by the branches. Eight of the nine distribution centers have been completed. The ninth, a DC located in New Jersey, is expected to be completed in April 2004. The DCs average more than 300,000 square feet in size and employ automated equipment and processes. DCs ship orders, including Internet orders, directly to customers for all branches located in their service area and replenish branch inventories. The DC located in Chicago is also a national distribution center providing customers and the entire network with slower moving inventory items.
3
Industrial Supply sells principally to customers which include industrial and commercial maintenance departments, service shops, manufacturers, hotels, government, retail organizations, transportation businesses, contractors, and healthcare and educational facilities. Sales transactions during 2003 were made to approximately 1.3 million customers. Approximately 24% of 2003 sales consisted of items bearing the Company’s registered trademarks, including DAYTON® (principally electric motors, heating and ventilation equipment), TEEL® (liquid pumps), SPEEDAIRE® (air compressors), AIR HANDLER® (air filtration equipment), DEM-KOTE® (spray paints), WESTWARD® (principally hand and power tools), CONDOR™ (safety products) and LUMAPRO® (task and outdoor lighting), as well as other Company trademarks. Grainger has taken steps to protect these trademarks against infringement and believes that they will remain available for future use in its business. Sales of remaining items generally consisted of products carrying the names of other well-recognized brands.
The current Industrial Supply catalog, issued in February 2004, offers more than 82,000 facility maintenance and other products. Approximately 1.5 million copies of the catalog were produced. A CD-ROM version of the catalog supplements the paper version. Approximately 550,000 copies of the CD-ROM catalog were produced.
Customers can purchase products through grainger.com. This Web site serves as a prominent service channel for the Industrial Supply division. Customers have access to a much larger selection of products through grainger.com than is contained in the catalog. It is available 24/7, providing real-time product availability, customer-specific pricing, multiple product search capabilities, customer personalization, and links to customer support and the fulfillment system. For large customers interested in connecting to grainger.com through sophisticated purchasing platforms, grainger.com has a universal connection. This technology translates the different data formats used by electronic marketplaces, exchanges, and e-procurement systems and allows information from these systems to be fed directly into Industrial Supply’s operating platform. Orders processed through grainger.com resulted in sales of $478.6 million in 2003, $419.5 million in 2002 and $332.5 million in 2001.
Industrial Supply purchases products for sale from approximately 1,200 suppliers, most of which are manufacturers. No single supplier comprised more than 10% of Industrial Supply’s purchases and no significant difficulty has been encountered with respect to sources of supply.
Acklands-Grainger Inc.
(Acklands)
Acklands is Canada’s leading
broad-line distributor of industrial, automotive fleet and safety supplies. It serves
customers through 174 branches and five distribution centers across Canada. Acklands
distributes tools, lighting products, safety supplies, pneumatics, instruments, welding
equipment and supplies, motors and shop equipment, and many other items. During 2003,
approximately 14,000 sales transactions were completed daily. A comprehensive catalog,
printed in both English and French, showcases the product line to facilitate customer
selection. This catalog, with more than 43,000 products, supports the efforts of field
sales representatives throughout Canada. In addition, customers can purchase products
through www.acklandsgrainger.com.
FindMRO
FindMRO is a sourcing service.
Through sophisticated search technologies and sourcing expertise, FindMRO locates
facilities maintenance and other products when a source is unknown to the customer.
FindMRO has access to more than 4,000 suppliers and five million products. Orders can be
placed with a Grainger sales representative or a branch employee.
Global Sourcing
Global Sourcing procures
competitively priced, high-quality products produced outside the United States. Grainger
businesses sell these items primarily under private labels. Products obtained through
Global Sourcing include WESTWARD® tools, LUMAPRO® lighting products and
CONDOR™ safety products, as well as products bearing other trademarks.
Parts
Parts provides customers access to
more than 2.5 million parts and accessories, stocking nearly 77,000 of them in its
Northbrook, Illinois, warehouse. Customers can purchase parts over the telephone, at
grainger.com, or through a Grainger sales representative or branch employee. Trained
customer service representatives have online access to more than 300,000 pages of detailed
parts diagrams. Parts handled approximately 1.6 million customer calls in 2003 through its
call centers in Northbrook, Illinois, and Waterloo, Iowa.
Mexico
Grainger’s operations in Mexico
provide local businesses with facility maintenance and other products from both Mexico and
the United States. From its five locations in Mexico and U.S. branches along the border,
the business provides delivery of approximately 63,000 products throughout Mexico. The
largest facility, an 85,000 square foot DC, is located outside of Monterrey, Mexico.
Customers can order products using a Spanish-language general catalog or purchase them
through www.grainger.com.mx.
4
Lab Safety
Lab Safety is a direct marketer of
safety and other industrial products to U.S. and Canadian businesses. Located in
Janesville, Wisconsin, Lab Safety primarily reaches its customers through the distribution
of multiple branded catalogs, including a CD-ROM version, and other marketing materials
distributed throughout the year to targeted markets. Customers can purchase products
through www.labsafety.com, www.benmeadows.com and www.gemplers.com.
Lab Safety offers extensive product depth, technical support and high service levels. It is a primary supplier for many small and medium-sized companies and a backup supplier for many larger companies. During 2003, Lab Safety issued 11 unique catalogs covering safety supplies, material handling, security and other products, targeted to specific customer groups. Lab Safety provides access to more than 130,000 products through its catalogs.
In April 2003, Lab Safety acquired substantially all of the assets and assumed certain liabilities of Gempler’s, a direct marketing division of Gempler’s, Inc. Gempler’s is a $32 million direct marketing business serving agricultural, horticultural, grounds maintenance and contractor markets with tools, safety supplies, clothing and other items.
Integrated Supply
Integrated Supply serves customers
who have chosen to outsource some or all of their indirect materials management processes.
This service enables customers to focus on their core business objectives. Integrated
Supply offers a full complement of on-site outsourcing solutions, including business
process reengineering, inventory and tool crib management, purchasing management and
information management.
Digital
In April 2001, Grainger announced it
was discontinuing the operations of Material Logic. All of Material Logic’s branded
e-commerce sites were shut down with the exception of FindMRO, which remains in the
Branch-based Distribution segment.
Industry Segments
For 2003, Grainger is reporting three
industry segments: Branch-based Distribution, Lab Safety and Integrated Supply. For
segment and geographical information and consolidated net sales and operating earnings see
“Item 7: Management’s Discussion and Analysis of Financial Condition and
Results of Operations” and “Item 8: Financial Statements and
Supplementary Data.”
Competition
Grainger faces competition in all
markets it serves, from manufacturers (including some of its own suppliers) that sell
directly to certain segments of the market, wholesale distributors, catalog houses and
certain retail enterprises.
Grainger competes with manufacturers and other distributors primarily through local product availability, efficient service, sales representatives, competitive pricing, catalogs (which include product descriptions and, in certain cases, extensive technical and application data), electronic and Internet commerce technology and other efforts to assist customers in lowering their total facility maintenance costs. Grainger believes that it can effectively compete with manufacturers on small orders, but manufacturers may have an advantage in filling large orders.
Grainger serves a number of diverse markets. In some markets, Grainger can reasonably estimate its competitive position. However, taken as a whole, Grainger is unable to determine with certainty its market share relative to others engaged in whole or in part in each of the markets where it competes.
Employees
As of December 31, 2003, Grainger had
14,701 employees, of whom 12,881 were full-time and 1,820 were part-time or temporary.
Grainger has never had a major work stoppage and considers employee relations to be good.
Web Site Access to
Company Reports
Grainger makes available, free of
charge, through its Web site, its Annual Report on Form 10-K, quarterly reports on Form
10-Q, current reports on Form 8-K and amendments to those reports, as soon as reasonably
practicable after this material is electronically filed with or furnished to the
Securities and Exchange Commission. This material may be accessed by visiting
www.grainger.com/investor.
5
As of December 31, 2003, Grainger’s owned and leased facilities totaled 17,991,000 square feet, an increase of approximately 2% from 2002. Industrial Supply and Acklands accounted for the majority of the total square footage. Industrial Supply facilities are located throughout the United States. Acklands facilities are located throughout Canada.
Industrial Supply branches range in size from 1,200 to 109,000 square feet and average approximately 20,000 square feet. Most are located in or near major metropolitan areas with many located in industrial parks. Typically, a branch is on one floor, is of masonry construction, consists primarily of warehouse space, sales areas and offices and has off-the-street parking for customers and employees. Grainger considers that its properties are generally in good condition and well maintained.
A brief description of significant facilities follows:
|
Location |
Facility and Use |
Size in Square Feet |
||
|
|
|
|
||
| Chicago Area (1) | Headquarters and General Offices | 1,136,000 | ||
| United States (1) | Nine Distribution Centers | 5,212,000 | ||
| United States (2) | 394 Industrial Supply branch locations | 7,713,000 | ||
| United States and Mexico (3) | All other facilities | 1,837,000 | ||
| Canada (4) | 174 Acklands facilities | 2,093,000 | ||
|
|
||||
| Total Square Feet |
17,991,000 |
|||
|
|
|
|
|
| (1) | These facilities are either owned or leased with most leases expiring between 2004 and 2009. The owned facilities are not subject to any mortgages. |
| (2) | Industrial Supply branches consist of 286 owned and 108 leased properties. The owned facilities are not subject to any mortgages. |
| (3) | Other facilities primarily include locations for Lab Safety and other business units and properties under construction. Two facilities are located in Puerto Rico and five are located in Mexico, all of which are leased. The owned facilities are not subject to any mortgages. |
| (4) | Acklands facilities consist of general offices, distribution centers and branches, of which 61 are owned and 113 leased. The owned facilities are not subject to any mortgages. |
As of January 28, 2004, Grainger is named, along with numerous other nonaffiliated companies, as a defendant in litigation involving asbestos and/or silica filed on behalf of approximately 3,300 plaintiffs in various states. These lawsuits typically involve claims of personal injury arising from the alleged exposure to asbestos and/or silica as a consequence of products purportedly distributed by Grainger. In 2003, lawsuits involving approximately 275 plaintiffs were dismissed with respect to Grainger based on the lack of product identification. Grainger has denied, or intends to deny, the allegations in the remaining lawsuits. If a specific product distributed by Grainger is identified in any of these lawsuits, Grainger would attempt to exercise indemnification remedies against the product manufacturer. In addition, Grainger believes that a substantial portion of these claims are covered by insurance. Grainger is engaged in active discussions with its insurance carriers regarding the scope and amount of coverage. While Grainger is unable to predict the outcome of these lawsuits, it believes that the ultimate resolution will not have, either individually or in the aggregate, a material adverse effect on Grainger’s consolidated financial position or results of operations.
No matters were submitted to a vote of security holders during the fourth quarter of 2003.
Following is information about the Executive Officers of Grainger including age in March 2004. Executive Officers of Grainger generally serve until the next annual election of officers, or until earlier resignation or removal.
|
Name and Age |
Positions and Offices Held and Principal |
|
|
|
| Judith E. Andringa (43) | Vice President and Controller. Before joining Grainger in 2002, Ms. Andringa was Controller of the Foodservice Division of Kraft Foods, Inc., a position assumed in 2000 after serving Kraft as Director of Finance, Marketing Services Group. Her prior positions at Kraft included Controller, Sales and Customer Service, and Director, Financial Planning and Analysis, of the Meals Division. |
6
|
Name and Age |
Positions and Offices Held and Principal |
|
|
|
| Yang C. Chen (56) | Senior Vice President, Supply Chain Management, a position assumed in 2003 after serving as Vice President, Supply Chain Services. Before assuming the last-mentioned position in 2002, Mr. Chen served as Vice President, International Internet Commerce. Previously, he served as Vice President, Asia Pacific. |
| Wesley M. Clark (52) | President and Chief Operating Officer, a position assumed in 2001 after serving as Group President. Before assuming the last-mentioned position in 1997, Mr. Clark served as Senior Vice President, Operations and Quality. |
| Timothy M. Ferrarell (47) | Senior Vice President, Enterprise Systems, a position assumed in 2001 after serving as Vice President, Quality and Business Planning. Before assuming the last-mentioned position in 1998, Mr. Ferrarell served as Vice President, Marketing. Previously, he served as Vice President, Product Management. |
| Nancy A. Hobor (57) | Senior Vice President (formerly Vice President), Communications and Investor Relations. Before joining Grainger in 1999, Ms. Hobor was Vice President, Corporate Communications and Investor Relations of Morton International, Inc. |
| John L. Howard (46) | Senior Vice President and General Counsel. Before joining Grainger in 2000, Mr. Howard was Vice President and General Counsel of Tenneco Automotive, a position assumed after serving as Vice President, Law and Assistant General Counsel of Tenneco, Inc. |
| Richard L. Keyser (61) | Chairman of the Board, a position assumed in 1997, and Chief Executive Officer, a position assumed in 1995. Previously, Mr. Keyser served as Grainger’s President and Chief Operating Officer. |
| Larry J. Loizzo (49) | Senior Vice President (formerly Vice President) of Grainger and President of Lab Safety Supply, Inc. |
| P. Ogden Loux (62) | Senior Vice President, Finance and Chief Financial Officer, positions assumed in 1997 after serving as Vice President, Finance. |
| James T. Ryan (45) | Executive Vice President, Marketing, Sales and Service, a position assumed in 2001, after serving as Vice President of Grainger and President of grainger.com. Previously, he served as Vice President, Information Services. |
| John A. Schweig (46) | Senior Vice President, Strategy and Development, a position assumed in 2003 after serving as Senior Vice President, Business Development and International. |
PART II
Grainger’s common stock is traded on the New York Stock Exchange and the Chicago Stock Exchange, with the ticker symbol GWW. The high and low sales prices for the common stock and the dividends declared and paid for each calendar quarter during 2003 and 2002 are shown below.
|
Prices |
|||||||
|
|
|||||||
| Quarters | High | Low | Dividends | ||||
|
|
|||||||
| 2003 First | $53.30 | $41.40 | $0.180 | ||||
| Second | 50.80 | 42.54 | 0.185 | ||||
| Third | 52.33 | 45.86 | 0.185 | ||||
| Fourth | 50.83 | 43.70 | 0.185 | ||||
|
| |||||||
| Year | $53.30 | $41.40 | $0.735 | ||||
|
| |||||||
| 2002 First | $59.40 | $46.60 | $0.175 | ||||
| Second | 59.00 | 47.09 | 0.180 | ||||
| Third | 50.74 | 40.40 | 0.180 | ||||
| Fourth | 55.20 | 39.20 | 0.180 | ||||
|
| |||||||
| Year | $59.40 | $39.20 | $0.715 | ||||
|
| |||||||
The approximate number of shareholders of record of Grainger’s common stock as of March 1, 2004 was 1,400.
7
Item 6: Selected Financial Data
| 2003 | 2002 | 2001 | 2000 | 1999 | |||||||
|
|
|
|
|
|
|||||||
|
(In thousands of dollars, except for per share amounts) |
|||||||||||
| Net sales | $4,667,014 | $4,643,898 | $4,754,317 | $4,977,044 | $4,636,275 | ||||||
| Net earnings | 226,971 | 211,567 | 174,530 | 192,903 | 180,731 | ||||||
| Net earnings per basic share | 2.50 | 2.30 | 1.87 | 2.07 | 1.95 | ||||||
| Net earnings per diluted share | 2.46 | 2.24 | 1.84 | 2.05 | 1.92 | ||||||
| Total assets | 2,624,678 | 2,437,448 | 2,331,246 | 2,459,601 | 2,564,826 | ||||||
| Long-term debt | |||||||||||
| (less current maturities) | 4,895 | 119,693 | 118,219 | 125,258 | 124,928 | ||||||
| Cash dividends paid per share | $ 0.735 | $ 0.715 | $ 0.695 | $ 0.670 | $ 0.630 | ||||||
The results for 2003 included an after-tax gain on the reduction of restructuring reserves established for the shutdown of Material Logic of $0.3 million.
The results for 2002 included an after-tax gain on the sale of securities of $4.5 million, or $0.04 per diluted share, and an after-tax gain on the reduction of restructuring reserves established for the shutdown of Material Logic of $1.2 million, or $0.01 per diluted share. These were offset by the cumulative effect of a change in accounting for the write-down of goodwill of $23.9 million after-tax, or $0.26 per diluted share.
The results for 2001 included an after-tax charge of $36.6 million, or $0.39 per diluted share, related to the restructuring charge established in connection with the closing of Material Logic and the write-down of investments in other digital enterprises.
The results for 2000 included an after-tax gain of $17.9 million, or $0.19 per diluted share, related to sales of investment securities.
For further information see “Item 7: Management’s Discussion and Analysis of Financial Condition and Results of Operations,” and Notes 3 and 5 to the Consolidated Financial Statements.
Overview
General. Grainger is the leading broad-line supplier of facilities
maintenance products in North America. Grainger reports its operating results in
three segments: Branch-based Distribution, Lab Safety and Integrated Supply.
Grainger distributes a wide range of products used by businesses and
institutions to keep their facilities and equipment up and running. Grainger
uses a multichannel business model to provide customers with a range of options
for finding and purchasing products through a network of branches, field sales
forces, direct marketing including catalogs and a variety of electronic and
Internet channels. Grainger serves customers through a network of 575 branches, 17 distribution centers and multiple Web sites.
Business Environment. Several economic factors and industry trends shape Grainger’s business environment. The current overall economy and leading economic indicators forecast by economists provide insight into anticipated economic factors for the near term and help in the development of projections for the upcoming year. At the start of 2004, the Consensus Forecast-USA is predicting GDP and Industrial Production growth of 4 to 5 percent for 2004. Grainger’s sales to manufacturers tend to correlate more with employment levels than with manufacturing output, so job creation, in addition to manufacturing production, is an indicator for potential sales growth. Most recently, declining employment in the manufacturing sector, due to increased productivity and production moving offshore, has adversely affected the operating results of Grainger.
This trend is likely to continue, and could adversely affect employment levels in one of Grainger’s largest sectors. To address this trend, Grainger has been focusing on government and commercial customers and healthcare institutions. To reach more customer groups, Grainger’s market expansion program will increase branch coverage, expand local availability of products and add local sales professionals in high potential markets through a multi-year program focused on local customers.
The customer’s buying behavior also affects Grainger’s business environment. In 2004, Grainger will continue to target large, multi-site customers including government and national accounts. Sales from government accounts grew from 13% of total sales in 2001 to 17% in 2003. Grainger believes that customers will increasingly focus on reducing their cost to procure facilities maintenance products. Grainger is addressing this anticipated shift in focus by expanding its market coverage and increasing product information available to branch employees for improved service to local customers by accelerating replacement of its legacy information systems. Grainger’s financial strength, including its low debt and strong cash flow, leaves it well positioned to fund initiatives to accelerate top line growth.
8
In 2004, Grainger will be investing in the branch network and information technology including the following major items:
|
|
|
|
In 2004, total capital expenditures of $200 to $225 million are anticipated, more than double that of recent years. Capital spending for the market expansion program may be affected by decisions to lease, rather than purchase, the related facilities and/or equipment.
Matters Affecting Comparability. The Emerging Issues Task Force (EITF) issued “Accounting by a Customer (Including a Reseller) for Certain Consideration Received from a Vendor,” (Issue 02-16) in November 2002 with transition provisions subsequently issued in January 2003. For more detailed information regarding this change in accounting, see Note 2 to the Consolidated Financial Statements. Grainger’s accounting treatment for vendor provided funds was consistent with Issue 02-16, with the exception of vendor funded advertising allowances, which had been accounted for as an offset to operating (advertising) expenses. This accounting treatment is only allowable under Issue 02-16 in certain specific circumstances. As a result of Issue 02-16, Grainger will classify the majority of its vendor provided allowances as an offset to cost of merchandise sold rather than operating (advertising) expenses. Application of Issue 02-16 is on a prospective basis as contracts are either modified or renewed. Since a majority of the 2003 contracts with provisions for advertising allowances were entered into prior to December 31, 2002, the amounts classified as a reduction of cost of merchandise sold of $7.9 million were not material to 2003. This change does not have any effect on net earnings.
Grainger’s operating results for 2003 include the operating results of Gempler’s, a direct marketing division of Gempler’s, Inc., from the acquisition date of April 14, 2003. Gempler’s results are included in the Lab Safety segment.
Effective January 1, 2002, Grainger adopted Statement of Financial Accounting Standards (SFAS) No. 142, “Goodwill and Other Intangible Assets.” As a result of the application of the new impairment methodology introduced by SFAS No. 142, Grainger recorded a noncash charge to earnings in 2002 of $32.3 million ($23.9 million after-tax, or $0.26 per diluted share) related to the write-down of Acklands goodwill. See Note 3 to the Consolidated Financial Statements.
In 2002, Acklands sales declined as automotive aftermarket parts sales were eliminated due to the creation of the joint venture with Uni-Select Inc. in Canada. See Note 9 to the Consolidated Financial Statements.
Results of Operations
The following table is included as an
aid to understanding changes in Grainger’s Consolidated Statements of Earnings.
|
For the Years Ended December 31, |
|||||||||||
|
|
|||||||||||
| Items in Consolidated Statements | Percent Increase/ | ||||||||||
| of Earnings as a Percent of | (Decrease) | ||||||||||
| Net Sales | from Prior Year | ||||||||||
|
|
|
||||||||||
|
2003 |
2002 |
2001 |
2003 |
2002 |
|||||||
|
|
|
|
|
|
|||||||
| Net sales | 100.0 | % | 100.0 | % | 100.0 | % | 0.5 | % | (2.3 | )% | |
| Cost of merchandise sold | 64.9 | 65.6 | 66.6 | (0.6 | ) | (3.8 | ) | ||||
| Operating expenses | 26.8 | 25.9 | 26.3 | 3.8 | (3.7 | ) | |||||
| Operating earnings | 8.3 | 8.5 | 7.1 | (1.5 | ) | 16.1 | |||||
| Other income (expense) | (0.1 | ) | 0.1 | (0.8 | ) | (231.8 | ) | 111.3 | |||
| Income taxes | 3.3 | 3.5 | 2.6 | (5.1 | ) | 32.3 | |||||
| Cumulative effect of | |||||||||||
| accounting change-expense | -- | 0.5 | -- | 100.0 | N/A | ||||||
| Net earnings | 4.9 | % | 4.6 | % | 3.7 | % | 7.3 | % | 21.2 | % | |
2003 Compared to 2002
Grainger’s net sales of $4,667.0
million for 2003 were essentially flat compared to 2002. Full year results were affected
by the general weakness in the U.S. economy. Sales in the Branch-based Distribution
business segment increased $19.2 million over 2002, generally unchanged year-over-year.
Revenue increased in the Lab Safety segment, while sales for Integrated Supply declined.
9
Despite the limited sales growth experienced during the year, gross profit margins improved in 2003 to 35.1% from 34.4% principally due to favorable changes in product mix and selected price increases designed to offset increased freight and other costs. Grainger’s operating earnings of $387.3 million in 2003 decreased 1.5% from the prior year. Operating margins declined to 8.3% in 2003 from 8.5% in 2002 reflecting higher operating expenses year-over-year. The principal driver of the operating expense increase was higher severance and healthcare expenses. Advertising expenses increased as a result of the classification of $7.9 million of vendor provided allowances in cost of merchandise sold rather than in operating (advertising) expenses.
Grainger’s net earnings of $227.0 million in 2003 increased $15.4 million or 7.3% as compared with 2002 net earnings of $211.6 million. Diluted earnings per share for the year increased to $2.46 in 2003 from $2.24 in 2002. In 2002, Grainger recorded a $23.9 million after-tax charge for the cumulative effect of a change in accounting principle. The results for 2002 also included an after-tax gain of $1.2 million, or $0.01 per diluted share, on the reduction of restructuring reserves established for the shutdown of Material Logic.
Segment Analysis
The following comments at the segment
level include external and intersegment net sales and operating earnings. Comments at the
business unit level include external and inter- and intrasegment net sales and operating
earnings. See Note 21 to the Consolidated Financial Statements.
Branch-based Distribution
Net sales at the Branch-based
Distribution businesses totaled $4,167.2 million in 2003 and were essentially flat when
compared with 2002 sales of $4,148.0 million. Sales in the United States declined
approximately 1% in 2003 as compared with 2002. Government account sales were up nearly
11% in 2003, while all other customer segments, including light and heavy manufacturing,
were down when compared with 2002. The declines noted in the other customer segments were
primarily due to the weakness in the U.S. economy, particularly in manufacturing. Within
these customer segments, sales to national accounts increased approximately 2% over 2002.
Sales growth through Internet channels continued in 2003, increasing 15.9% over 2002 and representing 12.6% of segment sales. Grainger will continue to invest in procurement technology to encourage online purchases by its customers and expects sales growth from Internet channels to continue in 2004.
Sales in Canada increased 15.4% in 2003, principally due to a favorable exchange rate. In local currency, sales grew 2.7%, primarily in Ontario and national accounts. In Mexico, sales declined 3.7% in 2003 as compared with 2002, principally due to a weak economy in Mexico.
Cost of merchandise sold of $2,682.6 million for 2003 in the Branch-based Distribution businesses was essentially flat compared to $2,699.4 million in 2002. Gross profit margins increased 0.7 percentage points to 35.6% in 2003 from 34.9% in 2002. Selected price increases designed to offset increased freight and other costs both in the United States and Canada, combined with a favorable change in product mix, contributed to the margin increase. The classification of vendor provided allowances from operating (advertising) expenses to cost of merchandise sold also increased gross profit margin by 0.2 percentage points.
Branch-based Distribution operating expenses increased 3.9% in 2003, primarily due to higher severance and healthcare expenses and increased occupancy costs. The classification of vendor provided allowances from operating (advertising) expenses to cost of merchandise sold also contributed to the increase.
Operating earnings of $390.2 million in 2003 declined by $4.7 million or 1.2% as compared with 2002. The increase in operating expenses year-over-year more than offset the improvement in gross profit margin.
Lab Safety
Net sales at Lab Safety increased by
$18.7 million to $305.5 million in 2003, a 6.5% increase over 2002. The sales growth was
attributable to incremental sales from Gempler’s, acquired on April 14, 2003.
Excluding the results of Gempler’s, year-over-year net sales decreased 2.0% as a
result of weakness in the manufacturing sector of the U.S. economy. A major portion of Lab
Safety’s sales are to manufacturers. The overall decline in the manufacturing sector
was partially offset by increased sales to customers in the forestry and public safety
markets.
The gross profit margin of 42.0% decreased 0.8 percentage points due to incremental sales of Gempler’s products, which have lower gross margins than the rest of Lab Safety’s products. In addition, in 2003 there was a shift in sales mix to lower margin new product sales.
Lab Safety operating expenses of $86.5 million increased 14.5% in 2003, when compared with $75.5 million for 2002. The primary driver of the year-over-year increase was the incremental costs associated with the addition of Gempler’s during the year and higher spending on catalog media.
As a result, operating earnings of $41.9 million for Lab Safety in 2003 declined 11.1% from operating earnings of $47.1 million in 2002.
10
Integrated Supply
Integrated Supply net sales of $211.7
million in 2003 were $14.3 million lower than $226.0 million of net sales in 2002. The
6.3% decrease in net sales resulted from six site disengagements, as well as lower volumes
from existing customers. The decrease in sales was partially offset by incremental sales
at seven new customer sites. Sales include both product sales, which are passed through to
the customer at cost, and management fees.
Gross profit declined $1.9 million in 2003 due to lower management fees. Operating expenses of $22.1 million increased 5.4% in 2003, when compared with $21.0 million for 2002. The increase of $1.1 million was principally due to a higher provision for bad debts, combined with incremental costs associated with a systems upgrade.
Operating earnings of $3.2 million in 2003 for Integrated Supply declined $3.0 million from operating earnings of $6.2 million in 2002.
Other Income and Expense
Other income and expense was $6.2
million of expense in 2003, an unfavorable change of $10.9 million as compared with $4.7
million of income in 2002. The following table summarizes the components of other income
and expense:
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For the Years Ended |
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December 31, |
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2003 |
2002 |
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(In thousands of dollars) |
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| Other income and (expense) | |||||
| Interest (expense), net of interest income | $(2,668 | ) | $(1,590 | ) | |
| Equity in loss of unconsolidated entities, net | (2,288 | ) | (3,025 | ) | |
| Write-down of investments in unconsolidated entities | (1,921 | ) | -- | ||
| Unclassified-net: | |||||
| Gains on sales of investment securities | 1,208 | 7,308 | |||
| Write-down of investments | (1,614 | ) | (3,192 | ) | |
| Gains on sales of fixed assets, net | 1,607 | 5,219 | |||
| Other | (495 | ) | (38 | ) | |
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| $(6,171 | ) | $ 4,682 | |||
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In the fourth quarter of 2003, Grainger wrote off its investment in two Asian joint ventures resulting in an after-tax charge to earnings of $1.9 million. See Note 9 to the Consolidated Financial Statements. The reduction in gains on sales of fixed assets resulted from the sale of one facility in 2003 versus two in 2002.
Income Taxes
Income taxes of $154.1 million in
2003 declined 5.1% as compared with $162.3 million in 2002.
Grainger’s effective tax rates were 40.4% and 40.8% in 2003 and 2002, respectively. Excluding the effect of the equity losses in unconsolidated entities and the write-down of these investments, which did not result in tax benefits, the effective income tax rates were 40.0% for 2003 and 40.5% for 2002. This change in effective tax rate was primarily driven by lower nondeductible losses in Mexico and a lower tax rate in Canada.
2002 Compared to 2001
Grainger’s net sales of $4,643.9
million for 2002 decreased 2.3% from net sales of $4,754.3 million in 2001. This decline
resulted principally from decreases in the Branch-based Distribution and Lab Safety
segments and the elimination of the Digital segment. The decrease was partially offset by
an 18.4% increase at Integrated Supply. The general weakness in the North American economy
affected overall sales performance.
Grainger’s cost of merchandise sold of $3,045.7 million for 2002 decreased 3.8% from the cost of merchandise sold of $3,165.0 million for 2001. This decrease was primarily volume related due to the decline in net sales and supply chain efficiencies. Operating expenses of $1,205.1 million for 2002 decreased 3.7% from operating expenses of $1,250.7 million for 2001. Operating expenses for 2002 included a pretax benefit related to a $1.9 million reduction of a portion of the Material Logic shutdown reserve established in 2001. Operating expenses for 2001 included a pretax restructuring charge of $39.1 million related to the shutdown of Material Logic. Despite tight expense controls in 2002, Grainger was unable to decrease expenses in line with the sales decline. Grainger’s operating earnings of $393.2 million for 2002 increased 16.1% from operating earnings of $338.6 million for 2001. Operating earnings were affected by a $1.9 million benefit and a $39.1 million expense for 2002 and 2001, respectively, related to the restructuring charge established for Material Logic. The results for 2001 included operating losses for the Digital segment totaling $10.2 million.
11
Grainger’s net earnings of $211.6 million for 2002 increased 21.2% compared with 2001 net earnings of $174.5 million. Grainger’s diluted earnings per share for the year increased 21.7% to $2.24 in 2002 from $1.84 in 2001. The results for 2002 included an after-tax charge of $23.9 million ($0.26 per diluted share) related to the cumulative effect of a change in accounting principle. The results for 2002 also included an after-tax gain of $4.5 million ($0.04 per diluted share) from the sales of investment securities and an after-tax gain of $1.2 million ($0.01 per diluted share) related to the reduction of restructuring reserves. The results for 2001 included an after-tax charge o