GWW.2014.03.31.14-10Q


 
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 
FORM 10-Q
 
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
 
For the quarterly period ended March 31, 2014
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

W.W. Grainger, Inc.
(Exact name of registrant as specified in its charter)

Illinois
 
36-1150280
(State or other jurisdiction of incorporation or organization)
 
(I.R.S. Employer Identification No.)
 
 
 
100 Grainger Parkway, Lake Forest, Illinois
 
60045-5201
(Address of principal executive offices)
 
(Zip Code)
(847) 535-1000
(Registrant’s telephone number including area code)
 
Not Applicable
(Former name, former address and former fiscal year; if changed since last report)
 
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 whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  Yes [X]  No [  ]
 
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company.  See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
 
Large accelerated filer [X]  Accelerated filer [  ]   Non-accelerated filer [  ]   Smaller reporting company [  ]
 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
Yes [  ]  No [X]
 
There were 68,430,856 shares of the Company’s Common Stock outstanding as of March 31, 2014.

1



 
TABLE OF CONTENTS
 
 
 
Page No.
PART I
FINANCIAL INFORMATION
 
 
 
 
Item 1.
Financial Statements (Unaudited)
 
 
 
 
 
Condensed Consolidated Statements of Earnings 
    for the Three Months Ended March 31, 2014 and 2013
 
 
 
 
Condensed Consolidated Statements of Comprehensive
    Earnings for the Three Months Ended March 31, 2014 and 2013
 
 
 
 
Condensed Consolidated Balance Sheets
    as of March 31, 2014 and December 31, 2013
 
 
 
 
Condensed Consolidated Statements of Cash Flows
    for the Three Months Ended March 31, 2014 and 2013
 
 
 
 
Notes to Condensed Consolidated Financial Statements
 
 
 
Item 2.
Management's Discussion and Analysis of Financial
    Condition and Results of Operations
 
 
 
Item 3.
Quantitative and Qualitative Disclosures About Market Risk
 
 
 
Item 4.
Controls and Procedures
 
 
 
PART II
OTHER INFORMATION
 
 
 
 
Item 1.
Legal Proceedings
 
 
 
Item 2.
Unregistered Sales of Equity Securities and Use of Proceeds
 
 
 
Item 6.
Exhibits
 
 
 
Signatures
 
 
 
 
EXHIBITS
 
 


2


PART I – FINANCIAL INFORMATION

Item 1.  Financial Statements

W.W. Grainger, Inc. and Subsidiaries
CONDENSED CONSOLIDATED STATEMENTS OF EARNINGS
(In thousands of dollars, except for share and per share amounts)
(Unaudited)
 
Three Months Ended
 
March 31,
 
2014
 
2013
Net sales
$
2,385,627

 
$
2,280,435

Cost of merchandise sold
1,309,656

 
1,248,699

Gross profit
1,075,971

 
1,031,736

Warehousing, marketing and administrative expenses
721,632

 
688,431

Operating earnings
354,339

 
343,305

Other income and (expense):
 

 
 

Interest income
640

 
898

Interest expense
(2,863
)
 
(3,166
)
Other non-operating income
167

 
1,982

Other non-operating expense
(670
)
 
(1,095
)
Total other expense
(2,726
)
 
(1,381
)
Earnings before income taxes
351,613

 
341,924

Income taxes
132,558

 
127,397

Net earnings
219,055

 
214,527

Less: Net earnings attributable to noncontrolling interest
2,402

 
2,689

Net earnings attributable to W.W. Grainger, Inc.
$
216,653

 
$
211,838

Earnings per share:
 

 
 

Basic
$
3.11

 
$
2.99

Diluted
$
3.07

 
$
2.94

Weighted average number of shares outstanding:
 

 
 

Basic
68,699,561

 
69,562,387

Diluted
69,677,438

 
70,774,614

Cash dividends paid per share
$
0.93

 
$
0.80

 
The accompanying notes are an integral part of these financial statements.

3


W.W. Grainger, Inc. and Subsidiaries
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE EARNINGS
(In thousands of dollars)
(Unaudited)
 
 
Three Months Ended
 
March 31,
 
2014
 
2013
Net earnings
$
219,055

 
$
214,527

Other comprehensive earnings (losses):
 

 
 

Foreign currency translation adjustments, net of tax (expense) benefit of $(2,028) and $1,529, respectively
(15,120
)
 
(31,111
)
Derivative instruments, net of tax benefit (expense) of $2,242 and $(1,132), respectively
(3,562
)
 
2,378

Other, net of tax benefit of $641 and $292, respectively
(1,032
)
 
248

Comprehensive earnings, net of tax
199,341

 
186,042

Comprehensive earnings (losses) attributable to noncontrolling interest
3,881

 
(4,078
)
Comprehensive earnings attributable to W.W. Grainger, Inc.
$
195,460

 
$
190,120

 
 
The accompanying notes are an integral part of these financial statements.

4


W.W. Grainger, Inc. and Subsidiaries
CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands of dollars, except for share and per share amounts)
 
 
(Unaudited)
 
 
ASSETS
Mar 31, 2014
 
Dec 31, 2013
CURRENT ASSETS
 
 
 
Cash and cash equivalents
$
375,564

 
$
430,644

Accounts receivable (less allowances for doubtful
 

 
 

accounts of $20,820 and $20,096, respectively)
1,159,556

 
1,101,656

Inventories – net
1,266,460

 
1,305,520

Prepaid expenses and other assets
121,177

 
115,331

Deferred income taxes
64,559

 
75,819

Prepaid income taxes
8,348

 
15,315

Total current assets
2,995,664

 
3,044,285

PROPERTY, BUILDINGS AND EQUIPMENT
2,886,009

 
2,941,090

Less: Accumulated depreciation and amortization
1,675,231

 
1,732,528

Property, buildings and equipment – net
1,210,778

 
1,208,562

DEFERRED INCOME TAXES
31,543

 
16,209

GOODWILL
522,063

 
525,467

OTHER ASSETS AND INTANGIBLES – NET
474,181

 
471,805

TOTAL ASSETS
$
5,234,229

 
$
5,266,328


5



W.W. Grainger, Inc. and Subsidiaries
CONDENSED CONSOLIDATED BALANCE SHEETS (Continued)
(In thousands of dollars, except for share and per share amounts)
 
 
(Unaudited)
 
 
LIABILITIES AND SHAREHOLDERS' EQUITY
Mar 31, 2014
 
Dec 31, 2013
CURRENT LIABILITIES
 
 
 
Short-term debt
$
104,167

 
$
66,857

Current maturities of long-term debt
32,465

 
30,429

Trade accounts payable
493,915

 
510,634

Accrued compensation and benefits
167,409

 
185,905

Accrued contributions to employees’ profit sharing plans
48,557

 
176,800

Accrued expenses
220,692

 
218,835

Income taxes payable
98,932

 
6,330

Total current liabilities
1,166,137

 
1,195,790

LONG-TERM DEBT (less current maturities)
438,068

 
445,513

DEFERRED INCOME TAXES AND TAX UNCERTAINTIES
114,812

 
113,585

EMPLOYMENT-RELATED AND OTHER NON-CURRENT LIABILITIES
186,621

 
184,604

SHAREHOLDERS' EQUITY
 

 
 

Cumulative Preferred Stock – $5 par value – 12,000,000 shares authorized; none issued nor outstanding
—

 
—

Common Stock – $0.50 par value – 300,000,000 shares authorized;
issued 109,659,219 shares
54,830

 
54,830

Additional contributed capital
900,745

 
893,055

Retained earnings
5,974,519

 
5,822,612

Accumulated other comprehensive earnings
7,721

 
28,914

Treasury stock, at cost – 41,228,363 and 40,805,281 shares, respectively
(3,689,708
)
 
(3,548,973
)
Total W.W. Grainger, Inc. shareholders’ equity
3,248,107

 
3,250,438

Noncontrolling interest
80,484

 
76,398

Total shareholders' equity
3,328,591

 
3,326,836

TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY
$
5,234,229

 
$
5,266,328

 
 
The accompanying notes are an integral part of these financial statements.

6


W.W. Grainger, Inc. and Subsidiaries
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands of dollars)
(Unaudited)
 
Three Months Ended
 
March 31,
 
2014
 
2013
CASH FLOWS FROM OPERATING ACTIVITIES:
 
 
 
Net earnings
$
219,055

 
$
214,527

Provision for losses on accounts receivable
2,413

 
1,496

Deferred income taxes and tax uncertainties
(2,671
)
 
(1,000
)
Depreciation and amortization
45,776

 
38,945

Stock-based compensation
11,262

 
11,547

Change in operating assets and liabilities – net of business 
  acquisitions and divestitures:
 

 
 

Accounts receivable
(78,676
)
 
(101,803
)
Inventories
30,608

 
60,122

Prepaid expenses and other assets
6,564

 
28,090

Trade accounts payable
(13,497
)
 
8,672

Other current liabilities
(146,616
)
 
(137,186
)
Current income taxes payable
92,410

 
52,085

Employment-related and other non-current liabilities
1,177

 
5,620

Other – net
(287
)
 
(4,698
)
Net cash provided by operating activities
167,518

 
176,417

CASH FLOWS FROM INVESTING ACTIVITIES:
 

 
 

Additions to property, buildings and equipment
(65,664
)
 
(42,962
)
Proceeds from sales of property, buildings and equipment
462

 
1,573

Other – net
13,023

 
(89
)
Net cash used in investing activities
(52,179
)
 
(41,478
)
CASH FLOWS FROM FINANCING ACTIVITIES:
 

 
 

Borrowings under lines of credit
26,821

 
36,167

Proceeds from issuance of commercial paper
40,000

 
—

Payments against lines of credit
(28,313
)
 
(39,999
)
Net decrease in long-term debt
(5,807
)
 
(3,750
)
Proceeds from stock options exercised
10,170

 
23,461

Excess tax benefits from stock-based compensation
6,807

 
12,650

Purchase of treasury stock
(150,553
)
 
(69,797
)
Cash dividends paid
(64,682
)
 
(56,546
)
Net cash used in financing activities
(165,557
)
 
(97,814
)
Exchange rate effect on cash and cash equivalents
(4,862
)
 
(3,672
)
NET CHANGE IN CASH AND CASH EQUIVALENTS
(55,080
)
 
33,453

Cash and cash equivalents at beginning of year
430,644

 
452,063

Cash and cash equivalents at end of period
$
375,564

 
$
485,516

 
 
The accompanying notes are an integral part of these financial statements.

7


W.W. Grainger, Inc. and Subsidiaries
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

1.    BACKGROUND AND BASIS OF PRESENTATION
 
W.W. Grainger, Inc. is a broad-line distributor of maintenance, repair and operating supplies, and other related products and services used by businesses and institutions.  W.W. Grainger, Inc.’s operations are primarily in the United States and Canada, with a presence in Europe, Asia and Latin America.  In this report, the words “Company” or “Grainger” mean W.W. Grainger, Inc. and its subsidiaries.
 
The Condensed Consolidated Financial Statements of the Company and the related notes are unaudited and should be read in conjunction with the consolidated financial statements and related notes for the year ended December 31, 2013 included in the Company’s Annual Report on Form 10-K filed with the Securities and Exchange Commission (SEC).
 
The Condensed Consolidated Balance Sheet as of December 31, 2013 has been derived from the audited consolidated financial statements at that date, but does not include all of the disclosures required by accounting principles generally accepted in the United States of America for complete financial statements.
 
The unaudited financial information reflects all adjustments (primarily consisting of normal recurring adjustments) which, in the opinion of management, are necessary for a fair presentation of the statements contained herein.

2.    DIVIDEND
 
On April 30, 2014, the Company’s Board of Directors declared a quarterly dividend of $1.08 per share, payable June 1, 2014, to shareholders of record on May 12, 2014. This represents a 16% increase from the prior quarterly rate of 93 cents per share.

3.    SHORT-TERM DEBT
 
At March 31, 2014, there was $40 million of commercial paper outstanding, issued for general working capital needs. The commercial paper matured on April 1, 2014, and was paid off in full.

4.    DERIVATIVE INSTRUMENTS

The Company uses derivative instruments to manage a portion of exposures to fluctuations in interest rates and foreign currency exchange rates. The Company does not enter into derivative financial instruments for trading or speculative purposes. The fair values of these instruments are determined by using quoted market forward rates (level 2 inputs) and reflect the present value of the amount that the Company would pay for contracts involving the same notional amounts and maturity dates. These instruments qualify for hedge accounting and the changes in fair value are reported as a component of other comprehensive earnings (losses) net of tax effects.

As of March 31, 2014 and December 31, 2013, the fair value of the Company's interest rate swap included on the balance sheet as a liability under Employment-related and other noncurrent liabilities was $3 million. The purpose of the interest rate swap is to partially hedge the future interest expense of the euro-denominated term loan entered into to fund a portion of the Fabory acquisition in 2011. The swap matures in August 2016.

The Company had fair values of $6 million and $1 million in forward contracts as of March 31, 2014 and December 31, 2013, respectively, included on the balance sheet as assets under Prepaid expenses and other assets. The forward contracts were entered into to hedge against adverse changes in the exchange rate on the Company's intercompany loan with the Canadian subsidiary. The contracts expire in September 2014.


8
W.W. Grainger, Inc. and Subsidiaries
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Unaudited)

5.    EMPLOYEE BENEFITS - POSTRETIREMENT
 
The Company has a postretirement healthcare benefits plan that provides coverage for a majority of its United States employees hired prior to January 1, 2013, and their dependents should they elect to maintain such coverage upon retirement. Covered employees become eligible for participation when they qualify for retirement while working for the Company. Participation in the plan is voluntary and requires participants to make contributions toward the cost of the plan, as determined by the Company.

The net periodic benefit costs charged to operating expenses, which are valued at the measurement date of January 1 and recognized evenly throughout the year, consisted of the following components (in thousands of dollars):
 
Three Months Ended March 31,
 
2014
 
2013
Service cost
$
2,251

 
$
2,727

Interest cost
2,637

 
2,350

Expected return on assets
(2,059
)
 
(1,769
)
Amortization of transition asset
(36
)
 
(35
)
Amortization of unrecognized losses
195

 
1,116

Amortization of prior service credits
(1,813
)
 
(1,853
)
Net periodic benefit costs
$
1,175

 
$
2,536

 
The Company has established a Group Benefit Trust to fund the plan and process benefit payments. The funding of the trust is an estimated amount which is intended to allow the maximum deductible contribution under the Internal Revenue Code of 1986 (IRC), as amended.  There are no minimum funding requirements and the Company intends to follow its practice of funding the maximum deductible contribution under the IRC. As of March 31, 2014, the plan was in an overfunded position, and the Company currently does not anticipate significant contributions to the trust in 2014.

6.    SEGMENT INFORMATION
 
The Company has two reportable segments: the United States and Canada. The United States operating segment reflects the results of the Company's U.S. business. The Canada operating segment reflects the results for Acklands – Grainger Inc., the Company’s Canadian business. Other businesses include operations in Europe, Asia, Latin America and also Zoro. These other businesses individually do not meet the definition of a reportable segment. Operating segments generate revenue almost exclusively through the distribution of maintenance, repair and operating supplies, as service revenues account for less than 1% of total revenues for each operating segment. Following is a summary of segment results (in thousands of dollars):

 
Three Months Ended March 31, 2014
 
United States
 
Canada
 
Other Businesses
 
Total
Total net sales
$
1,897,311

 
$
254,297

 
$
274,906

 
$
2,426,514

Intersegment net sales
(40,867
)
 
(46
)
 
26

 
(40,887
)
Net sales to external customers
$
1,856,444

 
$
254,251

 
$
274,932

 
$
2,385,627

Segment operating earnings
$
353,687

 
$
21,296

 
$
8,475

 
$
383,458

  

9
W.W. Grainger, Inc. and Subsidiaries
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Unaudited)

 
Three Months Ended March 31, 2013
 
United States
 
Canada
 
Other Businesses
 
Total
Total net sales
$
1,774,538

 
$
283,140

 
$
247,874

 
$
2,305,552

Intersegment net sales
(24,889
)
 
(39
)
 
(189
)
 
(25,117
)
Net sales to external customers
$
1,749,649

 
$
283,101

 
$
247,685

 
$
2,280,435

Segment operating earnings
$
330,888

 
$
32,856

 
$
8,251

 
$
371,995


 
United States
 
Canada
 
Other Businesses
 
Total
Segment assets:
 
 
 
 
 
 
 
March 31, 2014
$
2,093,098

 
$
354,643

 
$
371,486

 
$
2,819,227

December 31, 2013
$
2,045,564

 
$
392,147

 
$
359,007

 
$
2,796,718


Following are reconciliations of segment information with the consolidated totals per the financial statements (in thousands of dollars):
 
Three Months Ended March 31,
 
2014
 
2013
Operating earnings:
 
Total operating earnings for operating segments
$
383,458

 
$
371,995

Unallocated expenses and eliminations
(29,119
)
 
(28,690
)
Total consolidated operating earnings
$
354,339

 
$
343,305

 
 
Mar 31, 2014
 
Dec 31, 2013
Assets:
 
Total assets for operating segments
$
2,819,227

 
$
2,796,718

Other current and non-current assets
2,104,487

 
2,118,298

Unallocated assets
310,515

 
351,312

Total consolidated assets
$
5,234,229

 
$
5,266,328


Assets for operating segments include net accounts receivable and first-in, first-out inventory which are reported to the Company's Chief Operating Decision Maker.

Unallocated expenses and unallocated assets primarily relate to the Company headquarter's support services, which are not part of any business segment, as well as intercompany eliminations. Unallocated expenses include payroll and benefits, depreciation and other costs associated with headquarters-related support services. Unallocated assets include non-operating cash and cash equivalents, certain prepaid expenses and property, buildings and equipment-net.

Unallocated assets decreased by $41 million at March 31, 2014 compared to December 31, 2013, due to lower cash balances primarily driven by payments for the employee profit sharing plan.

10
W.W. Grainger, Inc. and Subsidiaries
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Unaudited)

7.    EARNINGS PER SHARE
 
The following table sets forth the computation of basic and diluted earnings per share under the two-class method (in thousands of dollars, except for share and per share amounts):
 
Three Months Ended
 
March 31,
 
2014
 
2013
Net earnings attributable to W.W. Grainger, Inc. as reported
$
216,653

 
$
211,838

Distributed earnings available to participating securities
(835
)
 
(891
)
Undistributed earnings available to participating securities
(2,113
)
 
(2,750
)
Numerator for basic earnings per share – Undistributed and distributed earnings available to common shareholders
213,705

 
208,197

Undistributed earnings allocated to participating securities
2,113

 
2,750

Undistributed earnings reallocated to participating securities
(2,084
)
 
(2,704
)
Numerator for diluted earnings per share – Undistributed and distributed earnings available to common shareholders
$
213,734

 
$
208,243

Denominator for basic earnings per share – weighted average shares
68,699,561

 
69,562,387

Effect of dilutive securities
977,877

 
1,212,227

Denominator for diluted earnings per share – weighted average shares adjusted for dilutive securities
69,677,438

 
70,774,614

Earnings per share two-class method
 

 
 

Basic
$
3.11

 
$
2.99

Diluted
$
3.07

 
$
2.94



8.    CONTINGENCIES AND LEGAL MATTERS

From time to time the Company is involved in various legal and administrative proceedings that are incidental to its business, including claims related to product liability, general negligence, contract disputes, environmental issues, wage and hour laws, intellectual property, employment practices, regulatory compliance or other matters and actions brought by employees, consumers, competitors, suppliers or governmental entities. As a government contractor selling to federal, state and local governmental entities, the Company is also subject to governmental or regulatory inquiries or audits or other proceedings, including those related to pricing compliance. It is not expected that the ultimate resolution of any of these matters will have, either individually or in the aggregate, a material adverse effect on the Company's consolidated financial position or results of operations.

11
W.W. Grainger, Inc. and Subsidiaries
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Unaudited)


Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations

General
Grainger is a broad-line distributor of maintenance, repair and operating supplies, and other related products and services used by businesses and institutions. Grainger’s operations are primarily in the United States and Canada, with a presence in Europe, Asia and Latin America. Grainger uses a multichannel business model to provide customers with a range of options for finding and purchasing products utilizing sales representatives, catalogs and direct marketing materials and eCommerce. Grainger serves more than 2 million customers worldwide through a network of highly integrated branches, distribution centers, multiple websites and export services.

Business Environment
Given Grainger's large number of customers and the diverse industries it serves, several economic factors and industry trends tend to shape Grainger’s business environment. The overall economy and leading economic indicators provide general insight into projecting Grainger's growth. Grainger’s sales in the United States and Canada tend to positively correlate with Gross Domestic Product (GDP), Industrial Production, Exports and Business Investment. In the United States, sales also tend to positively correlate with Business Inventory. The table below provides these estimated indicators for 2014:
 
2014 Forecasted Growth
 
United States
 
Canada
GDP
2.4%
 
2.2%
Industrial Production
3.1%
 
3.0%
Exports
4.1%
 
3.6%
Business Investment
6.0%
 
4.6%
Business Inventory
3.1%
 
—
Source: Global Insight (April 2014)
 
 
 

According to the Federal Reserve, overall industrial production increased 3.8% from March 2013 to March 2014. This improvement positively affected Grainger's sales growth for the three months of 2014. In addition, the light and heavy manufacturing customer end-markets have historically correlated with manufacturing employment levels and manufacturing output. The United States Department of Labor reported an increase of 0.6% in manufacturing employment levels from March 2013 to March 2014. According to the Federal Reserve, manufacturing output increased 2.8% from March 2013 to March 2014. Grainger’s heavy and light manufacturing customer end-markets outperformed these indicators as sales to these customer end-markets increased in the mid-single digits for the first quarter of 2014.

While full year 2014 forecasted growth for Canada is positive, in the first quarter of 2014, the Canadian economy experienced pressure as the Canadian dollar was negatively impacted by a broad based decline in commodity prices with energy, metals and agricultural prices all lower with few exceptions, according to Scotiabank. These factors, along with lower than expected job growth, impacted the Canadian business, which is heavily dependent on the natural resources sector.

Outlook
On April 16, 2014, Grainger reiterated its full year guidance of 5 to 9 percent sales growth and earnings per share of $12.10 to $12.85.

12
W.W. Grainger, Inc. and Subsidiaries
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS

Matters Affecting Comparability
There were 63 sales days in the first quarter of 2014 and 2013. Results in the first quarter of 2014 did not include the impact of Good Friday, while results in the first quarter of 2013 did, due to the timing of the holiday. Grainger completed the E&R Industrial and Safety Solutions acquisitions as well as the divestiture of the four direct marketing brands in the second half of 2013, all of which were immaterial individually and in the aggregate.

Results of Operations – Three Months Ended March 31, 2014
The following table is included as an aid to understanding the changes in Grainger’s Condensed Consolidated Statements of Earnings:
 
Three Months Ended March 31,
 
As a Percent of Net Sales
 
Percent Increase/(Decrease)
 
2014
 
2013
 
Net sales
100.0
 %
 
100.0
 %
 
4.6
 %
Cost of merchandise sold
54.9

 
54.8

 
4.9

Gross profit
45.1

 
45.2

 
4.3

Operating expenses
30.2

 
30.1

 
4.8

Operating earnings
14.9

 
15.1

 
3.2

Other income (expense)
(0.1
)
 
(0.1
)
 
97.4

Income taxes
5.6

 
5.6

 
4.1

Noncontrolling interest
0.1

 
0.1

 
(10.7
)
Net earnings attributable to W.W. Grainger, Inc.
9.1
 %
 
9.3
 %
 
2.3
 %

Grainger’s net sales of $2,386 million for the first quarter of 2014 increased 5% compared with sales of $2,280 million for the comparable 2013 quarter. The 5% increase for the quarter consisted of the following:
 
Percent Increase/(Decrease)
Volume
4
Business acquisitions
2
Price
1
Foreign exchange
(2)
Total
5%

Sales to all customer end markets, except contractors, increased in the first quarter of 2014. The increase in net sales was led by growth in sales to heavy and light manufacturing, retail and commercial service customers. Refer to the Segment Analysis below for further details.

Gross profit of $1,076 million for the first quarter of 2014 increased 4%. The gross profit margin during the first quarter of 2014 decreased 0.1 percentage point when compared to the same period in 2013, primarily driven by lower margins from the newly acquired businesses and faster growth with lower margin customers, partially offset by price inflation exceeding cost inflation.

Operating expenses of $722 million for the first quarter of 2014 increased 5%, driven primarily by $31 million in incremental growth and infrastructure spending as well as incremental expenses from the newly acquired businesses.

Operating earnings for the first quarter of 2014 were $354 million, an increase of 3% compared to the first quarter of 2013. The increase in operating earnings was primarily driven by higher sales, partially offset by lower gross margins and negative operating expense leverage.

13
W.W. Grainger, Inc. and Subsidiaries
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS

Net earnings attributed to W.W. Grainger, Inc. for the first quarter of 2014 increased by 2% to $217 million from $212 million in the first quarter of 2013. Diluted earnings per share of $3.07 in the first quarter of 2014 were 4% higher than the $2.94 for the first quarter of 2013, due to higher earnings and lower average shares outstanding.

Segment Analysis
Grainger’s two reportable segments are the United States and Canada. The United States segment reflects the results of Grainger’s U.S. operating segment. The Canada segment reflects the results for Acklands – Grainger Inc., Grainger’s Canadian operating segment. Other businesses include operations in Europe, Asia, Latin America and also Zoro.

The following comments at the segment and business unit level include external and intersegment net sales and operating earnings. See Note 6 to the Condensed Consolidated Financial Statements.

United States
Net sales were $1,897 million for the first quarter of 2014, an increase of $122 million, or 7%, when compared with net sales of $1,775 million for the same period in 2013. The 7% increase for the quarter consisted of the following:
 
Percent Increase
Volume
4
Business acquisitions
2
Price
1
Total
7%

The increase in net sales was led by high single digit growth to heavy manufacturing and natural resource customers, followed by mid-single digit growth to light manufacturing, commercial service and retail customers. Government and reseller customers were up in the low single digits and net sales to contractors were down in the low single digits.

The gross profit margin for the first quarter of 2014 decreased 0.3 percentage point compared to the same period in 2013, primarily driven by lower gross margins from the newly acquired businesses and faster growth with lower margin customers, partially offset by price inflation exceeding cost inflation.

Operating expenses were up 6% in the first quarter of 2014 versus the first quarter of 2013, driven by $26 million of incremental spending on growth initiatives such as new sales representatives, eCommerce and advertising as well as incremental expenses from the newly acquired businesses.

Operating earnings of $354 million for the first quarter of 2014 increased 7% from $331 million for the first quarter of 2013, driven by higher sales and positive operating expense leverage, partially offset by lower gross margins.

Canada
Net sales were $254 million for the first quarter of 2014, a decrease of $29 million, or 10%, when compared with $283 million for the same period in 2013. In local currency, sales decreased 2%. The 10% decrease for the quarter consisted of the following:
 
Percent (Decrease)
Foreign Exchange
(8)
Volume
(2)
Total
(10)%

Sales performance in Canada was driven by declines in the construction, light and heavy manufacturing, mining, government and oil and gas customer end markets, partially offset by growth from utilities, forestry and transportation customer end markets.
 
The gross profit margin decreased 0.2 percentage point in the first quarter of 2014 versus the first quarter of 2013, due to higher freight costs and the effect of unfavorable foreign exchange from products sourced from the United States.


14
W.W. Grainger, Inc. and Subsidiaries
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS

Operating expenses were flat in the first quarter of 2014 versus the first quarter of 2013. In local currency, operating expenses increased 9%, primarily due to higher payroll, benefits and severance costs as well as incremental spending related to information technology investments.

Operating earnings of $21 million for the first quarter of 2014 were down $12 million, or 35%, versus the first quarter of 2013. In local currency, operating earnings decreased by 29%, driven primarily by higher operating expenses, lower sales and lower gross margins.

Other Businesses
Net sales for other businesses, which include operations in Europe, Asia, Latin America and also Zoro, were $275 million for the first quarter of 2014, an increase of $27 million, or 11%, when compared with net sales of $248 million for the same period in 2013. The drivers of net sales for the quarter consisted of the following:
 
Percent Increase/(Decrease)
Volume/Price
18
Foreign exchange
(7)
Total
11%

Operating earnings of $8 million in the first quarter of 2014 were flat compared to the first quarter of 2013. The earnings performance for the quarter versus prior year was primarily driven by improved earnings from Zoro, partially offset by weaker performance in Latin America and costs associated with evaluating the new online business outside of the United States.

Income Taxes
Grainger’s effective income tax rates were 37.7% and 37.3% for the three months ended March 31, 2014 and 2013, respectively. The increase was primarily due to more earnings in the United States versus other jurisdictions with lower tax rates.

15
W.W. Grainger, Inc. and Subsidiaries
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS

Financial Condition

Cash Flow
Cash from operating activities continues to serve as Grainger’s primary source of liquidity. Net cash provided by operating activities was $168 million and $176 million for the three months ended March 31, 2014 and 2013, respectively. The reduction in cash flows from operating activities was driven primarily by lower trade accounts payable balances related to the timing of inventory purchases combined with a lower investment in inventory, partially offset by higher income tax liabilities due to the timing of payments.

Net cash used in investing activities was $52 million and $41 million for the three months ended March 31, 2014 and 2013, respectively. The higher use of cash was driven by cash expended for additions to property, buildings, equipment and capitalized software of $66 million in the three months ended March 31, 2014, compared to $43 million in 2013. Cash expenditures in the three months ended March 31, 2014, were partially offset by cash received from the sale of four direct marketing brands in the fourth quarter of 2013.

Net cash used in financing activities was $166 million and $98 million for the three months ended March 31, 2014 and 2013, respectively. The $68 million increase in cash used in financing activities for the three months ended March 31, 2014 was due to an increase in the purchase of treasury stock, partially offset by proceeds from the issuance of commercial paper.

Working Capital
Working capital consists of current assets (less non-operating cash) and current liabilities (less short-term debt and current maturities of long-term debt).

Working capital at March 31, 2014, was $1,742 million, an increase of $121 million when compared to $1,621 million at December 31, 2013. The working capital assets to working capital liabilities ratio increased to 2.7 at March 31, 2014, from 2.5 at December 31, 2013. The increase primarily related to higher receivable balances driven by sales volume as well as lower profit sharing accruals due to the timing of annual payments.

Debt
Grainger maintains a debt ratio and liquidity position that provide flexibility in funding working capital needs and long-term cash requirements. In addition to internally generated funds, Grainger has various sources of financing available, including bank borrowings under lines of credit. Total debt as a percent of total capitalization was 14.7% at March 31, 2014, and 14.0% at December 31, 2013.

16
W.W. Grainger, Inc. and Subsidiaries
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS

Critical Accounting Policies and Estimates
The preparation of financial statements, in conformity with accounting principles generally accepted in the United States of America, requires management to make judgments, estimates and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses in the financial statements. Management bases its estimates on historical experience and other assumptions, which it believes are reasonable. If actual amounts are ultimately different from these estimates, the revisions are included in Grainger’s results of operations for the period in which the actual amounts become known.

Accounting policies are considered critical when they require management to make assumptions about matters that are highly uncertain at the time the estimates are made and when there are different estimates that management reasonably could have made, which would have a material impact on the presentation of Grainger’s financial condition, changes in financial condition or results of operations. For a description of Grainger’s critical accounting policies see Grainger's Annual Report on Form 10-K for the year ended December 31, 2013.

Forward-Looking Statements
This Form 10-Q contains statements that are not historical in nature but concern future results and business plans, strategies and objectives and other matters that may be deemed to be “forward-looking statements” under the federal securities laws. Grainger has generally identified such forward-looking statements by using words such as “anticipate, assumptions, believes, continues, could, does not, estimated, estimates, expected, forecasted, full year guidance, future, guidance, historically correlated, if, intended, intends, maintain, maintains, may, not expected, projecting, provide, range, reasonably likely, should, tend, tend to positively correlate, tend to shape, trends, will, would, would pay" or similar expressions.
Grainger cannot guarantee that any forward-looking statement will be realized although Grainger does believe that its assumptions underlying its forward-looking statements are reasonable. Achievement of future results is subject to risks and uncertainties which could cause Grainger's results to differ materially from those which are presented.
Factors that could cause actual results to differ materially from those presented or implied in a forward-looking statement include, without limitation: higher product costs or other expenses; a major loss of customers; loss or disruption of source of supply; increased competitive pricing pressures; failure to develop or implement new technologies or business strategies; the outcome of pending and future litigation or governmental or regulatory proceedings; investigations, inquiries, audits and changes in laws and regulations; disruption of information technology or data security systems; general industry or market conditions; general global economic conditions; currency exchange rate fluctuations; market volatility; commodity price volatility; labor shortages; facilities disruptions or shutdowns; higher fuel costs or disruptions in transportation services; natural and other catastrophes and unanticipated weather conditions.
Caution should be taken not to place undue reliance on Grainger's forward-looking statements and Grainger undertakes no obligation to publicly update the forward-looking statements, whether as a result of new information, future events or otherwise.

17

W.W. Grainger, Inc. and Subsidiaries


Item 3.
Quantitative and Qualitative Disclosures About Market Risk
 
For quantitative and qualitative disclosures about market risk, see “Item 7A: Quantitative and Qualitative Disclosures About Market Risk” in Grainger's Annual Report on Form 10-K for the fiscal year ended December 31, 2013.

Item 4.
Controls and Procedures
 
Disclosure Controls and Procedures
Grainger carried out an evaluation, under the supervision and with the participation of its management, including the Chief Executive Officer and the Chief Financial Officer, of the effectiveness of the design and operation of Grainger’s disclosure controls and procedures pursuant to Exchange Act Rule 13a-15. Based upon that evaluation, the Chief Executive Officer and the Chief Financial Officer concluded that Grainger’s disclosure controls and procedures were effective as of the end of the period covered by this report.
 
Changes in Internal Control Over Financial Reporting
There were no changes in Grainger’s internal control over financial reporting that occurred during the first quarter that have materially affected, or are reasonably likely to materially affect, Grainger’s internal control over financial reporting.

PART II – OTHER INFORMATION
 
Items 1A, 3, 4 and 5 not applicable.

Item 1.
Legal Proceedings

Information on specific and significant legal proceedings is set forth in Note 8 to the Condensed Consolidated Financial Statements included under Item 1.



18

W.W. Grainger, Inc. and Subsidiaries


Item 2.
Unregistered Sales of Equity Securities and Use of Proceeds
 
Issuer Purchases of Equity Securities – First Quarter
 
Period
Total Number of Shares Purchased (A)
Average Price Paid per Share (B)
Total Number of Shares Purchased as Part of Publicly Announced Plans or Programs (C)
Maximum Number of
Shares That May Yet be Purchased Under the
Plans or Programs
Jan 1 – Jan 31
100,000
$237.22
100,000
3,521,668
Feb 1 – Feb 28
240,040
$240.01
240,040
3,281,628
Mar 1 – Mar 31
274,875
$251.82
274,875
3,006,753
Total
614,915
$244.84
614,915
 
 
(A)
There were no shares withheld to satisfy tax withholding obligations in connection with the vesting of employee restricted stock awards.
(B)
Average price paid per share includes any commissions paid and includes only those amounts related to purchases as part of publicly announced plans or programs.
(C)
Purchases were made pursuant to a share repurchase program approved by Grainger’s Board of Directors on July 28, 2010. The program has no specified expiration date. Effective April 30, 2014, the Board of Directors restored the authority to repurchase up to 10 million shares. Activity is reported on a trade date basis.


Item 6.
Exhibits

(a)
 
Exhibits (numbered in accordance with Item 601 of Regulation S-K)
 
 
(31)
Rule 13a – 14(a)/15d – 14(a) Certifications
 
 
 
(a)  Chief Executive Officer certification pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
 
 
 
(b)  Chief Financial Officer certification pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
 
 
(32)
Section 1350 Certifications
 
 
 
Certifications pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
 
101.INS
XBRL Instance Document.
 
101.SCH
XBRL Taxonomy Extension Schema Document.
 
101.CAL
XBRL Taxonomy Extension Calculation Linkbase Document.
 
101.DEF
XBRL Taxonomy Extension Definition Linkbase Document.
 
101.LAB
XBRL Taxonomy Extension Label Linkbase Document.
 
101.PRE
XBRL Taxonomy Extension Presentation Linkbase Document.

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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:
May 1, 2014
 
 
 
By:
 
 
 
/s/ R. L. Jadin
 
 
 
R. L. Jadin, Senior Vice President
and Chief Financial Officer
Date:
May 1, 2014
 
 
 
By:
 
 
 
/s/ G. S. Irving
 
 
 
G. S. Irving, Vice President
and Controller


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