W.W. Grainger, Inc. — Q1 2017 Form 10-Q
Business context and period. Unaudited results for the three months ended March 31, 2017, compared with Q1 2016. Grainger distributes maintenance, repair and operating supplies through U.S. and Canadian businesses and other operations, including online businesses. The quarter had 64 sales days in both years.
Financial performance
| Metric | Q1 2017 | Q1 2016 | Change |
|---|---|---|---|
| Net sales | $2.541 billion | $2.507 billion | +1% |
| Gross profit / margin | $1.019 billion / 40.1% | $1.045 billion / 41.7% | Profit -2%; margin -1.6 percentage points |
| Operating earnings / margin | $295.5 million / 11.6% | $317.1 million / 12.7% | -7% |
| Net earnings attributable to Grainger | $174.7 million | $186.7 million | -6% |
| Diluted EPS | $2.93 | $2.98 | -2% |
| Operating cash flow | $180.9 million | $160.6 million | +13% |
Sales growth reflected 5% volume growth, offset by a 3% price decline and 1% seasonal decline. eCommerce sales increased 15% to $1.293 billion, or 51% of sales versus 45% a year earlier. Reported diluted EPS included a $0.13 benefit from adoption of the stock-compensation accounting standard, including $7.6 million of excess tax benefits recognized in income taxes. Management’s adjusted diluted EPS, a non-GAAP measure, was $2.88 versus $3.18, down 9%.
Segments
- United States: Segment sales were $1.953 billion, down 1%; operating earnings were $312.5 million, down 6%. Strategic pricing reduced gross margin by 1.7 percentage points.
- Canada: Segment sales were $186.1 million, up 4% reported but 1% in local currency; operating loss widened to $16.7 million from $12.3 million. Lower gross margin reflected price deflation versus cost inflation and higher freight costs.
- Other businesses: Sales were $496.6 million, up 12%; operating earnings rose to $31.5 million from $21.8 million, primarily on strong performance by Zoro and MonotaRO.
Cash, liquidity and debt
- Cash and equivalents were $238.8 million at March 31, down from $274.1 million at year-end. Operating cash flow was $180.9 million; investing used $37.5 million and financing used $183.2 million.
- Capital expenditures were $78.8 million, compared with $51.8 million a year earlier. The company repurchased $159.1 million of shares and paid $72.1 million in dividends.
- Total debt was approximately $2.29 billion, including $421.6 million of short-term debt and $1.85 billion of long-term debt. Debt was 54.4% of total capitalization, versus 54.1% at December 31, 2016. Additional commercial paper was used for working capital and share repurchases.
- Company-defined working capital was $1.795 billion, up $73 million from year-end; its working-capital-assets-to-liabilities ratio was 2.4 at both dates. A quarterly dividend of $1.28 per share was declared on April 26, payable June 1, 2017.
Outlook, changes and risks
- On April 18, 2017, Grainger lowered its 2017 sales-growth outlook from 2%–6% to 1%–4%, and EPS guidance from $11.30–$12.40 to $10.00–$11.30. The revised outlook incorporates pricing initiatives and a 1% sales reduction from foreign exchange. Management said more competitive pricing, including lower web prices, is intended to support market share gains and customer acquisition.
- Pricing actions were the principal pressure on gross margin and U.S. operating earnings. Management also cited higher interest expense, reflecting $400 million of long-term debt issued in May 2016, and expected losses on clean-energy investments.
- Q1 operating expenses included a $9 million gain on U.S. branch sales and $4 million of restructuring costs. Restructuring costs were approximately $4 million, versus $16 million in Q1 2016; the remaining reserve was approximately $19 million, mostly expected to be paid in 2017. Prior-year comparisons also included a gain on sale of the former Toronto distribution center.
- Key stated risks include competitive pricing and the results of strategic pricing actions, product-cost and supply disruptions, economic conditions, foreign exchange, technology and cybersecurity issues, litigation and regulatory matters, and labor or transportation disruptions.
- A TCPA lawsuit relating to a 2009 fax campaign remained pending, with trial set for February 5, 2018. Grainger said it would defend the matter and did not expect a material adverse effect, but could not predict the outcome. The filing also describes routine legal and administrative proceedings.
- Grainger adopted several accounting updates in 2017; the stock-compensation update affected the tax rate and cash-flow classification. It planned modified-retrospective adoption of the new revenue standard on January 1, 2018 and said its initial assessment indicated no material financial-statement impact; assessment was ongoing.
Investor verification points
- Track sales, volume and realized pricing against revised guidance, particularly whether lower prices produce the intended share and customer gains.
- Verify margin recovery and the relative contribution of U.S., Canada and online businesses; Canada remained loss-making.
- Assess the sustainability of earnings and tax benefits, including the $0.13 per-share stock-compensation accounting benefit and management’s non-GAAP adjustments.
- Monitor commercial-paper borrowing, total debt, share repurchases, capital spending and cash conversion.
- Follow the TCPA litigation and the company’s implementation and quantified impact assessment of the revenue-recognition standard.