UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-Q

 

(Mark One)

☒ QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF

THE SECURITIES EXCHANGE ACT OF 1934

 

For the quarterly period ended September 30, 2019

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)

 

Securities registered pursuant to Section 12(b) of the Act:

Title of Each Class	Trading Symbol	Name of Each Exchange on Which Registered
Common Stock	GWW	New York Stock Exchange

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 ☒  No ☐

 

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted 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 ☒  No ☐

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a 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 ☒  Accelerated Filer ☐   Non-accelerated Filer ☐   Smaller Reporting Company ☐

Emerging Growth Company ☐

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 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).

Yes ☐  No ☒

 

There were 53,866,254 shares of the Company’s Common Stock, par value $0.50, outstanding as of September 30, 2019.

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	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, 2019 and 2018	4
	Condensed Consolidated Statements of Comprehensive     Earnings for the Three and Nine Months Ended September 30, 2019 and 2018	5
	Condensed Consolidated Balance Sheets     as of September 30, 2019 and December 31, 2018	6
	Condensed Consolidated Statements of Cash Flows     for the Nine Months Ended September 30, 2019 and 2018	7
	Condensed Consolidated Statements of Shareholders' Equity for the Three and Nine Months Ended September 30, 2019 and 2018	8
	Notes to Condensed Consolidated Financial Statements	10
Item 2:	Management's Discussion and Analysis of Financial     Condition and Results of Operations	18
Item 3:	Quantitative and Qualitative Disclosures About Market Risk	28
Item 4:	Controls and Procedures	28
	PART II OTHER INFORMATION	28
Item 1:	Legal Proceedings	28
Item 2:	Unregistered Sales of Equity Securities and Use of Proceeds	28
Item 6:	Exhibits	29
Signatures		30
EXHIBITS

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PART I – FINANCIAL INFORMATION

Item 1:  Financial Statements

W.W. Grainger, Inc. and Subsidiaries

CONDENSED CONSOLIDATED STATEMENTS OF EARNINGS

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

(Unaudited)

	Three Months Ended								Nine Months Ended
	September 30,								September 30,
	2019				2018				2019				2018
Net sales	$	2,947			$	2,831			$	8,639			$	8,458
Cost of goods sold	1,848				1,752				5,324				5,176
Gross profit	1,099				1,079				3,315				3,282
Selling, general and administrative expenses	761				890				2,234				2,414
Operating earnings	338				189				1,081				868
Other income (expense):
Interest income	1				2				4				4
Interest expense	(21		)		(22		)		(64		)		(70		)
Other, net	4				2				18				—
Total other expense, net	(16		)		(18		)		(42		)		(66		)
Earnings before income taxes	322				171				1,039				802
Income taxes	78				56				261				198
Net earnings	244				115				778				604
Less: Net earnings attributable to noncontrolling interest	11				11				32				31
Net earnings attributable to W.W. Grainger, Inc.	$	233			$	104			$	746			$	573
Earnings per share:
Basic	$	4.27			$	1.84			$	13.46			$	10.12
Diluted	$	4.25			$	1.82			$	13.40			$	10.04
Weighted average number of shares outstanding:
Basic	54,125,184				56,339,630				54,962,699				56,172,277
Diluted	54,354,904				56,803,857				55,220,266				56,588,530
Cash dividends paid per share	$	1.44			$	1.36			$	4.24			$	4.00

 

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

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W.W. Grainger, Inc. and Subsidiaries

CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE EARNINGS

(In millions of dollars)

(Unaudited)

	Three Months Ended								Nine Months Ended
	September 30,								September 30,
	2019				2018				2019				2018
Net earnings	$	244			$	115			778				604
Other comprehensive earnings (losses):
Foreign currency translation adjustments	(17		)		—				6				(25		)
Postretirement benefit plan reclassification, net of tax benefit of $1, $1, $3 and $2, respectively	(2		)		(2		)		(7		)		(8		)
Total other comprehensive earnings (losses)	(19		)		(2		)		(1		)		(33		)
Comprehensive earnings, net of tax	225				113				777				571
Less: Comprehensive earnings (losses) attributable to noncontrolling interest
Net earnings	11				11				32				31
Foreign currency translation adjustments	(1		)		(5		)		2				(3		)
Total comprehensive earnings (losses) attributable to noncontrolling interest	10				6				34				28
Comprehensive earnings attributable to W.W. Grainger, Inc.	$	215			$	107			$	743			$	543

 

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

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W.W. Grainger, Inc. and Subsidiaries

CONDENSED CONSOLIDATED BALANCE SHEETS

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

	As of
ASSETS	(Unaudited) September 30, 2019				December 31, 2018
CURRENT ASSETS
Cash and cash equivalents	$	286			$	538
Accounts receivable (less allowances for doubtful
accounts of $22 and $25, respectively)	1,495				1,385
Inventories	1,520				1,541
Prepaid expenses and other assets	86				83
Prepaid income taxes	9				10
Total current assets	3,396				3,557
PROPERTY, BUILDINGS AND EQUIPMENT, NET	1,384				1,352
DEFERRED INCOME TAXES	13				12
GOODWILL	425				424
INTANGIBLES, NET	422				460
OTHER ASSETS	282				68
TOTAL ASSETS	$	5,922			$	5,873
LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES
Short-term debt	$	51			$	49
Current maturities of long-term debt	219				81
Trade accounts payable	723				678
Accrued compensation and benefits	170				262
Accrued contributions to employees' profit sharing plans	70				133
Accrued expenses	327				269
Income taxes payable	12				29
Total current liabilities	1,572				1,501
LONG-TERM DEBT (less current maturities)	1,918				2,090
DEFERRED INCOME TAXES AND TAX UNCERTAINTIES	120				103
OTHER NON-CURRENT LIABILITIES	240				86
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	55				55
Additional contributed capital	1,161				1,134
Retained earnings	8,380				7,869
Accumulated other comprehensive losses	(174		)		(171		)
Treasury stock, at cost – 55,792,965 and 53,796,859 shares, respectively	(7,551		)		(6,966		)
Total W.W. Grainger, Inc. shareholders’ equity	1,871				1,921
Noncontrolling interest	201				172
Total shareholders' equity	2,072				2,093
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY	$	5,922			$	5,873

  

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

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W.W. Grainger, Inc. and Subsidiaries

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(In millions of dollars)

(Unaudited)

	Nine Months Ended
	September 30,
	2019				2018
CASH FLOWS FROM OPERATING ACTIVITIES:
Net earnings	$	778			$	604
Provision for losses on accounts receivable	7				7
Deferred income taxes and tax uncertainties	19				10
Depreciation and amortization	171				192
Net gains from sales of assets and divestitures	(5		)		(22		)
Impairment of goodwill, intangible and other assets	—				142
Stock-based compensation	32				36
Losses from equity method investment	—				18
Subtotal	224				383
Change in operating assets and liabilities:
Accounts receivable	(119		)		(172		)
Inventories	18				(53		)
Prepaid expenses and other assets	(15		)		(13		)
Trade accounts payable	50				4
Accrued liabilities	(137		)		(36		)
Income taxes, net	(16		)		39
Other non-current liabilities	(13		)		(13		)
Subtotal	(232		)		(244		)
Net cash provided by operating activities	770				743
CASH FLOWS FROM INVESTING ACTIVITIES:
Additions to property, buildings, equipment and intangibles	(163		)		(169		)
Proceeds from sales of assets	16				76
Equity method proceeds (investment)	2				(12		)
Net cash used in investing activities	(145		)		(105		)
CASH FLOWS FROM FINANCING ACTIVITIES:
Borrowings under lines of credit	22				24
Payments against lines of credit	(18		)		(28		)
Payments of long-term debt	(48		)		(89		)
Proceeds from stock options exercised	19				179
Payments for employee taxes withheld from stock awards	(10		)		(11		)
Purchases of treasury stock	(600		)		(283		)
Cash dividends paid	(242		)		(232		)
Other, net	2				3
Net cash used in financing activities	(875		)		(437		)
Exchange rate effect on cash and cash equivalents	(2		)		(11		)
NET CHANGE IN CASH AND CASH EQUIVALENTS	(252		)		190
Cash and cash equivalents at beginning of year	538				327
Cash and cash equivalents at end of period	$	286			$	517

 

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

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W.W. Grainger, Inc. and Subsidiaries

CONDENSED CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY

(In millions of dollars, except for per share amounts)

(Unaudited)

	Common Stock			Additional Contributed Capital			Retained Earnings			Accumulated Other Comprehensive Earnings (Losses)			Treasury Stock			Noncontrolling Interest			Total
Balance at January 1, 2018	$	55		$	1,041		$	7,405		$	(135	)	$	(6,676	)	$	138		$	1,828
Stock based compensation	—			24			—			—			44			—			68
Purchases of treasury stock	—			—			—			—			(160		)	—			(160		)
Net earnings	—			—			232			—			—			9			241
Other comprehensive earnings (losses)	—			—			—			12			—			9			21
Cash dividends paid ($1.28 per share)	—			—			(73		)	—			—			—			(73		)
Balance at March 31, 2018	$	55		$	1,065		$	7,564		$	(123	)	$	(6,792	)	$	156		$	1,925
Stock based compensation	—			14			—			—			23			—			37
Purchases of treasury stock	—			—			—			—			(28		)	—			(28		)
Net earnings	—			—			237			—			—			11			248
Other comprehensive earnings (losses)	—			—			—			(45		)	—			(7		)	(52		)
Capital contribution	—			—			—			—			—			2			2
Cash dividends paid ($1.36 per share)	—			—			(76		)	—			—			(6		)	(82		)
Balance at June 30, 2018	$	55		$	1,079		$	7,725		$	(168	)	$	(6,797	)	$	156		$	2,050
Stock based compensation	—			46			—			—			54			—			100
Purchases of treasury stock	—			—			—			—			(86		)	—			(86		)
Net earnings	—			—			104			—			—			11			115
Other comprehensive earnings (losses)	—			—			—			3			—			(5		)	(2		)
Cash dividends paid ($1.36 per share)	—			—			(77		)	—			—			—			(77		)
Balance at September 30, 2018	$	55		$	1,125		$	7,752		$	(165	)	$	(6,829	)	$	162		$	2,100

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

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W.W. Grainger, Inc. and Subsidiaries

CONDENSED CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY

(In millions of dollars, except for per share amounts)

(Unaudited)

	Common Stock			Additional Contributed Capital			Retained Earnings			Accumulated Other Comprehensive Earnings (Losses)			Treasury Stock			Noncontrolling Interest			Total
Balance at January 1, 2019	$	55		$	1,134		$	7,869		$	(171	)	$	(6,966	)	$	172		$	2,093
Stock based compensation	—			3			—			—			3			—			6
Purchases of treasury stock	—			—			—			—			(135		)	—			(135		)
Net earnings	—			—			253			—			—			9			262
Other comprehensive earnings (losses)	—			—			—			3			—			(2		)	1
Capital contribution	—			—			—			—			—			2			2
Cash dividends paid ($1.36 per share)	—			—			(77		)	—			—			—			(77		)
Balance at March 31, 2019	$	55		$	1,137		$	8,045		$	(168	)	$	(7,098	)	$	181		$	2,152
Stock based compensation	—			15			—			—			9			—			24
Purchases of treasury stock	—			—			—			—			(265		)	—			(265		)
Net earnings	—			—			260			—			—			12			272
Other comprehensive earnings (losses)	—			—			—			12			—			5			17
Cash dividends paid ($1.44 per share)	—			—			(79		)	—			—			(7		)	(86		)
Balance at June 30, 2019	$	55		$	1,152		$	8,226		$	(156	)	$	(7,354	)	$	191		$	2,114
Stock based compensation	—			9			—			—			3			—			12
Purchases of treasury stock	—			—			—			—			(200		)	—			(200		)
Net earnings	—			—			233			—			—			11			244
Other comprehensive earnings (losses)	—			—			—			(18		)	—			(1		)	(19		)
Cash dividends paid ($1.44 per share)	—			—			(79		)	—			—			—			(79		)
Balance at September 30, 2019	$	55		$	1,161		$	8,380		$	(174	)	$	(7,551	)	$	201		$	2,072

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

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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) products and services with operations primarily in North America, Europe and Japan. 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 (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, 2018 included in the Company’s Annual Report on Form 10-K filed with the Securities and Exchange Commission (SEC) on February 28, 2019.

 

The Condensed Consolidated Balance Sheet as of December 31, 2018 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 (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 June 2016, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) 2016-13, Financial Instruments - Credit Losses: Measurement of Credit Losses on Financial Instruments as modified by subsequently issued ASUs 2018-19, 2019-04 and 2019-05. This ASU requires estimating all expected credit losses for certain types of financial instruments, including trade receivables, held at the reporting date based on historical experience, current conditions and reasonable and supportable forecasts. The effective date of this ASU is for fiscal years and interim periods beginning after December 15, 2019 and the Company plans to adopt this ASU prospectively. The Company is evaluating the impact of this ASU and does not expect a material impact to the Company's Financial Statements.

On January 1, 2019, the Company adopted ASU 2016-02, Leases as modified subsequently by ASUs 2018-01, 2018-10, 2018-11, 2018-20 and 2019-01(Topic 842). The core principle of these ASUs is to improve 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 Company utilized the simplified modified retrospective transition method that allowed for a cumulative-effect adjustment in the period of adoption, and did not restate prior periods. Additionally, the Company elected the practical expedients package permitted under the transition guidance. Adoption of the new standard resulted in the recording of right of use (ROU) assets and lease liabilities of approximately $208 million and $205 million, respectively as of January 1, 2019 related to operating and finance leases. Adoption of the standard did not materially impact the Company’s Financial Statements. See Note 5 to the Financial Statements.

In July 2019, the FASB issued ASU 2019-07, Codification Updates to SEC Sections - Amendments to SEC Paragraphs Pursuant to SEC Final Rule Releases No. 33-10532, Disclosure Update and Simplification, and Nos. 33-10231 and 33-10442, Investment Company Reporting Modernization, and Miscellaneous Updates (SEC Update). This ASU clarifies or improves the disclosure and presentation requirements of a variety of codification topics by aligning with the SEC's regulations, thereby eliminating redundancies and making the codification easier to apply. This ASU was effective immediately upon issuance and did not have a material impact on the Company's Financial Statements and related disclosures.

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W.W. Grainger, Inc. and Subsidiaries

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)

3.    REVENUE

Company revenue is primarily comprised of MRO product sales and related activities, such as freight and services. Total service revenue is not material and accounted for approximately 1% of the Company's revenue for the three and nine months ended September 30, 2019 and 2018, respectively.

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:

	Three Months Ended September 30,
	2019									2018
	U.S.			Canada			Total Company (2)			U.S.			Canada			Total Company (2)
Government	20	%		5	%		15	%		20	%		5	%		15	%
Heavy Manufacturing	18	%		20	%		17	%		19	%		20	%		18	%
Light Manufacturing	12	%		6	%		10	%		13	%		6	%		11	%
Transportation	6	%		8	%		5	%		5	%		8	%		5	%
Commercial	17	%		9	%		13	%		16	%		9	%		13	%
Retail/Wholesale	9	%		4	%		7	%		8	%		4	%		7	%
Contractors	9	%		11	%		8	%		9	%		11	%		8	%
Natural Resources	3	%		33	%		4	%		3	%		34	%		4	%
Other (1)	6	%		4	%		21	%		7	%		3	%		19	%
Total net sales to external customers	100	%		100	%		100	%		100	%		100	%		100	%
Percent of Total Company Revenue	73	%		4	%		100	%		73	%		5	%		100	%

	Nine Months Ended September 30,
	2019									2018
	U.S.			Canada			Total Company (2)			U.S.			Canada			Total Company (2)
Government	19	%		6	%		14	%		19	%		6	%		14	%
Heavy Manufacturing	19	%		20	%		17	%		19	%		20	%		18	%
Light Manufacturing	13	%		6	%		11	%		13	%		6	%		11	%
Transportation	5	%		8	%		5	%		5	%		7	%		5	%
Commercial	17	%		9	%		13	%		16	%		10	%		13	%
Retail/Wholesale	8	%		4	%		7	%		8	%		4	%		7	%
Contractors	10	%		11	%		8	%		10	%		11	%		8	%
Natural Resources	3	%		32	%		4	%		3	%		33	%		4	%
Other (1)	6	%		4	%		21	%		7	%		3	%		20	%
Total net sales to external customers	100	%		100	%		100	%		100	%		100	%		100	%
Percent of Total Company Revenue	73	%		5	%		100	%		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 endless assortment businesses and operations in Europe, Asia and Latin America and accounts for approximately 23% and 22% of revenue for the three months ended September 30, 2019 and 2018, respectively, and accounts for 22% and 21% of revenue for the nine months ended September 30, 2019 and 2018, respectively.

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W.W. Grainger, Inc. and Subsidiaries

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)

Total accrued sales returns were approximately $26 million and $29 million as of September 30, 2019 and December 31, 2018, respectively and are reported as a reduction of Accounts receivable. Total accrued sales incentives were approximately $58 million and $62 million as of September 30, 2019 and December 31, 2018, respectively and are reported as part of Accrued expenses. The Company did not have any material unsatisfied performance obligations, contract assets or liabilities as of September 30, 2019 and December 31, 2018.

4.    PROPERTY, BUILDINGS AND EQUIPMENT

Property, buildings and equipment consisted of the following (in millions of dollars):

	As of
	September 30, 2019				December 31, 2018
Land	$	323			$	318
Building, structures and improvements	1,329				1,338
Furniture, fixtures, machinery and equipment	1,799				1,785
Property, buildings and equipment	$	3,451			$	3,441
Less: Accumulated depreciation and amortization	2,067				2,089
Property, buildings and equipment, net	$	1,384			$	1,352

5. LEASES

The Company leases certain properties and buildings (including branches, warehouses, distribution centers and office space) and equipment under various arrangements which provide the right to use the underlying asset and require lease payments for the lease term. The Company’s lease portfolio consists mainly of operating leases which expire at various dates through 2036. Finance leases and service contracts with lease arrangements are not material and the following disclosures pertain to the Company’s operating leases.

Many of the property and building lease agreements obligate the Company to pay real estate taxes, insurance and certain maintenance costs (hereinafter referred to as non-lease components). Certain of the Company’s lease arrangements contain renewal provisions from 1 to 30 years, exercisable at the Company's option. The Company’s lease agreements do not contain any material residual value guarantees or material restrictive covenants.

The Company determines if an arrangement is an operating lease at inception. Leases with an initial term of 12 months or less are not recorded on the balance sheet. All other leases are recorded on the balance sheet with ROU assets representing the right to use the underlying asset for the lease term and lease liabilities representing the obligation to make lease payments arising from the lease.

ROU assets and lease liabilities are recognized at commencement date based on the present value of lease payments over the lease term and include options to extend or terminate the lease when they are reasonably certain to be exercised. The present value of lease payments is determined primarily using the incremental borrowing rate based on the information available at lease commencement date. Lease agreements with lease and non-lease components are generally accounted for as a single lease component. The Company’s operating lease expense is recognized on a straight-line basis over the lease term and is recorded in Selling, general and administrative expenses (SG&A).

12

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W.W. Grainger, Inc. and Subsidiaries

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)

Information related to operating leases is as follows (in millions of dollars):

		As of September 30, 2019
ROU Assets
Other assets		$	207
Operating lease liabilities
Accrued expenses		54
Other non-current liabilities		159
Total operating lease liabilities		$	213

		Nine Months Ended September 30, 2019
Weighted average remaining lease term		6 years
Weighted average incremental borrowing rate		2.3		%
Cash paid for operating leases		$	49
ROU assets obtained in exchange for operating lease obligations		15

Rent expense related to operating leases included in SG&A for the three and nine months ended September 30, 2019, was $19 million and $54 million, respectively.

Maturities of operating lease liabilities as of September 30, 2019 (in millions of dollars) are as follows:

Year		Maturity of operating lease liabilities
2019 (remaining 3 months)		$	15
2020		57
2021		48
2022		37
2023		25
Thereafter		42
Total lease payments		224
Less interest		(11		)
Present value of lease liabilities		$	213

As of September 30, 2019, the Company's future lease obligations that have not yet commenced are immaterial.

13

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W.W. Grainger, Inc. and Subsidiaries

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)

6.    GOODWILL AND INTANGIBLE ASSETS

The balances and changes in the carrying amount of Goodwill by segment are as follows (in millions of dollars):

		United States				Canada				Other businesses				Total
Balance at January 1, 2018		$	192			$	130			$	222			$	544
Impairment		—				—				(105		)		(105		)
Translation		—				(10		)		(5		)		(15		)
Balance at December 31, 2018		192				120				112				424
Translation		—				3				(2		)		1
Balance at September 30, 2019		$	192			$	123			$	110			$	425

The cumulative goodwill impairment charges by segment as of September 30, 2019 and December 31, 2018 are as follows (in millions of dollars):

		United States				Canada				Other businesses				Total
Cumulative goodwill impairment charges		$	24			$	32			$	176			$	232

The balances and changes in Intangible assets, net are as follows (in millions of dollars):

			September 30, 2019												December 31, 2018
	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		$	391			$	212			$	179			$	410			$	204			$	206
Trademarks, trade names and other	13.8 years		36				20				16				24				15				9
Non-amortized trade names and other			96				—				96				99				—				99
Capitalized software	4.2 years		618				487				131				657				511				146
Total intangible assets	8.7 years		$	1,141			$	719			$	422			$	1,190			$	730			$	460

Grainger tests reporting units' goodwill and intangible assets for impairment annually during the fourth quarter and more frequently if impairment indicators exist. Accordingly, Grainger periodically performs qualitative assessments of significant events and circumstances such as reporting units' historical and current results, assumptions regarding future performance, strategic initiatives and overall economic factors to determine the existence of impairment indicators and assess if it is more likely than not that the fair value of reporting units or intangible assets is less than their carrying value and if a quantitative impairment test is necessary.

Grainger's qualitative assessment for the nine months ended September 30, 2019 did not indicate the presence of any impairment triggering events. Changes in assumptions regarding future performance, as well as the ability to execute on growth initiatives and productivity improvements, may have a significant impact on future cash flows. Likewise, an unfavorable economic environment and changes in market conditions, discount rates or other factors may result in future impairments of goodwill and intangible assets.

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W.W. Grainger, Inc. and Subsidiaries

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)

7.     RESTRUCTURING

Restructuring activity for the three and nine months ended September 30, 2019 was not material. In the three and nine months ended September 30, 2018, the Company recorded restructuring charges of approximately $4 million and $27 million, respectively. These charges primarily consisted of involuntary employee termination costs in Canada and the U.S., net of gains from the sales of branches and are included in SG&A. The reserve balance as of September 30, 2019 and December 31, 2018 was approximately $16 million and $47 million, respectively, and is primarily included in Accrued compensation and benefits. The remaining reserves are expected to be paid through 2020.

8.    SHORT-TERM AND LONG-TERM DEBT

 

Short-term debt consisted of outstanding lines of credit of $51 million and $49 million at September 30, 2019 and December 31, 2018, respectively. Long-term debt consisted of the following (in millions of dollars):

	As of September 30, 2019								As of December 31, 2018
	Carrying Value				Fair Value				Carrying Value				Fair Value
4.60% senior notes due 2045	$	1,000			$	1,178			$	1,000			$	1,026
3.75% senior notes due 2046	400				417				400				357
4.20% senior notes due 2047	400				448				400				383
British pound term loan	157				157				174				174
Euro term loan	120				120				126				126
Canadian dollar revolving credit facility	45				45				44				44
Other	36				36				49				49
Subtotal	2,158				2,401				2,193				2,159
Less current maturities	(219		)		(219		)		(81		)		(81		)
Debt issuance costs and discounts, net of amortization	(21		)		(21		)		(22		)		(22		)
Long-term debt (less current maturities)	$	1,918			$	2,161			$	2,090			$	2,056

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.

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W.W. Grainger, Inc. and Subsidiaries

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)

9.    INCOME TAXES

For the three months ended September 30, 2019, the Company's effective tax rate was 24.2% compared to 32.7% in the three months ended September 30, 2018. The higher tax rate in the prior year was driven primarily by impairment charges related to the Cromwell business in the U.K., which lowered reported operating earnings and were not tax deductible.

10.    SEGMENT INFORMATION

Grainger's two reportable segments are the U.S. and Canada. The U.S. reportable segment reflects the results of Grainger's U.S. businesses. The Canada reportable segment reflects the results of Acklands-Grainger, Inc. and its subsidiaries. Other businesses include the endless assortment businesses, Zoro Tools, Inc. (Zoro) in the U.S. and MonotaRO Co. (MonotaRO) in Japan, and smaller high-touch solutions businesses in Europe, Asia and Mexico. These businesses individually do not meet the criteria of a reportable segment.

Following is a summary of segment results (in millions of dollars):

	Three Months Ended September 30, 2019
	U.S.				Canada				Total Reportable Segments				Other businesses				Total
Total net sales	$	2,277			$	129			$	2,406			$	673			$	3,079
Intersegment net sales	(131		)		—				(131		)		(1		)		(132		)
Net sales to external customers	$	2,146			$	129			$	2,275			$	672			$	2,947
Segment operating earnings	$	343			$	—			$	343			$	30			$	373

	Three Months Ended September 30, 2018
	U.S.				Canada				Total Reportable Segments				Other businesses				Total
Total net sales	$	2,188			$	149			$	2,337			$	610			$	2,947
Intersegment net sales	(115		)		—				(115		)		(1		)		(116		)
Net sales to external customers	$	2,073			$	149			$	2,222			$	609			$	2,831
Segment operating earnings	$	326			$	(4	)		$	322			$	(99	)		$	223

	Nine Months Ended September 30, 2019
	U.S.				Canada				Total Reportable Segments				Other businesses				Total
Total net sales	$	6,648			$	400			$	7,048			$	1,969			$	9,017
Intersegment net sales	(376		)		—				(376		)		(2		)		(378		)
Net sales to external customers	$	6,272			$	400			$	6,672			$	1,967			$	8,639
Segment operating earnings	$	1,088			$	(4	)		$	1,084			$	87			$	1,171

	Nine Months Ended September 30, 2018
	U.S.				Canada				Total Reportable Segments				Other businesses				Total
Total net sales	$	6,471			$	508			$	6,979			$	1,820			$	8,799
Intersegment net sales	(338		)		—				(338		)		(3		)		(341		)
Net sales to external customers	$	6,133			$	508			$	6,641			$	1,817			$	8,458
Segment operating earnings	$	1,032			$	(38	)		$	994			$	(22	)		$	972

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W.W. Grainger, Inc. and Subsidiaries

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)

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

	Three Months Ended September 30,								Nine Months Ended September 30,
	2019				2018				2019				2018
Operating earnings:
Total operating earnings for reportable segments	$	343			$	322			$	1,084			$	994
Other businesses	30				(99		)		87				(22		)
Unallocated expenses	(35		)		(34		)		(90		)		(104		)
Total consolidated operating earnings	$	338			$	189			$	1,081			$	868
	As of
	September 30, 2019				December 31, 2018
Assets:
United States	$	2,637			$	2,496
Canada	166				188
Assets for reportable segments	2,803				2,684
Other current and noncurrent assets	3,016				2,879
Unallocated assets	103				310
Total consolidated assets	$	5,922			$	5,873

The Company is a broad-line distributor of MRO products and services. 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.

Unallocated expenses primarily relate to the Company's headquarters support services and intercompany eliminations, which are not part of any reportable segment. Unallocated expenses include supply chain, product management and procurement, finance, communications, human resources, information systems, legal and compliance, internal audit and real estate.

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.

11.    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.

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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) products and services with operations primarily in North America, Europe and Japan. More than 3.5 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 5,000 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 high-touch solutions businesses in those geographies. Other businesses include the endless assortment businesses, (Zoro in the U.S. and MonotaRO in Japan), and smaller high-touch solutions businesses in Europe, Asia and Mexico.

Business Environment

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 and provide general insight into projecting Grainger's growth. Grainger’s sales in the United States (U.S.) and Canada tend to positively correlate with Business Investment, Business Inventory, Exports, Industrial Production and Gross Domestic Product (GDP). Sales in Canada also tend to positively correlate with oil prices. The table below provides these estimated indicators for 2019:

	U.S.			Canada
	Estimated 2018	Forecasted 2019		Estimated 2018	Forecasted 2019
Business Investment	6.8%	1.6%		1.2%	(2.0)%
Business Inventory	1.8%	2.8%		—	—
Exports	3.0%	(0.2)%		3.2%	2.6%
Industrial Production	3.9%	0.9%		3.1%	0.8%
GDP	2.9%	2.3%		1.9%	1.4%
Oil Prices	—	—		$65/barrel	$59/barrel
Source: Global Insight U.S. (October 2019), Global Insight Canada (September 2019)

In the U.S., Business Investment and Exports are two major indicators of MRO spending. Per the Global Insight October 2019 forecast, Business Inventory is forecast to improve while Business Investment, Industrial Production, Exports and GDP are forecast to soften, as a result of the trade tensions and associated uncertainty around tariff policy, slowing global growth and a strong U.S. dollar, diminishing support from fiscal stimulus and a decline in the pace of inventory accumulation.

Per the Global Insight September 2019 forecast, Canada's Business Investment, Exports, Industrial Production and GDP are expected to slow due to elevated global trade uncertainties, a reduction in spending, delayed investments and slowing global oil demand.

Outlook

Each business in Grainger’s portfolio has a specific set of strategic imperatives focused on creating unique value for customers.

In the U.S. business, Grainger is focused on growing market share through the three pillars of its strategy: (i) building advantaged MRO solutions, which means being able to get customers the exact product they need to solve a problem quickly; (ii) offering differentiated sales and services; Grainger has an advantage in serving complex businesses at their place of business through its direct customer relationships and onsite services and (iii) delivering unparalleled customer service; Grainger is committed to providing the absolute best customer experience in the industry through its effort to deliver flawlessly on every customer transaction.

 

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W.W. Grainger, Inc. and Subsidiaries

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL

CONDITION AND RESULTS OF OPERATIONS

Matters Affecting Comparability

There were 64 sales days in the three months ended September 30, 2019 and 63 sales days in the three months ended September 30, 2018.

Results of Operations – Three Months Ended September 30, 2019

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
	2019				2018						2019			2018
Net sales	$	2,947			$	2,831		4	%		100.0	%		100.0	%
Cost of goods sold	1,848				1,752			5			62.7			61.9
Gross profit	1,099				1,079			2			37.3			38.1
Selling, general and administrative expenses	761				890			(14	)		25.9			31.4
Operating earnings	338				189			78			11.4			6.7
Other expense, net	16				18			(16	)		0.5			0.6
Income taxes	78				56			39			2.6			2.0
Net earnings	244				115
Noncontrolling interest	11				11			7			0.4			0.4
Net earnings attributable to W.W. Grainger, Inc.	$	233			$	104		123	%		7.9	%		3.7	%

Grainger’s net sales of $2,947 million for the third quarter of 2019 increased $116 million, or 4% compared to the same period in 2018. On a daily basis, net sales increased 2.5%. The increase in net sales was primarily driven by volume increases in the U.S. business and the endless assortment businesses, partially offset by lower sales in the Canada business and Cromwell in the United Kingdom (U.K.), which is included in other businesses. For the three months ended September 30, 2019, price inflation and foreign exchange were flat. See the Segment Analysis below for further details related to segment revenue.

Gross profit of $1,099 million for the third quarter of 2019 increased $20 million compared to the same quarter in 2018. The gross profit margin of 37.3% during the third quarter of 2019 decreased 0.8 percentage point when compared to the same quarter in 2018. This decrease was driven by the timing of pricing adjustments during the year which resulted in negative price cost spread in the U.S. business and increased net sales in the endless assortment businesses, which have a lower gross profit. See the Segment Analysis below for further details related to segment gross profit.

The table below reconciles reported Selling, general and administrative expenses (SG&A), operating earnings, net earnings attributable to W.W. Grainger, Inc. and effective tax rate determined in accordance with U.S. generally accepted accounting principles (GAAP) to adjusted SG&A, operating earnings, net earnings attributable to W.W. Grainger, Inc. and effective tax rate, 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 millions of dollars:

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W.W. Grainger, Inc. and Subsidiaries

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL

CONDITION AND RESULTS OF OPERATIONS

	Three Months Ended
	September 30,
	2019				2018				%
SG&A reported	$	761			$	890			(14	)%
Restructuring, net of branch gains (U.S.)	—				3
Restructuring (Canada)	1				—
Restructuring (Other businesses)	—				1
Impairment charges (Other businesses)	—				139
Total restructuring, net and impairment charges	1				143
SG&A adjusted	$	760			$	747			2	%

	2019				2018				%
Operating earnings reported	$	338			$	189			78	%
Total restructuring, net and impairment charges	1				143
Operating earnings adjusted	$	339			$	332			2	%

	2019				2018				%
Net earnings attributable to W.W. Grainger, Inc. reported	$	233			$	104			123	%
Total restructuring, net and impairment charges	1				143
Tax effect of impairment (1)	—				(6		)
Tax effect (1)	(1		)		(1		)
Total restructuring, net, impairment charges and tax	—				136
Net earnings attributable to W.W. Grainger, Inc. adjusted	$	233			$	240			(3	)%

(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.

	Three Months Ended September 30,
	2019			2018			Bps impact
Effective tax rate reported	24.2	%		32.7	%		(850	)
Restructuring, net and impairment charges	—			(12.7	)
Effective tax rate adjusted	24.2	%		20.0	%		420

SG&A of $761 million for the third quarter of 2019 decreased $129 million, or 14% compared to the third quarter of 2018. Excluding restructuring, net and impairment charges in both periods as noted in the table above, SG&A increased $13 million, or 2%.

Operating earnings of $338 million for the third quarter of 2019 increased $149 million, or 78% compared to the third quarter of 2018. Excluding restructuring, net and impairment charges in both periods as noted in the table above, operating earnings increased $7 million or 2%, driven primarily by higher gross profit dollars.

Other expense, net was $16 million for the third quarter of 2019, a decrease of $2 million, or 16% compared to the third quarter of 2018. The decrease was primarily due to lower losses from the Company's clean energy investments which were concluded in the second half of 2018.

Income taxes of $78 million for the third quarter of 2019 increased $22 million, or 39% compared to the third quarter of 2018. Grainger's effective tax rates were 24.2% and 32.7% for the three months ended September 30, 2019 and 2018, respectively. The higher tax rate in the prior year quarter was driven primarily by Cromwell impairment charges which lowered reported operating earnings and were not tax deductible. Excluding restructuring, net and impairment charges in both periods as noted in the table above, the effective tax rates were 24.2% and 20.0% for the three months

20

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W.W. Grainger, Inc. and Subsidiaries

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL

CONDITION AND RESULTS OF OPERATIONS

ended September 30, 2019 and 2018, respectively. The increase in effective tax rate was primarily driven by lower tax benefit from stock-based compensation and the absence of the Company's clean energy tax benefits in 2019 as the Company concluded its investment in 2018.

Net earnings attributable to W.W. Grainger, Inc. of $233 million for the third quarter of 2019 increased $129 million or 123% compared to the third quarter of 2018. Excluding restructuring, net and impairment charges from both periods in the table above, net earnings decreased $7 million or 3%.

Diluted earnings per share of $4.25 in the third quarter of 2019 was up 134% versus the $1.82 for the third quarter of 2018, primarily due to higher net earnings and lower average shares outstanding, partially offset by higher taxes due to lower tax benefits from stock-based compensation. Excluding restructuring, net and impairment charges from both periods in the table above, diluted earnings per share of $4.26 in the third quarter of 2019 increased 2% from $4.19 for the third quarter of 2018.

Segment Analysis

The following results at the U.S. and Canada segments and Other businesses level include external and intersegment net sales and operating earnings. See Note 10 to the Financial Statements.

United States

Net sales were $2,277 million for the third quarter of 2019, an increase of $89 million, or 4% compared to the same period in 2018. On a daily basis, net sales increased 2.5% and consisted of the following:

	Percent Increase/(Decrease)
Volume	2.5%
Intercompany sales to Zoro (included in other businesses)	0.5
Other	(0.5)
Total	2.5%

 

Overall, revenue increases were primarily driven by market share gains. Price inflation was flat. See Note 3 to the Financial Statements for information related to disaggregated revenue.

The gross profit margin for the third quarter of 2019 decreased 0.8 percentage point compared to the same period in 2018, driven by the timing of pricing adjustments during the year which resulted in negative price cost spread.

SG&A in the third quarter of 2019 was flat when compared to the third quarter of 2018.

Operating earnings of $343 million for the third quarter of 2019 increased $17 million, or 5% from $326 million for the third quarter of 2018. This increase was driven primarily by SG&A leverage.

Canada

Net sales were $129 million for the third quarter of 2019, a decrease of $20 million, or 14% compared to the same period in 2018. On a daily basis, net sales decreased 15.5%, or 14.5% in local currency and consisted of the following:

	Percent (Decrease)/Increase
Volume	(15.5)%
Foreign exchange	(1.0)
Price	1.0
Total	(15.5)%

For the third quarter of 2019, volume was down 15.5 percentage points compared to the same period in 2018 primarily due to market share declines.

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MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL

CONDITION AND RESULTS OF OPERATIONS

The gross profit margin increased 0.5 percentage points in the third quarter of 2019 versus the third quarter of 2018, driven by inventory management efficiencies, partially offset by negative price cost spread.

SG&A decreased 19% in the third quarter of 2019 compared to the third quarter of 2018. Excluding restructuring costs in both periods as noted in the table above, SG&A would have decreased 22%, primarily due to the 2018 cost take out actions.

Operating earnings was break even for the third quarter of 2019 compared to operating losses of $4 million in the third quarter of 2018. Excluding restructuring, net in both periods as noted in the table above, operating earnings would have been $1 million compared to operating losses of $4 million in the prior period primarily due higher gross profit and lower SG&A.

Other businesses

Net sales were $673 million for the third quarter of 2019, an increase of $63 million, or 11% when compared to the same period in 2018. On a daily basis, net sales increased 9.0%. The increase in net sales was due to strong growth in the endless assortment businesses.

The gross profit margin decreased 1.3 percentage points in the third quarter of 2019 versus the third quarter 2018, driven by higher promotional activities, freight headwinds and mix in the endless assortment businesses.

Operating earnings of $30 million for the third quarter of 2019 were up $129 million compared to operating losses of $99 million for the third quarter of 2018. Other businesses' 2018 results included impairment charges relating to the Cromwell business in the U.K. Excluding restructuring, net and impairment charges in both periods as noted in the table above, operating earnings would have decreased $11 million or 26%. This decrease is primarily due to the endless assortment businesses' investments to drive long-term growth and under performance in the international high-touch solutions businesses.

Matters Affecting Comparability

There were 191 sales days in the nine months ended September 30, 2019 and 2018.

Results of Operations – Nine Months Ended September 30, 2019

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
	2019				2018						2019			2018
Net sales	$	8,639			$	8,458		2	%		100.0	%		100.0	%
Cost of goods sold	5,324				5,176			3			61.6			61.2
Gross profit	3,315				3,282			1			38.4			38.8
Selling, general and administrative expenses	2,234				2,414			(7	)		25.9			28.5
Operating earnings	1,081				868			24			12.5			10.3
Other expense, net	42				66			(38	)		0.5			0.8
Income taxes	261				198			32			3.0			2.3
Net earnings	778				604
Noncontrolling interest	32				31			6			0.4			0.4
Net earnings attributable to W.W. Grainger, Inc.	$	746			$	573		30	%		8.6	%		6.8	%

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W.W. Grainger, Inc. and Subsidiaries

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL

CONDITION AND RESULTS OF OPERATIONS

Grainger’s net sales of $8,639 million for the nine months ended September 30, 2019 increased $181 million, or 2% compared to the same period in 2018 and consisted of the following:

	Percent Increase/(Decrease)
Volume	2.5%
Price	0.5
Foreign exchange	(0.5)
Other	(0.5)
Total	2.0%

The increase in net sales was primarily driven by volume increases in the U.S. business due to market share gain and continued double digit growth in the endless assortments businesses, offset by lower sales in the Canada business and other businesses. See the Segment Analysis below for further details related to segment revenue.

Gross profit of $3,315 million for the nine months ended September 30, 2019 increased $33 million, or 1% compared to the same period in 2018. The gross profit margin of 38.4% decreased 0.4 percentage point when compared to the same period in 2018, primarily driven by the endless assortment businesses.

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 millions of dollars:

	Nine Months Ended
	September 30,
	2019				2018				%
SG&A reported	$	2,234			$	2,414			(7	)%
Restructuring, net of branch gains (U.S.)	—				5
Restructuring (Canada)	(1		)		23
Restructuring (Other businesses)	—				3
Impairment charges (Other businesses)	—				139
Restructuring (Unallocated expense)	—				(5		)
Total restructuring, net and impairment charges	(1		)		165
SG&A adjusted	$	2,235			$	2,249			(1	)%

	2019				2018				%
Operating earnings reported	$	1,081			$	868			24	%
Total restructuring, net and impairment charges	—				166
Operating earnings adjusted	$	1,081			$	1,034			5	%

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MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL

CONDITION AND RESULTS OF OPERATIONS

	2019				2018				%
Net earnings attributable to W.W. Grainger, Inc. reported	$	746			$	573			30	%
Total restructuring, net	(1		)		166
Tax effect of impairment (1)	—				(6		)
Tax effect (1)	1				(6		)
Total restructuring, net and impairment charges and tax	—				154
Net earnings attributable to W.W. Grainger, Inc. adjusted	$	746			$	727			3	%

(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 $2,234 million for the nine months ended September 30, 2019 decreased $180 million, or 7% from $2,414 million for the nine months ended September 30, 2018. Excluding restructuring, net in both periods as noted in the table above, SG&A decreased $14 million, or 1% primarily due to 2018 cost take-out actions in Canada.

Operating earnings for the nine months ended September 30, 2019 were $1,081 million, an increase of $213 million, or 24% compared to the same period in 2018. Excluding restructuring, net in both periods as noted in the table above, operating earnings increased $47 million or 5%, driven primarily by cost take-out actions in the Canadian business and SG&A leverage in the U.S. business.

Other expense, net was $42 million for the nine months ended September 30, 2019, a decrease of $24 million, or 38% compared to the nine months ended September 30, 2018. The decrease was primarily due to lower losses from the Company's clean energy investments which were concluded in the second half of 2018.

Income taxes of $261 million for the nine months ended September 30, 2019 increased $63 million, or 32% compared with $198 million for the comparable 2018 period. Grainger's effective tax rates were 25.1% and 24.7% for the nine months ended September 30, 2019 and 2018, respectively. The increase was primarily driven by lower tax benefit from stock-based compensation and the absence of the Company's clean energy tax benefits in 2019 as the Company concluded its investments in 2018.

Net earnings attributable to W.W. Grainger, Inc. for the nine months ended September 30, 2019 increased $173 million or 30% to $746 million from $573 million for the nine months ended September 30, 2018. Excluding restructuring, net from both periods in the table above, net earnings increased $19 million, or 3%. The increase in net earnings primarily resulted from lower SG&A and lower other expense, net.

Diluted earnings per share of $13.40 in the nine months ended September 30, 2019 was up 33% versus the $10.04 for the same period in 2018, due to higher earnings and lower average shares outstanding. Excluding restructuring, net from both periods in the table above, diluted earnings per share would have been $13.40 compared to $12.74 in 2018, an increase of 5%.

Segment Analysis

The following comments at the segment and other businesses level include external and intersegment net sales and operating earnings. See Note 10 to the Financial Statements.

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MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL

CONDITION AND RESULTS OF OPERATIONS

United States

Net sales were $6,648 million for the nine months ended September 30, 2019, an increase of $177 million, or 3%, compared to the same period in 2018 and consisted of the following:

	Percent Increase/(Decrease)
Volume	2.0%
Price	0.5
Intercompany sales to Zoro (included in other businesses)	0.5
Other	(0.5)
Total	2.5%

Overall, revenue increases were primarily driven by market share gains and pricing. See Note 3 to the Financial Statements for information related to disaggregated revenue.

The gross profit margin decreased 0.1 percentage point compared to the same period in 2018.

SG&A for the nine months ended September 30, 2019 increased $5 million compared to the same period in 2018. The increase was primarily driven by digital marketing and advertising.

Operating earnings of $1,088 million for the nine months ended September 30, 2019 increased $56 million, or 5% from $1,032 million for the nine months ended September 30, 2018. This increase was driven primarily by higher sales, higher gross profit dollars and improved SG&A leverage.

 

Canada

Net sales were $400 million for the nine months ended September 30, 2019, a decrease of $108 million, or 21% compared to the same period in 2018 and consisted of the following:

	Percent (Decrease)/Increase
Volume	(21.5)%
Foreign exchange	(2.5)
Price	2.5
Total	(21.5)%

For the nine months ended September 30, 2019, volume was down 21.5 percentage points compared to the same period in 2018 due to customer disruption as a result of actions taken to reduce the branch footprint and sales coverage optimization activities.

The gross profit margin decreased 1.1 percentage points in the nine months ended September 30, 2019 compared to the nine months ended September 30, 2018, primarily due to negative price cost spread.

SG&A decreased $73 million, or 36% in the nine months ended September 30, 2019 compared to the nine months ended September 30, 2018. Excluding restructuring, net in both periods as noted in the table above, SG&A would have decreased $48 million, or 27% compared to the prior period. This decrease was primarily due to cost reduction actions and lower variable expense as the result of lower sales volume.

Operating losses were $4 million for the nine months ended September 30, 2019 compared to losses of $38 million in the nine months ended September 30, 2018. Excluding restructuring, net in both periods as noted in the table above, operating losses would have been $5 million compared to $15 million in the prior period primarily due to lower gross profit, partially offset by lower SG&A.

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MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL

CONDITION AND RESULTS OF OPERATIONS

Other businesses

Net sales for other businesses were $1,969 million for the nine months ended September 30, 2019 an increase of $149 million, or 8% compared to the same period in 2018 and consisted of the following:

	Percent Increase/(Decrease)
Price/volume	10.0%
Foreign exchange	(2.0)
Total	8.0%

The net sales increase was primarily due to customer acquisition growth from the endless assortment businesses, partially offset by foreign exchange headwinds from the euro and pound sterling.

Operating earnings of $87 million for the nine months ended September 30, 2019 increased $109 million from operating losses of $22 million in the comparable period from the prior year. Other businesses' 2018 results included impairment charges relating to the Cromwell business in the U.K. Excluding restructuring, net and impairment charges in both periods as noted in the table above, operating earnings would have decreased $34 million or 28%.This decrease is primarily due to the endless assortment businesses' investments to drive long-term growth and performance in the high-touch solutions businesses.

 

Financial Condition

Cash Flow

Net cash provided by operating activities was $770 million and $743 million for the nine months ended September 30, 2019 and 2018, respectively. The increase in cash provided by operating activities is primarily the result of higher net earnings and favorable changes in working capital, partially offset by higher income tax payments and higher net payments related to employee variable compensation and benefits paid under annual incentive plans.

Net cash used in investing activities was $145 million and $105 million for the nine months ended September 30, 2019 and 2018, respectively. This increase in net cash used in investing activities was primarily driven by lower proceeds from the sales of assets when compared to the prior year.

Net cash used in financing activities was $875 million and $437 million in the nine months ended September 30, 2019 and 2018, respectively. The increase in net cash used in financing activities was primarily driven by higher treasury stock repurchases in 2019 compared to 2018.

Working Capital

Internally generated funds are the primary source of working capital and funds used for growth initiatives and capital expenditures. Grainger's working capital is not impacted by significant seasonality trends throughout the year.

Working capital consists of current assets (less non-operating cash) and current liabilities (less short-term debt, current maturities of long-term debt and lease liabilities). Working capital at September 30, 2019, was $2,059 million, an increase of $161 million when compared to $1,898 million at December 31, 2018. The increase was primarily driven by an increase in accounts receivable and a decrease in accrued contributions to employees profit-sharing plans due to the annual cash contribution. At these dates, the ratio of current assets to current liabilities was 2.6 and 2.4, respectively.

Debt

Grainger maintains a debt ratio and liquidity position that provides flexibility in funding working capital needs and long-term cash requirements. In addition to internally generated funds, Grainger has various sources of financing available, including bank borrowings under lines of credit. Total debt, which is defined as total interest-bearing debt (short-term, current maturities and long-term) and lease liabilities as a percent of total capitalization was 53.7% at September 30, 2019, and 51.5% at December 31, 2018.

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MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL

CONDITION AND RESULTS OF OPERATIONS

Critical Accounting Estimates

The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make judgments, estimates and assumptions about future events that affect the amounts reported in the financial statements and accompanying notes.

Accounting estimates are considered critical when they require management to make subjective and complex judgments, estimates and assumptions about matters that have a material impact on the presentation of Grainger’s financial statements and accompanying notes. For a description of Grainger’s critical accounting estimates, see Grainger's Annual Report on Form 10-K for the fiscal year ended December 31, 2018.

Management has discussed the development and selection of these critical accounting estimates with the Audit Committee of the Board of Directors and with the Company's independent registered public accounting firm.

Forward-Looking Statements

From time to time, in this Quarterly Report on Form 10-Q, as well as in other written reports, communications and verbal statements, Grainger makes forward-looking statements that are not historical in nature but concern forecasts of future results, business plans, analyses, prospects, strategies, objectives and other matters that may be deemed to be “forward-looking statements” under the federal securities laws. Forward-looking statements can generally be identified by their use of terms such as “anticipate,” “estimate,” “believe,” “expect,” “could,” “forecast,” “may,” “intend,” “plan,” “predict,” “project” “will” or “would” and similar terms and phrases, including references to assumptions.

Grainger cannot guarantee that any forward-looking statement will be realized and achievement of future results is subject to risks and uncertainties, many of which are beyond the Company’s control, which could cause Grainger’s results to differ materially from those that are presented.

Important factors that could cause actual results to differ materially from those presented or implied in the forward-looking statements include, without limitation: higher product costs or other expenses; a major loss of customers; loss or disruption of sources of supply; increased competitive pricing pressures; failure to develop or implement new technology initiatives or business strategies; failure to adequately protect intellectual property or successfully defend against infringement claims; the implementation, timing and results of the Company’s strategic pricing initiatives and other responses to market pressures; the outcome of pending and future litigation or governmental or regulatory proceedings, including with respect to wage and hour, anti-bribery and corruption, environmental, advertising, privacy and cybersecurity matters; investigations, inquiries, audits and changes in laws and regulations; disruption of information technology or data security systems; general industry, economic, market or political conditions; general global economic conditions; currency exchange rate fluctuations; market volatility, including volatility or price declines of the Company’s common stock; commodity price volatility; labor shortages; facilities disruptions or shutdowns; higher fuel costs or disruptions in transportation services; natural and other catastrophes; unanticipated and/or extreme weather conditions; loss of key members of management; the Company’s ability to operate, integrate and leverage acquired businesses; changes in effective tax rates and other factors identified under Item 1A: Risk Factors in the Company’s Annual Report on Form 10-K for the year ended December 31, 2018, as updated in the Company’s Quarterly Reports on Form 10-Q.

Caution should be taken not to place undue reliance on Grainger’s forward-looking statements and Grainger undertakes no obligation to update or revise any of its forward-looking statements, whether as a result of new information, future events or otherwise, except as required by law.

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Item 3.	Quantitative and Qualitative Disclosures About Market Risk

 

For quantitative and qualitative disclosures about market risk, see “Item 7A: Quantitative and Qualitative Disclosures About Market Risk” in Grainger's Annual Report on Form 10-K for the fiscal year ended December 31, 2018.

Item 4.	Controls and Procedures

 

Disclosure Controls and Procedures

Grainger carried out an evaluation, under the supervision and with the participation of its management, including the Chief Executive Officer and the Chief Financial Officer, of the effectiveness of Grainger's disclosure controls and procedures (as defined in Rule 13a-15(e) under the Securities Exchange Act of 1934, as amended (the Exchange Act)) as of the end of the period covered by this report. Based upon that evaluation, the Chief Executive Officer and the Chief Financial Officer concluded that Grainger’s disclosure controls and procedures were effective as of the end of the period covered by this report in (i) ensuring that information required to be disclosed by Grainger in the reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the SEC's rules and forms and (ii) ensuring that information required to be disclosed by the Company in the reports that it files or submits under the Exchange Act is accumulated and communicated to the Company's management, including the Company's Chief Executive Officer and Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosure.

 

Changes in Internal Control Over Financial Reporting

There have been no changes in Grainger's internal control over financial reporting for the quarter ended September 30, 2019, that have materially affected, or are reasonably likely to materially affect, Grainger’s internal control over financial reporting.

PART II – OTHER INFORMATION

 

Item 1.	Legal Proceedings

For a description of the Company’s legal proceedings, see Note 11 - Contingencies and Legal Matters - to the Condensed Consolidated Financial Statements included under Item 1 - Financial Statements, of Part I of this report.

Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds

 

Issuer Purchases of Equity Securities – Third Quarter

Period	Total Number of Shares Purchased (A)	Average Price Paid per Share (B)	Total Number of Shares Purchased as Part of Publicly Announced Plans or Programs (C)	Maximum Number of Shares That May Yet be Purchased Under the Plans or Programs
July 1 – July 31	440,612	$273.08	440,612	3,682,923
Aug. 1 – Aug. 31	128,913	$270.42	128,913	3,554,010
Sept. 1 – Sept. 30	156,390	$286.52	156,390	3,397,620
Total	725,915		725,915

 

(A)	There were no shares withheld to satisfy tax withholding obligations.

(B)	Average price paid per share includes any commissions paid and includes only those amounts related to purchases as part of publicly announced plans or programs.

(C)	Purchases were made pursuant to a share repurchase program approved by Grainger’s Board of Directors and announced by the Company on April 24, 2019, which authorizes the repurchase of up to 5 million shares with no expiration date.

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Item 6.        Exhibits

A list of exhibits filed with this report on Form 10-Q is provided in the Exhibit Index on page 31 of this report.

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SIGNATURES

 

Pursuant to the requirements of the Securities Exchange Act of 1934, as amended, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

 

			W.W. GRAINGER, INC.
Date:	October 23, 2019	By:	/s/ Thomas B. Okray
			Thomas B. Okray, Senior Vice President and Chief Financial Officer
			(Principal Financial Officer)
Date:	October 23, 2019	By:	/s/ Eric R. Tapia
			Eric R. Tapia, Vice President and Controller
			(Principal Accounting Officer)

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EXHIBIT INDEX

EXHIBIT NO.		DESCRIPTION
31.1		Certification of Principal Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
31.2		Certification of Principal Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
32		Certification of Principal Executive Officer and Principal Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
101.INS		XBRL Instance Document - the instance document does not appear in the Interactive Data File because its XBRL tags are embedded within the Inline XBRL document.
101.SCH		XBRL Taxonomy Extension Schema Document.
101.CAL		XBRL Taxonomy Extension Calculation Linkbase Document.
101.DEF		XBRL Taxonomy Extension Definition Linkbase Document.
101.LAB		XBRL Taxonomy Extension Label Linkbase Document.
101.PRE		XBRL Taxonomy Extension Presentation Linkbase Document.

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