W.W. Grainger Q3 2021 Earnings Call Transcript

Quartr
Provided by Quartr
October 28, 2021

There are 16 speakers on the call.

Operator

Greetings, and welcome to the W. W. Grainger Third Quarter 2021 Earnings Conference Call. At this time, all participants are in a listen only mode. A question and answer session will follow the formal presentation.

Operator

Please note that this conference is being recorded. I will now turn the conference over to our host, Irene Holman, Vice President of Investor Relations. Thank you. You may begin.

Speaker 1

Good morning. Welcome to Grainger's Q3 2021 earnings call. With me are D. G. MacPherson, Chairman and CEO and Dean Merriweather, Senior Vice President and CFO.

Speaker 1

As a reminder, some of our comments today may include forward looking statements. Actual results may differ materially due to various risks and uncertainties, including those detailed in our SEC filings. Reconciliations of any non GAAP financial measures with their corresponding GAAP measures are found in the tables at the end of this presentation and in our Q3 earnings release, both of which are available on our IR website. This morning's call will focus on adjusted results, which exclude restructuring and other items that are outlined in our earnings release. We will also share results related to Monetaro.

Speaker 1

Please remember that Monotaro is a public company and follows Japanese GAAP, which differs from U. S. GAAP and is reported in our results 1 month in arrears. As a result, the numbers disclosed today will differ somewhat from Monitaro's public statements. With that, I'll turn it over to DG.

Speaker 2

Thanks, Irene. Good morning and thank you for joining us. The Grainger Edge is our framework that defines who we are, Why we exist and where we're going, while establishing a set of operating principles. I'm proud of the ways that we use the principles to guide decisions and deliver results. I wanted to start this quarter with a big thank you.

Speaker 2

Things are very challenging on many fronts. Given the ongoing pandemic and labor and material shortages, Nothing in the world seems to be working exactly the way it should. Our manufacturing partners, transportation partners, Grainger team members And certainly our customers are all finding harder than ever to keep the world working. I want to thank all of them for their tremendous efforts. I also want to offer particular thank you The frontline workers who continue to go above and beyond.

Speaker 2

Grainger is proud to support the hospital staff, government agencies, teachers and many others We continue to do great work in a very challenging environment. I might say that in spite of these challenges we performed very well, but in reality it's partly because of how we are wired The Grainger is doing so well. We've seen strong demand this quarter, especially in the U. S. We have product available in our network and have been able to ship it to customers quickly.

Speaker 2

Our service to customers has been exceptional given the circumstances. We are leveraging our scale, demonstrating our agility and gaining share. Our goal is to always be in an advantage position to help our customers solve their problems. As I've been out with customers this past quarter time and again, I hear that Grainger is executing well. Customers tell me that they are pleased with our performance and you can see this in our revenue growth.

Speaker 2

While the current supply chain environment is volatile uncertain. We are confident in our current plans and our readiness to respond to any evolving dynamics. In the face of labor and material shortages throughout Supply chain, we are providing strong relative service and helping our customers avoid disruptions. We continue to actively leverage our network even if sometimes we had The orders from less optimal locations at a higher cost. We are investing in inventory while actively monitoring the freight market and the West Coast ports.

Speaker 2

And as it relates to labor, we have made great progress in closing staffing gaps and training team members, which has resulted in improvements especially in our DC operations. Our customer research shows that this is driving customer satisfaction. Turning to our financial highlights, demand in the quarter was robust, resulting in strong revenue and gross margin performance and well managed SG and A. We achieved organic daily sales growth of 11.9% for the total company on a constant currency basis. When compared to Q3 2019, the quarter was up 17.3% on a daily organic basis, driven primarily by core non pandemic product sales, which is a positive indicator of our underlying run rate performance.

Speaker 2

Our High Touch Solutions North America segment grew 11.6% on a daily constant currency basis. In the U. S, we drove approximately 100 basis points of share outgrowth versus the prior year and 4 75 basis points on a 2 year average. We remain confident in our ability to grow 300 to 400 basis points faster than the market on an ongoing basis. Our service to customers, especially the last 2 years, has contributed to meaningful share gain.

Speaker 2

Our endless assortment segment finished the quarter with 14.9% daily sales growth on a constant currency basis. I'd like to note 2 things that temporarily moderated growth in this segment. First, Zoro lapped a very strong Q3 in 2020. For context, we opened up pandemic product supply to Zoro customers in Q3 2020 that was previously reserved mostly for government and healthcare customers. In the Q3 of 2021, Zoro managed to drive 11.9% revenue growth and when we compare that to Q3 2019, we are up 30.6%, which is really strong.

Speaker 2

Also, Monotaro was impacted by several external factors, including a slow start to vaccinations and a generally slower Japanese economy. In local days and local currency sales were up about 17.5% compared to Q3 2020. And Menotro continues to take share especially as COVID restrictions lift And we grow with our targeted enterprise customers. And as we look at results versus Q3 2019, Monotaro sales are up over 37%. We feel that the comparison to 2019 for both businesses is more indicative of our underlying business strength.

Speaker 2

We still expect the segment to close the year with growth at about 20% above prior year. We saw strong gross margin expansion across all segments even above our expectations that we discussed last quarter. Hi Touch Solutions North America was up 140 basis points Over Q3 of the prior year, an endless assortment was up 115 basis points. Dee will cover the drivers for both segments. Lastly, we returned $327,000,000 to shareholders through dividends and share repurchases in the 3rd quarter and we maintained strong return on invested capital of 31.4%.

Speaker 2

Turning to our quarterly results for the company, I discussed most of what's on this slide, but wanted to point out a few additional items. First, our SG and A was $812,000,000 right where we thought it would be. We continue to invest in marketing and labor, primarily through increased variable compensation And rate wage rates in the DCs. And like many companies, we're also starting to see increased healthcare costs as team members return to routine medical visits and undergo deferred elective procedures. And while overall spending is up versus the prior year, we are still gaining significant leverage when compared to 2019.

Speaker 2

Our operating earnings were $438,000,000 up 17.4 percent and our resulting EPS is $5.65 for the quarter, Which is growth of 25%. Overall, it was a really strong quarter. With that, I'll turn it over to Dee to take us through more detail. Dee?

Speaker 3

Thanks, DG. Turning to our Hy Tech Solutions segment. We continue to see a robust recovery with daily sales up 12% compared to the 3rd quarter of 2020 and up 14.5% compared to the Q3 of 2019. In the U. S, we saw strong growth, especially in our core non pandemic product categories.

Speaker 3

Both large And midsize customers saw significant growth at 10% 19%, respectively. Canada continues to be slow as recurring shutdowns in many of the larger provinces kept businesses closed or operating at minimal capacity. As vaccination rates improve and businesses reopen, we expect more typical purchasing behavior to resume and sales to follow. Canadian daily sales were up 11.7 percent or 5.7 percent in local days and local Currency compared to the Q3 of 2020. For the Hi Tech Solutions segment, GP Margins finished the quarter at 39.4%, up 140 basis points versus the prior year Q3.

Speaker 3

Our focus and diligence on managing price cost spread contributed to our GP improvement. In the quarter, we saw strong price realization to customers both on contract and web pricing. Our realization was better than anticipated, and as a result, pricecost spread was above neutral. In addition, consistent with the Q2, our U. S.

Speaker 3

Pandemic product mix was about 22%, an improvement versus 28% in the Q3 of 2020. We are confident that our run rate GP remains strong and will finish in line with the expectations we set forth for the Q4. On Slide 20, You'll find a chart with details on the U. S. And Canadian businesses.

Speaker 3

This information has been provided to help Bridge our prior reportable segments to our new High Touch Solutions North American segment. I'd like to give you some advanced notice that we will continue to show daily sales and gross margin by business. However, as our operating expenses across the segment have become more intertwined, Our operating margin by geography will no longer be provided in our 2022 reporting. On Slide 9, taking a deeper dive into high-tech solutions for the U. S, the delta variant and the renewed mask mandates in July reversed the declining trend we were seeing in the Q2 for pandemic products.

Speaker 3

As the virus surged, we saw pandemic product demand picked back up, especially for mass. However, of particular note, our core non pandemic sales growth was atorabove20% every month in Q3. We are encouraged to see this growth as a sign of more regular business and economic activity. When comparing core non pandemic sales to Q3 2019, sales were up 12%, which is quite strong. In total, our U.

Speaker 3

S. High-tech Solutions business is up 12% for the Q3 2021 and up 16% as compared to 2019. Looking at market outgrowth on Slide 10. In the Q3, as expected, we saw our share gain grow as we lap more reasonable yet still inflated Q3 2020 comparisons. In the quarter, we estimate that the U.

Speaker 3

S. Market grew between 10.5% and 11.5%, resulting in our estimated outgrowth of Approximately 100 basis points versus Q3 2020. To normalize for volatility, We are continuing to show the 2 year average share gain, which was about 4.75 basis points over the market for the Q3 of 2021, a really exceptional result. Given the noise and fluctuations in the market number across industrials, The 2 year average is a better estimate of our true market outgrowth. We remain focused on our key initiatives, which give us confidence in our ability to achieve our U.

Speaker 3

S. Share gain goal of growing 300 basis points to 400 basis points faster than the market. Now let's cover our USGP rate. We saw a significant lift in the high touch USGP performance in the quarter. Sequentially, we wanted to comment on 2 of the biggest factors that make up the difference between the 2nd quarter and the 3rd quarter.

Speaker 3

First, the biggest contributor, the inventory adjustments are behind us as anticipated. In addition, we are seeing greater price realization than I'll note that while we sold some of the pandemic inventory that was previously written down, the impact to GP was immaterial. We're encouraged by these results and are confident in our ability to achieve our expected 40.1% GP rate in Q4 Based on continued pandemic mix improvements, our expected price realization in the 4th quarter and our ability to navigate supply chain challenges. Moving to our endless assortment segment. Daily sales increased 12.7% or 14.9% on a constant currency basis, driven by continued strength in our new customer acquisition at both Zoro and Monitaro as well as growth of larger enterprise customers at Monitaro.

Speaker 3

GP expanded 115 basis points year over year, driven primarily by Zurow U. S. We took a number of pricing actions based on evolving market conditions, and we deemphasized lower margin channels. In addition, we experienced improved freight efficiencies at Zorro, primarily as a result of fewer B2C customers who typically place smaller orders that are more Operating margin for the segment finished up 80 basis points over the prior year Q3, due primarily to improved gross profit margin. I'll go into more detail on the next slide as we provide further transparency on the results for both businesses.

Speaker 3

Moving to Slide 13, in local currency and using Japan's local selling days, which occasionally differ from U. S. Selling days. Monotaro daily sales grew 17.5% compared to the Q3 of 2020. GP margin finished the quarter at 25.8%, 30 basis points below the prior year Q3, as we continue to grow with enterprise customers.

Speaker 3

As a result, operating margin decreased 65 basis points to 12%. Switching to Zoro US, daily sales grew 11.9% as compared to the strongest sales quarter of 2020. Dural GP grew 3.75 basis points to 33.9 percent and achieved 3.25 basis points of In addition to the strong financial performance in this segment, We also continue to execute well on our key initiatives. 1st, when it comes to our registered users, we saw continued growth across both businesses, which is an important driver of top line performance. And on the right, Laurel continues to actively add SKUs to the portfolio.

Speaker 3

At the end of the Q3 of 2021, we had a total of 8,000,000 SKUs available online, Achieving our goal for the year a quarter early, adding nearly 2,000,000 SKUs in the last 9 months. We remain encouraged by our progress with SKU additions. Once again, I would like to provide some color commentary as it relates to the Q4 and the full year. For the Q4, for revenues, we expect total company daily sales to be between 11.5% 12.5%. We anticipate company gross margin will fall between 37.2% 37.4%.

Speaker 3

As discussed before, we expect the U. S. GP rate to exit the year at or above pre pandemic levels. And for SG and A, we expect a similar level of spending in the 4th quarter as we saw in the 3rd quarter, between $810,000,000 $15,000,000 with increased variable compensation, wages and health care expenses. And while it's unclear at this point, We may have some additional risk as it relates to vaccine mandate costs.

Speaker 3

Given the strong performance in the quarter, we remain confident in our guidance range. For the full year, we expect revenue to be at or above the midpoint and all other metrics to be stronger than the low end of the range we discussed at the end of the second quarter, but likely still below the midpoint given the pandemic inventory adjustments taken in the first half. With that, I'd like to turn it back to D. G. For some closing remarks.

Speaker 3

G.

Speaker 2

Moriarty:] Thank you, D. Before I open it up for questions, I have just a few points. First, I'm immensely proud of the Grainger team and their commitment. It's been very challenging, but we continue to demonstrate the strength and resilience of our team and our supply chain. 2nd, it was a very good quarter across the board.

Speaker 2

The results were above our expectations. And finally, despite the current market and supply chain uncertainties, We are confident in our ability to deliver solid performance in the Q4 and into 2022. And with that, we'll open it up for questions.

Operator

Thank you. And at this time, we'll be conducting our question and answer session. Our first question comes from Chris Snyder with UBS. Please state your question.

Speaker 4

Thank you. So my first question is on North America high touch growth relative to Zoro. Is it fair to assume that the company prioritizes High touch volumes over endless assortment during periods of tight supply, just given the better margin and more important customers or at least Stickier customers

Speaker 2

on the high margin side? Thanks for the question. The answer to that question is no. In terms of Inventory position, we've been able to serve both the Hightouch model and Zoro well throughout this period. What I would say is that if you're thinking about Zoro's growth, there's a couple of things that are impacting Zoro's growth right In the quarter and they will get better as we move forward.

Speaker 2

One was last year we opened up in the Q3 the safety products And as a result, customer acquisitions and revenue were extremely high and a lot of the customer acquisitions were consumers as well, As people are just looking and scrambling to find product. The other thing is we've been very clear and focused on Attractive business acquisitions. And as a result, we have shut off some channels for acquisition that weren't as profitable long term. And so that's going away moving forward as well. And so that's been a bit of a drag on Zuora, but it hasn't been because we haven't been shipping product From Zuora, we've been serving customers well across both models.

Speaker 4

Appreciate that. And then second question, just wanted to talk about the midsize Prior to the 2017 price reset, if I remember correctly, the company had lost a lot of that midsized business prior to the reset, but it's coming back really strong, up almost 20% in Q3. Can you just help us Frame this opportunity going forward? Is there any risk around Zoro cannibalization? And then what kind of gross margin tailwinds could this bring to the company?

Speaker 2

Sure. So yes, I mean that was a big part of the reason for resetting prices was we had gone through a long period of decline With midsize customers and here we're really talking about midsize customers that have some sort of mechanical complexities. So think about midsize manufacturers or Companies that really value some of the technical product support, search capabilities of the Grainger model. Obviously, since the price said we've captured a lot of that back. We're still fairly significantly below our high point with midsized customers.

Speaker 2

We feel like we've got a long runway ahead of us. We are getting smarter all the time. We are not seeing much cannibalization with Zoro. Zoro tends to focus on smaller businesses and businesses that are maybe a little more narrow And what their needs are and so they tend to segment to different types of customers more. The Granger midsize Typically has fairly high mechanical complexity or complexity of some type.

Speaker 2

And so we are really pleased with what we're seeing. I would say, I think we went from about $2,000,000,000 to less than $1,000,000,000 in that space over a 10 year period. And now we've We covered some of that. We haven't recovered all of it. We think we can get back above $2,000,000,000 So we think we've got a long runway ahead.

Speaker 3

And D. G, I would just add as it relates To contribution to gross margin, in the quarter, it helped us about 10 basis points. And based upon the difference in the large growth rate versus the medium growth rate, if it's around that Amount, 10% versus 19%, 10% of gross margin basis points improvement It's reasonable.

Operator

Thank you. Our next question comes from Christopher Glynn with Oppenheimer. Please go ahead with your question.

Speaker 5

Yes, thanks. Congratulations on a good quarter. So you kind of affirmed the approximately 20 And outlook for endless assortment for the year, it does imply pretty decent sequential ramp into the 4th quarter. I'm just curious, you mentioned the Japanese economy. I don't know if you're seeing a pivot there right now.

Speaker 5

And you also mentioned the channel emphasis shifts at Zoro. Does that imply they've kind of That they're lapping or something?

Speaker 2

Yes, yes. Both of those things are correct. So in Japan, they got a really slow start The vaccinations and had fairly hard shutdowns over the summer and that has they've rectified that problem. They now have High vaccination rates and we're starting to see more activity with larger manufacturing customers in particular in Japan. So we are seeing some improvement there I'd expect to see that continue.

Speaker 2

With Zoro, yes, we have effectively lapped some of the actions we took to focus more on profitable So both of those things should help us

Operator

moving into the 4th quarter.

Speaker 5

Great. And then The price realization obviously came in better than you expected, as you said. You have a lot of Freight contracts that have been good, at some point those come up. And you also, at times in the past, have had ability to Kind of defer cost increases from suppliers at times. So I'm wondering how those Figure in, given that you've been really locked down really tightly on the gross margin view here and how it transpired, Are we in kind of a sweet spot there as you pivot into 'twenty two with some of those things I mentioned come into play?

Speaker 2

So let me try to answer the question. So we generally try to think about managing cost as well as we possibly can. We are obviously working with our suppliers on a constant basis in this environment to make sure that we are taking cost increases that make sense and pushing back things if they don't make sense. Our suppliers have been great about sort of working with us to find the right path for cost increases. And then on Transportation, sort of the same thing.

Speaker 2

We really are focused on understanding what cost increases are reasonable And working with our suppliers and our partners to get the right outcome. We price to market. I think in general, when you have inflationary periods, Not this type of inflationary period, but normal inflationary periods, we've historically probably been able to take market price increases And not have as much cost increase or have it delayed. And so we will sometimes have a period of advantage. I think right now, Given the pace of cost increases, I think we're pretty well matched and we'll continue to be pretty well matched and that's our expectation Given there's been a lot of off cycle cost increases and we've been able to price those through as So I would say I don't think there's a big gap right now or a big benefit right now.

Speaker 2

It's just it's a fairly wild time obviously in the supply chain and we are I think we're navigating through it

Operator

Our next question comes from Ryan Merkel with William Blair. Please go ahead with your question.

Speaker 6

Thanks. Good morning. DG, you mentioned that you're navigating supply chain costs and freight challenges well. Can you talk about some of the actions that you took?

Speaker 2

Well, I guess, probably can't talk about all the details, but there's Challenges at every stage of the supply chain at this point. And so I think the amount of work that's required to navigate here It's much more than you would find in a typical setting. One of the things we did do is we saw some challenges coming on the horizon. We actually ordered pre ordered a bunch of product Early in the year, try to get inventory in and we have been able to build some inventory throughout the year. Maybe not as much as we'd like, but we have been able to build some inventory that's helped us.

Speaker 2

Our supplier management team and product teams are working very close together to find make sure we've got the right substitute product So we can serve customers if there's a gap in a particular supplier that can't provide us product. We are actively prioritizing product coming off of Asia. We have up wages Distribution centers and gotten staffing right. So we are basically clean consistently now, which is good. That was a little bit of a bit of a challenge back in May.

Speaker 2

So basically if you follow the supply chain view at every single step we are working at every single step of the way. And there's really no other path right now than just to make sure we are executing as well as possible at easing our agility and our scale To try to make sure we can service our customers and we've done that. We've done that well.

Speaker 6

Got it. Makes sense. Okay. And my follow-up is on SG and A leverage. I know in 2021 you had costs returning and then of course higher costs from supply chain issues.

Speaker 6

My question is how should we think about SG and A leverage in 'twenty two, are you able to have productivity offset higher costs or do you expect costs to ramp further off of the 4Q baseline?

Speaker 3

So I can take that, DG. Our Our focus right now is making sure that we can continue to serve customers well. Some The ramp, as you've noted, is due to some of the actions we took last year to really have tight cost Controls around that time period. And so when I think a good measure is probably to look at our 2019 costs And look at some of the SG and A leverage we have been able to gain over that time period since we haven't provided any Real guidance related to 2022 yet, but that's how we're focusing on it. And we are still looking to Continue to gain leverage as we head into 2022, Very similar to what we were doing around 2019 timeframe is the best I'd be able to tell you at this point in time.

Speaker 3

But we are not getting off The fact that we are focused on continuing to gain SG and A leverage over the longer term.

Operator

Thanks. Our next question comes from Deane Dray with RBC Capital Markets. Please state your question.

Speaker 7

Thank you. Good morning, everyone.

Speaker 8

Good morning.

Speaker 7

Hey. Good morning. Hey, good morning. I appreciate you gave price cost for the U. S.

Speaker 7

High touch business. What was price cost Steve, for the total company, if you can be specific or directionally. And then do you have a target for 2021, Just given the circumstances in terms of supply chain pressures, inflation, etcetera?

Speaker 3

Yes, we don't measure EA on a price cost So that's why you don't hear us talk about total company price cost. But the thing I will say is all of the segments And all of the businesses are very focused on, 1, maintaining price competitiveness and 2, in this inflationary period, Being able to pass on costs to customers. So that is a consistent tenet for us. So that is what I can say.

Speaker 2

The other thing I would say, Dean, to your question, I mean clearly Zoro had very high price cost leverage given the GP improvement. Like we said, some of that's just segment specific, which customers they're acquiring and how they're thinking about acquiring it. But we do expect The MS assortment to continue to have strong profitability and profitability improvement within Zoro's.

Speaker 7

Appreciate that. And then as a follow-up, just related to price, the 3 percentage points in price and high touch this quarter, Just what's the expectation for 4Q? Does that carry are there other price actions that you've taken? And do you was that will that all carry into 2022? Is there any sense there'll be some pushback, Tivity issues in terms of pricing.

Speaker 7

So do we carry that into 2022 or not?

Speaker 3

So We did take some pricing actions in September, and we saw some good results There and also through the month of October thus far. So we expect that momentum to carry us through to Q4. And like always, D. G. Mentioned, our supply management team is continuing to work with our supply base on what Increases look like for 2022, and we expect to continue we do get more costs

Operator

Thank you. Our next question comes from David Manthey with Baird. Please state your question.

Speaker 9

Thank you. Good morning. So as a percentage of sales, gross margin and OpEx, I think we'll be very different in 2022 versus what they were in 2019. And the reason I mentioned that, Dee, you made a comment about Leverage in 2022 being similar to 2019, were you referring to contribution margins there or if you could just Help clarify that statement.

Speaker 3

Sure, sure, David. So, I was trying to get some context since we are not Talking about 2022 at this point, just to help you understand that we're focused on gaining leverage. And back in 2019, we had set out a path to say that we were looking to continue to focus Growing expenses less than sales. So that's the tenet that I was trying to Since we are not giving guidance on 2022 at this point.

Speaker 9

Okay, understood. And then, as it relates to your pricing mechanisms, I think you talked before about the open pricing on the websites, you can Sort of adjust immediately,

Speaker 2

but could you talk

Speaker 9

about contract pricing? And what I'm wondering is Where are you being most effective in recapturing inflation these days? Is it just the most spot prices or is it Surcharges or renegotiating contracts, how are you being so effective at this point?

Speaker 3

So we are capturing price inflation in all areas, I would say, with Customers that primarily buy on web price and with contract customers. Earlier in the year, we talked about the fact that it would be little lumpy because of the timing, as it relates to when we could pass on price with customers. But similar to Some of the actions that DG articulated, that we are executing as it relates to supply chain, That also goes for the commercial teams as they are working with customers to Pass on price. So we're close to the end of the year now. And a lot of those discussions that both our sales team and then online, We've been able to pass on these costs pretty effectively.

Speaker 3

So that applies to contract customers as well as web based customers.

Operator

Thank you. Our next question comes from Adam Uhlman with Cleveland Research. Please state your question.

Speaker 10

Hey, guys. Good morning. I guess I was wondering if you could share with us what you're seeing with your KeepStock business. How sales been unfolding there? And it would seem like you should be having better access in the customer sites.

Speaker 10

I'm wondering if you could Share any insights about new customer wins or any new initiatives recently or maybe what you have planned for next year?

Speaker 2

Sure. So we continue to view KeepStock as really a critical portion of our business. It's been a portion of our business has Obviously busy throughout the pandemic. We've had access to all of our customer inventory, well not all, but the vast majority of our customer inventory locations and have continued to serve We have put in a number of improvements to help us be more effective And planning customers inventory and fulfilling customers inventory to keep stock. We continue to get significant growth out of keep stock.

Speaker 2

Certainly, as heavy manufacturing has come back this year, it's been very, very good for our keep stock business and that because that's a pretty heavy keep stock area. I won't talk too much about sort of what we're investing in other than to say we are investing significantly in Improved software capabilities to enable us to provide better service to customers and better analytical insights to customers and that's going to be a continuous focus for us around the KeepStock

Speaker 10

Okay, got you. Thanks. That's helpful. And then, Dee, I think you had mentioned Vaccine mandate costs and I believe that there's some element of with the GSA contract, there might be a requirement for Vaccination, could you just help me understand what all that might mean for Grainger and the Potential costs for the business?

Speaker 2

Do you want to I'll take this one. This is a kind of a challenging one in many ways, we are certainly a federal contractor. We will comply with the GSA order. We have plans in place to comply with that. I would say that the OSHA Ruling and how that comes down is probably more of a question mark in terms of vaccine mandate cost.

Speaker 2

We are ready to do what we need to do and prepared to do whatever needs to happen. We are hopeful that The vaccine mandate is done in a way that doesn't hurt the supply chain. I've been in our transportation depots and Our facilities and our customers' facilities and a vaccine mandate that's not well thought through could cause significant problems to an already challenged supply chain. And so we are we don't know where all that's going to land, just to be clear, but we are prepared and we've done some things to There for any eventuality there and trying to understand what the best path forward is going to be depending on how well that shakes out.

Operator

Thank you. Our next question comes from Jacob Levenson with Melius Research. Please state your question.

Speaker 8

Good morning, everybody.

Speaker 3

Good morning.

Speaker 8

I just wanted to I mean, you guys have a pretty Clean balance sheet at this point. And D. J, I know when you took the helm a couple of years ago, you flexed up a little bit and did some more aggressive buybacks. Maybe you can just help us think through how you're looking at the balance sheet today and maybe secondarily to that whether M and A could play a role over the next couple of years?

Speaker 3

This is Dee. I'll start off. We like our credit rating, of course, And we don't see any big changes related to our capital allocation strategy. We did provide guidance that from a share buyback, we thought we would be somewhere between the $600,000,000 to $700,000,000 range for the year. And we think we're going to be at the high end for this year.

Speaker 3

And so no real, I would say, changes to our The fees that we've had in the past, that's working well for us.

Speaker 8

Okay, that's helpful. And then maybe this is a bit of a nitpick, but Cromwell is something that we don't it doesn't get a lot of airtime these days. So maybe you can help us understand How that business is doing and how the turnaround has been going, any update there?

Speaker 2

So maybe I'll Did

Speaker 3

you want to start?

Speaker 2

I'll just give prospects. So Cromwell is a relatively it's obviously not a huge business for us, but it's an important one in terms of understanding whether we can get the growth we need to get in the UK. I'd say the UK market has been challenged. Team has done a nice job of improving service and Serving customers through this time, they have over the last 2 years, they will consistently lower the loss. And we feel like it's a Business that has a potential to be a strong contributor from a profit perspective over time, but we still have some work to do, but I would say that they've reset their cost structure, they're providing great service Customers and they have lowered their losses over the last 2 years and we would expect them to show Profitability coming out of 2022.

Speaker 3

D. G, the only thing I'd add there is that in the quarter, Cromwell was able to cut their losses year over year, and we expect them to come close to cutting them in half, which is What the focus has been

Speaker 2

year over year.

Operator

Our next question comes from Hamzah Mazadi with Jefferies.

Speaker 11

Good morning. Thank you. My question was just around Zoro US. Maybe just talk about the competitive dynamic in that market. I know it's smaller customers online only, etcetera.

Speaker 11

But just maybe talk about who you're competing with there and then I guess you have 8,000,000 SKUs, where could that SKU count go eventually?

Speaker 2

Well, so on the second half of that question, we have 8,000,000 SKUs today. We would expect to get to 10,000,000 in the next couple of years at a minimum. And whether or not it goes to 15 or more is probably still open for debate, but we know we A long ways to go to get the SKU count right. In terms of the competitive market, it's really very, very broad online. So it's Big Internet players, it's certain marketplaces, customers sometimes buy through smaller local retailers As well.

Speaker 2

And so there's a very broad competitive set when you look at small businesses and how they buy, sometimes they buy through hardware stores. And it's pretty fragmented And there's a lot of different options for small businesses to buy MRO products. And so we that market in particular is super fragmented. And so we feel like we're growing and gaining share from a number of different sources. But it's not like there's sort of 1 or 2 players that are sort of dominating that Space, it is very, very broad in terms of the competitive set.

Speaker 11

Got it. And my follow-up question, I'll turn it over. Just On achieving pre pandemic gross margins in the U. S. Business exiting this year, I know you talked about price realization, you talked about inventory Smurnt, etcetera.

Speaker 11

But maybe just talk about the confidence level there and what could go wrong for you not to I know we're already in the Q4, so there's 2 months left or whatever. So any thoughts there would be helpful. Thank you.

Speaker 5

Go ahead, Deepa.

Speaker 3

Yes. So what I would say is, we're pretty confident, and that's why we continue to focus On showing you where we've come from and where we're going in the deck and to continue to talk about it, The 2 biggest factors that really give us confidence is the product mix, where we are versus last year, we were at In the U. S, we're at 28% on pandemic, and now we're at 22% and trending as we would expect. And then price, which we've talked quite a bit about here today. And so I noted earlier that we Implemented some price increases in September and the realization in September October is looking good.

Speaker 3

We expect that to continue through the 4th quarter, And we expect it to cover costs that we have visibility to. And as it relates So anything else related to supply chain challenges, Didi talked a lot about that. We are very focused on it, and we believe Our scale puts us in a unique position to deal with some of those challenges today. We have good availability And we're managing the cost process well. So I think we're pretty confident.

Operator

Thank you. Our next question comes from Chris Dankert with Loop Capital. Please go ahead with your question.

Speaker 12

Hey, good morning.

Speaker 13

Thanks for taking my question. I guess thinking about the analyst assortment business here, again 20% growth kind of over the medium term, Aggressive, very impressive growth. But I guess strategically, what's the biggest bottleneck to growth in that business? I mean, given the scalability of digital, I mean, is it simply customer awareness and engagement, I mean, which obviously takes time, but why couldn't that be 30% or something even higher at this point?

Speaker 2

Yes. I think if you look at the long history of Monotro, you start to understand Kind of the limits obviously that business has gone from nothing to over US2 $1,000,000,000 and Has a very long history of growing very, very quickly. But 20% has been a number that they've been at for a long time. Most of that has to be is really about making sure that you have the processes, systems in place To acquire attractive small business customers or business customers and then you have to work very hard to get them to repeat and to become regular purchasing customers. And that is not something that throwing a whole bunch of money at necessarily helps.

Speaker 2

You've got to be very targeted in how you're acquiring customers and you have to be targeted about how you're working and identifying what segment they're in and what matters to them, So you can actually get the growth that you want to get. So it isn't an easy thing. It is a scalable business for sure. But our experience has been that the team's ability to build the capabilities, learn and have high quality growth Limits you at about 20% in many cases and that we've seen that through Monotra.

Speaker 13

Got it. No, that's very, very helpful. Thank you. And I guess, again, fairly sizable investment in that business this year. As we go forward, just how do we think about SG and A growth in that business?

Speaker 13

I mean, at this Point, is it principally advertising and analytics spend? Or is there do we need any additional kind of physical assets there? Just how we think about SG and A growth in analyst assortment?

Speaker 2

Yes, I would say I would have different answers to Menuchro and Zoro. Zoro, it's mostly around Marketing data analytics systems, they've built much of their own system infrastructure. Now they continue to invest in systems. So the investments aren't Huge physical assets. In Menotra, you have that plus you have given their growth and their size, they're going to be investing in the next 3 to 4 years, 5 years in pretty significant distribution center efforts as well.

Speaker 2

And so While we don't talk about that much, they have been exceptional actually at building physical assets to serve their customers and they have More of those investments that they will make over the next 3 or 4 years.

Operator

Thank you. Our next question comes from Josh Pokrzywinski with Morgan Stanley.

Speaker 14

Just first question on, I guess, kind of the Competitive benefit of just having a better supply chain and some of your smaller competitors. How do you go about ensuring that This year you've picked up on that converts at some reasonable level to something permanent. Like, is there something you can point to in the past, maybe even the pandemic related stuff in Like converting those marginal customers or spot buy customers into something more structural, like how is what's your approach been like on that?

Speaker 2

Yes, it's a great question. I think the reality is that when you out serve customers, that becomes pretty Growth always has been in our business. And so when you're able to have better service than the market in general, typically you see a Fairly long time horizon when you can continue to grow. Right now, I'd say our customers are having all kinds of conversations with us about Sort of sustainability of supply chain and how we can leverage our capabilities to help them grow into the future. So it certainly doesn't feel like this is a 1 and done advantage.

Speaker 2

It feels like people are trying to figure out how to make sure that they can function really effectively going We're having all kinds of conversations about how to help customers lower their processing costs, improve their inventory management, the core things that we We work on with customers we are really engaged with right now. So, I would just say that we feel like Certainly there'll be some of this. We talked about that last year having pandemic products, some of that growth, some of our very outsized share growth last year Was not going to repeat, but the 475 basis point to your share growth feels like That's repeating. And it feels like it's sustainable in terms of the volume that we've captured is sustainable.

Speaker 14

Got it. That's helpful. And then I appreciate the color on kind of the inventory repricing and kind of both one for 1 or kind of matching that in real know a lot of temporary benefit, but maybe just looking at the other side of the equation with some bigger customers on contract, How are you sort of keeping up with the price cost equation there? Is it getting a little bit more kind of exotic with things like surcharges? And then what are you anchoring that sort of stuff to because inflation feels a little bit more unusual than just like, Hey, steel is higher.

Speaker 14

I mean, everything is higher and not every product category has like the same pain points. So how are you managing with that Customers that are maybe on a bit more long term contractor tend to be a little bit more inflexible on price.

Operator

Steve, do you want to

Speaker 12

take that or let me

Speaker 3

take that? Yes. I was about to jump in, sorry. Not seeing a big difference between customers. I would say at this point, I think especially during this time, our product availability is really What is at the forefront of some of our relationships, whether you're midsized local large local or large Contracts.

Speaker 3

In addition to the things that D. G. Just kind of noted related to The way we serve customers in a multi channel way right now, I think, is also boding very well for us In addition to how easy it is for them to find the products on our website, which time is money for a lot of these customers Right now, they are dealing with a lot of challenges like we are experiencing. And I think that availability It's what's really, really, really making the big, big difference even for large contract customers. There is some and flexibility in some pricing, but we do have more Right now, then I would say we've had of late.

Operator

Thank you. Our next question comes from Nigel Coe with Wolfe Research. Please state your question.

Speaker 15

Thanks. Good morning, everyone. I Wanted to ask a sort of a short term question and then a sort of a more strategic question. But last quarter, you were Pointing towards the lower end of the range, lower end of the margin range anyway. Now you're pointing towards the low to midpoint.

Speaker 15

So I'm just curious, I think I know the answer, but I'd be curious, D. G, what's changed from your perspective from July to now? And I'm specifically interested in whether pricing has been stronger, whether the retention on pricing has been stronger, has that surprised you the upside?

Speaker 3

So yes, you just said it there at the end. Q3 was better than what we expected. We had improved mix and improved price. And that favorability is flowing through the full year EPS for us. And revenue, But that volume coming through at that price was better than what we expected.

Speaker 3

And so just to reiterate The total company expectations, we've flowed that through to talk to you about Where we expect to be on a full year basis, revenue being stronger. And so then we said that we're going to be at the midpoint of the range there. And then for everything else, I reiterated that at least with these results that we would be Low end up to the midpoint. So we've tried to pull in the improvement that we saw in Q3.

Speaker 15

And the pricing for that equation, has that been surprisingly good?

Speaker 3

Yes, price realization is better than we would have Expected at this point.

Speaker 15

Okay, that's great. And then the medium sized customer growth regain, market share regain strategy, The inside sales, obviously, a very important part of that strategy alongside the repricing initiatives. So just curious, maybe just give us an update, D. G, on sort of what's happening with the inside sales force and some of the metrics around that and whether you're still investing in that capability? Sure.

Speaker 2

I would say that inside sales has had a really nice bounce back this year. They covered customers last year, obviously, that some of which had been struggling. But we've seen a really nice revenue path with inside sales. One thing I would point out is that during the pandemic, we have been fairly locked In our coverage, and the reason is we wanted the relationships to be stable as customers went through the pandemic. And so We haven't invested a lot more or and we haven't invested any less in inside sales.

Speaker 2

We consider it to be an important part of our future. And we've liked the results we've had, but given the pandemic, we haven't really changed coverage really anywhere During the pandemic, we're talking about sort of adding some coverage potentially in the future, but we'll talk about that as we head into the future. But so far, it's been a very stable And nice growth path for us this year, the inside sales team.

Operator

Thank you. Our next question comes from Patrick Baumann with JPMorgan. Please state your question.

Speaker 12

Hi, good morning. Thanks for taking my question. First one is on the Zoro gross margins. I thought that the view here was that Zoro was going to face some mix headwinds over time from a more third party product and I can see the SKUs have gone up a lot in that area. Is that still the case?

Speaker 12

Or is this like shift in customer channel enough to offset that That gross margins there can actually improve?

Speaker 2

Well, yes, I mean, I think what you saw is that the shifts we've made in terms of how we're acquiring customers And focusing on acquiring really strong business customers has helped gross margin more than the 3rd party shipping has heard it. 3rd party shipping will be a small drag, we think over the next several years as it becomes a bigger portion of the mix. But we still think we've got ways to continue to improve gross margin. We've seen that this year and then hold gross margin closer to steady moving

Speaker 12

How big is third party shipping now as a percentage of mix or whatever?

Operator

What's that?

Speaker 12

As a percentage of sales, I guess, or wherever you want to talk about it?

Speaker 2

It's a growing portion of sales. I don't think we've typically talked about that number. We'll probably talk about that at the The year we talk about sort of the path moving forward.

Speaker 12

And then a quick one on receivables. Can you just talk about the comment in the release about like the $268,000,000 of growth being driven by growth in credit sales. Is that a change in how things are normally done? I just I'm asking because I don't recall seeing that kind of language from you before. Maybe I missed it.

Speaker 3

Yes. It's not a change. It's just in relation to the fact that our sales are up and as a result of that, that's driving accounts

Operator

Thank you. Our next question comes from Michael McGinn with Wells Fargo. Please state your question.

Speaker 2

Hey, just a quick one for me. Do

Speaker 9

the majority of your contracts reprice at

Speaker 2

a certain time, like calendar year end or are they kind of Staggered throughout the year and what kind of percentage of your contracts have yet to reset at the new pricing? So contracts can be of different durations. They can be 1, 2, 3, 4, 5 years. I'd say 3 years is kind of a more common version. But in general, when we set contracts, we set specific times, multiple times a year when we can Alter price either up or down based on market conditions.

Speaker 2

So most of our contracts have the ability to reset price multiple times during the year, 3 times a year Is the most common number of times you can reach that price.

Operator

Thanks. Thank you. And there are no further questions at this time. I'll turn the call back to D. G.

Operator

Macpherson for closing remarks.

Speaker 2

Great. Well, thanks everybody for joining us. We really appreciate it. Hopefully, you can tell we feel good about the quarter, but more importantly, I think we feel good about How we're growing, how we're gaining share, our ability to navigate the supply chain issues and still continue to invest in core initiatives that we think are going to be important to our long term success. So we feel really good about the path forward as well.

Speaker 2

Wish all of you A safe Halloween and look forward to talking to you soon. Thanks so much.

Operator

Thank you. This concludes today's conference. All parties may disconnect. Have a good day.

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Earnings Conference Call
W.W. Grainger Q3 2021
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