-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, DqdvVHqEATa9v2+SyO2Zbb3kwM01snu/5j3eaiSsHuWYlkdcOaJCGsX5vBrLdGb5 x6BujwMm45UQUtdPgC6V8A== 0000277135-98-000007.txt : 19980325 0000277135-98-000007.hdr.sgml : 19980325 ACCESSION NUMBER: 0000277135-98-000007 CONFORMED SUBMISSION TYPE: 10-K405 PUBLIC DOCUMENT COUNT: 8 CONFORMED PERIOD OF REPORT: 19971231 FILED AS OF DATE: 19980324 SROS: CSE SROS: NYSE FILER: COMPANY DATA: COMPANY CONFORMED NAME: GRAINGER W W INC CENTRAL INDEX KEY: 0000277135 STANDARD INDUSTRIAL CLASSIFICATION: WHOLESALE-DURABLE GOODS [5000] IRS NUMBER: 361150280 STATE OF INCORPORATION: IL FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-K405 SEC ACT: SEC FILE NUMBER: 001-05684 FILM NUMBER: 98571390 BUSINESS ADDRESS: STREET 1: 455 KNIGHTSBRIDGE PARKWAY CITY: LINCOLNSHIRE STATE: IL ZIP: 60069-3620 BUSINESS PHONE: 7089829000 10-K405 1 FORM 10-K W.W.GRAINGER, INC. 60 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, 1997 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, and New York Stock Exchange 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. ( X ) The aggregate market value of the voting stock held by non-affiliates of the registrant was $3,790,415,972 as of the close of trading reported on the Consolidated Transaction Reporting System on March 2, 1998. 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 48,834,587 shares outstanding as of March 2, 1998 DOCUMENTS INCORPORATED BY REFERENCE Portions of the proxy statement relating to the annual meeting of shareholders of the registrant to be held on April 29, 1998 are incorporated by reference into Part III hereof. The Exhibit Index appears on page 14 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 CONTENTS Page PART I Item 1: BUSINESS......................................................... 3-6 THE COMPANY.................................................... 3 GRAINGER BRANCH-BASED BUSINESS................................. 3-4 PARTS COMPANY OF AMERICA....................................... 4 ACKLANDS - GRAINGER INC........................................ 5 GRAINGER, S.A. de C.V.......................................... 5 GRAINGER INTEGRATED SUPPLY OPERATIONS.......................... 5 COMMODITY MANAGEMENT........................................... 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.................................. 9-13 RESULTS OF OPERATIONS.......................................... 9-11 YEAR 2000...................................................... 11-12 FINANCIAL CONDITION............................................ 12-13 INFLATION AND CHANGING PRICES.................................. 13 Item 8: FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA...................... 13 Item 9: DISAGREEMENTS ON ACCOUNTING AND FINANCIAL DISCLOSURE............. 13 PART III Item 10: DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT............... 13 Item 11: EXECUTIVE COMPENSATION........................................... 13 Item 12: SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT... 13 Item 13: CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS................... 13 PART IV Item 14: EXHIBITS, FINANCIAL STATEMENT SCHEDULE, AND REPORTS ON FORM 8-K.. 14 Signatures................................................................ 15 INDEX TO FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA...................... 16 FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA............................... 17-36 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 engaged in the distribution of maintenance, repair, and operating (MRO) supplies and related information to the commercial, industrial, contractor, and institutional markets in North America. 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 1997, the Company refocused its organization into three general groups: branch-based distribution - businesses serving traditional customers with immediate MRO needs; materials management services - businesses serving customers with more complex needs; and emerging channels - businesses serving customers who prefer to purchase through non-traditional channels, such as the Internet and direct marketing. The branch-based distribution businesses include the Grainger branch-based business, Grainger Global Sourcing, Parts Company of America, Acklands - Grainger Inc., and Grainger, S.A. de C.V. The materials management services businesses include Grainger Integrated Supply Operations (GISO), Commodity Management, and Grainger Consulting Services. The emerging market channels include Internet Commerce and Lab Safety Supply, Inc. The Company's business support functions provide 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, Insurance and Risk Management, Internal Audit, International, 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 operating units. A number of Company-wide strengths provide each business with a significant advantage in serving its market. These include technology and information management, powerful supplier partnerships, supply chain integration skills, and a keen understanding of the customers' MRO environments. The Company does not engage in basic or substantive product research and development activities. New items are added regularly to its product line on the basis of market information, recommendations of its employees, customers, and suppliers, and other factors. 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 The Company's branch-based businesses provide customers with solutions to their immediate MRO needs throughout North America. Branches are close by and the logistics networks are configured for rapid availability. A broad selection of MRO products is offered with user-friendly catalogs. Grainger Branch-Based Business - ------------------------------ The focus of the Grainger branch-based business (Grainger) 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, sometimes referred to as "direct marketing customers" based on how they are reached. It also addresses large-sized companies' immediate MRO needs. As used in this section, the data within the Grainger branch-based business reflects the operations of the Company excluding Acklands - Grainger Inc., Lab Safety Supply, Inc., and Parts Company of America. Grainger operates 350 branches in all 50 states, Puerto Rico, and Mexico. They are located within 20 minutes of the majority of U.S. businesses and carry inventory to support their local market. Products are available for immediate pick-up, same-day shipment, or delivery. An average branch has 16 employees and handles about 275 transactions per day. During 1997, an average of approximately 96,600 sales transactions were completed daily. Each branch tailors its inventory to local product demand. In 1997, Grainger invested more than $19,800,000 in the continuation of its facilities optimization program, which consisted of new branches, relocations, and additions to branches. Two new branches were opened in 1997, six were relocated and a number of remodeling projects were completed. A new operating process introduced at the New Jersey Zone Distribution Center (ZDC) allows ZDCs to increase the number of branches they can support. 3 To provide same day pick-up service to areas beyond the normal reach of a branch, Grainger opened its first "will-call center" in April. Located within Denver International Airport, this 1,000 square foot facility receives three daily deliveries from Denver's two branches and serves the MRO needs of area businesses. Grainger has six ZDCs in operation. The ZDC logistics network strategy provides a break-bulk function for faster branch stock replenishment. In addition, ZDCs handle shipped orders for 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) 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 shipment facility servicing the entire network with slower moving inventory items. During the year, Grainger shut down its satellite communications network in favor of a land-based frame relay communications network. Frame relay, which allows all branches to communicate with each other and with Chicago's central systems, is faster and more reliable than the network it replaced. In addition, intranet-based software was integrated with the branches' primary operating systems, adding functionality and increasing branch employee access to information sources. In late 1997, Grainger made an important change to its marketing and sales approach. Instead of distinct outside sales, telesales, and direct mail organizations with separate goals, Grainger has set goals geographically. It is up to local management to harness the combined power of these three tools to penetrate each market. Grainger employed 1,629 sales representatives at December 31, 1997, to serve customers throughout North America. Grainger sells principally to contractors, service shops, industrial and commercial maintenance departments, manufacturers, hotels, and health care and educational facilities. Sales transactions during 1997 averaged $142 and were made to more than 1,300,000 customers. Sales to the largest single customer were 1.1% of sales. Grainger estimates that approximately 25% of 1997 sales consisted of items bearing the Company's registered trademarks, including "DAYTON(R)" (principally electric motors and ventilation equipment), "DEMCO(R)" (power transmission belts), "DEM-KOTE(R)" (spray paints), "SPEEDAIRE(R)" (air compressors), and "TEEL(R)" (liquid pumps), 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. The Grainger Catalog offers more than 78,000 MRO products from more than 1,000 suppliers, most of whom are manufacturers. Approximately two million copies are printed and distributed. The most current edition was issued in January 1998. The largest supplier in 1997, a diversified manufacturer through 21 of its divisions, accounted for 10.6% of purchases. No significant difficulty has been encountered with respect to sources of supply. The Grainger 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's offerings, complete with specifications, prices, and pictures. Other Electronic Catalog features include a cross-reference function that allows customers to retrieve product information using their own stock numbers. More than 150,000 copies of the current version of the Electronic Catalog are in use. The Electronic Catalog is also used at the branches as a training tool and a resource for identifying appropriate products for customers' applications. Grainger is an important resource for both product and procurement process information. Grainger provides technical information on products as well as information on historic usage of products to customers. Grainger also provides feedback to suppliers concerning their products. Also in 1997, Grainger formed a global sourcing operation to procure high quality products from around the world. These items will be sold, primarily under private label, by Grainger and the Company's other businesses. Parts Company of America - ------------------------ Parts Company of America (PCA) provides access to over 230,000 parts and accessories to Grainger products through its centralized warehouse located in Northbrook, Illinois. Over 140,000 pages of parts diagrams are maintained on-line. PCA handled about 1,800,000 customer calls in 1997 in its call centers in Northbrook, Illinois and Waterloo, Iowa, resulting in over 600,000 orders. PCA maintained its ISO 9002 certification in 1997. PCA's 100% compliance with its standards ranked it among the top 10% of all ISO-certified companies. 4 Acklands - Grainger Inc. (AGI) - ------------------------------ AGI, acquired in December 1996, is the leading branch-based Canadian broad line MRO distributor. It serves customers through 172 branches and 5 distribution centers across Canada. AGI made a number of changes during 1997. A new 193,000 square foot office and distribution center in Edmonton, Alberta, allowed AGI to consolidate its separate Edmonton warehouses. This facility serves over 90 branches daily. AGI standardized its product offering across Canada and added several new lines of traditionally strong Grainger products. AGI distributes tools, lighting, HVAC, safety supplies, pneumatics, instruments, welding equipment and supplies, motors, shop equipment, as well as many other items. A comprehensive catalog was created to showcase the product line and to help customers select the product. This catalog, with over 260,000 products listed, supports the efforts of 250 sales representatives throughout Canada. This catalog will be sent to customers in the first quarter of 1998. During 1997, an average of 18,000 sales transactions were completed daily. Grainger, S.A. de C.V. - ---------------------- Grainger, S.A. de C.V. serves the traditional MRO product needs of Mexico's industrial interior. From its 40,000 square foot branch outside Monterrey, the business provides rapid delivery of over 39,000 products. Materials Management Services Since the formation of Grainger's National Accounts group, the Company's sales to larger businesses has grown dramatically. While some of these larger companies have immediate MRO needs that can be handled by the Company's branch-based businesses, many also require materials management services to handle their more complex purchasing and operating environments. For these customers, Materials Management Services offers a number of solutions. Grainger Integrated Supply Operations (GISO) - -------------------------------------------- GISO is focused on customers who have chosen to outsource their entire indirect materials management process. By hiring GISO to keep their operations running smoothly, these organizations are better able to focus on their core business objectives and improve their global competitiveness. GISO offers a full complement of on-site outsourcing solutions, including business process reengineering, inventory management, supply chain management, tool crib management, and information management. GISO provides its clients with access to millions of products through its relationships with world class manufacturers, service providers, and distributors, including Grainger's branch-based business. Products not covered through these partnerships are found through GISO's product sourcing process. Commodity Management - -------------------- In the fourth quarter of 1997, the Company made the decision to form an organization specifically targeting the needs of larger companies that require materials management services, but do not wish to outsource their procurement process. These customers typically select a primary distributor for each major commodity line. These businesses also tend to have custom handling, service, systems, and reporting requirements. Many items within each commodity line are purchased repetitively. Once fully operational, this new organization will provide a low-cost logistics solution for these repetitive purchases. Its access to the Grainger branch-based business for its customers' immediate product needs will give it an advantage over traditional commodity line distributors. Plans call for this unit to commence operations in the second half of 1998. Grainger Consulting Services - ---------------------------- Many customers realize that they are not effectively managing their MRO supplies, but are not sure what approach to take. Grainger Consulting Services is the leading professional services firm specializing in MRO materials management consulting. In 1997, Grainger Consulting Services added stockroom design and construction and product cross-referencing to its service offering. The practice offers consulting services which include process reengineering, inventory database development, and "turn-key" stockroom set up. It has generated the most comprehensive database of real-world MRO procurement statistics. Emerging Channels As technology advances and the MRO marketplace evolves, some customers are choosing to buy products through less traditional channels. The Company offers customers the option to purchase through the Internet, as well as through the high-growth business-to-business direct marketing channel. 5 Internet Commerce - ----------------- Since grainger.com was launched in 1995, the Company has been in the forefront of business-to-business Internet technology, and intends to lead the MRO industry in utilizing this technology for its customers' benefit. The grainger.com site was one of the first MRO Web sites. In 1996, a separate organization was formed to pursue electronic commerce opportunities. Now, as administrator of grainger.com, Grainger Internet Commerce currently provides customers with access to approximately 200,000 products and state-of-the-art systems for quick reference to detailed product information and on-line ordering of MRO supplies. Lab Safety Supply, Inc. - ----------------------- Lab Safety Supply is the leading direct marketer of safety products and other industrial supplies to American business. Located in Janesville, Wisconsin, Lab Safety Supply reaches its customers through its award-winning General Catalog, targeted catalogs, and other marketing materials throughout the year. Customers select Lab Safety Supply for its extensive product depth (over 40,000 products in the 1998 General Catalog), its superior technical knowledge, and its industry-leading service. It is a primary supplier for many small- and medium-sized companies and a critical back-up supplier for many larger companies. Fueled by the success of the Material Handling Direct(TM) catalog introduced in 1996, Lab Safety Supply launched several new initiatives in 1997. In June, Maintenance Direct(TM) was published, featuring 436 pages of facilities maintenance products. During 1997 Lab Safety Supply committed a portion of its resources to increasing its presence in the Canadian marketplace. It mailed various targeted catalogs to Canadian customers and prospects. Industry Segments The Company has concluded that its business is within a single industry segment. For information as to 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: 1997, $1,997,821,000; 1996, $2,119,021,000; 1995, $1,669,243,000; 1994, $1,534,751,000; and 1993, $1,376,664,000. 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, 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, 1997, the Company had 15,299 employees, of whom 12,603 were full-time and 2,696 were part-time or temporary. The Company has never had a major work stoppage and believes that its employee relations are good. Item 2: Properties As of December 31, 1997, the Company's facilities totaled 16,458,000 square feet, an increase of 0.6% over 1996. The Company's Grainger branch-based business and Acklands - Grainger Inc. (AGI) branches account for 8,980,000 square feet of the Company's total square footage. Grainger branches are located in the United States, Mexico, and Puerto Rico. AGI branches are located throughout Canada. 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 Company's Grainger 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. 6 The significant facilities of the Company are briefly described below: Size in Location Facility and Use Square Feet - ---------------------------- --------------------------------- ----------- Chicago Area (1) General Offices & National Distribution Center 1,463,000 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 and Mexico (2) 350 Grainger branch locations 7,703,000 United States (3) Lab Safety Supply, PCA, and other facilities 1,150,000 Canada (4) 171 AGI Facilities 2,272,000 ---------- Total square feet 16,458,000 ========== 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. It is expected that certain Chicago-area owned or leased office facilities will be vacated when this new facility becomes operational. - -------------------------------------------------------------------------------- (1) These facilities are either owned or leased with leases expiring between 1998 and 2000. The owned facilities are not subject to any mortgages. (2) Grainger branches consist of 271 owned and 79 leased properties. The owned facilities are not subject to any mortgages. 348 branches are located in the U.S., 1 branch is located in Puerto Rico, and 1 branch is located in Monterrey, Mexico. (3) Other facilities represent owned and leased general branch offices, distribution centers, and branches. 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. 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 1997. Executive Officers of the Company Following is information about the Executive Officers of the Company as of March 1, 1998. 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 (65) Senior Vice President (a position assumed in 1995 after serving as Vice President), General Counsel, and Secretary. Donald E. Bielinski (48) Group President, Emerging Businesses, 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 (45) Group President, Standard Solutions, 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 (56) Vice Chairman. Mr. Fluno is a member of the Office of the Chairman. Gary J. Goberville (51) Vice President, Human Resources. Before joining the Company in 1995, Mr. Goberville served as an executive with GenCorp, Inc. David W. Grainger (70) 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 (55) 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 (55) Senior Vice President, Finance and Chief Financial Officer, a position 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 (55) Vice President, Financial Reporting and Investor Relations, a position assumed in 1995 after serving as Vice President and Treasurer. James T. Ryan (39) 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 (40) 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. (52) 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 1997 and 1996, are shown below.
Prices ----------------------- Quarters High Low Dividends - -------------------------------------------------------------------------------- 1997 First $82 1/2 $73 5/8 $0.25 Second 81 70 1/2 0.27 Third 99 3/4 78 0.27 Fourth 98 9/16 85 1/4 0.27 - -------------------------------------------------------------------------------- Year $99 3/4 $70 1/2 $1.06 - -------------------------------------------------------------------------------- 1996 First $71 1/8 $62 5/8 $0.23 Second 78 5/8 64 0.25 Third 78 1/4 66 0.25 Fourth 81 1/2 68 3/4 0.25 - -------------------------------------------------------------------------------- Year $81 1/2 $62 5/8 $0.98 - --------------------------------------------------------------------------------
The approximate number of shareholders of record of the Company's common stock as of March 2, 1998 was 1,800. 8 Item 6: Selected Financial Data
Years Ended December 31, ---------------------------------------------------------------------- (In thousands of dollars except for per share amounts) 1997 1996 1995 1994 1993 ----------- ----------- ----------- ----------- ----------- Net sales ............................... $ 4,136,560 $ 3,537,207 $ 3,276,910 $ 3,023,076 $ 2,628,398 Net earnings before cumulative effect of accounting changes .......... 231,833 208,526 186,665 127,874 149,267 Cumulative effect of accounting changes . -- -- -- -- (820) Net earnings ............................ 231,833 208,526 186,665 127,874 148,447 Net earnings per basic share before cumulative effect of accounting changes 4.61 4.08 3.67 2.52 2.91 Cumulative effect of accounting changes . -- -- -- -- (0.02) Net earnings per basic share ............ 4.61 4.08 3.67 2.52 2.89 Net earnings per diluted share before cumulative effect of accounting changes 4.54 4.04 3.64 2.50 2.88 Cumulative effect of accounting changes . -- -- -- -- (0.02) Net earnings per diluted share .......... 4.54 4.04 3.64 2.50 2.86 Total assets ............................ 1,997,821 2,119,021 1,669,243 1,534,751 1,376,664 Long-term debt .......................... 131,201 6,152 8,713 1,023 6,214 Cash dividends paid per share ........... $ 1.06 $ 0.98 $ 0.89 $ 0.78 $ 0.705 NOTE: 1994 and 1993 net earnings include restructuring charges of $49,779 and $482, respectively.
Item 7: Management's Discussion and Analysis of Financial Condition and the Results of Operations RESULTS OF OPERATIONS 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, 1997, 1996, 1995, and 1994, and the percent of increase (decrease) in such items in 1997, 1996, and 1995 from the prior year.
Years Ended December 31, -------------------------------------------------------------- Items in Consolidated Statements Percent of Increase of Earnings as a Percent of (Decrease) from Net Sales Prior Year -------------------------------- ------------------------ 1997 1996 1995 1994 1997 1996 1995 ------ ------ ------ ------ ------ ------ ----- Net sales............................................ 100.0% 100.0% 100.0% 100.0% 16.9% 7.9% 8.4% Cost of merchandise sold............................. 63.9 64.2 63.9 64.5 16.4 8.3 7.4 Operating expenses................................... 26.6 26.0 26.5 27.9 19.5 6.5 3.0 Other (income) deductions, net....................... 0.1 (0.1) 0.1 0.1 (204.9) (181.1) 48.9 Income taxes......................................... 3.8 4.0 3.8 3.3 12.4 11.9 24.4 Net earnings......................................... 5.6% 5.9% 5.7% 4.2% 11.2% 11.7% 46.0% Note: The percent of increase from the prior year for net earnings, excluding restructuring charges, was 5.1% for 1995. Net earnings, excluding restructuring charges, as a percent of net sales was 5.9% for 1994.
9 Net Sales 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 Acklands - Grainger Inc. (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 years 1997 with 1996. The Grainger 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. All geographic areas for the Grainger branch-based business contributed to the sales growth, with the percent increases for regions west of the Mississippi River being slightly higher than for the regions east of the Mississippi River. The 1996 Company net sales increase of 7.9%, as compared with 1995, was principally volume related. This increase was affected by 1996 having two more sales days than 1995 (on a daily basis, net sales increased 7.1%). Excluding the incremental net sales of AGI, the Canadian industrial distribution business acquired on December 2, 1996, net sales increased 7.2% (6.4% on a daily basis). This increase primarily represented the effects of the Company's marketing initiatives which included new product additions, the continuing expansion of branch facilities, the addition of Zone Distribution Centers (ZDCs), and the National Accounts, Integrated Supply, and Direct Marketing programs. Partially offsetting the growth from these initiatives were two factors. First quarter 1996 net sales for the Company's Grainger branch-based business were negatively affected by the sluggish economy and adverse weather experienced by much of the East Coast during January. The second factor was that net sales of seasonal products within the Grainger branch-based business declined approximately 18% in the 1996 third quarter as compared with the same 1995 period. Many regions of the country experienced milder weather in July and August of 1996 as compared to the same periods in 1995. This contributed to a full year decline in seasonal product sales estimated at 1%. The Grainger branch-based business experienced selling price increases of about 1.9% when comparing 1996 with 1995. The Grainger National Accounts program showed strong growth for the year, with net sales increasing to approximately $849,000,000. Daily net sales to these National Account customers increased about 20%, on a comparable basis, over 1995. All geographic areas for the Grainger branch-based business contributed to the sales growth, with the percent increases for regions west of the Mississippi River being slightly higher than for the regions in the east of the Mississippi River. Net Earnings 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. During 1997, interest income was affected by the purchase of 4,217,986 shares of the Company's common stock versus 409,600 shares purchased in 1996. These incremental purchases contributed to lower average daily invested balances. The decrease in interest income 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 10 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 $0.06 per share. Net earnings for 1996 increased 11.7% over 1995. This increase for 1996 was higher than the net sales increase primarily due to operating expenses increasing at a slower rate than net sales, higher interest income, and lower interest expense, partially offset by lower gross profit margins. The rate of growth in operating expenses was lower than the net sales increase primarily due to the following factors: 1. Payroll and employee benefits expenses grew at a slower rate than net sales. 2. Freight-out expenses declined. Partially offsetting the above factors were the following: 1. Data processing expenses increased at a faster rate than net sales. 2. Advertising expenses increased at a faster rate than net sales. 3. Expenses related to marketing initiatives and business process improvement programs increased at a faster rate than net sales. 4. Incremental expenses related to the acquisition of AGI in December 1996. The increase in interest income resulted from higher average daily invested balances, partially offset by lower average interest rates earned. The decrease in interest expense resulted from lower average borrowings and lower interest rates paid on all outstanding debt, partially offset by lower capitalized interest. Partially offsetting these decreases in interest expense was incremental interest expense attributable to $132,874,000 in short-term debt added in December 1996 relating to the acquisition of AGI. The Company's gross profit margin decreased by 0.22 percentage point when comparing the full years of 1996 and 1995. This decrease was principally the result of an unfavorable change in selling price category mix, which primarily resulted from the growth in sales to Company's larger volume customers. The addition of AGI had a minor effect on this decrease. Partially offsetting the above factors were the following: 1. Selling price increases exceeded the level of cost increases. 2. The change in product mix was favorable as sales of seasonal products declined. Historically, the sales of seasonal products have lower than average gross profit margins. Year 2000 The Company uses various software and technology which 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, send invoices to customers, or to engage in similar normal business activities. The Year 2000 issue affects virtually all companies and organizations. 11 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, and replacing hardware and software for other systems. The major new system initiative, in addition to solving some Year 2000 issues, 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 planned installation of a new business enterprise system to replace a majority of the Company's primary operating systems. The major system initiative has been undertaken to improve the Company's ability to quickly respond to changing market conditions and reduce the cost of maintaining and supporting existing systems. The Company is using both internal and external resources to reprogram, replace, and test the software and hardware for Year 2000 compliance. The Company plans to have a Year 2000 solution for all mission critical systems by late 1998. Year 2000 work for non-critical systems and testing of all system revisions is planned to be completed by mid-1999. The expenses associated with this project include both a reallocation of existing internal resources plus the use of outside services. Project expenses for 1997 amounted to an estimated $13 million. The total remaining expenses associated with the Year 2000 project are estimated to be between $60 and $65 million. Due to the Year 2000 project and the major new system initiative, 1998 data processing expenses will be higher than 1997. The data processing expenses for 1998 are estimated to be a net $20 to $25 million higher than the 1997 expenses as adjusted for 1998 volume related changes. It is estimated that 1999 data processing expenses will approximate 1998 expenses, adjusted only for 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 initiated formal communications with suppliers, customers, and others with whom the Company does business. This is being done to determine the extent to which the Company is vulnerable to a third parties' failure to remediate their own Year 2000 issue. However, there can be no guarantee that the systems of other companies on which the Company's systems interact will be timely converted, that a failure to convert by another company, or a conversion that is incompatible with the Company's systems, would not have material adverse effect on the Company. The estimated expenses for these projects and the date on which the Company will complete the Year 2000 modifications 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 materially adverse effect on the Company and is committed to devoting the appropriate resources to ensure a Year 2000 solution. FINANCIAL CONDITION Working capital was $649,107,000 at December 31, 1997 compared with $704,175,000 at December 31, 1996 and $618,524,000 at December 31, 1995. The ratio of current assets to current liabilities was 2.2, 2.1, and 2.4 at such dates. Net cash flows from operations of $426,079,000 in 1997, $272,410,000 in 1996, and $126,237,000 in 1995, 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 as summarized in the following table.
1997 1996 1995 -------- ------- --------- (In thousands of dollars) Land, buildings, structures, and improvements.................. $ 78,529 $31,881 $ 55,280 Furniture, fixtures, and other equipment......................... 29,723 30,170 56,655 Total.............................. $108,252 $62,051 $111,935
On April 30, 1997, the Company's Board of Directors voted to restore an existing share repurchase authorization to its original level of 5,000,000 shares. The Company repurchased 4,217,986 shares of its common stock during 1997 and 409,600 shares of its common stock during 1996. The Company did not repurchase any shares of common stock 12 during 1995. As of December 31, 1997, approximately 2,000,000 shares of common stock remain available under this repurchase authorization. Dividends paid to shareholders were $53,934,000 in 1997, $50,035,000 in 1996, and $45,227,000 in 1995. 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 2,039,886 shares of W.W. Grainger, Inc. common stock valued at $152,533,000. The Company repurchased the 2,039,886 shares during 1997, which is included in the 4,217,986 shares repurchased during the year. Internally generated funds have been the primary source of working capital and funds needed for expanding the business (including capital expenditures relating to the facilities optimization program), supplemented by debt as circumstances dictated. In addition to continuing facilities optimization efforts and systems and other infrastructure developments, long-term cash requirements are anticipated 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 12%, 11%, and 5%, at December 31, 1997, 1996, and 1995, respectively. 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 17 to 36. See the Index to Financial Statements and Supplementary Data on page 16. 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 29, 1998, 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 29, 1998, 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 29, 1998, 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 29, 1998, and, to the extent required, is incorporated herein by reference. 13 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(a) to the Company's Annual Report on Form 10-K for the year ended December 31, 1994. (b) By-laws, as amended. 37-53 (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) Compensatory Plans or Arrangements (i) W.W. Grainger, Inc. Director Stock Plan, incorporated by reference to Appendix A of the Company's Proxy Statement dated March 26, 1997. (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, incorporated by reference to Appendix C of the Company's Proxy Statement dated March 26, 1997. (iv) W.W. Grainger, Inc. 1975 Non-Qualified Stock Option Plan as Amended and Restated March 3, 1988, 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, incorporated by reference to Exhibit 10(c)(iii) to the Company's Annual Report on Form 10-K for the year ended December 31, 1995. (vi) Executive Deferred Compensation Plan dated December 30, 1983, 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 dated December 31, 1984, incorporated by reference to Exhibit 10(f) to the Company's Annual Report on Form 10-K for the year ended December 31, 1990. (viii)Summary Description of Management Incentive Program Based on Improved Economic Earnings. 54-59 (ix) Supplemental Profit Sharing Plan, incorporated by reference to Exhibit 10(c)(viii) to the Company's Annual Report on Form 10-K for the year ended December 31, 1995. (11) Computations of Earnings Per Share. See Index to Financial Statements and Supplementary Data. (21) Subsidiaries of the Company. 60 (23) Consent of Independent Certified Public Accountants. See Index to Financial Statements and Supplementary Data. (27) Financial Data Schedules. (a) For the year ended December 31, 1997. (b) As restated, for 1997 interim periods. (c) As restated, for the year ended December 31, 1996 and 1996 interim periods. (d) As restated, for the year ended December 31, 1995. (b) Reports on Form 8-K. No reports on Form 8-K were filed during the last quarter of 1997.
14 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, 1998 W.W. GRAINGER, INC. By: /s/ D. W. Grainger By: /s/ P. O. Loux --------------------------------- ----------------------- D. W. Grainger P.O. Loux Senior Chairman of the Board Senior Vice President, Finance (a Principal Executive Officer and and Chief Financial Officer a Director) (Principal Financial Officer) By: /s/ R. L. Keyser By: /s/ R. D. Pappano --------------------------------- ----------------------- R. L. Keyser R. D. Pappano Chairman of the Board Vice President, Financial Reporting and Chief Executive Officer and Investor Relations (a Principal Executive Officer and (Principal Accounting Officer) a Director) By: /s/ J. D. Fluno --------------------------------- J. D. Fluno Vice Chairman (a Principal Executive Officer and a Director) /s/ George R. Baker March 24, 1998 /s/ James D. Slavik March 24, 1998 - ---------------------- --------------- --------------------- --------------- George R. Baker James D. Slavik Director Director /s/ Robert E. Elberson March 24, 1998 /s/ Harold B. Smith March 24, 1998 - ---------------------- --------------- -------------------- --------------- Robert E. Elberson Harold B. Smith Director Director /s/ Wilbur H. Gantz March 24, 1998 /s/ Fred L. Turner March 24, 1998 - ---------------------- --------------- -------------------- --------------- Wilbur H. Gantz Fred L. Turner Director Director /s/ John W. McCarter, Jr. March 24, 1998 /s/ Janiece S. Webb March 24, 1998 - ------------------------- -------------- -------------------- --------------- John W. McCarter, Jr. Janiece S. Webb Director Director 15 INDEX TO FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA December 31, 1997, 1996, and 1995 Page REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS...................... 17 FINANCIAL STATEMENTS CONSOLIDATED BALANCE SHEETS ASSETS................................................... 18 LIABILITIES AND SHAREHOLDERS' EQUITY..................... 19 CONSOLIDATED STATEMENTS OF EARNINGS............................. 20 CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY................. 21 CONSOLIDATED STATEMENTS OF CASH FLOWS........................... 22-23 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS...................... 24-33 SCHEDULE II - ALLOWANCE FOR DOUBTFUL ACCOUNTS........................... 34 EXHIBIT 11 - COMPUTATIONS OF EARNINGS PER SHARE......................... 35 EXHIBIT 23 - CONSENT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS........ 36 16 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, 1997, 1996, and 1995, and the related consolidated statements of 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, 1997, 1996, and 1995, 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, 1997, 1996, and 1995. 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, 1998 17 W.W. Grainger, Inc., and Subsidiaries CONSOLIDATED BALANCE SHEETS (In thousands of dollars)
December 31, ------------------------------------ ASSETS 1997 1996 1995 ---------- ---------- ---------- CURRENT ASSETS Cash and cash equivalents ................... $ 46,929 $ 126,935 $ 11,460 Accounts receivable, less allowances for doubtful accounts of $15,803 for 1997, $15,302 for 1996, and $14,229 for 1995 .... 455,457 433,575 369,576 Inventories ................................. 612,132 686,925 602,639 Prepaid expenses ............................ 9,122 11,971 11,746 Deferred income tax benefits ................ 59,348 60,837 67,239 ---------- ---------- ---------- Total current assets .................. 1,182,988 1,320,243 1,062,660 PROPERTY, BUILDINGS, AND EQUIPMENT Land ........................................ 133,213 132,095 123,431 Buildings, structures, and improvements ..... 583,823 510,386 472,154 Furniture, fixtures, machinery, and equipment 370,122 343,231 302,115 --------- ---------- ---------- 1,087,158 985,712 897,700 Less accumulated depreciation and amortization .......................... 494,245 434,728 379,349 --------- ---------- ---------- Property, buildings, and equipment--net .......................... 592,913 550,984 518,351 OTHER ASSETS Goodwill .................................... 187,963 192,555 25,635 Customer lists and other intangibles ........ 89,699 91,882 97,332 ---------- ---------- ---------- 277,662 284,437 122,967 Less accumulated amortization ............... 70,814 54,574 50,356 ---------- ---------- ---------- 206,848 229,863 72,611 Sundry ...................................... 15,072 17,931 15,621 ---------- ---------- ---------- Other assets--net ......................... 221,920 247,794 88,232 ---------- ---------- ---------- TOTAL ASSETS .................................. $1,997,821 $2,119,021 $1,669,243 ========== ========== ==========
18 W.W. Grainger, Inc., and Subsidiaries CONSOLIDATED BALANCE SHEETS--CONTINUED (In thousands of dollars)
December 31, ----------------------------------------- LIABILITIES AND SHAREHOLDERS' EQUITY 1997 1996 1995 ----------- ------------ ----------- CURRENT LIABILITIES Short-term debt ............................... $ 2,960 $ 135,275 $ 23,577 Current maturities of long-term debt .......... 23,834 24,753 23,241 Trade accounts payable ........................ 261,802 240,779 204,925 Accrued contributions to employees' profit sharing plans ........................ 62,234 56,258 53,618 Accrued expenses .............................. 148,149 131,199 115,310 Income taxes .................................. 34,902 27,804 23,465 ----------- ------------ ----------- Total current liabilities ............... 533,881 616,068 444,136 LONG-TERM DEBT (less current maturities) ........ 131,201 6,152 8,713 DEFERRED INCOME TAXES ........................... 2,871 2,207 8,539 ACCRUED EMPLOYMENT RELATED BENEFITS COSTS ....... 35,207 31,932 28,746 SHAREHOLDERS' EQUITY Cumulative Preferred Stock-- $5 par value--authorized, 6,000,000 shares, issued and outstanding, none ................ -- -- -- Common Stock--$0.50 par value--authorized, 150,000,000 shares; issued, 53,485,762 shares, 1997, 53,338,026 shares, 1996, and 50,894,629 shares, 1995 ..................... 26,743 26,669 25,447 Additional contributed capital ................ 269,032 262,318 86,548 Treasury stock, at cost--4,624,786 shares, 1997 and 409,600 shares, 1996 .................... (378,899) (32,090) -- Unearned restricted stock compensation ........ (16,528) (17,597) (19) Cumulative translation adjustments ............ (9,210) (2,262) -- Retained earnings ............................. 1,403,523 1,225,624 1,067,133 ----------- ------------ ----------- Total shareholders' equity .............. 1,294,661 1,462,662 1,179,109 ----------- ------------ ----------- TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY .......................... $ 1,997,821 $ 2,119,021 $ 1,669,243 =========== =========== =========== The accompanying notes are an integral part of these financial statements.
19 W.W. Grainger, Inc., and Subsidiaries CONSOLIDATED STATEMENTS OF EARNINGS (In thousands of dollars except for per share amounts)
Years Ended December 31, ------------------------------------------ 1997 1996 1995 ------------ ---------- ----------- Net sales........................................ $4,136,560 $3,537,207 $3,276,910 Cost of merchandise sold......................... 2,642,208 2,269,993 2,095,552 ------------ ---------- ----------- Gross profit.............................. 1,494,352 1,267,214 1,181,358 Warehousing, marketing, and administrative expenses........................ 1,101,193 921,685 865,067 ------------ ------------ ----------- Operating earnings........................ 393,159 345,529 316,291 Other income or (deductions) Interest income................................ 2,896 4,554 162 Interest expense............................... (5,461) (1,228) (4,260) Unclassified--net.............................. (958) 33 (44) ------------ ------------ ----------- (3,523) 3,359 (4,142) ------------ ---------- ----------- Earnings before income taxes.............. 389,636 348,888 312,149 Income taxes..................................... 157,803 140,362 125,484 ------------ ---------- ----------- Net earnings ............................. $231,833 $208,526 $186,665 ============ ========== =========== Earnings per share: Basic.......................................... $4.61 $4.08 $3.67 ============ ========== =========== Diluted........................................ $4.54 $4.04 $3.64 ============ ========== =========== Average number of shares outstanding: Basic.......................................... 50,302,259 51,147,753 50,815,081 ============ ========== =========== Diluted........................................ 51,089,476 51,636,204 51,241,217 ============ ========== =========== The accompanying notes are an integral part of these financial statements.
20 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 --------- ---------- --------- ------------- ------------- ---------- Balance at January 1, 1995............. $25,375 $81,796 $-- $(61) $-- $925,695 Exercise of stock options.............. 72 4,746 -- -- -- -- Amortization of unearned restricted stock compensation........ -- 6 -- 42 -- -- Net earnings........................... -- -- -- -- -- 186,665 Cash dividends paid ($0.89 per share).................... -- -- -- -- -- (45,227) Balance at December 31, 1995........... 25,447 86,548 -- (19) -- 1,067,133 --------- ---------- --------- ------------- ------------- ---------- Exercise of stock options.............. 84 6,489 -- -- -- -- Issuance of 2,039,886 shares of common stock for business acquisition............. 1,020 151,513 -- -- -- -- Issuance of 235,000 shares of restricted common stock........... 118 17,742 -- (17,860) -- -- Amortization of unearned restricted stock compensation........ -- 26 -- 282 -- -- Purchase of 409,600 shares of treasury stock....................... -- -- (32,090) -- -- -- Cumulative translation adjustments.......................... -- -- -- -- (2,262) -- Net earnings........................... -- -- -- -- -- 208,526 Cash dividends paid ($0.98 per share).................... -- -- -- -- -- (50,035) Balance at December 31, 1996........... 26,669 262,318 (32,090) (17,597) (2,262) 1,225,624 --------- ---------- --------- ------------- ------------- ---------- Exercise of stock options.............. 69 5,822 -- -- -- -- Issuance of 10,000 shares of restricted common stock........... 5 798 -- (803) -- -- Amortization of unearned restricted stock compensation........ -- 107 -- 1,872 -- -- Purchase of 4,215,186 shares of treasury stock, net of 2,800 shares issued.................. -- (13) (346,809) -- -- -- Cumulative translation adjustments.......................... -- -- -- -- (6,948) -- Net earnings........................... -- -- -- -- -- 231,833 Cash dividends paid ($1.06 per share).................... -- -- -- -- -- (53,934) --------- ---------- ---------- ------------- ------------- ----------- Balance at December 31, 1997........... $26,743 $269,032 $(378,899) $(16,528) $(9,210) $1,403,523 ========= ======== ========== ============= ============= =========== The accompanying notes are an integral part of these financial statements.
21 W.W. Grainger, Inc., and Subsidiaries CONSOLIDATED STATEMENTS OF CASH FLOWS (In thousands of dollars)
Years Ended December 31, ----------------------------------- 1997 1996 1995 --------- --------- --------- Cash flows from operating activities: Net earnings .......................................... $ 231,833 $ 208,526 $ 186,665 Provision for losses on accounts receivable ........... 9,984 9,131 7,780 Depreciation and amortization: Property, buildings, and equipment .................. 63,257 61,585 57,760 Intangibles and goodwill ............................ 16,394 12,676 13,090 Change in operating assets and liabilities-- net of the effects of the business acquisition: (Increase) in accounts receivable ................... (31,866) (28,871) (31,563) Decrease (increase) in inventories .................. 74,793 (7,430) (82,673) Decrease in prepaid expenses ........................ 2,849 255 2,487 Decrease (increase) in deferred income taxes ........ 2,153 70 (5,515) Increase (decrease) in trade accounts payable ....... 21,023 1,891 (21,534) Increase (decrease) in other current liabilities .... 22,926 3,724 (3,431) Increase in current income taxes payable ............ 7,098 4,339 815 Increase in accrued employment related benefits costs 3,275 3,186 2,051 Other--net ............................................ 2,360 3,328 305 --------- --------- --------- Net cash provided by operating activities ............... 426,079 272,410 126,237 Cash flows from investing activities: Additions to property, buildings, and equipment ....... (108,252) (62,051) (111,935) Proceeds from sale of property, buildings, and equipment--net .................................. 3,066 8,069 4,966 Net cash paid for business acquisition ................ -- (136,144) -- Other--net ............................................ 2,044 (1,932) 378 --------- --------- --------- Net cash (used in) investing activities ................. (103,142) (192,058) (106,591)
22 W.W. Grainger, Inc., and Subsidiaries CONSOLIDATED STATEMENTS OF CASH FLOWS--CONTINUED (In thousands of dollars)
Years Ended December 31, ----------------------------------- 1997 1996 1995 --------- --------- --------- Cash flows from financing activities: Net increase (decrease) in short-term debt ............................. $(132,315) $ 111,698 $ 12,443 Proceeds from long-term debt ........................................... 126,127 1,500 5,665 Long-term debt payments ................................................ (1,997) (2,549) (1,183) Stock options exercised ................................................ 2,239 2,890 2,147 Tax benefit of stock incentive plan .................................... 3,759 3,709 2,677 Purchase of treasury stock--net ........................................ (346,822) (32,090) -- Cash dividends paid .................................................... (53,934) (50,035) (45,227) ---------- ---------- ---------- Net cash (used in) provided by financing activities ...................... (402,943) 35,123 (23,478) ---------- ---------- ---------- NET (DECREASE) INCREASE IN CASH AND CASH EQUIVALENTS ................................................... (80,006) 115,475 (3,832) Cash and cash equivalents at beginning of year ........................... 126,935 11,460 15,292 ---------- ---------- ---------- Cash and cash equivalents at end of year ................................. $ 46,929 $ 126,935 $ 11,460 ========== ========== ========== 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 ========== The accompanying notes are an integral part of these financial statements
23 W.W. Grainger, Inc., and Subsidiaries NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 1997, 1996, and 1995 NOTE 1--SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES INDUSTRY INFORMATION The Company is engaged in the distribution of maintenance, repair, and operating (MRO) supplies and related information to the commercial, industrial, contractor, and institutional markets in North America. The Company's business is within a single industry segment. 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. 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. LONG - LIVED ASSETS Effective January 1, 1996, the Company adopted Statement of Financial Accounting Standards (SFAS) No. 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed Of." The effect of adopting this new standard was immaterial to the financial statements. 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 $1,810,000, $1,772,000, and $2,136,000, in 1997, 1996, and 1995, 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. 24 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. EARNINGS PER SHARE The Company has adopted Statement of Financial Accounting Standards (SFAS) No. 128, "Earnings per Share," as of December 31, 1997. This statement established new standards for computing and disclosing earnings per share. In accordance with SFAS No. 128, all earnings per share amounts for prior periods have been restated to conform with the new standard. RECENTLY ISSUED ACCOUNTING STANDARDS During 1997 the Financial Accounting Standards Board (FASB) issued Statements of Financial Accounting Standards (SFAS) No. 130, "Reporting Comprehensive Income" and SFAS No. 131, "Disclosures about Segments of an Enterprise and Related Information," both effective for fiscal years beginning after December 15, 1997. 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. In accordance with the release, the Company plans to adopt SFAS No. 130 in the first quarter of 1998. SFAS No. 131 requires disclosures of certain segment information based on the way that management evaluates segments for making decisions and assessing performance. It also requires disclosure of certain information about products and services, the geographic areas in which the Company operates, and major customers. In accordance with the release, the Company plans to adopt SFAS No. 131 for the year ended December 31, 1998. 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 2,039,886 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 1995. 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 such periods and is not necessarily indicative of results which may be obtained in the future.
Years Ended December 31, ------------------------------ 1996 1995 ---------- ---------- (Pro-forma, in thousands of dollars except for per share amounts) Net sales........................... $3,847,665 $3,585,964 Operating earnings.................. $368,203 $336,336 Net earnings........................ $216,680 $191,528 Earnings per share: Basic............................. $4.07 $3.62 Diluted........................... $4.04 $3.59
25 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:
1997 1996 1995 -------- -------- -------- (In thousands of dollars) Interest (net of amounts capitalized).... $5,773 $974 $4,167 ======== ======== ======== Income taxes............................. $143,471 $131,726 $127,041 ======== ======== ========
NOTE 4--CASH Checks outstanding of $54,218,000, $35,366,000, and $40,027,000 are included in Trade accounts payable at December 31, 1997, 1996, and 1995, 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 $215,707,000, $209,305,000, and $194,854,000 higher than reported at December 31, 1997, 1996, and 1995, 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. Other assets increased in 1996 primarily due to the business acquisition described in Note 2. 26 NOTE 8--SHORT-TERM DEBT The following summarizes information concerning short-term debt:
1997 1996 1995 -------- -------- ------- Bank Debt (In thousands of dollars) - --------- Outstanding at December 31 .................... $ 2,960 $135,275 $ 3,186 Maximum month-end balance during the year ..... $139,187 $135,275 $ 64,853 Average amount outstanding during the year .... $119,962 $ 13,796 $ 22,576 Weighted average interest rates during the year 3.5% 3.8% 6.2% Weighted average interest rates at December 31 6.2% 3.2% 6.2% Commercial Paper - ---------------- Outstanding at December 31 .................... -- -- $ 20,391 Maximum month-end balance during the year ..... $ 81,355 -- $ 79,734 Average amount outstanding during the year .... $ 15,429 $ 1,436 $ 43,357 Weighted average interest rates during the year 5.7% 5.7% 6.0% Weighted average interest rates at December 31 -- -- 5.8%
The Company and its subsidiaries had committed lines of credit totaling $168,983,000 at December 31, 1997, including $13,983,000 denominated in Canadian dollars. A Company subsidiary also has a $34,958,000 uncommitted line of credit denominated in Canadian dollars. At December 31, 1997, borrowings under the subsidiaries' lines of credit were $2,960,000. 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. Available lines of credit at December 31, 1995 totaled $54,500,000, including a working capital line of credit of $4,500,000. 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 $55,052,000, $49,450,000, and $47,323,000 for the years ended December 31, 1997, 1996, and 1995, 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 these benefits when they qualify for retirement while working for the Company. The amount charged to operating expense for postretirement benefits was $3,653,000, $3,578,000, and $3,488,000 for the years ended December 31, 1997, 1996, and 1995, respectively. Components of the expense were:
1997 1996 1995 ------- ------- ------- (In thousands of dollars) Service cost .......................................... $ 2,442 $ 2,309 $ 1,973 Interest cost ......................................... 2,272 2,080 2,025 Actual return on assets ............................... (3,745) (2,008) (2,282) Deferral of gain on return on assets .................. 3,007 1,397 1,913 Amortization of transition asset (22 year amortization) (143) (143) (143) Amortization of unrecognized gain ..................... (262) (139) (80) Amortization of prior service cost .................... 82 82 82 -------- -------- -------- $ 3,653 $ 3,578 $ 3,488 ======== ======== ========
27 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 and 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, include modifications to eligibility requirements and the adjustment of benefit maximums. These changes will not materially affect the Company's anticipated future benefits expense. 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 6.7%, which is net of a 37.9% 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 $859,000, $379,000, and $2,409,000 for the years ended December 31, 1997, 1996, and 1995, respectively. A reconciliation of the funded status of the Benefit obligation as of December 31, 1997, 1996, and 1995 is as follows:
1997 1996 1995 --------- --------- --------- (In thousands of dollars) Accumulated Postretirement Benefit Obligation (APBO): Retirees and their dependents ..................... $ (5,543) $ (3,739) $ (3,852) Fully eligible active plan participants ........... (2,390) (1,825) (1,767) Other active plan participants .................... (27,933) (26,345) (27,863) --------- -------- -------- Total APBO .......................................... (35,866) (31,909) (33,482) Plan assets at fair value ........................... 16,127 12,307 10,288 --------- --------- --------- Funded status ....................................... (19,739) (19,602) (23,194) Unrecognized transition asset ....................... (2,428) (2,570) (2,713) Unrecognized net (gain) loss ........................ (4,589) (4,388) 2,464 Unrecognized prior service cost ..................... (1,003) 1,595 1,677 --------- --------- --------- Accrued postretirement benefits costs ............... $(27,759) $(24,965) $(21,766) ========= ========= =========
To determine the APBO as of December 31, 1997, the assumed weighted average discount rate used was 7.0%. To determine the APBO as of December 31, 1996 and 1995, the assumed weighted average discount rate used was 7.5%. The assumed health care cost trend rate for 1998 through 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% will be achieved. If the assumed health care cost trend rate was increased by one percentage point for each year, the APBO as of December 31, 1997 would increase by $8,520,000. The aggregate of the service cost and interest cost components of the 1997 net periodic postretirement benefits expense would increase by $1,277,000. NOTE 10--LONG-TERM DEBT Long-term debt consisted of the following at December 31:
1997 1996 1995 -------- ------ ------ (In thousands of dollars) Uncommitted revolving credit facility................ $126,127 $ -- $ -- Industrial development revenue bonds................. 27,650 27,650 26,150 Other................................................ 1,258 3,255 5,804 -------- ------ ------ 155,035 30,905 31,954 Less current maturities.............................. 23,834 24,753 23,241 -------- ------ ------ $131,201 $ 6,152 $ 8,713 ======== ======= =======
As part of the permanent financing for the acquisition described in Note 2, the Company entered into a $139,831,000 uncommitted revolving credit facility, denominated in Canadian dollars. The Company has $126,127,000, denominated in Canadian dollars, outstanding at December 31, 1997, with a weighted average interest rate of 5.06%. 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. 28 The industrial development revenue bonds include various issues that bear interest at a variable rate up to 15%, or variable rates up to 78.20% 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, 1997 for which the Company compensated a bank through a commitment fee of 0.07%. There were no borrowings related to this facility at December 31, 1997. The Company classified $22,755,000 of bonds currently subject to redemption options in current maturities of long-term debt at December 31, 1997, and 1996. The Company classified $21,255,000 of bonds subject to redemption options in current maturities of long-term debt at December 31, 1995. The aggregate amounts of long-term debt maturing in each of the five years subsequent to December 31, 1997 are as follows:
Amounts Amounts Payable Under Subject to Terms of Redemption Agreements Options ------------- ----------- (In thousands of dollars) 1998..................................... $ 1,079 $ 22,755 1999..................................... 76 -- 2000..................................... 83 4,895 2001..................................... 126,147 -- 2002..................................... -- --
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, 1997, the approximate future minimum aggregate payments for all leases were as follows:
Operating Leases --------------------------- Real Personal Capital Property Property Total Leases -------- -------- ------- ------- (In thousands of dollars) 1998 .................................... $15,832 $ 1,599 $17,431 $ 75 1999 .................................... 13,765 30 13,795 75 2000 .................................... 7,505 -- 7,505 75 2001 .................................... 4,624 -- 4,624 15 2002 .................................... 3,480 -- 3,480 -- Thereafter .............................. 8,500 -- 8,500 -- -------- -------- ------- ------ Total minimum payments required ......... 53,706 1,629 55,335 240 Less amounts representing sublease income 4,023 -- 4,023 -------- -------- ------- $49,683 $ 1,629 $51,312 ======== ======== ======= Less imputed interest................................ 29 Present value of minimum lease payments ------ (included in long-term debt)....................... $ 211 ======
Total rent expense, including both items under lease and items rented on a month-to-month basis, was $21,396,000, $18,434,000, and $20,084,000 for 1997, 1996, and 1995, respectively. 29 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 4,028,414 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 10,000 shares of restricted stock issued in 1997 with a fair market value of $80.25 per share. There were 235,000 shares of restricted stock issued in 1996 with a fair market value of $76 per share. The shares are scheduled to vest ten years from issuance, although accelerated vesting is provided in certain instances. There were no shares of restricted stock issued in 1995. Restricted stock released totaled 500, 1,000, and 1,050 shares in 1997, 1996, and 1995, 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 $1,872,000, $282,000, and $42,000 in 1997, 1996, and 1995, respectively. During 1997 the Company adopted a Director Stock Plan in which non-employee directors participate. A total of 250,000 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, 1997, eight directors held Stock Units, in connection with which the Company had recognized expense of $1,850,000. Transactions involving stock options are summarized as follows:
Weighted Average Price Per Option Shares Share Exercisable ------------- --------- ----------- Outstanding at January 1, 1995................... 1,514,204 $41.91 1,124,164 Granted........................................ 221,620 $61.91 =========== Exercised...................................... (207,402) $29.44 Canceled or expired............................ (14,480) $60.68 ------------- Outstanding at December 31, 1995................. 1,513,942 $46.36 916,762 Granted........................................ 288,730 $67.62 =========== Exercised...................................... (241,181) $33.99 Canceled or expired............................ (29,930) $62.12 ------------- Outstanding at December 31, 1996................. 1,531,561 $52.01 855,091 Granted........................................ 347,330 $74.75 =========== Exercised...................................... (206,351) $38.33 Canceled or expired............................ (25,860) $67.26 ------------- Outstanding at December 31, 1997................. 1,646,680 $58.28 839,950 ============= ===========
All options were issued at market price on the date of grant. Options were issued with initial vesting periods ranging from six months to five years. 30 Information about stock options outstanding at December 31, 1997 is as follows: Options Outstanding - -------------------------------------------------------------------------------- Weighted Average ----------------------------------- Range of Exercise Number Remaining Contractual Exercise Prices Outstanding Life (Years) Price - ----------------- ----------- --------------------- -------- $27.88-$47.38 385,660 2.33 $36.16 $51.50-$62.13 645,250 5.97 $58.82 $67.50-$90.25 615,770 8.87 $71.57 Options Exercisable - ------------------------------------------------------------ Range of Exercise Number Weighted Average Prices Exercisable Exercise Price - ----------------- ----------- ---------------- $27.88-$47.38 385,660 $36.16 $51.50-$67.50 454,290 $57.56 Shares available for future awards were 2,383,509, 2,471,719, and 2,965,519 at December 31, 1997, 1996, and 1995, respectively. In accordance with 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:
1997 1996 1995 -------- -------- -------- (In thousands of dollars except for per share amounts) Net earnings......................... $229,107 $206,696 $186,010 Earnings per share: Basic.............................. $ 4.55 $ 4.04 $ 3.66 Diluted............................ $ 4.49 $ 4.00 $ 3.63
The weighted average fair value of the stock options granted during 1997, 1996, and 1995 was $25.90, $21.75, and $20.33, 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:
1997 1996 1995 --------- --------- --------- Risk-free interest rate.............. 6.71% 6.55% 6.82% Expected life........................ 7.0 years 6.5 years 6.5 years Expected volatility.................. 20.97% 21.75% 21.75% Expected dividend yield.............. 1.46% 1.46% 1.46%
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 two-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 $125, 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. 31 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 The asset and liability approach of SFAS No. 109, "Accounting for Income Taxes," requires the recognition of deferred tax liabilities and assets for the expected future tax consequences of temporary differences between the financial bases and the tax bases of assets and liabilities. Income tax expense consisted of the following:
1997 1996 1995 -------- -------- -------- (In thousands of dollars) Current provision: Federal (including foreign)............. $128,470 $113,968 $106,690 State................................... 27,180 26,324 24,309 --------- --------- --------- Total current......................... 155,650 140,292 130,999 Deferred tax expense (benefits)........... 2,153 70 (5,515) --------- --------- --------- Total provision........................... $157,803 $140,362 $125,484 ========= ========= =========
The deferred tax expense (benefits) represent the net effect of the changes in the amounts of temporary differences. The income tax effects of temporary differences that gave rise to the net deferred tax asset as of December 31, 1997, 1996, and 1995 were:
1997 1996 1995 --------- --------- --------- (In thousands of dollars) Current deferred tax assets (liabilities): Inventory valuations ........................ $ 23,761 $ 25,059 $ 26,896 Administrative and general expenses deducted on a paid basis for tax purposes . 28,267 26,759 25,004 Employment related benefits expense ......... 2,160 1,778 1,566 Restructuring costs ......................... 5,432 7,428 13,957 Other ....................................... (272) (187) (184) --------- --------- --------- Total net current deferred tax asset ...... 59,348 60,837 67,239 --------- --------- --------- Noncurrent deferred tax assets (liabilities): Purchased tax benefits ...................... (26,185) (29,693) (32,781) Differences related to property, buildings, and equipment .................. (816) (400) (1,013) Intangible amortization ..................... 9,116 14,681 13,208 Employment related benefits expense ......... 14,012 12,709 11,441 Other ....................................... 1,002 496 606 --------- --------- --------- Total net noncurrent deferred tax liability (2,871) (2,207) (8,539) --------- --------- --------- Net deferred tax asset ........................ $ 56,477 $ 58,630 $ 58,700 ========= ========= =========
32 The purchased tax benefits represent lease agreements acquired in prior years under the provisions of the Economic Recovery Act of 1981. A reconciliation of income tax expense with U.S. federal income taxes at the statutory rate follows:
1997 1996 1995 ---------- ---------- ---------- (In thousands of dollars) Federal income taxes at the statutory rate ........... $ 136,373 $ 122,111 $ 109,252 Foreign rate differences ............................. 2,034 (4) -- State income taxes, net of federal income tax benefits 17,954 17,010 15,141 Other--net ........................................... 1,442 1,245 1,091 ---------- ---------- ---------- Income tax expense ................................. $ 157,803 $ 140,362 $ 125,484 ========== ========== ========== Effective tax rate ................................. 40.5% 40.2% 40.2% ========== ========== ==========
NOTE 15--FOREIGN OPERATIONS Foreign operations consisted of the following for the year ended December 31, 1997 (in thousands of dollars): Net Sales: Canada ............................... $ 351,312 Other North American operations ...... 3,785,248 ---------- Total ................................ $4,136,560 ========== Operating Profit: Canada ............................... $ 24,872 Other North American operations ...... 368,287 ---------- Total ................................ $ 393,159 ========== Identifiable Assets: Canada ............................... $ 342,258 Other North American operations ...... 1,655,563 ---------- Total ................................ $1,997,821 ==========
The Company's revenue and operating earnings from foreign operations were less than 10% of consolidated results for the years ending December 31, 1997, 1996 and 1995. Primarily as a result of the business acquisition described in Note 2, identifiable assets in foreign countries were $349,332,000 and $332,388,000 at December 31, 1997 and 1996, respectively. Identifiable assets in foreign countries were less than 10% of consolidated assets for the year ended December 31, 1995. NOTE 16--SELECTED QUARTERLY FINANCIAL DATA (UNAUDITED) A summary of selected quarterly information for 1997 and 1996 is as follows:
1997 Quarter Ended ----------------------------------------------------------------------------- (In thousands of dollars except for per share amounts) March 31 June 30 September 30 December 31 Total ---------- ---------- ------------ ----------- ---------- 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 ..... $ 1.05 $ 1.14 $ 1.14 $ 1.28 $ 4.61 Earnings per share-diluted ... $ 1.03 $ 1.13 $ 1.12 $ 1.26 $ 4.54 1996 Quarter Ended --------------------------------------------------------------------------- (In thousands of dollars except for per share amounts) March 31 June 30 September 30 December 31 Total ---------- -------- ------------ ----------- ---------- Net sales .................... $842,647 $888,624 $901,858 $904,078 $3,537,207 Gross profit ................. $300,498 $309,607 $319,534 $337,575 $1,267,214 Net earnings ................. $ 50,124 $ 49,547 $ 52,272 $ 56,583 $ 208,526 Earnings per share-basic ..... $ 0.98 $ 0.98 $ 1.02 $ 1.10 $ 4.08 Earnings per share-diluted ... $ 0.98 $ 0.96 $ 1.02 $ 1.08 $ 4.04
33 W.W. Grainger, Inc. and Subsidiaries SCHEDULE II--ALLOWANCE FOR DOUBTFUL ACCOUNTS FOR THE YEARS ENDED DECEMBER 31, 1997, 1996, AND 1995
Balance at Charged to Balance beginning costs and at end Description of period expenses Deductions (a) Other (b) of period - -------------------------------- ---------- ---------- -------------- --------- --------- (In thousands of dollars) Allowance for doubtful accounts 1997 ........................... $15,302 $9,984 $9,483 $-- $15,803 1996 ........................... 14,229 9,131 8,824 766 15,302 1995 ........................... 15,333 7,780 8,884 -- 14,229 (a) Accounts charged off as uncollectible, less recoveries. (b) Business acquired.
34
W.W. Grainger, Inc. and Subsidiaries EXHIBIT 11 COMPUTATIONS OF EARNINGS PER SHARE 1997 1996 1995 ------------ ------------ ------------ BASIC: Average number of shares outstanding during the year ........ 50,302,259 51,147,753 50,815,081 ============ ============ ============ Net earnings ................................................ $231,833,000 $208,526,000 $186,665,000 ============ ============ ============ Earnings per share .......................................... $ 4.61 $ 4.08 $ 3.67 ============ ============ ============ DILUTED: Average number of shares outstanding during the year (basic) 50,302,259 51,147,753 50,815,081 Common equivalents Shares issuable under outstanding options ............... 1,624,745 1,532,878 1,297,551 Shares which could have been purchased based on the average market value for the period ............... 1,092,051 1,096,632 883,851 ------------ ------------ ------------ 532,694 436,246 413,700 Dilutive effect of exercised options prior to being exercised 9,023 16,721 9,355 ------------ ------------ ------------ Shares for the portion of the period that the options were outstanding ......................... 541,717 452,967 423,055 Contingently issuable shares ................................ 245,500 35,484 3,081 ------------ ------------ ------------ 787,217 488,451 426,136 Average number of shares outstanding during the year ........ 51,089,476 51,636,204 51,241,217 ============ ============ ============ Net earnings ................................................ $231,833,000 $208,526,000 $186,665,000 ============ ============ ============ Earnings per share .......................................... $ 4.54 $ 4.04 $ 3.64 ============ ============ ============
35 EXHIBIT 23 CONSENT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS We hereby consent to the incorporation of our report on page 17 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, 1998 36 EX-3.(II) 2 BY-LAWS Exhibit 3(b) to the Annual Report on Form 10-K of W.W. Grainger, Inc. for the year ended December 31, 1997 As Amended August 8, 1997 BY-LAWS OF W.W. GRAINGER, INC. ARTICLE I OFFICES The principal office of the corporation shall be located in the State of Illinois. The corporation may have such other offices, either within or without the State of Illinois, as the business of the corporation may require from time to time. The registered office of the corporation required by the Illinois Business Corporation Act to be maintained in the State of Illinois may be, but need not be, identical with the principal office in the State of Illinois, and the address of the registered office may be changed from time to time by the board of directors. ARTICLE II SHAREHOLDERS SECTION 1. ANNUAL MEETING. (a) The annual meeting of the shareholders shall be held on the last Wednesday of April, in each year, or at such time as may be determined by the board of directors, for the purpose of electing directors and for the transaction of such other business as may properly come before the meeting. If the day fixed for the annual meeting shall be a legal holiday, such meeting shall be held on the next succeeding business day. If the election of the directors shall not be held on the day designated herein for any annual meeting or adjournment thereof, the board of directors shall cause the election to be held at a meeting of the shareholders as soon thereafter as conveniently may be. (b) At any annual meeting or adjournment thereof only such business shall be conducted as shall have been brought before the meeting (i) by or at the direction of the 37 board of directors or (ii) by any shareholder (x) who is entitled to vote at the time of giving notice provided for in this Section 1(b) and remains such until the meeting and (y) who complies with the procedures set forth in this Section 1(b). For business to be properly brought before an annual meeting or adjournment thereof by a shareholder, the shareholder must have given timely notice thereof in proper written form to the secretary. To be timely, a shareholder's notice must be delivered to or mailed and received at the principal office of the corporation no less than thirty days nor more than sixty days prior to the meeting; provided, however, that in the event that less than forty days' notice or prior public disclosure of the date of the meeting is given or made to shareholders, notice by the shareholder to be timely must be received not later than the close of business on the tenth day following the day on which such notice of the date of the annual meeting was mailed or such public disclosure was made. To be in proper written form, a shareholder's notice to the secretary shall set forth in writing as to each matter the shareholder proposes to bring before the meeting (i) a brief description of the business desired to be brought before the meeting and the reasons for conducting such business at the meeting, (ii) the name and address, as they appear on the corporation's books, of the shareholder proposing such business, (iii) the class and number of shares of the corporation which are beneficially owned by the shareholder and (iv) any material interest of the shareholder in such business. Notwithstanding anything in these by-laws to the contrary, no business shall be conducted at any annual meeting or adjournment thereof except in accordance with the procedures set forth in this Section 1(b). The officer or other person presiding shall, if the facts warrant, determine and declare to the meeting that business was not properly brought before the meeting in accordance with the procedures set forth in this Section 1(b), and if he should so determine, he shall so declare to the meeting and any such business not properly brought before the meeting shall not be transacted. SECTION 2. SPECIAL MEETINGS. Special meetings of the shareholders may be called by the chairman of the board, the vice chairman, the president and chief executive officer, the board of directors or by the holders of not less than one-fifth of all the outstanding shares of the corporation, for the purpose or purposes for which the meeting is called. Unless otherwise stated in the notice of special meeting, no other business may be transacted at any such meeting. SECTION 3. PLACE OF MEETING. The board of directors may designate any place, either within or without the State of Illinois, as the place of meeting for any annual meeting or for any special meeting called by the board of directors. If no designation is made, or if a special meeting be otherwise called, the place of meeting shall be the principal office of the corporation in the State of Illinois. SECTION 4. NOTICE OF MEETINGS. Written notice stating the place, day and hour of the meeting and, in case of a special meeting, the purpose or purposes for which the meeting is called, shall be delivered not less than ten nor more than sixty days before the date of the meeting, or in the case of a merger, consolidation, share exchange, dissolution or sale, lease or exchange of assets, not less than twenty days nor more than sixty days before the date of the meeting, either personally or by mail, by 38 or at the direction of the chairman of the board or the secretary, or the officer or persons calling the meeting, to each shareholder of record entitled to vote at such meeting. If mailed, such notice shall be deemed to be delivered when deposited in the United States mail, addressed to the shareholder at his address as it appears on the records of the corporation, with postage thereon prepaid. SECTION 5. FIXING OF RECORD DATE. For the purpose of determining shareholders entitled to notice of or to vote at any meeting of shareholders, or shareholders entitled to receive payment of any dividend, or in order to make a determination of shareholders for any other proper purpose, the board of directors of the corporation may fix in advance a date as the record date for any such determination of shareholders, such date in any case to be not more than sixty days and, in case of a meeting of shareholders, not less than ten days, or in the case of a merger, consolidation, share exchange, dissolution or sale, lease or exchange of assets, not less than twenty days, prior to the date on which the particular action, requiring such determination of shareholders, is to be taken. If no record date is fixed for the determination of shareholders entitled to notice of or entitled to vote at a meeting of shareholders, or entitled to receive payment of a dividend, the date on which notice of the meeting is mailed or the date on which the resolution of the board of directors declaring such dividend is adopted, as the case may be, shall be the record date for such determination of shareholders. When a determination of shareholders entitled to vote at any meeting of shareholders has been made as provided above, such determination shall apply to any adjournment thereof. SECTION 6. VOTING LISTS. The officer or agent having charge of the transfer books for shares of the corporation shall make within twenty days after the record date for a meeting of shareholders, or ten days before such meeting of shareholders, whichever is earlier, a complete list of the shareholders entitled to vote at such meeting, arranged in alphabetical order, with the address of and the number of shares held by each, which list, for a period of ten days prior to such meeting, shall be kept on file at the principal office of the corporation in the State of Illinois and shall be subject to inspection by any shareholder at any time during usual business hours and to copying at the shareholder's expense. Such list shall also be produced and kept open at the time and place of the meeting and shall be subject to the inspection of any shareholder during the whole time of the meeting. The original share ledger or transfer book, or a duplicate thereof kept in the State, shall be prima facie evidence as to who are the shareholders entitled to examine such list or share ledger, or transfer book or to vote at any meeting of shareholders. SECTION 7. QUORUM. A majority of the outstanding shares of the corporation, entitled to vote on a matter, represented in person or by proxy, shall constitute a quorum at any meeting of shareholders; provided, that if less than a majority of the outstanding shares are represented at said meeting, a majority of the shares so represented may adjourn the meeting from time to time without further notice. 39 SECTION 8. PROXIES. At all meetings of shareholders, a shareholder may vote by proxy executed in writing by the shareholder or by his duly authorized attorney-in-fact. Such proxy shall be filed with the secretary of the corporation before or at the time of the meeting. No proxy shall be valid after eleven months from the date of its execution, unless otherwise provided in the proxy. SECTION 9. VOTING OF SHARES. Subject to the provisions of Section 11 of this Article, each outstanding share, regardless of class, shall be entitled to one vote upon each matter submitted to vote at a meeting of shareholders. SECTION 10. VOTING OF SHARES BY CERTAIN HOLDERS. Shares standing in the name of another corporation, domestic or foreign, may be voted by such officer, agent, or proxy as the by-laws of such corporation may prescribe, or, in the absence of such provision, as the board of directors of such corporation may determine. Shares standing in the name of a deceased person may be voted by his administrator or executor, either in person or by proxy. Shares standing in the name of a guardian, conservator, or trustee may be voted by such fiduciary, either in person or by proxy, but no guardian, conservator, or trustee shall be entitled, as such fiduciary, to vote shares held by him without a transfer of such shares into his name. Shares standing in the name of a receiver may be voted by such receiver, and shares held by or under the control of a receiver may be voted by such receiver without the transfer thereof into his name if authority to do so be contained in an appropriate order of the court by which such receiver was appointed. A shareholder whose shares are pledged shall be entitled to vote such shares until the shares have been transferred into the name of the pledgee, and thereafter the pledgee shall be entitled to vote the shares so transferred. Shares of its own stock belonging to this corporation shall not be voted, directly or indirectly, at any meeting and shall not be counted in determining the total number of outstanding shares at any given time, but shares of its own stock held by it in a fiduciary capacity may be voted and shall be counted in determining the total number of outstanding shares at any given time. SECTION 11. CUMULATIVE VOTING. In all elections for directors, every shareholder shall have the right to vote, in person or by proxy, the number of shares owned by him, for as many persons as there are directors to be elected, or to cumulate said shares, and give one candidate as many votes as the number of directors multiplied by the number of his shares shall equal, or to distribute them on the same principle among as many candidates as he shall see fit. 40 SECTION 12. VOTING BY BALLOT. Voting on any question or in any election may be by voice, unless the officer or other person presiding over the meeting shall order or any shareholder shall demand that voting be by ballot. ARTICLE III DIRECTORS SECTION 1. GENERAL POWERS. The business and affairs of the corporation shall be managed under the direction of its board of directors. SECTION 2. NUMBER, TENURE AND QUALIFICATIONS. The number of directors of the corporation shall be not less than seven nor more than twelve. The number of directors may be fixed or changed from time to time, within the minimum and maximum, by the directors or the shareholders without amending these by-laws. Each director shall hold office until the next annual meeting of shareholders or until his successor shall have been elected and qualified. Directors need not be residents of Illinois or shareholders of the corporation. SECTION 3. REGULAR MEETINGS. A regular meeting of the board of directors shall be held without other notice than this by-law, immediately after the annual meeting of shareholders. The board of directors may provide by resolution, the time and place, either within or without the State of Illinois, for the holding of additional regular meetings without other notice than such resolution. SECTION 4. SPECIAL MEETINGS. Special meetings of the board of directors may be called by or at the request of the chairman of the board or any two directors. The person or persons authorized to call special meetings of the board of directors may fix any place, either within or without the State of Illinois, as the place for holding any special meeting of the board of directors called by them. SECTION 5. NOTICE. Notice of any special meeting shall be given at least two days previously thereto by written notice delivered personally or mailed to each director at his business address, or by telegram. If mailed, such notice shall be deemed to be delivered 24 hours after deposited in the United States mail, next-day delivery guaranteed, so addressed with postage thereon prepaid. If notice to be given by telegram, such notice shall be deemed to be delivered 24 hours after the telegram is delivered to the telegraph company. Any director may waive notice of any meeting. The attendance of a director at any meeting shall constitute a waiver of notice of such meeting, except where a director attends a meeting for the express purpose of objecting to the transaction of any business because the meeting is not lawfully called or convened. Neither the business to be transacted at, nor the purpose of, any regular or special meeting of the board of directors need be specified in the notice or waiver of notice of such meeting. 41 SECTION 6. QUORUM. A majority of the board of directors shall constitute a quorum for transaction of business at any meeting of the board of directors, provided, that if less than a majority of the directors are present at said meeting, a majority of the directors present may adjourn the meeting from time to time without further notice. SECTION 7. MANNER OF ACTING. The act of the majority of the directors present at a meeting at which a quorum is present shall be the act of the board of directors. SECTION 8. VACANCIES. Any vacancy occurring in the board of directors and any directorship to be filled by reason of an increase in the number of directors may be filled by election at an annual meeting or at a special meeting of shareholders called for that purpose; provided, however, vacancies arising between meetings of shareholders by reason of an increase in the number of directors or otherwise may be filled by a majority of the board of directors then remaining. A director elected by the shareholders to fill a vacancy shall hold office for the balance of the term for which elected. A director appointed by the directors to fill a vacancy shall serve until the next meeting of shareholders at which directors are to be elected. SECTION 9. COMPENSATION. By resolution of the board of directors, the directors may be paid their expenses, if any, for attendance at each meeting of the board or of a committee thereof, and may be paid a fixed sum for attendance at meetings and/or a stated retainer as directors. No such payment shall preclude any director from serving the corporation in any other capacity and receiving compensation therefor. SECTION 10. PRESUMPTION OF ASSENT. A director of the corporation who is present at a meeting of the board of directors at which action on any corporate matter is taken shall be conclusively presumed to have assented to the action taken unless his dissent shall be entered in the minutes of the meeting or unless he shall file his written dissent to such action with the person acting as the secretary of the meeting before the adjournment thereof or shall forward such dissent by registered mail to the secretary of the corporation immediately after the adjournment of the meeting. Such right to dissent shall not apply to a director who voted in favor of such action. SECTION 11. COMMITTEES. Committees of the board of directors shall consist of an audit committee, a compensation committee, a board affairs and nominating committee, and such other committees as the board of directors by resolution may create. Each committee shall have such number of members and shall exercise such authority and carry out such duties as are set forth in resolutions of the board of directors. Committee members shall be elected annually but shall serve at the discretion of the board of directors and may be removed by the board of directors. The board of directors may increase or decrease the number of members of any committee at any time and may designate one or more directors as alternate members of any committee, who may replace any absent or disqualified member or members at any meeting of the committee. A majority of members of a committee shall constitute a 42 quorum and, unless otherwise set forth in resolutions of the board of directors, a majority of those members present at a meeting and not disqualified from voting shall constitute the acts of the committee. SECTION 12. INFORMAL ACTION BY DIRECTORS. (a) Any action required to be taken at a meeting of the board of directors of the corporation, or any other action which may be taken at a meeting of the board of directors or a committee thereof, may be taken without a meeting if a consent in writing, setting forth the action so taken, shall be signed by all of the directors entitled to vote with respect to the subject matter thereof, or by all of the members of such committee, as the case may be. (b) The consent shall be evidenced by one or more written approvals, each of which sets forth the action taken and bears the signature of one or more directors. All the approvals evidencing the consent shall be delivered to the secretary to be filed in the corporate records. The action taken shall be effective when all the directors have approved the consent unless the consent specifies a different effective date. (c) Any such consent signed by all the directors or all the members of a committee shall have the same effect as a unanimous vote, and may be stated as such in any document filed with the Secretary of State. SECTION 13. TELEPHONE ATTENDANCE. (a) Members of the board of directors or of any committee of the board of directors may participate in and act at any meeting of such board or committee through the use of a conference telephone or other communications equipment by means of which all persons participating in the meeting can hear each other. Participation in such meeting shall constitute attendance and presence in person at the meeting of the person or persons so participating. (b) The board of directors or any committee may, at its option, provide for a tape recording of any such conference telephone portion of a meeting but the lack thereof shall not affect the validity of any actions taken at such meeting. SECTION 14. REMOVAL OF DIRECTORS. One or more of the directors may be removed, with or without cause, at a meeting of shareholders by the affirmative vote of the holders of a majority of the outstanding shares then entitled to vote at an election of directors, except that: (1) No director shall be removed at a meeting of shareholders unless the notice of such meeting shall state that a purpose of the meeting is to vote upon the removal of one or more directors named in the notice. Only the named director or directors may be removed at such meeting; (2) If less than the entire board is to be removed, no director may be removed, with or without cause, if the votes cast against his removal would be sufficient to elect him, if then cumulatively voted at an election of the entire board of directors; and 43 (3) If a director is elected by a class or series of shares, he may be removed only by the shareholders of that class or series. SECTION 15. DIRECTOR CONFLICT OF INTEREST. If a transaction is fair to the corporation at the time it is authorized, approved or ratified, the fact that a director of the corporation is directly or indirectly a party to the transaction shall not be grounds for invalidating the transaction. SECTION 16. NOMINATIONS OF DIRECTORS. (a) Except for directors elected to fill vacancies pursuant to these by-laws, nominations for election for the board of directors may be made by the board of directors, or by the nominating committee of the board of directors and approved by the board of directors. Such nominations shall be submitted to a vote of the shareholders at the next annual meeting of shareholders or at a special meeting of shareholders called for such purpose. (b) Nominations for election to the board of directors may be made by any shareholder of any outstanding class of stock of the corporation entitled to vote for the election of directors provided that; (i) any such shareholder nominating a director shall, not later than the date with respect to submission of shareholders' proposals for the next annual meeting as set forth in the corporation's proxy statement for the preceding annual meeting of shareholders, notify the chairman of the board of the corporation in writing of the intent to so nominate one or more persons and shall further set forth in such notice the names of all such nominees together with, with respect to each such nominee, his principal occupation, age, holdings of equity securities of the corporation and such other information as would be required under applicable laws, including the various securities laws, to be set forth by the corporation in its proxy statement and related materials if such person were a nominee of the board of directors; (ii) such shareholder so proposing to nominate a person remains a shareholder of the corporation through the date of the annual meeting at which such shareholder, or such shareholder's proxy, nominates such person for election as a director; and (iii) such shareholder delivers the consent of each such nominee to serve as director, or states in the notice that each such nominee, if elected, has consented to serve as director. ARTICLE IV OFFICERS SECTION 1. NUMBER. The officers of the corporation shall be a chairman of the board, a vice chairman of the board, a senior chairman of the board, one or more presidents, one or more vice presidents, a treasurer, a secretary, and such other officers and such assistant or administrative officers as may be elected or appointed as hereinafter provided. Any two or more offices may be held by the same person. SECTION 2. ELECTION, APPOINTMENT AND TERM OF OFFICE. Officers of the corporation shall be elected or appointed annually by the board of directors, 44 although vacancies may be filled or new offices created and filled at any meeting of the board of directors. Each officer elected or appointed by the board of directors shall hold office until the next annual election or appointment of officers by the board of directors, or until his earlier death, resignation or removal. Officers and assistant or administrative officers of the corporation may also be appointed from time to time by the chairman of the board, to serve as such at his pleasure. SECTION 3. REMOVAL. Any officer or assistant or administrative officer of the corporation elected or appointed by the board of directors may be removed by the board of directors whenever in its judgment the best interests of the corporation would be served thereby. Any officer or assistant or administrative officer of the corporation appointed by the chairman of the board may be removed by the chairman of the board whenever in his judgment the best interests of the corporation would be served thereby. Any removal provided for in this Section 3 shall be without prejudice to the contract rights, if any, of the person so removed. Election or appointment of an officer or assistant or administrative officer of the corporation shall not itself create contract rights. SECTION 4. CHAIRMAN OF THE BOARD. The chairman of the board shall be the chief executive officer. He shall preside at all meetings of the shareholders and the board of directors or, from time to time, may delegate any part of such responsibilities to the vice chairman of the board or any other member of the board of directors. He may sign, with the secretary or any other authorized officer, certificates for shares of the corporation. He shall be primarily responsible for carrying out the policies established by and the directions of the board of directors and shall perform such other duties as may be prescribed from time to time by the board of directors. He may from time to time, to the extent not delegated by the board of directors, delegate and re-delegate any part of any of the responsibilities and authority set forth herein to the vice chairman of the board, the senior chairman of the board and/or a president. The chairman of the board must be a director of the corporation. SECTION 5. VICE CHAIRMAN OF THE BOARD. The vice chairman of the board shall perform such duties as may from time to time be prescribed by the board of directors or delegated to him by the chairman of the board, including the presiding at meetings of the shareholders and the board of directors. He may sign, with the secretary or any other authorized officer, certificates for shares of the corporation. The vice chairman of the board must be a director of the corporation. SECTION 6. SENIOR CHAIRMAN OF THE BOARD. The senior chairman of the board shall, in the absence of the chairman of the board, the vice chairman of the board, or another director to whom the responsibilities have been delegated, preside at all meetings of the shareholders and the board of directors. He shall advise the chairman of the board on matters of long- and short-term strategic planning and policy and other significant matters affecting the corporation, and shall perform such other duties as may from time to time be prescribed by the board of directors, or delegated to him by the chairman of the board. The senior chairman of the board must be a director of the corporation. 45 SECTION 7. OFFICE OF THE CHAIRMAN. The chairman of the board, the vice chairman of the board, and the senior chairman of the board shall comprise the office of the chairman, which shall act as the senior management of the corporation. By agreement of the members of the office of the chairman, any member or members thereof shall be authorized to act as the office of the chairman. Any member of the office of the chairman and a president may sign deeds, mortgages, bonds, contracts or other instruments which the board of directors has authorized to be executed, except in cases where the signing and execution thereof shall be expressly delegated by the board of directors or by these by-laws to some other officer or agent of the corporation, or shall be required by law to be otherwise signed or executed. The office of the chairman and a president may delegate signing authority to other persons within the corporation as shall be deemed necessary. SECTION 8. PRESIDENTS. The president or, if there be more than one, the presidents shall oversee and direct such operations, shall be responsible for such day-to-day activities, and shall do and perform such other duties as from time to time may be assigned by the board of directors or the chairman of the board. If there be more than one president, the board of directors may designate one or more of them as group president or use a similar descriptive designation. SECTION 9. VICE PRESIDENTS. Each of the vice presidents shall be responsible for those activities and shall perform those duties as from time to time may be assigned by the board of directors, the chairman of the board, the vice chairman of the board, or a president. The board of directors may designate one or more of the vice presidents as executive, group or senior vice presidents or use a similar descriptive designation. SECTION 10. TREASURER. If required by the board of directors, the treasurer shall give a bond for the faithful discharge of his duties in such sum and with such surety or sureties as the board of directors shall determine. He shall (a) have charge and custody of and be responsible for all funds and securities of the corporation, (b) receive and give receipts for moneys due and payable to the corporation from any source whatsoever, and deposit all such moneys in the name of the corporation in such banks, trust companies or other depositories as shall be selected in accordance with the provisions of Article V of these by-laws and (c) in general perform all the duties incident to the office of treasurer and such other duties as from time to time may be assigned to him by the board of directors, the chairman of the board, the vice chairman of the board, or the chief financial officer. SECTION 11. SECRETARY. The secretary shall (a) keep the minutes of the shareholders' and of the board of directors' meetings in one or more books provided for that purpose, (b) see that all notices are duly given in accordance with the provisions of these by-laws or as required by law, (c) be custodian of the corporate records and of the seal of the corporation and see that the seal of the corporation is affixed to all 46 certificates for shares prior to the issue thereof and to all documents, the execution of which on behalf of the corporation under its seal is duly authorized in accordance with the provisions of these by-laws, (d) keep, or cause the transfer agent to keep, a register of the post office address of each shareholder which shall be furnished to the secretary by such shareholder, (e) sign with the chairman of the board or the vice chairman of the board certificates for shares of the corporation, the issue of which shall have been authorized by resolution of the board of directors, (f) have general charge of the stock transfer books of the corporation and (g) in general perform all duties incident to the office of secretary and such other duties as from time to time may be assigned to him by the board of directors, the chairman of the board, or the vice chairman of the board. SECTION 12. SALARIES. The salaries of the officers elected or appointed by the board of directors shall be fixed from time to time by the board of directors and no such officer shall be prevented from receiving such salary by reason of the fact that he is also a director of the corporation. ARTICLE V CONTRACTS, LOANS, CHECKS AND DEPOSITS SECTION 1. CONTRACTS. The board of directors may authorize any officer or officers, agent or agents, to enter into any contract or execute and deliver any instrument in the name of and on behalf of the corporation, and such authority may be general or confined to specific instances. SECTION 2. LOANS. No loans shall be contracted on behalf of the corporation and no evidences of indebtedness shall be issued in its name unless authorized by a resolution of the board of directors. Such authority may be general or confined to specific instances. SECTION 3. CHECKS, DRAFTS, ETC. All checks, drafts or other orders for the payment of money, notes, or other evidences of indebtedness issued in the name of the corporation, shall be signed by such officer or officers, agent or agents of the corporation and in such manner as shall from time to time be determined by resolution of the board of directors. SECTION 4. DEPOSITS. All funds of the corporation not otherwise employed shall be deposited from time to time to the credit of the corporation in such banks, trust companies, or other depositaries as the board of directors may select. 47 ARTICLE VI CERTIFICATES FOR SHARES AND THEIR TRANSFER SECTION 1. CERTIFICATES FOR SHARES. The issued shares of the corporation shall be represented by certificates, except as and to the extent determined by, or pursuant to, resolution adopted by the board of directors. Certificates representing shares of the corporation shall be in such form as may be determined by the board of directors. Such certificates shall be signed by the chairman of the board or the vice chairman of the board, and by the secretary or an assistant secretary, and shall be sealed with the seal of corporation. All certificates for shares shall be consecutively numbered or otherwise identified. The name of the person to whom the shares represented thereby are issued, with the number of shares and date of issue, shall be entered in the books of the corporation, as shall similar information with respect to shares that are uncertificated. All certificates surrendered to the corporation for transfer shall be canceled. No new certificate shall be issued until the former certificate for a like number of shares, unless the shares are uncertificated, shall have been surrendered and canceled except that in the case of a lost, destroyed or mutilated certificate a new one may be issued therefor upon such terms and indemnity to the corporation as the board of directors may prescribe. SECTION 2. TRANSFERS OF SHARES. Transfers of shares of the corporation shall be made either on the books of the corporation or on the books of the duly authorized and appointed agent or agents of the corporation by the holder of record thereof or by his legal representative, who shall furnish proper evidence of authority to transfer, or by his attorney thereunto authorized by power of attorney duly executed and filed with the secretary of the corporation or proper officer of the transfer agent and, unless such shares are uncertificated, on surrender for cancellation of the certificate for such shares. The person in whose name shares stand on the books of the corporation or its duly authorized and appointed transfer agent or agents shall be deemed the owner thereof for all purposes as regards the corporation. ARTICLE VII FISCAL YEAR The fiscal year of the corporation shall begin on the first day of January in each year and end on the last day of December in each year. 48 ARTICLE VIII DIVIDENDS The board of directors may from time to time, declare, and the corporation may pay, dividends on its outstanding shares in the manner and upon the terms and conditions provided by law and its articles of incorporation. ARTICLE IX SEAL The board of directors shall provide a corporate seal which shall be in the form of a circle and shall have inscribed thereon the name of the corporation and the words, "Corporate Seal, Illinois". ARTICLE X WAIVER OF NOTICE Whenever any notice whatever is required to be given under the provisions of these by-laws or under the provisions of the articles of incorporation or under the provisions of the Illinois Business Corporation Act, a waiver thereof in writing, signed by the person or persons entitled to such notice, whether before or after the time stated therein shall be deemed equivalent to the giving of such notice. ARTICLE XI AMENDMENTS These by-laws may be altered, amended or repealed and new by-laws may be adopted at any meeting of the board of directors of the corporation by a majority vote of the directors present at the meeting. ARTICLE XII INDEMNIFICATION OF DIRECTORS AND OFFICERS SECTION 1. The corporation shall indemnify any person who was or is a party or is threatened to be made a party to any threatened, pending or completed action, suit or proceeding, whether civil, criminal, administrative or investigative (other than an action by or in the right of the corporation) by reason of the fact that he is or was a 49 director or officer of the corporation, or is or was serving at the request of the corporation as a director or officer of another corporation, partnership, joint venture, trust or other enterprise, against expenses (including attorneys' fees), judgments, fines and amounts paid in settlement actually and reasonably incurred by him in connection with such action, suit or proceeding, if he acted in good faith and in a manner he reasonably believed to be in, or not opposed to the best interests of the corporation, and, with respect to any criminal action or proceeding, had no reasonable cause to believe his conduct was unlawful. The termination of any action, suit or proceeding by judgment, order, settlement, conviction, or upon a plea of nolo contendere or its equivalent shall not, of itself, create a presumption that the person did not act in good faith and in a manner which he reasonably believed to be in or not opposed to the best interests of the corporation, and, with respect to any criminal action or proceeding, had reasonable cause to believe that his conduct was unlawful. SECTION 2. The corporation shall indemnify any person who was or is a party, or is threatened to be made a party to any threatened, pending or completed action, suit or proceeding by or in the right of the corporation to procure a judgment in its favor by reason of the fact that he is or was a director or officer of the corporation, or is or was serving at the request of the corporation as a director or officer of another corporation, partnership, joint venture, trust or other enterprise, against expenses (including attorneys' fees) actually and reasonably incurred by him in connection with the defense or settlement of such action, suit or proceeding, if he acted in good faith and in a manner he reasonably believed to be in, or not opposed to the best interests of the corporation, and except that no indemnification shall be made with respect to any claim, issue or matter as to which such person has been finally adjudged to have been liable to the corporation, unless, and only to the extent that the court in which such action or suit was brought shall determine upon application that, despite the adjudication of liability, but in view of all the circumstances of the case, such person is fairly and reasonably entitled to indemnity for such expenses as the court shall deem proper. SECTION 3. Any indemnification under Sections 1 or 2 (unless ordered by a court) shall be made only as authorized in the specific case, upon a determination that indemnification of the director or officer is proper in the circumstances because he has met the applicable standard of conduct set forth in Sections 1 or 2. Such determination shall be made (1) by the board of directors by a majority vote of a quorum consisting of directors who were not parties to such action, suit or proceeding, or (2) if such a quorum is not obtainable (or, even if obtainable, a quorum of disinterested directors so directs) by independent legal counsel in a written opinion, or (3) by the shareholders. In any event, to the extent that a director or officer of the corporation has been successful, on the merits or otherwise, in the defense of any action, suit or proceeding referred to in Sections 1 or 2 or in defense of any claim, issue or matter therein, he shall be indemnified against expenses (including reasonable attorneys' fees) actually and reasonably incurred by him in connection therewith. 50 SECTION 4. (a) Reasonable expenses incurred in defending a civil or criminal action, suit or proceeding shall be paid by the corporation in advance of the final disposition of such action, suit or proceeding, upon receipt of (i) a statement signed by such director or officer to the effect that such director or officer acted in good faith and in a manner which he believed to be in, or not opposed to the best interests of the corporation and (ii) an undertaking by or on behalf of the director or officer to repay such amount, if it shall ultimately be determined that he is not entitled to be indemnified by the corporation as authorized in this Article. (b) The board of directors may, by separate resolution adopted under and referring to this Article of the by-laws, provide for securing the payment of authorized advances by the creation of escrow accounts, the establishment of letters of credit or such other means as the board deems appropriate and with such restrictions, limitations and qualifications with respect thereto as the board deems appropriate in the circumstances. SECTION 5. (a) The indemnification and advancement of expenses provided by or granted under other subsections of this Article shall not be deemed exclusive of any other rights to which those seeking indemnification or advancement of expenses may be entitled under any by-law, agreement, vote of shareholders or disinterested directors, or otherwise, both as to action in his official capacity and as to action in another capacity while holding such office, and shall continue as to a person who has ceased to be a director or officer and shall inure to the benefit of the heirs, executors and administrators of such a person. (b) The provisions of this ARTICLE XII shall be deemed to be a contract between the corporation and each director and officer who serves in such capacity at anytime while this ARTICLE XII is in effect and any indemnification provided under this ARTICLE XII to a person shall continue after such person ceases to be an officer, director, agent or employee of the corporation as to all facts, circumstances and events occurring while such person was such officer, director, agent or employee, and shall not be decreased or diminished in scope without such person's consent, regardless of the repeal or modification of this Article or any repeal or modification of the Illinois Business Corporation Act or any other applicable law. If the scope of indemnity provided by this ARTICLE XII or any replacement article, or pursuant to the Illinois Business Corporation Act or any modification or replacement thereof is increased, then such person shall be entitled to such increased indemnification as is in existence at the time indemnity is provided to such person, it being the intent, subject to Section 10 of this ARTICLE XII, to indemnify persons under this ARTICLE XII to the fullest extent permitted by law. SECTION 6. The corporation may purchase and maintain insurance on behalf of any person who is or was a director, officer, employee or agent of the corporation, or is or was serving at the request of the corporation as a director, officer, employee or agent of another corporation, partnership, joint venture, trust or other enterprise, against any liability asserted against him and incurred by him in any such capacity, or arising out of 51 his status as such, whether or not the corporation would have the power to indemnify him against such liability under the provisions of this Article. SECTION 7. Subject to Section 10 of this Article, if a claim under this Article is not promptly paid in full by the corporation after a written claim has been received by the corporation or if expenses pursuant to Section 4 of this Article have not been promptly advanced after a written request for such advancement accompanied by the statement and undertaking required by Section 4 of this Article has been received by the corporation, the director or officer may at any time thereafter bring suit against the corporation to recover the unpaid amount of the claim or the advancement of expenses. If successful, in whole or in part, in such suit, such director or officer shall also be entitled to be paid the reasonable expense thereof, including attorneys' fees. It shall be a defense to any such action (other than an action brought to enforce a claim for expenses incurred in defending any proceeding in advance of its final disposition where the required undertaking has been tendered to the corporation) that the director or officer has not met the standards of conduct which make it permissible under the Illinois Business Corporation Act for the corporation to indemnify the director or officer for the amount claimed, but the burden of proving such defense shall be on the corporation. Neither the failure of the corporation (including its board of directors, independent legal counsel, or its shareholders) to have made a determination, if required, prior to the commencement of such action that indemnification of the director or officer is proper in the circumstances because he or she has met the applicable standard of conduct required under the Illinois Business Corporation Act, nor an actual determination by the corporation (including its board of directors, independent legal counsel, or its shareholders) that the director or officer had not met such applicable standard of conduct, shall be a defense to the action or create a presumption that the director or officer had not met the applicable standard of conduct. SECTION 8. For purposes of this Article, references to "the corporation" shall include, in addition to the surviving corporation, any merging corporation (including any corporation having merged with a merging corporation) absorbed in a merger which, if its separate existence had continued, would have had the power and authority to indemnify its directors, officers and employees or agents, so that any person who was a director or officer of such merging corporation, or was serving at the request of such merging corporation as a director or officer of another corporation, partnership, joint venture, trust or other enterprise, shall stand in the same position under the provisions of this Article with respect to the surviving corporation as such person would have with respect to such merging corporation if its separate existence had continued. SECTION 9. For purposes of this Article, references to "other enterprises" shall include employee benefit plans; references to "fines" shall include any excise taxes assessed on a person with respect to an employee benefit plan; references to "serving at the request of the corporation" shall include any service as a director, officer, employee or agent of the corporation which imposes duties on, or involves services by such director, officer, employee, or agent with respect to an employee benefit plan, its participants, or beneficiaries; and references to "officers" shall include elected and 52 appointed officers. A person who acted in good faith and in a manner he reasonably believed to be in the best interest of the participants and beneficiaries of an employee benefit plan shall be deemed to have acted in a manner "not opposed to the best interest of the corporation" as referred to in this Article. SECTION 10. Anything herein to the contrary notwithstanding, if the corporation purchases insurance in accordance with Section 6 of this ARTICLE XII, the corporation shall not be required to, but may (if the board of directors so determines in accordance with this ARTICLE XII) reimburse any party instituting any action, suit or proceeding if a result of the institution thereof is the denial of or limitation of payment of losses under such insurance when such losses would have been paid thereunder if a non-insured third party had instituted such action, suit or proceedings. ARTICLE XIII INDEMNIFICATION OF EMPLOYEES AND AGENTS The corporation may indemnify any agent or employee of the corporation who was or is a party or is threatened to be made a party to any threatened, pending or completed action, suit or proceeding (including, but not limited to any such proceeding by or in the right of the corporation) whether civil, criminal, administrative or investigative, by reason of the fact that he is or was serving the corporation at its request and in the course and scope of his duties and acting in good faith and in a manner he reasonably believed to be in, or not opposed to, the best interests of the corporation, against expenses (including reasonable attorney's fees) actually and reasonably incurred by him in connection with the defense or settlement of such action, suit or proceeding. The standards of conduct, the provisions for payment and advances, and the terms and conditions contained in Article XII, Sections 1, 2, 3, 4, 5(a), 6, 8, 9 and 10 shall apply to any indemnification hereunder. 53 EX-10 3 1997 MANAGEMENT INCENTIVE PROGRAM (MIP) Exhibit 10(c)(viii) to the Annual Report on form 10-K of W.W. Grainger, Inc. for the year ended December 31, 1997 SUMMARY DESCRIPTION OF THE 1997 MANAGEMENT INCENTIVE PROGRAM (MIP) BASED ON IMPROVED ECONOMIC EARNINGS FOR W.W. GRAINGER, INC. I. INTRODUCTION The Company Management Incentive Program (MIP) was initiated January 1, 1993 for employees in grades 13 and above with the first payout in March 1994. For eligible participants, this program replaced participation in both the discontinued Team Achievement Bonus (TAB) and the Long-Term Incentive Program (LTIP). The effective date of the Team Incentive Program (TIP) was January 1, 1994. For eligible participants, this program replaced the discontinued Team Achievement Bonus (TAB) program and other short-term incentive programs. Effective January 1, 1997, the MIP and the TIP were combined into one program. Changes were made to various provisions to accomplish this transition. This Summary Description details the provisions of the combined program. II. BACKGROUND During 1993, the Company adopted Economic Earnings (EE) as a key financial measurement. EE incorporates the attributes of growth, asset management and earnings to evaluate financial performance. Conceptually, long-term improvements in EE should correspond to long-term improvements in shareholder value. The MIP is designed to encourage decision making that results in improvement in EE and to compensate executives, middle managers and key staff appropriately for positive or negative performance resulting from business decisions. By linking EE to incentive compensation, the MIP should influence participants to make business decisions consistent with long-term shareholders' interests. III. ELIGIBILITY FOR PARTICIPATION Employees in salary grades 10 and above are eligible to participate in this program, subject to the eligibility provisions in Section IV. These employees are responsible for decisions affecting EE and/or major policy direction. 54 Managers of Lab Safety Supply, Inc. (LSS) and Parts Company of America (PCA) are on separate programs unique to their business units. Effective January 1, 1997, members of the Office of the Chairman participate in the Office of the Chairman Incentive Plan (OCIP). IV. ELIGIBILITY PROVISIONS Specific eligibility provisions are developed and reviewed annually. Eligibility provisions are as follows: A. Full-Year Participation - Employees in grades 10 and above who were employed in those grades for the full year will be eligible to receive a full award under the MIP, except as noted below. B. First-Year Participation - Individuals who are hired or promoted into a position eligible for participation in the MIP on or before July 1 will be eligible to receive a pro-rata award based on the number of months in the eligible position. C. Transfer From Another EE-Based Program - Individuals who are promoted or transferred into an eligible position from a position eligible for incentive pay under another EE-Based incentive program will receive an award prorated based on the number of months in each eligible position. D. Promotions within MIP - Participants who are promoted during the year from one MIP eligible position to another shall have their target award percentage based on the salary grade in effect on July 1. E. Ungraded Positions - Participants who are in an ungraded position will be considered, for purposes of this program, to be in the grade indicated on the most recently approved PAF. If none has been indicated, Human Resources, in conjunction with the functional Vice President, will determine the grade to be used. F. Transfer to Other Business Units - An employee who transfers to another Company business unit and no longer participates in the MIP will receive a pro-rata award for the number of months the person was in a participating position on the next regular incentive payment date and also will receive any account balance on that date. 55 G. Job Elimination or Downgrade - If a participant's job is eliminated for business reasons or is downgraded and the employee's new job is at a non-participating level, a pro-rata award for the current year will be made on the next regular incentive payment date. The employee also will receive any account balance on that date. In the event the participant does not continue employment, a pro-rata award for the current year will be made on the next regular incentive payment date and the participant will receive any account balance on that date also. H. Voluntary Resignation - If a participant leaves before October 1, no award will be paid for the current year and any remaining account balance will be forfeited. If a participant leaves after October 1, but before the end of a calendar year, the employee will be deemed to have earned that year's payment and will receive that year's payout on the next regular incentive payment date. The salary to be used in calculations will be the actual amount paid in the year rather than an annualized amount. Any remaining account balance will be forfeited. I. Involuntary Termination - For Misconduct or Performance Related Reasons - In these instances, a participant's account balance will be forfeited and no award will be granted for the current year or the prior year if not yet paid at the time of termination. "For Misconduct" means: The participant has engaged, or intends to engage, in competition with the Company, has induced any customer of the Company to breach any contract with the Company, has made any unauthorized disclosure of any of the secrets or confidential information of the Company, has committed an act of embezzlement, fraud or theft with respect to the property of the Company, or has deliberately disregarded the rules of the Company in such a manner as to cause any loss, damage or injury to, or otherwise endanger the property, reputation or employees of the Company. J. Death, Retirement or Long-Term Disability - A pro-rata award for the current year will be added to any participant account balance and the employee or his/her estate will receive the account balance in a lump sum on the next regular incentive payment date. Retirement is defined the same as under the W.W. Grainger, Inc. or Lab Safety Supply, Inc. Profit Sharing Plan. K. Employees rated 1 or 2 are not eligible for participation. Exceptions to the above provisions can only be approved by the CCOM. 56 V. ADMINISTRATION OF PROGRAM The administration of the MIP is the responsibility of the Compensation Committee of Management (CCOM), subject to the review and approval of the Compensation Committee of the Board (CCOB). The CCOM shall have the sole and complete authority to interpret this program, determine all questions relating to it, and to modify its provisions. All determinations, interpretations or other actions made or taken by the CCOM in connection with it shall be final and conclusive for all purposes and upon all persons. VI. OVERVIEW The MIP consists of two components - quantitative and qualitative. The quantitative component is built around target bonuses, which are established for each of grades 10 and above. The target bonuses are stated as a percentage of annualized base salary as of December 31. The target bonus for all participants is based solely on Company EE. The target bonus is adjusted upward or downward based on the relationship between Actual Company EE and Target Company EE for each year. The qualitative component consists of a discretionary adjustment. The discretionary adjustment, if any, begins as a pool and can be plus or minus up to 10% of the base salaries of the bonus group. Once the amount of the pool is determined, it is allocated pro-rata across the group according to the quantitative component earned by each participant. Target Company EE is based on a weighted average of the three prior years' Actual Company EE before MIP accrual plus a 10% improvement factor. The Target Company EE formula is: Target Company EE = [(50% x EE-1) + (30% x EE-2) + (20% x EE-3)] x 110% Where: EE-1 equals EE in prior year (year one) EE-2 equals EE in year prior to year one (year two) EE-3 equals EE in year prior to year two (year three) Note: The improvement factor applicable to any prior year having negative EE is 90%. 57 The bonus calculation includes a mechanism to identify significant strategic investments and adjust for their impact. The forecast short-term negative impact from such investments would be excluded from Target EE with corresponding increases in subsequent years' targets. The next step involves comparison of Actual EE to Target EE in order to calculate the bonus earned. Two factors are employed: the Bonus Interval and the Bonus Multiple. The Bonus Interval is the variance from Target EE required to double the bonus earned or result in no bonus earned. The Bonus Multiple can be expressed as: EE Bonus Multiple = (Actual EE - Target EE) / Bonus Interval + 1.00 The Bonus Earned is computed as: Bonus Earned = (Target EE Bonus $ x EE Bonus Multiple) The Bonus Earned constitutes the quantitative component of the MIP. The total bonus earned is equal to this quantitative component plus or minus any discretionary adjustment as recommended by the CCOM and approved by the CCOB. A MIP account will be established for each participant. MIP accounts are not funded with actual cash amounts; they represent a paper record of unpaid earned bonuses for an individual. Former LTIP participants had an opening MIP account balance. It was equal to LTIP amounts theoretically earned for 1991 and 1992 which had not been paid to eligible participants. Employees new to the MIP, either through promotion or as new hires, will have no beginning account balance. Each year, the Bonus Earned will be posted to each participant's account. Next, the Bonus Paid will be calculated (see below). If the Bonus Paid is less than or equal to the participant's account balance, the participant will be paid the full Bonus Paid. If the Bonus Paid is calculated to be more than the participant's incentive account balance, the participant will be paid the entire account balance. Account balances of less than $1,000 will be paid out immediately. Each year, the beginning account balance, if any, will be adjusted by the merit budget percentage established for that year. 58 MIP accounts were in existence for employees in grades 13 and above prior to the combination of MIP and TIP. Thus for 1995 and later years, the Bonus Paid will be equal to the target bonus times an average of that year's and the prior two years' bonus multiples plus or minus any discretionary adjustment. The only condition imposed on these calculations is that payment of the bonus may not result in a negative ending account balance. For employees in grades 10 through grade 12, the above formula will be used beginning in 1999. In 1997, the Bonus Paid will equal the Bonus Earned. For 1998, the current year (1998) and the prior year (1997) will be averaged. The only condition imposed on these calculations is that payment of the bonus may not result in a negative account balance. It shall be noted from the last two formulas that the EE bonus multiple can be a negative number and, as a result, the Bonus Earned can also be a negative number. If the Bonus Earned is negative, it is posted to the MIP account just as any other bonus amount would be. If the MIP account balance is negative after this posting, no bonus can be paid. No bonus will be paid until positive bonuses in subsequent years restore a positive MIP account balance. VII. OTHER A. Target bonus for the president of Lab Safety Supply (LSS) is based 75% on the EE of LSS, 25% on Company-wide EE; target bonus for the president of Parts Company of America (PCA) is based 50% on Company-wide EE and 50% on the EE of PCA. Other eligible MIP participants at either LSS or PCA are on programs unique to those business units. B. 100% of incentive dollars paid out will be included in "admissible compensation" under the Profit Sharing Trust Plan. C. Payouts under the MIP will not have any effect on the level of life insurance or disability coverage. Coverages will remain as at present under those programs as "compensation" is defined as base salary and commissions. D. Notwithstanding anything herein to the contrary, payment of all or part of awards under the MIP that are subject to or otherwise result in disallowance as deductions for employee remuneration under Section 162(m) of the Internal Revenue Code of 1986, as amended, shall be deferred as and to the extent provided by the Board of Directors or the CCOB. THE COMPANY RESERVES THE RIGHT TO MODIFY, AMEND OR TERMINATE THE PROGRAM AT ANY TIME WITH OR WITHOUT PRIOR NOTICE. 59 EX-21 4 SUBSIDIARIES Exhibit 21 to the Annual Report on Form 10-K of W.W. Grainger, Inc. for the year ended December 31, 1997 W.W. GRAINGER, INC. Subsidiaries as of December 31, 1997 Acklands - Grainger Inc. (Canada) - 370071 Alberta Ltd. (Alberta) (50% owned) - 655206 Alberta Ltd. (Alberta) (50% owned) - AGI Investment Corporation (Alberta) - Wilter Auto & Industrial Supply (Lloyd) Ltd. (Alberta) (50% owned) Dayton Electric Manufacturing Co. (Illinois) Grainger Caribe, Inc. (Illinois) Grainger FSC, Inc. (U.S. Virgin Islands) Grainger International, Inc. (Illinois) - WWG de Mexico, S.A. de C.V. (Mexico) - Grainger, S.A. de C.V. (Mexico) - WWG Servicios, S.A. de C.V. (Mexico) - Grainger Canada Inc. (Canada) Lab Safety Supply, Inc. (Wisconsin) 60 EX-27.A 5 DECEMBER 31, 1997 FINANCIAL DATA SCHEDULE
5 1,000 12-mos DEC-31-1997 DEC-31-1997 46,929 0 471,260 15,803 612,132 1,182,988 1,087,158 494,245 1,997,821 533,881 131,201 0 0 26,743 1,267,918 1,997,821 4,136,560 4,136,560 2,642,208 2,642,208 1,103,193 9,984 5,461 389,636 157,803 231,833 0 0 0 231,833 4.61 4.54
EX-27.B 6 RESTATED 1997 INTERIM FINANCIAL DATA SCHEDULES
5 1,000 9-mos 6-mos 3-mos DEC-31-1997 DEC-31-1997 DEC-31-1997 SEP-30-1997 JUN-30-1997 MAR-31-1997 57,502 31,692 101,664 0 0 0 511,429 514,823 482,040 17,869 17,003 16,203 576,481 587,422 627,712 1,202,817 1,195,939 1,274,259 1,053,855 1,026,525 1,002,639 479,566 465,015 450,553 2,008,602 1,993,741 2,065,260 642,435 668,529 619,836 27,697 27,697 27,698 0 0 0 0 0 0 26,738 26,716 26,693 1,295,376 1,255,748 1,379,991 2,008,602 1,993,741 2,065,260 3,103,689 2,036,762 985,556 3,103,689 2,036,762 985,556 2,006,228 1,312,453 632,276 2,006,228 1,312,453 632,276 800,717 527,183 257,359 9,290 6,033 2,993 4,012 2,576 1,148 283,442 188,517 91,780 114,794 76,349 37,171 168,648 112,168 54,609 0 0 0 0 0 0 0 0 0 168,648 112,168 54,609 3.33 2.19 1.05 3.28 2.16 1.03
EX-27.C 7 RESTATED 1996 FINANCIAL DATA SCHEDULE
5 1,000 12-mos 9-mos 6-mos 3-mos DEC-31-1996 DEC-31-1996 DEC-31-1996 DEC-31-1996 DEC-31-1996 SEP-30-1996 JUN-30-1996 MAR-31-1996 126,935 131,553 94,399 43,597 0 0 0 0 448,877 434,528 447,861 403,807 15,302 15,537 15,694 15,178 686,925 565,873 545,847 558,968 1,320,243 1,189,969 1,154,466 1,076,966 985,712 928,340 917,918 907,959 434,728 421,257 407,545 394,724 2,119,021 1,774,118 1,745,275 1,674,479 616,068 438,311 466,391 411,194 27,297 27,706 26,215 26,206 0 0 0 0 0 0 0 0 26,669 25,515 25,492 25,483 1,435,993 1,270,141 1,231,292 1,193,509 2,119,021 1,774,118 1,745,275 1,674,479 3,537,207 2,633,129 1,731,271 842,647 3,537,207 2,633,129 1,731,271 842,647 2,269,993 1,703,490 1,121,166 542,149 2,269,993 1,703,490 1,121,166 542,149 907,967 666,906 437,123 213,373 9,131 7,986 5,734 3,035 1,228 662 574 271 348,888 254,085 166,674 83,819 140,362 102,142 67,003 33,695 208,526 151,943 99,671 50,124 0 0 0 0 0 0 0 0 0 0 0 0 208,526 151,943 99,671 50,124 4.08 2.98 1.96 0.98 4.04 2.96 1.94 0.98
EX-27.D 8 RESTATED DECEMBER 31, 1995 FINANCIAL DATA SCHEDULE
5 1,000 12-mos DEC-31-1995 DEC-31-1995 11,460 0 383,805 14,229 602,639 1,062,660 897,700 379,349 1,669,243 444,136 26,206 0 0 25,447 1,153,662 1,669,243 3,276,910 3,276,910 2,095,552 2,095,552 857,169 7,780 4,260 312,149 125,484 186,665 0 0 0 186,665 3.67 3.64
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