W.W. Grainger, Inc. — 2018 Form 10-K
Reporting period: Fiscal year ended December 31, 2018. The filing also reports unaudited fourth-quarter results. Grainger distributes maintenance, repair and operating products and services, primarily in North America, Europe and Japan, through high-service businesses and online “endless assortment” businesses, including Zoro and MonotaRO.
Financial performance
| Metric | FY 2018 | FY 2017 | Change |
|---|---|---|---|
| Net sales | $11.221 billion | $10.425 billion | +8% reported; +7% per sales day |
| Gross profit / margin | $4.348 billion / 38.7% | $4.098 billion / 39.3% | Margin down 0.6 percentage points |
| Operating earnings / margin | $1.158 billion / 10.3% | $1.035 billion / 9.9% | +12% |
| Net earnings attributable to Grainger | $782 million | $586 million | +33% |
| Diluted EPS | $13.73 | $10.02 | +37% |
| Cash provided by operations | $1.057 billion | $1.057 billion | Unchanged |
Fourth-quarter sales were $2.763 billion, versus $2.633 billion in Q4 2017; operating earnings were $290 million versus $236 million; net earnings attributable to Grainger were $209 million versus $151 million; diluted EPS was $3.68 versus $2.63.
Gross margin was pressured by pricing and mix; approximately 0.5 percentage points of the annual decline reflected the new revenue-recognition standard’s reclassification of certain KeepStock costs from SG&A to cost of goods sold. Excluding specified restructuring, impairment and other items, management reported adjusted operating earnings of $1.344 billion and adjusted net earnings attributable to Grainger of $952 million. These are non-GAAP measures and are not directly comparable across companies.
Segments and cash generation
- U.S. external-customer sales were $8.131 billion, up about 8%; growth reflected market-share gains and improved demand.
- Canada sales were $653 million, down 13% reported (down 14% per sales day). Volume fell 23 percentage points, partly offset by 9 percentage points from pricing.
- Other businesses, including Zoro and MonotaRO, recorded $2.437 billion in external sales, up about 15%; operating earnings fell to $8 million, including Cromwell impairment charges.
- Investing cash outflow was $166 million and financing cash outflow was $670 million. Capital expenditures were $239 million. Operating cash flow less capital expenditures was approximately $818 million, calculated from the reported figures.
- Cash and cash equivalents were $538 million at year-end, compared with $327 million. Working capital was $1.898 billion; the current ratio was 2.4.
Debt, liquidity and shareholder returns
Total debt was approximately $2.242 billion, including $49 million of short-term debt and $2.193 billion of long-term debt before issuance costs and current-maturity presentation. Debt as a percentage of total capitalization was 51.5%, down from 56.2%. Grainger reported compliance with debt covenants and access to a $750 million U.S. revolving credit facility, with no borrowings outstanding under it at year-end. The company paid $5.36 per share in dividends and repurchased $425 million of treasury stock during 2018.
Material changes and unusual items
- Reported earnings included a $139 million Cromwell goodwill and trade-name impairment charge, recorded in Q3, and restructuring costs net of gains. The filing reports $170 million of total restructuring and impairment adjustments, net of related tax effects, in its reconciliation to adjusted attributable earnings.
- The Cromwell charge comprised $105 million of goodwill impairment and $34 million of trade-name impairment. Grainger cited weaker performance, a lower outlook, U.K. market uncertainty including Brexit, and higher discount-rate assumptions.
- The effective tax rate declined to 23.9% from 33.5%, primarily reflecting the U.S. Tax Act and excess tax benefits from stock-based awards, partly offset by nondeductible goodwill impairment.
- Grainger substantially completed restructuring initiatives during 2018. Canada continued to face lower volumes after branch closures and sales-coverage changes, while management said the cost-structure reset was largely complete.
Outlook, risks and contingencies
Grainger forecast 2019 capital expenditures of $300 million to $350 million, primarily funded from operating cash flow. It did not provide a clear consolidated revenue or earnings forecast in the supplied filing text. Management’s priorities include U.S. market-share growth, profitable expansion of the endless-assortment businesses, and stabilizing Canada’s volume performance. Its cited macroeconomic outlook anticipated slower U.S. business investment and industrial production, and slower Canadian investment, exports and industrial production.
- Key risks include economic and customer-demand cyclicality, intense price and e-commerce competition, commodity and freight cost inflation, tariffs and supply-chain disruption, and foreign-currency movements.
- Information-system failures and cybersecurity breaches could disrupt operations or expose sensitive data. Grainger disclosed prior cybersecurity incidents that it said were not material; it cautioned that a future incident could be material.
- Legal matters include ordinary-course claims and asbestos/silica litigation. The company stated it did not expect these matters to have a material adverse effect, while noting uncertainty in outcomes.
- At year-end, the postretirement healthcare obligation was $190 million and related trust assets available for benefits were $176 million. A recorded liability of approximately $41 million for tax uncertainties and interest was excluded from the contractual-obligations table.
- Adoption of the new lease standard in 2019 was expected to add approximately $210 million to $230 million of right-of-use assets and corresponding lease liabilities, with no material impact expected on earnings or cash flows.
Important facts for investors to verify
- Review the sustainability of sales growth and margins, separating underlying performance from pricing, mix, accounting reclassification and foreign exchange effects.
- Track Canada’s volume recovery and the profitability of the U.S. business and endless-assortment businesses.
- Assess whether cash generation can fund the higher 2019 capital-spending plan while maintaining dividends, buybacks and debt service.
- Examine Cromwell’s post-impairment performance and the potential for further goodwill or intangible-asset impairments.
- Review the detailed debt maturities, tax contingencies and legal disclosures. The auditor issued an unqualified opinion on the financial statements, and management and the auditor concluded internal control over financial reporting was effective at year-end.