W.W. Grainger, Inc. — 2016 Form 10-K
Business context and reporting period. Grainger distributes maintenance, repair and operating supplies, primarily in the United States and Canada, with additional international and online businesses. This filing covers the fiscal year ended December 31, 2016; quarterly figures below identify the fourth quarter where relevant.
Financial performance
| Metric | 2016 | 2015 | Change |
|---|---|---|---|
| Net sales | $10.14 billion | $9.97 billion | +2% |
| Gross margin | 40.6% | 42.4% | -1.8 percentage points |
| Operating earnings | $1.12 billion | $1.30 billion | -14% |
| Net earnings attributable to Grainger | $606 million | $769 million | -21% |
| Diluted EPS | $9.87 | $11.58 | -15% |
| Cash from operations | $1.00 billion | $990 million | +$13 million |
| Capital expenditures | $284 million | $374 million | -$90 million |
Sales growth reflected the Cromwell acquisition (+3%) and volume (+1%), partly offset by price deflation (-2%). Gross margin pressure resulted primarily from price deflation exceeding cost deflation and an unfavorable customer mix. Management reported adjusted diluted EPS of $11.58 for 2016, down 3% from $11.94 in 2015; this non-GAAP measure excludes specified charges and discrete tax items.
Fourth-quarter sales were $2.47 billion, versus $2.48 billion a year earlier. Operating earnings were $174 million versus $252 million, and diluted EPS was $1.01 versus $2.30.
Liquidity, debt and capital allocation
- Year-end cash and cash equivalents were $274 million. Working capital was $1.72 billion and the current ratio was 2.4, compared with 2.5 at year-end 2015.
- Total debt as a percentage of capitalization rose to 54.1% from 45.8%; debt/EBITDA was 1.7x, above management’s 1.0–1.5x target. The company issued $400 million of 30-year notes at 3.75% in May 2016.
- Cash dividends paid were $303 million, or $4.83 per share. Treasury stock purchases were $790 million, down from $1.40 billion in 2015.
- Management planned 2017 capital expenditures of $250–$275 million, funded primarily from operating cash, and a $600 million share-repurchase target to help reduce short-term debt.
Material changes and segment trends
- United States: Sales declined 1% to $7.87 billion; operating earnings declined 7% to $1.27 billion. U.S. eCommerce sales increased 12% to $3.66 billion, or 46% of segment sales. Grainger closed 55 U.S. branches during 2016.
- Canada: Sales fell 18% to $734 million, including a 15% decline in local currency; the segment recorded a $65 million operating loss versus $27 million of earnings in 2015. Weak oil and gas markets, ERP implementation disruption, freight costs and a $10 million inventory adjustment weighed on results. Management said restructuring and system investments were intended to return the business to break-even by the end of 2017.
- Other businesses: Sales increased 34% to $1.88 billion, mainly due to Cromwell and growth at Zoro and MonotaRO. Operating earnings were $41 million versus $48 million, including $52 million of goodwill and intangible impairment charges.
- Consolidated eCommerce sales increased 15% to $4.76 billion, or 47% of total sales. Including KeepStock inventory-management revenue, management reported 56% of sales through those channels.
Outlook, unusual items and risks
- Grainger reiterated 2017 guidance of 2%–6% sales growth and diluted EPS of $11.30–$12.40. Its outlook cited expected improvement in U.S. and Canadian economic indicators, while acknowledging uncertainty in market conditions.
- 2016 results included a reported net expense of $105 million, or $1.71 per share, from restructuring, impairment, unclaimed-property and government-contract contingencies, a Canadian inventory adjustment, and discrete tax items. The $52 million impairment was noncash.
- Grainger recorded a $36 million pretax charge for unclaimed-property obligations principally related to 2008–2012. It concluded the matter was not material to prior periods and did not revise those statements.
- Acklands-Grainger agreed to pay a C$500,000 fine under a negotiated plea agreement concerning sales of products containing an ozone-depleting substance. The company intends to seek supplier indemnification.
- Key risks include economic weakness and cyclical customer demand, online and price-based competition, margin pressure from deflation and customer mix, supply-chain or systems disruption, cybersecurity incidents, foreign exchange, and legal, regulatory and tax contingencies. Grainger also noted the potential for additional Fabory impairment; $55 million of Fabory goodwill remained at year-end.
- Management and the auditor concluded that internal control over financial reporting was effective as of December 31, 2016; the auditor issued unqualified opinions on the financial statements and internal controls.
Important facts for investors to verify
- Whether 2017 sales and EPS guidance was achieved, particularly given the weak 2016 gross-margin trend.
- Whether Canadian restructuring and ERP remediation restored service levels and delivered the expected break-even outcome.
- Whether debt/EBITDA declined toward the 1.0–1.5x target and how debt-funded repurchases affected leverage and per-share results.
- Whether Fabory’s performance or assumptions led to further impairment, and whether other unusual charges recur.
- Updates on the unclaimed-property obligation, GSA audit reserve, TCPA litigation and supplier-indemnification claims.