W.W. Grainger, Inc. — Q3 2017 Form 10-Q
Reporting period: Three and nine months ended September 30, 2017. Grainger distributes maintenance, repair and operating supplies and related services, primarily in the U.S. and Canada, with additional international businesses. Financial statements are unaudited.
Financial performance
| Metric | Q3 2017 | Q3 2016 | Nine months 2017 | Nine months 2016 |
|---|---|---|---|---|
| Net sales | $2.636 billion | $2.596 billion | $7.792 billion | $7.666 billion |
| Gross profit | $1.017 billion | $1.040 billion | $3.076 billion | $3.125 billion |
| Gross margin | 38.6% | 40.0% | 39.5% | 40.8% |
| Operating earnings | $281 million | $323 million | $809 million | $945 million |
| Net earnings attributable to Grainger | $162 million | $186 million | $435 million | $545 million |
| Diluted EPS | $2.79 | $3.05 | $7.39 | $8.82 |
Q3 sales rose 2% (3% on a daily basis); nine-month sales rose 2% (also 2% daily). Pricing actions drove volume but weighed on margins, particularly in the U.S. Operating earnings fell 13% in Q3 and 14% for the nine months. Nine-month diluted EPS declined 16%; fewer average shares partly offset the earnings decline. Q3 effective tax rate was 31.7%, versus 34.0%; the nine-month rates were 36.7% and 35.4%, respectively.
Cash flow, debt and liquidity
- Nine-month operating cash flow was $721 million, compared with $689 million in 2016. Capital expenditures were $191 million, versus $214 million.
- Investing activities used $100 million, compared with $185 million used in 2016. Financing activities used $619 million, versus $518 million.
- Cash was $285 million at September 30, 2017. Total interest-bearing debt, including current maturities and short-term debt, was approximately $2.323 billion. Debt as a percentage of total capitalization was 55.0%, versus 54.1% at December 31, 2016.
- Working capital, as defined by the company, was $1.740 billion, up from $1.722 billion at year-end; its working-capital-assets-to-liabilities ratio decreased to 2.3 from 2.4.
- Grainger issued $400 million of 4.20% senior notes due 2047 in May; proceeds partly repaid commercial paper. No commercial paper was outstanding at quarter-end. On October 6, the company replaced its $900 million revolving credit facility with a five-year $750 million facility, expandable to $1.125 billion subject to conditions.
Business developments and material changes
- U.S. segment sales were roughly flat for the first nine months, while operating earnings declined 10%. U.S. pricing actions reduced gross margin by 1.6 percentage points for the period.
- Canada nine-month sales increased 2%, but the segment reported a $59 million operating loss, compared with a $55 million loss. Other Businesses sales rose 11%; operating earnings fell to $44 million from $76 million, including restructuring costs.
- Company-wide eCommerce sales rose 14% to $4.029 billion for the first nine months and represented 52% of sales, versus 46% in 2016.
- Nine-month restructuring costs, net of gains, were $69.5 million, including $41.3 million in Other Businesses, primarily related to the Colombia wind-down. The company reported a $7.2 million goodwill impairment in the U.S.; separate tests of Canada and Other Businesses identified no goodwill or indefinite-lived intangible impairment at September 30.
- A postretirement plan design change for post-65 retirees, effective January 1, 2018, reduced the plan obligation by $75.7 million. A related after-tax remeasurement gain of $46.5 million was recorded in other comprehensive earnings.
Outlook, commentary and risks
On October 17, Grainger narrowed its 2017 guidance to sales growth of 1.5%–2.5% and EPS of $10.40–$10.90, from prior ranges of 1%–4% sales growth and $10.00–$11.30 EPS. Management attributed sales growth to online businesses and volume gains associated with U.S. pricing actions; those actions also reduced gross margins. Q3 had one fewer sales day than the prior-year quarter, and the first nine months had one fewer sales day than the comparable period.
Key risks identified include competitive pricing and execution of pricing strategy, product costs, customer or supply disruptions, economic and currency conditions, labor and transportation costs, technology and cybersecurity disruptions, regulatory or litigation outcomes, and the ability to execute growth and productivity initiatives. Management said routine legal and administrative matters were not expected to have a material adverse effect. The company settled an individual Telephone Consumer Protection Act claim; the case was dismissed with prejudice in September.
The company expects the new revenue-recognition standard to have no material financial-statement impact and planned modified-retrospective adoption on January 1, 2018. The company reported no material change in internal controls and concluded disclosure controls were effective.
Important facts for investors to verify
- Whether pricing actions deliver sustainable volume, customer gains and market share without further significant margin erosion.
- Progress against the narrowed 2017 sales and EPS guidance, including the contribution and profitability of online businesses.
- Restructuring execution and costs, particularly the Colombia wind-down and Canada operations; assess assumptions behind goodwill and intangible-asset valuations.
- Debt, interest costs, and capital allocation, including share repurchases and dividends; the filing reports $436 million of treasury-stock purchases and $226 million of dividends paid in the first nine months.
- Effects of the postretirement plan change and adoption of new accounting standards.