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

 

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

(Exact name of registrant as specified in its charter)

 

 

Large accelerated filer [X]  Accelerated filer [  ]   Non-accelerated filer [  ]   Smaller reporting company [  ]

 

 

PART I – FINANCIAL INFORMATION

Item 1.  Financial StatementsStatements.

W.W. Grainger, Inc. and Subsidiaries

CONDENSED CONSOLIDATED STATEMENTS OF EARNINGS

(In thousands of dollars, except for share and per share amounts)

(Unaudited)

 

The accompanying notes are an integral part of these financial statements.

W.W. Grainger, Inc. and Subsidiaries

CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE EARNINGS

(In thousands of dollars)

(Unaudited)

 

 

 

The accompanying notes are an integral part of these financial statements.

W.W. Grainger, Inc. and Subsidiaries

CONDENSED CONSOLIDATED BALANCE SHEETS

(In thousands of dollars, except for share and per share amounts)

 

 

 

The accompanying notes are an integral part of these financial statements.

W.W. Grainger, Inc. and Subsidiaries

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(In thousands of dollars)

(Unaudited)

 

The accompanying notes are an integral part of these financial statements.

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 distributor of maintenance, repair and operating (MRO) supplies, and other related products and services used by businesses and institutions.  W.W. Grainger, Inc.’s operations are primarily in the United States 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.

 

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, 20142015 included in the Company’s Annual Report on Form 10-K filed with the Securities and Exchange Commission (SEC).

 

The Condensed Consolidated Balance Sheet as of December 31, 20142015 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 United States of America 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 herein.

2.    NEW ACCOUNTING STANDARDS

investment, results of operations and retained earnings when an investment qualifies for use of the equity method as a result of an increase in the level of ownership interest or degree of influence. The amendment requires that the investor add the cost of acquiring the additional interest to the current basis of the investor's previously held interest and adopt the equity method of accounting as of the date the investment becomes qualified for equity method accounting. The effective date for the standard is for fiscal years and interim periods within those years beginning after December 15, 2016. The amendment should be applied prospectively and early application is permitted. This ASU is not expected to have a material impact on the Company's consolidated financial statements.

3.    DIVIDEND

 

6.    SHORT-TERM AND LONG-TERM DEBT

 

On June 11, 2015,May 16, 2016, the Company issued $1 billion$400 million of unsecured 4.60%3.75% Senior Notes (the "Notes")(3.75% Notes) that mature on JuneMay 15, 2045.2046. The 3.75% Notes require no principal payments until the maturity date and interest is payable semi-annually on JuneMay 15 and DecemberNovember 15, beginning on DecemberNovember 15, 2015.2016. Prior to DecemberNovember 15, 2044,2045, the Company may redeem the 3.75% Notes in whole at any time or in part from time to time at a “make-whole” redemption price. This redemption price is calculated by reference to the then currentthen-current yield on a USU.S. treasury security with a maturity comparable to the remaining term of the 3.75% Notes plus 20 basis points, together with accrued and unpaid interest, if any, to the redemption date. On or after November 15, 2045, the Company may redeem the 3.75% Notes in whole at any time or in part from time to time at 100% of their principal amount, together with accrued and unpaid interest, if any, to the redemption date. Costs of approximately $4 million associated with the issuance of the 3.75% Notes, representing underwriting fees and other expenses, have been recorded as a contra-liability within Long-term debt and will be amortized to interest expense over the term of the 3.75% Notes. The fair value of the 3.75% Notes was approximately $420 million as of June 30, 2016.

On June 11, 2015, the Company issued $1 billion of unsecured 4.60% Senior Notes (4.60% Notes) that mature on June 15, 2045. The 4.60% Notes require no principal payments until the maturity date and interest is payable semi-annually on June 15 and December 15, beginning on December 31, 2015. Prior to December 15, 2044, the Company may redeem the 4.60% Notes in whole at any time or in part from time to time at a “make-whole” redemption price. This redemption price is calculated by reference to the then-current yield on a U.S. treasury security with a maturity comparable to the remaining term of the 4.60% Notes plus 25 basis points, together with accrued and unpaid interest, if any, to the redemption date. On or after December 15, 2044, the Company may redeem the 4.60% Notes in whole at any time or in part from time to time at 100% of their principal amount, together with accrued and unpaid interest, if any, to the redemption date. Costs of approximately $10 million associated with the issuance of the 4.60% Notes, representing underwriting fees and other expenses, have been recorded as a contra-liability within Long-term debt and will be amortized to interest expense over the term of the 4.60% Notes.

The estimated fair value of the Company’s 3.75% Notes and 4.60% Notes was based on available external pricing data and current market rates for similar debt instruments, among other factors, andwhich are classified as level 2 inputs within the fair value hierarchy. The carrying value of other long-term debt approximates fair value due to the variable interest rates.

5.7.    DERIVATIVE INSTRUMENTS

The Company uses derivative instruments to manage a portion of exposures to fluctuations in interest rates and foreign currency exchange rates. The Company does not enter into derivative financial instruments for trading or speculative purposes. The fair values of these instruments are determined by using quoted market forward rates (level 2 inputs) and reflect the present value of the amount that the Company would pay for contracts involving the same notional amounts and maturity dates. These instruments qualify for hedge accounting and the changes in fair value are reported as a component of other comprehensive earnings (losses) net of tax effects.

As of June 30, 2015 and December 31, 2014, theThe fair value of the Company's interest rate swap was approximately $0.3 million and $1 million as of June 30, 2016 and December 31, 2015, respectively, and was included on the balance sheet as a liability under Employment-related and other noncurrent liabilities was $1 million and $2 million, respectively.Accrued expenses. The purpose of the interest rate swap is to partially hedge the future interest expense of the euro-denominated term loan entered into to fund a portion of the Fabory acquisition in 2011. The swap matures in August 2016. All remaining derivative instruments were immaterial individually and in the aggregate as of June 30, 20152016 and December 31, 2014.2015.

6.8.    EQUITY METHOD INVESTMENT

In Mayaddition to the investment made in 2015, in January 2016, the Company invested in a second limited liability company (“LLC”) established to produce refined coal, which is then sold to a utility to produce electricity.  The production and sale of refined coal is eligible for renewable energy tax credits under Section 45 of the Internal Revenue Code.  Under the terms of the investment, effective control lies with a co-investor who manages the day-to-day operations of the entity.  The Company will fund its share of operating expenses ofentity, and as such the entity through January 2019 and receive tax credits in proportion to its equity investment. The investment will beinvestments are accounted for under the equity method of accounting.  

As of June 30, 2016 and December 31, 2015, the investment balance of the combined refined coal investments was $6$7 million million and $9 million, respectively, and is included on the balance sheet under Other assets and intangibles-net.assets. During the period,three and six months ended June 30, 2016, the Company recorded $4$5 million and $12 million, respectively, in equity losses and thelosses. The total tax benefit of $14 million including energy tax credits, is reflected in the Company’s effective tax rate.rate for the six months ended June 30, 2016. The investments contributed $1.7 million to net earnings for six months ended June 30, 2016.

 

The Company has a postretirement healthcare benefits plan that provides coverage for a majority of its United States employees hired prior to January 1, 2013, and their dependents should they elect to maintain such coverage upon retirement. Covered employees become eligible for participation when they qualify for retirement while working for the Company. Participation in the plan is voluntary and requires participants to make contributions toward the cost of the plan, as determined by the Company.

The net periodic benefit costs charged to operating expenses, which are valued at the measurement date of January 1 and recognized evenly throughout the year, consisted of the following components (in thousands of dollars):

 

The Company has established a Group Benefit Trust to fund the plan and process benefit payments. The funding of the trust is an estimated amount which is intended to allow the maximum deductible contribution under the Internal Revenue Code of 1986 (IRC), as amended.  There are no minimum funding requirements and the Company intends to follow its practice of funding the maximum deductible contribution under the IRC. DuringThe Company did not make a contribution to the trust during the three and six months ended June 30, 2015, the Company contributed $1.7 million and $2.1 million, respectively, to the trust.2016.

8.10.    SEGMENT INFORMATION

 

The Company has two reportable segments: the United States and Canada. The United States operating segment reflects the results of the Company's U.S. business. The Canada operating segment reflects the results for Acklands – Grainger Inc. (Acklands-Grainger), the Company’s Canadian business. Other businesses include Zoro, the single channel business in the United States, and operationsbusiness units in Europe, Asia and Latin America. These otherOther businesses individually do not meet the definition of a reportable segment. Operating segments generate revenue almost exclusively through the distribution of maintenance, repair and operating supplies, as service revenues account for less than 1% of total revenues for each operating segment. Following is a summary of segment results (in thousands of dollars):

  

 

Following are reconciliations of segment information with the consolidated totals per the financial statements (in thousands of dollars):

 

Assets for operating 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 asset balances for the operating segments.

Unallocated expenses and unallocated assets primarily relate to the Company headquarter's support services, which are not part of any business segment, as well as intercompany eliminations. Unallocated expenses include payroll and benefits, depreciation and other costs associated with headquarters-related support services. Unallocated assets include non-operating cash and cash equivalents, certain prepaid expenses and property, buildings and equipment-net. Unallocated assetsexpenses of $45 million increased by $616 million at22% in the three months ended June 30, 2015 compared2016 versus $37 million in the prior year quarter. The increase was driven primarily by a $9 million write-down of a corporate aircraft that the Company plans to December 31, 2014, primarily due to increased cash balances fromsell in connection with the issuanceoutsourcing of $1 billion in long-term debt.the aviation department.

Intersegment net sales for the U.S. segment increased by $38$17 million and $36 million for the three and six months of 2015ended June 30, 2016, respectively, compared to the prior year, driven by increased sales from the U.S. business to Zoro. The U.S. business' supply chain network is Zoro's primary source of inventory.

9.11.    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):

10.12.    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, environmental issues, wage and hour laws, intellectual property, employment practices, regulatory compliance or other matters and actions brought by employees, consumers, competitors, suppliers or governmental entities. As a government contractor selling to federal, state and local governmental entities, the Company is also subject to governmental or regulatory inquiries or audits or other proceedings, including those related to 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.

Item 2. Management's Discussion and Analysis of Financial Condition and Results of OperationsOperations.

Grainger is a broad-line distributor of maintenance, repair and operating (MRO) supplies, and other related products and services used by businesses and institutions. Grainger’s operations are primarily in the United States and Canada, with a presence in Europe, Asia and Latin America. Grainger uses a combination of multichannel and single channel business models to provide customers with a range of options for finding and purchasing products utilizing sales representatives, catalogs, direct marketing materials and eCommerce. Grainger serves more than 2approximately 3 million customers worldwide through a network of highly integrated branches, distribution centers and websites.

Given Grainger's large number of customers and the diverse industries it serves, several economic factors and industry 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 United States and Canada tend to positively correlate with Gross Domestic Product (GDP), Industrial Production,Business Investment, Business Inventory, Exports and Business Investment.Industrial Production. In the United States, sales also tend to positively correlate with Business Inventory.Gross Domestic Product (GDP). In Canada, sales also tend to positively correlate with oil prices. The table below provides these estimated indicators for 2015:2016:

On July 17, 2015,19, 2016, Grainger revised the 20152016 sales growth guidance from a range of 10 to 46 percent to a range of 01 to 24 percent and also revised the 20152016 earnings per share guidance from a range of $12.25$11.00 to $12.95$12.80 to a range of $12.00$11.20 to $12.50.$12.20. The revised sales and earnings per share guidance reflects expectationslower than expected volume in the U.S. and Canada, partially offset by improved gross profit and operating expense leverage in the second half of slower macroeconomic growth.the year. In addition, the Company is now expecting a higher effective tax rate for the year due to an increased concentration of earnings in higher tax rate jurisdictions and lower benefit from the clean energy investments.

The increase in net sales was ledprimarily driven by growththe acquisition of Cromwell in sales to government, diversified commercial servicesSeptember 2015 and light manufacturing customers. The sales growth was partially offset by declines tosingle channel online businesses in the natural resources, heavy manufacturing, resellersU.S. and contractors customer end markets.Japan. Refer to the Segment Analysis below for further details.

Gross profit of $1,073$1,040 million for the second quarter of 20152016 decreased 1%3%. The gross profit margin of 40.6% during the second quarter of 20152016 decreased 0.52.0 percentage pointpoints when compared to the same period in 2014,2015, due primarily driven by faster growth with lower margin customers, lower supplier rebates tied to lower-than-expected volume and price deflation versusexceeding cost inflation driven by foreign exchange.deflation, negative customer selling mix, as well as an inventory reserves adjustment in Canada.

Grainger’s two reportable segments are the United States and Canada. The United States operating segment reflects the results of Grainger’s U.S. operating segment.business. The Canada operating segment reflects the results for Acklands – Grainger Inc., Grainger’s Canadian operating segment.business. Other businesses include Zoro U.S. and operationsbusiness units in Europe, Asia and Latin America.

The following comments at the segment and business unit level include external and intersegment net sales and operating earnings. See Note 810 to the Condensed Consolidated Financial Statements.

Sales to government, commercial servicenatural resource customers and light manufacturing customers. Retail customers were up in the low single digits and heavy manufacturing and contractorsresellers were down in the low single digits. Net sales to resellersmid-teens. Contractor customers were down in the high single digits and the natural resources customer end marketheavy manufacturing was down in the mid-single digits. Commercial customers were down in the low teens.single digits and light manufacturing was flat. Low oil prices negatively impacted the performance of the heavy manufacturing and natural resources customer end markets.customers. These decreases were slightly offset by low single digit growth in government and retail. Sales to Zoro also contributedcontinue to contribute to sales growth as the U.S. business' supply chain network is Zoro's primary source of inventory.

Net sales for other businesses, which include Zoro U.S. and operations, business units in Europe, Asia, and Latin America, and the newly acquired Cromwell, were $319$474 million for the second quarter of 2015,2016, an increase of $20$155 million or 7%, when compared with net sales of $299$319 million for the same period in 2014.2015, primarily due to the acquisition of Cromwell. On a daily sales basis, sales were up 49%. The drivers of netthe increase in daily sales for the quarter consisted of the following:

Other income and expense was $23 million of expense in the second quarter of 2016 compared to $8 million of expense in the second quarter of 2015 compared to $2 million of expense in the second quarter of 2014.2015. The increase in expense was driven by higherprimarily due to interest expense from the new $1 billion of debt the Company issued in long-termJune 2015 and $400 million of debt issued in early June,May 2016, as well as operatingexpected losses from a new investmentthe Company's investments in a limited liability company established to produce clean energy. As discussed below, the operating losses in this investment were offset by energy tax credits that lowered Grainger's tax rate, which provided Grainger with positive net earnings and cash flow.

There were 127128 sales days in the six months of 2015 and 2014. Grainger completed the WFS acquisitionended June 30, 2016 compared to 127 sales days in the third quarter of 2014 and announced plans to close the business in Brazil in the fourth quarter of 2014, both of which were immaterial individually and in the aggregate.2015.

Grainger’s net sales of $4,962$5,070 million for the six months of 2015ended June 30, 2016 increased 1%2% compared with sales of $4,892$4,962 million for the comparable 20142015 period. TheOn a daily sales basis, sales increased 1% increase for the periodquarter and consisted of the following:

The table below reconciles reported diluted earnings per share determined in accordance with generally accepted accounting principles (GAAP) in the United States to adjusted diluted earnings per share, a non-GAAP measure. Management believes adjusted diluted earnings per share is an important indicator of operations because it excludes 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 this financial measure with other companies' non-GAAP financial measures having the same or similar names.

Grainger’s two reportable segments are the United States and Canada. The United States segment reflects the results of Grainger’s U.S. operating segment. The Canada segment reflects the results for Acklands – Grainger Inc., Grainger’s Canadian operating segment. Other businesses include Zoro U.S. and operations in Europe, Asia and Latin America.

The following comments at the segment and business unit level include external and intersegment net sales and operating earnings. See Note 810 to the Condensed Consolidated Financial Statements.

Net sales were $4,002$3,945 million for the six months ended June 30, 2016, a decrease of 2015, an increase of $112 million, or 3%1%, when compared with net sales of $3,890$4,002 million for the same period in 2014. The 3% increase2015. On a daily basis, sales decreased 2% for the period and consisted of the following:

Net sales were $373 million for the six months ended June 30, 2016, a decrease of $101 million, or 21%, when compared with $474 million for the same period in 2015. In local currency, sales decreased 16%. On a daily basis, sales decreased 22% for the period and consisted of the following:

Operating expenses in the six months ended June 30, 2016 were $145 million compared to $159 million for the six months ended June 30, 2015. The decrease was due to the benefit of a $7 million gain from the sale of property, lower advertising costs and SAP project costs, partially offset by growth from utilities, mining, governmentrestructuring costs of $10 million.

Operating losses were $40 million for the six months ended June 30, 2016 versus operating earnings of $19 million in the six months ended June 30, 2015. Excluding the restructuring costs and light manufacturing customer end markets.the inventory adjustment mentioned above, the operating losses would have been $19 million driven by the sales decline, lower gross profit margin and expenses declining at a slower rate than sales.

Net sales for other businesses, which include Zoro U.S. and operations in Europe, Asia and Latin America, were $617$920 million for the six months of 2015,ended June 30, 2016, an increase of $43$303 million, or 7%, when compared with net sales of $574$617 million for the same period in 2014.2015. The drivers of net sales for the period consisted of the following: