UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-Q

 

(Mark One)

[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF

THE SECURITIES EXCHANGE ACT OF 1934

 

OR

 

[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF

THE SECURITIES EXCHANGE ACT OF 1934

 

For the transition period from ______ to _______

 

Commission file number 1-5684

(Exact name of registrant as specified in its charter)

 

 

Large accelerated filer [X]  Accelerated filer [  ]   Non-accelerated filer [  ]   Smaller reporting company [  ]

Emerging growth company [  ]

 

 

PART I – FINANCIAL INFORMATION

Item 1.  Financial Statements.

W.W. Grainger, Inc. and Subsidiaries

CONDENSED CONSOLIDATED STATEMENTS OF EARNINGS

(In thousands of dollars, except for share and per share amounts)

(Unaudited)

 

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

W.W. Grainger, Inc. and Subsidiaries

CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE EARNINGS

(In thousands of dollars)

(Unaudited)

 

  

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

W.W. Grainger, Inc. and Subsidiaries

CONDENSED CONSOLIDATED BALANCE SHEETS

(In thousands of dollars, except for share and per share amounts)

 

W.W. Grainger, Inc. and Subsidiaries

CONDENSED CONSOLIDATED BALANCE SHEETS (Continued)

(In thousands of dollars, except for share and per share amounts)

 

 

 

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

W.W. Grainger, Inc. and Subsidiaries

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(In thousands of dollars)

(Unaudited)

 

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

W.W. Grainger, Inc. and Subsidiaries

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

1.    BACKGROUND AND BASIS OF PRESENTATION

 

W.W. Grainger, Inc. is a broad-linebroad line, business-to-business distributor of maintenance, repair and operating (MRO) supplies, and other related products and services used by businesses and institutions.services.  W.W. Grainger, Inc.’s operations are primarily in the United States (U.S.) and Canada, with a presence in Europe, Asia and Latin America.  In this report, the words “Company” or “Grainger” mean W.W. Grainger, Inc. and its subsidiaries.

 

The Condensed Consolidated Financial Statements of the Company and the related notes are unaudited and should be read in conjunction with the consolidated financial statements and related notes for the year ended December 31, 2016 included in the Company’s Annual Report on Form 10-K filed with the Securities and Exchange Commission (SEC).

 

The Condensed Consolidated Balance Sheet as of December 31, 2016 has been derived from the audited consolidated financial statements at that date, but does not include all of the disclosures required by U. S. generally accepted accounting principles generally accepted in the United States of America(U.S. GAAP) for complete financial statements.

 

The unaudited financial information reflects all adjustments (primarily consisting of normal recurring adjustments) which, in the opinion of management, are necessary for a fair presentation of the statements contained herein.

Certain amounts in the Condensed Consolidated Statements of Cash Flows, as previously reported, have been reclassified to conform to the 2017 presentation. In March 2016, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) 2016-09, Stock Based Compensation: Improvements to Employee Share-Based Payment Accounting, which became effective January 1, 2017. As a result, the Company reclassified $16.7$19 million of employee taxes paid from cash flows from operating activities to cash flows from financing activities in the Consolidated Statements of Cash Flows for the sixnine months ended JuneSeptember 30, 2016.

2.    NEW ACCOUNTING STANDARDS

 

REVENUE RECOGNITION STANDARDS

The effective dates of ASU 2016-08, ASU 2016-10, ASU 2016-20 and ASU 2016-202017-05 are consistent with ASU 2014-09. The Company has elected not to early adopt these ASUs. The standard permits the use of either the full retrospective or the modified retrospective adoption method. The Company is planning to elect the modified retrospective method and recognize the cumulative effect of initially applying the new standard as an adjustment to the opening balance of equity as of January 1, 2018.

These ASUs require expanded qualitative and quantitative disclosures of revenue and cash flows emerging from contracts with customers. The Company has evaluated the provisions of the new standard and is in the process of assessingassessed its impact on financial statements,statement disclosures, information systems, business processes and financial statement disclosures. Based on initial reviews, theinternal controls. The standard is not expected to have a material impact on the Company's Consolidated Financial Statements.

3.    DIVIDEND

 

4.    GOODWILL AND OTHER INTANGIBLE ASSETS

Grainger had approximately $1.1 billion of goodwill and intangible assets as of JuneSeptember 30, 2017 and December 31, 2016, or 19% and 20% of total assets, respectively. GoodwillGrainger tests reporting units’ goodwill and intangible assets with indefinite lives are tested for impairment at least annually or when events or changes in circumstances indicateduring the carrying value of these assets might exceed their current fair values. To detect these events,fourth quarter and more frequently if impairment indicators exist. Accordingly, Grainger periodically performs qualitative assessments of factorssignificant events and circumstances such as reporting units' historical and current results, assumptions regarding future performance, strategic initiatives and overall economic factors and assumptions regarding future performance, to determine the existence of impairment indicators and assess if it is more likely than not that the goodwill andfair value of the reporting unit or indefinite-lived intangible assets might be impairedis less than its carrying value and whether it is necessary to perform the two-stepif a quantitative impairment test.test is necessary. In the quantitative test, Grainger compares the carrying value of the reporting unit or an indefinite-lived intangible asset with its fair value. Any excess of the carrying value over fair value is recorded as an impairment charge.

Grainger’s quarterlyindefinite-lived intangibles are primarily trade names. The fair value of trade names is calculated primarily using the relief from royalty method, which estimates the expected royalty savings attributable to the ownership of the trade name asset. The key assumptions when valuing a trade name are the revenue base, the royalty rate and the discount rate.

During the quarter ended September 30, 2017, the Company performed qualitative assessment did not indicateassessments of its reporting units’ goodwill and intangible assets. The operating performance of two of its reporting units has been below expectations and resulted in lowered short-term forecasts. Accordingly, the presenceCompany concluded that further evaluation was required. Based on the results of the quantitative tests, the Company concluded that there was no impairment triggering events forof goodwill andor indefinitely-lived intangible assets as of JuneSeptember 30, 2017. The Company consideredfair values of the restructuring actions discussed in Note 5 below to determine if it were more likely than not thatreporting units exceeded their carrying values by approximately 31 percent for the goodwill of its Canada reporting unit was impaired and concluded that the two-step quantitative impairment test was not necessary as of June 30, 2017. However, as Canada’s improvement plan evolves, volume growth, price increases and execution of market pricing programs and productivity initiatives may have a significant impact on15 percent for the reporting unit’s cash flows.

Additionally, the Company performed an impairment test on the intangible assets may result.subject to amortization for the two reporting units. The first step of the impairment test is to compare the undiscounted cash flows of the reporting units to their carrying values. If the results of the test determine that the undiscounted cash flows of the reporting units are less than their carrying values, then an impairment risk exists and further testing is required. An impairment charge

The Company continues to evaluate performance and take restructuring actions such as the consolidation of the contact center network in the U.S., branch closures in the U.S. and Canada, the disposition of under performing assets in the U.S. and Canada and the wind-down of operations in Colombia which is part of the Other businesses. The purpose of these initiatives is to reduce costs in the U.S., and to streamline and focus on profitability in Canada and Other Businesses. Total restructuring and related charges for the Company were $62 million and $57 million in the three and six months ended June 30, 2017, respectively, net of gains on sale of branches of $13 million and $23 million for the same periods. Total restructuring and other charges for the Company were $17 million and $37 million in the three and six months ended June 30, 2016, respectively, net of gains on sale of branches of $15 million for the same periods. Approximately 80% and 50% of the charges in the six months ended June 30, 2017 and 2016, respectively, were non-cash. The total amount the Company expects to incur in connection with these restructuring activities is an additional $17 million, approximately, through 2018. The current year net charges are primarily comprised of the following:

6.    SHORT-TERM AND LONG-TERM DEBT

 

As of JuneSeptember 30, 2017 and December 31, 2016, there was $100$0 million and $370 million, respectively, of commercial paper outstanding. A portion of the proceeds from the May 2017 bond issuance (see below) werewas used to redeem outstanding commercial paper.

Notes, representing underwriting fees and other expenses, have been recorded as a contra-liability within Long-term debt and will be amortized to interest expense over the term of the 4.20% Notes.

similar debt instruments, among other factors, which are classified as level 2 inputs within the fair value hierarchy. The fair value of the 4.20% Notes was approximately $410$407 million as of JuneSeptember 30, 2017. The fair value of the 3.75% Notes was approximately $384$380 million and $371 million as of JuneSeptember 30, 2017 and December 31, 2016, respectively. The fair value of the 4.60% Notes was approximately $1.1 billion as of JuneSeptember 30, 2017 and December 31, 2016, respectively. The carrying value of other long-term debt approximates fair value due to their variable interest rates.

7.    EMPLOYEE BENEFITS - POSTRETIREMENT

 

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

The net periodic benefit(benefits) costs charged to operatingrecorded in Warehousing, marketing and administrative expenses which are valued at the measurement date of January 1 and recognized evenly throughout the year, consisted of the following components (in thousands of dollars):

The Company has established a Group Benefit Trust (Trust) to fund thepostretirement healthcare benefits plan obligations and process benefit payments. The funding of the trustTrust is an estimated amount which is intended to allow the maximum deductible contribution under the Internal Revenue Code of 1986 (IRC), as amended. There are zerono minimum funding requirements and the Company did not make contributions to the trust during the six months ended June 30, 2017. The Company intends to follow its practice of funding the maximum deductible amountscontribution under the IRC. The Company did not make a contribution to the Trust during the nine months ended September 30, 2017.

8.    SEGMENT INFORMATION

 

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

  

 

Following are reconciliations of segment information with the consolidated totals per the financial statements (in thousands of dollars):

 

Assets for reportable segments include net accounts receivable and first-in, first-out inventory which are reported to the Company's Chief Operating Decision Maker. Other current and non-current assets include all other assets of the reportable segments.

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

Intersegment net sales for the U.S. segment increased by $16$12 million and $29$40 million for the three and sixnine months ended JuneSeptember 30, 2017, respectively, compared to the prior year, driven by increased sales from the U.S. business to Zoro. Zoro's primary source of inventory is the U.S. business' supply chain network.

9.    EARNINGS PER SHARE

 

The following table sets forth the computation of basic and diluted earnings per share under the two-class method (in thousands of dollars, except for share and per share amounts):

10.    CONTINGENCIES AND LEGAL MATTERS

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

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

W.W. Grainger, Inc. (Grainger) is a broad-linebroad line, business-to-business distributor of maintenance, repair and operating (MRO) supplies, and other related products and services used by businesses and institutions. Grainger’swith operations are primarily in the United States (U.S.) and Canada, with a presence in Europe, Asia and Latin America. More than 3.2 million businesses and institutions worldwide rely on Grainger usesfor products such as safety, gloves, ladders, motors and janitorial supplies, along with services like inventory management and technical support. These customers represent a combinationbroad collection of multichannelindustries including commercial, government, healthcare and single channel business models to provide customers with a range of options for finding and purchasing products utilizingmanufacturing. They place orders online, on mobile devices, through sales representatives, catalogs, direct marketing materialsover the phone and eCommerce.at local branches. Approximately 5,000 suppliers provide Grainger serves approximately 3with more than 1.6 million customers worldwide through a network of highly integrated branches,products stocked in Grainger's distribution centers (DCs) and websites.branches worldwide.

Given Grainger's large number of customers and the diverse industries it serves, several economic factors and industry trends tend to shape Grainger’s business environment. The overall economy and leading economic indicators provide general insight into projecting Grainger's growth. Grainger’s sales in the U.S. and Canada tend to positively correlate with Business Investment, Business Inventory, Exports and Industrial Production. In the U.S., sales tend to positively correlate with Gross Domestic Product (GDP). In Canada, sales tend to positively correlate with oil prices. The table below provides these estimated indicators for 2017:

Per the Global Insight JulyOctober 2017 forecast, Canada economic growth, as measured by GDP, is forecast to grow to 2.5%3.1% in 2017. The 2017 forecast assumes that oil prices will continue to grow and stabilize as compared to 2016 and that business nonresidentalnonresidential investment (a component of Business Investment) will begin to increase. The latest forecast is for the Canadian dollar to strengthen against the U.S. dollar over the next two years.quarters.

Outlook

On July 19,October 17, 2017, Grainger reiteratednarrowed its sales and earnings per share guidance for 2017. The Company now expects 2017 sales growth of 1.5 to 2.5 percent and earnings per share of $10.40 to $10.90. The Company's previous 2017 guidance included sales growth of 1 to 4 percent and the 2017 adjusted earnings per share guidance of the range of $10.00 to $11.30. The second quarter performance was as expected and the Company anticipates continued positive response to the U.S. pricing actions in the second half of the year.

Matters Affecting Comparability

There were 6463 sales days in the secondthird quarter of 2017 andcompared to 64 sales days in 2016.

Results of Operations – Three Months Ended JuneSeptember 30, 2017

The following table is included as an aid to understanding the changes in Grainger’s Condensed Consolidated Statements of Earnings (in millions of dollars):

(A) May not sum due to rounding

The increase in net sales was primarily driven by the single channel online businesses in the U.S. and Japan, as well as volume increases in the U.S. business as a result of the pricing actions. Refer to the Segment Analysis below for further details.

Gross profit of $1,040$1,017 million for the secondthird quarter of 2017 was flatdecreased $23 million or 2% compared to the same quarter in 2016. The gross profit margin of 39.8%38.6% during the secondthird quarter of 2017 decreased 0.81.4 percentage pointpoints when compared to the same period in 2016, driven primarily by customer response tothe pricing actions in the U.S. pricing actions.business.

Operating expenses of $808$736 million for the secondthird quarter of 2017 increased 10%3% from $734$717 million for the comparable 2016 quarter. The increase was primarily due to the following:

Operating earnings for the third quarter of 2017 were $281 million, a decrease of 13% compared to the third quarter of 2016. The decrease in operating earnings decreased 9%,was driven primarily by lower gross profit from the pricing actions in the U.SU.S. business and increased operating expense based on higher volume.employee related costs.

Net earnings attributable to W.W. Grainger, Inc. for the secondthird quarter of 2017 decreased 43%13% to $98$162 million from $173$186 million in the secondthird quarter of 2016. Excluding restructuring costs and gains on sales of assets in both periods mentioned above, net earnings decreased 10%,2016, primarily related to lower gross profit and higher operating expenses.

Diluted earnings per share of $1.67$2.79 in the secondthird quarter of 2017 were down 40%9% versus the $2.79$3.05 for the secondthird quarter of 2016 due to lower earnings, partially offset by lower average shares outstanding.

The table below reconciles reported operating earnings determined in accordance with U.S. generally accepted accounting principles (GAAP) to adjusted operating earnings, a non-GAAP measure. Management believes adjusted operating earnings is an important indicator of operations because it excludes items that may not be indicative of core operating results. Because non-GAAP financial measures are not standardized, it may not be possible to compare this financial measure with other companies' non-GAAP financial measures having the same or similar names.

Segment Analysis

Grainger’s two reportable segments are the U.S. and Canada. The U.S. operating segment reflects the results of Grainger’s U.S. business.businesses. The Canada operating segment reflects the results for Acklands – Grainger.Grainger Inc. and its subsidiaries. Other businesses include MonotaRO in Japan, Zorothe single channel online businesses (Zoro in the U.S. and MonotaRO in Japan) and operations in Europe, Asia and Latin America.

The following comments at the segment and business unit level include external and intersegment net sales and operating earnings. See Note 8 to the Condensed Consolidated Financial Statements.

Net sales were $1,999$2,016 million for the secondthird quarter of 2017, an increasea decrease of 1% when compared with net sales of $1,979$2,028 million for the same period in 2016. TheOn a daily basis, sales increased 1% increaseand consisted of the following:

Sales to Zoro continue to contribute to sales growth as the U.S. business' supply chain network is Zoro's primary source of inventory, as well as volume increasescustomers in the U.S. as a result of the pricing actions.natural resources increased high single digits. Resellers, transportation and retail end markets increased mid-single digits, while heavy manufacturing and government increased low single digits.

Operating expenses of $507$493 million in the secondthird quarter of 2017 increased $20 million, or 4%were flat versus the secondthird quarter of 2016. Operating expenses in 2017 included2016 demonstrating leverage on volume growth as a $13 million benefit from the gain on saleresult of branches and $13 million of restructuring costs. Excluding restructuring costs and gain on sale of assets in both periods mentioned above, operating expenses increased 2% on 5% of volume growth.pricing actions.

Operating earnings of $312$298 million for the secondthird quarter of 2017 decreased 11%13% from $349$343 million for the secondthird quarter of 2016 . Excluding the restructuring charges and gain on the sale of assets in both periods mentioned above, operating earnings decreased 8%, primarily driven primarily by the pricing actions.

Net sales were $189$188 million for the secondthird quarter of 2017, a decreasean increase of $5$9 million, or 3%5%, when compared with $194$179 million for the same period in 2016. In local currency,On a daily basis, sales increased 2%. The 3% decrease7% and consisted of the following:

The gross profit margin increased 4.1improved 0.8 percentage points in the secondthird quarter of 2017 versus the secondthird quarter of 2016 primarily due largely to a favorable comparison to animproved management and disposition of obsolete or discontinued inventory adjustmentand thus lower inventory reserve requirements in the prior year. During the quarter ended June 30, 2016, the Canadian business recorded an additional reserve of $10 million, as a result of additional visibility to inventory performance provided by the conversion to the North American ERP platform.2017 and incremental vendor rebates.

 

Operating expenses increased $6$4 million, or 8%6% in the secondthird quarter of 2017 versus the secondthird quarter of 2016. Excluding restructuring costs in both quarters mentioned above, operating expenses decreased 6%,2016, primarily related to reductions inforeign exchange and higher employee related costs.

Net sales for other businesses which include MonotaRO in Japan, Zoro in the U.S., and operations in Europe, Asia and Latin America, were $527$537 million for the secondthird quarter of 2017, an increase of $52$55 million, or 11%, when compared with net sales of $474$482 million for the same period in 2016. SalesOn a daily basis, sales increased 11% for the quarter13% and consisted of the following: