Item 2: Management's Discussion and Analysis of Financial Condition and Results of Operations
Item 3. Quantitative and Qualitative Disclosures About Market Risk
Item 4. Controls and Procedures
Part II - Other Information
Item 1. Legal Proceedings
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
Item 6. Exhibits
Exhibits
EX-10.1
gww-2018093018xex101.htm
EX-31.1
gww-2018093018xex311.htm
EX-31.2
gww-2018093018xex312.htm
EX-32
gww-2018093018xex32.htm
Grainger W W Earnings 2018-09-30
GWW 10Q Quarterly Report
Balance Sheet
Income Statement
Cash Flow
10-Q 1 gww2018093018-10q.htm 10-Q Document
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 2018
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from ______ to _______
Commission file number 1-5684
W.W. Grainger, Inc.
(Exact name of registrant as specified in its charter)
Illinois
36-1150280
(State or other jurisdiction of incorporation or organization)
(I.R.S. Employer Identification No.)
100 Grainger Parkway, Lake Forest, Illinois
60045-5201
(Address of principal executive offices)
(Zip Code)
(847) 535-1000
(Registrant’s telephone number including area code)
Not Applicable
(Former name, former address and former fiscal year; if changed since last report)
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes [X] No [ ]
Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). Yes [X] No [ ]
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company” and "emerging growth company" in Rule 12b-2 of the Exchange Act.
Large accelerated filer [X] Accelerated filer [ ] Non-accelerated filer [ ] Smaller reporting company [ ]
Emerging growth company [ ]
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. [ ]
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
1
Yes [ ] No [X]
There were 56,320,463 shares of the Company’s Common Stock, par value $0.50, outstanding as of September 30, 2018.
2
TABLE OF CONTENTS
Page No.
PART I FINANCIAL INFORMATION
Item 1:
Financial Statements (Unaudited)
Condensed Consolidated Statements of Earnings for the Three and Nine Months Ended September 30, 2018 and 2017
(In thousands of dollars, except for share and per share amounts)
(Unaudited)
Three Months Ended
Nine Months Ended
September 30,
September 30,
2018
2017
2018
2017
Net sales
$
2,831,429
$
2,635,999
$
8,458,042
$
7,792,397
Cost of goods sold
1,752,194
1,618,819
5,176,107
4,716,069
Gross profit
1,079,235
1,017,180
3,281,935
3,076,328
Selling, general and administrative expenses
890,113
739,442
2,413,997
2,277,009
Operating earnings
189,122
277,738
867,938
799,319
Other income (expense):
Interest income
2,003
707
3,645
1,365
Interest expense
(22,353
)
(23,790
)
(69,942
)
(64,971
)
Losses from equity method investment
(3,731
)
(10,635
)
(18,271
)
(25,130
)
Other, net
5,976
5,978
18,001
17,284
Total other expense, net
(18,105
)
(27,740
)
(66,567
)
(71,452
)
Earnings before income taxes
171,017
249,998
801,371
727,867
Income taxes
55,972
79,182
197,798
267,239
Net earnings
115,045
170,816
603,573
460,628
Less: Net earnings attributable to noncontrolling interest
10,668
8,810
30,680
25,957
Net earnings attributable to W.W. Grainger, Inc.
$
104,377
$
162,006
$
572,893
$
434,671
Earnings per share:
Basic
$
1.84
$
2.80
$
10.12
$
7.43
Diluted
$
1.82
$
2.79
$
10.04
$
7.39
Weighted average number of shares outstanding:
Basic
56,339,630
57,316,532
56,172,277
58,010,222
Diluted
56,803,857
57,521,348
56,588,530
58,329,925
Cash dividends paid per share
$
1.36
$
1.28
$
4.00
$
3.78
The accompanying notes are an integral part of these financial statements.
4
W.W. Grainger, Inc. and Subsidiaries
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE EARNINGS
(In thousands of dollars)
(Unaudited)
Three Months Ended
Nine Months Ended
September 30,
September 30,
2018
2017
2018
2017
Net earnings
$
115,045
$
170,816
$
603,573
$
460,628
Other comprehensive (losses) earnings:
Foreign currency translation adjustments
213
24,563
(25,142
)
100,409
Postretirement benefit plan re-measurement, net of tax expense $29,172 (see note 8)
—
46,543
—
46,543
Postretirement benefit plan reclassification, net of tax benefit of $825, $962, $2,475 and $2,720, respectively
(2,440
)
(1,540
)
(7,317
)
(4,338
)
Other
1
1
23
(11
)
Total other comprehensive (losses) earnings
(2,226
)
69,567
(32,436
)
142,603
Comprehensive earnings, net of tax
112,819
240,383
571,137
603,231
Less: Comprehensive earnings (losses) attributable to noncontrolling interest
Net earnings
10,668
8,810
30,680
25,957
Foreign currency translation adjustments
(4,472
)
(8
)
(2,248
)
4,338
Comprehensive earnings attributable to noncontrolling interest
6,196
8,802
28,432
30,295
Comprehensive earnings attributable to W.W. Grainger, Inc.
$
106,623
$
231,581
$
542,705
$
572,936
The accompanying notes are an integral part of these financial statements.
5
W.W. Grainger, Inc. and Subsidiaries
CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands of dollars, except for share and per share amounts)
As of
(Unaudited)
ASSETS
September 30, 2018
Dec 31, 2017
CURRENT ASSETS
Cash and cash equivalents
$
516,850
$
326,876
Accounts receivable (less allowances for doubtful
accounts of $27,336 and $29,267, respectively)
1,481,300
1,325,186
Inventories, net
1,473,117
1,429,199
Prepaid expenses and other assets
93,586
86,667
Prepaid income taxes
18,491
38,061
Total current assets
3,583,344
3,205,989
PROPERTY, BUILDINGS AND EQUIPMENT, NET
1,348,914
1,391,967
DEFERRED INCOME TAXES
20,726
22,362
GOODWILL
429,818
543,903
INTANGIBLES, NET
479,521
569,115
OTHER ASSETS
69,860
70,918
TOTAL ASSETS
$
5,932,183
$
5,804,254
LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES
Short-term debt
$
49,429
$
55,603
Current maturities of long-term debt
36,973
38,709
Trade accounts payable
730,215
731,582
Accrued compensation and benefits
215,727
254,560
Accrued contributions to employees' profit sharing plans
93,509
92,682
Accrued expenses
302,263
313,766
Income taxes payable
39,216
19,759
Total current liabilities
1,467,332
1,506,661
LONG-TERM DEBT (less current maturities)
2,148,399
2,248,036
DEFERRED INCOME TAXES AND TAX UNCERTAINTIES
115,644
111,710
EMPLOYMENT-RELATED AND OTHER NON-CURRENT LIABILITIES
100,754
110,114
SHAREHOLDERS' EQUITY
Cumulative preferred stock – $5 par value – 12,000,000 shares authorized; none issued nor outstanding
—
—
Common stock – $0.50 par value – 300,000,000 shares authorized; 109,659,219 shares issued
54,830
54,830
Additional contributed capital
1,124,831
1,040,493
Retained earnings
7,751,677
7,405,192
Accumulated other comprehensive losses
(164,862
)
(134,674
)
Treasury stock, at cost – 53,338,756 and 53,330,356 shares, respectively
(6,828,773
)
(6,675,709
)
Total W.W. Grainger, Inc. shareholders’ equity
1,937,703
1,690,132
Noncontrolling interest
162,351
137,601
Total shareholders' equity
2,100,054
1,827,733
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY
$
5,932,183
$
5,804,254
The accompanying notes are an integral part of these financial statements.
6
W.W. Grainger, Inc. and Subsidiaries
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands of dollars)
(Unaudited)
Nine Months Ended
September 30,
2018
2017
CASH FLOWS FROM OPERATING ACTIVITIES:
Net earnings
$
603,573
$
460,628
Provision for losses on accounts receivable
6,784
15,187
Deferred income taxes and tax uncertainties
10,004
(15,261
)
Depreciation and amortization
191,602
194,338
Net gains from sales of assets and divestitures
(22,270
)
(7,163
)
Impairment of goodwill, intangible and other assets
142,155
18,459
Stock-based compensation
36,241
27,152
Losses from equity method investment
18,271
25,130
Change in operating assets and liabilities:
Accounts receivable
(171,829
)
(145,631
)
Inventories
(53,270
)
34,851
Prepaid expenses and other assets
(12,920
)
(4,206
)
Trade accounts payable
4,419
56,717
Other current liabilities
(36,377
)
29,643
Income taxes payable, net
38,666
18,015
Accrued employment-related benefits cost
(18,408
)
4,306
Other, net
6,363
8,713
Net cash provided by operating activities
743,004
720,878
CASH FLOWS FROM INVESTING ACTIVITIES:
Additions to property, buildings and equipment and intangibles
(168,896
)
(191,183
)
Proceeds from sales of assets and business divestitures
75,558
110,421
Equity method investment
(11,875
)
(22,430
)
Other, net
—
3,554
Net cash used in investing activities
(105,213
)
(99,638
)
CASH FLOWS FROM FINANCING ACTIVITIES:
Net increase (decrease) in commercial paper
18
(369,748
)
Borrowings under lines of credit
23,782
33,931
Payments against lines of credit
(27,899
)
(39,705
)
Proceeds from issuance of long-term debt
185
424,020
Payments of long-term debt
(89,408
)
(15,812
)
Proceeds from stock options exercised
179,549
27,255
Payments for employee taxes withheld from stock awards
(11,381
)
(17,546
)
Purchase of treasury stock
(282,746
)
(435,983
)
Cash dividends paid
(232,289
)
(225,504
)
Other, net
2,747
—
Net cash used in financing activities
(437,442
)
(619,092
)
Exchange rate effect on cash and cash equivalents
(10,375
)
8,281
NET CHANGE IN CASH AND CASH EQUIVALENTS
189,974
10,429
Cash and cash equivalents at beginning of year
326,876
274,146
Cash and cash equivalents at end of period
$
516,850
$
284,575
The accompanying notes are an integral part of these financial statements.
7
W.W. Grainger, Inc. and Subsidiaries
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
1. BACKGROUND AND BASIS OF PRESENTATION
W.W. Grainger, Inc. is a broad line, business-to-business distributor of maintenance, repair and operating (MRO) supplies, and other related products and services. W.W. Grainger, Inc.’s operations are primarily in the United States (U.S.) and Canada, with a presence in Europe, Asia and Latin America. In this report, the words “Company” or “Grainger” mean W.W. Grainger, Inc. and its subsidiaries, except where the context makes it clear that the reference is only to W.W. Grainger, Inc. itself and not its subsidiaries.
The Condensed Consolidated Financial Statements of the Company and the related notes are unaudited and should be read in conjunction with the consolidated financial statements and related notes for the year ended December 31, 2017 included in the Company’s Annual Report on Form 10-K filed with the Securities and Exchange Commission (SEC) on February 26, 2018.
The Condensed Consolidated Balance Sheet as of December 31, 2017 has been derived from the audited consolidated financial statements at that date, but does not include all of the disclosures required by accounting principles generally accepted in the U.S. for complete financial statements.
The unaudited financial information reflects all adjustments (primarily consisting of normal recurring adjustments) which, in the opinion of management, are necessary for a fair presentation of the statements contained in this report.
2. NEW ACCOUNTING STANDARDS
In March 2017, the Financial Accounting Standards Board (FASB) issued Accounting Standard Update (ASU) 2017-07, Compensation Retirement Benefits (Topic 715): Improving the Presentation of Net Periodic Pension Cost and Net Periodic Postretirement Benefit Cost (ASU 2017-07). This ASU improves the presentation of net periodic pension cost and net periodic postretirement benefit cost. The effective date of this ASU was for fiscal years and interim periods beginning after December 15, 2017. The Company adopted this ASU as of January 1, 2018. This ASU was applied retrospectively for the presentation of the net periodic postretirement cost components in the Condensed Consolidated Statement of Earnings for the three and nine months ended September 30, 2017 and prospectively, after the effective date. The guidance limiting the capitalization of net periodic benefit cost in assets to the service cost component is applied prospectively. The impact of the ASU for the three and nine months ended September 30, 2017 was an increase of $3.4 million and $9.4 million, respectively, in Selling, general and administrative expenses (SG&A) offset by a reduction in Total other expense, net of $3.4 million and $9.4 million, respectively, related to the reclassification of interest cost, expected return on plan assets and amortization of unrecognized gains and prior service credits. See Note 8 to the Financial Statements.
In February 2018, the FASB issued ASU 2018-02, Reclassification of Certain Tax Effects from Accumulated Other Comprehensive Income. This ASU allows a reclassification from Accumulated other comprehensive earnings to Retained earnings for stranded tax effects resulting from the 2017 Tax Cuts and Jobs Act. The effective date of this ASU is for fiscal years and interim periods beginning after December 15, 2018, and early adoption is permitted. The
Company has evaluated the provisions of this standard and is in the process of assessing the amount to reclassify from Accumulated other comprehensive losses to Retained earnings.
In August 2018, the FASB issued ASU 2018-14, Retirement Benefits - Defined Benefit Plans - Changes to the Disclosure Requirements for Defined Benefit Plans. This ASU removes disclosures that are no longer considered cost beneficial, clarifies specific requirements of the disclosure and adds disclosure requirements identified as relevant to improve the effectiveness of the disclosures. The effective date of this ASU is for fiscal years and interim periods beginning after December 15, 2020 and early adoption is permitted. The Company is evaluating the impact of this ASU.
In September 2018, the FASB issued ASU 2018-15, Intangibles - Goodwill and Other Internal Use Software (Subtopic 350-40) Customer's Accounting for Implementation Costs Incurred in a Cloud Computing Arrangement That is a Service Contract. This ASU aligns the requirements for capitalizing implementation costs incurred in a hosting arrangement that is a service contract with the requirements for capitalizing implementation costs incurred to develop or obtain internal-use software. The effective date of this ASU is for fiscal years and interim periods beginning after December
8
W.W. Grainger, Inc. and Subsidiaries
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Unaudited)
15, 2019, and early adoption is permitted. The Company has elected to early adopt prospectively and does not expect a material impact to the Company's Consolidated Financial Statements.
LEASE ACCOUNTING STANDARDS
In February 2016, the FASB issued ASU 2016-02, Leases as modified by subsequently issued ASUs 2018-01, 2018-10 and 2018-11. The core principle of the ASU improves transparency and comparability related to the accounting and reporting of leasing arrangements, including balance sheet recognition for assets and liabilities associated with rights and obligations created by leases with terms greater than twelve months, among other changes.
The effective date of these ASUs is for fiscal years and interim periods beginning after December 15, 2018 and early adoption is permitted. The Company has elected not to early adopt these ASUs. The Company plans to elect the modified retrospective application with practical expedient to adopt the new guidance effective January 1, 2019. Grainger will record the right of use assets and corresponding liabilities and does not expect a material impact to the Company's Consolidated Financial Statements.
3. REVENUE
Company revenue is primarily comprised of MRO product sales and related activities, such as freight and services.
Recognition
The Company recognizes revenue when a sales arrangement with a customer exists (e.g., contract, purchase orders, others), transaction price is fixed or determinable and the Company has satisfied its performance obligation per the sales arrangement. The Company's sales arrangements generally have standard payment terms that do not exceed a year.
The majority of Company revenue originates from contracts with a single performance obligation to deliver products, whereby the Company’s performance obligations are satisfied when control of the product is transferred to the customer per the arranged shipping terms. Some Company contracts contain a combination of product sales and services, which are distinct and accounted for as separate performance obligations. The Company’s performance obligations for services are satisfied when the services are rendered within the arranged service period. Total service revenue is not material and accounted for approximately 1% of total Company revenue for the three and nine months ended September 30, 2018.
The Company records a contract asset when it has a right to payment from a customer that is conditioned on events other than the passage of time. The Company also records a contract liability when customers prepay but the Company has not yet satisfied its performance obligation. The Company did not have any material unsatisfied performance obligations, contract assets or liabilities as of September 30, 2018 and December 31, 2017.
Measurement
The Company’s revenue is reported as Net sales and is measured at the determinable transaction price, net of any variable considerations (e.g., rights to return product, sales incentives, others) and any taxes collected from customers and subsequently remitted to governmental authorities. The Company considers shipping and handling as activities to fulfill its performance obligation. Billings for freight are accounted for as Net sales and shipping and handling costs are accounted for in Cost of goods sold.
The Company offers customers rights to return product and sales incentives, which primarily consist of volume rebates. The Company’s rights of return and sales incentives generally do not exceed a year. The Company estimates sales returns and volume rebate accruals throughout the year based on various factors, including contract terms, historical experience and performance levels. Total accrued sales returns were approximately $28 million as of both September 30, 2018 and December 31, 2017, respectively, and are reported as a reduction of Accounts receivable, net. Total accrued sales incentives were approximately $63 million and $55 million as of September 30, 2018 and December 31, 2017, respectively, and are reported as part of Accrued expenses.
9
W.W. Grainger, Inc. and Subsidiaries
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Unaudited)
Disaggregation of Revenues
Grainger serves a large number of customers in diverse industries, which are subject to different economic and market specific factors. The Company's presentation of revenue by industry most reasonably depicts how the nature, amount, timing and uncertainty of Company revenue and cash flows are affected by economic and market specific factors. The
following table presents the Company's percentage of revenue by reportable segment and by major customer industry for the three and nine months ended September 30, 2018:
Three Months Ended September 30, 2018
U.S.
Canada
Total Company (2)
Government
20
%
5
%
15
%
Heavy Manufacturing
19
%
20
%
18
%
Light Manufacturing
13
%
6
%
11
%
Transportation
5
%
8
%
5
%
Commercial
16
%
9
%
13
%
Retail/Wholesale
8
%
4
%
7
%
Contractors
9
%
11
%
8
%
Natural Resources
3
%
34
%
4
%
Other (1)
7
%
3
%
19
%
Total net sales
100
%
100
%
100
%
Percent of Total Company Revenue
73
%
5
%
100
%
Nine Months Ended September 30, 2018
U.S.
Canada
Total Company (2)
Government
19
%
6
%
14
%
Heavy Manufacturing
19
%
20
%
18
%
Light Manufacturing
13
%
6
%
11
%
Transportation
5
%
7
%
5
%
Commercial
16
%
10
%
13
%
Retail/Wholesale
8
%
4
%
7
%
Contractors
10
%
11
%
8
%
Natural Resources
3
%
33
%
4
%
Other (1)
7
%
3
%
20
%
Total net sales
100
%
100
%
100
%
Percent of Total Company Revenue
73
%
6
%
100
%
(1) Other category primarily includes revenue from individual customers not aligned to major industry segment, including small businesses and consumers and intersegment net sales.
(2) Total Company includes other businesses, which include the Company's single channel businesses and operations in Europe, Asia and Latin America and account for approximately 22% and 21% of revenue for the three and nine months ended September 30, 2018, respectively.
Cost of Goods Sold
Cost of goods sold includes products and product-related costs, vendor consideration, shipping and handling costs and service costs.
10
W.W. Grainger, Inc. and Subsidiaries
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Unaudited)
4. PROPERTY, BUILDINGS AND EQUIPMENT
Property, buildings and equipment consisting of the following (in thousands of dollars):
As of
September 30, 2018
December 31, 2017
Land
$
319,990
$
348,739
Building, structures and improvements
1,339,754
1,342,508
Furniture, fixtures, machinery and equipment
1,781,459
1,753,413
Property, buildings and equipment
$
3,441,203
$
3,444,660
Less: Accumulated depreciation and amortization
2,092,289
2,052,693
Property, buildings and equipment, net
$
1,348,914
$
1,391,967
5. GOODWILL AND INTANGIBLE ASSETS
The balances and changes in the carrying amount of Goodwill by segment, including cumulative goodwill impairment charges are as follows (in thousands of dollars):
United States
Canada
Other businesses
Total
Balance at January 1, 2017
$
202,020
$
122,140
$
202,990
$
527,150
Divestiture
(3,316
)
—
—
(3,316
)
Impairment
(7,169
)
—
—
(7,169
)
Translation
—
8,282
18,956
27,238
Balance at December 31, 2017
191,535
130,422
221,946
543,903
Divestiture
—
—
—
—
Impairment
—
—
(104,461
)
(104,461
)
Translation
—
(3,304
)
(6,320
)
(9,624
)
Balance at September 30, 2018
$
191,535
$
127,118
$
111,165
$
429,818
Cumulative goodwill impairment charges, December 31, 2017
$
24,207
$
32,265
$
70,299
$
126,771
Impairment
—
—
104,461
104,461
Cumulative goodwill impairment charges, September 30, 2018
$
24,207
$
32,265
$
174,760
$
231,232
11
W.W. Grainger, Inc. and Subsidiaries
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Unaudited)
The balances and changes in Intangible assets, net are as follows (in thousands of dollars):
September 30, 2018
December 31, 2017
Weighted average life
Gross carrying amount
Accumulated amortization
Net carrying amount
Gross carrying amount
Accumulated amortization
Net carrying amount
Customer lists and relationships
14.3 years
$
413,216
$
199,645
$
213,571
$
430,026
$
195,842
$
234,184
Trademarks, trade names and other
14.5 years
24,073
14,945
9,128
25,886
16,054
9,832
Non-amortized trade names and other
99,172
—
99,172
137,491
—
137,491
Capitalized software
4.2 years
652,501
494,851
157,650
632,431
444,823
187,608
Total intangible assets
8.2 years
$
1,188,962
$
709,441
$
479,521
$
1,225,834
$
656,719
$
569,115
The Company tests goodwill and intangible assets for impairment annually during the fourth quarter and more frequently if impairment indicators exist. Qualitative assessments of significant events or changes in circumstances are performed quarterly to determine the existence of impairment indicators and assess if it is more likely than not that the carrying value of these assets may not be recoverable and determine if quantitative impairment tests are necessary. Factors evaluated include declines in stock price, market capitalization and reporting units' historical and projected results, deteriorations of industry growth assumptions, declining economic indicators and other structural variables.
For the quantitative impairment tests for goodwill, the Company compares reporting units’ carrying values with their fair values and records an impairment charge for any excess of carrying value over fair value. Reporting unit fair values are estimated primarily using the income-based discounted cash flow (DCF) method. Value indicators from a market-based approach are used to evaluate overall reasonableness. The DCF method incorporates various assumptions including the amount and timing of reporting unit future expected cash flows, including revenues, gross margins, operating expenses, capital expenditures and working capital based on reporting units’ budgets, long-range strategic plans and other estimates, plus a terminal value that estimates the perpetual growth for the reporting units. Estimates of market-participant risk-adjusted weighted average cost of capital are used to discount reporting units’ future expected cash flows and terminal value to net present value.
For the quantitative tests for indefinite-lived intangible assets, which are primarily trade names, the Company compares the assets' carrying values with their fair values and records an impairment charge for any excess of carrying value over fair value. Trade name fair values are estimated using the relief from royalty method, which estimates the expected royalty savings attributable to the ownership of the trade name asset. The key assumptions when valuing trade names are revenue, royalty rate and discount rate.
For the quantitative tests for amortizable intangible assets, the Company first estimates the future undiscounted cash flows through the useful lives of the assets and compares them to the assets’ carrying value. If carrying values exceed future undiscounted cash flows, then a second step is performed whereas the assets’ fair value is estimated and an impairment charge is recorded for any excess of carrying value over fair value.
Third Quarter 2018 Qualitative Tests
During the quarter ended September 30, 2018, the Company performed qualitative goodwill and intangible asset assessments. With the exception of the Cromwell reporting unit, the Company did not identify any significant events or changes in circumstances that indicated the existence of impairment indicators, and as such quantitative impairment tests were not required. However, changes in assumptions, judgments and estimates regarding reporting unit performance and structural economic conditions may have a significant impact on the fair value of reporting units and intangible assets in the future. If future earnings and cash flow projections are not achieved or structural economic conditions are unfavorable, future impairments of goodwill or intangible assets could result.
12
W.W. Grainger, Inc. and Subsidiaries
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Unaudited)
Cromwell Goodwill and Intangible Assets
The operating performance of the Cromwell reporting unit has deteriorated from the second quarter of 2018 and the Company lowered its short-term forecasts and long-term outlook projections. These factors, combined with sustained economic uncertainty in the U.K market and higher interest rates, led the Company to conclude that it was more likely than not that the carrying value of Cromwell’s goodwill and intangible assets may not be recoverable. Accordingly, quantitative tests were performed during the quarter ended September 30, 2018.
In the quantitative test for goodwill performed in 2017, the fair value of the Cromwell reporting unit exceeded its carrying value by 15%. During the third quarter 2018 test, the Company considered the impact of the prolonged softness and uncertainty in the U.K. market due to Brexit and other unfavorable structural economic conditions, as well as Cromwell’s underperformance compared to expectations, prior year quantitative test assumptions and future performance projections. The revised outlook and uncertainty beyond 2018 were factored into lower revenues, earnings and cash flow projections which, combined with an increase in the discount rate, resulted in the calculated fair value of the Cromwell reporting unit below its carrying value. Accordingly, during the quarter ended September 30, 2018, the Company recorded a full goodwill impairment charge of $105 million with no tax benefit due to the nondeductibility of goodwill in the relevant taxing jurisdictions. The revised revenue and gross margin projections also resulted in the reduction of royalty rate and value attributable to the Cromwell trade name for which the Company recorded a $34 million impairment charge during the same period. The cumulative indefinite-lived intangible impairment charge of $34 million was recorded in other businesses as of September 30, 2018 and there were none as of December 31, 2017. The goodwill and intangible asset impairment charges were recorded in SG&A.
The Company also performed an impairment test on Cromwell’s intangible assets subject to amortization and long-lived assets using the undiscounted cash flows method and no impairment charge was required during the quarter ended September 30, 2018.
6. RESTRUCTURING
The Company continues to execute on its previously announced restructuring actions to reduce costs in the U.S. and at the Company level (Unallocated expense) and to focus on profitability in Canada and other businesses. Restructuring costs, net, for the three and nine months ended September 30, 2018 and 2017 are as follows (in thousands of dollars):
Three Months Ended September 30,
2018
2017
Cost of goods sold
Selling, general and administrative expenses
Total
Cost of goods sold
Selling, general and administrative expenses
Total
Involuntary employee termination costs
Other charges (gains)
Involuntary employee termination costs
Other charges (gains)
U.S.
$
48
$
3,453
$
(1
)
$
3,500
$
(100
)
$
10,917
$
(2,873
)
$
7,944
Canada
(189
)
3,431
(4,123
)
(881
)
—
1,882
3,055
4,937
Other businesses
—
—
1,115
1,115
581
73
(864
)
(210
)
Total
$
(141
)
$
6,884
$
(3,009
)
$
3,734
$
481
$
12,872
$
(682
)
$
12,671
13
W.W. Grainger, Inc. and Subsidiaries
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Unaudited)
Nine Months Ended September 30,
2018
2017
Cost of goods sold
Selling, general and administrative expenses
Total
Cost of goods sold
Selling, general and administrative expenses
Total
Involuntary employee termination costs
Other charges (gains)
Involuntary employee termination costs
Other charges (gains)
U.S.
$
348
$
12,133
$
(7,444
)
$
5,037
$
(100
)
$
19,459
$
(17,634
)
$
1,725
Canada
(611
)
23,131
(463
)
22,057
2,574
9,842
14,093
26,509
Other businesses
1,083
1,564
2,015
4,662
581
3,595
37,124
41,300
Unallocated expense
—
—
(4,688
)
(4,688
)
—
—
—
—
Total
$
820
$
36,828
$
(10,580
)
$
27,068
$
3,055
$
32,896
$
33,583
$
69,534
Other charges (gains) primarily include asset impairment charges in Canada and other exit-related costs, net of gains from the sales of branches in the U.S., Canada and corporate offices. Other charges (gains) in 2017 reflect charges related to the wind-down of the Colombia business, including $16 million of accumulated foreign currency translation losses reclassified from Accumulated other comprehensive losses to SG&A in Other businesses.
The following summarizes the restructuring activity for the nine months ended September 30, 2018 (in thousands of dollars):
Current asset write-downs
Property, buildings and equipment write-downs and disposals
Current liabilities
Involuntary employee termination costs
Lease termination costs
Other costs
Total
Balances as of December 31, 2017
$
13,101
$
741
50,289
$
4,893
$
12,764
$
81,788
Restructuring costs, net of (gains)
4,201
(17,847
)
36,828
3,456
430
27,068
Cash (paid) received, net
(844
)
45,020
(45,056
)
(3,886
)
(1,632
)
(6,398
)
Non-cash, translation and other
(13,866
)
(27,293
)
(1,276
)
(1,729
)
(6,393
)
(50,557
)
Balances as of September 30, 2018
$
2,592
$
621
$
40,785
$
2,734
$
5,169
$
51,901
The cumulative amounts incurred to date since the inception of the program and expected through the end of 2019 (excluding results of sales of real estate) in connection with the Company's restructuring actions for active programs are as follows (in thousands of dollars):
Cumulative amount incurred to date
Additional amount expected
U.S.
$
67,435
$
2,339
Canada
80,525
6,749
Other businesses
65,378
545
Unallocated expense
14,852
—
Total
$
228,190
$
9,633
14
W.W. Grainger, Inc. and Subsidiaries
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Unaudited)
7. SHORT-TERM AND LONG-TERM DEBT
Short-term debt consisted of outstanding lines of credit. Long-term debt consisted of the following (in thousands of dollars):
As of September 30, 2018
As of December 31, 2017
Carrying Value
Fair Value
Carrying Value
Fair Value
4.60% senior notes due 2045
$
1,000,000
$
1,046,760
$
1,000,000
$
1,089,000
3.75% senior notes due 2046
400,000
364,980
400,000
384,200
4.20% senior notes due 2047
400,000
392,540
400,000
410,800
British pound term loan
177,180
177,180
194,574
194,574
Euro term loan
127,689
127,689
131,956
131,956
Canadian dollar revolving credit facility
54,247
54,247
99,388
99,388
Capital lease obligations and other
48,867
48,867
84,274
84,274
Subtotal
2,207,983
2,212,263
2,310,192
2,394,192
Less current maturities
(36,973
)
(36,973
)
(38,709
)
(38,709
)
Debt issuance costs and discounts
(22,611
)
(22,611
)
(23,447
)
(23,447
)
Long-term debt (less current maturities)
$
2,148,399
$
2,152,679
$
2,248,036
$
2,332,036
The estimated fair value of the Company’s senior notes was based on available external pricing data and current market rates for similar debt instruments, among other factors, which are classified as level 2 inputs within the fair value hierarchy. The carrying value of other long-term debt approximates fair value due to their variable interest rates.
8. EMPLOYEE BENEFITS
The Company has a postretirement healthcare benefits plan that provides coverage for a majority of its U.S. employees hired prior to January 1, 2013. Effective January 1, 2018, the Company implemented plan design changes, which moved all post-65 Medicare eligible retirees to healthcare exchanges and provides them a subsidy, based on years of service, to purchase insurance.
The net periodic benefits for the Company's postretirement healthcare benefits plan, which are valued at the measurement date of January 1 for each year and recognized evenly throughout the year, consisted of the following (in thousands of dollars):
Three Months Ended September 30,
Nine Months Ended September 30,
2018
2017
2018
2017
Selling, general and administrative expenses
Service cost
$
1,629
$
1,856
$
4,887
$
5,649
Other income (expense)
Interest cost
1,712
2,026
5,136
6,323
Expected return on assets
(3,315
)
(2,957
)
(9,945
)
(8,670
)
Amortization of unrecognized gains
(840
)
(609
)
(2,520
)
(1,919
)
Amortization of prior service credits
(2,424
)
(1,893
)
(7,272
)
(5,139
)
Net periodic benefit
$
(3,238
)
$
(1,577
)
$
(9,714
)
$
(3,756
)
The Company has established a Group Benefit Trust (Trust) to fund postretirement healthcare plan obligations and process benefit payments. The Company has no minimum funding requirement and did not make a contribution to the Trust during the nine months ended September 30, 2018.
15
W.W. Grainger, Inc. and Subsidiaries
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Unaudited)
9. INCOME TAXES
The reconciliation of income tax expense with federal income taxes at statutory rate follows (in thousands of dollars):
Three Months Ended September 30,
Nine Months Ended September 30,
2018
2017
2018
2017
Federal income tax (21% in 2018 and 35% in 2017)
$
35,914
$
87,499
$
168,288
$
254,753
States income taxes, net of federal income tax benefit
4,817
5,996
22,572
17,458
Clean energy credit
(2,897
)
(8,902
)
(13,575
)
(25,917
)
Foreign rate difference
1,895
2,152
8,880
6,265
Impairment and other charges
27,875
—
27,875
19,188
Stock compensation benefit
(8,289
)
(575
)
(18,899
)
(8,314
)
Other, net
(3,343
)
(6,988
)
2,657
3,806
Income tax expense
$
55,972
$
79,182
$
197,798
$
267,239
Effective tax rate
32.7
%
31.7
%
24.7
%
36.7
%
The Tax Cut and Jobs Act (the Tax Act) was enacted on December 22, 2017. The Company applied Staff Accounting Bulletin (SAB) 118 when accounting for the enactment-date effects of the Tax Act at December 31, 2017 and recorded estimates primarily related to the revaluation of deferred tax balances and the one-time transition tax. As of September 30, 2018, the Company had not completed the analysis for all of the tax effects of the Tax Act and had not recorded any additional adjustments to the amounts recorded at December 31, 2017. The Company expects to complete the Tax Act estimates in the fourth quarter of 2018 and does not expect a material impact to the Consolidated Financial Statements.
16
W.W. Grainger, Inc. and Subsidiaries
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Unaudited)
10. EARNINGS PER SHARE
The following table sets forth the computation of basic and diluted earnings per share under the two-class method (in thousands of dollars, except for share and per share amounts):
Three Months Ended
Nine Months Ended
September 30,
September 30,
2018
2017
2018
2017
Net earnings attributable to W.W. Grainger, Inc. as reported
$
104,377
$
162,006
$
572,893
$
434,671
Distributed earnings available to participating securities
(640
)
(603
)
(1,596
)
(1,576
)
Undistributed earnings available to participating securities
(243
)
(806
)
(3,108
)
(1,966
)
Numerator for basic earnings per share – Undistributed and distributed earnings available to common shareholders
103,494
160,597
568,189
431,129
Undistributed earnings allocated to participating securities
243
806
3,108
1,966
Undistributed earnings reallocated to participating securities
(242
)
(803
)
(3,086
)
(1,956
)
Numerator for diluted earnings per share – Undistributed and distributed earnings available to common shareholders
$
103,495
$
160,600
$
568,211
$
431,139
Denominator for basic earnings per share – weighted average shares
56,339,630
57,316,532
56,172,277
58,010,222
Effect of dilutive securities
464,227
204,816
416,253
319,703
Denominator for diluted earnings per share – weighted average shares adjusted for dilutive securities
56,803,857
57,521,348
56,588,530
58,329,925
Earnings per share two-class method
Basic
$
1.84
$
2.80
$
10.12
$
7.43
Diluted
$
1.82
$
2.79
$
10.04
$
7.39
11. DIVIDEND
On October 31, 2018, the Company’s Board of Directors declared a quarterly dividend of $1.36 per share, payable December 1, 2018, to shareholders of record on November 12, 2018.
12. SEGMENT INFORMATION
Grainger's two reportable segments are the U.S. and Canada. These reportable segments reflect the results of the Company's businesses in those geographies, except for Zoro Tools, Inc. (Zoro), which is in the U.S. Other businesses include the Company's single channel businesses (Zoro and MonotaRO in Japan) and small operations in Europe, Asia and Latin America. These businesses individually do not meet the criteria of a reportable segment.
17
W.W. Grainger, Inc. and Subsidiaries
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Unaudited)
Following is a summary of segment results (in thousands of dollars):
Three Months Ended September 30, 2018
U.S.
Canada
Other businesses
Total
Total net sales
$
2,188,324
$
149,782
$
609,317
$
2,947,423
Intersegment net sales
(115,007
)
(22
)
(965
)
(115,994
)
Net sales to external customers
$
2,073,317
$
149,760
$
608,352
$
2,831,429
Segment operating earnings
$
326,273
$
(4,051
)
$
(99,831
)
$
222,391
Three Months Ended September 30, 2017
U.S.
Canada
Other businesses
Total
Total net sales
$
2,015,968
$
188,216
$
536,927
$
2,741,111
Intersegment net sales
(103,667
)
(13
)
(1,432
)
(105,112
)
Net sales to external customers
$
1,912,301
$
188,203
$
535,495
$
2,635,999
Segment operating earnings
$
294,603
$
(14,972
)
$
26,892
$
306,523
Nine Months Ended September 30, 2018
U.S.
Canada
Other businesses
Total
Total net sales
$
6,471,116
$
508,414
$
1,819,562
$
8,799,092
Intersegment net sales
(337,912
)
(55
)
(3,083
)
(341,050
)
Net sales to external customers
$
6,133,204
$
508,359
$
1,816,479
$
8,458,042
Segment operating earnings
$
1,032,491
$
(37,875
)
$
(22,509
)
$
972,107
Nine Months Ended September 30, 2017
U.S.
Canada
Other businesses
Total
Total net sales
$
5,968,565
$
563,470
$
1,560,894
$
8,092,929
Intersegment net sales
(297,247
)
(15
)
(3,270
)
(300,532
)
Net sales to external customers
$
5,671,318
$
563,455
$
1,557,624
$
7,792,397
Segment operating earnings
$
913,705
$
(59,428
)
$
44,177
$
898,454
Three Months Ended September 30,
Nine Months Ended September 30,
2018
2017
2018
2017
Operating earnings:
Segment operating earnings
$
222,391
$
306,523
$
972,107
$
898,454
Unallocated expenses and eliminations
(33,269
)
(28,785
)
(104,169
)
(99,135
)
Total consolidated operating earnings
$
189,122
$
277,738
$
867,938
$
799,319
Segment and total consolidated operating earnings for the three and nine months ended September 30, 2017 were restated for the implementation of ASU 2017-07. See Note 2 to the Financial Statements.
Unallocated expenses and eliminations primarily relate to the Company's headquarters support services and intercompany eliminations, which are not part of any reportable segment. Unallocated expenses are primarily comprised of employee compensation costs, depreciation and other administrative costs.
18
W.W. Grainger, Inc. and Subsidiaries
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Unaudited)
The Company is a broad-line distributor of MRO supplies, and other related products. Products are regularly added and deleted from the Company's inventory. Accordingly, it would be impractical to provide sales information by product category due to the way the business is managed.
Following are reconciliations of segment assets with the total consolidated assets per the financial statements (in thousands of dollars):
U.S.
Canada
Other businesses
Total
Segment assets:
September 30, 2018
$
2,515,137
$
213,525
$
672,854
$
3,401,516
December 31, 2017
$
2,309,734
$
278,633
$
605,452
$
3,193,819
As of
Total assets:
September 30, 2018
December 31, 2017
Assets for reportable segments
3,401,516
3,193,819
Other current and non-current assets
2,251,555
2,428,074
Unallocated assets
279,112
182,361
Total consolidated assets
$
5,932,183
$
5,804,254
Assets for reportable segments include net accounts receivable and first-in, first-out inventory which are reported to the Company's Chief Operating Decision Maker. Other current and non-current assets include all other assets of the reportable segments. Unallocated assets are primarily comprised of non-operating cash and cash equivalents, property, buildings and equipment, net, and certain prepaid expenses related to the Company's headquarters support services.
13. CONTINGENCIES AND LEGAL MATTERS
From time to time the Company is involved in various legal and administrative proceedings that are incidental to its business, including claims related to product liability, general negligence, contract disputes, cybersecurity incidents, privacy matters, environmental issues, wage and hour laws, intellectual property, employment practices, advertising laws, regulatory compliance, and other matters and actions brought by employees, customers, competitors, suppliers and governmental entities. As a government contractor selling to federal, state and local governmental entities, the Company is also subject to governmental and regulatory inquiries, audits and other proceedings, including those related to contract administration and pricing compliance. It is not expected that the ultimate resolution of any of these matters will have, either individually or in the aggregate, a material adverse effect on the Company's consolidated financial position or results of operations.
19
W.W. Grainger, Inc. and Subsidiaries
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
Item 2: Management's Discussion and Analysis of Financial Condition and Results of Operations
General
W.W. Grainger, Inc. (Grainger or the Company) is a broad line, business-to-business distributor of maintenance, repair and operating (MRO) supplies and other related products and services with operations primarily in the United States (U.S.) and Canada, with a presence in Europe, Asia and Latin America. More than 3 million customers worldwide rely on Grainger for products such as safety gloves, ladders, motors and janitorial supplies, along with services like inventory management and technical support. These customers represent a broad collection of industries (see Note 3 in the Condensed Consolidated Financial Statements (Financial Statements)). They place orders online, on mobile devices, through sales representatives, over the phone and at local branches. Approximately 5,200 suppliers provide Grainger with approximately 1.7 million products stocked in Grainger's distribution centers (DCs) and branches worldwide.
Grainger's two reportable segments are the U.S. and Canada (Acklands - Grainger Inc. and its subsidiaries). These reportable segments reflect the results of the Company's businesses in those geographies, except for Zoro Tools, Inc. (Zoro) which is in the U.S. Other businesses include the Company's single channel businesses (Zoro and MonotaRO in Japan) and operations in Europe, Asia and Latin America.
Business Environment
Given Grainger's large number of customers and the diverse industries it serves, several economic factors and market specific trends tend to shape Grainger’s business environment. The overall economy and leading economic indicators provide general insight into projecting Grainger's growth. Grainger’s sales in the U.S. and Canada tend to positively correlate with Business Investment, Business Inventory, Exports and Industrial Production. Sales in the U.S. also tend to positively correlate with Gross Domestic Product (GDP). Sales in Canada also tend to positively correlate with oil prices. The table below provides these estimated indicators for 2018:
U.S. 2018 Forecast
Canada 2018 Forecast
October
July
September
June
Business Investment
7.0%
7.0%
4.6%
5.8%
Business Inventory
1.1%
2.0%
—
—
Exports
4.0%
5.1%
2.8%
1.7%
Industrial Production
3.7%
3.5%
3.1%
2.0%
GDP
2.9%
3.0%
2.2%
2.2%
Oil Prices
—
—
$69/barrel
$66/barrel
Source: Global Insight U.S. (October 2018 and July 2018), Global Insight Canada (September 2018 and June 2018)
In the U.S., Business Inventory and Exports are forecast to slow from the July forecast but all indicators are expected to remain strong during 2018, supported by expanding domestic and global markets, stable GDP and Exports, low capital costs and a stable regulatory climate. In Canada, Exports and Industrial Production are expected to improve, while Business Investment remains strong. Oil prices have signaled a recovery as the price per barrel has trended upward.
In the third quarter of 2018, the office of the United States Trade Representative enacted tariffs on a significant number of Chinese imports which may affect the Company’s business environment, product availability, gross margins and results of operations. Grainger is currently validating tariff increases, working with suppliers to minimize the cost impact, identifying alternative suppliers and evaluating pricing actions while ensuring the that the Company’s pricing is market based to mitigate tariff impact.
Outlook
Grainger’s portfolio consists of its U.S. business, its Canada business and other businesses. Grainger’s imperative to create unique value for customers is focused on: (i) continuing to grow its share of business with large and mid-size customers in the U.S. by executing its high-value sales and service model and building advantaged MRO solutions by leveraging its product and customer expertise; (ii) completing the business model reset in Canada; (iii) driving profitable growth in its international portfolio and (iv) continuing the strong growth of its single channel businesses by expanding their assortment and innovating around customer acquisition. Grainger is also focused on improving the end-to-end customer experience by making investments in its eCommerce and digital capabilities and executing continuous improvement initiatives within its supply chain and order-to-cash processes.
20
W.W. Grainger, Inc. and Subsidiaries
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
Matters Affecting Comparability
There were 63 sales days in the three months ended September 30, 2018 and 2017.
Results of Operations – Three Months Ended September 30, 2018
The following table is included as an aid to understand the changes in Grainger’s Condensed Consolidated Statements of Earnings (in millions of dollars):
Three Months Ended September 30,
Percent Increase/(Decrease)
As a Percent of Net Sales
2018 (A)
2017 (A)
2018
2017
Net sales
$
2,831
$
2,636
7
%
100.0
%
100.0
%
Cost of goods sold
1,752
1,619
8
%
61.9
61.4
Gross profit
1,079
1,017
6
%
38.1
38.6
Selling, general and administrative expenses
890
739
20
%
31.4
28.1
Operating earnings
189
278
(32
)%
6.7
10.5
Other expense, net
18
28
(35
)%
0.6
1.1
Income taxes
56
79
(29
)%
2.0
3.0
Net earnings
115
171
Noncontrolling interest
11
9
21
%
0.4
0.3
Net earnings attributable to W.W. Grainger, Inc.
$
104
$
162
(36
)%
3.7
%
6.1
%
(A) May not sum due to rounding
Grainger’s net sales of $2,831 million for the third quarter of 2018 increased $195 million, or 7% compared to the same period in 2017, and consisting of the following:
Percent Increase/(Decrease)
Volume
7
Price
1
Foreign exchange
(1)
Total
7%
The increase in net sales was primarily driven by volume increases in the U.S. business due to market share gain, an improved demand environment and continued double digit growth in the single channel businesses, partially offset by lower sales in the Canada business. See Note 3 to the Financial Statements and refer to the Segment Analysis below for further details.
Gross profit of $1,079 million for the third quarter of 2018 increased $62 million, or 6% compared to the same quarter in 2017, primarily due to higher sales during the period. The gross profit margin of 38.1% during the third quarter of 2018 decreased 0.5 percentage point when compared to the same quarter in 2017. The lower gross profit margin includes a 0.5 percentage point decline from the implementation of the Financial Accounting Standards Board (FASB) new revenue recognition standard that primarily reclassifies certain costs related to KeepStock® services from Selling, general and administrative expenses (SG&A) to Cost of goods sold. Excluding this impact, gross profit margin would have been flat compared to the prior year.
The table below reconciles reported SG&A, operating earnings and net earnings attributable to W.W. Grainger, Inc. determined in accordance with U.S. generally accepted accounting principles (GAAP) to adjusted SG&A, operating earnings and net earnings attributable to W.W. Grainger, Inc., which are all considered non-GAAP measures. The Company believes that these non-GAAP measures provide meaningful information to assist shareholders in understanding financial results and assessing prospects for future performance as they provide a better baseline for
21
W.W. Grainger, Inc. and Subsidiaries
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
analyzing the ongoing performance of its businesses by excluding items that may not be indicative of core operating results. Because non-GAAP financial measures are not standardized, it may not be possible to compare these measures with other companies' non-GAAP measures having the same or similar names. All tables below are in thousands of dollars:
Three Months Ended
September 30,
2018
2017
%
Selling, general and administrative expenses reported
$
890,113
$
739,442
20
%
Restructuring (U.S.)
3,452
13,251
Branch gains (U.S.)
—
(5,207
)
Other charges (U.S.)
—
(3,023
)
Restructuring (Canada)
(692
)
4,937
Restructuring (Other businesses)
1,115
(791
)
Impairment charges (Other businesses)
138,750
—
Subtotal
142,625
9,167
Selling, general and administrative expenses adjusted
$
747,488
$
730,275
2
%
2018
2017
%
Operating earnings reported
$
189,122
$
277,738
(32
)%
Total restructuring and impairments charges, net of branch gains and other charges
142,484
9,648
Operating earnings adjusted
$
331,606
$
287,386
15
%
2018
2017
%
Net earnings attributable to W.W. Grainger, Inc. reported
$
104,377
$
162,006
(36
)%
Total restructuring and impairment charges, net of branch gains and other charges
142,484
9,648
Tax effect of impairment
(5,829
)
—
Tax effect (1)
(626
)
(3,129
)
Total restructuring and impairment charges, net of branch gains and other charges and tax
136,029
6,519
Net earnings attributable to W.W. Grainger, Inc. adjusted
$
240,406
$
168,525
43
%
(1) The tax impact of adjustments is calculated based on the income tax rate in each applicable jurisdiction, subject to deductibility limitations and the Company's ability to realize the associated tax benefits.
SG&A of $890 million for the third quarter of 2018 increased $151 million, or 20% compared to the third quarter of 2017. During the quarter ended September 30, 2018, the Company recorded $139 million of impairment charges related to goodwill and tradename intangible asset at the Cromwell business. See Note 5 to the Financial Statements. Excluding restructuring and impairment charges net of branch gains and other charges in both periods as noted in the table above, SG&A increased $17 million, or 2% primarily due to higher variable costs in connection with higher sales, primarily payroll and variable compensation.
Operating earnings of $189 million for the third quarter of 2018 decreased $89 million, or 32% compared to the third quarter of 2017. Excluding restructuring and impairment charges net of branch gains and other charges in both periods as noted in the table above, operating earnings increased $45 million or 15%, driven primarily by higher sales, higher gross profit dollars and improved SG&A leverage.
Other expense, net was $18 million for the third quarter of 2018, a decrease of 35% compared to the third quarter of 2017. The decrease was primarily due to lower losses from the Company's clean energy investments.
Income taxes of $56 million for the third quarter of 2018 decreased $23 million, or 29% compared to the third quarter of 2017. Grainger's effective tax rates were 32.7% and 31.7% for the three months ended September 30, 2018 and
22
W.W. Grainger, Inc. and Subsidiaries
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
2017, respectively. The higher effective tax rate in 2018 is primarily due to the impact of Cromwell impairment charges that lowered reported earnings and were not tax deductible, net of the benefit from the Tax Cut and Jobs Act (the Tax Act) and the excess tax benefits from stock-based awards.
Net earnings attributable to W.W. Grainger, Inc. of $104 million for the third quarter of 2018 decreased $58 million or 36% compared to the third quarter of 2017. Excluding restructuring and impairment charges net of branch gains and other charges from both periods in the table above, net earnings increased $71 million, or 43%. The increase in net earnings primarily resulted from higher gross profit, lower SG&A and lower income taxes.
Diluted earnings per share of $1.82 in the third quarter of 2018 was down 35% versus the $2.79 for the third quarter of 2017, primarily due to lower net earnings. Excluding restructuring and impairment charges net of branch gains and other charges from both periods in the table above, diluted earnings per share of $4.19 in the third quarter 2018 increased 44% from $2.90 for the third quarter 2017.
Segment Analysis
The following comments at the U.S. and Canada segments and Other businesses level include external and intersegment net sales and operating earnings. See Note 12 to the Financial Statements.
United States
Net sales were $2,188 million for the third quarter of 2018, an increase of $172 million, or 9% compared to the same period in 2017, and consisting of the following:
Percent Increase/(Decrease)
Volume
8
Price
1
Total
9%
Sales to customers in the heavy manufacturing, government and retail end markets increased high single digits. Natural resources and contractors increased mid-single digits and light manufacturing end markets increased low-single digits. Overall, revenue increases were primarily driven by market share gains and improved demand in all industries. See Note 3 to the Financial Statements.
The gross profit margin for the third quarter of 2018 decreased 0.4 percentage point compared to the same period in 2017. The decline was primarily driven by a 0.6 percentage point decrease due to the implementation of the FASB's new revenue recognition standard. Excluding the impact of the implementation of the revenue recognition standard, gross profit margin would have shown a favorable 0.2 percentage point increase due to sales volume growth.
SG&A increased 6% in the third quarter of 2018 compared to the third quarter 2017. The increase was primarily driven by higher variable compensation due to stronger than anticipated performance, partially offset by the implementation of the FASB's new revenue recognition standard.
Operating earnings of $326 million for the third quarter of 2018 increased $31 million, or 11% from $295 million for the third quarter of 2017. This increase was driven primarily by higher sales, higher gross profit dollars and improved SG&A leverage.
Canada
Net sales were $150 million for the third quarter of 2018, a decrease of $38 million, or 20% compared to the same period in 2017 and consisting of the following:
Percent (Decrease)/Increase
Volume
(27)
Foreign exchange
(3)
Price
10
Total
(20)%
23
W.W. Grainger, Inc. and Subsidiaries
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
For the third quarter of 2018, volume was down 27 percentage points compared to the same period in 2017 due to branch closures and sales coverage optimization activities, partially offset by price increases and continued contract negotiations of 10 percentage points for the third quarter of 2018.
The gross profit margin decreased 0.3 percentage point in the third quarter of 2018 versus the third quarter of 2017, primarily related to prior year adjustments related to excess and obsolete inventory, vendor rebates not repeating in 2018 and the implementation of the FASB's new revenue recognition standard.
SG&A decreased 31% in the third quarter of 2018 compared to the third quarter of 2017. Excluding restructuring costs in both periods (as noted in the table above and Note 6 to the Financial Statements), SG&A would have decreased 26%. This decrease was primarily due to cost reduction actions and lower variable expense due to lower sales volume.
Operating losses were $4 million for the third quarter of 2018 compared to $15 million in the third quarter of 2017. Excluding restructuring costs in both periods (as noted in the table above and Note 6 to the Financial Statements), operating losses would have been $5 million compared to $10 million in the prior period due to lower SG&A and lower sales volume.
Other businesses
Net sales were $609 million for the third quarter of 2018, an increase of $72 million, or 13% when compared to the same period in 2017 and consisting of the following:
Percent Increase
Price/volume
14
Foreign exchange
(1)
Total
13%
The net sales increase was primarily due to continued growth in the single channel businesses as a result of increased customer acquisition and improved sales growth in the international businesses.
Operating losses of $100 million for the third quarter of 2018 were down $127 million compared to operating earnings of $27 million the third quarter of 2017. Other businesses included impairment charges relating to the Cromwell business in the U.K. See Note 5 to the Financial Statements. Excluding restructuring and impairment charges in both periods, operating earnings increased $13 million or 50%, primarily due to strong performance from the single channel businesses.
24
W.W. Grainger, Inc. and Subsidiaries
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
Matters Affecting Comparability
There were 191 sales days in the nine months ended September 30, 2018 and 2017.
Results of Operations – Nine Months Ended September 30, 2018
The following table is included as an aid to understanding the changes in Grainger’s Condensed Consolidated Statements of Earnings (in millions of dollars):
Nine Months Ended September 30,
Percent Increase/(Decrease)
As a Percent of Net Sales
2018 (A)
2017 (A)
2018
2017
Net sales
$
8,458
$
7,792
9
100.0
%
100.0
%
Cost of goods sold
5,176
4,716
10
61.2
60.5
Gross profit
3,282
3,076
7
38.8
39.5
Selling, general and administrative expenses
2,414
2,277
6
28.5
29.2
Operating earnings
868
799
9
10.3
10.3
Other expense, net
67
71
(7
)
0.8
1.0
Income taxes
198
267
(26
)
2.3
3.4
Net earnings
604
461
Noncontrolling interest
31
26
18
0.4
0.3
Net earnings attributable to W.W. Grainger, Inc.
$
573
$
435
32
%
6.8
%
5.6
%
(A) May not sum due to rounding
Grainger’s net sales of $8,458 million for the nine months ended September 30, 2018 increased $666 million, or 9% compared to the same period in 2017, and consisting of the following:
Percent Increase/(Decrease)
Volume
8
Foreign exchange
1
Total
9%
The increase in net sales was primarily driven by volume increases in the U.S. business due to market share gain and an improved demand environment and continued double digit growth in the single channel businesses, offset by lower sales in the Canada business. See Note 3 to the Financial Statements and refer to the Segment Analysis below for further details.
Gross profit of $3,282 million for the nine months ended September 30, 2018 increased $206 million, or 7% compared to the same period in 2017. The gross profit margin of 38.8% decreased 0.7 percentage point when compared to the same period in 2017. The lower gross profit margin includes a 0.5 percentage point decline from the implementation of the FASB's new revenue recognition standard. Excluding this impact, gross profit margin would have decreased 0.2 percentage point compared to the prior year, driven primarily by the strategic pricing actions in the U.S. business, partially offset by positive customer mix in the U.S. business and improved performance in the Canada business.
The table below reconciles reported SG&A, operating earnings and net earnings attributable to W.W. Grainger, Inc. determined in accordance with U.S. GAAP to adjusted SG&A, operating earnings and net earnings attributable to W.W. Grainger, Inc., which are all considered non-GAAP measures. The Company believes that these non-GAAP measures provide meaningful information to assist shareholders in understanding financial results and assessing prospects for future performance as they provide a better baseline for analyzing the ongoing performance of its businesses by excluding items that may not be indicative of core operating results. Because non-GAAP financial measures are not standardized, it may not be possible to compare these measures with other companies' non-GAAP measures having the same or similar names. All tables below are in thousands of dollars: