116 PAGES COMPLETE UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-K ANNUAL REPORT (Mark One) [X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the fiscal year ended December 31, 1998 OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 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 (I.R.S. Employer incorporation or organization) Identification No.) 455 Knightsbridge Parkway, Lincolnshire, Illinois 60069-3620 (Address of principal executive offices) (Zip Code) Registrant's telephone number including area code: 847/793-9030 Securities registered pursuant to Section 12(b) of the Act: Title of each class Name of each exchange on which registered Common Stock $0.50 par value, New York Stock Exchange and accompanying Preferred Stock Chicago Stock Exchange Purchase Rights 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. ( ) The aggregate market value of the voting stock held by non-affiliates of the registrant was $3,283,966,623 as of the close of trading reported on the Consolidated Transaction Reporting System on March 1, 1999. APPLICABLE ONLY TO CORPORATE REGISTRANTS 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 93,315,991 shares outstanding as of March 1, 1999 DOCUMENTS INCORPORATED BY REFERENCE Portions of the proxy statement relating to the annual meeting of shareholders of the registrant to be held on April 28, 1999 are incorporated by reference into Part III hereof. The Exhibit Index appears on page 15 in the sequential numbering system. (The Securities and Exchange Commission has not approved or disapproved of this report nor has it passed on the accuracy or adequacy hereof.) 1
<TABLE> <S> <C> CONTENTS Page PART I Item 1: BUSINESS............................................................. 3-6 THE COMPANY........................................................ 3 GRAINGER INDUSTRIAL SUPPLY......................................... 3-4 ACKLANDS-GRAINGER INC.............................................. 4 GRAINGER PARTS..................................................... 5 GRAINGER, S.A. de C.V.............................................. 5 GRAINGER GLOBAL SOURCING........................................... 5 GRAINGER CUSTOM SOLUTIONS.......................................... 5 GRAINGER INTEGRATED SUPPLY......................................... 5 GRAINGER CONSULTING SERVICES....................................... 5 INTERNET COMMERCE.................................................. 6 LAB SAFETY SUPPLY, INC............................................. 6 INDUSTRY SEGMENTS.................................................. 6 COMPETITION........................................................ 6 EMPLOYEES.......................................................... 6 Item 2: PROPERTIES........................................................... 6-7 Item 3: LEGAL PROCEEDINGS.................................................... 7 Item 4: SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.................. 7 Executive Officers Of The Company................................................... 7-8 PART II Item 5: MARKETS FOR REGISTRANT'S COMMON EQUITY AND RELATED SHAREHOLDER MATTERS.................................... 8 Item 6: SELECTED FINANCIAL DATA.............................................. 9 Item 7: MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND THE RESULTS OF OPERATIONS...................................... 9-14 RESULTS OF OPERATIONS.............................................. 9-11 YEAR 2000.......................................................... 12-13 FINANCIAL CONDITION................................................ 13 INFLATION AND CHANGING PRICES...................................... 14 Item 8: FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.......................... 14 Item 9: DISAGREEMENTS ON ACCOUNTING AND FINANCIAL DISCLOSURE................. 14 PART III Item 10: DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT................... 14 Item 11: EXECUTIVE COMPENSATION............................................... 14 Item 12: SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT....... 14 Item 13: CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS....................... 14 PART IV Item 14: EXHIBITS, FINANCIAL STATEMENT SCHEDULE, AND REPORTS ON FORM 8-K...... 15 Signatures.......................................................................... 16 INDEX TO FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA................................ 17 FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA......................................... 18-38 </TABLE> 2
PART I Item 1: Business The Company The registrant, W.W. Grainger, Inc., was incorporated in the State of Illinois in 1928. It is the leading North American provider of maintenance, repair, and operating (MRO) supplies, services, and related information to businesses and institutions. W.W. Grainger, Inc. regards itself as being in the service business. As used herein, "Company" means W.W. Grainger, Inc., and/or its subsidiaries as the context may require. In late 1997, the Company began an organizational restructuring with the formation of several business operations. Several of these operations were originally part of the Grainger branch-based business. In addition, Grainger Integrated Supply began refocusing on serving customers through materials management service contracts. These changes were made to create greater focus and accountability in serving the diverse needs of the Company's customers. 1998 was a transition year in establishing the refocused organization. The Company offers a breadth of MRO solutions by combining products, services, and information. It tailors its capabilities toward the objective of providing the lowest total cost MRO solution to select customer groups. The Company serves the diverse needs of its customers through several focused businesses. The Branch-based Distribution businesses serve traditional customers with immediate MRO needs. The other businesses of the Company serve customers with more complex needs and/or customers who prefer to purchase through less traditional channels, such as the Internet and direct marketing. The Company also has a business support function which provides coordination and guidance in the areas of Accounting, Administrative Services, Aviation, Business Development, Communications, Compensation and Benefits, Employee Development, Finance, Government Regulations, Human Resources, Industrial Relations, Investor Relations, Insurance and Risk Management, Internal Audit, International Operations, Legal, Planning, Real Estate and Construction Services, Security and Safety, Taxes, and Treasury services. These services are provided in varying degrees to all of the business units. A number of Company-wide strengths provide each business with an advantage in serving its market. These strengths include technology and information management, supplier partnerships, supply chain integration skills, and an understanding of the customers' MRO environments. The Company's efforts are guided by two major initiatives to drive growth and provide value: o Create focused businesses to serve customer needs and find new growth opportunities within existing businesses. o Develop and embrace new technologies that strengthen the Company's current capabilities and help drive the future of the MRO marketplace. The Company does not engage in basic or substantive product research and development activities. New items are added regularly to the Company's product lines on the basis of market information, recommendations of its employees, customers, and suppliers, and other factors. The Company's research and development, instead, are focused on new methods of serving customers. For a discussion of the Year 2000 issue, see "Item 7: Management's Discussion and Analysis of Financial Condition and the Results of Operations" appearing later in this report. Branch-based Distribution Businesses The Company's Branch-based Distribution businesses provide customers with solutions to their immediate MRO needs throughout North America. Logistics networks are configured for rapid availability. A broad selection of MRO products is offered at local branches through user-friendly catalogs and via the Internet. The Branch-based Distribution businesses include Grainger Industrial Supply, Acklands-Grainger Inc., Grainger Parts, Grainger, S.A. de C.V., Puerto Rico, Grainger Export, and Grainger Global Sourcing. Grainger Industrial Supply - --------------------------- The focus of Grainger Industrial Supply is to provide a broad-line of MRO products quickly and easily to American businesses of all sizes. Its primary customers are small and medium-sized companies. It also addresses large-sized companies' immediate MRO needs. Grainger Industrial Supply operates 349 branches in all 50 states. These branches are located within 20 minutes of the majority of U.S. businesses and carry inventory to support their local market needs. Products are available for immediate pick-up, same-day shipment, or delivery. 3
An average branch has 15 employees and handles about 280 transactions per day. During 1998, an average of approximately 98,100 sales transactions were completed daily. Each branch tailors its inventory to local product demand. In 1998, Grainger Industrial Supply invested more than $8,900,000 in new branches, relocations, and additions to branches. Three new branches were opened, seven were relocated, and a number of remodeling projects were completed during the year. Grainger Industrial Supply has six Zone Distribution Centers (ZDCs) in operation. The ZDC logistics network provides a break-bulk function for faster branch stock replenishment. In addition, ZDCs handle shipped orders for all branches located in their zone. Large computer controlled stocks, which are maintained at two Regional Distribution Centers (RDCs), located in Greenville County, South Carolina, and Kansas City, Missouri, and a National Distribution Center (NDC) located in the Chicago area, provide the branches and customers with some protection against variable demand and delayed factory deliveries. The NDC is a centralized storage and shipping facility servicing the entire network with slower moving inventory items. During 1998, Grainger Industrial Supply began its conversion from its legacy systems to a new business enterprise system. This conversion will continue into 1999. Grainger Industrial Supply sells principally to contractors, service shops, industrial and commercial maintenance departments, manufacturers, hotels, government, and health care and educational facilities. Sales transactions during 1998 were made to more than 1,300,000 customers. Grainger Industrial Supply estimates that approximately 24% of 1998 sales consisted of items bearing the Company's registered trademarks, including DAYTON(R) (principally electric motors, heating and ventilation equipment), TEEL(R) (liquid pumps), SPEEDAIRE(R) (air compressors), AirHandler(R) (air filtration equipment), DEM-KOTE(R) (spray paints), WESTWARD(R) (hand and power tools), and LUMAPRO(TM) (task and outdoor lighting), as well as other trademarks. The Company 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 other well recognized brands. Grainger Industrial Supply's marketing programs had important changes in 1998. Now, all marketing resources are integrated to achieve maximum results during each promotion. Sales calls, phone sales, branch merchandising, direct marketing, and advertising are all focused around the overall marketing program. The Grainger Industrial Supply Catalog offers more than 81,000 MRO products from more than 1,000 suppliers, most of whom are manufacturers. Approximately 2 million copies of the catalog are printed and distributed. The most current edition was issued in January 1999. The largest supplier in 1998, a diversified manufacturer through 20 of its divisions, accounted for 10.8% of purchases. No significant difficulty has been encountered with respect to sources of supply. The Grainger Industrial Supply Electronic Catalog brings, directly to the customer's place of business, a fast, easy way to select products. Through the Electronic Catalog, the customer can use a variety of ways to describe a needed product, and then review Grainger Industrial Supply's offerings, complete with specifications, prices, and pictures. Another Electronic Catalog feature includes a cross-reference function that allows customers to retrieve product information using their own stock numbers. More than 350,000 copies of the current version of the Electronic Catalog have been distributed. The Electronic Catalog is also used at the branches as a training tool and a resource for identifying appropriate products for customers' applications. The Internet is an important growth initiative for Grainger Industrial Supply. Access to Grainger Industrial Supply 24 hours a day, 7 days a week, is a major convenience for many customers. Acklands-Grainger Inc. (AGI) - ---------------------------- AGI, acquired in December 1996, is the leading branch-based Canadian broad line MRO distributor. It serves customers through 180 branches and 6 distribution centers across Canada. AGI distributes tools, lighting, HVAC, safety supplies, pneumatics, instruments, welding equipment and supplies, motors, and shop equipment, as well as many other items. A comprehensive catalog is used to showcase the product line and to help customers select products. This catalog, with over 70,000 products listed, supports the efforts of 268 sales representatives throughout Canada. A French language catalog was introduced during 1998. During 1998, an average of 17,800 sales transactions were completed daily. 4
Grainger Parts - -------------- Grainger Parts provides access to over 250,000 parts and accessories through its centralized warehouse located in Northbrook, Illinois. Over 180,000 pages of parts diagrams are maintained on-line. Grainger Parts handled about 1,800,000 customer calls in 1998 through its call centers in Northbrook, Illinois and Waterloo, Iowa. Grainger Parts maintained its ISO 9002 certification in 1998. Grainger Parts' 100% compliance with ISO 9002 standards ranked them among the top 10% of all ISO-certified companies. Grainger, S.A. de C.V. - ---------------------- Grainger, S.A. de C.V. serves the traditional MRO product needs of customers in Mexico. The business employed 66 sales representatives at December 31, 1998. From its 80,000 square foot facility outside Monterrey, the business provides rapid delivery of over 60,000 products throughout Mexico. Grainger Global Sourcing - ------------------------ Grainger Global Sourcing procures competitively priced, high quality products sourced outside the United States. These items are sold primarily under private label by Grainger Industrial Supply and the Company's other businesses. Products obtained through Grainger Global Sourcing in 1998 include WESTWARD(R) tools and LUMAPRO(TM) lighting products. Other Business Units While some larger companies have immediate MRO needs that can be handled by the Company's Branch-based Distribution businesses, many also require integrated supply or commodity management services to handle their more complex purchasing and operating environments. In addition, as technology advances and the MRO marketplace evolves, some customers are choosing to buy products through less traditional channels such as the Internet and direct marketing. For these customers, the Company offers a number of solutions. These businesses include Grainger Custom Solutions, Grainger Integrated Supply, Grainger Consulting Services, Internet Commerce, and Lab Safety Supply, Inc. Grainger Custom Solutions - ------------------------- Grainger Custom Solutions was formed in 1998 and serves large customers that are looking to businesses to manage entire MRO product categories. Many companies are looking for some of the benefits of integrated supply, but are not ready for a total outsourcing solution or on-site management services. Grainger Custom Solutions offers customers management of six major product categories, along with access to the other broad product lines from Grainger Industrial Supply. Customers are guaranteed specific cost reductions, with incentives for both them and Grainger Custom Solutions if targets are exceeded. In 1998, the business began operating two call centers and four distribution centers. Grainger Custom Solution's customers' additional broad product needs are fulfilled through the Grainger Industrial Supply branch system. Grainger Integrated Supply - -------------------------- Grainger Integrated Supply is focused on customers who have chosen to outsource their entire indirect materials management process. By retaining Grainger Integrated Supply for this purpose, these organizations are better able to focus on their core business objectives and improve their global competitiveness. Grainger Integrated Supply offers a full complement of on-site outsourcing solutions, including business process reengineering, inventory management, supply chain management, tool crib management, and information management. Grainger Integrated Supply provides its clients with access to millions of products through its relationships with world class manufacturers, service providers, and distributors, including Grainger Industrial Supply. Products not covered through these partnerships are found through Grainger Integrated Supply's product sourcing process. Grainger Consulting Services - ---------------------------- Many customers realize that they are not effectively managing their MRO procurement process, but are not sure what approach to take to improve the process. Grainger Consulting Services is a leading professional services firm specializing in MRO materials management consulting. Grainger Consulting Services provides the expertise and professional resources that help clients address indirect materials management issues and improve operating efficiencies, productivity, and asset utilization. The business offers consulting services which include process reengineering, inventory database development, and "turn-key" stockroom set up. 5
Internet Commerce - ----------------- The Company's product information content, relationships with leading manufacturers and distributors, and access to over two million business customers position the Company uniquely to benefit from Internet commerce. The Grainger.com site was one of the first MRO Web sites. In 1998, Internet Commerce continued to invest to increase its Internet presence. New functionality for Grainger.com included the introduction of CasterMatch(SM), another in the Company's MatchMaker(SM) series and a new, more powerful search capability was added. Grainger.com also began accepting credit card purchases in 1998. The Company was pleased to have Grainger.com once again be named among the top ten business-to-business Internet sites in the world by Advertising Age's Business Marketing Magazine. In February 1999, the Company announced OrderZone.com by Grainger, an Internet marketplace where customers can buy products from a number of different suppliers using a single site. The Company has brought six industry leaders together to create a one-stop, on-line, business-to-business service for the procurement of a wide variety of products and services. OrderZone.com is a powerful, easy, and convenient solution for businesses looking to streamline their procurement process. Internet Commerce applied its expertise to create this Internet-based multi-distributor site. Customers can search across products from a number of leading complementary distributors. A single order can be placed across multiple distributors, and customers will receive a single invoice. Currently in test market, OrderZone.com is expected to open for business later in 1999. Lab Safety Supply, Inc. - ----------------------- Lab Safety Supply is a leading direct marketer of safety products and other industrial supplies to U.S. businesses. Located in Janesville, Wisconsin, Lab Safety Supply reaches its customers through its General Catalog, targeted catalogs, and other marketing materials which are distributed throughout the year. Customers select Lab Safety Supply for its extensive product depth (over 50,000 products in the 1999 General Catalog), its superior technical knowledge, and its excellent service. It is a primary safety supplier for many small and medium-sized companies and a critical safety back-up supplier for many larger companies. Industry Segments The Company has concluded that it has one reportable industry segment: Branch-based Distribution. For segment information and the Company's consolidated revenue and operating earnings see "Item 7: Management's Discussion and Analysis of Financial Condition and the Results of Operations," and "Item 8: Financial Statements and Supplementary Data." The total assets of the Company for the last five years were: 1998, $2,103,902,000; 1997, $1,997,821,000; 1996, $2,119,021,000; 1995, $1,669,243,000; and 1994, $1,534,751,000. Competition The Company faces competition in all the markets it serves, from manufacturers (including some of the Company's own suppliers) that sell directly to certain segments of the market, from wholesale distributors, catalog houses, and certain retail enterprises. The principal means by which the Company competes with manufacturers and other distributors is by providing local stocks, efficient service, account managers, competitive prices, its several catalogs, which include product descriptions and in certain cases, extensive technical and application data, procurement process consulting services, utilizing electronic and Internet commerce technology, and other efforts to assist customers in lowering their total MRO costs. The Company believes that it can effectively compete on a price basis with its manufacturing competitors on small orders, but that such manufacturers may enjoy a cost advantage in filling large orders. The Company serves a number of diverse markets, and is able in some markets to reasonably estimate the Company's competitive position within that market. However, taken as a whole, the Company is unable to determine its market shares relative to others engaged in whole or in part in similar activities. Employees As of December 31, 1998, the Company had 15,270 employees, of whom 12,967 were full-time and 2,303 were part-time or temporary. The Company has never had a major work stoppage and considers its employee relations generally to be good. Item 2: Properties As of December 31, 1998, the Company's facilities totaled 16,799,000 square feet, an increase of 2.1% over 1997. The Company's Grainger Industrial Supply and Acklands-Grainger Inc. (AGI) businesses account for the majority of the Company's total square footage. Grainger Industrial Supply facilities are located throughout the United States. AGI facilities are located throughout Canada. 6
The Company's Grainger Industrial Supply branches range in size from 2,000 to 109,000 square feet and average 22,000 square feet. Most are located in or near major metropolitan areas, many in industrial parks. A typical owned branch is on one floor, is of masonry construction, consists primarily of warehouse space, contains an air-conditioned office and sales area, and has off-the-street parking for customers and employees. The Company considers that its properties are generally in good condition and well maintained, and are suitable and adequate to carry on the Company's business. The significant facilities of the Company are briefly described below: <TABLE> <CAPTION> Size in Location Facility and Use Square Feet - ---------------------------- ---------------------------------------------- ------------ <S> <C> Chicago Area (1) General Offices & National Distribution Center 1,517,000 Kansas City, MO (1) Regional Distribution Center 1,435,000 Greenville County, SC (1) Regional Distribution Center 1,090,000 United States (1) 6 Zone Distribution Centers 1,345,000 United States (2) 349 Grainger Industrial Supply branch locations 7,581,000 United States and Mexico (3) All other facilities 1,573,000 Canada (4) 181 AGI facilities 2,258,000 ---------- Total square feet 16,799,000 ========== <FN> The Company is constructing an office facility to house a large portion of the Chicago-area office workforce on owned property. Construction of this Lake Forest, Illinois facility is scheduled to be completed during 1999. Certain Chicago-area owned and leased office facilities will be vacated when this new facility becomes operational. - ------------------------------------------------------------------------------- (1) These facilities are either owned or leased with leases expiring between 1999 and 2003. The owned facilities are not subject to any mortgages. (2) Grainger Industrial Supply branches consist of 278 owned and 71 leased properties. The owned facilities are not subject to any mortgages. (3) Other facilities represent owned and leased general branch offices, distribution centers, and branches. 2 branches are located in Puerto Rico, and 1 branch/distribution center is located in Monterrey, Mexico. The owned facilities are not subject to any mortgages. (4) The majority of these facilities were acquired through the acquisition of the industrial distribution business of Acklands Limited on December 2, 1996. The properties consist of general offices, distribution centers, and branches that are either owned or leased. The owned facilities are not subject to any mortgages. </FN> </TABLE> Item 3: Legal Proceedings There are pending various legal and administrative proceedings involving the Company that are incidental to the business. It is not expected that the outcome of any such proceeding will have a material adverse effect upon the Company's consolidated financial position or its results of operations. Item 4: Submission of Matters to a Vote of Security Holders No matters were submitted to a vote of security holders during the fourth quarter of 1998. Executive Officers of the Company Following is information about the Executive Officers of the Company as of March 1, 1999. Executive Officers of the Company generally serve until the next annual election of officers, or until earlier resignation or removal. Positions and Offices Held and Principal Name and Age Occupations and Employment During the Past Five Years - ------------------------- ----------------------------------------------------- James M. Baisley (66) Senior Vice President (a position assumed in 1995 after serving as Vice President), General Counsel, and Secretary. Donald E. Bielinski (49) Group President, a position assumed in 1997 after serving as Senior Vice President, Marketing and Sales. Prior to assuming the last-mentioned position in 1995, Mr. Bielinski served as Senior Vice President, Organization and Planning. He has also served as Vice President and Chief Financial Officer. Wesley M. Clark (46) Group President, a position assumed in 1997 after serving as Senior Vice President, Operations and Quality. Prior to assuming the last-mentioned position earlier in 1997, Mr. Clark served as Vice President, Field Operations and Quality. Previously, he served as President of the Sanitary Supply and Equipment businesses. (continued on next page) 7
Positions and Offices Held and Principal Name and Age Occupations and Employment During the Past Five Years - ------------------------- ----------------------------------------------------- Jere D. Fluno (57) Vice Chairman. Mr. Fluno is a member of the Office of the Chairman. Gary J. Goberville (52) Vice President, Human Resources. Before joining the Company in 1995, Mr. Goberville served as an executive with GenCorp, Inc. David W. Grainger (71) Senior Chairman of the Board, a position assumed in 1997 after serving as Chairman of the Board. He was the Company's Chief Executive Officer until 1995 and President from 1992 to 1994. Mr. Grainger is a member of the Office of the Chairman. Richard L. Keyser (56) Chairman of the Board, a position assumed in 1997, and Chief Executive Officer, a position assumed in 1995. Other positions in which he served during the past five years were President, Chief Operating Officer, Executive Vice President, and Grainger Division President. Mr. Keyser is a member of the Office of the Chairman. P. Ogden Loux (56) Senior Vice President, Finance and Chief Financial Officer, positions assumed in 1997 after serving as Vice President, Finance. Prior to assuming the last-mentioned position in 1994, Mr. Loux served the Grainger Division as Vice President, Business Support. Robert D. Pappano (56) Vice President, Financial Reporting and Investor Relations, a position assumed in 1995 after serving as Vice President and Treasurer. James T. Ryan (40) Vice President, Information Services, a position assumed in 1994 after serving as President, Parts Company of America. Prior to assuming the last-mentioned position in 1993, Mr. Ryan served as Director, Product Management of the Grainger Division. John A. Schweig (41) Senior Vice President (a position assumed in 1997 after serving as Vice President), Business Development and International. Prior to assuming these responsibilities in 1996, Mr. Schweig served as Vice President and General Manager, Direct Marketing. Previously, he served the Grainger Division as Vice President, Marketing. John W. Slayton, Jr. (53) Senior Vice President, Supply Chain Management, a position assumed in 1997 after serving as Senior Vice President, Product Management. Prior to assuming the last-mentioned position in 1995, Mr. Slayton served as Vice President, Product Management of the Grainger Division. PART II Item 5: Markets for Registrant's Common Equity and Related Shareholder Matters The Company'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 1998 and 1997, as adjusted to reflect the Company's 2-for-1 stock split effective May 11, 1998, are shown below. Prices ---------------------------- Quarters High Low Dividends - ---------------------------------------------------------------------------- 1998 First $51 13/16 $46 1/2 $0.135 Second 54 23/32 49 1/8 0.15 Third 51 13/16 39 3/16 0.15 Fourth 47 36 7/16 0.15 - ---------------------------------------------------------------------------- Year $54 23/32 $36 7/16 $0.585 - ---------------------------------------------------------------------------- 1997 First $41 1/4 $36 13/16 $0.125 Second 40 1/2 35 1/4 0.135 Third 49 7/8 39 0.135 Fourth 49 9/32 42 5/8 0.135 - ---------------------------------------------------------------------------- Year $49 7/8 $35 1/4 $0.53 - ---------------------------------------------------------------------------- The approximate number of shareholders of record of the Company's common stock as of March 1,1999 was 1,800. 8
Item 6: Selected Financial Data <TABLE> <CAPTION> Years Ended December 31, -------------------------------------------------------------------- (In thousands of dollars except for per share amounts) 1998 1997 1996 1995 1994 ---------- ---------- ---------- ---------- ---------- <S> <C> <C> <C> <C> <C> Net sales............................. $4,341,269 $4,136,560 $3,537,207 $3,276,910 $3,023,076 Net earnings.......................... 238,504 231,833 208,526 186,665 127,874 Net earnings per basic share.......... 2.48 2.30 2.04 1.84 1.26 Net earnings per diluted share........ 2.44 2.27 2.02 1.82 1.25 Total assets.......................... 2,103,902 1,997,821 2,119,021 1,669,243 1,534,751 Long-term debt........................ 122,883 131,201 6,152 8,713 1,023 Cash dividends paid per share......... $ 0.585 $ 0.53 $ 0.49 $ 0.445 $ 0.39 NOTE: 1994 net earnings include restructuring charges of $49,779. </TABLE> Item 7: Management's Discussion and Analysis of Financial Condition and the Results of Operations RESULTS OF OPERATIONS The Company has adopted Statement of Financial Accounting Standards (SFAS) No.131, "Disclosures About Segments of an Enterprise and Related Information." SFAS No. 131 requires disclosure of certain business segment information based on how management evaluates the business. In late 1997, the Company began an organizational restructuring with the formation of several business operations to meet the diverse needs of its customers. The Company has reported 1998 data reflecting this new organization. 1997 and 1996 segment data were not reported because it is impractical to restate these years to reflect the new organization. (See Note 15 to the Consolidated Financial Statements included in the Company's 1998 Form 10-K). All per share data have been adjusted to reflect the 2-for-1 stock split effective May 11, 1998. The following table, which is included as an aid to understanding changes in the Company's Consolidated Statements of Earnings, presents various items in the earnings statements expressed as a percent of net sales for the years ended December 31, 1998, 1997, and 1996, and the percent of increase (decrease) in such items in 1998 and 1997 from the prior year. <TABLE> <CAPTION> Years Ended December 31, --------------------------------------------------------------- Items in Consolidated Statements Percent of Increase of Earnings as a Percent of (Decrease) from Net Sales Prior Year --------------------------------- ---------------------- 1998 1997 1996 1998 1997 ----- ----- ----- ----- ----- <S> <C> <C> <C> <C> <C> Net sales............................................ 100.0% 100.0% 100.0% 4.9% 16.9% Cost of merchandise sold............................. 63.2 63.9 64.2 3.8 16.4 Operating expenses................................... 27.4 26.6 26.0 8.0 19.5 Other (income) deductions, net....................... 0.2 0.1 (0.1) 102.5 (204.9) Income taxes......................................... 3.7 3.8 4.0 2.9 12.4 Net earnings......................................... 5.5% 5.6% 5.9% 2.9% 11.2% </TABLE> As used in "Item 7: Management's Discussion and Analysis of Financial Condition and the Results of Operations," "Grainger branch-based business" reflects the operations of the Company excluding Acklands-Grainger Inc., Lab Safety Supply, Inc., and Grainger Parts. Net Sales The 1998 Company net sales increase of 4.9%, as compared with 1997, was principally volume related. This increase primarily represented the effects of the Company's market initiatives which included new product additions, and the National Accounts, Integrated Supply, and direct marketing programs. Partially offsetting the growth from these initiatives was a decline in sales at Acklands-Grainger Inc. (AGI), the Company's Canadian subsidiary. This decline resulted from an unfavorable change in the Canadian exchange rate. In Canadian dollars, AGI's sales rate was relatively flat when comparing 1998 with 1997. Weak demand in the mining, forestry, oil, exploration, and agriculture sectors was the primary cause for AGI's flat sales performance. The Company's sales growth rate was 6.1% after excluding AGI from both 1998 and 1997. 9
The Company's Grainger branch-based business experienced selling price increases of about 0.7% when comparing 1998 with 1997. Sales to National Account customers within the Grainger branch-based business increased to approximately $1,120,000,000. Sales to National Account customers increased about 8%, on a comparable basis, over 1997. The 1997 Company net sales increase of 16.9%, as compared with 1996, was principally volume related. This increase was affected by 1997 having one less sales day than 1996 (on a daily basis, net sales increased 17.4%). Excluding the incremental net sales of AGI, the Canadian industrial distribution business acquired on December 2, 1996, net sales increased 7.7% (8.1% on a daily basis). This increase primarily represented the effects of the Company's marketing initiatives which included new product additions, the expansion of branch facilities, and the National Accounts, Integrated Supply, and direct marketing programs. Partially offsetting the growth from these initiatives were two factors. Sales in the 1997 third quarter were negatively affected by the United Parcel Service's (UPS) work stoppage which began on August 4, 1997, and lasted more than two weeks. The Company estimates that 1997 sales were approximately $14,000,000 lower as a result of the UPS work stoppage. The second factor was that daily sales of seasonal products for the Company, excluding AGI, declined an estimated 4% in the year 1997, as compared with the same 1996 period. Many regions of the United States experienced milder weather during most of 1997 versus 1996. The Company's Grainger branch-based business experienced selling price increases of about 1.1% when comparing the year 1997 with 1996. The Grainger branch-based business National Accounts program showed strong growth for the year, with sales increasing to approximately $1,015,000,000. Daily sales to National Account customers increased approximately 17%, on a comparable basis, over 1996. Net Earnings Net earnings for 1998 increased 2.9% over 1997. The increase for 1998 was lower than the increase in net sales due to losses incurred in developing business ventures, operating expenses increasing at a rate faster than the growth rate in net sales, lower interest income, higher interest expense, and higher unclassified-net expenses, partially offset by higher gross profit margins. A number of factors contributed to 1998 net earnings increasing at a slower rate than 1998 net sales. 1. The Company continues to invest in developing its business operations. The following operations experienced pre-tax operating losses for the year 1998: Operating (Loss) Net Sales (pre-tax) --------- ---------- (In thousands of dollars) Grainger Integrated Supply....... $80,577 $(17,685) Mexico business.................. 49,325 (3,399) Grainger Integrated Supply's average daily sales grew about 56% for the year 1998 as compared with 1997. Grainger Integrated Supply serves customers through materials management services contracts. These contracts are characterized by a complete outsourcing of the indirect materials process. Customers not meeting the above definition were transferred to the Company's Grainger Custom Solutions and Grainger Industrial Supply businesses during 1998. Average daily sales in Mexico grew about 21% for the year 1998 as compared with 1997. Grainger Integrated Supply and the Mexico business continue to grow sales, improve processes, develop systems, and expand marketing programs. 2. The Company's business-to-business Web site, Grainger.com, allows customers to do business using the Internet. The Company developed an Internet marketplace where customers will be able to buy products from a number of different suppliers using a single site. This marketplace concept is currently being tested with customers. In developing these Internet initiatives, the Company incurred operating expenses of approximately $14,000,000 in 1998 and $6,000,000 in 1997. 3. Operating expenses related to data processing were higher by an estimated $15,000,000 as compared with 1997, as adjusted for 1998 volume increases. This was primarily due to incurring expenses related to Year 2000 compliance and the ongoing installation of the new business enterprise system. 4. Operating expenses were also higher in 1998 versus 1997 as a result of the following investments: a. Development of the Grainger Custom Solutions business; and b. Expanded marketing programs at Lab Safety Supply. 10
The decrease in interest income resulted from lower average daily invested balances and from lower average interest rates earned. The increase in interest expense resulted from higher average interest rates paid on all outstanding debt, partially offset by lower average borrowings and by higher capitalized interest. The higher unclassified-net expense primarily resulted from foreign currency translation losses relating to the Company's operations in Mexico and to a write-off of abandoned capital projects. The Company's gross profit margin increased by 0.67 percentage point when comparing the years 1998 and 1997. Of note are the following factors affecting the Company's gross profit margin: 1. Ongoing programs to reduce product costs improved the gross profit margin. 2. Selling price increases of 0.7% on Grainger Industrial Supply Catalog products improved the gross profit margin. 3. The change in product mix improved the gross profit margin. The sales of Lab Safety Supply (generally higher than average gross profit margins) increased as a percent of total sales. The sales of AGI (generally lower than average gross profit margins) decreased as a percent of total sales. Net earnings for 1997 increased 11.2% over 1996. This increase for 1997 was lower than the increase in net sales due to operating expenses increasing at a rate faster than the rate of growth in net sales, lower interest income, higher interest expense, and a higher effective income tax rate, partially offset by higher gross profit margins. Factors contributing to the increase in operating expenses were the following: 1. Payroll and other operating expenses were higher as a result of the following initiatives: a. Continued expansion of the Company's integrated supply business; b. Continued development of the Company's full service marketing capabilities on the Internet; c. Continued refocus and realignment of the Direct Sales force; d. Increased advertising expenses supporting the Company's marketing initiatives; and e. Expansion of the Company's telesales capability. 2. Payroll and other operating expenses were higher by an estimated $13,000,000 for Year 2000 compliance, of which approximately $10,000,000 related to outside services. 3. The operating expenses of AGI, which contributed to the increase, were included for the entire year of 1997 as compared with only the month of December in 1996. The decrease in interest income resulted from lower average daily invested balances. This decrease was partially offset by higher average interest rates earned. The increase in interest expense resulted from higher average borrowings, partially offset by lower average interest rates paid on all outstanding debt. The increase in interest expense was primarily related to debt added to finance the AGI acquisition and to the short-term debt added to partially fund the repurchase of shares of the Company's common stock. The Company's effective income tax rate was 40.5% for the year 1997 versus 40.2% for the year 1996. The increase in the effective income tax rate is attributable to proportionately higher income generated in Canada (AGI), which is taxed at a higher rate than domestic income. The Company's gross profit margin increased by 0.30 percentage point when comparing the years 1997 and 1996. Excluding AGI, the Company's gross profit margin increased 0.56 percentage point when comparing the years of 1997 and 1996. Of note were the following factors affecting the gross profit margin for the Company, excluding AGI: 1. The change in product mix was favorable as sales of seasonal products (generally lower than average gross profit margins) declined, and Lab Safety Supply sales (generally higher than average gross profit margins) increased as a percent of total sales. 2. Selling price increases exceeded the level of cost increases. Partially offsetting the above factors was an unfavorable change in selling price category mix, which primarily resulted from the growth in sales to the Company's larger volume customers. Net earnings were negatively affected by the UPS work stoppage which occurred in August 1997. The gross profit margin lost on the estimated $14,000,000 in lost sales, along with the incremental operating expenses incurred to serve customers during this period, resulted in an estimated negative effect on net earnings of about $0.03 per share. 11
Year 2000 The Company uses various software and technology that is affected by the Year 2000 issue. The Year 2000 issue is the result of computer programs being written using two digits rather than four to define the applicable year. Computer programs that have date-sensitive software may recognize a date using "00" as the year 1900 rather than the year 2000. This could result in a system failure or in miscalculations causing disruptions to operations, including, among other things, a temporary inability to process transactions, to send invoices to customers, or to engage in similar normal business activities. The Year 2000 issue affects virtually all companies and organizations. The Company has put in place project teams dedicated to implementing a Year 2000 solution and to improving the Company's overall systems capabilities. The teams are actively working to achieve the objectives of Year 2000 compliance and improved internal systems. The work includes the modification of certain existing systems, a major new system initiative, replacing hardware and software for other systems, the creation of contingency plans, and surveying suppliers of goods and services with whom the Company does business. In addition to solving some Year 2000 issues, the major new system initiative reduces the complexity which has evolved over time from the development of in-house systems. This complexity, which makes it difficult to change and modify systems quickly, has resulted in a proliferation of programs and databases. These issues will be addressed by the installation of a new business enterprise system to replace a majority of the Company's primary operating systems. This major system initiative has been undertaken to improve the Company's ability to quickly respond to changing market conditions, to reduce the cost of maintaining and supporting existing systems, and to leverage the use of information. The Company is using a standard methodology with three phases for the Year 2000 compliance project. Phase I includes conducting a complete inventory of potentially affected areas of the business (including information technology and non-information technology), assessing and prioritizing the information collected during the inventory, and completing detailed project plans to address all key areas of the project. Phase II includes the remediation and testing of all mission critical areas of the project, surveying suppliers of goods and services with whom the Company does business, and the creation of contingency plans to address potential Year 2000 related problems. Phase III of the project includes the remediation and testing of non-mission critical areas of the project, and the implementation of contingency plans as may be necessary. The Company completed Phase I. Phase II and Phase III are in process. The Company is using both internal and external resources to reprogram, replace, and test the software and hardware for Year 2000 compliance. Year 2000 work for mission critical and most non-mission critical systems and testing of all system revisions is planned to be completed in the third quarter of 1999. The expenses associated with this project include both a reallocation of existing internal resources plus the use of outside services. Project expenses for 1998 and 1997 amounted to an estimated $39 million. The total remaining expenses associated with the Year 2000 project are estimated to be between $34 and $39 million. Due to the Year 2000 project and the major new system initiative, 1998 data processing expenses were approximately $15 million higher than 1997 expenses as adjusted for 1998 volume related charges. The data processing expenses for 1999 are estimated to be a net $10 to $12 million higher than the 1998 expenses as adjusted for 1999 volume related changes. It is expected that these projects will be funded through the Company's operating cash flows. In addition to addressing internal systems, the Company's Year 2000 project team has surveyed suppliers of goods and services with whom the Company does business. This is being done to determine the extent to which the Company is vulnerable to failures by third parties to remediate their own Year 2000 issues. However, there can be no guarantee that the systems of other companies, including those on which the Company's systems interact, will be timely converted. A failure to convert by another company on a timely basis or a conversion by another company that is incompatible with the Company's systems, may have a material adverse effect on the Company. As part of Phase II of the Year 2000 project, the Company is creating contingency plans to address potential Year 2000 related problems with key business processes. These plans, which are scheduled to be completed and tested in the second quarter of 1999, are expected to address risks to the Company's systems as well as risks from third party suppliers, customers, and others with whom the Company does business. It is recognized that while the Company cannot eliminate all potential risks, the effect of the risks on the business can be partially mitigated by creating and testing contingency plans where appropriate. 12
The estimated expenses for these projects and the dates by which the Company will complete the Year 2000 work are based on management's current assessment and were derived utilizing numerous assumptions of future events, including the continued availability of certain resources, third-party modification plans, and other factors. However, there can be no guarantee that these estimates will be achieved or that all components of Year 2000 compliance will be addressed as planned. Uncertainties include, but are not limited to, the availability and cost of personnel trained in this area, the ability to locate and correct all relevant computer codes, and the sources and timeliness of various systems replacements. Management believes that failure to address the Year 2000 issue on a timely basis could have a material adverse effect on the Company and continues to be committed to devoting the appropriate resources to address the Year 2000 issue. FINANCIAL CONDITION Working capital was $541,872,000 at December 31, 1998, compared with $649,107,000 at December 31, 1997, and $704,175,000 at December 31, 1996. The ratio of current assets to current liabilities was 1.8, 2.2, and 2.1 at such dates. Net cash flows from operations of $334,591,000 in 1998, $426,563,000 in 1997, and $272,410,000 in 1996, have continued to improve the Company's financial position and serve as the primary source of funding for capital requirements. For information as to the Company's cash flows, see "Item 8: Financial Statements and Supplementary Data." In each of the past three years, a portion of working capital has been used for additions to property, buildings, and equipment, and capitalized software as summarized in the following table. <TABLE> <CAPTION> 1998 1997 1996 -------- -------- ------- (In thousands of dollars) <S> <C> <C> <C> Land, buildings, structures, and improvements....... $85,016 $78,529 $31,881 Furniture, fixtures, machinery, and equipment....... 45,170 29,723 30,170 -------- -------- ------- 130,186 108,252 62,051 Capitalized software................................ 36,983 122 900 -------- -------- ------- Total............................................... $167,169 $108,374 $62,951 ======== ======== ======= </TABLE> On April 29, 1998, the Company's Board of Directors voted to restore an existing share repurchase authorization to its original level of 10,000,000 shares. The Company repurchased 4,483,100 shares of its common stock during 1998, 8,435,972 shares of its common stock during 1997, and 819,200 shares of its common stock during 1996. As of December 31, 1998, approximately 5,600,000 shares of common stock remain available under this repurchase authorization. Dividends paid to shareholders were $56,683,000 in 1998, $53,934,000 in 1997, and $50,035,000 in 1996. On December 2, 1996, the Company acquired AGI for approximately $289,334,000, including transaction expenses. The purchase consisted of cash payments and transaction expenses of $136,801,000 (funded principally by short-term debt of $132,874,000), and the issuance of 4,079,772 shares of W.W. Grainger, Inc. common stock valued at $152,533,000. The Company repurchased the 4,079,772 shares during 1997, which is included in the 8,435,972 shares repurchased during 1997. Internally generated funds have been the primary source of working capital and funds needed for expanding the business, supplemented by debt as circumstances dictated. In addition to continuing facilities optimization efforts, business development, and systems and other infrastructure enhancements, funds are being expended for the consolidation of Chicago-area offices into the Lake Forest, Illinois office facility currently being constructed. The Company continues to maintain a low debt ratio and strong liquidity position, which provides flexibility in funding working capital needs and long-term cash requirements. In addition to internally generated funds, the Company has various sources of financing available, including commercial paper sales and bank borrowings under lines of credit and otherwise. Total debt as a percent of shareholders' equity was 18%, 12%, and 11%, at December 31, 1998, 1997, and 1996, respectively. 13
INFLATION AND CHANGING PRICES Inflation during the last three years has not been a significant factor to operations. The predominant use of the last-in, first-out (LIFO) method of accounting for inventories and accelerated depreciation methods for financial reporting and income tax purposes result in a substantial recognition of the effects of inflation in the primary financial statements. The major impact of inflation is on buildings and improvements, where the gap between historic cost and replacement cost continues to be significant for these long lived assets. The related depreciation expense associated with these assets increases significantly when adjusting for the cumulative effect of inflation. The Company believes the most positive means to combat inflation and advance the interests of investors lies in continued application of basic business principles, which include improving productivity, increasing working capital turnover, and offering products and services which can command proper price levels in the marketplace. Item 8: Financial Statements and Supplementary Data The financial statements and supplementary data are included on pages 18 to 38. See the Index to Financial Statements and Supplementary Data on page 17. Item 9: Disagreements on Accounting and Financial Disclosure None. PART III Item 10: Directors and Executive Officers of the Registrant Information regarding directors of the Company will be set forth in the Company's proxy statement relating to the annual meeting of shareholders to be held April 28, 1999, and, to the extent required, is incorporated herein by reference. Information regarding executive officers of the Company is set forth under the caption "Executive Officers." Item 11: Executive Compensation Information regarding executive compensation will be set forth in the Company's proxy statement relating to the annual meeting of shareholders to be held April 28, 1999, and, to the extent required, is incorporated herein by reference. Item 12: Security Ownership of Certain Beneficial Owners and Management Information regarding security ownership of certain beneficial owners and management will be set forth in the Company's proxy statement relating to the annual meeting of shareholders to be held April 28, 1999, and, to the extent required, is incorporated herein by reference. Item 13: Certain Relationships and Related Transactions Information regarding certain relationships and related transactions will be set forth in the Company's proxy statement relating to the annual meeting of shareholders to be held April 28, 1999, and, to the extent required, is incorporated herein by reference. 14
<TABLE> <S> <C> PART IV Item 14: Exhibits, Financial Statement Schedule, and Reports on Form 8-K (a) 1. Financial Statements. See Index to Financial Statements and Supplementary Data. 2. Financial Statement Schedule. See Index to Financial Statements and Supplementary Data. 3. Exhibits: Exhibit Index ------------- (3) (a) Restated Articles of Incorporation dated April 27, 1994, incorporated by reference to Exhibit 3(i) to the Company's Quarterly Report on Form 10-Q for the quarter ended June 30, 1998. (b) By-laws, as amended, incorporated by reference to Exhibit 3(b) to the Company's Annual Report on Form 10-K for the year ended December 31, 1997. (10) Material Contracts: (a) No instruments which define the rights of holders of the Company's Industrial Development Revenue Bonds are filed herewith, pursuant to the exemption contained in Regulation S-K, Item 601(b)(4)(iii). The Company hereby agrees to furnish to the Securities and Exchange Commission, upon request, a copy of any such instrument. (b) Shareholders rights agreement dated April 26, 1989, incorporated by reference to Exhibit 10(m) to the Company's Annual Report on Form 10-K for the year ended December 31, 1989, and a related Certificate of Adjustment, incorporated by reference to Exhibit 4 to the Company's Quarterly Report on Form 10-Q for the quarter ended June 30, 1991. (c) Certificate of Adjustment pursuant to the Rights Agreement dated as of April 26, 1989, between the Company and The First National Bank of Boston, as Rights Agent, which Certificate relates to the two-for-one stock split of the Company effective at the close of business on May 11, 1998, incorporated by reference to Exhibit 10(a) to the Company's Quarterly Report on Form 10-Q for the quarter ended March 31, 1998. (d) Compensatory Plans or Arrangements (i) W.W. Grainger, Inc. Director Stock Plan, as amended. 39-52 (ii) W.W. Grainger, Inc. Office of the Chairman Incentive Plan, incorporated by reference to Appendix B of the Company's Proxy Statement dated March 26, 1997. (iii) W.W. Grainger, Inc. 1990 Long-Term Stock Incentive Plan, as amended. 53-66 (iv) W.W. Grainger, Inc. 1975 Non-Qualified Stock Option Plan as Amended and Restated, incorporated by reference to Exhibit 10(a) to the Company's Annual Report on Form 10-K for the year ended December 31, 1987. (v) Executive Death Benefit Plan, as amended. 67-75 (vi) Executive Deferred Compensation Plan, incorporated by reference to Exhibit 10(e) to the Company's Annual Report on Form 10-K for the year ended December 31, 1989. (vii) 1985 Executive Deferred Compensation Plan, as amended. 76-87 (viii) Summary Description of Management Incentive Program Based on Improved Economic Earnings. 88-93 (ix) Supplemental Profit Sharing Plan, as amended, incorporated by reference to Exhibit 10(c)(ii) to the Company's Quarterly Report on Form 10-Q for the quarter ended September 30, 1998. (x) Form of Change in Control Employment Agreement between the Company and certain of its executive officers. 94-115 (11) Computations of Earnings Per Share. See Index to Financial Statements and Supplementary Data. (21) Subsidiaries of the Company. 116 (23) Consent of Independent Certified Public Accountants. See Index to Financial Statements and Supplementary Data. (27) Financial Data Schedule. (b) Reports on Form 8-K. No reports on Form 8-K were filed during the last quarter of 1998. </TABLE> 15
SIGNATURES Pursuant to the requirements of Section 13 of the Securities Exchange Act of 1934, the Company has duly issued this report to be signed on its behalf by the undersigned, thereunto duly authorized. DATE: March 24, 1999 W.W. GRAINGER, INC. By: /s/ R. L. Keyser By: /s/ P. O. Loux --------------------------------- ----------------------- R. L. Keyser P.O. Loux Chairman of the Board Senior Vice President, Finance and Chief Executive Officer and Chief Financial Officer (a Principal Executive Officer and (Principal Financial Officer) a Director) By: /s/ J. D. Fluno By: /s/ R. D. Pappano --------------------------------- ----------------------- J. D. Fluno R. D. Pappano Vice Chairman Vice President, Financial Reporting (a Principal Executive Officer and and Investor Relations a Director) (Principal Accounting Officer) By: /s/ D. W. Grainger --------------------------------- D. W. Grainger Senior Chairman of the Board (a Principal Executive Officer and a Director) /s/ George R. Baker March 24, 1999 /s/ James D. Slavik March 24, 1999 - ---------------------- --------------- --------------------- --------------- George R. Baker James D. Slavik Director Director /s/ Robert E. Elberson March 24, 1999 /s/ Harold B. Smith March 24, 1999 - ---------------------- --------------- -------------------- --------------- Robert E. Elberson Harold B. Smith Director Director /s/ Wilbur H. Gantz March 24, 1999 /s/ Fred L. Turner March 24, 1999 - ---------------------- --------------- -------------------- --------------- Wilbur H. Gantz Fred L. Turner Director Director /s/ John W. McCarter, Jr. March 24, 1999 /s/ Janiece S. Webb March 24, 1999 - ------------------------- -------------- -------------------- --------------- John W. McCarter, Jr. Janiece S. Webb Director Director 16
INDEX TO FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA December 31, 1998, 1997, and 1996 Page REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS....................... 18 FINANCIAL STATEMENTS CONSOLIDATED STATEMENTS OF EARNINGS.............................. 19 CONSOLIDATED STATEMENTS OF COMPREHENSIVE EARNINGS................ 19 CONSOLIDATED BALANCE SHEETS ASSETS.................................................... 20 LIABILITIES AND SHAREHOLDERS' EQUITY...................... 21 CONSOLIDATED STATEMENTS OF CASH FLOWS............................ 22-23 CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY.................. 24 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS....................... 25-36 SCHEDULE II - ALLOWANCE FOR DOUBTFUL ACCOUNTS............................ 36 EXHIBIT 11 - COMPUTATIONS OF EARNINGS PER SHARE.......................... 37 EXHIBIT 23 - CONSENT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS......... 38 17
REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS To the Shareholders and Board of Directors of W.W. Grainger, Inc. We have audited the accompanying consolidated balance sheets of W.W. Grainger, Inc., and Subsidiaries as of December 31, 1998, 1997, and 1996, and the related consolidated statements of earnings, comprehensive earnings, shareholders' equity, and cash flows for the years then ended. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of W.W. Grainger, Inc., and Subsidiaries as of December 31, 1998, 1997, and 1996, and the consolidated results of their operations and their consolidated cash flows for the years then ended, in conformity with generally accepted accounting principles. We have also audited Schedule II of W.W. Grainger, Inc., and Subsidiaries for the years ended December 31, 1998, 1997, and 1996. In our opinion, this Schedule presents fairly, in all material respects, the information required to be set forth therein. GRANT THORNTON LLP Chicago, Illinois February 3, 1999 18
<TABLE> <CAPTION> W.W. Grainger, Inc., and Subsidiaries CONSOLIDATED STATEMENTS OF EARNINGS (In thousands of dollars except for per share amounts) Years Ended December 31, ----------------------------------------------- 1998 1997 1996 ------------- ------------ ------------- <S> <C> <C> <C> Net sales .............................. $ 4,341,269 $ 4,136,560 $ 3,537,207 Cost of merchandise sold ............... 2,743,598 2,642,208 2,269,993 ------------- ------------- ------------- Gross profit ................... 1,597,671 1,494,352 1,267,214 Warehousing, marketing, and administrative expenses .............. 1,189,689 1,101,193 921,685 ------------- ------------- ------------- Operating earnings ............. 407,982 393,159 345,529 Other income or (deductions) Interest income ...................... 1,560 2,896 4,554 Interest expense ..................... (6,652) (5,461) (1,228) Unclassified--net .................... (2,043) (958) 33 ------------- ------------- ------------- (7,135) (3,523) 3,359 ------------- ------------- ------------- Earnings before income taxes ... 400,847 389,636 348,888 Income taxes ........................... 162,343 157,803 140,362 ------------- ------------- ------------- Net earnings ................... $ 238,504 $ 231,833 $ 208,526 ============= ============= ============= Earnings per share: Basic ................................ $ 2.48 $ 2.30 $ 2.04 ============= ============= ============= Diluted .............................. $ 2.44 $ 2.27 $ 2.02 ============= ============= ============= Average number of shares outstanding: Basic ................................ 96,231,829 100,604,518 102,295,506 ============= ============= ============= Diluted .............................. 97,846,658 102,178,952 103,272,408 ============= ============= ============= <FN> The accompanying notes are an integral part of these financial statements. </FN> </TABLE> <TABLE> <CAPTION> W.W. Grainger, Inc., and Subsidiaries CONSOLIDATED STATEMENTS OF COMPREHENSIVE EARNINGS (In thousands of dollars) Years Ended December 31, ----------------------------------- 1998 1997 1996 --------- --------- --------- <S> <C> <C> <C> Net Earnings ................................ $ 238,504 $ 231,833 $ 208,526 Other comprehensive earnings: Foreign currency translation adjustments .. (10,354) (6,948) (2,262) --------- --------- --------- Comprehensive earnings ...................... $ 228,150 $ 224,885 $ 206,264 ========= ========= ========= <FN> The accompanying notes are an integral part of these financial statements. </FN> </TABLE> 19
<TABLE> <CAPTION> W.W. Grainger, Inc., and Subsidiaries CONSOLIDATED BALANCE SHEETS (In thousands of dollars) December 31, ------------------------------------ ASSETS 1998 1997 1996 ---------- ---------- ---------- <S> <C> <C> <C> CURRENT ASSETS Cash and cash equivalents .................................. $ 43,107 $ 46,929 $ 126,935 Accounts receivable, less allowances for doubtful accounts of $15,951 for 1998, $15,803 for 1997, and $15,302 for 1996 ..................................... 463,377 455,457 433,575 Inventories ................................................ 626,731 612,132 686,925 Prepaid expenses ........................................... 11,950 9,122 11,971 Deferred income tax benefits ............................... 61,200 59,348 60,837 ---------- ---------- ---------- Total current assets ................................... 1,206,365 1,182,988 1,320,243 PROPERTY, BUILDINGS, AND EQUIPMENT Land ....................................................... 135,636 133,213 132,095 Buildings, structures, and improvements .................... 662,236 583,823 510,386 Furniture, fixtures, machinery, and equipment .............. 411,295 370,122 343,231 ---------- ---------- ---------- 1,209,167 1,087,158 985,712 Less accumulated depreciation and amortization ......................................... 548,639 494,245 434,728 ---------- ---------- ---------- Property, buildings, and equipment--net ......................................... 660,528 592,913 550,984 DEFERRED INCOME TAXES ........................................ 3,187 -- -- other assets Goodwill ................................................... 177,355 187,963 192,555 Customer lists and other intangibles ....................... 89,573 89,699 91,882 ---------- ---------- ---------- 266,928 277,662 284,437 Less accumulated amortization .............................. 86,296 70,814 54,574 ---------- ---------- ---------- 180,632 206,848 229,863 Capitalized software--net .................................. 33,280 970 2,369 Sundry ..................................................... 19,910 14,102 15,562 ---------- ---------- ---------- Other assets--net ........................................ 233,822 221,920 247,794 ---------- ---------- ---------- TOTAL ASSETS ................................................. $2,103,902 $1,997,821 $2,119,021 ========== ========== ========== </TABLE> 20
<TABLE> <CAPTION> W.W. Grainger, Inc., and Subsidiaries CONSOLIDATED BALANCE SHEETS--CONTINUED (In thousands of dollars) December 31, ----------------------------------------- LIABILITIES AND SHAREHOLDERS' EQUITY 1998 1997 1996 ----------- ----------- ----------- <S> <C> <C> <C> CURRENT LIABILITIES Short-term debt ............................................. $ 88,060 $ 2,960 $ 135,275 Current maturities of long-term debt ........................ 22,831 23,834 24,753 Trade accounts payable ...................................... 287,055 261,802 240,779 Accrued contributions to employees' profit sharing plans ...................................... 75,113 62,234 56,258 Accrued expenses ............................................ 158,214 148,149 131,199 Income taxes ................................................ 33,220 34,902 27,804 ----------- ----------- ----------- Total current liabilities ............................... 664,493 533,881 616,068 LONG-TERM DEBT (less current maturities) ...................... 122,883 131,201 6,152 DEFERRED INCOME TAXES ......................................... -- 2,871 2,207 ACCRUED EMPLOYMENT RELATED BENEFITS COSTS ..................... 37,785 35,207 31,932 SHAREHOLDERS' EQUITY Cumulative Preferred Stock-- $5 par value--authorized, 12,000,000 shares, issued and outstanding, none .............................. -- -- -- Common Stock--$0.50 par value--authorized, 300,000,000 shares; issued, 107,233,771 shares, 1998, 106,971,524 shares, 1997, and 106,676,052 shares, 1996 .................................. 53,617 53,486 53,338 Additional contributed capital .............................. 249,482 242,289 235,649 Treasury stock, at cost--13,728,672 shares, 1998, 9,249,572 shares, 1997, and 819,200 shares, 1996 .................................. (572,900) (378,899) (32,090) Unearned restricted stock compensation ...................... (17,238) (16,528) (17,597) Cumulative translation adjustments .......................... (19,564) (9,210) (2,262) Retained earnings ........................................... 1,585,344 1,403,523 1,225,624 ----------- ----------- ----------- Total shareholders' equity .............................. 1,278,741 1,294,661 1,462,662 ----------- ----------- ----------- TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY ........................................ $ 2,103,902 $ 1,997,821 $ 2,119,021 =========== =========== =========== <FN> The accompanying notes are an integral part of these financial statements. </FN> </TABLE> 21
<TABLE> <CAPTION> W.W. Grainger, Inc., and Subsidiaries CONSOLIDATED STATEMENTS OF CASH FLOWS (In thousands of dollars) Years Ended December 31, ----------------------------------- 1998 1997 1996 --------- --------- --------- <S> <C> <C> <C> Cash flows from operating activities: Net earnings ................................................ $ 238,504 $ 231,833 $ 208,526 Provision for losses on accounts receivable ................. 10,310 9,984 9,131 Depreciation and amortization: Property, buildings, and equipment ........................ 58,256 63,257 61,585 Intangibles and goodwill .................................. 15,964 16,394 12,676 Capitalized software ...................................... 4,645 1,556 2,474 Change in operating assets and liabilities- net of the effects of the business acquisition: (Increase) in accounts receivable ......................... (18,230) (31,866) (28,871) (Increase) decrease in inventories ........................ (14,599) 74,793 (7,430) (Increase) decrease in prepaid expenses ................... (2,828) 2,849 255 (Increase) decrease in deferred income taxes .............. (7,910) 2,153 70 Increase in trade accounts payable ........................ 25,253 21,023 1,891 Increase in other current liabilities ..................... 22,944 22,926 3,724 (Decrease) increase in current income taxes payable ............................ (1,682) 7,098 4,339 Increase in accrued employment related benefits costs .................................. 2,578 3,275 3,186 Other--net .................................................. 1,386 1,288 854 --------- --------- --------- Net cash provided by operating activities ..................... 334,591 426,563 272,410 Cash flows from investing activities: Additions to property, buildings, and equipment ............. (130,186) (108,252) (62,051) Proceeds from sale of property, buildings, and equipment--net ........................................ 4,315 3,066 8,069 Expenditures for capitalized software ....................... (36,983) (122) (900) Net cash paid for business acquisition ...................... -- -- (136,144) Other--net .................................................. (13,488) 1,682 (1,032) --------- --------- --------- Net cash (used in) investing activities ....................... (176,342) (103,626) (192,058) </TABLE> 22
<TABLE> <CAPTION> W.W. Grainger, Inc., and Subsidiaries CONSOLIDATED STATEMENTS OF CASH FLOWS--CONTINUED (In thousands of dollars) Years Ended December 31, ----------------------------------- 1998 1997 1996 --------- --------- --------- <S> <C> <C> <C> Cash flows from financing activities: Net increase (decrease) in short-term debt .................. $ 85,100 $(132,315) $ 111,698 Proceeds from long-term debt ................................ -- 126,127 1,500 Long-term debt payments ..................................... (1,079) (1,997) (2,549) Stock options exercised ..................................... 443 2,239 2,890 Tax benefit of stock incentive plan ......................... 4,107 3,759 3,709 Purchase of treasury stock--net ............................. (193,959) (346,822) (32,090) Cash dividends paid ......................................... (56,683) (53,934) (50,035) --------- --------- --------- Net cash (used in) provided by financing activities ........... (162,071) (402,943) 35,123 --------- --------- --------- NET (DECREASE) INCREASE IN CASH AND CASH EQUIVALENTS ........................................ (3,822) (80,006) 115,475 Cash and cash equivalents at beginning of year ................ 46,929 126,935 11,460 --------- --------- --------- Cash and cash equivalents at end of year ...................... $ 43,107 $ 46,929 $ 126,935 ========= ========= ========= Non-cash investing and financing activities from acquisition of business: Fair value of assets acquired ............................. $ 338,101 Liabilities acquired ...................................... (49,424) Fair value of common stock issued ......................... (152,533) --------- Net cash paid for business acquisition ........................ $ 136,144 ========= <FN> The accompanying notes are an integral part of these financial statements. </FN> </TABLE> 23
<TABLE> <CAPTION> W.W. Grainger, Inc., and Subsidiaries CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY (In thousands of dollars except for per share amounts) Unearned Additional Restricted Cumulative Common Contributed Treasury Stock Translation Retained Stock Capital Stock Compensation Adjustments Earnings ----------- ----------- ----------- ------------ ----------- ----------- <S> <C> <C> <C> <C> <C> <C> Balance at January 1, 1996 ............. $ 50,894 $ 61,101 $ -- $ (19) $ -- $ 1,067,133 Exercise of stock options .............. 169 6,404 -- -- -- -- Issuance of 4,079,772 shares of common stock for business acquisition ............. 2,040 150,493 -- -- -- -- Issuance of 470,000 shares of restricted common stock ........... 235 17,625 -- (17,860) -- -- Amortization of unearned restricted stock compensation ........ -- 26 -- 282 -- -- Purchase of 819,200 shares of treasury stock ....................... -- -- (32,090) -- -- -- Cumulative translation adjustments .......................... -- -- -- -- (2,262) -- Net earnings ........................... -- -- -- -- -- 208,526 Cash dividends paid ($0.49 per share) .................... -- -- -- -- -- (50,035) ----------- ----------- ----------- ------------ ----------- ----------- Balance at December 31, 1996 ........... 53,338 235,649 (32,090) (17,597) (2,262) 1,225,624 Exercise of stock options .............. 138 5,753 -- -- -- -- Issuance of 20,000 shares of restricted common stock ........... 10 793 -- (803) -- -- Amortization of unearned restricted stock compensation ........ -- 107 -- 1,872 -- -- Purchase of 8,430,372 shares of treasury stock, net of 5,600 shares issued .................. -- (13) (346,809) -- -- -- Cumulative translation adjustments .......................... -- -- -- -- (6,948) -- Net earnings ........................... -- -- -- -- -- 231,833 Cash dividends paid ($0.53 per share) .................... -- -- -- -- -- (53,934) ----------- ----------- ----------- ------------ ----------- ----------- Balance at December 31, 1997 ........... 53,486 242,289 (378,899) (16,528) (9,210) 1,403,523 Exercise of stock options .............. 105 4,316 -- -- -- -- Issuance of 52,500 shares of restricted common stock ........... 26 2,706 -- (2,732) -- -- Amortization of unearned restricted stock compensation ........ -- 129 -- 2,022 -- -- Purchase of 4,479,100 shares of treasury stock, net of 4,000 shares issued .................. -- 42 (194,001) -- -- -- Cumulative translation adjustments .......................... -- -- -- -- (10,354) -- Net earnings ........................... -- -- -- -- -- 238,504 Cash dividends paid ($0.585 per share) ................... -- -- -- -- -- (56,683) ----------- ----------- ----------- ------------ ----------- ----------- Balance at December 31, 1998 ........... $ 53,617 $ 249,482 $ (572,900) $ (17,238) $ (19,564) $ 1,585,344 =========== =========== =========== ============ =========== =========== <FN> The accompanying notes are an integral part of these financial statements. </FN> </TABLE> 24
W.W. Grainger, Inc., and Subsidiaries NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 1998, 1997, and 1996 NOTE 1--SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES INDUSTRY INFORMATION The Company is engaged in the distribution of maintenance, repair, and operating (MRO) supplies, services, and related information to businesses and institutions in North America. Principles of Consolidation The consolidated financial statements include the accounts of the Company and its subsidiaries. All significant intercompany transactions are eliminated from the consolidated financial statements. STOCK SPLIT The consolidated financial statements have been retroactively restated to reflect the 2-for-1 stock split effective May 11, 1998. MANAGEMENT ESTIMATES In preparing financial statements in conformity with generally accepted accounting principles, management is required to make estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities, and the estimates of revenues and expenses. Actual results could differ from those estimates. REVENUE RECOGNITION The Company recognizes revenue at the date products are shipped or at the date services are completed. INVENTORIES Inventories are valued at the lower of cost or market. Cost is determined primarily by the last-in, first-out (LIFO) method. PROPERTY, BUILDINGS, AND EQUIPMENT Property, buildings, and equipment are valued at cost. For financial statement purposes, depreciation and amortization are provided in amounts sufficient to relate the cost of depreciable assets to operations over their estimated service lives, principally on the declining-balance and sum-of-the-years-digits methods. The principal estimated useful lives used in determining depreciation are as follows: Buildings, structures, and improvements.......... ... 10 to 45 years Furniture, fixtures, machinery, and equipment........ 3 to 10 years Improvements to leased property are amortized over the initial terms of the respective leases or the estimated service lives of the improvements, whichever is shorter. The Company capitalized interest costs of $2,323,000, $1,810,000, and $1,772,000, in 1998, 1997, and 1996, respectively. FOREIGN CURRENCY TRANSLATION The financial statements of the Company's foreign subsidiaries are generally measured using the local currency as the functional currency. Net exchange gains or losses resulting from the translation of financial statements of foreign operations, and related long-term debt, except for those from highly inflationary economies, are recorded as a separate component of shareholders' equity. PURCHASED TAX BENEFITS The Company purchased tax benefits through leases as provided by the Economic Recovery Tax Act of 1981. Realized tax benefits, net of repayments, are included in Deferred Income Taxes. INCOME TAXES Income taxes are recognized during the year in which transactions enter into the determination of financial statement income, with deferred taxes being provided for temporary differences between financial and tax reporting. COMPREHENSIVE INCOME Effective January 1, 1998, the Company adopted Statement of Financial Accounting Standards (SFAS) No. 130, "Reporting Comprehensive Income." 25
SFAS No. 130 requires disclosure of the components of and total comprehensive income in the period in which they are recognized in the financial statements. Comprehensive income is defined as the change in equity (net assets) of a business enterprise arising from transactions and other events and circumstances from non-owner sources. It includes all changes in shareholders' equity during the reporting period except those resulting from investments by owners and distributions to owners. The Company's comprehensive income includes foreign currency translation adjustments with no related income tax effects. The cumulative amount of other comprehensive income adjustments were ($19,564,000), ($9,210,000), and ($2,262,000) at December 31, 1998, 1997, and 1996, respectively. SEGMENT INFORMATION Effective December 31, 1998, the Company adopted Statement of Financial Accounting Standards (SFAS) No. 131, "Disclosures About Segments of an Enterprise and Related Information." SFAS No. 131 supersedes SFAS No. 14, "Financial Reporting for Segments of a Business Enterprise," replacing the "industry segment" approach with the "management" approach. The management approach designates the internal organization that is used by management for making operating decisions and assessing performance as the source of the Company's reportable segments. SFAS No. 131 also requires disclosures about products and services, geographic areas, and major customers. EMPLOYEE BENEFITS Effective January 1, 1998, the Company adopted Statement of Financial Accounting Standards (SFAS) No. 132, "Employers' Disclosures about Pensions and Other Postretirement Benefits." The provisions of SFAS No. 132 revise employers' disclosures about pension and other postretirement benefit plans. SFAS No. 132 does not change the measurement or expense recognition of these plans. CAPITALIZED SOFTWARE Statement of Position (SOP) 98-1, "Accounting for the Costs of Computer Software Developed or Obtained for Internal Use," is effective for fiscal years beginning after December 15, 1998. SOP 98-1 provides guidance on accounting for the costs of computer software developed or obtained for internal use. The Company plans to adopt SOP 98-1 beginning January 1,1999. NOTE 2--BUSINESS ACQUISITION Effective December 2, 1996, the Company purchased the stock of a subsidiary of Acklands Limited (a Canadian corporation). The business acquired is the largest nationwide distributor of broad line industrial supplies in Canada. The aggregate purchase price was approximately $289,334,000 including transaction expenses. The purchase consisted of cash payments and transaction expenses of $136,801,000 (funded principally by short-term debt of $132,874,000) and the issuance of 4,079,772 shares of W.W. Grainger, Inc. common stock valued at $152,533,000. The acquisition is being accounted for as a purchase, and accordingly, the financial statements include results of operations from the date of acquisition. The purchase included intangibles, including trademarks and goodwill, valued at $173,420,000 to be amortized over periods of five to forty years. The following unaudited pro forma summary presents the combined results of operations of the Company and the acquired business, as if the acquisition had occurred at the beginning of 1996. The pro forma amounts give effect to certain adjustments, including the amortization of intangibles, foreign currency translation, increased interest expense and income tax effects. This pro forma summary does not necessarily reflect the results of operations as they would have been if the businesses had constituted a single entity during this period and is not necessarily indicative of results which may be obtained in the future. Year Ended December 31, 1996 (Pro forma, in thousands of dollars except for per share amounts) Net sales................................. $3,847,665 Operating earnings........................ $ 368,203 Net earnings.............................. $ 216,680 Earnings per share: Basic................................... $ 2.04 Diluted................................. $ 2.02 26
NOTE 3--CASH FLOWS The Company considers investments in highly liquid debt instruments, purchased with an original maturity of ninety days or less, to be cash equivalents. For cash equivalents the carrying amount approximates fair value due to the short maturity of these instruments. Cash paid during the year for: 1998 1997 1996 -------- -------- -------- (In thousands of dollars) Interest (net of amounts capitalized).. $5,027 $5,773 $974 ======== ======== ======== Income taxes........................... $165,668 $143,471 $131,726 ======== ======== ======== NOTE 4--CASH Checks outstanding of $74,183,000, $54,218,000, and $35,366,000, are included in Trade accounts payable at December 31, 1998, 1997, and 1996, respectively. These amounts are immaterial to the consolidated financial statements. NOTE 5--CONCENTRATION OF CREDIT RISK The Company places temporary cash investments with institutions of high credit quality and, by policy, limits the amount of credit exposure to any one institution. The Company has a broad customer base representing many diverse industries doing business in all regions of the United States as well as other areas of North America. Consequently, in management's opinion, no significant concentration of credit risk exists for the Company. NOTE 6--INVENTORIES Inventories primarily consist of merchandise purchased for resale. Inventories would have been $217,455,000, $215,707,000, and $209,305,000 higher than reported at December 31, 1998, 1997, and 1996, respectively, if the first-in, first-out (FIFO) method of inventory accounting had been used for all Company inventories. Inventories under FIFO approximate replacement cost. NOTE 7--OTHER ASSETS Included in other assets are intangibles such as customer lists and goodwill. Customer lists are amortized on a straight-line basis over periods of five to sixteen years. Goodwill represents the cost in excess of net assets of acquired companies and is amortized on a straight-line basis over periods of five to forty years. The Company's goodwill is predominately denominated in Canadian dollars and accordingly, the changes in the asset balance are due to foreign exchange rate fluctuations. Other assets also includes net capitalized software used in the Company's business. During 1998, the Company acquired a new business enterprise software system. Amortization of capitalized software is predominately on a straight-line basis over five years. Amortization expense was $4,645,000, $1,556,000, and $2,474,000 for the years ended December 31, 1998, 1997, and 1996, respectively. 27
NOTE 8--SHORT-TERM DEBT The following summarizes information concerning short-term debt: <TABLE> <CAPTION> 1998 1997 1996 ---------- ---------- ---------- Bank Debt (In thousands of dollars) - --------------------------------------------------------------- <S> <C> <C> <C> Outstanding at December 31 .................................... $ 3,704 $ 2,960 $ 135,275 Maximum month-end balance during the year ..................... $ 3,704 $ 139,187 $ 135,275 Average amount outstanding during the year .................... $ 2,565 $ 119,962 $ 13,796 Weighted average interest rates during the year ............... 6.0% 3.5% 3.8% Weighted average interest rates at December 31 ................ 5.7% 6.2% 3.2% Commercial Paper - --------------------------------------------------------------- Outstanding at December 31 .................................... $ 84,356 -- -- Maximum month-end balance during the year ..................... $ 84,356 $ 81,355 -- Average amount outstanding during the year .................... $ 15,668 $ 15,429 $ 1,436 Weighted average interest rates during the year ............... 5.3% 5.7% 5.7% Weighted average interest rates at December 31 ................ 5.4% -- -- </TABLE> The Company and its subsidiaries had committed lines of credit totaling $318,069,000 and $168,983,000 at December 31, 1998 and 1997, respectively, including $13,069,000 and $13,983,000 denominated in Canadian dollars. A Company subsidiary also has a $32,673,000 and $34,958,000 uncommitted line of credit denominated in Canadian dollars as of December 31, 1998 and 1997, respectively. At December 31, 1998, borrowings under the subsidiaries' committed lines of credit were $3,704,000. The Company has guaranteed these borrowings. At December 31, 1996, available lines of credit were $186,483,000 including a $36,483,000 working capital line of credit denominated in Canadian dollars. At December 31, 1996, in connection with the business acquisition described in Note 2, a Company subsidiary had approximately $131,000,000 in outstanding banker's acceptances included in short-term debt. During 1997 this debt was refinanced as described in Note 10. NOTE 9--EMPLOYEE BENEFITS RETIREMENT PLANS. A majority of the Company's employees are covered by a noncontributory profit sharing plan. This plan provides for annual employer contributions based upon a formula primarily related to earnings before federal income taxes, limited to 15% of the total compensation paid to all eligible employees. The Company also sponsors additional profit sharing and defined benefit plans which cover most of the other employees. Provisions under all plans were $65,576,000, $55,052,000, and $49,450,000 for the years ended December 31, 1998, 1997, and 1996, respectively. POSTRETIREMENT BENEFITS. The Company has a health care benefits plan covering most of its retired employees and their dependents. A majority of the Company's employees become eligible for participation when they qualify for retirement while working for the Company. The amount charged to operating expense for postretirement health care benefits was $4,256,000, $3,653,000, and $3,578,000 for the years ended December 31, 1998, 1997, and 1996, respectively. Components of the expense were: <TABLE> <CAPTION> 1998 1997 1996 ------- ------- ------- (In thousands of dollars) <S> <C> <C> <C> Service cost ............................................... $ 3,076 $ 2,442 $ 2,309 Interest cost .............................................. 2,546 2,272 2,080 Expected return on assets .................................. (968) (738) (611) Amortization of transition asset (22 year amortization) .... (143) (143) (143) Amortization of unrecognized gain .......................... (180) (262) (139) Amortization of prior service cost ......................... (75) 82 82 ------- ------- ------- $ 4,256 $ 3,653 $ 3,578 ======= ======= ======= </TABLE> 28
Participation in the plan is voluntary at retirement and requires participants to make contributions, as determined by the Company, toward the cost of the plan. The accounting for the health care benefits plan anticipates future cost-sharing changes to retiree contributions that will maintain the current cost-sharing ratio between the Company and the retirees. Plan design and eligibility changes effective January 1, 1998, included modifications to eligibility requirements and the adjustment of benefit maximums. A Group Benefit Trust has been established as the vehicle to process benefit payments. The assets of the trust are invested in a Standard & Poor's 500 index fund. The assumed weighted average long-term rate of return is 7.4%, which is net of a 32.4% tax rate. 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, as amended, and was $2,444,000, $859,000, and $379,000 for the years ended December 31, 1998, 1997, and 1996, respectively. A reconciliation of the beginning and ending balances of the accumulated postretirement benefit obligation (APBO), the fair value of assets, and the funded status of the benefit obligation as of December 31, 1998, 1997, and 1996, is as follows: <TABLE> <CAPTION> 1998 1997 1996 -------- -------- -------- (In thousands of dollars) <S> <C> <C> <C> Benefit obligation at beginning of year .......... $ 35,866 $ 31,909 $ 33,482 Service cost ................................... 3,076 2,442 2,310 Interest cost .................................. 2,546 2,272 2,080 Plan participants' contributions ............... 366 376 293 Amendments ..................................... -- (2,516) -- Actuarial loss (gain) .......................... 3,503 2,544 (5,442) Benefits paid .................................. (1,682) (1,161) (814) -------- -------- -------- Benefit obligation at end of year ................ 43,675 35,866 31,909 -------- -------- -------- Fair value of plan assets at beginning of year ... 16,127 12,307 10,288 Actual return on plan assets ................... 4,444 3,745 2,161 Employer contribution .......................... 2,444 859 379 Plan participants' contributions ............... 366 377 293 Benefits paid .................................. (1,682) (1,161) (814) -------- -------- -------- Fair value of plan assets at end of year ......... 21,699 16,127 12,307 -------- -------- -------- Funded status .................................... (21,976) (19,739) (19,602) Unrecognized transition asset .................... (2,285) (2,428) (2,570) Unrecognized net actuarial gain .................. (4,359) (4,589) (4,388) Unrecognized prior (benefits) service cost ....... (927) (1,003) 1,595 -------- -------- -------- Accrued postretirement benefits costs ............ $(29,547) $(27,759) $(24,965) ======== ======== ======== </TABLE> To determine the APBO as of December 31, 1998, 1997, and 1996, the assumed weighted average discount rate used was 6.8%, 7.0%, and 7.5%, respectively. The assumed health care cost trend rate for 1999 is 8.0%. Beginning in 2000, the assumed health care cost trend rate declines on a straight-line basis until 2009, when the ultimate trend rate of 5.0% is achieved. If the assumed health care cost trend rate was increased by one percentage point for each year, the APBO as of December 31, 1998, would increase by $9,822,000. The aggregate of the service cost and interest cost components of the 1998 net periodic postretirement benefits expense would increase by $1,453,000. If the assumed health care cost trend rate was decreased by one percentage point for each year, the APBO as of December 31, 1998, would decrease by $7,637,000. The aggregate of the service cost and interest cost components of the 1998 net periodic postretirement benefits expense would decrease by $1,108,000. 29
NOTE 10--LONG-TERM DEBT Long-term debt consisted of the following at December 31: <TABLE> <CAPTION> 1998 1997 1996 -------- -------- ------- (In thousands of dollars) <S> <C> <C> <C> Uncommitted revolving credit facility...... $117,885 $126,127 $ -- Industrial development revenue bonds....... 27,650 27,650 27,650 Other...................................... 179 1,258 3,255 145,714 155,035 30,905 Less current maturities.................... 22,831 23,834 24,753 -------- -------- ------- $122,883 $131,201 $ 6,152 ======== ======== ======= </TABLE> As part of the permanent financing for a Canadian Subsidiary, the Company maintained a $130,693,000 uncommitted revolving credit facility, denominated in Canadian dollars. The Company has $117,885,000 outstanding at December 31, 1998 relating to this facility with a weighted average interest rate of 5.6%. The Company has the intent and the ability to refinance the obligation on a long-term basis through its credit lines and therefore it is included in long-term debt. The industrial development revenue bonds include various issues that bear interest at a variable rate up to 15%, or variable rates up to 78.2% of the prime rate, and come due in various amounts from 2001 through 2021. Interest rates on some of the issues are subject to change at certain dates in the future. The bondholders may require the Company to redeem certain bonds concurrent with a change in interest rates and certain other bonds annually. In addition, $13,545,000 of these bonds had an unsecured liquidity facility available at December 31, 1998, for which the Company compensated a bank through a commitment fee of 0.1%. There were no borrowings related to this facility at December 31, 1998. The Company classified $22,755,000 of bonds currently subject to redemption options in current maturities of long-term debt at December 31, 1998, 1997, and 1996. The aggregate amounts of long-term debt maturing in each of the five years subsequent to December 31, 1998, are as follows: Amounts Amounts Payable Under Subject to Terms of Redemption Agreements Options ------------- ----------- (In thousands of dollars) 1999.................................. $76 $22,755 2000.................................. 83 4,895 2001.................................. 20 -- 2002.................................. -- -- 2003.................................. 117,885 -- 30
NOTE 11--LEASES The Company leases various land, buildings, and equipment. The Company capitalizes all significant leases which qualify as capital leases. At December 31, 1998, the approximate future minimum aggregate payments for all leases were as follows: <TABLE> <CAPTION> Operating Leases ---------------------------------- Real Personal Capital Property Property Total Leases ---------- ---------- ---------- ------- (In thousands of dollars) <S> <C> <C> <C> <C> 1999 ................................................. $ 17,604 $ 798 $ 18,402 $ 75 2000 ................................................. 10,617 224 10,841 75 2001 ................................................. 7,503 -- 7,503 15 2002 ................................................. 6,349 -- 6,349 -- 2003 ................................................. 3,426 -- 3,426 -- Thereafter ........................................... 4,751 -- 4,751 -- ---------- ---------- ---------- ------- Total minimum payments required ...................... 50,250 1,022 51,272 165 Less amounts representing sublease income ............ 3,842 -- 3,842 ---------- ---------- ---------- $ 46,408 $ 1,022 $ 47,430 ========== ========== ========== Less imputed interest ................................ 14 ------- Present value of minimum lease payments (included in long-term debt) ....................... $ 151 ======= </TABLE> Total rent expense, including both items under lease and items rented on a month-to-month basis, was $16,336,000, $21,396,000, and $18,434,000 for 1998, 1997, and 1996, respectively. NOTE 12--STOCK INCENTIVE PLANs The Company's Long-Term Stock Incentive Plan ("The Plan") allows the Company to grant a variety of incentive awards to key employees of the Company. A maximum of 8,056,828 shares of common stock are authorized for issuance under the Plan, in connection with awards of non-qualified stock options, stock appreciation rights, restricted stock, phantom stock rights, and other stock-based awards. The Plan authorizes the granting of restricted stock which is held by the Company until certain terms and conditions as specified by the Company are satisfied. Except for the right of disposal, holders of restricted stock have full shareholders' rights during the period of restriction, including voting rights and the right to receive dividends. The Plan authorizes the granting of options to purchase shares at a price of not less than 100% of the closing market price on the last trading day preceding the date of grant. The options expire within ten years after the date of grant. Shares covered by terminated, surrendered or canceled options or stock appreciation rights that are unexercised, by forfeited restricted stock, or by the forfeiture of other awards that do not result in shares being issued, are again available for awards under the Plan. There were 52,500 shares of restricted stock issued in 1998 with a weighted average fair market value of $52.04 per share. There were 20,000 shares of restricted stock issued in 1997 with a fair market value of $40.125 per share. There were 470,000 shares of restricted stock issued in 1996 with a fair market value of $38 per share. The shares are scheduled to vest ten years from issuance, although accelerated vesting is provided in certain instances. Restricted stock released totaled 400, 1,000, and 2,000 shares in 1998, 1997, and 1996, respectively. Compensation expense related to restricted stock awards is based upon market price at date of grant and is charged to earnings on a straight-line basis over the period of restriction. Total compensation expense relating to restricted stock was $2,022,000, $1,872,000, and $282,000 in 1998, 1997, and 1996, respectively. 31
During 1997, the Company adopted a Director Stock Plan in which non-employee directors participate. A total of 500,000 shares of common stock were reserved for issuance in connection with awards of stock, stock units, stock options, restricted stock, and other stock-based awards under the new plan. The Company awarded Stock Units under the Director Stock Plan in connection with the termination of previous director compensation plans. A Stock Unit is essentially the economic equivalent of a share of Company stock. Additional deferred fees and dividends are converted to Stock Units based on the market value of the stock at the relevant time. Payment of the value of Stock Units generally will be made after the termination of service as a director. As of December 31, 1998 and 1997, eight directors held Stock Units, in connection with which the Company had recognized expense of $286,000 and $1,850,000, respectively. Transactions involving stock options are summarized as follows: <TABLE> <CAPTION> Weighted Average Price Per Option Shares Share Exercisable ------------ ---------- ----------- <S> <C> <C> <C> Outstanding at January 1, 1996........... 3,027,884 $23.18 1,833,524 ========== Granted................................ 577,460 $33.81 Exercised.............................. (482,362) $17.00 Canceled or expired.................... (59,860) $31.06 ---------- Outstanding at December 31, 1996......... 3,063,122 $26.01 1,710,182 ========== Granted................................ 694,660 $37.38 Exercised.............................. (412,702) $19.17 Canceled or expired.................... (51,720) $33.63 ---------- Outstanding at December 31, 1997......... 3,293,360 $29.14 1,679,900 ========== Granted................................ 884,620 $51.35 Exercised.............................. (335,900) $19.94 Canceled or expired.................... (51,640) $38.32 ---------- Outstanding at December 31, 1998......... 3,790,440 $35.01 1,732,300 ========== ========== </TABLE> All options were issued at market price on the date of grant. Options were issued with initial vesting periods ranging from one to five years. Information about stock options outstanding at December 31, 1998, is as follows: Options Outstanding - -------------------------------------------------------------------------------- Weighted Average ----------------------------------------- Range of Exercise Number Remaining Contractual Exercise Prices Outstanding Life (Years) Price - ----------------- ----------- --------------------- -------- $13.94-$29.44 1,074,840 2.9 $23.32 $33.75-$38.75 1,822,020 7.2 $33.99 $41.13-$52.88 893,580 9.3 $51.06 Options Exercisable - ------------------------------------------------------------ Range of Exercise Number Weighted Average Prices Exercisable Exercise Price - ----------------- ----------- --------------------- $13.94-$29.44 1,074,840 $23.32 $33.75-$41.13 657,460 $30.95 Shares available for future awards were 3,877,538, 4,767,018, and 4,943,438, at December 31, 1998, 1997, and 1996, respectively. 32
In accordance with Statement of Financial Accounting Standard (SFAS) No. 123, "Accounting for Stock-Based Compensation," the Company has elected to continue to account for stock compensation under Accounting Principles Board Opinion No. 25. Pro forma net earnings and earnings per share, as calculated under SFAS No. 123, are as follows: 1998 1997 1996 -------- -------- -------- (In thousands of dollars except for per share amounts) Net earnings.................. $234,257 $229,107 $206,696 Earnings per share: Basic....................... $ 2.43 $ 2.28 $ 2.02 Diluted..................... $ 2.39 $ 2.25 $ 2.00 The weighted average fair value of the stock options granted during 1998, 1997, and 1996 was $16.12, $12.95, and $10.88, respectively. The fair value of each option grant was estimated using the Black-Scholes option-pricing model based on the date of the grant and the following weighted average assumptions: 1998 1997 1996 -------- -------- -------- Risk-free interest rate....... 5.8% 6.7% 6.6% Expected life................. 7.0 years 7.0 years 6.5 years Expected volatility........... 20.1% 21.0% 21.8% Expected dividend yield....... 1.5% 1.5% 1.5% NOTE 13--ISSUANCE OF PREFERRED SHARE PURCHASE RIGHTS The Company adopted a Shareholder Rights Plan, under which there is outstanding one preferred share purchase right (Right) for each outstanding share of the Company's common stock. Each Right, under certain circumstances, may be exercised to purchase one four-hundredth of a share of Series A Junior Participating Preferred Stock (intended to be the economic equivalent of one share of the Company's common stock) at a price of $62.50, subject to adjustment. The Rights become exercisable only after a person or a group, other than a person or group exempt under the plan, acquires or announces a tender offer for 20% or more of the Company's common stock. If a person or group, other than a person or group exempt under the plan, acquires 20% or more of the Company's common stock or if the Company is acquired in a merger or other business combination transaction, each Right generally entitles the holder, other than such person or group, to purchase, at the then-current exercise price, stock and/or other securities or assets of the Company or the acquiring company having a market value of twice the exercise price. The Rights expire on May 15, 1999, unless earlier redeemed. They generally are redeemable at $.01 per Right until thirty days following announcement that a person or group, other than a person or group exempt under the plan, has acquired 20% or more of the Company's common stock. They are also automatically redeemable, at the redemption price, upon consummation of certain transactions approved by shareholders in accordance with procedures provided in the plan. The Rights do not have voting or dividend rights and, until they become exercisable, have no dilutive effect on the earnings of the Company. NOTE 14--INCOME TAXES Income tax expense consisted of the following: 1998 1997 1996 -------- --------- -------- (In thousands of dollars) Current provision: Federal (including foreign).......... $141,462 $128,470 $113,968 State................................ 28,791 27,180 26,324 -------- --------- -------- Total current...................... 170,253 155,650 140,292 Deferred tax (benefits) expense........ (7,910) 2,153 70 -------- --------- -------- Total provision........................ $162,343 $157,803 $140,362 ======== ========= ======== The deferred tax (benefits) expense represent the net effect of the changes in the amounts of temporary differences. 33
The income tax effects of temporary differences that gave rise to the net deferred tax asset as of December 31, 1998, 1997, and 1996 were: <TABLE> <CAPTION> 1998 1997 1996 -------- -------- -------- (In thousands of dollars) Current deferred tax assets (liabilities): <S> <C> <C> <C> Inventory valuations ..................................... $ 22,648 $ 23,761 $ 25,059 Administrative and general expenses deducted on a paid basis for tax purposes .............. 30,926 28,267 26,759 Employment related benefits expense ...................... 2,454 2,160 1,778 Restructuring costs ...................................... 5,214 5,432 7,428 Other .................................................... (42) (272) (187) -------- -------- -------- Total net current deferred tax asset ................... 61,200 59,348 60,837 -------- -------- -------- Noncurrent deferred tax assets (liabilities): Purchased tax benefits ................................... (22,185) (26,185) (29,693) Differences related to property, buildings, and equipment ............................... (388) (816) (400) Intangible amortization .................................. 9,135 9,116 14,681 Employment related benefits expense ...................... 15,038 14,012 12,709 Net operating loss carryforwards ......................... 4,372 1,785 -- Other .................................................... 1,587 1,002 496 -------- -------- -------- Total gross noncurrent deferred tax asset (liability) .... 7,559 (1,086) (2,207) Less valuation allowance ................................. (4,372) (1,785) -- -------- -------- -------- Total net noncurrent deferred tax asset (liability) .... 3,187 (2,871) (2,207) -------- -------- -------- Net deferred tax asset ..................................... $ 64,387 $ 56,477 $ 58,630 ======== ======== ======== </TABLE> The purchased tax benefits represent lease agreements acquired in prior years under the provisions of the Economic Recovery Act of 1981. Net Operating Loss carryforwards (NOLs) represent temporary differences that enter into the calculation of deferred tax balances. Since 1997, the Company has experienced NOLs for a foreign start-up operation. The full amount of the deferred tax asset is offset by a valuation allowance due to the uncertainty of utilizing these NOLs. A reconciliation of income tax expense with U.S. federal income taxes at the statutory rate follows: <TABLE> <CAPTION> 1998 1997 1996 -------- -------- -------- (In thousands of dollars) <S> <C> <C> <C> Federal income taxes at the statutory rate.................. $140,296 $136,373 $122,111 Foreign rate differences.................................... 1,703 2,034 (4) State income taxes, net of federal income tax benefits...... 17,637 17,954 17,010 Other--net.................................................. 2,707 1,442 1,245 -------- -------- -------- Income tax expense........................................ $162,343 $157,803 $140,362 Effective tax rate........................................ 40.5% 40.5% 40.2% </TABLE> 34
NOTE 15--SEGMENT INFORMATION The Company has one reportable segment: Branch-based Distribution. The Branch-based Distribution segment provides customers with solutions to their immediate MRO needs. Branch-based Distribution is an aggregation of the following business segments: Grainger Industrial Supply, Acklands-Grainger Inc., Grainger Parts, Grainger, S.A. de C.V., Puerto Rico, Grainger Export, and Grainger Global Sourcing. The Other column includes the Grainger Custom Solutions, Grainger Integrated Supply, Grainger Consulting Services, Internet Commerce, and Lab Safety Supply, Inc. segments. The Company's segments offer differing ranges of services and/or products and require different resources and marketing strategies. The segments were formed in late 1997 as the Company refocused its organization to meet the diverse needs of its customers. The restatement of comparable financial information for 1997 and 1996 is not practicable. The accounting policies of the segments are the same as those described in the summary of significant accounting policies. Intersegment transfer prices were established at external selling prices less costs not incurred due to the related party sale. 1998 --------------------------------------- (In thousands of dollars) Branch-based Distribution Other Totals ---------- ---------- ---------- Total net sales ...................... $3,881,237 $ 728,020 $4,609,257 Intersegment net sales ............... 260,230 7,758 267,988 Net sales from external customers .... 3,621,007 720,262 4,341,269 Segment operating earnings ........... 435,167 11,214 446,381 Segment assets ....................... $1,805,396 $ 189,298 $1,994,694 Depreciation and amortization ........ 54,500 19,638 74,138 Additions to long-lived assets ....... 115,905 21,954 137,859 Following are reconciliations of the segment information with the consolidated totals per the financial statements (in thousands of dollars). 1998 ------------ Operating earnings: Total operating earnings for reportable segments ............ $ 446,381 Unallocated expenses ........................................ (38,326) Elimination of intersegment profits ......................... (73) ------------ Total Consolidated operating earnings ..................... $ 407,982 ============ Assets: Total assets for reportable segments ........................ $ 1,994,694 Unallocated assets .......................................... 109,208 ------------ Total Consolidated assets ................................. $ 2,103,902 ============ 1998 -------------------------------------- Segment Consolidated Other Significant Items: Totals Adjustments Totals -------- ---------- ------------ Depreciation and amortization ........ $ 74,138 $ 4,727 $ 78,865 Additions to long-lived assets ....... 137,859 31,981 169,840 Long-lived Geographic Information: Revenues Assets ---------- ---------- United States ............................ $3,940,604 $ 692,747 Canada ................................... 329,565 180,613 Other foreign countries .................. 71,100 1,080 ---------- ---------- $4,341,269 $ 874,440 ========== ========== Long-lived assets consists of property, buildings, equipment, capitalized software, goodwill, and other intangibles. Revenues are attributed to countries based on location of customer. 35
NOTE 16--SELECTED QUARTERLY FINANCIAL DATA (Unaudited) A summary of selected quarterly information for 1998 and 1997 is as follows: <TABLE> <CAPTION> 1998 Quarter Ended ---------------------------------------------------------------------------- (In thousands of dollars except for per share amounts) March 31 June 30 September 30 December 31 Total ------------- ------------- ------------- ------------ ------------- <S> <C> <C> <C> <C> <C> Net sales ........................ $ 1,057,107 $ 1,118,970 $ 1,120,038 $ 1,045,154 $ 4,341,269 Gross profit ..................... $ 385,155 $ 401,959 $ 405,311 $ 405,246 $ 1,597,671 Net earnings ..................... $ 57,172 $ 59,250 $ 56,089 $ 65,993 $ 238,504 Earnings per share--basic ........ $ 0.59 $ 0.61 $ 0.58 $ 0.70 $ 2.48 Earnings per share--diluted ...... $ 0.58 $ 0.60 $ 0.57 $ 0.69 $ 2.44 </TABLE> <TABLE> <CAPTION> 1997 Quarter Ended ---------------------------------------------------------------------------- (In thousands of dollars except for per share amounts) March 31 June 30 September 30 December 31 Total ------------- ------------- ------------- ------------ ------------- <S> <C> <C> <C> <C> <C> Net sales ........................ $ 985,556 $ 1,051,206 $ 1,066,927 $ 1,032,871 $ 4,136,560 Gross profit ..................... $ 353,280 $ 371,029 $ 373,152 $ 396,891 $ 1,494,352 Net earnings ..................... $ 54,609 $ 57,559 $ 56,480 $ 63,185 $ 231,833 Earnings per share--basic ........ $ 0.52 $ 0.57 $ 0.57 $ 0.64 $ 2.30 Earnings per share--diluted ...... $ 0.52 $ 0.56 $ 0.56 $ 0.63 $ 2.27 </TABLE> <TABLE> <CAPTION> W.W. Grainger, Inc., and Subsidiaries SCHEDULE II--ALLOWANCE FOR DOUBTFUL ACCOUNTS FOR THE YEARS ENDED DECEMBER 31, 1998, 1997, AND 1996 Balance at Charged to Balance beginning costs and at end Description of period expenses Deductions (a) Other (b) of period - ---------------------------------- --------- ---------- -------------- --------- --------- (In thousands of dollars) <S> <C> <C> <C> <C> <C> Allowance for doubtful accounts 1998.............................. $15,803 $10,310 $10,162 $ -- $15,951 1997.............................. 15,302 9,984 9,483 -- 15,803 1996.............................. 14,229 9,131 8,824 766 15,302 (a) Accounts charged off as uncollectible, less recoveries. (b) Business acquired. </TABLE> 36
<TABLE> <CAPTION> W.W. Grainger, Inc., and Subsidiaries EXHIBIT 11 COMPUTATIONS OF EARNINGS PER SHARE 1998 1997 1996 ------------ ------------ ------------ Basic: <S> <C> <C> <C> Average number of shares outstanding during the year ................. 96,231,829 100,604,518 102,295,506 ============ ============ ============ Net earnings ......................................................... $238,504,000 $231,833,000 $208,526,000 ============ ============ ============ Earnings per share ................................................... $ 2.48 $ 2.30 $ 2.04 ============ ============ ============ Diluted: Average number of shares outstanding during the year (basic) ......... 96,231,829 100,604,518 102,295,506 Common equivalents Shares issuable under outstanding options ........................ 3,187,915 3,249,490 3,065,756 Shares which could have been purchased based on the average market value for the period ........................ 2,114,482 2,184,102 2,193,264 ------------ ------------ ------------ 1,073,433 1,065,388 872,492 Dilutive effect of exercised options prior to being exercised ........ 21,604 18,046 33,442 ------------ ------------ ------------ Shares for the portion of the period that the options were outstanding .................................. 1,095,037 1,083,434 905,934 Contingently issuable shares ......................................... 519,792 491,000 70,968 ------------ ------------ ------------ 1,614,829 1,574,434 976,902 ------------ ------------ ------------ Average number of shares outstanding during the year ................. 97,846,658 102,178,952 103,272,408 ============ ============ ============ Net earnings ......................................................... $238,504,000 $231,833,000 $208,526,000 ============ ============ ============ Earnings per share ................................................... $ 2.44 $ 2.27 $ 2.02 ============ ============ ============ </TABLE> 37
EXHIBIT 23 CONSENT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS We hereby consent to the incorporation of our report on page 18 of this Form 10-K by reference in the prospectuses constituting part of the Registration Statements on Form S-8 (Nos. 2-67983, 2-54995, 33-43902, and 333-24215) and on Form S-4 (No. 33-32091) of W.W. Grainger, Inc. GRANT THORNTON LLP Chicago, Illinois March 24, 1999 38