W.W. Grainger, Inc. — Q2 2017 Form 10-Q
Business context and reporting period. Grainger distributes maintenance, repair and operating supplies and related services, primarily in the U.S. and Canada, with additional international operations. This unaudited report covers the three and six months ended June 30, 2017; comparisons are with the corresponding 2016 periods.
Key financial metrics
| Metric | Q2 2017 | Six months 2017 |
|---|---|---|
| Net sales | $2.615 billion, up 2% | $5.156 billion, up 2% |
| Gross profit / margin | $1.040 billion / 39.8% (down 0.8 percentage point) | $2.059 billion / 39.9% (down 1.2 points) |
| Operating earnings | $232 million, down 24%; 8.9% of sales | $528 million, down 15%; 10.2% of sales |
| Net earnings attributable to Grainger | $98 million, down 43% | $273 million, down 24% |
| Diluted EPS | $1.67, down 40% | $4.61, down 20% |
| Operating cash flow | Not separately reported for the quarter | $372 million, versus $343 million |
Q2 eCommerce sales were $1.349 billion, up 14%, or 52% of sales. Six-month eCommerce sales were $2.642 billion, up 14%, or 51% of sales. Cash and equivalents were $275 million at June 30, 2017. Working capital was $1.862 billion, up $140 million from year-end; the working-capital-assets-to-liabilities ratio was 2.5, versus 2.4.
At June 30, short-term debt was $129 million and long-term debt, including current maturities, was approximately $2.297 billion. Total interest-bearing debt was 56.8% of total capitalization, compared with 54.1% at December 31, 2016. The company issued $400 million of 4.20% senior notes due 2047 in May; part of the proceeds repaid commercial paper.
For the first half, investing activities used $75 million, including $131 million of capital expenditures; financing activities used $304 million. Grainger repurchased $314 million of stock and paid $152 million in dividends. Cash increased by $1 million to $275 million.
Material changes versus prior comparable periods
- Sales increased modestly, but gross margin declined, primarily due to customer response to U.S. pricing actions. For Q2, volume contributed 7% to sales growth while price reduced growth by 3%; for the first half, volume contributed 6% and price reduced growth by 3%.
- Reported operating earnings and EPS fell substantially. Excluding restructuring charges and branch-sale gains, adjusted operating earnings declined 9% in Q2 and 11% in the first half; these are company-defined non-GAAP measures.
- Q2 operating expenses rose 10%, including restructuring and Colombia wind-down costs. The effective tax rate was 48.4% for Q2 and 39.4% for the first half, elevated by the inability to recognize tax benefits associated with the Colombia exit.
- Segment results were uneven: U.S. Q2 sales rose 1% and operating earnings fell 11%; Canada sales fell 3% in U.S. dollars (up 2% in local currency) and the operating loss was $28 million; Other Businesses sales rose 11% but reported a $14 million operating loss, including Colombia exit-related charges.
- Operating cash flow improved year over year despite lower earnings, primarily due to lower employee-benefit payments. The 2016 comparison reflects a $17 million reclassification from operating to financing cash flows under a newly adopted stock-compensation accounting standard.
Outlook, management commentary and risks
- On July 19, Grainger reiterated 2017 sales growth guidance of 1%–4% and adjusted EPS guidance of $10.00–$11.30. Management said Q2 performance was as expected and anticipated continued positive response to U.S. pricing actions in the second half. The company expected a full-year effective tax rate of approximately 35%–36%.
- Restructuring continues in the U.S., Canada and Other Businesses. Canada announced closure of 59 underperforming branches; Colombia operations are being wound down, with completion expected in 2018. The company expected approximately $17 million of additional restructuring costs through 2018. Colombia-related charges included a $16 million foreign-currency translation loss reclassified to expense; the company cannot recognize the associated tax benefit.
- Management reported no goodwill or indefinite-lived intangible impairment trigger as of June 30, but cited sensitivity to Canada’s execution, volume growth, pricing, productivity, cost inflation and market conditions. Goodwill and intangible assets totaled approximately $1.1 billion.
- Risks identified include competitive pricing, product and operating cost increases, customer or supply disruption, execution of pricing and technology strategies, economic and currency changes, litigation and regulatory matters, cybersecurity and IT disruption, labor and transportation constraints, and weather or other catastrophes.
- Routine legal matters were not expected to materially adversely affect results or financial position. A TCPA lawsuit concerning a 2009 fax campaign remained pending, with trial scheduled for February 5, 2018; the company said it would defend the case and could not predict the outcome.
Important facts for investors to verify
- Whether U.S. pricing actions deliver the guided sales and adjusted EPS outcomes without further pressure on gross margin.
- Whether restructuring, the Canadian branch closures and Colombia wind-down remain within the disclosed cost and timing expectations, and how adjusted results reconcile to GAAP.
- Whether Canada and Other Businesses improve operating performance, and whether goodwill assumptions remain supportable as their plans progress.
- Debt, interest expense, cash generation and capital returns following the 2047 note issuance and continued share repurchases.
- The eventual resolution and financial impact, if any, of the TCPA litigation and other contingencies.