Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations

General

W.W. Grainger, Inc. (Grainger) is a broad line, business-to-business distributor of maintenance, repair and operating (MRO) products and services with operations primarily in North America, Europe and Japan. More than 3.5 million customers worldwide rely on Grainger for products such as safety, gloves, ladders, motors and janitorial supplies, along with services like inventory management and technical support. These customers represent a broad collection of industries (see Note 2 to the Consolidated Financial Statements (Financial Statements)). They place orders online, on mobile devices, through sales representatives, over the phone and at local branches. Approximately 5,000 suppliers provide Grainger with about 1.7 million products stocked in Grainger's distribution centers (DCs) and branches worldwide.

Grainger’s two reportable segments are the U.S. and Canada (Acklands - Grainger, Inc. and its subsidiaries). These reportable segments reflect the results of the Company's high-touch, high-service businesses in those geographies. Other businesses include the endless assortment businesses, (Zoro in the U.S. and MonotaRO in Japan), and smaller high-touch, high-service businesses in Europe, Asia and Mexico.

Business Environment

Given Grainger's large number of customers and the diverse industries it serves, several economic factors and industry trends tend to shape Grainger’s business environment and provide general insight into projecting Grainger's growth. Grainger’s sales in the U.S. and Canada tend to positively correlate with Business Investment, Business Inventory, Exports, Industrial Production and Gross Domestic Product (GDP). Sales in Canada also tend to positively correlate with oil prices. The table below provides these estimated indicators for 2018 and 2019:

	U.S.						Canada
	Estimated 2018			Forecasted 2019			Estimated 2018			Forecasted 2019
Business Investment	7.3	%		3.4	%		2.8	%		1.2	%
Business Inventory	1.6	%		2.7	%		—			—
Exports	4.0	%		4.1	%		3.2	%		2.2	%
Industrial Production	3.9	%		2.4	%		2.6	%		1.0	%
GDP	2.9	%		2.5	%		2.1	%		2.0	%
Oil Prices	—			—			$65/barrel			$55/barrel
Source: Global Insight U.S. (January 2019), Global Insight Canada (January 2019)

In the U.S., Business Investment and Exports are two major indicators of MRO spending. Per the Global Insight January 2019 forecast, Business Inventory and Exports are forecast to improve while Business Investment, Industrial Production and GDP are forecast to slow, yet still remain stable during 2019 despite slowing global growth, financial market volatility and fading fiscal stimulus.

Per the Global Insight January 2019 forecast, Canada's Business Investment, Exports and Industrial Production are expected to slow due to a reduction in spending and oil production quotas and increasing interest rates.

Outlook

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

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

The Canada business is focused on stabilizing volume performance in 2019 after completing the majority of its cost structure reset.

In other businesses, the Company is focused on growing the endless assortment businesses profitably, investing in product assortment and innovating around customer acquisition by building marketing and analytics capabilities. The high-touch, high-service international businesses are focused on the same initiatives as the U.S. business, as mentioned above.

Matters Affecting Comparability

There were 255 sales days in the full years 2018 and 2016 versus 254 sales days in the full year 2017. Grainger completed one divestiture in 2017, which was immaterial.

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
	2018				2017				2018			2018			2017
Net sales	$	11,221			$	10,425			8	%		100.0	%		100.0	%
Cost of goods sold	6,873				6,327				9	%		61.3			60.7
Gross profit	4,348				4,098				6	%		38.7			39.3
Selling, general and administrative expenses	3,190				3,063				4	%		28.4			29.4
Operating earnings	1,158				1,035				12	%		10.3			9.9
Other expense, net	77				99				(22	)%		0.7			0.9
Income taxes	258				313				(18	)%		2.3			3.0
Net earnings	823				623				32	%		7.3			6.0
Noncontrolling interest	41				37				11	%		0.4			0.4
Net earnings attributable to W.W. Grainger, Inc.	$	782			$	586			33	%		7.0	%		5.6	%

2018 Compared to 2017

Grainger's net sales of $11,221 million for 2018 increased $796 million, or 8%, compared to the same period in 2017. On a daily basis, net sales increased 7%. The increase in net sales was primarily driven by volume increases in the U.S. business due to market share gain and an improved demand environment and continued double digit growth in the endless assortment businesses, offset by lower sales in the Canada business. See Note 17 to the Financial Statements and refer to the Segment Analysis below for further details.

Gross profit of $4,348 million for 2018 increased $250 million, or 6% compared with the same period in 2017. The gross profit margin of 38.7% decreased 0.6 percentage points when compared to the same period in 2017. The lower gross profit margin reflects a 0.5 percentage point decline from the implementation of the Financial Accounting Standards Board (FASB) new revenue recognition standard that primarily reclassified certain costs related to KeepStock® services from Selling, general and administrative expenses (SG&A) to Cost of goods sold (COGS). Excluding this impact, gross profit margin would have decreased 0.1 percentage point compared to the prior year.

The tables below reconcile reported SG&A, operating earnings and net earnings attributable to W.W. Grainger, Inc., determined in accordance with Generally Accepted Accounting Principles (GAAP) in the United States of America to adjusted SG&A, operating earnings and net earnings attributable to W.W. Grainger, Inc., which are all considered non-GAAP measures. The Company believes that these non-GAAP measures provide meaningful information to assist shareholders in understanding financial results and assessing prospects for future performance as they provide a better baseline for analyzing the ongoing performance of its businesses by excluding items that may not be indicative of core operating results. Because non-GAAP financial measures are not standardized, it may not be possible to

compare these measures with other companies' non-GAAP measures having the same or similar names. All tables below are in millions of dollars:

	Twelve Months Ended
	December 31,
	2018				2017			%
SG&A reported	$	3,190			$	3,063		4	%
Restructuring (U.S.)	19				43
Branch gains (U.S.)	(10		)		(33		)
Other (gains) charges (U.S.)	—				(4		)
Restructuring (Canada)	36				31
Branch gains (Canada)	(1		)		—
Restructuring (Other businesses)	5				51
Impairment charges (Other businesses)	139				—
Restructuring (Unallocated expense)	(2		)		11
Subtotal	186				99
SG&A adjusted	$	3,004			$	2,964		1	%
	2018				2017			%
Operating Earnings reported	$	1,158			$	1,035		12	%
Total restructuring and impairment charges, net of branch gains and other charges	186				112
Operating earnings adjusted	$	1,344			$	1,147		17	%
	2018				2017			%
Net earnings attributable to W.W. Grainger, Inc. reported	$	782			$	586		33	%
Total restructuring and impairment charges, net of branch gains and other charges	186				112
Tax effect (1)	(16		)		(13		)
U.S. tax legislation (2)	—				(3		)
Discrete tax items	—				(12		)
Total restructuring and impairment charges, net of branch gains and other charges and tax	170				84
Net earnings attributable to W.W. Grainger, Inc. adjusted	$	952			$	670		42	%
(1) The tax impact of adjustments is calculated based on the income tax rate in each applicable jurisdiction, subject to deductibility and the Company's ability to realize the associated tax benefits.
(2) U.S. tax legislation reflects the 2017 impact of the benefit of remeasurement of deferred taxes, partially offset by one-time deemed repatriation tax.

SG&A of $3,190 million for 2018 increased $127 million, or 4% from $3,063 million compared with the same period in 2017. In the third quarter of 2018 Grainger recorded $139 million of impairment charges related to goodwill and tradename intangible asset at the Cromwell business. Excluding restructuring and impairment charges net of branch gains and other charges in both periods as noted in the table above, SG&A increased $40 million or 1%, driven primarily by higher variable costs in connection with higher sales.

Operating earnings of $1,158 million for 2018 increased $123 million, or 12% from $1,035 million for 2017. Excluding restructuring and impairment charges net of branch gains and other charges in both periods as noted in the table above, operating earnings increased $197 million, or 17%, driven primarily by higher sales and improved SG&A leverage.

Other expense, net was $77 million in 2018, a decrease of $22 million, or 22% compared to the same period in 2017. The decrease in expense was primarily due to lower losses from the conclusion of the Company's clean energy investments during the second half of 2018.

Income taxes of $258 million in 2018 decreased $55 million, or 18% compared with $313 million for the same period in 2017. Grainger's effective tax rates were 23.9% and 33.5% in 2018 and 2017, respectively. The lower effective tax rate in 2018 was primarily due to the impact of the Tax Cuts and Jobs Act (the Tax Act) and excess tax benefits from stock-based awards, partially offset by the impact of nondeductible goodwill impairment. The 2017 effective tax rate was impacted by the wind-down of the Colombia business and the inability to realize the associated tax benefit. In addition, Grainger recognized a net tax benefit of $3.2 million for the year ended December 31, 2017, related to the impact of the Tax Act.

Net earnings attributable to W.W. Grainger, Inc. for 2018 increased $196 million, or 33% to $782 million from $586 million in the same period in 2017. The increase in net earnings primarily resulted from higher operating earnings and lower income taxes. Excluding restructuring and impairment charges net of branch gains and other charges and income taxes net from both periods as noted in the table above, net earnings increased $282 million, or 42%.

Diluted earnings per share of $13.73 in 2018 increased 37% compared to $10.02 for the same period in 2017, due to higher net earnings and lower average shares outstanding. Excluding restructuring and impairment charges net of branch gains and other charges net of income taxes from both periods in the table above, diluted earnings per share would have been $16.70 compared to $11.46 in 2017, an increase of 46%.

2017 Compared to 2016

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
	2017				2016				2017			2017			2016
Net sales	$	10,425			$	10,137			3	%		100.0	%		100.0	%
Cost of goods sold	6,327				6,022				5	%		60.7			59.4
Gross profit	4,098				4,115				—	%		39.3			40.6
Selling, general and administrative expenses	3,063				3,002				2	%		29.4			29.6
Operating earnings	1,035				1,113				(7	)%		9.9			11.0
Other expense, net	99				94				5	%		0.9			0.9
Income taxes	313				386				(19	)%		3.0			3.8
Net earnings	623				633				(2	)%		6.0			6.2
Noncontrolling interest	37				27				37	%		0.4			0.3
Net earnings attributable to W.W. Grainger, Inc.	$	586			$	606			(3	)%		5.6	%		6.0	%

Grainger's net sales were $10,425 million for 2017, an increase of 3% when compared with net sales of $10,137 million for the comparable 2016 period. On a daily basis, the 3% increase for the year consisted of the following:

	Percent Increase/ (Decrease)
Volume	8
Divestiture	(1)
Price	(4)
Total	3%

The increase in net sales was primarily driven by the endless assortment businesses in the U.S. and Japan, as well as volume increases in the U.S. business as a result of the pricing actions. The U.S. business pricing actions were primarily implemented in the first and third quarters of 2017 and included adjusting list price and introducing new lower web prices on the entire business assortment, which drove faster growth in 2017 through share gains with existing customers and acquisition of new customers. Refer to the Segment Analysis below for further details

Gross profit of $4,098 million for 2017 decreased by $17 million compared with $4,115 million for 2016. The gross profit margin for 2017 was 39.3%, a decrease of 1.3 percentage points compared with 2016, driven primarily by the pricing actions in the U.S. business.

The tables below reconcile reported SG&A, operating earnings and net earnings attributable to W.W. Grainger, Inc., determined in accordance with U.S. GAAP to adjusted SG&A, operating earnings and net earnings attributable to W.W. Grainger, Inc., which are all considered non-GAAP measures. The Company believes that these non-GAAP measures provide meaningful information to assist shareholders in understanding financial results and assessing prospects for future performance as they provide a better baseline for analyzing the ongoing performance of its businesses by excluding items that may not be indicative of core operating results. Because non-GAAP financial measures are not standardized, it may not be possible to compare these measures with other companies' non-GAAP measures having the same or similar names. All tables below are in millions of dollars:

	Twelve Months Ended
	December 31,
	2017				2016			%
SG&A reported	$	3,063			$	3,002		2	%
Restructuring (U.S.)	43				31
Branch gains (U.S.)	(33		)		(18		)
Other (gains) charges (U.S.)	(4		)		45
Restructuring (Canada)	31				13
Restructuring (Other businesses)	51				—
Impairment charges (Other businesses)	—				52
Restructuring (Unallocated expense)	11				9
Subtotal	99				132
SG&A adjusted	$	2,964			$	2,870		3	%
	2017				2016			%
Operating earnings reported	$	1,035			$	1,113		(7	)%
Total restructuring and impairment charges, net of branch gains and other charges	112				147
Operating earnings adjusted	$	1,147			$	1,260		(9	)%
	2017				2016			%
Net earnings attributable to W.W. Grainger, Inc. reported	$	586			$	606		(3	)%
Total restructuring and impairment charges, net of branch gains and other charges	112				147
Tax effect (1)	(13		)		(33		)
U.S. tax legislation (2)	(3		)		—
Discrete tax items	(12		)		(9		)
Total restructuring and impairment charges, net of branch gains and other charges and tax	84				105
Net earnings attributable to W.W. Grainger, Inc. adjusted	$	670			$	711		(6	)%
(1) The tax impact of adjustments is calculated based on the income tax rate in each applicable jurisdiction, subject to deductibility and the Company's ability to realize the associated tax benefits.
(2) U.S. tax legislation reflects the 2017 impact of the benefit of remeasurement of deferred taxes, partially offset by one-time deemed repatriation tax.

SG&A of $3,063 million for 2017 increased 2% from $3,002 million for 2016. Excluding restructuring and impairment charges net of branch gains and other charges in both periods as noted in the table above, operating expenses increased 3%, driven primarily by higher employee-related costs.

Operating earnings of $1,035 million for 2017 decreased 7% from $1,113 million for 2016. Excluding restructuring and impairment charges net of branch gains and other charges in both periods as noted in the table above, operating earnings decreased 9% or $113 million, driven primarily by lower gross profit and higher operating expenses.

Other expense, net was $99 million in 2017 compared to $94 million of expense in 2016. The increase in expense was primarily due to incremental interest expense on $400 million in long-term debt issued in May 2016 and $400 million in long-term debt issued in May 2017, as well as higher operating losses from the Company's clean energy investments partially offset by higher benefits related to the Company's postretirement plan. See Note 10 to the Financial Statements for additional information.

Income taxes of $313 million in 2017 decreased 19% compared with $386 million in 2016. Grainger's effective tax rates were 33.5% and 37.9% in 2017 and 2016, respectively. The lower rate versus the prior year is primarily due to discrete tax items and U.S. tax legislation.

On December 22, 2017, the Tax Act was signed into law, which significantly revised the U.S. corporate income tax system by lowering corporate income tax rates from 35% to 21% effective January 1, 2018, allowing accelerated expensing of qualified capital investments for a specific period, limiting net interest expense deductions and transitioning U.S. international taxation from a worldwide to a territorial tax system, among other changes. Grainger recognized a net provisional tax benefit of $3.2 million for the year ended December 31, 2017, related to the estimated impact of the Tax Act. See Note 15 to the Financial Statements for additional information.

Net earnings attributable to W.W. Grainger, Inc. for 2017 decreased by 3% to $586 million from $606 million in 2016. The decrease in net earnings primarily resulted from lower operating earnings, partially offset by lower income taxes. Excluding restructuring and impairment charges net of branch gains and other charges net of income tax and discrete tax items from both years mentioned in the table above, net earnings decreased 6%.

Diluted earnings per share of $10.02 in 2017 were 2% higher than $9.87 for 2016, due to lower average shares outstanding partially offset by lower earnings. Excluding restructuring and impairment charges net of branch gains and other charges net of income taxes in the table above, diluted earnings per share would have been $11.46 compared to $11.58 in 2016, a decrease of 1%.

Segment Analysis - 2018 Compared to 2017

The following comments at the reportable segment and other business unit level include external and intersegment net sales and operating earnings. See Note 17 to the Financial Statements.

United States

Net sales were $8,588 million for 2018, an increase of $628 million, or 8% when compared with net sales of $7,960 million for 2017. On a daily basis, the 7% increase consisted of the following:

	Percent Increase (Decrease)
Volume	8%
Divestiture	(1)%
Total	7%

Sales to customers in the government end market increased in the low teens and natural resources increased in the high single digits. Retail/wholesale, commercial and heavy manufacturing end markets increased in the mid-single digits. Contractors increased in the low single digits while the light manufacturing end segment was flat year over year. Overall, revenue increases were primarily driven by market share gains and improved demand in all industries, partially offset by the Company's pricing actions and the July 2017 divestiture of a specialty business. See Note 2 to the Financial Statements.

Gross profit margin decreased 0.7 percentage point compared to the same period in 2017. The decline was primarily driven by 0.5 percentage point due to the implementation of the FASB's new revenue recognition standard. Excluding the impact of the implementation of the new revenue recognition standard, gross profit margin would have been unfavorable by 0.2 percentage points.

SG&A for 2018 increased 3% compared to the same period in 2017. This increase was primarily driven by variable compensation to reflect stronger performance, partially offset by the implementation of the FASB's new revenue recognition standard.

Operating earnings of $1,338 million increased $138 million, or 12% from $1,200 million in the same period of 2017. This increase was driven primarily by higher sales, higher gross profit dollars and improved SG&A leverage.

Canada

Net sales were $653 million for 2018, a decrease of $100 million, or 13% when compared with $753 million for 2017. On a daily basis, the 14% decrease consisted of the following:

	Percent (Decrease)/Increase
Volume	(23)
Price	9
Total	(14)%

During 2018, volume decreased by 23 percentage points compared to the same period in 2017 due to branch closures and sales coverage optimization activities, partially offset by price increases and continued contract negotiations of 9 percentage points for 2018.

Gross profit margin increased 2.9 percentage points in 2018 compared to the same period in 2017, primarily due to 3.9 percentage points from price increases that began in late 2017 and improved customer mix, net of 1.0 percentage point from the implementation of the new revenue recognition standard.

SG&A decreased $40 million, or 13% in 2018 compared to the same period in 2017. The decrease was primarily due to cost reduction actions and lower variable expense on lower sales volume.

Operating losses were $49 million for 2018 compared to losses of $77 million in the same period in 2017. Excluding restructuring and impairment charges net of branch gains and other charges in both periods (as noted in the table above and Note 7 to the Financial Statements), operating losses would have been $14 million compared to $37 million in the prior period primarily due to lower SG&A and lower sales volume.

Other businesses

Net sales for other businesses were $2,441 million for 2018, an increase of $321 million, or 15%, when compared to the same period in 2017. The net sales increase was primarily due to incremental sales at Zoro and MonotaRO. On a daily basis, the 15% increase consisted of the following:

	Percent Increase
Volume	13
Foreign exchange	2
Total	15%

The net sales increase was primarily due to growth in the endless assortment businesses as a result of increased customer acquisition and incremental sales in other international businesses. Foreign currencies strengthened in the countries where the Company operates. These currencies primarily include the euro, pound sterling and yen.

Operating earnings for other businesses were $8 million for 2018, a decrease of $48 million, or 86% compared to $56 million for 2017. Other businesses included impairment charges in 2018 relating to the Cromwell business in the U.K. See Note 4 and Note 7 to the Financial Statements. Excluding restructuring and impairment charges net of branch gains and other charges in both periods, operating earnings increased $42 million or 38%, primarily due to strong performance from the endless assortment businesses.

Segment Analysis - 2017 Compared to 2016

United States

Net sales were $7,960 million for 2017, an increase of $90 million, or 1% when compared with net sales of $7,870 million for 2016. On a daily basis, the 2% increase consisted of the following:

	Percent Increase/(Decrease)
Volume	7
Intercompany sales to Zoro	1
Divestiture	(1)
Price	(5)
Total	2%

Sales to customers in natural resources, resellers and retail end markets increased mid-single digits, while heavy manufacturing and government increased low single digits. The sales growth was partially offset by declines in contractors and commercial services. Volume increased year over year, primarily driven by the pricing actions.

Gross profit margin decreased 1.7 percentage points in 2017 compared to 2016, driven by price deflation exceeding higher volume in response to pricing actions.

SG&A of $2,007 decreased by 1% for 2017 compared to 2016. Excluding restructuring and impairment charges net of branch gains and other charges in both periods, operating expenses increased 1% or $26 million, driven by higher employee related costs. See Note 7 to the Financial Statements.

Operating earnings of $1,200 million for 2017 decreased 5% compared to $1,269 million in 2016. Excluding restructuring and impairment charges net of branch gains and other charges in both periods, operating earnings decreased 9% or $123 million, driven primarily by price deflation. See Note 7 to the Financial Statements.

Canada

Net sales were $753 million for 2017, an increase of $19 million, or 3%, when compared with $734 million for 2016. On a daily basis, the 3% increase consisted of volume across all end segments.

Gross profit margin increased 1.0 percentage point in 2017 versus 2016, primarily due to a favorable comparison to an inventory adjustment in the second quarter of 2016 that did not repeat in 2017, partially offset by price deflation, cost inflation and higher freight costs from an increase in shipping directly to customers in 2017.

SG&A decreased 9% in 2017 versus 2016. Excluding restructuring and impairment charges net of branch gains and other charges in both periods as noted in the table above, operating expenses would have increased 3%, primarily related to higher professional service fees related to the business transformation.

Operating losses of $77 million for 2017 increased versus operating losses of $65 million in 2016. Excluding the restructuring and impairment charges net of branch gains and other charges and the inventory adjustment mentioned in the table above, operating losses would have been $37 million compared to $41 million in the prior year.

Other businesses

Net sales for other businesses were $2,120 million for 2017, an increase of $235 million, or 12%, when compared to $1,885 million for 2016. The net sales increase was primarily due to incremental sales at Zoro and MonotaRO. On a daily basis, the 13% increase consisted of the following:

	Percent Increase/(Decrease)
Volume	15
Foreign exchange	(2)
Total	13%

Operating earnings for other businesses were $56 million for 2017 compared to $40 million for 2016. Excluding restructuring charges in 2017 and the goodwill and intangible impairment charges of $52 million in the Fabory and Colombia businesses in the prior year, operating earnings increased $18 million or 19%, due to strong performance from the endless assortment businesses.

Financial Condition

Grainger expects its strong working capital position, cash flows from operations and borrowing capacity to continue, allowing it to fund its operations, growth initiatives and capital expenditures as well as pay cash dividends, repurchase shares and repay its long-term debt obligations while maintaining an adequate credit rating.

Cash and Cash Equivalents

At December 31, 2018, 2017 and 2016, Grainger had cash and cash equivalents of $538 million, $327 million and $274 million, respectively. Approximately 49%, 66% and 71% were outside the U.S. business as of December 31, 2018, 2017 and 2016, respectively. Grainger has no material limits or restrictions on its ability to use these foreign liquid assets.

Cash Flow

2018 Compared to 2017

Net cash provided by operating activities was $1,057 million for the twelve months ended December 31, 2018 and 2017, as increased net earnings were offset by investment in inventory and timing of payables.

Net cash used in investing activities was $166 million and $146 million for the twelve months ended December 31, 2018 and 2017, respectively. The increase in net cash used in investing activities was driven by lower proceeds primarily from the sales of branch real estate assets in the U.S. and a U.S. business divestiture when compared to the prior year.

Net cash used in financing activities was $670 million and $867 million in the twelve months ended December 31, 2018 and 2017, respectively. The decrease in net cash used in financing activities was primarily driven by lower stock repurchases in 2018 compared to 2017 and higher proceeds from the exercise of stock options.

2017 Compared to 2016

Net cash provided by operating activities was $1,057 million and $1,024 million for the twelve months ended December 31, 2017 and 2016, respectively. The increase in cash provided by operating activities is primarily the result of higher accruals related to employee benefits, partially offset by lower earnings and higher working capital.

Net cash used in investing activities was $146 million and $262 million for the twelve months ended December 31, 2017 and 2016, respectively. The decrease in net cash used in investing activities was driven by lower additions to property, buildings and equipment compared to the prior year and higher proceeds primarily from the sales of branch real estate assets in the U.S. and a U.S. business divestiture when compared to the prior year.

Net cash used in financing activities was $867 million and $776 million in the twelve months ended December 31, 2017 and 2016, respectively. The increase in net cash used in financing activities was primarily driven by higher net payments of commercial paper, offset by lower stock repurchases in 2017 compared to 2016 and lower payments of long-term debt.

Working Capital

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

Working capital consists of current assets (less non-operating cash) and current liabilities (less short-term debt and current maturities of long-term debt). Working capital was $1,898 million at December 31, 2018, compared with $1,669 million at December 31, 2017, primarily due to an increase in accounts receivable and inventory and decreases in accounts payable. At these dates, the ratio of current assets to current liabilities was 2.4 and 2.2, respectively.

Capital Expenditures

In each of the past three years, a portion of the Company's net cash flows has been used for additions to property, buildings, equipment and capitalized software (presented in Intangibles - net on the Consolidated Balance Sheet) as summarized in the following table (in millions of dollars):

	For the Years Ended December 31,
	2018				2017				2016
Land, buildings, structures and improvements	$	69			$	109			$	71
Furniture, fixtures, machinery and equipment	137				66				139
Subtotal	206				175				210
Capitalized software	33				62				74
Total	$	239			$	237			$	284

In 2018, the Company continued to invest in its North American distribution network (e.g. new or expanding existing facilities and technology). Other investments include the consolidation of facility and office locations and development of software solutions.

In 2017, the Company continued to invest in its worldwide distribution network (e.g. new or expanding existing facilities and technology), digital platforms (e.g. eCommerce websites and inventory management solutions), capital maintenance of its existing branch networks across the enterprise and other supporting information technology assets.

In 2016, the Company continued to invest in the North America distribution network, as well as the distribution network in other businesses and sales productivity initiatives. Other significant investments in 2016 included the eCommerce platform, sustaining capital investments in branches and distribution centers and other technology infrastructure.

In 2019, capital expenditures are expected to range from $300 million to $350 million. Projected spending includes continued investments in the supply chain, investment in a DC in Japan, software development and inventory management solutions. Grainger expects to fund 2019 capital spending primarily from operating cash flows.

Debt

Grainger maintains a debt ratio and liquidity position that provides flexibility in funding working capital needs and long-term cash requirements. In addition to internally generated funds, Grainger has various sources of financing available, including bank borrowings under lines of credit. Total debt, which is defined as total interest-bearing debt (short-term current and long-term) as a percent of total capitalization was 51.5% and 56.2%, as of December 31, 2018 and 2017, respectively.

In the years 2015-2017, Grainger issued $1.8 billion in long-term debt to partially fund the repurchase of $2.8 billion in shares of the total $3 billion previously announced. The remaining share repurchases were funded from internally generated cash. Debt was issued as follows:

•	In June 2015, $1.0 billion payable in 30 years and carries a 4.60% interest rate, payable semiannually.

•	In May 2016, $400 million payable in 30 years and carries a 3.75% interest rate, payable semiannually.

•	In May 2017, $400 million payable in 30 years and carries a 4.20% interest rate, payable semiannually.

Refer to Note 9 to the Financial Statements included in Item 8.

Commitments and Other Contractual Obligations

At December 31, 2018 Grainger's contractual obligations, including estimated payments due by period, are as follows (in millions of dollars):

	Payments Due by Period
	Total Amounts Committed				Less than 1 Year				1 - 3 Years				4 - 5 Years				More than 5 Years
Debt obligations	$	2,193			$	81			$	308			$	4			$	1,800
Interest on debt	2,115				82				158				156				1,719
Operating lease obligations	233				65				85				45				38
Purchase obligations:
Uncompleted additions to property, buildings and equipment	67				67				—				—				—
Commitments to purchase inventory	574				574				—				—				—
Other goods and services	366				248				92				26				—
Other liabilities	159				130				8				5				16
Total	$	5,707			$	1,247			$	651			$	236			$	3,573

See Notes 8, 9 and 11 to the Financial Statements for further detail related to debt, interest on debt and operating lease obligations.

Purchase obligations are made in the normal course of business to meet operating needs. While purchase orders for both inventory purchases and non-inventory purchases are generally cancelable without penalty, certain vendor agreements provide for cancellation fees or penalties depending on the terms of the contract.

Other liabilities represent future payments for profit sharing and other employee benefit plans.

The Company’s obligation for the postretirement healthcare benefits plan, as determined by actuarial projections, is $190 million at December 31, 2018. The Company has established a Group Benefit Trust (Trust) to fund the plan obligations. The Trust assets available for benefits payments are $176 million at December 31, 2018. The Company has no minimum funding requirements and the timing and amounts of the Company’s additional contributions into the Trust have not been determined. Other employment-related benefits obligations of $53 million have also not been included in this table as the timing of benefit payments is not predictable. See Note 10 to the Financial Statements for further detail.

Grainger has recorded a noncurrent liability of approximately $41 million for tax uncertainties and interest at December 31, 2018. This amount is excluded from the table above, as Grainger cannot predict the timing of these cash payments by period. See Note 15 to the Financial Statements.

Off-Balance Sheet Arrangements

Grainger does not have any material exposures to off-balance sheet arrangements. All significant contractual obligations are recorded on the Company's Consolidated Balance Sheet or disclosed in the notes to Grainger's Consolidated Financial Statements.

Critical Accounting Estimates

Note 1 to the Financial Statements describes the significant accounting policies used in the preparation of the Consolidated Financial Statements. As discussed in Note 1, the preparation of financial statements, in conformity with U.S. GAAP, requires management to make judgments, estimates and assumptions about future events that affect the amounts reported in the financial statements and accompanying notes.

Accounting policies and estimates are considered critical when they require management to make subjective and complex judgments, estimates and assumptions about matters that have a material impact on Grainger's financial statements and accompanying notes.

The Company believes that the following discussion addresses Grainger’s most critical accounting policies and estimates.

Inventory Reserves

Grainger establishes inventory reserves for excess and obsolete inventory. Grainger regularly reviews inventory to evaluate continued demand and identify any obsolete or excess quantities. Grainger records provisions for the difference between excess and obsolete inventory cost and its estimated realizable value. Estimated realizable value is based on anticipated future product demand, market conditions and liquidation values. As Grainger's inventory consists of approximately 1.7 million stocked products, it is not practical to quantify the actual disposition of excess and obsolete inventory against estimated amounts at a stock keeping unit (SKU) level and no individual SKU is material. There were no material differences noted between reserve levels compared to the level of write-offs historically.

Grainger's methodology for estimating reserves is continually evaluated based on current experience and provides for a materially accurate level of reserves at any reporting date. Actual results could differ materially from projections and require changes to reserves that could have a material effect on Grainger's results of operations, based on significant changes in product demand, market conditions or liquidation value. If business or economic conditions change, Grainger's estimates and assumptions may be revised as appropriate. For fiscal years 2018, 2017 and 2016, actual results did not vary materially from estimated amounts.

Goodwill and Indefinite-Lived Intangible Assets

Grainger’s goodwill and indefinite-lived intangible assets are evaluated for impairment annually during the fourth quarter, or more frequently if an event occurs or circumstances change. The Company tests for impairment by first assessing qualitative factors to determine whether it is more likely than not that the fair value of a reporting unit or indefinite-lived intangible asset is less than its carrying value. Some of the factors considered in the assessment include general macroeconomic, industry and market trends and significant events impacting reporting units’ current and future performance. If the Company concludes that it is more likely than not that goodwill and intangible assets may be impaired, a quantitative impairment test is performed.

In the quantitative impairment tests, the Company uses the discounted cash flow, market approach and royalty relief methods, which require significant assumptions and judgments with respect to future volume, revenue and expense growth rates, capital investments, changes in working capital use, the selection of an appropriate discount rate and terminal growth rate, among other assumptions and estimates. The use of alternative estimates and assumptions could impact the Company’s estimated fair values of reporting units and indefinite-lived intangible assets and potentially result in different impacts on the Company’s results of operations. Actual results could differ from the Company’s assumptions and estimates. See Note 4 to the Financial Statements for further information.

Income Taxes

The tax balances and income tax expense recognized by Grainger are based on management's interpretations of the tax laws of multiple jurisdictions. Income tax expense reflects Grainger's best estimates and assumptions regarding, among other items, the level of future taxable income, interpretation of tax laws and tax planning opportunities, plans for reinvestment of cash overseas and uncertain tax positions. On December 22, 2017, the Tax Cuts and Jobs Act was signed into law, which significantly revised the U.S. corporate income tax system including lowering the corporate income tax rates from 35% to 21% effective January 1, 2018. See Note 15 to the Financial Statements for additional information.

Future rulings by tax authorities and future changes in tax laws and their interpretation, changes in projected levels of taxable income, changes in planned need for cash overseas and future tax planning strategies could impact the actual effective tax rate and tax balances recorded by Grainger.

Contingent Liabilities

At any time, Grainger may be subject to investigations, legal proceedings or claims related to the ongoing operation of its business, including claims both by and against Grainger. Such proceedings typically involve claims related to product liability, general negligence, contract disputes, environmental issues, unclaimed property, wage and hour laws, intellectual property, employment practices, regulatory compliance or other matters and actions brought by employees, customers, 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 contract administration or to pricing compliance. Grainger retains a significant portion of the risk of certain losses related to workers' compensation, auto liability, general liability and property losses

through the utilization of high deductibles and self-insured retentions. Grainger routinely assesses the likelihood of any adverse outcomes related to these matters on a case by case basis, as well as the potential ranges of losses and fees. Grainger establishes accruals for its potential exposures, as appropriate, for claims against Grainger when losses become probable and the financial impact of an adverse outcome is reasonably estimable. Legal fees are recognized as incurred and are not included in accruals for contingencies. Where Grainger is able to reasonably estimate a range of potential losses, Grainger records the amount within that range that constitutes Grainger's best estimate. Grainger also discloses the nature of and range of loss for claims against Grainger when losses are reasonably possible and the exposure is considered material to Grainger's Consolidated Financial Statements. These accruals and disclosures are determined based on the facts and circumstances related to the individual cases and require estimates and judgments regarding the interpretation of facts and laws, as well as the effectiveness of strategies or other factors beyond Grainger's control. If the assessment of any of these factors changes, the estimates may change. Predicting the outcome of claims and litigation and estimating related costs and exposure involves substantial uncertainties that could cause actual costs to vary materially from estimates and accruals.

Other

Other significant accounting policies, not involving the same level of measurement uncertainties as those discussed above, are nevertheless important to an understanding of the financial statements. Policies such as revenue recognition, depreciation, intangibles, long-lived assets, fair value measurements and valuations and warranties require judgments on complex matters that are often subject to multiple external sources of authoritative guidance such as the Financial Accounting Standards Board and the Securities and Exchange Commission. Possible changes in estimates or assumptions associated with these policies are not expected to have a material effect on the financial condition or results of operations of Grainger. More information on these additional accounting policies can be found in Note 1 to the Financial Statements.

Effects of Inflation and Changing Prices

Grainger is affected by inflation through increased product and operating costs, and the ability to pass on cost increases to customers over time is dependent upon market conditions. The ability to achieve sales growth through increased prices is also subject to inflation and normal competitive conditions. The predominant use of the last-in, first-out (LIFO) method of accounting for inventories and accelerated depreciation methods for financial reporting and income tax purposes result in a substantial recognition of the effects of inflation in the financial statements.

Some of Grainger's products contain significant amounts of commodity-priced materials, such as steel, copper, petroleum derivatives or rare earth minerals, and are subject to price changes based upon fluctuations in the commodities market.

Grainger believes the most positive means to combat inflation and advance the interests of investors lie in the continued application of basic business principles, which include improving productivity, maintaining working capital turnover and offering products and services that can command appropriate prices in the marketplace.

Forward-Looking Statements

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

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

Important factors that could cause actual results to differ materially from those presented or implied in the forward-looking statements include, without limitation: higher product costs or other expenses; a major loss of customers; loss or disruption of sources of supply; increased competitive pricing pressures; failure to develop or implement new technology initiatives or business strategies; failure to adequately protect intellectual property or successfully defend against infringement claims; the implementation, timing and results of the Company's strategic pricing initiatives and other responses to market pressures; the outcome of pending and future litigation or governmental or regulatory

proceedings, including with respect to wage and hour, anti-bribery and corruption, environmental, advertising, privacy and cybersecurity matters; investigations, inquiries, audits and changes in laws and regulations; disruption of information technology or data security systems; general industry, economic, market or political conditions; general global economic conditions; currency exchange rate fluctuations; market volatility, including volatility or price declines of the Company's common stock; commodity price volatility; labor shortages; facilities disruptions or shutdowns; higher fuel costs or disruptions in transportation services; natural and other catastrophes; unanticipated and/or extreme weather conditions; loss of key members of management; the Company's ability to operate, integrate and leverage acquired businesses; changes in effective tax rates and other factors identified under Item 1A: Risk Factors and elsewhere in this Form 10-K.

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