GWW.2015.06.30.15-10Q


 
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 
FORM 10-Q
 
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
 
For the quarterly period ended June 30, 2015
OR
 
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
 
For the transition period from ______ to _______
 
Commission file number 1-5684

W.W. Grainger, Inc.
(Exact name of registrant as specified in its charter)

Illinois
 
36-1150280
(State or other jurisdiction of incorporation or organization)
 
(I.R.S. Employer Identification No.)
 
 
 
100 Grainger Parkway, Lake Forest, Illinois
 
60045-5201
(Address of principal executive offices)
 
(Zip Code)
(847) 535-1000
(Registrant’s telephone number including area code)
 
Not Applicable
(Former name, former address and former fiscal year; if changed since last report)
 
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  Yes [X]  No [  ]
 
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  Yes [X]  No [  ]
 
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company.  See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
 
Large accelerated filer [X]  Accelerated filer [  ]   Non-accelerated filer [  ]   Smaller reporting company [  ]
 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
Yes [  ]  No [X]
 
There were 65,975,137 shares of the Company’s Common Stock outstanding as of June 30, 2015.

1




 
TABLE OF CONTENTS
 
 
 
Page No.
PART I
FINANCIAL INFORMATION
 
 
 
 
Item 1.
Financial Statements (Unaudited)
 
 
 
 
 
Condensed Consolidated Statements of Earnings 
    for the Three and Six Months Ended June 30, 2015 and 2014
 
 
 
 
Condensed Consolidated Statements of Comprehensive
    Earnings for the Three and Six Months Ended June 30, 2015 and 2014
 
 
 
 
Condensed Consolidated Balance Sheets
    as of June 30, 2015 and December 31, 2014
 
 
 
 
Condensed Consolidated Statements of Cash Flows
    for the Six Months Ended June 30, 2015 and 2014
 
 
 
 
Notes to Condensed Consolidated Financial Statements
 
 
 
Item 2.
Management's Discussion and Analysis of Financial
    Condition and Results of Operations
 
 
 
Item 3.
Quantitative and Qualitative Disclosures About Market Risk
 
 
 
Item 4.
Controls and Procedures
 
 
 
PART II
OTHER INFORMATION
 
 
 
 
Item 1.
Legal Proceedings
 
 
 
Item 2.
Unregistered Sales of Equity Securities and Use of Proceeds
 
 
 
Item 6.
Exhibits
 
 
 
Signatures
 
 
 
 
EXHIBITS
 
 


2



PART I – FINANCIAL INFORMATION

Item 1.  Financial Statements

W.W. Grainger, Inc. and Subsidiaries
CONDENSED CONSOLIDATED STATEMENTS OF EARNINGS
(In thousands of dollars, except for share and per share amounts)
(Unaudited)
 
Three Months Ended
 
Six Months Ended
 
June 30,
 
June 30,
 
2015
 
2014
 
2015
 
2014
Net sales
$
2,522,565

 
$
2,506,104

 
$
4,962,226

 
$
4,891,731

Cost of merchandise sold
1,449,133

 
1,425,418

 
2,795,052

 
2,735,074

Gross profit
1,073,432

 
1,080,686

 
2,167,174

 
2,156,657

Warehousing, marketing and administrative expenses
716,715

 
739,935

 
1,459,209

 
1,461,567

Operating earnings
356,717

 
340,751

 
707,965

 
695,090

Other income and (expense):
 

 
 

 
 
 
 
Interest income
277

 
413

 
469

 
1,053

Interest expense
(4,184
)
 
(2,757
)
 
(5,819
)
 
(5,620
)
Loss from equity method investment
(4,302
)
 

 
(4,302
)
 

Other non-operating income
484

 
177

 
726

 
345

Other non-operating expense
(306
)
 
(159
)
 
(2,714
)
 
(830
)
Total other expense
(8,031
)
 
(2,326
)
 
(11,640
)
 
(5,052
)
Earnings before income taxes
348,686

 
338,425

 
696,325

 
690,038

Income taxes
123,451

 
129,348

 
256,944

 
261,906

Net earnings
225,235

 
209,077

 
439,381

 
428,132

Less: Net earnings attributable to noncontrolling interest
4,687

 
3,162

 
7,818

 
5,564

Net earnings attributable to W.W. Grainger, Inc.
$
220,548

 
$
205,915

 
$
431,563

 
$
422,568

Earnings per share:
 

 
 

 
 
 
 
Basic
$
3.28

 
$
2.97

 
$
6.38

 
$
6.08

Diluted
$
3.25

 
$
2.94

 
$
6.32

 
$
6.00

Weighted average number of shares outstanding:
 

 
 

 
 

 
 

Basic
66,652,130

 
68,453,602

 
66,939,110

 
68,576,232

Diluted
67,317,131

 
69,341,885

 
67,647,689

 
69,509,125

Cash dividends paid per share
$
1.17

 
$
1.08

 
$
2.25

 
$
2.01

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

3



W.W. Grainger, Inc. and Subsidiaries
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE EARNINGS
(In thousands of dollars)
(Unaudited)
 
 
Three Months Ended
 
Six Months Ended
 
June 30,
 
June 30,
 
2015
 
2014
 
2015
 
2014
Net earnings
$
225,235

 
$
209,077

 
$
439,381

 
$
428,132

Other comprehensive earnings (losses):
 

 
 

 
 

 
 

Foreign currency translation adjustments:
 
 
 
 
 
 
 
Foreign currency translation adjustments, net of tax benefit of $0, $2,098, $0 and $75, respectively
9,061

 
23,309

 
(66,954
)
 
8,175

Net investment hedge, net of tax (expense) benefit of $0, $(1,987), $0 and $255, respectively

 
3,185

 

 
(409
)
Net foreign currency translation (loss)
9,061

 
26,494

 
(66,954
)
 
7,766

Defined postretirement benefit plan:
 
 
 
 
 
 
 
Reclassification adjustments related to amortization, net of tax benefit (expense) of $512, $(1,687), $1,021 and $(1,051), respectively
(810
)
 
6,031

 
(1,623
)
 
5,013

Derivative instrument change in fair value of cash flow hedge
245

 
(9
)
 
727

 
23

Comprehensive earnings, net of tax
233,731

 
241,593

 
371,531

 
440,934

Less: Comprehensive earnings (losses) attributable to noncontrolling interest
 
 
 
 
 
 
 
Net earnings
4,687

 
3,162

 
7,818

 
5,564

Foreign currency translation adjustments
(1,509
)
 
1,551

 
(1,802
)
 
3,030

Comprehensive earnings attributable to W.W. Grainger, Inc.
$
230,553

 
$
236,880

 
$
365,515

 
$
432,340

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

4



W.W. Grainger, Inc. and Subsidiaries
CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands of dollars, except for share and per share amounts)
 
 
(Unaudited)
 
 
ASSETS
June 30, 2015
 
Dec 31, 2014
CURRENT ASSETS
 
 
 
Cash and cash equivalents
$
819,786

 
$
226,644

Accounts receivable (less allowances for doubtful
 

 
 

accounts of $20,600 and $22,121, respectively)
1,197,856

 
1,172,924

Inventories – net
1,302,977

 
1,356,396

Prepaid expenses and other assets
95,008

 
102,669

Deferred income taxes
60,295

 
61,387

Prepaid income taxes
47,824

 
47,529

Total current assets
3,523,746

 
2,967,549

PROPERTY, BUILDINGS AND EQUIPMENT
3,150,247

 
3,115,130

Less: Accumulated depreciation and amortization
1,825,696

 
1,790,784

Property, buildings and equipment – net
1,324,551

 
1,324,346

DEFERRED INCOME TAXES
17,360

 
16,718

GOODWILL
486,612

 
506,905

OTHER ASSETS AND INTANGIBLES – NET
474,640

 
467,531

TOTAL ASSETS
$
5,826,909

 
$
5,283,049


5




W.W. Grainger, Inc. and Subsidiaries
CONDENSED CONSOLIDATED BALANCE SHEETS (Continued)
(In thousands of dollars, except for share and per share amounts)
 
 
(Unaudited)
 
 
LIABILITIES AND SHAREHOLDERS' EQUITY
June 30, 2015
 
Dec 31, 2014
CURRENT LIABILITIES
 
 
 
Short-term debt
$
30,495

 
$
56,896

Current maturities of long-term debt
26,275

 
23,404

Trade accounts payable
498,416

 
554,088

Accrued compensation and benefits
155,048

 
191,696

Accrued contributions to employees’ profit sharing plans
70,130

 
178,076

Accrued expenses
255,910

 
245,300

Income taxes payable
10,828

 
12,256

Total current liabilities
1,047,102

 
1,261,716

LONG-TERM DEBT (less current maturities)
1,348,642

 
403,333

DEFERRED INCOME TAXES AND TAX UNCERTAINTIES
95,464

 
95,455

EMPLOYMENT-RELATED AND OTHER NON-CURRENT LIABILITIES
236,263

 
238,444

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;
issued 109,659,219 shares
54,830

 
54,830

Additional contributed capital
975,147

 
948,340

Retained earnings
6,615,081

 
6,335,990

Accumulated other comprehensive losses
(162,721
)
 
(96,673
)
Treasury stock, at cost – 43,684,082 and 42,227,178 shares, respectively
(4,461,822
)
 
(4,032,615
)
Total W.W. Grainger, Inc. shareholders’ equity
3,020,515

 
3,209,872

Noncontrolling interest
78,923

 
74,229

Total shareholders' equity
3,099,438

 
3,284,101

TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY
$
5,826,909

 
$
5,283,049

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

6



W.W. Grainger, Inc. and Subsidiaries
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands of dollars)
(Unaudited)
 
Six Months Ended
 
June 30,
 
2015
 
2014
CASH FLOWS FROM OPERATING ACTIVITIES:
 
 
 
Net earnings
$
439,381

 
$
428,132

Provision for losses on accounts receivable
4,630

 
4,782

Deferred income taxes and tax uncertainties
1,995

 
(9,605
)
Depreciation and amortization
106,937

 
93,796

Stock-based compensation
27,043

 
28,988

(Gains) losses from non-cash charges and sales of assets
(51
)
 
14,576

Losses from equity method investment
4,302

 

Change in operating assets and liabilities – net of business 
  acquisitions and divestitures:
 

 
 

Accounts receivable
(50,586
)
 
(98,574
)
Inventories
26,075

 
(13,497
)
Prepaid expenses and other current assets
6,929

 
(4,610
)
Trade accounts payable
(29,144
)
 
2,852

Accrued liabilities
(169,123
)
 
(127,930
)
Current income taxes payable
(847
)
 
1,601

Employment-related and other non-current liabilities
4,231

 
6,712

Other – net
(2,267
)
 
1,243

Net cash provided by operating activities
369,505

 
328,466

CASH FLOWS FROM INVESTING ACTIVITIES:
 

 
 

Additions to property, buildings and equipment
(170,873
)
 
(156,210
)
Proceeds from sales of property, buildings and equipment
10,119

 
5,416

Equity method investment
(10,190
)
 

Net cash received for business divestitures
1,114

 
19,199

Other – net
(567
)
 

Net cash used in investing activities
(170,397
)
 
(131,595
)
CASH FLOWS FROM FINANCING ACTIVITIES:
 

 
 

Borrowings under lines of credit
26,842

 
44,686

Payments against lines of credit
(46,649
)
 
(64,634
)
Proceeds from issuance of long-term debt and commercial paper borrowings
995,880

 
54,997

Payments of long-term debt and commercial paper
(30,597
)
 
(9,538
)
Proceeds from stock options exercised
35,549

 
31,816

Excess tax benefits from stock-based compensation
17,106

 
22,177

Purchase of treasury stock
(442,595
)
 
(235,847
)
Cash dividends paid
(153,906
)
 
(140,885
)
Net cash provided by (used in) financing activities
401,630

 
(297,228
)
Exchange rate effect on cash and cash equivalents
(7,596
)
 
1,420

NET CHANGE IN CASH AND CASH EQUIVALENTS
593,142

 
(98,937
)
Cash and cash equivalents at beginning of year
226,644

 
430,644

Cash and cash equivalents at end of period
$
819,786

 
$
331,707

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

7



W.W. Grainger, Inc. and Subsidiaries
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

1.    BACKGROUND AND BASIS OF PRESENTATION
 
W.W. Grainger, Inc. is a broad-line distributor of maintenance, repair and operating 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, 2014 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, 2014 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

In February 2015, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) 2015-02, Consolidation (Topic 810): Amendments to the Consolidation Analysis. This ASU which is effective for annual periods, and interim periods within those annual periods, beginning after December 15, 2015, changes the consolidation analysis required under U.S. GAAP for limited partnerships and other variable interest entities. Early adoption is permitted and the ASU allows for either retrospective or modified retrospective application. This ASU is not expected to have a material impact on the Company's consolidated financial statements.

In July 2015, the FASB announced a one-year delay in the effective date of ASU 2014-09, Revenue from Contracts with Customers. The standard will now be effective for interim and annual periods beginning after December 15, 2017. The standard also permits adoption as early as the original effective date, which was for interim and annual periods beginning after December 15, 2016. This ASU is not expected to have a material impact on the Company's consolidated financial statements.

In April 2015, the FASB issued ASU 2015-03, Simplifying the Presentation of Debt Issuance Costs. This ASU which is effective for fiscal years and interim periods beginning after December 15, 2015, changes the presentation of debt issuance costs in financial statements as a direct deduction from the related debt liability rather than as an asset. Early adoption is permitted and retrospective application is required. Effective June 30, 2015, the Company has adopted ASU 2015-03 and the Condensed Consolidated Balance Sheet was retroactively restated under the new presentation. The adoption of ASU 2015-03 did not have a material impact to the Company's consolidated financial statements, as existing debt issuance costs were immaterial.

In April 2015, the FASB issued ASU 2015-05, Customer's Accounting for Fees Paid in a Cloud Computing Arrangement. This ASU which is effective for annual periods, and interim periods within those annual periods, beginning after December 15, 2015, provides guidance to customers about whether a cloud computing arrangement includes a software license. Early adoption is permitted and the ASU allows for either retrospective or prospective application. This ASU is not expected to have a material impact on the Company's consolidated financial statements.

3.    DIVIDEND
 
On July 29, 2015, the Company’s Board of Directors declared a quarterly dividend of $1.17 per share, payable September 1, 2015, to shareholders of record on August 10, 2015.

8

W.W. Grainger, Inc. and Subsidiaries
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Unaudited)


4.    LONG-TERM DEBT
 
On June 11, 2015, the Company issued $1 billion of unsecured 4.60% Senior Notes (the "Notes") that mature on June 15, 2045. The Notes require no principal payments until the maturity date and interest is payable semi-annually on June 15 and December 15, beginning on December 15, 2015. Prior to December 15, 2044, the Company may redeem the 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 US treasury security with a maturity comparable to the remaining term of the 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 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 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 Notes.

The approximate fair value of the Company's Notes is $1 billion as of June 30, 2015, and approximates the carrying amount. The estimated fair value of the Company’s Notes was based on available external pricing data and current market rates for similar debt instruments, among other factors, and are classified as level 2 inputs within the fair value hierarchy.

5.    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, the fair value of the Company's interest rate swap included on the balance sheet as a liability under Employment-related and other noncurrent liabilities was $1 million and $2 million, respectively. 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, 2015 and December 31, 2014.

6.    EQUITY METHOD INVESTMENT

In May 2015, the Company invested in a 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 of the entity through January 2019 and receive tax credits in proportion to its equity investment. The investment will be accounted for under the equity method of accounting.  As of June 30, 2015, the investment balance was $6 million and is included on the balance sheet under Other assets and intangibles-net. During the period, the Company recorded $4 million in equity losses and the tax benefit of energy tax credits is reflected in the Company’s effective tax rate.




9

W.W. Grainger, Inc. and Subsidiaries
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Unaudited)

7.    EMPLOYEE BENEFITS - POSTRETIREMENT
 
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):
 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
2015
 
2014
 
2015
 
2014
Service cost
$
2,532

 
$
2,252

 
$
5,064

 
$
4,503

Interest cost
2,412

 
2,637

 
4,824

 
5,274

Expected return on assets
(2,594
)
 
(2,060
)
 
(5,188
)
 
(4,119
)
Amortization of transition asset

 
(35
)
 

 
(71
)
Amortization of unrecognized losses
378

 
195

 
756

 
390

Amortization of prior service credits
(1,700
)
 
(1,814
)
 
(3,400
)
 
(3,627
)
Net periodic benefit costs
$
1,028

 
$
1,175

 
$
2,056

 
$
2,350

 
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. During the three and six months ended June 30, 2015, the Company contributed $1.7 million and $2.1 million, respectively, to the trust.


10

W.W. Grainger, Inc. and Subsidiaries
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Unaudited)

8.    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., the Company’s Canadian business. Other businesses include Zoro, the single channel business in the United States, and operations in Europe, Asia and Latin America. These other 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):

 
Three Months Ended June 30, 2015
 
United States
 
Canada
 
Other Businesses
 
Total
Total net sales
$
2,030,633

 
$
239,466

 
$
318,898

 
$
2,588,997

Intersegment net sales
(65,394
)
 
(17
)
 
(1,021
)
 
(66,432
)
Net sales to external customers
$
1,965,239

 
$
239,449

 
$
317,877

 
$
2,522,565

Segment operating earnings
$
369,533

 
$
9,499

 
$
15,158

 
$
394,190

  
 
Three Months Ended June 30, 2014
 
United States
 
Canada
 
Other Businesses
 
Total
Total net sales
$
1,992,955

 
$
264,046

 
$
298,926

 
$
2,555,927

Intersegment net sales
(49,358
)
 
(42
)
 
(423
)
 
(49,823
)
Net sales to external customers
$
1,943,597

 
$
264,004

 
$
298,503

 
$
2,506,104

Segment operating earnings
$
365,099

 
$
19,212

 
$
(456
)
 
$
383,855


 
Six Months Ended June 30, 2015
 
United States
 
Canada
 
Other Businesses
 
Total
Total net sales
$
4,002,088

 
$
473,996

 
$
616,697

 
$
5,092,781

Intersegment net sales
(128,585
)
 
(53
)
 
(1,917
)
 
(130,555
)
Net sales to external customers
$
3,873,503

 
$
473,943

 
$
614,780

 
$
4,962,226

Segment operating earnings
$
735,622

 
$
18,886

 
$
24,684

 
$
779,192

  
 
Six Months Ended June 30, 2014
 
United States
 
Canada
 
Other Businesses
 
Total
Total net sales
$
3,890,265

 
$
518,342

 
$
573,832

 
$
4,982,439

Intersegment net sales
(90,225
)
 
(88
)
 
(395
)
 
(90,708
)
Net sales to external customers
$
3,800,040

 
$
518,254

 
$
573,437

 
$
4,891,731

Segment operating earnings
$
718,786

 
$
40,508

 
$
8,019

 
$
767,313






11

W.W. Grainger, Inc. and Subsidiaries
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Unaudited)

 
United States
 
Canada
 
Other Businesses
 
Total
Segment assets:
 
 
 
 
 
 
 
June 30, 2015
$
2,188,815

 
$
348,508

 
$
356,992

 
$
2,894,315

December 31, 2014
$
2,181,521

 
$
394,342

 
$
345,987

 
$
2,921,850



Following are reconciliations of segment information with the consolidated totals per the financial statements (in thousands of dollars):
 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
2015
 
2014
 
2015
 
2014
Operating earnings:
 
 
 
Total operating earnings for operating segments
$
394,190

 
$
383,855

 
$
779,192

 
$
767,313

Unallocated expenses and eliminations
(37,473
)
 
(43,104
)
 
(71,227
)
 
(72,223
)
Total consolidated operating earnings
$
356,717

 
$
340,751

 
$
707,965

 
$
695,090

 
 
June 30, 2015
 
Dec 31, 2014
Assets:
 
Total assets for operating segments
$
2,894,315

 
$
2,921,850

Other current and non-current assets
2,069,484

 
2,113,900

Unallocated assets
863,110

 
247,299

Total consolidated assets
$
5,826,909

 
$
5,283,049


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 assets increased by $616 million at June 30, 2015 compared to December 31, 2014, primarily due to increased cash balances from the issuance of $1 billion in long-term debt.

Intersegment net sales for the U.S. segment increased by $38 million for the six months of 2015 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.

Other current and non-current assets decreased by $44 million at June 30, 2015 compared to December 31, 2014, primarily due to lower goodwill and intangible balances, as a result of foreign currency translation.

12

W.W. Grainger, Inc. and Subsidiaries
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Unaudited)

9.    EARNINGS PER SHARE
 
The following table sets forth the computation of basic and diluted earnings per share under the two-class method (in thousands of dollars, except for share and per share amounts):
 
Three Months Ended
 
Six Months Ended
 
June 30,
 
June 30,
 
2015
 
2014
 
2015
 
2014
Net earnings attributable to W.W. Grainger, Inc. as reported
$
220,548

 
$
205,915

 
$
431,563

 
$
422,568

Distributed earnings available to participating securities
(742
)
 
(727
)
 
(1,510
)
 
(1,562
)
Undistributed earnings available to participating securities
(1,418
)
 
(1,666
)
 
(2,879
)
 
(3,765
)
Numerator for basic earnings per share – Undistributed and distributed earnings available to common shareholders
218,388

 
203,522

 
427,174

 
417,241

Undistributed earnings allocated to participating securities
1,418

 
1,666

 
2,879

 
3,765

Undistributed earnings reallocated to participating securities
(1,404
)
 
(1,645
)
 
(2,850
)
 
(3,716
)
Numerator for diluted earnings per share – Undistributed and distributed earnings available to common shareholders
$
218,402

 
$
203,543

 
$
427,203

 
$
417,290

Denominator for basic earnings per share – weighted average shares
66,652,130

 
68,453,602

 
66,939,110

 
68,576,232

Effect of dilutive securities
665,001

 
888,283

 
708,579

 
932,893

Denominator for diluted earnings per share – weighted average shares adjusted for dilutive securities
67,317,131

 
69,341,885

 
67,647,689

 
69,509,125

Earnings per share two-class method
 

 
 

 
 
 
 
Basic
$
3.28

 
$
2.97

 
$
6.38

 
$
6.08

Diluted
$
3.25

 
$
2.94

 
$
6.32

 
$
6.00



10.    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.

11.    SUBSEQUENT EVENTS

On July 30, 2015, the Company announced an agreement to acquire Cromwell Group (Holdings) Limited, together with its subsidiaries, a distributor of MRO products headquartered in Leicester, England, for £310 million GBP, subject to customary adjustments.  The transaction is expected to be completed in early September 2015. The acquisition will be funded with debt, both in the United Kingdom and United States.

13

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
Grainger is a broad-line distributor of maintenance, repair and operating 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 2 million customers worldwide through a network of highly integrated branches, distribution centers and websites.

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. 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, Exports and Business Investment. In the United States, sales also tend to positively correlate with Business Inventory. In Canada, sales also tend to positively correlate with oil prices. The table below provides these estimated indicators for 2015:
 
United States
 
Canada
 
2015 Forecast (April)
2015 Forecast (July)
 
2015 Forecast (April)
2015 Forecast (July)
GDP
2.8%
2.2%
 
1.9%
1.5%
Industrial Production
1.9%
1.5%
 
1.3%
(1.8)%
Exports
2.2%
2.2%
 
3.9%
2.9%
Business Investment
7.9%
5.3%
 
(1.2)%
(2.1)%
Business Inventory
3.1%
2.7%
 
Oil Prices
$48/barrel
$55/barrel
 
$48/barrel
$55/barrel
Source: Global Insight
 
 
 
 
 

In the United States, exports and business investment are two major indicators of MRO spend. According to Global Insight, export volumes slowed in the first half of 2015 due to the strengthening U.S. dollar and port slowdowns on the West Coast. For the remainder of the year, exports are projected to grow in the low single digits. The large decline in crude oil prices over the past year had a significant impact on business investment, specifically within energy-related industries where companies have reduced capital spending. The United States business was negatively impacted as it has customers in these industries, but not to the extent of the Canadian business which is heavily dependent on the natural resources sector.
The light and heavy manufacturing customer end markets, which represent approximately 30% of Grainger’s sales, have historically correlated with manufacturing employment levels and manufacturing output. The United States Department of Labor reported an increase of 1.3% in manufacturing employment levels from June 2014 to June 2015. According to the Federal Reserve, manufacturing output increased 1.8% from June 2014 to June 2015. Grainger’s heavy and light manufacturing customer end-markets performed consistent with these indicators as sales to these customer end-markets increased in the low to mid-single digits for the six months of 2015.
According to Global Insight, the Canadian economy deteriorated through the first half of 2015 as the Canadian dollar weakened relative to the U.S. dollar to new six-year lows and as oil and commodity prices remained low. As a result, the outlook for business investment is weak, especially as companies in energy-related geographies and sectors plan to further curtail capital spending, according to the Bank of Canada. These market factors led to weaker performance in the Alberta region, which represents slightly more than one-third of sales in the Canadian business and is heavily dependent on the oil and gas industries. Sales to the oil and gas sector for the Canadian business were down in the mid-teens for the six months of 2015.
Outlook
On July 17, 2015, Grainger revised the 2015 sales growth guidance from a range of 1 to 4 percent to a range of 0 to 2 percent and also revised the 2015 earnings per share guidance from a range of $12.25 to $12.95 to a range of $12.00 to $12.50. The revised sales and earnings per share guidance reflects expectations of slower macroeconomic growth.

14

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 second quarter of 2015 and 2014. Grainger completed the WFS Enterprises, Inc. (WFS) acquisition 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.

Results of Operations – Three Months Ended June 30, 2015
The following table is included as an aid to understanding the changes in Grainger’s Condensed Consolidated Statements of Earnings:
 
Three Months Ended June 30,
 
As a Percent of Net Sales
 
Percent Increase/(Decrease)
 
2015
 
2014
 
Net sales
100.0
 %
 
100.0
 %
 
0.7
 %
Cost of merchandise sold
57.4

 
56.9

 
1.7

Gross profit
42.6

 
43.1

 
(0.7
)
Operating expenses
28.5

 
29.5

 
(3.1
)
Operating earnings
14.1

 
13.6

 
4.7

Other income (expense)
(0.3
)
 
(0.1
)
 
245.3

Income taxes
4.9

 
5.2

 
(4.6
)
Noncontrolling interest
0.2

 
0.1

 
48.2

Net earnings attributable to W.W. Grainger, Inc.
8.7
 %
 
8.2
 %
 
7.1
 %

Grainger’s net sales of $2,523 million for the second quarter of 2015 increased 1% compared with sales of $2,506 million for the comparable 2014 quarter. The 1% increase for the quarter consisted of the following:
 
Percent Increase/(Decrease)
Volume
4
Business acquisition
1
Foreign exchange
(3)
Price
(1)
Total
1%

The increase in net sales was led by growth in sales to government, diversified commercial services and light manufacturing customers. The sales growth was partially offset by declines to the natural resources, heavy manufacturing, resellers and contractors customer end markets. Refer to the Segment Analysis below for further details.

Gross profit of $1,073 million for the second quarter of 2015 decreased 1%. The gross profit margin during the second quarter of 2015 decreased 0.5 percentage point when compared to the same period in 2014, primarily driven by faster growth with lower margin customers, lower supplier rebates tied to lower-than-expected volume and price deflation versus cost inflation driven by foreign exchange.

Operating expenses of $717 million for the second quarter of 2015 decreased 3% from $740 million for the comparable 2014 quarter. Operating expenses in 2015 included $2 million in costs associated with shutting down the business in Brazil and restructuring the business in Europe. Operating expenses in 2014 included a $14 million charge related to the transition of the employee retirement plan in Europe. Excluding these charges from both years, operating expenses decreased 2%, driven primarily by lower payroll and benefits and savings from productivity initiatives in the United States, partially offset by $25 million in incremental growth and infrastructure spending.

Operating earnings for the second quarter of 2015 were $357 million, an increase of 5% compared to the second quarter of 2014. Excluding the charges in both years mentioned above, operating earnings increased 1%, driven by higher sales and positive operating expense leverage, partially offset by lower gross profit margins.

15

W.W. Grainger, Inc. and Subsidiaries
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS

Net earnings attributed to W.W. Grainger, Inc. for the second quarter of 2015 increased by 7% to $221 million from $206 million in the second quarter of 2014. Diluted earnings per share of $3.25 in the second quarter of 2015 were up 11% versus the $2.94 for the second quarter of 2014, due to higher earnings and lower average shares outstanding.

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.

 
Three Months Ended
 
 
June 30,
 
 
2015
 
2014
%
Diluted earnings per share reported
$3.25
 
$2.94
11
%
Restructuring costs in Brazil and Europe
0.02
 
 
Retirement plan transition
 
0.15
 
Diluted earnings per share adjusted
$3.27
 
$3.09
6
%

Segment Analysis
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 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 8 to the Condensed Consolidated Financial Statements.

United States
Net sales were $2,031 million for the second quarter of 2015, an increase of $38 million, or 2%, when compared with net sales of $1,993 million for the same period in 2014. The 2% increase for the quarter consisted of the following:
 
Percent Increase/(Decrease)
Volume
2
Intercompany sales to Zoro
1
Price
(1)
Total
2%

The increase in net sales was led by mid-single digit growth to government, commercial service and light manufacturing customers. Retail customers were up in the low single digits and heavy manufacturing and contractors were down in the low single digits. Net sales to resellers were down in the high single digits and the natural resources customer end market was down in the low teens. Low oil prices negatively impacted the performance of the heavy manufacturing and natural resources customer end markets. Sales to Zoro also contributed to sales growth as the U.S. business' supply chain network is Zoro's primary source of inventory.

The gross profit margin for the second quarter of 2015 decreased 0.7 percentage point compared to the same period in 2014, primarily driven by faster growth with large customers, price deflation exceeding cost deflation and the lower transfer price on intercompany sales to Zoro. Excluding sales to Zoro, the gross profit margin decreased 0.4 percentage point versus prior year.

Operating expenses were down slightly in the second quarter of 2015 versus the second quarter of 2014, driven by lower payroll and benefits and savings from productivity initiatives, partially offset by $23 million of incremental spending on growth initiatives such as new sales representatives, eCommerce and inventory management solutions.


16

W.W. Grainger, Inc. and Subsidiaries
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS

Operating earnings of $370 million for the second quarter of 2015 increased 1% from $365 million for the second quarter of 2014, driven by higher sales and positive operating expense leverage, partially offset by lower gross margins.

Canada
Net sales were $239 million for the second quarter of 2015, a decrease of $25 million, or 9%, when compared with $264 million for the same period in 2014. In local currency, sales increased 2%. The 9% decrease for the quarter consisted of the following:
 
Percent Increase/(Decrease)
Foreign exchange
(11)
Volume
(10)
Business acquisition
8
Price
4
Total
(9)%

Sales performance in Canada was driven by declines in the oil and gas, construction, reseller, commercial, retail and heavy manufacturing customer end markets, partially offset by growth from government, mining, utilities and light manufacturing customer end markets. The Alberta region, which represents more than one-third of the sales in the Canadian business, decreased 18% versus prior year as it was negatively impacted by lower oil prices. Sales growth for the remaining regions in aggregate was positive.
 
The gross profit margin decreased 1.1 percentage points in the second quarter of 2015 versus the second quarter of 2014, primarily due to lower margins from WFS. Excluding the impact of WFS, gross margins decreased 0.3 percentage point due to the effect of unfavorable foreign exchange from products sourced from the United States and inventory write-downs associated with transitioning to the new Toronto distribution center, partially offset by price increases and higher freight revenue.

Operating expenses decreased 3% in the second quarter of 2015 versus the second quarter of 2014. In local currency, operating expenses increased 10%, primarily due to incremental costs from WFS, one-time costs related to the relocation to the new Toronto distribution center and incremental spending related to information technology investments.

Operating earnings of $9 million for the second quarter of 2015 were down $10 million, or 51%, versus the second quarter of 2014. In local currency, operating earnings decreased by 44%, driven by lower gross profit margins and negative operating expense leverage.

Other Businesses
Net sales for other businesses, which include Zoro U.S. and operations in Europe, Asia and Latin America, were $319 million for the second quarter of 2015, an increase of $20 million, or 7%, when compared with net sales of $299 million for the same period in 2014. The drivers of net sales for the quarter consisted of the following:
 
Percent Increase/(Decrease)
Volume/Price
21
Foreign exchange
(14)
Total
7%

Operating earnings were $15 million in the second quarter of 2015 versus breakeven in the second quarter of 2014. Operating earnings in 2015 included $2 million in costs associated with shutting down the business in Brazil and restructuring the business in Europe. Operating earnings in 2014 included a $14 million charge related to the transition of the employee retirement plan in Europe and a $2 million write-off of capitalized software development costs in Mexico. Excluding these charges, operating earnings increased by $2 million versus the comparable 2014 period. The earnings performance for the quarter versus prior year was primarily driven by improved earnings from Zoro U.S. and the business in Japan, partially offset by startup costs for the single channel online business in Europe.

17

W.W. Grainger, Inc. and Subsidiaries
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS

Costs associated with the shutdown of the business in Brazil and restructuring expenses for the business in Europe are expected to continue through the second half of 2015.

Other Income and Expense
Other income and expense was $8 million of expense in the second quarter of 2015 compared to $2 million of expense in the second quarter of 2014. The increase in expense was driven by higher interest expense from the new $1 billion in long-term debt issued in early June, as well as operating losses from a new investment 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.

Income Taxes
Grainger’s tax rates were 35.4% and 38.2% for the three months ended June 30, 2015 and 2014, respectively. The decrease in the tax rate was primarily due to energy tax credits associated with the investment in the limited liability company established to produce clean energy and the related benefit for the first quarter of 2015 recorded in the second quarter. Excluding the first quarter benefit, the tax rate for the second quarter of 2015 was 36.9%. In comparison, the 2014 second quarter reflected a higher tax rate due to the effect of the retirement plan transition in Europe.  Excluding the retirement plan transition cost, the tax rate was 37.7% in the 2014 second quarter. Grainger is expecting a tax rate of approximately 36.6% to 37.2% for 2015.

Matters Affecting Comparability
There were 127 sales days in the six months of 2015 and 2014. Grainger completed the WFS acquisition 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.

Results of Operations – Six Months Ended June 30, 2014
The following table is included as an aid to understanding the changes in Grainger’s Condensed Consolidated Statements of Earnings:
 
Six Months Ended June 30,
 
As a Percent of Net Sales
 
Percent Increase/(Decrease)
 
2015
 
2014
 
Net sales
100.0
 %
 
100.0
 %
 
1.4
 %
Cost of merchandise sold
56.3

 
55.9

 
2.2

Gross profit
43.7

 
44.1

 
0.5

Operating expenses
29.4

 
29.9

 
(0.2
)
Operating earnings
14.3

 
14.2

 
1.9

Other income (expense)
(0.2
)
 
(0.1
)
 
130.4

Income taxes
5.2

 
5.4

 
(1.9
)
Noncontrolling interest
0.2

 
0.1

 
40.5

Net earnings attributable to W.W. Grainger, Inc.
8.7
 %
 
8.6
 %
 
2.1
 %

Grainger’s net sales of $4,962 million for the six months of 2015 increased 1% compared with sales of $4,892 million for the comparable 2014 period. The 1% increase for the period consisted of the following:
 
Percent Increase/(Decrease)
Volume
3
Business acquisition
1
Foreign exchange
(3)
Total
1%


18

W.W. Grainger, Inc. and Subsidiaries
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS

The increase in net sales for the six months of 2015 was led by growth in sales to government, light manufacturing and commercial service customers. The sales growth was partially offset by declines in the natural resources, contractors and reseller end markets. Refer to the Segment Analysis below for further details.

Gross profit of $2,167 million for the six months of 2015 was flat compared to the same period in 2014. The gross profit margin during the six months of 2015 decreased 0.4 percentage point when compared to the same period in 2014, primarily driven by faster growth with lower margin customers, lower supplier rebates tied to lower-than-expected volume and price deflation versus cost inflation driven by foreign exchange.

Operating expenses of $1,459 million for the six months of 2015 were flat to the $1,462 million for the comparable 2014 period. Operating expenses in 2015 included $4 million in costs associated with shutting down the business in Brazil and restructuring the business in Europe. Operating expenses in 2014 included a $14 million charge related to the transition of the employee retirement plan in Europe. Excluding these charges from both years, operating expenses for 2015 were slightly higher than the comparable 2014 period, primarily driven by $58 million in incremental growth and infrastructure spending, offset by lower payroll and benefits and savings from productivity initiatives in the United States.
 
Operating earnings for the six months of 2015 were $708 million, an increase of $13 million, compared to the six months of 2014. Excluding the charges in both years mentioned above, operating earnings were flat versus prior year. Higher sales and positive operating expense leverage were offset by lower gross profit margins.

Net earnings attributed to W.W. Grainger, Inc. for the six months of 2015 increased by 2% to $432 million from $423 million in the six months of 2014. Diluted earnings per share of $6.32 in the six months of 2015 were 5% higher than the $6.00 for the six months of 2014, due to higher earnings and lower average shares outstanding.

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.

 
Six Months Ended
 
 
June 30,
 
 
2015
 
2014
%
Diluted earnings per share reported
$6.32
 
$6.00
5
%
Restructuring costs in Brazil and Europe
0.05
 
 
Retirement plan transition
 
0.15
 
Diluted earnings per share adjusted
$6.37
 
$6.15
4
%



19

W.W. Grainger, Inc. and Subsidiaries
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS

Segment Analysis
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 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 8 to the Condensed Consolidated Financial Statements.

United States
Net sales were $4,002 million for the six months of 2015, an increase of $112 million, or 3%, when compared with net sales of $3,890 million for the same period in 2014. The 3% increase for the period consisted of the following:
 
Percent Increase/(Decrease)
Volume
3
Intercompany sales to Zoro
1
Price
(1)
Total
3%

The increase in net sales was led by mid-single digit growth to commercial service, light manufacturing and government customers. Retail and heavy manufacturing customers were up in the low single digits and net sales to contractors were down in the low single digits. Resellers were down in the mid-single digits and the natural resources customer end market was down in the high single digits. Sales to Zoro also contributed to sales growth as the U.S. business' supply chain network is Zoro's primary source of inventory.

The gross profit margin for the six months of 2015 decreased 0.6 percentage point compared to the same period in 2014, primarily driven by faster growth with large customers, price deflation exceeding cost deflation and the lower transfer price on intercompany sales to Zoro. Excluding sales to Zoro, gross profit margins decreased 0.2 percentage point versus prior year.

Operating expenses were up 1% in the six months of 2015 versus the six months of 2014, driven by $45 million of incremental spending on growth initiatives such as new sales representatives, eCommerce and inventory management solutions, partially offset by lower payroll and benefits and savings from productivity initiatives.

Operating earnings of $736 million for the six months of 2015 increased 2% from $719 million for the six months of 2014, driven by higher sales and positive operating expense leverage, partially offset by lower gross margins.

Canada
Net sales were $474 million for the six months of 2015, a decrease of $44 million, or 9%, when compared with $518 million for the same period in 2014. In local currency, sales increased 2%. The 9% decrease for the period consisted of the following:
 
Percent Increase/(Decrease)
Foreign Exchange
(11)
Volume
(8)
Business acquisition
7
Price
3
Total
(9)%

Sales performance in Canada was driven by declines in the oil and gas, construction, commercial services and heavy manufacturing customer end markets, partially offset by growth from utilities, mining, government and light manufacturing customer end markets.
 

20

W.W. Grainger, Inc. and Subsidiaries
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS

The gross profit margin decreased 0.9 percentage point in the six months of 2015 versus the six months of 2014, primarily due to lower margins from WFS. Excluding the impact of WFS, gross margins decreased 0.2 percentage point due to the effect of unfavorable foreign exchange from products sourced from the United States and inventory write-downs associated with transitioning to the new Toronto distribution center, partially offset by price increases and higher freight revenue.

Operating expenses in the six months of 2015 were flat versus the six months of 2014. In local currency, operating expenses increased 13%, primarily due to incremental costs from WFS, and one-time costs related to the relocation to the new Toronto distribution center.

Operating earnings of $19 million for the six months of 2015 were down $22 million, or 53%, versus the six months of 2014. In local currency, operating earnings decreased by 47%, driven by negative operating expense leverage and lower gross margins.

Other Businesses
Net sales for other businesses, which include Zoro U.S. and operations in Europe, Asia and Latin America, were $617 million for the six months of 2015, an increase of $43 million, or 7%, when compared with net sales of $574 million for the same period in 2014. The drivers of net sales for the period consisted of the following:
 
Percent Increase/(Decrease)
Volume/Price
21
Foreign exchange
(14)
Total
7%

Operating earnings of $25 million in the six months of 2015 increased $17 million compared to the six months of 2014.
Operating earnings in 2015 included $4 million in costs associated with shutting down the business in Brazil and restructuring the business in Europe. Operating earnings in 2014 included a $14 million charge related to the transition of the employee retirement plan in Europe and a $2 million write-off of capitalized software development costs in Mexico. Excluding these charges, operating earnings increased by $5 million versus the comparable 2014 period. The earnings performance for the period versus prior year was primarily driven by improved earnings from Zoro U.S. and the business in Japan, partially offset by startup costs for the single channel online business in Europe. Costs associated with the shutdown of the business in Brazil and restructuring expenses for the business in Europe are expected to continue through the second half of 2015.

Other Income and Expense
Other income and expense was $12 million of expense in the six months of 2015 compared to $5 million of expense in the six months of 2014. The increase in expense was primarily driven by operating losses from a new investment 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.

Income Taxes
Grainger’s tax rates were 36.9% and 38.0% for the six months ended June 30, 2015 and 2014, respectively. The decrease in the tax rate was due to energy tax credits associated with the investment in the limited liability company established to produce clean energy. Excluding the retirement plan transition cost, the tax rate was 37.7% in the 2014 period. Grainger is expecting a tax rate of approximately 36.6% to 37.2% for 2015.


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W.W. Grainger, Inc. and Subsidiaries
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS

Financial Condition

Cash Flow
Cash from operating activities continues to serve as Grainger’s primary source of liquidity. Net cash provided by operating activities was $370 million and $328 million for the six months ended June 30, 2015 and 2014, respectively. Higher cash flows from operating activities was driven primarily by higher earnings and other changes in operating assets and liabilities.

Net cash used in investing activities was $170 million and $132 million for the six months ended June 30, 2015 and 2014, respectively. The higher use of cash was driven by cash expended for additions to property, buildings, and equipment, mostly related to supply chain investments. Additionally, in 2015, Grainger made a new investment in a limited liability company established to produce clean energy. The investment provided Grainger with energy tax credits that lowered the tax rate, and positively impacted net earnings and cash flow.

Net cash provided by financing activities was $402 million for the six months ended June 30, 2015, compared to $297 million used in financing activities for the six months ended June 30, 2014. Financing activity for the 2015 period was primarily driven by proceeds from the issuance of $1 billion in long-term debt in early June. This was partially offset by an increase in the purchase of treasury stock and dividends paid.

Working Capital
Working capital consists of current assets (less non-operating cash) and current liabilities (less short-term debt and current maturities of long-term debt).

Working capital at June 30, 2015, was $1,847 million, an increase of $150 million when compared to $1,697 million at December 31, 2014. The working capital assets to working capital liabilities ratio increased to 2.9 at June 30, 2015, from 2.4 at December 31, 2014. The increase primarily related to lower profit sharing accruals due to the timing of annual payments as well as lower accrued compensation and benefits.

Debt
Grainger maintains a debt ratio and liquidity position that provide 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 as a percent of total capitalization was 31.2% at June 30, 2015, and 12.8% at December 31, 2014.

On April 16, 2015, Grainger announced plans to issue $1.8 billion in long-term debt over the next three years, to partially fund the repurchasing of $3 billion in shares. The remaining amount is expected to be funded from internally generated cash. In June 2015, Grainger issued $1 billion in long-term debt, which is the first of three expected debt issuances. The new debt is payable in 30 years and carries a 4.60% interest rate, payable semi-annually. With the new long-term debt, Grainger expects to maintain a debt to EBITDA ratio in the 1.0-1.5x range. EBITDA, which is defined as Earnings before Interest, Taxes, Depreciation and Amortization, is a non-GAAP measure and may not be defined and calculated by other companies in the same manner. See Note 4 to the Condensed Consolidated Financial Statements.

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W.W. Grainger, Inc. and Subsidiaries
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS

Critical Accounting Policies and 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 that affect the reported amounts of assets, liabilities, revenues and expenses in the financial statements. Management bases its estimates on historical experience and other assumptions, which it believes are reasonable. If actual amounts are ultimately different from these estimates, the revisions are included in Grainger’s results of operations for the period in which the actual amounts become known.

Accounting policies are considered critical when they require management to make assumptions about matters that are highly uncertain at the time the estimates are made and when there are different estimates that management reasonably could have made, which would have a material impact on the presentation of Grainger’s financial condition, changes in financial condition or results of operations. For a description of Grainger’s critical accounting policies see Grainger's Annual Report on Form 10-K for the year ended December 31, 2014.

Forward-Looking Statements
This Form 10-Q contains statements that are not historical in nature but concern future results and business plans, strategies and objectives and other matters that may be deemed to be “forward-looking statements” under the federal securities laws. These forward-looking statements include, but are not limited to, the Company’s expected or forecasted sales, earnings, tax rate, share repurchases, long-term debt, or earnings per share, and any associated guidance.

Grainger cannot guarantee that any forward-looking statement will be realized although Grainger does believe that its assumptions underlying its forward-looking statements are reasonable. Achievement of future results is subject to risks and uncertainties which could cause Grainger's results to differ materially from those which are presented.

Factors that could cause actual results to differ materially from those presented or implied in a forward-looking statement include, without limitation: higher product costs or other expenses; a major loss of customers; loss or disruption of source of supply; increased competitive pricing pressures; failure to develop or implement new technologies or business strategies; the outcome of pending and future litigation or governmental or regulatory proceedings; investigations, inquiries, audits and changes in laws and regulations; disruption of information technology or data security systems; general industry or market conditions; general global economic conditions; currency exchange rate fluctuations; market volatility; commodity price volatility; labor shortages; facilities disruptions or shutdowns; higher fuel costs or disruptions in transportation services; natural and other catastrophes and unanticipated weather conditions.

Caution should be taken not to place undue reliance on Grainger's forward-looking statements and Grainger undertakes no obligation to publicly update the forward-looking statements, whether as a result of new information, future events or otherwise.

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W.W. Grainger, Inc. and Subsidiaries


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, 2014.

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 the design and operation of Grainger’s disclosure controls and procedures pursuant to Exchange Act Rule 13a-15. 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.
 
Changes in Internal Control Over Financial Reporting
There were no changes in Grainger’s internal control over financial reporting that occurred during the second quarter that have materially affected, or are reasonably likely to materially affect, Grainger’s internal control over financial reporting.

PART II – OTHER INFORMATION
 
Items 1A, 3, 4 and 5 not applicable.

Item 1.
Legal Proceedings

Information on specific and significant legal proceedings is set forth in Note 10 to the Condensed Consolidated Financial Statements included under Item 1.



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W.W. Grainger, Inc. and Subsidiaries


Item 2.
Unregistered Sales of Equity Securities and Use of Proceeds
 
Issuer Purchases of Equity Securities – Second 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
Apr. 1 – Apr. 30
213,303
$246.00
213,303
14,786,697
May 1 – May 31
495,602
$246.56
495,602
14,291,095
June 1 – June 30
580,613
$240.05
580,613
13,710,482
Total
1,289,518
$243.54
1,289,518
 
 
(A)
There were no shares withheld to satisfy tax withholding obligations in connection with the vesting of employee restricted stock awards.
(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 on April 6, 2015. Activity is reported on a trade date basis.

Item 6.
Exhibits

(a)
 
Exhibits (numbered in accordance with Item 601 of Regulation S-K)
 
 
 
 
 
 
(3)
(ii) Bylaws, as amended
 
 
(10)
Material Contracts
 
 
 
(b)(i) Separation Agreement and General Release by and between Grainger and Court Carruthers dated July 22, 2015.
 
 
(31)
Rule 13a – 14(a)/15d – 14(a) Certifications
 
 
 
(a)  Chief Executive Officer certification pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
 
 
 
(b)  Chief Financial Officer certification pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
 
 
(32)
Section 1350 Certifications
 
 
 
Certifications pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
 
101.INS
XBRL Instance 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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SIGNATURES


 
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
 
 
 
 
W.W. Grainger, Inc.
 
 
 
(Registrant)
Date:
July 30, 2015
 
 
 
By:
 
 
 
/s/ R. L. Jadin
 
 
 
R. L. Jadin, Senior Vice President
and Chief Financial Officer
Date:
July 30, 2015
 
 
 
By:
 
 
 
/s/ W. Lomax
 
 
 
W. Lomax, Vice President
and Controller


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