W.W. GRAINGER, INC. (GWW) FY 2022 MD&A
This page reproduces the company's own Item 7 MD&A text from the linked SEC filing. It is filer text, not grepcent analysis, scoring, or investment advice.
Item 7: Management’s Discussion and Analysis of Financial Condition and Results of Operations
Objective
The following Management’s Discussion and Analysis (MD&A) of Financial Condition and Results of Operations is intended to help the reader understand the results of operations and financial condition of W.W. Grainger, Inc. (Grainger or Company) as it is viewed by the Company. The following discussion should be read in conjunction with the Consolidated Financial Statements and accompanying notes included in Part II, Item 8: Financial Statements and Supplementary Data of this Form 10-K. This section of this Form 10-K generally discusses 2022 and 2021 items and year-to-year comparisons between 2022 and 2021. Discussions of 2020 items and year-to-year comparisons between 2021 and 2020 are not included in this Form 10-K, and can be found in MD&A of Financial Condition and Results of Operations in Part II, Item 7 of the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2021.
Percentage figures included in this section have not been calculated on the basis of such rounded figures but on the basis of such amounts prior to rounding. For this reason, percentage amounts in this section may vary slightly from those obtained by performing the same calculations using the figures in the Company's Consolidated Financial Statements or in the associated text.
Overview
W.W. Grainger, Inc. is a broad line distributor of maintenance, repair and operating (MRO) products and services with operations primarily in North America (N.A.), Japan and the United Kingdom (U.K.). Grainger uses a combination of its high-touch solutions and endless assortment businesses to serve its customers worldwide, which rely on Grainger for products and services that enable them to run safe, sustainable and productive operations.
Strategic Priorities
The Company’s continued strategic priority for 2023 is to relentlessly expand Grainger’s leadership position in the MRO space by being the go-to partner for people who build and run safe and productive operations. To achieve this, each Grainger business has a set of strategic objectives. The high-touch solutions businesses are focused on key initiatives that drive top-line revenue and MRO market outgrowth. Additionally, the high-touch solutions businesses are focused on growing through differentiated sales and services (e.g., direct customer relationships and onsite services), advantaged MRO solutions (e.g., get customers the exact products and services they need to solve a problem quickly) and unparalleled customer service (e.g., deliver flawlessly on every customer transaction). The endless assortment businesses are focused on product assortment expansion and innovative customer acquisition and retention. Additionally, all Grainger businesses are focused on continuously improving customer experience, productivity and optimizing and scaling cost structures and investing in digital marketing, technology and supply chain infrastructure to ultimately deliver long-term returns for shareholders.
Recent Events
Inflation Reduction Act of 2022
In August 2022, the Inflation Reduction Act of 2022 (IRA) was signed into United States (U.S.) law. Under the IRA, there is a new 15% corporate minimum tax and a new 1% excise tax on net stock repurchases, effective after December 31, 2022. In addition, the IRA contains provisions relating to climate change, energy and health care. Based on Grainger's current analysis of the provisions, the Company does not anticipate compliance with the IRA will result in a material impact to the Consolidated Financial Statements.
Inflationary Cost Environment and Macroeconomic Pressures
In combination with the economic recovery of the ongoing COVID-19 pandemic, the global economy continues to experience volatile disruptions including to the commodity, labor and transportation markets. These disruptions have contributed to an inflationary environment which has affected, and may continue to affect, the price and availability of certain products and services necessary for the Company's operations. Such disruptions have impacted, and may continue to impact, the Company's business, financial condition and results of operations. As a result of continued inflation, the Company has implemented strategies designed to mitigate certain adverse effects of higher costs while also remaining market price competitive.
The Company continues to monitor economic conditions in the U.S. and globally, and the impact of macroeconomic pressures, including rising interest rates, fluctuating currency exchange rates and recession fears, on the Company’s business, customers, suppliers and other third parties. Historically, the Company’s broad and diverse
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customer base and the nondiscretionary nature of the Company’s products to its customers has helped it perform well in the industrial MRO market in recessionary periods. The full extent and impact of these conditions are uncertain and cannot be predicted at this time.
Geopolitical Events
In February 2022, Russia invaded Ukraine. In response to the conflict, the U.S. and other countries have implemented economic and other sanctions. While Grainger has limited direct exposure in Russia and Ukraine, the Company continues to monitor any broader impact on the global economy, including with respect to inflation, supply chains and fuel prices. The full impact of the conflict on the Company’s business and financial results remains uncertain and will depend on the severity and duration of the conflict and its impact on global and regional economic conditions.
The Company does not currently expect significant disruption to its overall business resulting from these events.
For further discussion of the Company's risks and uncertainties, see Part I, Item 1A: Risk Factors of this Form 10-K.
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Results of Operations
The following table is included as an aid to understanding changes in Grainger's Consolidated Statements of Earnings (in millions of dollars).
| For the Years Ended December 31, | ||||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| Percent Increase/(Decrease) from Prior Year | As a Percent of Net Sales | |||||||||||||||
| 2022 | 2021 | 2022 | 2021 | |||||||||||||
| Net sales(1) | $ | 15,228 | $ | 13,022 | 16.9 | % | 100.0 | % | 100.0 | % | ||||||
| Cost of goods sold | 9,379 | 8,302 | 13.0 | 61.6 | 63.8 | |||||||||||
| Gross profit | 5,849 | 4,720 | 23.9 | 38.4 | 36.2 | |||||||||||
| Selling, general and administrative expenses | 3,634 | 3,173 | 14.5 | 23.9 | 24.4 | |||||||||||
| Operating earnings | 2,215 | 1,547 | 43.2 | 14.5 | 11.9 | |||||||||||
| Other expense – net | 69 | 62 | 10.6 | 0.4 | 0.5 | |||||||||||
| Income tax provision | 533 | 371 | 43.8 | 3.5 | 2.8 | |||||||||||
| Net earnings | 1,613 | 1,114 | 44.8 | 10.6 | 8.6 | |||||||||||
| Noncontrolling interest | 66 | 71 | (7.1) | 0.4 | 0.5 | |||||||||||
| Net earnings attributable to W.W. Grainger, Inc. | $ | 1,547 | $ | 1,043 | 48.4 | 10.2 | 8.0 | |||||||||
| Diluted earnings per share: | $ | 30.06 | $ | 19.84 | 51.5 | % | ||||||||||
| (1) For further information regarding the Company's disaggregated revenue, see Note 3 of the Notes to the Consolidated Financial Statements in Part II, Item 8: Financial Statements and Supplementary Data of this Form 10-K. |
The following table is included as an aid to understanding the changes in Grainger's total net sales and daily sales from the prior period to the most recent period (in millions of dollars):
| For the Years Ended December 31, | ||||||
|---|---|---|---|---|---|---|
| 2022 | 2021 | |||||
| Net Sales | $ | 15,228 | $ | 13,022 | ||
| $ Change from prior-year period | 2,206 | 1,225 | ||||
| % Change from prior-year period | 16.9 | % | 10.4 | % | ||
| Daily sales(1) | $ | 59.7 | $ | 51.3 | ||
| $ Change from prior-year period | 8.4 | 5.2 | ||||
| % Change from prior-year period | 16.5 | % | 11.3 | % | ||
| Daily sales impact of currency fluctuations | (2.8) | % | 0.3 | % | ||
| (1) Daily sales are defined as the total net sales for the period divided by the number of U.S. selling days in the period. There were 255 and 254 sales days in the full year 2022 and 2021, respectively. |
Net sales of $15,228 million for the year ended December 31, 2022 increased $2,206 million, or 16.9%, compared to the same period in 2021. The increase in net sales was primarily due to growth in the High-Touch Solutions N.A. and Endless Assortment segments in 2022. For further discussion on the Company's net sales, see the Segment Analysis section below.
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Gross profit of $5,849 million for the year ended December 31, 2022 increased $1,129 million, or 24%, compared to the same period in 2021. Gross profit margin of 38.4% increased 2.2 percentage points compared to the same period in 2021. The increase was driven by favorability in the High-Touch Solutions N.A. and Endless Assortment segments. For further discussion on the Company's gross profit, see the Segment Analysis section below.
SG&A of $3,634 million for the year ended December 31, 2022 increased $461 million, or 15%, compared to the same period in 2021. The increase was primarily due to higher marketing, payroll and variable compensation expenses in 2022.
Operating earnings of $2,215 million for the year ended December 31, 2022 increased $668 million, or 43%, compared to the same period in 2021. The increase was driven by higher gross profit dollars, partially offset by higher SG&A.
Other expense – net of $69 million for the year ended December 31, 2022 increased $7 million, or 11%, compared to the same period in 2021. The increase was primarily driven by unfavorable changes in market interest rates in 2022.
Income taxes of $533 million for the year ended December 31, 2022 increased $162 million, or 44%, compared to the same period in 2021. The increase was primarily driven by higher taxable operating earnings for the full year 2022. Grainger's effective tax rates were 24.8% and 25.0% for the twelve months ended December 31, 2022 and 2021, respectively.
Net earnings of $1,547 million attributable to W.W. Grainger, Inc. for the year ended December 31, 2022 increased $504 million, or 48%, compared to the same period in 2021.
Diluted earnings per share was $30.06 for the year ended December 31, 2022, an increase of 52% compared to $19.84 for the same period in 2021. The increase was primarily due to higher net earnings in 2022.
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Non-GAAP Measures
The following tables reconcile reported selling, general and administrative (SG&A) expenses, operating earnings, net earnings attributable to W.W. Grainger, Inc. and diluted earnings per share determined in accordance with U.S. generally accepted accounting principles (GAAP) to non-GAAP measures including adjusted SG&A, adjusted operating earnings, adjusted net earnings attributable to W.W. Grainger, Inc. and adjusted diluted earnings per share. The Company believes that these non-GAAP measures provide meaningful information to assist investors 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.
The following tables provide a reconciliation of GAAP to non-GAAP measures (in millions of dollars):
| For the Years Ended December 31, | |||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|
| 2022 | 2021 | Percent Increase from Prior Year | |||||||||
| Reported selling, general, and administration expenses | $ | 3,634 | $ | 3,173 | 14.5 | % | |||||
| Business divestiture | 21 | — | |||||||||
| Adjusted selling, general, and administration expenses | $ | 3,655 | $ | 3,173 | 15.2 | % | |||||
| Reported operating earnings | $ | 2,215 | $ | 1,547 | 43.2 | % | |||||
| Business divestiture | (21) | — | |||||||||
| Adjusted operating earnings | $ | 2,194 | $ | 1,547 | 41.9 | % | |||||
| Reported net earnings attributable to W.W. Grainger, Inc. | $ | 1,547 | $ | 1,043 | 48.4 | % | |||||
| Business divestiture | (21) | — | |||||||||
| Adjusted net earnings attributable to W.W. Grainger, Inc. | $ | 1,526 | $ | 1,043 | 46.4 | % | |||||
| Reported diluted earnings per share | $ | 30.06 | $ | 19.84 | 51.5 | % | |||||
| Business divestiture | (0.40) | — | |||||||||
| Adjusted diluted earnings per share | $ | 29.66 | $ | 19.84 | 49.5 | % | |||||
| For further information regarding the Company's business divestitures, see Note 2 of the Notes to the Consolidated Financial Statements in Part II, Item 8: Financial Statements and Supplementary Data of this Form 10-K. |
Noted in the table above for the twelve months ended December 31, 2022, Grainger divested Cromwell's wholly owned software business in the U.K. (Cromwell subsidiary). As a result of the divestiture, the Company recorded a gain in Other businesses of $21 million in SG&A in the fourth quarter of 2022.
Excluding the business divestiture, adjusted SG&A and adjusted operating earnings for the full year 2022 were $3,655 and $2,194, an increase of $482 million and $647 million, or 15% and 42%, respectively, compared to the same period in 2021.
Grainger's adjusted effective tax rate was 25.1% for the twelve months ended December 31, 2022. The divestiture was non-taxable.
The Company's adjusted net earnings attributable to W.W. Grainger Inc. for the full year 2022 was $1,526 million, an increase of $483 million, or 46%, compared to the same period in 2021.
Adjusted diluted earnings per share of $29.66 increased 49% compared to $19.84 for the twelve months ended December 31, 2021.
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Segment Analysis
For further segment information, see Note 14 of the Notes to Consolidated Financial Statements in Part II, Item 8: Financial Statements and Supplementary Data of this Form 10-K.
High-Touch Solutions N.A.
The following table shows reported segment results (in millions of dollars):
| For the Years Ended December 31, | ||||||||||
|---|---|---|---|---|---|---|---|---|---|---|
| 2022 | 2021 | Percent Increase from Prior Year | ||||||||
| Net sales | $ | 12,182 | $ | 10,186 | 19.6 | % | ||||
| Gross profit | $ | 4,951 | $ | 3,906 | 26.8 | % | ||||
| Selling, general and administrative expenses | $ | 2,968 | $ | 2,572 | 15.4 | % | ||||
| Operating earnings | $ | 1,983 | $ | 1,334 | 48.7 | % |
Net sales of $12,182 million for the year ended December 31, 2022 increased $1,996 million, or 19.6%, compared to the same period in 2021. On a daily basis, net sales increased 19.1%. This consisted of increased price, which includes customer mix, of 10.6% and increased volume, which includes product mix, of 8.7%, partially offset by unfavorable foreign exchange of 0.2%.
Gross profit of $4,951 million for the year ended December 31, 2022 increased $1,045 million, or 27%, compared to the same period in 2021. Gross profit margin of 40.6% increased 2.3 percentage points compared to the same period in 2021. The increase was primarily due to favorable product mix and lapping of prior year pandemic-related inventory adjustments.
SG&A of $2,968 million for the year ended December 31, 2022 increased $396 million, or 15%, compared to the same period in 2021. The increase was primarily due to higher payroll, marketing and variable compensation expenses in 2022. SG&A leverage improved by 0.9 percentage point.
Operating earnings of $1,983 million for the year ended December 31, 2022 increased $649 million, or 49%, compared to the same period in 2021. The increase was driven by higher gross profit dollars, partially offset by higher SG&A.
Endless Assortment
The following table shows reported segment results (in millions of dollars):
| For the Years Ended December 31, | ||||||||||
|---|---|---|---|---|---|---|---|---|---|---|
| 2022 | 2021 | Percent Increase (decrease) from Prior Year | ||||||||
| Net sales | $ | 2,787 | $ | 2,576 | 8.2 | % | ||||
| Gross profit | $ | 817 | $ | 729 | 12.0 | % | ||||
| Selling, general and administrative expenses | $ | 594 | $ | 497 | 19.4 | % | ||||
| Operating earnings | $ | 223 | $ | 232 | (3.8) | % |
Net sales of $2,787 million for the year ended December 31, 2022 increased $211 million, or 8.2%, compared to the same period in 2021 and on a daily basis, net sales increased 7.7%. The increase was due to sales growth of 20.1%, driven by strong new customer acquisition and repeat business for the segment, as well as enterprise customer growth at MonotaRO, partially offset by unfavorable foreign exchange of 12.4% due to changes in the exchange rate between the U.S. dollar and the Japanese yen.
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Gross profit of $817 million for the year ended December 31, 2022 increased $88 million, or 12%, compared to the same period in 2021. Gross profit margin of 29.3% increased 1.0 percentage point compared to the same period in 2021. The increase was driven by freight efficiencies and business unit mix in 2022.
SG&A of $594 million for the year ended December 31, 2022 increased $97 million, or 19%, compared to the same period in 2021. The increase was due to higher payroll and benefits, occupancy and marketing expenses to support the continued growth of the segment in 2022. SG&A leverage decreased 2.0 percentage points.
Operating earnings of $223 million for the year ended December 31, 2022 decreased $9 million, or 4%, compared to the same period in 2021. The decrease was primarily driven by higher SG&A, partially offset by higher gross profit dollars.
Other
Net sales of $259 million for the year ended December 31, 2022 decreased $1 million, or 0.2%, compared to the same period in 2021. The decrease was driven by unfavorable foreign exchange of 11.3% due to changes in the exchange rate between the U.S. dollar and British pound sterling, partially offset by increased sales growth due to improved customer mix of 11.1%.
Operating earnings of $9 million for the year ended December 31, 2022 increased $28 million, or 145%, compared to the same period in 2021. The increase was due to the divestiture of Cromwell's software business in the fourth quarter of 2022.
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Liquidity and Capital Resources
Grainger believes its current balances of cash and cash equivalents, marketable securities and availability under its revolving credit facilities will be sufficient to meet its liquidity needs for the next 12 months and beyond. Grainger also maintains access to capital markets and may issue debt or equity securities from time to time, which may provide an additional source of liquidity. The Company will continue to assess its liquidity position and potential sources of supplemental liquidity in view of Grainger's operating performance, current economic and capital market conditions and other relevant circumstances.
Sources of Liquidity
Cash and Cash Equivalents
As of December 31, 2022 and 2021, Grainger had cash and cash equivalents of $325 million and $241 million, respectively. The increase in cash was primarily due to cash flows from operations and lower volume of share repurchases, partially offset by working capital changes and higher tax disbursements in 2022. The Company had approximately $1.6 billion in available liquidity as of December 31, 2022.
Cash Flows
The following table shows the Company's cash flow activity for the periods presented (in millions of dollars):
| For the Years Ended December 31, | ||||||
|---|---|---|---|---|---|---|
| 2022 | 2021 | |||||
| Total cash provided by (used in): | ||||||
| Operating activities | $ | 1,333 | $ | 937 | ||
| Investing activities | (263) | (226) | ||||
| Financing activities | (972) | (1,039) | ||||
| Effect of exchange rate changes on cash and cash equivalents | (14) | (16) | ||||
| Increase (decrease) in cash and cash equivalents | $ | 84 | $ | (344) |
Debt
Grainger maintains a debt ratio and liquidity position that provides flexibility in funding working capital needs and long-term cash requirements. Grainger has various sources of financing available. For further information regarding the Company's debt instruments and available financing sources, see Note 6 of the Notes to the Consolidated Financial Statements in Part II, Item 8: Financial Statements and Supplementary Data of this Form 10-K.
Total debt, which is defined as total interest-bearing debt and lease liabilities as a percent of total capitalization, was 49.9% and 56.2%, as of December 31, 2022 and 2021, respectively.
Credit Ratings
Grainger receives ratings from two independent credit ratings agencies: Moody's Investor Service (Moody's) and Standard & Poor's (S&P). Both credit rating agencies currently rate the Company's corporate credit at investment grade.
The following table summarizes the Company's credit ratings as of December 31, 2022:
| Corporate | Senior Unsecured | Short-term | |||
|---|---|---|---|---|---|
| Moody's | A3 | A3 | P2 | ||
| S&P | A+ | A+ | A1 |
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Uses of Liquidity
Internally generated cash flows are the primary source of Grainger's working capital and growth initiatives, including capital expenditures. The Company expects to continue to return excess capital to shareholders through share repurchases and dividends.
Working Capital
The Company's working capital was $2,864 million at December 31, 2022, compared to $2,455 million at December 31, 2021. The increase was driven by higher accounts receivable and inventory primarily due to sales growth and inflation, partially offset by increased accounts payable. As of December 31, 2022 and 2021, the ratio of current assets to current liabilities was 2.5 and 2.7, respectively.
Capital Expenditures
In fiscal 2022, the Company continued U.S. and Japanese supply chain investments. Capital expenditures were $256 million and $255 million for the years ended December 31, 2022 and 2021, respectively. Capital project spending for 2023 is expected to be in the range of $450 and $525 million. This includes continued supply chain capacity expansion and technology enhancements across the Company.
Share Repurchases
For the years ended December 31, 2022 and 2021, Grainger repurchased shares of its common stock in the open market for $603 million and $695 million, respectively. Share repurchases are executed at prices the Company determines appropriate subject to various factors, including market conditions and the Company's financial performance and may be effected through accelerated share repurchase programs, open market purchases or privately negotiated transactions, including through Rule 10b5-1 plans. Share repurchases for 2023 are expected to be in the range of $550 and $700 million.
Dividends
For the years ended December 31, 2022 and 2021, Grainger declared and paid $370 million and $357 million, respectively, in dividends to holders of the Company's common stock.
Commitments and Other Contractual Obligations
The Company's material cash requirements include the following commitments and other contractual obligations.
Debt
As of December 31, 2022, the Company had outstanding debt obligations with varying maturities for an aggregate principal amount of $2,374 million, with $35 million payable within 12 months. Total future interest payments associated with the Company's outstanding debt obligations was $1,843 million, with $87 million payable within 12 months.
Purchase Obligations
Grainger had purchase obligations of approximately $1,563 million as of December 31, 2022, which includes approximately $1,407 million payable within 12 months. Grainger's purchase obligations primarily include commitments to purchase inventory, uncompleted additions to property, buildings and equipment and other goods and services. Purchase obligations are made in the normal course of business to meet operating needs and are primarily noncancelable.
Leases
The Company has lease arrangements for certain properties, buildings and equipment (including branches, warehouses, DCs and office space). As of December 31, 2022, the Company had fixed operating lease payment obligations of $405 million, with $77 million payable within 12 months.
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Critical Accounting Estimates
The preparation of Grainger’s Consolidated Financial Statements and accompanying notes are in conformity with GAAP and the Company’s discussion and analysis of its financial condition and operating results require the Company’s management to make assumptions and estimates that affect the reported amounts. The Company considers an accounting policy to be a critical estimate if: (1) it involves assumptions that are uncertain when judgment was applied, and (2) changes in the estimate assumptions, or selection of a different estimate methodology, could have a significant impact on Grainger’s consolidated financial position and results. While the Company believes the assumptions and estimates used are reasonable, the Company’s management bases its estimates on historical experience and on various other assumptions it believes to be reasonable under the circumstances. Note 1 of the Notes to Consolidated Financial Statements in Part II, Item 8: Financial Statements and Supplementary Data of this Form 10-K describes the significant accounting policies and methods used in the preparation of the Company’s Consolidated Financial Statements.
Inventories
Company inventories primarily consist of merchandise purchased for resale and are valued at the lower of cost or net realizable value. The majority of the Company’s inventory is accounted for using the last-in, first-out (LIFO) method. Net realizable value is based on an analysis of inventory trends including, but not limited to, reviews of inventory levels, sales and cost information and on-hand quantities relative to the sales history for the product and shelf-life. The Company's methodology for estimating whether adjustments are necessary is continually evaluated for factors including significant changes in product demand, liquidation or disposition history values and market conditions such as inflation and other acquisition costs, including freight and duties. If business or economic conditions change, estimates and assumptions may be adjusted as deemed appropriate.
Goodwill and Other Intangible Assets
The Company evaluates goodwill and indefinite-lived intangible assets for impairment annually during the fourth quarter and more frequently if impairment indicators exist. The fair value of reporting units is calculated primarily using the discounted cash flow method and utilizing value indicators from a market approach to evaluate the reasonableness of the resulting fair values. The Company’s indefinite-lived intangible assets are primarily trade names. The fair value of trade names is calculated primarily using the relief-from-royalty method, which estimates the expected royalty savings attributable to the ownership of the trade name asset.
The estimates used to calculate the fair values of reporting units and indefinite-lived intangible assets involve the use of significant assumptions, estimates and judgments and changes from year to year based on operating results, market conditions, macroeconomic developments and other factors. Changes in these estimates and assumptions could materially affect the determination of fair value and impairment for each reporting unit and indefinite-lived intangible asset. For further information on the Company's goodwill and other intangible assets, see Note 5 of the Notes to Consolidated Financial Statements in Part II, Item 8: Financial Statements and Supplementary Data of this Form 10-K.
Contingencies and Legal Matters
The Company is subject to various claims and legal proceedings that arise in the ordinary course of business, the outcomes of which are inherently uncertain. The Company accrues for costs relating to litigation claims and other contingent matters when it is probable that a liability has been incurred and the amount of the assessment can be reasonably estimated. A detailed summary of the Company’s contingencies and legal matters is included in Note 15 of the Notes to Consolidated Financial Statements in Part II, Item 8: Financial Statements and Supplementary Data of this Form 10-K.
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