Apr 14, 2008
Executives
Laura Brown - VP, IR Bill Chapman - Director, IR
Presentation
Laura Brown - Vice President, Investor Relations
Hello. This is Laura Brown, Vice President of Investor Relations; and I am here with Bill Chapman, Director of Investor Relations.
Welcome to Grainger's quarterly audio webcast covering results for the first quarter ending March 31st, 2008. This recording is intended to provide you with information on our recent performance.
We invite you to use this information in conjunction with the earnings release and other financial information posted on our Investor Relations website. Before we begin, I'd like to reinforce the fact that certain statements and projections of future results made in the press release and this webcast constitute forward-looking information.
This information is 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 as they relate to forward-looking statements.
First quarter, 2008 sales were up 7% versus last year's first quarter. Both quarters contained 64 selling days.
Net earnings increased 12% and earnings per share grew by 22% to $1.43. Sales, earnings, and earnings per share were all quarterly records.
Operating margins increased 70 basis points in the quarter to 11.2%. This operating margin expansion was due to positive operating expense leverage and a modest increase in gross profit margins.
As noted at our analyst meeting in November, we expect operating margin expansion going forward to come from a combination of gross margin improvement and operating expense leverage. Operating expenses as a percent of sales moved down from 30.4% in the first quarter of 2007 to 29.7% in the 2008 first quarter, led by the Grainger branch-based segment.
And pretax return on invested capital or ROIC increased 60 basis points to 29.4% from 28.8% a year ago. Earnings contributions from the company's growth programs combined with efforts to improve productivity led to this performance.
The 22% increase in earnings per share for the quarter was a combination of the 12% increase in net earnings in our aggressive share repurchase. During the quarter, we bought back 2.6 million shares of stock for $196 million.
This is an addition to the 415,000 shares we received in early January as part of the final settlement of the accelerated share repurchase program. At the November analyst meeting, we disclosed the intention to repurchase between $180 million and $220 million worth of shares in 2008.
The company plans to remain active in the market throughout the remainder of the year, although not as aggressively as we were in the first quarter. Let's now focus on performance drivers during the quarter.
In doing so, we'll cover the following topics. First, sales by customers end market and geography in the quarter ended in the month of March; second, an update of our key growth initiatives in the United States; third, our operating performance; fourth, our cash generation and capital deployment; and last, our revised 2008 EPS guidance of $5.80 to $6.10.
As described in the press release, the company's two main growth programs market expansion and product line expansion contributed a total of about 2% points to sales growth. Most of that attributable to product line expansion.
That being said, it is becoming increasingly difficult to separate sales contribution from each program, because they have become so closely intertwined. Foreign exchange added another percentage point to sales growth in the quarter, primarily the Canadian dollar's appreciation over the U.S.
dollar, which rose dramatically starting in the 2007 second quarter. Sales were negatively affected by approximately 1 percentage point due to the timing of the Easter holiday falling in March this year and April last year.
Sales in Grainger's branch-based business, which includes operations in the United States, Mexico, and China, increased 6%. Sales were positively affected by 3 percentage points from the growth initiatives and negatively affected by approximately 1 percentage point due to the Easter holiday.
In addition, a decline in the sales of seasonal products resulted in about a 1 percentage point reduction in the sales growth rate for the quarter. Sales in the United States increased 6%.
The 6% sales increase was driven by growth to virtually all customer end markets. Here is a complete list.
Government, light manufacturing and commercial were up mid single-digits. It is important to note that our government business was up against a difficult comparison.
Last year in the first quarter, government was the strongest category, growing in the mid-20% range. In 2007, we benefited from a large contract with the State of California for Homeland Security products.
This contract concluded in May 2007. Heavy-manufacturing, contractor and reseller were up low single-digits.
Retail was down low single-digits and was the only customer sector that was negative in the quarter. On a geographic basis, within in the United States, we saw strength in the south central Pacific mountain and Northeast regions, while sales grew at a slower pace in the Great Lakes region.
Sales in Mexico were up 17%, 15% in local currency for the quarter. As mentioned earlier, sales growth was negatively affected by the timing of Easter.
We estimate that this extended holiday had about a 6 percentage point drag on sales growth in Mexico for the quarter. For the Acklands-Grainger branch-based segment in Canada, sales were up 25%, 7% in local currency.
The timing of the Easter holiday had about a 2 percentage point negative effect in Canada as calculated in U.S. dollars.
We saw continued strength in the oil sands, mining, and government sectors partially offset by weakness in forestry. The strongest growth was in the Saskatchewan, Quebec, and Atlantic regions.
Sales for the Lab Safety Supply segment were up 3%. Sales from the McFeeley's acquisition completed in May 2007 contributed essentially all of the sales growth for the quarter.
Sales performance continued to be below expectations due to flat performance with the existing business and the absence of any additional direct marketing acquisitions. We have not yet seen a material improvement in sales growth as a result of the media changes we described at our analyst meeting in November.
We are actively evaluating ways to improve the growth of the business. Company sales in March were up 7% on a daily basis.
March had one less selling day than a year ago. Foreign exchange contributed about a 1 percentage point growth while the Easter holiday represented about 2 percentage points drag for the month.
In the Grainger branch-based segment, March sales were up 5% on a daily basis. The timing of the Easter holiday negatively affected sales growth by about 2 percentage points.
Daily sales in the United States for March were up 5%. Let's take a look at results by customer end market for the month.
Government was up high single-digits, light manufacturing, contractor, commercial and reseller segments were up low single-digits. Heavy manufacturing and retail were both down in the low single-digits.
Sales in Mexico were up 15%, 11% in local currency. Due to the extended Easter holiday celebrated in Mexico, we estimate that the holiday had about a 17 percentage points drag on sales growth.
For the Acklands-Grainger branch-based segment daily sales were up 28%, 10% in local currency. For this business, we estimate that Easter had a 7 percentage points drag on sales growth.
Sales for the Lab Safety segment in March were up 3%; excluding the sales from the McFeeley's acquisition, lab safety was down 1%. As we move into the second quarter, we are encouraged by the early read on April sales growth.
For the first two weeks of April, daily sales growth is tracking ahead of the 7% growth seen in March as we would expect given the comparison with the Easter holiday, last year. Now, I'd like to turn over the call to Bill Chapman.
Bill Chapman - Director, Investor Relations
Thanks Laura. Let's move on to review of our key growth initiatives in the United States.
During the quarter market expansion and product line expansion continued to deliver incremental sales growth and market share gains. Beginning with market expansion, the company completed 10 branch projects during the quarter including three new branches, two expansions, three relocations, one showroom upgrade and one closure.
The sales contribution from each of the market expansion phases is included in the press release. Phases I and III continued to be the strongest, with sales up 11% in both.
Phase V was up 7% with Phoenix particularly strong in the quarter. Phase II, which includes Southern California was up 6%, due impart to some large orders in Los Angeles.
Similarly, Phase VI was up 6% with South Florida dragging down the rest of the cities in that phase. Finally, Phase VI was up 5%, and the Bay area was the slowest performer in that phase.
While sales results in the top 25 markets were affected by the timing of the Easter holiday in March, these markets delivered sales growth that exceeded the rest of the network. Moving on to the product line expansion program, we added approximately 44,000 new products in the most recently issued catalog, bringing the total numbers of items to 183,000.
The new products included fleet maintenance, power transmission and additional line extensions. We remain pleased by this program's ability to drive growth, and plan to continue to add new products for several more years.
First quarter operating earnings for the company increased by 14% versus the 2007 first quarter. The majority of the improvement came from the Grainger branch-based segment, and Acklands-Grainger.
This 14% increase for the company was the result of positive operating leverage, attained through the 7% sales growth in operating expenses, which grew 5%. Let's take a look at the operating performances by segment.
Operating earnings for the Grainger branch-based business increased 10%, versus the 2007 first quarter. Operating margins increased 45 basis points to 12.8%.
This margin expansion was primarily the result of positive operating expense leverage combined with a 10 basis point improvement in gross margins for this segment. Operating expenses as a percent of sales declined 36 basis points, despite absorbing operating losses from the businesses in China and Mexico.
In 2007, we decided to accelerate the expansion program in Mexico to be the first to establish a nationwide footprint. Since we are in an investment mode and plan to open nine new branches in 2008, we expect some short-term losses.
In China, our investments are made ahead of the expected sales response. We know that other companies experience losses for several years before reaching breakeven.
We continue to monitor the results closely, knowing that China remains a huge opportunity for MRO distribution. Operating expenses in the U.S.
branch-based business also included a higher provision for bad debt expense. The company has elected to provide for bad debts at the 2007 full year rate.
We believe that this approach is prudent as we worked to improve our collection efficiency during the year. We added collection agents while working on long-term technology solutions.
Pretax ROIC for this segment declined 40 basis points to 36% reflecting improvements in operating performance, offset by additional investments in working capital. Let's move on to the Acklands-Grainger branch-based segment, where operating earnings increased 30% for the quarter, the result of the 25% sales increase in improved gross profit margins.
Operating margins in Canada increased 30 basis points to 6.6% from 6.3% in the 2007 first quarter, as the result of the higher gross profit margin partially offset by higher operating expenses. Pre-tax RIOC improved to 12.5% versus 11.4% a year ago.
We remain delighted by the continued turnaround orchestrated by the Acklands-Grainger management team. Operating earnings for the Lab Safety segment increased by about 1 percentage point for the first quarter versus 2007.
The 3% sales growth combined with higher medical costs were primarily responsible for this performance. Lab remains a highly profitable business with the highest operating earnings as a percent of sales of all the segments, although the sluggish sales growth remains a disappointment.
Lastly, let's take a look at cash flow. Operating cash flow was $13 million for the quarter.
Cash flow is historically lighter in the first quarter versus the remainder of the year, because in March the company makes its annual contribution to its profit sharing plan and awards incentive plan payments. This is also the time of year when the company traditionally builds inventory in preparation for the summer season.
During the quarter the company used its cash flow and short-term debt to fund growth initiatives through capital expenditures of $36 million, and return cash to shareholders through dividends of $28 million and $196 million in share repurchases. As announced on April 4, the company is arranging a four year term loan of up to $500 million.
Proceeds from the loan are expected to be used primarily to pay off short-term debt, which at the end of the quarter was $330 million, and to fund additional share repurchases. Although market conditions will dictate the final details of the financing arrangement, we anticipate that the debt will carry a floating interest rate tied to the LIBOR rate and will begin to amortize in the second year of the loan.
I also want to mention our comments in the press release about the GSA contract, which in 2007, represented less than 2% of total company revenue. Today's press release notes that while we have started the process of meeting with government, these issues may take a long time to resolve.
We don't know how long it will take, but what the outcome will be. Going forward, we will provide you an update in our public filings.
As mentioned in today's earnings release, we raised both the lower and upper ends of the earnings per share range; and we now expect 2008 earnings per share a $5.80 to $6.10. Looking forward, here are some additional items to consider as you think about the 2008 second quarter.
The 2007 second quarter included $2.8 million or $0.02 a share for gains on the sale of assets. We are projecting an effective tax rate of 38.9% in 2008 versus the 38.5% in 2007.
Excluding the effect of equity in net income from unconsolidated entities, and finally we expect to close on the term loan in early May. To conclude, we are very pleased about the results for the quarter with sales up 7%, net earnings up 12% and earnings per share up 22%.
And we remain optimistic about our full year performance as evidenced by our revised earnings per share guidance. Thank you for your interest in Grainger.
Our annual meeting will be on April 30th. Please mark your calendar also for May12, when we plan to issue sales results for the month of April.
Bill Chapman - Director, Investor Relations