Kyle Bland:

Good morning. Welcome to Grainger's second quarter earnings call. With me are D.G. Macpherson, Chairman and CEO; and Dee Merriwether, Senior Vice President and CFO. As a reminder, some of our comments today may include forward-looking statements that are subject to various risks and uncertainties. Additional information regarding factors that could cause actual results to differ materially is included in the company's most recent Form 8-K and other periodic reports filed with the SEC. This morning's call will focus on the adjusted results for the second quarter of 2024, which exclude $16 million of pre-tax restructuring costs incurred in the quarter. Please remember that we have also included a daily organic constant currency sales growth metric within these materials to normalize for the divestiture of our E&R Industrial sales subsidiary, which was sold at the end of 2023. Definitions and full reconciliations of this and any other non-GAAP financial measures with their corresponding GAAP measures are found in the tables at the end of this presentation and in our earnings release, both of which are available on our IR website. We will also share results related to MonotaRO. Please remember that MonotaRO was a public company and followed Japanese GAAP, which differs from US GAAP, and as reported in our results one month in arrears. As a result, the numbers disclosed will differ from MonataRO's public statements. Now I'll turn it over to D.G.

Deidra Merriwether:

Thank you, D.G. Turning to Slide 7. You can see the high-level second quarter results for the total company, including 5.1% growth on a daily organic constant currency basis. The quarter played out largely as anticipated, despite the persistent demand softness D.G. mentioned. Operating margins were down 40 basis points year-over-year, generally following normal seasonal trends. Gross margins were flat year-over-year as the number of items offset within the period and SG&A de-levered 40 basis points as we ramp our demand generation investment. In total, we delivered diluted EPS for the quarter of $9.76, up 5.2% or $0.48 over the prior year period. Moving on to segment level results, the High-Touch Solutions segment continues to perform well with sales up 3.1% on a reported basis or 3.7% daily organic constant currency basis. Results were driven by strong volume growth and moderate price contribution across all geographies in the period. In the U.S. specifically, nearly all customer end markets were up year-over-year with warehousing, contractors and healthcare customers having the largest gains. For the segment, gross profit margin finished the quarter at 41.7%, flat versus the prior year. In the quarter, we expanded an unfavorable lap of roughly 40 basis points from the nonrecurring rebate benefit captured in Q2 of 2023, which was offset by several small tailwinds in the current year period. When excluding the unfavorable lap of nonrecurring rebate, price cost was roughly neutral in the quarter. SG&A de-levered 40 basis points in Q2 as DC capacity came online, and we continue to invest in demand-generating activities like marketing and seller head count. Annual merit increases that went live in April were offset by productivity actions and lower variable compensation expense within the period. Overall, it was a solid quarter of growth and profitability for the High-Touch Solutions business. Looking at market outgrowth on Slide 9, we estimate that the U.S. MRO market, including volume and price grew in quarter between 2.5% and 3%, with price contributing nearly all of the growth. Within our High-Touch Solutions U.S. business, growing at 3.6% organically, our mathematical market outgrowth in the quarter was roughly 100 basis points in total. This includes approximately 300 basis points of volume outgrowth contribution, netted against the continued price tailwinds when comparing our price contribution to PPI. As we said before, there is no perfect way to measure the MRO market, and we're currently in a cycle where the headline PPI and IP metrics don't completely reflect what we're seeing in the MRO specific space. With the differences in product and customer mix, these disconnects happen from time to time and cause short-term noise within our external market share gain calculation. Given the current dislocation we're seeing this year, it's unlikely we will mathematically achieve our market outlook target in 2024. However, we have several different ways, including both internal and external data points to understand our relative performance and know we're performing quite well in the current environment. History would suggest that this dislocation will normalize over a multiyear period and we believe this metric remains useful in tracking our relative performance over time. We're still generating strong returns on our demand-generating investments, which gives us confidence that over the long-term, we will continue to outload the market by 400 basis points to 500 basis points annually on average. Now turning to the Endless Assortment segment. Sales increased 3.3% or 11.7% on a daily constant currency basis, which adjusts for the impact of the depreciated Japanese yen. Zoro US was up 8.7%, with MonotaRO achieving 13.2% in local days local currency. At a business level, Zoro saw improved growth from core B2B customers who were up mid-teens in the quarter. Performance was driven by B2B customer acquisition and improved repeat purchase rates, which were aided by service enhancements to increase same-day shipping and better communicate delivery date. Headlines from the continued unwind of non-core business, including B2C, B2C like volumes started to dissipate in the quarter but remained down low-double-digits year-over-year. We expect these B2C headwinds to continue to subside as the year progresses. At MonotaRO, sales were strong from continued growth with enterprise customers, coupled with solid acquisition and repeat purchase rates with small and midsized businesses. On a reported basis, these results were all offset by continued foreign exchange rate pressures as the yen continues to show incremental weakness against the dollar. On profitability, operating margins for the segment declined 70 basis points to 7.9%. This decline was driven by lower gross margins at MonotaRO from product and customer headwinds, combined with SG&A deleverage at Zoro as the business ramps marketing investments and re-baselines on lower B2C and B2C like volume. As these volumes normalize, this should create a better baseline to relever the business going forward. Overall, for Endless Assortment, we're encouraged by the strong progress in the quarter, and are track to finish the year at or above our original expectations. Now moving to the updated outlook for the remainder of 2024. As D.G. mentioned at the beginning of the call, we are we are trimming the top end of most estimates to reflect continued market softness as macroeconomic uncertainties persist in the US. With this, now expecting total company daily organic constant currency sales to grow between 4% and 6% for the full year of 2024. When including the continued deterioration of the Japanese yen, this translates to an updated reported sales range between $17 billion and $17.3 billion and an EPS range between $38 and $39.50. As you can see on this slide, we flow these changes through and have also made slight tweaks to the margin outlook based upon how we're performing in the first half. I want to note, while we continue to remain diligent on managing expenses and measuring returns, given the softer top-line, our ability to generate leverage is challenged this year as we invest in our growth engines to power long-term share gain. Setting that aside, we remain strongly committed to growing SG&A slower than sales over time and have a track record of doing so. Supplemental guidance ranges, including increased operating cash flow and share repurchase expectations can be found in the appendix of this presentation. On seasonality, as we move to the second half of the year, we expect relatively normal sequential growth from Q2 to Q3 and into the fourth quarter. There are some puts and takes from a profitability perspective, but we anticipate operating margins and earnings to remain healthy and relatively consistent in the third quarter when compared to the second. As we start the third quarter, a number of external factors have impacted our results in July. The sales started to ramp in the final few days of the month. This led preliminary July sales results to finish up roughly 2% on the total company daily organic constant currency basis. Of note, this number will be approximately 100 basis points higher if you normalize for the tough comp caused by an elevated level of project-related service engagement in July of last year. Altogether, at the total company level, we're performing well and are confident in our ability to drive solid growth and strong profitability in the second half of the year. With that, I'll pass it back to D.G.

Operator:

Thank you. [Operator Instructions] Our first question is from Tommy Moll with Stephens Inc. Please proceed.

Donald Macpherson:

Good morning.

Donald Macpherson:

Yes. Thanks, Tommy. I think most -- almost all of the growth in midsize customer and the outgrowth would be share gain. The reality is that -- and I think most people know the story. We, at one point, we're close to $2 billion in revenue. We got down to $800 million. We're back up to where we were. We think there's a long runway ahead. We believe that the digital capabilities we've built and the customer and product information assets we built help us with midsized customers significantly. And so really, we think it's what we're doing to build relationships with them through digital capabilities, a lot of those customers when you look at how they buy, start digital and that's their main channel.

Donald Macpherson:

Yeah. Yeah. We do believe we'll land in price cost neutrality by the end of the year, the price realization the realization of the pricing actions on May 1st have been basically as expected. We talked about at the beginning of the year we were a little bit behind on price increases. We are making some of that up as the year progresses. And notably, gross profit remains strong. So we are not concerned about ending the year as we expect.

Dave Manthey:

Yeah. Thank you. Good morning everyone. You may have mentioned this, but June average daily sales running up $7 million after sort of $4 million to $5 million all years? Is there anything we can read into that? And again, I apologize if you mentioned it, but did you make any comments on the trends in July so far?

Dave Manthey:

Okay. Thank you.

Dave Manthey:

Yeah, makes sense. Thank you for that. And then, I know other international is small, but we're talking $300 million drag on overall profitability, maybe a distraction, I don't know, could you update us on the other international operations and what you're targeting there medium-term?

Operator:

Our next question is from Ryan Merkel with William Blair. Please proceed.

Donald Macpherson:

So I guess what I'd say is we follow two tenants. We want to make sure that we are priced competitively, and we want to make sure that over time, we're shooting for price/cost neutrality. I think we will do that this year. Our price increases this year will be modest overall. Our cost increases will be modest overall on product cost. But we are making adjustments both at May 1 and September 1, and those adjustments aren't meaningful in aggregate, we would expect to be in that 1% range that we talked about roughly at the beginning of the year, 1% to 2%.

Ryan Merkel:

Okay, got it. That's helpful. And then just back to the macro, D.G., any factors you would point out that caused you to lower the second half or maybe just rank the things that drove that? And generally, what are you hearing from customers about the outlook?

Operator:

Our next question is from Jacob Levinson with Melius Research. Please proceed.

Donald Macpherson:

Good morning, Jake.

Donald Macpherson:

So the way we measure marketing, we look at -- we run tests all the time. And that guides us on how much to spend. So you could argue that in certain macro environment, those tests might show different results. But in general, that's not going to change how we think about spending. We're spending to levels that give us a margin return that we expect. And none of that's changed and I wouldn't expect that to change through time.

Donald Macpherson:

Yeah. We're -- the network is pretty busy, I'd say. We probably -- I think we talked about this in 2022. We were probably a bit behind. It was difficult to actually build anything during the pandemic to get materials and finished things. We have remedied some of that situation, we've put in three new bulk warehouses, the building in the Northwest, the shell the building is up and we will start receiving by end of this year, and start shipping next year. We have a building in Houston. That is just land now, but that's going to go up as well. So we've talked about those two and announced those two buildings. I would say that the biggest bulge in capital right now, we would project would be probably next year as we finish those two buildings out and then we expect to be in probably more normal times after that and being a little bit better shape from capacity perspective. But yeah the plan has just been executed exactly, as we expected and timing that we haven't changed on any of that.

Jeff Reive:

This is Jeff Reive on for Deane. My first question is on the Endless Assortment segment, pretty nice organic growth this quarter. I know one of your peers had some eCommerce stumbles recently. Curious if, you're winning share there or if that may be created an opportunity to do so?

Jeff Reive:

Got it. And then, just on guidance, the kind of turning the high end. I think you called out kind of the weaker macro and yen devaluation. If you had to kind of peg it percentage to each of those buckets, kind of how should we think about it?

Jeff Reive:

Yes. Yes. So you trimmed guidance and basically called out, it's a combination of a weaker macro and then also the yen devaluation. I was curious if you could just kind of point to kind of give a percentage to each one into the kind of the reason behind the trimming of the guidance.

Jeff Reive:

Is it more macro, is it more yen? Yeah.

Operator:

Our next question is from Christopher Glynn with Oppenheimer. Please proceed.

Donald Macpherson:

Yeah. I mean, so for contractors, in particular, I'd also make a point that we're pretty small. So we start with a pretty small base. So I'm not sure that you can compare that to what's going on in the broader market. Warehousing, there's some comparisons to last year with some customers that are positive right now that's driving that. I wouldn't read too much into those just to be fair. I think that we're performing fairly consistently across the segments and then you have sort of in-year impacts that are a little unusual into the [indiscernible].

Donald Macpherson:

Yeah. What I would say is that, probably low point, it was probably fourth quarter was last end of last year. We think from now on, we're going to get better consistently, and we'll be able to get SG&A leverage as we move forward given the growth rates we're seeing. So, it will start to get better through the back half of this year and we think into next year as well. And so we're pretty confident that we'll start the rise. It's not going to be fast. It's going to be very consistent in terms of getting improved margins into the business.

Patrick Baumann:

Good morning. Quick one maybe for Dee. Can you talk about the external factors that you mentioned impacting the July growth rate. And you mentioned a ramp back toward the end of the month and something about sequential growth from second quarter to the third quarter, but my line cut out. So just wondering if you could rehash what you were saying on that.

Patrick Baumann:

Okay. And then I may have missed, but did you talk about the restructuring you did in the quarter? Was it just kind of what was it? And what is the expected benefit from it? Is there more to come in terms of the restructuring? Or was it kind of isolated just to the second quarter?

Operator:

We have reached the end of our question-and-answer session. I would like to turn the conference back over to D.G. for closing remarks.

Operator:

Thank you. This will conclude today's conference. You may disconnect your lines at this time and thank you for your participation.

Donald Macpherson:

Thanks, Kyle. Good morning and thanks for joining the call. 2024 started well. As we remain grounded in the Grainger Edge, we are focused on starting with the customer and staying focused on what matters most. I've seen this play out in several ways throughout the quarter.

Deidra Merriwether:

Thanks, D.G. On Slide 7, you can see the high-level results for the total company, including 4.9% growth on the daily organic constant currency basis.

Donald Macpherson:

Thanks, Dee. Grainger's ongoing success is made possible by our people. And I'm fortunate that I'm routinely able to spend time with our frontline team members. And it's clear that they are deeply connected to our customers, working side by side to help solve their most challenging problems. I believe this commitment to our customers is because of the emphasis we put on building a culture where every team member knows that they can make a difference.

Quinn Fredrickson:

This is Quinn Fredrickson on for Dave. First, can you update us on -- you made some comments about taking some pricing actions. I think before you were saying 0% to 1% price in High-Touch this year. Can you update us on that? And then just any gross margin implications from here?

Quinn Fredrickson:

That's helpful, D.G. Maybe on the Endless Assortment segment. Any color you can share just on that, the B2C portion? I guess, are you seeing that kind of progressed as you would expect and still anticipating that inflecting positively in the back half of the year? And then, obviously, you reported that 10% segment growth even in spite of that. So any change to the 7% to 10% constant currency growth assumption for the year?

Operator:

Our next question is from Nigel Coe with Wolfe Research.

Deidra Merriwether:

So yes, I'll start with the first part of your question. So the majority of MonotaRO's COGS are in the end. They do have some U.S.-denominated, but it's a much smaller portion of their COGS. And they've done a really nice job over the last several years of being able to pass on inflation through price to account for the disaggregation between the yen and the dollar.

Nigel Coe:

Right. Okay. That's helpful. And then just to tie boon in the second quarter kind of color, I guess. It seems like sales growth might be a little bit better year-over-year. Perhaps, margins a bit more contraction year-over-year than 1Q. How does price/cost look in 2Q versus 1Q in light of the pricing actions? And maybe just talk about how that price/cost develops from 1Q to 2Q. I know there's a lot there, but any more color on 2Q would be helpful.

Nigel Coe:

D.G., I wanted to start on the core B2B Zoro customers where I think you said from a customer perspective, you're up high singles this quarter. What can you tell us about some of the initiatives internally? We've redoubled efforts to continue to drive that stickiness and repeat transaction rate among that cohort. And how are those initiatives progressing?

Deidra Merriwether:

So I would say it was a couple of things. So one, D.G. talked a little bit about like misjudging the path of inflation here. We started to lower some prices at the end of last year. And so probably did that a little too quickly. And then when we started and assessed the 2024 increases in Q1, probably a little softer there.

Operator:

Our next question is from Jacob Levinson with Melius Research.

Donald Macpherson:

I would say that it's all planned. There hasn't been any change in the path. And we invest in many ways, I'd say. But from a cash perspective, supply chain investments, we've talked about the new building in the Northwest and Houston. Those are in full swing. We also invest in technology. That's the other primary investment we make from a cash perspective. And then from an expense perspective, marketing is a big part of it.

Jacob Levinson:

Okay. That makes sense. Just on a different topic. And you folks have been a pretty consistent repurchaser of your own stock for a very long period of time. But the shares have obviously had a phenomenal run in the last couple of years -- does that. And you've got a potentially underlevered balance sheet. Has that changed the capital at all and how you're thinking about sort of the external capital allocation priorities here?

Operator:

Our next question is from Christopher Glynn with Oppenheimer.

Donald Macpherson:

Yes. So what I would say is that they're both relatively small for us. And so in utilities in particular, there's a single customer that has had some challenges, and that has had a big impact there. So it isn't really a sector. We don't play big enough in utilities to really be a sector barometer. So I would say it's sort of noise there.

Donald Macpherson:

Yes. I mean a lot of the things that we're doing around the business, certainly, we have a supply chain that's built very effectively for both large and midsized customers. We have a lot of our resources attached to large customers, all of our sales force, our inventory management teams and some of our support teams. And that is the lion's share of our revenue.

Deane Dray:

I joined a little bit late, so I apologize if you had gotten any of the specifics. But I know you called out the timing of the holiday. Just for Easter holiday, can you size that? And was there any impact on January weather that you could detect?

Donald Macpherson:

No, I don't think there's any change in outgrowth expectations. We talked earlier, if you weren't on, about the fact that price in our market has been a little lower than PPI. Sometimes the broad metrics may not track exactly to our market, but that evens out over time. But our volume growth has been very strong through the quarter, and we're taking action to improve the pricing environment starting May 1. So I think really there's -- we don't think there's really any change dynamic.

Christopher Dankert:

Apologies if I missed it, but on the step-up in SG&A in the first quarter here, was there anything onetime there? Maybe just if you could walk through some of the moving parts for the kind of drove that step-up.

Donald Macpherson:

Yes. I mean -- so we've been on a several year journey to improve our customer information. What I would say is customer information in our market is really messy. So there isn't clean data sources that tell you who customers are and what they do and how many team members they have and that type of thing. So we've been building our own.

Operator:

Our next question is from Patrick Baumann with JPMorgan.

Deidra Merriwether:

Well, you would expect it to flow into April to the extent that we could pick that up, yes. And the answer is yes to your first question because I think you noted it excludes FX.

Deidra Merriwether:

Organic.

Donald Macpherson:

Yes. Thanks. What I would say is that we are very focused on productivity improvements throughout the business. I think we are seeing productivity improve. The last few years have been a bit odd, to say the least, in terms of some of the challenges that everybody has had to deal with. And we have really sort of refocused our attention on getting better, getting more productive in every part of the operation. We're going to continue to do that.

Operator:

We have reached the end of our question-and-answer session. I would like to turn the conference back over to D.G. for closing remarks.

Kyle Bland:

Good morning. Welcome to Grainger's Fourth Quarter and Full Year 2023 Earnings Call. With me are D. G. Macpherson, Chairman and CEO; and D. Merriwether, Senior Vice President and CFO. As a reminder, some of our comments today may include forward-looking statements that are subject to various risks and uncertainties. Additional information regarding factors that could cause actual results to differ materially is included in the company's most recent Form 8-K and periodic reports filed with the SEC. This morning's call will focus on our adjusted earnings for the fourth quarter and full year 2023, which excludes the loss on the divestiture of our E&R Industrial sales subsidiary. We have also included a daily organic constant currency growth metric to normalize for the impact on revenue. Definitions and full reconciliations of these non-GAAP financial measures with their corresponding GAAP measures are found in the tables at the end of this presentation and in our earnings release, both of which are available on our IR website. We will also share results related to MonotaRo. Please remember that MonotaRO was a public company and followed Japanese GAAP, which differs from U.S. GAAP, and as reported in our results one month in arrears. As a result, the numbers disclosed will differ from Monotaro's public statements. Now I'll turn it over to D.G.

Deidra Merriwether:

Thanks, D.G. And I pause those upfront, everyone. I'm a little [indiscernible] today, so please bear with me. Turning to our [Technical Difficulty] fourth quarter results. We had a solid quarter to finish out the year with profitability coming in stronger than expected, but also reflected some top line softness as we exited the year. For the total company results, daily sales grew 5.1% or 5.5% on a daily organic constant currency basis, which was driven by growth across both segments. Consistent with what we've seen all year, year-over-year top line growth rates continue to moderate as we wrap price pass in the prior year. While sales finished within our implied guidance range for the quarter, we did see more holiday-related softness than anticipated as we ended the quarter. The total company gross margin for the quarter finished at 39.1%. And declining by 50 basis points over the prior year period. Both segments saw slight year-over-year margin contraction as expected, which I will detail in the coming slides, but in total, finished the quarter at the top end of our implied fourth quarter guidance. Total company operating margin was up 80 basis points which was aided by a lap of roughly $35 million of onetime expenses in the prior year period. When excluding this impact, SG&A as a percentage of sales was still favorable versus prior year by roughly 40 basis points. In total, we delivered diluted EPS for the quarter of $8.33, which was up over 16% versus the fourth quarter of 2022. Moving on to segment level results. The High Tech Solutions segment continues to perform well, with sells up 4.7% of both the reported and daily organic constant currency basis, fueled by growth across all geographies. Volume growth remains strong and accounts for a vast majority of the overall year-over-year expansion. In the U.S., almost all customer end markets continue to see growth in the fourth quarter with government contractors and health care seeing the strongest year-over-year performance. Canada grew slowly in Q4, driven by a softer macro but the business remains solidly profitable in the quarter and finished 2023 with their most profitable year and over half a decade. For the segment, gross profit margin finished the quarter at 41.4%, down 50 basis points versus the prior year due to negative price/cost spread a year-end inventory cost adjustments, which included the lap of a prior year LIFO inventory benefit that we did not repeat in 2023. These headwinds were partially offset by the continued supply chain tailwinds we've seen all year as improved product availability and lower fuel and container costs drove year-over-year favorability. Although we were price cost negative in the quarter and for the full year of 2023, we are nearly neutral on a 2-year stack as the timing favorability captured in 2022 as fully unwound and we enter 2024 on a neutral [indiscernible]. At the operating margin line, we saw an improvement of 90 basis points year-over-year as the slight GP decline was offset by leverage in the business despite continued investment in marketing and head count to drive long-term growth. As mentioned, the year-over-year SG&A leverage was aided by roughly 90 basis points due to the lap of onetime expenses in the prior year period. Overall, it was another solid quarter for the High-Touch Solutions North American segment, wrapping up a great year. Looking at market outlook on Slide 13. We estimate that the U.S. MRO market grew in the quarter between 2.5% and 3%, largely driven by price with industrial production, our proxy for volume remaining roughly flat year-over-year. This indicates that the High-Touch Solutions U.S. business achieved roughly 225 basis points of outgrowth in the fourth quarter in total. This more muted quarterly outgrowth reflects higher market-based inflation and Grainger's Q4 price contribution due to the timing of where we pass price versus the market. On a pure volume basis, when looking at our volume contribution versus IP growth our market out growth was closer to 475 basis points. In any case, as D.G. mentioned, looking at the full year, we achieved an annual outgrowth target by capturing approximately 525 basis points of growth above the market and remain poised to deliver against our target again in 2024. Moving to our endless assortment segment. Sales increased 6% or 8.2% on a daily constant currency basis, which adjusts for the impact of the depreciated Japanese yen. Zoro U.S. was up 2.6%, while MonotaRO achieved 9.9% growth in local days local currency. At a business level, Zoro's growth reflects the continuation of headwinds they've experienced all year with declines in noncore B2C volume and slowing macro environment impacting its B2B customers. B2B customer growth remained steady in the high single digits for the quarter while noncore B2C and B2C light customer performance remained down over 20% year-over-year. At MonotaRO, macro-related headwinds continued to impact results, however, the business still drove strong growth with increased sales to new and enterprise customers while also maintaining strong repeat purchase rate. From a profitability perspective, gross margins in the segment declined 60 basis points versus the prior year as MonotaRO favorability was offset by year-over-year declines at Zoro. As in the prior quarters, MonotaRO results reflect continued freight efficiencies, while the Zoro decline was driven by negative product mix and the impact of unfavorable timing from prior year price increases. Operating margins for this segment expanded by 50 basis points to 7.8% as the unfavorable gross margin was offset by SG&A leverage aided by the lap of onetime distribution center and commissioning costs in the prior year. Now looking forward to 2024. We expect to deliver another solid year of performance [indiscernible] more muted MRO market. Our outlook for the year includes revenue to be between $17.2 billion and $17.7 billion at the total company level with daily organic constant currency sales growth between 4% and 7%, driven by top line growth in both segments. With our High-Touch Solutions segment, we expect daily organic constant currency sales growth between 3.5% and 6.5%. In the U.S., we're planning for the total MRO market growth to be largely flat with a range of down 0.5% to plus 1.5%. This assumes the flattish volume range coupled with price inflation between 0 and 1%. On top of this market outlook, we expect to continue executing against our strategic growth engines to achieve 400 to 500 basis points of U.S. market outlook in 2024. In the endless assortment segment, we anticipate daily constant grocery sales to grow between 7% and 10%, which normalizes for the impact of 2 additional business days and expected foreign currency exchange headwinds. MonotaRO is expected to grow in the low double digits in local currency and local gains as they continue to ramp new and enterprise customers [indiscernible] an expected slower macro demand environment. Zoro is anticipated to grow in the mid-single digits as we anticipate that many of the macro-related headwinds impacting their core B2B customers hold over to 2024. We also expect the continued unwind of B2C and B2C like customers, which include resellers and marketplaces to impact results, especially in the first half of the year. In 2024, the team will focus on growing long-term relationships with its core B2B customers, including work to improve targeted marketing, fine-tune their pricing model and drive consistent service for all of their customers. Moving to our margin expectations. Even after normalizing to some onetime gross margin benefits we realized in 2023, we expect total company operating margins to remain quite healthy in 2024. In the High-Touch Solutions segment, operating margins will stay relatively flat year-over-year between 17.4% and 17.9%. We expect gross profit margins to be down in 2024 after lapping roughly 50 basis points of onetime benefits captured in 2023. We anticipate price cost for the year will be the only neutral as we worked our way through the timing discrepancy we've seen over the last couple of years. On the SG&A side, we expect modest leverage while we continue to make incremental investments towards our strategic initiatives to fuel our growth. In endless assortment, we are modeling operating margins to be roughly consistent to what we've seen in the back half of 2023 and 7.3% to 7.8% range as the segment rebaseline following Zoro's revenue declines with the noncore B2C and B2C-like customers. At the business unit level, Zoro's operating margins are expected to decline, while MonotaRO's operating margins are expected to be neutral for the year. Turning now to capital allocation. We expect the business will continue to generate strong cash flow in the year with an expected range of $1.9 billion to $2.1 billion, implying operating cash conversion around 100%. We plan to continue to execute a consistent return-driven approach to our capital allocation strategy, meaning our priorities remain largely unchanged from prior years. First, we look at investing in the business and both organic investment and opportunistic M&A. For 2024, we expect capital spending in the range of $400 million to $500 million. Spending here includes continued supply chain expansion in the United States as we worked to [indiscernible] facilities in the Pacific Northwest and the Houston area. We also plan to further invest in our homegrown data and technology capabilities, helping power our growth engines and further our customer value proposition. Lastly, sustainability-related spin remains a priority. We will continue to invest in projects with solid returns to help achieve our emissions targets. On M&A, we remain highly selective, but are also open to investing in capabilities and acquiring the right assets to further our strategy. And we have a small dedicated team who continually evaluate opportunities in this area. Secondly, we expect to return the balance of our excess cash to shareholders in the form of dividends and share repurchase. As always, we'll formally set our 2024 dividend in the second quarter, but I can say we remain proud of our history of increasing the dividend for 52 consecutive years we expect to do so in day this year. We do not tie our dividend payout to specific metrics. However, we anticipate consistent annual dividend increases in the high single digits to low double-digit percentage range every year. Lastly, we expect to allocate the balance of our cash flow to share repurchases and anticipate the amount to be between $900 million and $1.1 billion in 2024. We think this return-focused allocation philosophy provides the organization optimal flexibility to efficiently manage investment while maximizing shareholder returns. In summary, rolling all this up at the total company level, as mentioned, we plan to grow top line by [indiscernible] 4% to 7% on the daily organic constant currency basis. Note that reported sales growth is a bit higher than our daily organic constant currency range as we are normalizing for the divestiture of our [indiscernible] ENR subsidiary, FX changes and the impact of 2 additional selling days in 2024 compared to the prior year. A reconciliation of these impacts is provided in the appendix of this presentation. Operating margin, as we discussed ranged from 15.3% to 15.8% leading to expected EPS growth of 3.6% to 10.5% or $38 to $40.50 per share. From a seasonality perspective, we do expect both revenue and profitability to be more back half weighted as we move through the year. This includes a softer start in January from the timing of the New Year's holiday and cold weather disruptions experienced mid-month across a large portion of the U.S. With this, January sales started slowly, but picked up momentum as not progress with preliminary results of 4.4% on a daily organic constant currency basis. On profitability with more muted inflation in the year, we won't see the price timing favorability we normally captured in the first quarter. With this, those margins will show very little seasonality and remain reasonably subsistent with our full year gross margin outlook throughout the year. For SG&A, we expect year-over-year deleverage in the first quarter as we ramp up investment spending in 2024. Leverage will improve each quarter, looking to a tailwind in the back half of the year. Altogether, this will drive EPS growth to be flat to slightly down in the first quarter and will ramp thereafter as the year [indiscernible] before I hand it back to D.G., I wanted to quickly touch on our long-term outlook and where we expect to take the business over the next several years. As we discussed on our last call, we made great progress towards the 2025 targets we rolled out at our Investor Day in September 2022. We remain on track to hit our revenue goals that are meaningfully ahead on most of our profitability targets. With this, we're replacing our 2025 targets with an updated long-term earnings framework. The framework is actually quite similar to what we've discussed previously, as we continue to target double-digit annual EPS growth in a normalized MRO market, driven by continued strong top line growth, including 400 to 500 basis points of annual market outgrowth in the High-Touch U.S. business and annual growth in the [indiscernible] stable gross profit margins, which should normalize from the 2024 baseline and SG&A growing Florida sales while still investing in demand generation activities to drive sustainable long-term growth. You will notice we made a few tweaks to the earnings framework, which largely offset. First, we've widened the top line outlook for analyst assortment as each business there is facing dynamics making it harder to achieve historical growth rate. With MonotaRO, at this stage of their maturity, the business has onboarded most of the large and midsized business within the market. With this, the team is pivoting its marketing strategy from firm level of customer acquisition to end user penetration in an effort to expand total customer share win. As though, following the post-pandemic volume decline from B2C and B2C customers, the business is refocusing their efforts on B2B customers as they work to build long-term profitable relationships with the core -- with this core customer set. As the business be focused, we think it's prudent to widen range of growth outcomes for this segment over the next few years. Regardless, we still expect to deliver very strong growth through this segment and remain confident in the model's ability to continue to take share and drive profitable operating scale to the total business overall. Second, as we [indiscernible] shadowed last quarter, we expect to maintain elevated gross margins in the High-Touch Solutions segment, which is underpinned by the confidence we have in executing against our 2 core pricing [indiscernible] remaining market price competitive while maintaining price cost neutrality. Adding these together, net-net, we end at roughly the same outlook as we discussed at Investor Day. Strong earnings growing in double digits annually. When we drive these results, the business with [indiscernible] considerable amount of cash, which we will allocate through a consistent and turn driven approach. This includes continuing to invest in the business at an elevated level for the next few years as we add incremental supply chain capacity and continue to build out our technology capability. And all this up, and we think this represents an attractive return profile, we remain well positioned to drive significant value creation for our shareholders. With that, I'll turn it back to D.G. for some closing remarks.

Operator:

[Operator Instructions]. Our first questions come from the line of Ryan Merkel with William Blair.

Deidra Merriwether:

Let me start with the first question first, and then maybe I'll have you reask the second part of it to make sure I don't forget anything. So when we go back to 2019, I think we've done a pretty good job on just product gross margins in general and being able to prophetize customers based upon the services that we provide from the High-Touch Solutions business. In addition to that, the pricing strategy change has taken allow to be completely executed as we said over a number of years, and that included making sure that we could get pricing right on all of our for -- all of our customers. So some of that evidence also flows into our product GP. And then as of late, we've continued to gain quite a bit of supply chain efficiencies from coming out of the pandemic as well as some other COGS efficiencies related to supplier rebates related to negotiations. Those would be some of the key differences between where we are today and where we were in 2019. So can you repeat your second part of the question for me, please?

Deidra Merriwether:

Yes. So some of the offsets we made to the fact that as we go into this year, we're going to have a faster pricing environment. And based upon that, we want to make sure that we're providing a range such that is realistic for us to hit also in a softer volume environment for the overall business. And so those are some of the 2 primary reasons why being officially flat we would expect to be closer to the high end. We've got some tailwinds that will continue to normalize after some of the disruptions that we've had over the past few years, specific to supply chain and mix, and that will help as well.

Thomas Moll:

I wanted to expand on the gross margin conversation with what's perhaps the obligatory question here. But I just want to make sure that I'm tracking the message correctly over time. So if we go back to your Investor Day, the anchor for your high-touch business was in that 40% range. Since that time, you've outperformed it significantly and indicated that maybe that was too low a number. And if I'm hearing the message correctly today, in 2024 at the midpoint, you're somewhere a little bit north of 41% and 25% and thereafter stable around that range. So I just want to make sure I've tracked all that correctly or if there's anything you'd like to amend there.

Thomas Moll:

Sure. Pivoting to the commentary you offered today on service levels earlier in your remarks, D.G. So it sounds like you're back to roughly your own pre-pandemic service levels. You've invested and will invest substantially in the capacity and automation and other areas as well. So I'm just curious, strategically, do you feel more confident in leaning into these forms of investment and versus what you've communicated in the past, should we read from today that with that increased confidence, you see this as a repeatable and sustainable advantage that you can repeat pretty consistently to take share?

Operator:

Our next questions come from the line of Jake Levinson with Melius Research.

Donald Macpherson:

I mean I'll start and Dee, if you want to add in, you can. I think the thing to note is that we tend to look at productivity from a core productivity standpoint. So distribution centers, contact centers, seller productivity, all those levers. And we really see opportunity across the business. And I think we're going to see really nice core productivity this year. The headwinds are more around the growth investments, which we think are absolutely the right thing to do, they're high return growth investments. But we are spending more money in marketing and we're investing in the sales force. And so those things make it -- the headline number looked a little more challenging. And it's a time in place when we are investing in those things and believe that's the right thing to do. But we're going to continue to get core productivity. It's an evergreen initiative for us to look everywhere in the business. And I think we've got a whole bunch of things teed up to improve the productivity of the core business.

Donald Macpherson:

It's a mix. It's a mix. And I think it just practically, if you thought about it, we're a lot bigger than 2019. There was almost no way to actually build buildings productively during the pandemic, you couldn't get things going. And so we were a little bit behind. We talked about that in 2022. So a part of it is catch-up but a part of it is planning for the future growth as well. And I would say the square footage isn't exactly capacity because the bulk warehouse portion of those is lower cost and doesn't quite give you as much capacity as does the other buildings, but certainly, Houston and Portland are added capacity similar to the other capacity of the number.

David Manthey:

First off, a couple of quick ones for Dee. What specifically is the range of price expectations you're baking into the 2024 guidance range? And second, on Slide 20, you talked about stable gross margins. I'm not clear if you're referring to segment gross margins are consolidated. Could you help me with that?

David Manthey:

And then, D.G., could you talk about what opportunistic M&A would look like to Grainger today?

Operator:

Our next questions come from the line of Chris Snyder with UBS.

Donald Macpherson:

Yes. So without getting overly detailed, I would say that the demand generation investments are typically SG&A investments, so marketing and seller ads or SG&A investments. Whereas a lot of the capacity investments we're making in productivity investments or AI investments or technology investments, most of this showing capital, some shows up in expense for sure. But if you think about -- when we talk about spending $450 million, $550 million in capital, the vast majority of that comes from supply chain investments and capacity increases and in technology. And so I would think of it in those terms. And technology is building capabilities and advantage in information assets and supporting the growth initiatives in the core business as well versus marketing to our more direct spend that go into demand generation.

Donald Macpherson:

Yes, it talked about it. Yes, we do expect to get SG&A leverage over time, and we are probably making more incremental investments in this year than others. Yes. So that is probably true. We're also -- just I would just point out, in a fairly flat price environment, that SG&A is -- its more difficult to get SG&A leverage as well. So there's a number of factors going on. Dee, do you have any?

Donald Macpherson:

Yes. And the other thing I'd add to that is that both in marketing and seller coverage, we are very well measured. So we are -- everything is tested. We don't make the investments lightly. We know exactly what returns are getting. So if they're a positive return, we will make them even if in the year, they might slow down our SG&A leverage because it is the right thing to do for the overall profitability of the business.

Deidra Merriwether:

Yes. I mean it was really small. And I think if you go back to -- we forecast -- and it should be no surprise with our price cost outcome will be in Q4. We've been looking at this and talking about it for the last 2 years. If you go back to 2022, we noted that we were going to be significantly price cost positive in that year, and it would unwind in 2023 and it did, and you saw that and experience that in the second half of of 2023. And so a lot of it is timing, as we know we talked about price and cost in our business is very lumpy being north of 70% of our business will contract customers and the timing of those things. And so on a 2-year stack being essentially neutral and exiting this year and start in 2024, the neutral footing, I think was really important.

Deane Dray:

Love to go a little bit deeper on the comments about January getting off to a slower start. And we've heard this recently from a number of companies pointing to the weather as really hampering some of the activities. So if you could size for us what you think that weather impact was. And a related question is the underlying assumption of MRO for activity for 2024, down 0.5% to up 1.5%. Just given the trends we're seeing now in the ISM coming back, new orders going back above 50, just it seems like you could see a risk to the upside in that and maybe that's a bit conservative and just take us through that assumption as well, please.

Deane Dray:

Got it. And then for Dee or D G. either. The outlook for an expected increase in buybacks for 2024, the uptick there. Just what's the expectation in terms of the pace of the buybacks through the year?

Operator:

Our next questions come from the line of Christopher Glynn with Oppenheimer.

Deidra Merriwether:

So this is the -- we've gone from a as you know, over the last year or so a highly cost inflationary environment to something that is much more muted today -- coming down today are much more reasonable or normalized is the term I would use is what we're seeing. I would say, our product management team, utilizes the same sets of strategic and tactical activities with our supply base. We want to remain to be a customer of choice for them. And so we're working to ensure that we continue to have advantage price and advantaged access to products at the best price possible. So things are getting to more normal level for us today.

Donald Macpherson:

Yes. So I think what I would say there is that, obviously, as the B2C and B2C like volume shrinks, it becomes less of an impact on the rest of the business and our business customer activity has actually been reasonably healthy through the entire quarter. We do expect some of the decline to be less impactful in the back half of the year. So we should have less drag in the back half of the year than we have in the first half of the year from the decline B2C lifeline.

Ken Newman:

I know there's a lot of moving pieces here, but I am wondering if you are seeing or have seen any impact from some of the [indiscernible] shipping dynamics and how are you thinking about shipping and screen expenses in '24 and how that flows through your OpEx guide for the year?

Ken Newman:

Yes. Just curious, as a follow-up to that, how you're thinking about freight expenses in general. I feel -- I think most companies are seeing those kind of come up here? And how do you see that flowing through your OpEx line as it relates to your guide for the year? .

Ken Newman:

Got it. And then if I could just squeeze one more in here. I think you mentioned in the new framework that you expect Zoro and MonotaRO to kind of get back to that low teens type of growth range. It's been a tougher couple of years here recently. As I think about the seasonality comments on the first half year kind of unwinding in the first half, is it reasonable to say, could you get back to that double -- low double-digit range here within the back half of '24? Or is that more of a 25% type of aspirational target?

Operator:

Our next questions come from the line of Patrick Baumann with JPMorgan.

Deidra Merriwether:

No. No. I think your -- Slide 13, you're kind of looking at what we have listed as what we think the market performance has been by quarter.

Deidra Merriwether:

Yes. And so that difference is really that our price in the quarter was lower than the PMI print in the quarter. And so we were just highlighting for you that if you just look at the volume for IP versus our volume, then our share gain would have been 4.75. So there's a difference in the market price as published today in Q4 versus what we realized from a price perspective. And the comments I was making earlier about timing is that our timing is not always going to be in line with the timing of price in the market. And this quarter was just one example of that. But you also have other examples if you look back over the course of several other quarters as we've outperformed the market. So we try to look at it on a 2-year stack, trying to get to neutral over a longer period of time.

Deidra Merriwether:

Yes. So no, we always put through price if prices warranted early in the year, but it's more like a seasonality question. So I'll probably respond to it in that way. We do expect a lot of the outlook that we've given for 2024 to be back-end weighted. We talked a little bit about pieces of it, which was sales starting slower, tougher comp. Q1 last year was a very strong year for us, which included a whole lot of price in that quarter with a price outlook of 0 to 1. Of course, our price for this year, the quarter will be more muted versus that. And we expect price to become more favorable throughout the year and for gross margins to be relatively stable versus the outlook that we have given. And so that's what I mean when you talk about kind of sales and price in the first quarter versus the prior year.

Deidra Merriwether:

Q1 and full year.

Operator:

Our final questions will come from the line of Nigel Coe with Wolfe Research.

Deidra Merriwether:

Well, like we've talked a little bit about freight. We'll continue to get freight and supply chain efficiencies and some product mix. But again, it all starts with the fact that we don't expect to have a lot of price in the market this year, just generally so. We expect gross margins to be reasonably consistent from what we talked about all through the year. So that's the basic reason for that muted price.

Deidra Merriwether:

So yes. So yes, SG&A is going to deleverage in the first quarter because we're going to continue, as noted, to ramp our investments in marketing and sellers and others and the like. But we do expect leverage will improve as the year progress, flipping to more of a tailwind in the back half of the year for us. And then just if you kind of move down a little bit, we think operating margin in Q1 will be at its lowest point as well and EPS will be flattish year-over-year in the first quarter as well.

Deidra Merriwether:

I missed that last part. I heard you say that. Could you repeat it? .

Donald Macpherson:

Yes. I think it was basically neutral. We did have -- you're right, midsize customers did grow faster than the largest customers. Overall, it was not a meaningful impact, as I understand it. Dee and I are in different rooms, so she's sequestered. So we're looking at each other through a camera here.

Donald Macpherson:

All right. Sorry, we're a few minutes over. Thanks for joining the call. What I would say is that and we're certainly proud of the results we had in 2023. We are very focused on continuing to drive forward and create value for our customers in 2024 and a lot of that is really the same despite the more muted growth in the market that a lot of that's just a continuation of driving forward the initiatives that matter, both from a growth perspective and a productivity perspective. And we remain very positive about the outlook and our ability to gain share profitably for years to come. So thanks for the time. Hope you all have a great weekend. Take care.

Kyle Bland :

Good morning. Welcome to Grainger's third quarter 2023 earnings call. With me are D.G. Macpherson, Chairman and CEO; and Dee Merriwether, Vice President and CFO. As a reminder, some of our comments today may include forward-looking statements. Actual results may differ materially as a result of 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 our third quarter 2023 results, which are consistent on both a reported and adjusted basis for all periods presented. We will also share results related to MonotaRO. Please remember that MonotaRO was 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 will differ somewhat from MonotaRO's public statements. Now I'll turn it over to D.G.

Dee Merriwether:

Thanks, D.G. On Slide 7, you can see the high-level results for the total company, including strong sales growth of 8.7% on a daily constant currency basis driven by growth across both segments. This is a relatively stable growth rate compared to the second quarter, even as price contribution declined as we wrap inflation pass in the prior year period. Total company operating margin was up 60 basis points, primarily due to expanded gross margin in High-Touch, which more than offset lower EA gross margin and slight SG&A deleverage across the business. In total, we delivered diluted EPS for the quarter of $9.43, which was up over 14% versus the third quarter of 2022. Moving on to segment level results. The High-Touch Solutions segment continues to perform well, with sales up 8.5% in daily constant currency underpinned by growth across all geographies. Volume accelerated sequentially and contributed 6 percentage points of growth, excluding price contribution for the first time in 5 quarters. In the U.S., we continue to drive year-over-year growth in all customer in segments with government and transportation growing faster. Canadian daily sales were strong, up 9.1% in local days in local currency. For this segment, gross profit margin finished the quarter at 41.7%, up 110 basis points versus the prior year. We continue to benefit from improved product availability, which drove freight and supply chain efficiencies in the quarter. Product mix also remained a tailwind, partially driven by an outsized number of project-related value-added services in the current year period, a level which we don't expect to repeat going forward. As expected, price/cost spread was negative as the timing favorability captured in 2022 continues to unwind. This price/cost trend will continue in the fourth quarter, and we anticipate finishing nearly neutral on a 2-year stack for the full year 2022 and 2023 combined. At the operating line, we saw improvement of 70 basis points year-over-year as GP favorability was partially offset by continued marketing and headcount investments to drive long-term growth. SG&A leverage was further impacted by one less selling day in the current year period. Overall, it was another strong quarter for the High-Touch Solutions North American segment. Looking at market outgrowth on Slide 9, we estimate that the U.S. MRO market grew between 2.5% and 3.5%, indicating that we achieved roughly 550 basis points of outgrowth for the High-Touch Solutions U.S. business in the quarter. Performance remains above our annual target to outgrow the market by 400 basis points to 500 basis points, driven by consistent execution across our 5 growth engines. We continue to remain confident in our ability to achieve our annual outlook target through any economic cycle. Moving to our Endless Assortment segment. Sales increased 4.3% or 9.2% on a daily constant currency basis, which adjust for the impact of the depreciated Japanese yen. Zoro U.S. was up 1.2%, while MonotaRO achieved 12.6% growth in local days, local currency. At the business level, while we're seeing some signs of macro-related softness at MonotaRO, the business still drove strong growth with new and enterprise customers and remain focused on growing repeat business with its core B2B customer. At Zoro results reflect a continuation of headwinds discussed last quarter with tough prior year comp decline was noncore B2C volume and a slowing macro environment all contributing to more muted top line growth. Noncore B2C customer performance was down nearly 20% year-over-year as we continue to focus our growth efforts on stickier B2B customers. Core B2B customer growth remains in the high single digits for the quarter and continues to reflect a slower macro for small businesses and in end markets where Zoro is more skewed. We expect these pressures to persist for at least the balance of the year. From a profitability perspective, gross margin for the segment declined 20 basis points versus the prior year as MonotaRO favorability was offset by year-over-year declines at Zoro. MonotaRO results reflect continued freight efficiencies and strong price realization in the quarter while the Zoro decline was driven by negative product mix and the impact of unfavorable timing from prior year price increases. These gross margin headwinds coupled with the continued demand generation investments in softer Zoro top line drove a 70 basis point decline in operating margins for the segment. On Slide 11, we continue to propel the Endless Assortment flywheel as we add new users and grow our SKU count. Total registered users were up 15% in total across the segment, and we continue to grow our assortment at Zoro having added roughly 600,000 SKUs in the quarter, pushing the portfolio total to over 12.8 million products offered. Now looking forward to the rest of the year, you can see that we've narrowed our guidance ranges for the full year 2023. The new outlook includes total company daily sales growth between 8.5% and 9.5% and an EPS range between $36 and $36.60. These updated figures imply a Q4 daily sales growth between 4.5% and 8.5%, which includes 4% month-to-date growth in October, which is in line with our expectations and reflects a total comparison given hurricane-related sales in the prior year. This month-to-date growth is roughly 100 basis points higher in constant currency. From a margin perspective, we are raising the lower end of our ranges and now expect operating margin for the full year to be between 15.6% and 15.7%, a record year for the total company. The new range implies fourth quarter operating margin will be lower sequentially as we anticipate product mix to normalize with fewer value-added service engagement and SG&A margin to delever in line with typical seasonality in the fourth quarter. Supplemental guidance covering cash flow and share repurchase expectations, which have also been increased can be found in the appendix of the presentation. All told, we're pleased to achieve full year results that includes the absorbed price for sales, profitability and cash flow further strengthening of our track record of delivering strong returns for Grainger shareholders. With that, I'll turn it back to D.G. for closing remarks.

Operator:

[Operator Instructions] And our first question comes from Ryan Merkel with William Blair.

Dee Merriwether:

Ryan, this is Dee. Thanks for your question. Like, if you kind of go back in time and think about where we were about a year ago, we were in the midst of kind of coming out of the pandemic. Product availability was not exactly where we wanted it to be, even though our relative performance was pretty good. And we were expecting to get back in line with product availability much later in this year. That snapped forward really quickly in Q1, and it helped us significantly improve our margins. That's one piece. The other piece I will point you to is we target price cost neutrality over time. And last year around that time, we expected cost to come in a lot sooner than what they did this year. We had passed price earlier last year in anticipation of that cost. Costs really are now flowing through GP as we expected. So a lot of things are timing related. We do -- we are performing better than what we had anticipated at that time, but really it's due to product availability, price/cost timing as we continue to focus on neutrality. And then we've continued to do very well as it relates to freight and supply chain efficiencies. That was also another timing element.

D.G. Macpherson:

Yes. So government, I think a lot of that. Government has been very strong across the board. We have won some new contracts that have come on board that have helped us this year. And so that has been certainly a tailwind. When we say transportation, I think, arguably, we mean aerospace there. Aerospace has been very, very strong. I think the aerospace companies can't build enough airplanes now. So we're benefiting from that. And I would say the market in general remains stable. There's puts and takes, but those two have been certainly on the plus side for us. In terms of the 4% in growth that we've seen through October so far, there's a couple of things going on there. One is our market share gain, we think, is going to be pretty strong in October, but we did have Hurricane Ian basically generated a lot of startle and other sales last year for us. And so that compare makes the month look a little worse than it actually it is. The underlying volumes are actually still quite good.

Operator:

Our next question comes from Tommy Moll with Stephens.

D.G. Macpherson:

Well, I think the reality is the volume this year, the volume in the market has been near 0, pretty much all year. And so all of our volume share gain -- all volume pluses have been share gain, that will continue. I think the biggest difference is moving through the fourth quarter. We had price that happened last year that has been an increase in our revenue line for the first three quarters, but we lapped that going into the fourth quarter. So we don't really see any changes. There's nothing to be made up, but this is exactly how we predicted the year to play out and it's playing out pretty much exactly as we expected. So we are not at all concerned about the revenue line. It's exactly what we expected.

Dee Merriwether:

Sure. So you're right, it feels a little early for us to start resetting things. At this point, which I've kind of reiterated the last couple of quarters. But what I would say related to High-Touch and if you compare really Q3 to where we think we're going to go sequentially Q4, I will call out, like in my prepared remarks that we've mentioned our service-related or product mix. That happened as a benefit both in Q2 and in Q3. We don't expect that to continue into Q4. In addition to that, there are some other pieces like that fall into the price cost related to rebates last year. Both years we're doing very good in volume as D.G. noted, but again, volume was really strong last year, still very strong, and then that reset some of your rebates. And so that will kind of fall off a little bit and then price/cost will continue to unwind, Q3 to Q4.

Jacob Levinson :

Just touching on the margins. I know you talked about some favorable items you have this year, and you're certainly trending well above those 2025 targets that you laid out, but D.G. or Dee, for that manner, maybe you can just give us a sense of how you're thinking about operating leverage in the business going forward because it -- I would think at least that the growth is there that you're probably not going to see margins contracting meaningfully, even if mix was a little bit worse or price/cost is a little bit worse?

Jacob Levinson :

Okay. That's helpful. And just switching gears, I think your balance sheet is probably the least levered maybe since you took over D.G., is that reflecting some conservatism on the macro? Or is there appetite for more aggressive share buybacks or special dividend or otherwise returning more cash to shareholders?

Operator:

Your next question comes from Christopher Glynn with Oppenheimer.

Dee Merriwether:

So just to answer your first question, price/cost for High-Touch was 2.5% in the quarter. And again, we take a longer-term view of price competitiveness, remaining price competitive. And due to the lumpiness of all of the components of price and costs that impact the business, if you look at a 2-year stack, we expect to be close to neutral if you accrue '22 and '23. I would say that would be looking ahead, we would not change that position. We are targeting price cost neutrality over time. When we get to early next year and set the 2024 guide, we'll talk in more detail about 2024.

Christopher Glynn :

Okay. And then on Zoro and MonotaRO, just curious how you're thinking about path back to the kind of 16% to 18% long-term top line targets?

Operator:

Our next question comes from David Manthey with Baird.

D.G. Macpherson:

Yes. So what I would say is there's two pieces to growth to Zoro. One is that this a very simplified, but one is acquiring customers, Zoro has always been really good at acquiring customers. They've been a good customer acquisition engine. The other is developing repeat business for those customers, so you become the place of choice to shop. We've had some success with that. We have a lot of long-term customers. We need to get better at that piece. So most of what we're talking about doing is how to make alterations, it's not really a strategy change, but we're testing a bunch of things to figure out how to improve that part of the business. And that will be the big area of focus going forward.

D.G. Macpherson:

Yes. I mean I think that -- let's start with -- as you know, we are building some of our own software for the first time in a long time and customer information and product information were early in the cycle. Product information, in particular, with a core publishing system that we've developed to help the website, help customer positivity on our website, and this helped really drive a lot of growth through both marketing and merchandising. The customer information system is supporting marketing efforts. It's also supporting seller coverage, which we have been adding sellers and that help us understand where we can add and become more refined in that. So both of those have been a big driver of growth and will continue to be so going forward. And I think that we still have a long ways to go, particularly customer information to leverage it for all of our sales team and all of our marketing activities, but we continue to get better in those areas.

Nigel Coe :

So looking at this -- the fourth quarter margin, Dee, you called out, I think, 50 basis points or thereabouts of sequential margin kind of versus third quarter. Is that math correct, first of all? And then how does that shake out between High-Touch and Endless Assortment? And then I've got a follow-on on the Zoro gross margins as well.

Nigel Coe :

Yes, 3Q to 4Q gross margin.

Nigel Coe :

Okay. And then just to calibrate the comments about price/cost normalization. We're no longer looking at 40% gross margin High-Touch, you're thinking you maintain a higher plateau than that?

Nigel Coe :

Okay. That's helpful. And then just a quick one on the Zoro gross margins because as you burn off B2C focus on B2B, I thought B2B gross margins would have been higher than B2C. So therefore, you actually get a gross margin mix up. So just wanted to understand that dynamic.

Operator:

Our next question comes from Steve Volkmann with Jefferies.

D.G. Macpherson:

Well, we haven't really talked about that yet. But we do know that we're not seeing as much product cost pressure as we've seen in the last two years. And there are certain categories where costs will be down that are commodity related and certainly will be up. But generally, we're not seeing a lot of cost pressure. We'll talk about price cost and the actual numbers at the end of the year for next year.

D.G. Macpherson:

Yes. I mean we're going to continue to invest in the business, but we do believe that we will have consistent over -- in any quarter, you may not see it, but over time, we will have SG&A leverage as we continue to find ways to improve our cost position for us to investing into this.

Chris Dankert :

I hate to keep harping on Zoro here, but I'm curious, again, you talked about a couple of different initiatives. But I mean, is there a friction in that system that we need to pull out? Or kind of what can you really get that customer acquisition up? Given SKU count has been moving up and doing well, what else kind of has to happen to the system perhaps on a more holistic basis?

Chris Dankert :

Got it. And just as far as like benchmarking, given the greater cyclicality in that business, how should we be thinking about growth there beyond just this year and some of the challenges we've seen?

Operator:

And our next question comes from Deane Dray with RBC Capital Markets.

D.G. Macpherson:

No. That really never comes up in customer visits. I was out in Northern California last week. And I would say for our types of products, customers just generally don't ever have like overstock of our inventory, they're buying when they need it. And frankly, a lot of our value proposition is helping them not have too much. So we really pride ourselves in making sure that customers have what they need to keep the business running, and that's really all they have.

D.G. Macpherson:

Yes. Certainly, we've talked about it before, marketing has been a big part of what's helping us gain share. In terms of media advertising, we generally measure returns based on A/B tests where we test in certain markets and understand what the actual pull-through is from those. And so we -- I would say our marketing area is probably the -- as well in measured areas you could possibly imagine. So we can tell you with a lot of precision what's working and what's not, and that helps us figure out what to do.

Chris Snyder :

I wanted to ask on the project-related value-added services. I guess first, just to confirm, it sounds like that was a 60 basis point boost to high such gross margin in Q3? And then I guess kind of just higher level, can you just talk a little bit about what are these project-related value-added services that the company is providing? And what makes them 1 time or transitory in nature?

Chris Snyder :

And then was that right? Or did you say earlier, it was a 60 basis point boost in Q3 to the High-Touch gross margin?

Chris Snyder :

Okay. Thank you. And then maybe staying on the topic of services. D.G., in your opening remarks, you talked a lot about the value-added services that Grainger is bringing to the table. I guess as we think about those going forward, do you view those services as a way for you guys to continue to drive price even in a cost environment or purchase environment as called out going sideways? Or do you view those more as just -- well, that's why we can outgrow the market by mid-single digits on a volume basis?

Operator:

And our next question comes from Patrick Baumann with JPMorgan.

Dee Merriwether:

Yes. When I was calling out...

Dee Merriwether:

Yes, that is if you are looking to normalize '23 and are thinking about gross margins on a go-forward basis, that's the 40 basis points.

Dee Merriwether:

Correct.

Dee Merriwether:

Yes. So I think when you look at our results quarter-over-quarter, there are some timing things that happen. We continue to invest in demand generation to help us ensure that we can drive specifically in the U.S. long-term market outgrowth. When you look at prior year quarter, we had a number of things happen. I think you recall, in Q4, we had a LIFO benefit last year that we will all be cycling. But just zooming out a little bit, if you go back to our framework, over time, we want to outgrow the market in the U.S. by 400 to 500 basis points. D.G. talked a little bit about the fact that we are -- while we are looking to invest in long-term growth, we also look to gain leverage. And if you really looked into how we're doing that, most of our SG&A investments are really targeted towards high-return demand-generating investments. And a lot of the SG&A productivity are leverage. We are gaining in our noncore SG&A expenses and we accomplished that through really continuous improvement. So we're really targeting things that help us with achieving an improved customer experience, but also assist us with operating more efficiently and effectively. Our intent is to continue to invest in demand gen but also look to offset as much of that as we can -- reasonably can do through continuous improvement activities. If you look at that algorithm that we laid out for Investor Day, it talks about driving double-digit EPS growth over the cycle. And so we still expect to do that.

D.G. Macpherson:

All right. Thanks, everyone. We recognize that today is a very busy day for all of you in terms of the number of people that are releasing results, and I appreciate you spending time with us. Yes, I would just reiterate that we feel really good about the way the year has played out. It's played out pretty similar to what we expected. We continue to invest in the business to drive profitable share gain. That is our primary focus, and we continue to invest not only that, but in our team and in making sure that our customers are successful. So appreciate you joining us. I hope you have a great day. Thank you.

Kyle Bland:

Good morning. Welcome to Grainger’s second quarter 2023 earnings call. With me are D.G. Macpherson, Chairman and CEO and Dee Merriwether, Senior Vice President and CFO. As a reminder, some of our comments today may include forward-looking statements. Actual results may differ materially as a result of the 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 Q2 earnings release, both of which are available on our IR website. This morning’s call will focus on our second quarter 2023 results, which are consistent on both a reported and adjusted basis for all periods presented. We will also share results related to MonotaRO. Please remember that MonotaRO was 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 will differ somewhat from MonotaRO’s public statements. Now, I will turn it over to D.G.

Dee Merriwether:

Thanks, D.G. Starting with Slide 8 you can see the high-level results for the total company, including strong daily sales growth of 10.1% on a daily constant currency basis. Although year-over-year growth rates decelerated compared to Q1 as inflation cools and as we lap a tougher prior year comparison, daily sales dollars remained strong and we are on track to deliver a great year. Total company operating margin was up 190 basis points as expanded gross margins in both segments were further aided by SG&A leverage in the High-Touch Solutions North American segment. In total, we delivered diluted EPS in the quarter of $9.28, which was up 29% versus the second quarter of 2022. Diving into segment level details, for the second quarter, we continued to see strong results within our High-Touch segment, with daily sales up 9.9%, fueled by revenue growth in all geographies. Although year-over-year growth rates have slowed as we lap prior year price inflation, volume growth remains healthy and was generally in line with our expectations for the quarter. In the U.S., we continue to see positive growth in nearly all customer end segments. However, this does include pockets of softness, including decelerating growth in manufacturing and commercial services. However, given our diversified customer base, this is countered by strong growth in other areas such as government and healthcare. In Canada, the economy remains stable and we are seeing strong results with Canadian daily sales up about 7% in local days and local currency. For this segment, GP margin finished the quarter at 41.7%, up 200 basis points versus the prior year. Product availability levels remained high, resulting in fewer packages and shorter distance shipments in the current year as service returned to near pre-pandemic levels. This one coupled with lower fuel and container rates is driving significant fuel and supply chain tailwinds in the quarter. Product mix was also favorable primarily due to improved product availability and a higher mix of margin-accretive products and services. Price/cost spread was slightly negative after adjusting for non-recurring – a non-recurring 40 basis point supplier rebate benefit recognized in the quarter. As expected, the favorability captured in 2022 began to unwind in the second quarter and we expect this to continue for the remainder of the year as we turn towards our long-term neutrality target. At the operating margin line, we saw improvement of 230 basis points year-over-year as the GP favorability fell to the bottom and revenue growth more than offset continued demand generation investments in headcount and marketing. Overall, this was another strong quarter for the High-Touch North American segment. Looking at market outgrowth on Slide 10, we estimate the U.S. MRO market grew between 4.5% and 5%, indicating that we achieved roughly 525 basis points of outgrowth in the quarter. Although this is a sequential slowdown from Q1, we comped a very strong prior year quarter and performance remains above our annual target to outgrow the market by 400 to 500 basis points through economic cycles. We are well on our way towards achieving that target again in 2023. Moving to our Endless Assortment segment, sales increased 4.5% or 10.1% on a daily constant currency basis, which adjusts for the impact of the depreciated Japanese yen. Zoro U.S. was up 2.8%, while MonotaRO achieved 12.6% growth in local days, local currency. At a business level, MonotaRO continues to execute well and is driving solid year-over-year revenue growth as they increase registered users and grow the enterprise customers. At Zoro, while slower growth partially reflects a tougher prior year comparison, we are seeing slowing demand across their customer base. Similar to Q1, non-core B2C business remained a headwind in the quarter and was down in the mid-teens year-over-year. Further, we have seen a slowdown in Zoro’s core B2B business, which makes up a majority of Zoro’s revenue. While we are still growing in the high single-digits with these core customers, macro-related factors are impacting demand given Zoro’s end market mix as well as their tilt to smaller sized businesses, which seem to be struggling more in this environment. We expect both of these headwinds to persist for the remainder of the year. Stepping back, Zoro has delivered great results over the last 2 years as we have added SKUs to our assortment, increased registered users and served both core and non-core customers well during the pandemic. As we plan for our next leg of growth, the new local leadership team is focusing their efforts to drive repeat profitable growth with core B2B customers. This should help propel our results through the cycle as we continue to provide a one-stop endless aisle with easy-to-find products and a no-hassle delivery experience for smaller, less complex businesses in the U.S. From a profitability perspective, gross margin for the segment expanded 50 basis points versus the prior year due to continued freight efficiencies and strong price realization at MonotaRO, which offset unfavorable product mix at Zoro. Operating margins declined slightly year-over-year to 8.6% as gross margin favorability was offset by continued investments in marketing and slower-than-expected top line growth at Zoro. On Slide 12, we continue to see positive results with our key Endless Assortment operating metrics. On the left-hand side, in line with prior quarter growth, total registered users grew nicely with Zoro and MonotaRO combined up 16% over the prior year. On the right, we also continue to see growth of the Zoro SKU portfolio, which grew by 200,000 SKUs in the second quarter and stands at over 12.2 million in total. Now looking forward to the rest of the year. Given our strong share gain to date and the continued supportive demand environment, we are raising the midpoint of our full year 2023 outlook by increasing the lower end of our revenue and earnings ranges. Our revised outlook includes daily sales growth of 8.5% to 11% for total company, which is roughly a 75 basis point increase at the midpoint compared to the prior range. High-Touch growth continues to trend slightly higher than expected as we continue to gain share amidst a reasonably steady demand environment. The strength in High-Touch is offsetting lower-than-expected top line performance with Endless Assortment primarily due to the softness at Zoro as previously mentioned. Altogether, at the total company level, we are confident in our ability to drive growth in the second half and achieve our updated estimates. Looking specifically at July, we’ve started the third quarter strong and reported month-to-date sales up over 8%, which is roughly 50 basis points higher on a daily constant currency basis. From a margin perspective, both gross profit margin and operating margin rate expectations remain unchanged from our previous update. From a seasonality perspective, we expect Q3 margin rates to decline sequentially quarter-over-quarter as the one-time supplier rebate we captured this quarter falls off and as price/cost favorability continues to unwind. Couple this with the continued rapid demand generation investments, and we expect total company operating margins to be lower in the back half of the year. However, we’re still on track to finish 2023 with full year operating margins at an all-time high. All in, the resulting revised EPS range has been raised and stands between $35 and $36.75. Supplemental guidance covering cash flow and share repurchase, which have also been raised, can be found in the appendix of the deck. In summary, I look forward to the remainder of 2023 feeling confident in our team’s ability to continue to serve our customers well, achieve profitable growth and drive strong results for our shareholders. With that, I’ll turn it back to D.G. for some closing remarks.

Operator:

Thank you. [Operator Instructions] Our first question comes from Tommy Moll with Stephens. Please state your question.

D.G. Macpherson:

Good morning.

D.G. Macpherson:

Yes, Tommy, I’ll take that. Yes. So if you think about the vertical industry mix that Zoro serves, some of the fastest-growing segments in the Grainger model, the High-Touch model would be government healthcare, some manufacturing like aerospace, Zoro does not participate in those really at all. And then the other trend we’re seeing is Zoro is sort of small businesses a lot more than Grainger does. And those customers appear to be a little softer than the larger customers that we serve. So those two factors have a significant impact. Zoro did increase the repeat rate in the quarter, but they have some work to do to continue to increase the repeat rate. So we’re working hard to do that. But the segment mix is a pretty big impact on Zoro right now.

D.G. Macpherson:

Yes. So we break ground in a couple of weeks, and like we said, 2025 is when the building will be fully up. And so that’s the time frame on it. What I would say is that we have been serving the Northwest out of our branches and out of a very small distribution center in Seattle, and we have outgrown that pretty substantially. And we’ve also been serving out of Patterson, California. So putting the building up in the Northwest allows us to have more SKUs in market, better service. It also allows us to lower transportation costs because we have much shorter routes from that building to our customers in Seattle, Portland throughout the Northwest. So it’s basically just a normal course of action where we evaluate our footprint and continue to expand where it makes sense.

Ryan Merkel:

Hi, good morning, thanks for taking the questions. A couple of questions on gross margin. So how should we think about gross margins in the second half? Is it around 39? Is that the right metric? And then does it dip a little bit in 3Q and then increase sequentially a little bit in 4Q?

Ryan Merkel:

Got it. Okay. That’s helpful. And then just a higher-level question on gross margin. I think the guidance you put out there for ‘25 was High-Touch gross margin about 40%. We’re a good bit above that here in ‘23. Are you planning on updating that outlook anytime soon? Or how should we think about any new thoughts you might have there?

Operator:

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

Dee Merriwether:

Yes, I do think that’s the right way to look – to think about it. So we are getting some tailwinds that we have this year specifically related to supply chain and freight efficiencies, which are somewhat significant. And those can flip on us at any time. But right now, we feel like we’re in line with where diesel fuel is as well as we’ve gotten some benefits from those friction costs that we talked about, D.G. just mentioned this, talking about transportation costs and extra legs of transportation that we had over the prior years. We’re fairly normalized in those areas, getting close to pre-pandemic levels as it relates to that. We did have in the quarter some one-time favorability, about 40 basis points related to that one-time rebate. And we are seeing as we kind of talked about price/cost in the quarter turned slightly negative, which we expect to continue. So, those are some of the puts and takes as it relates, but again, our target 40-ish 2025, we are not changing at this point in time. But I do feel very good about the stability of High-Touch margins in that range.

David Manthey:

Okay. Thank you. And then you mentioned price as a driver for High-Touch, but then you have been saying you are in this negative price/cost position. Dee, you had mentioned that it’s a little tricky to line things up exactly from a timing standpoint. What opportunities do you have to take actions over the next six months, say, to reestablish price/cost neutrality if you plan to do that at all?

Operator:

Thank you. Our next question comes from Chris Snyder with UBS. Please state your question.

Dee Merriwether:

Yes. So, price/cost in this quarter when you adjust for the one-time supplier rebate was slightly negative. And as we started the year, we provided an outlook that as the year continues to flow that we would become price/cost negative because we had favorable price last year. And costs did not come in as we had expected because we had the opportunity to continue to work with our supply base on the cost inflation, which is now coming this year. So, that is why price/cost will become more negative as we go into the second half of this year.

Dee Merriwether:

Yes. So, I wouldn’t over-pivot on the one-time adjustment. It was related to the prior period. It’s not something that we would expect to continue. And I would say the other thing I would add, if you look at our price/cost over a longer period, maybe a 2-year period, we do not expect it to be negative. That’s how we end up hitting our target of price/cost neutrality over time. So, I would not read into that some of the impacts that we are going to have in the second half of this year are expected to continue any longer than that period.

Christopher Glynn:

Thanks for taking the question. I had a question on Endless Assortment. Curious how you considered the thought that perhaps the fundamental kind of algorithm for 16% to 18% growth to ‘25 temporary lull or maybe more practical to reconsider long-term, perhaps high-single digits, low-double digits. I know Zoro is rationalizing some of the customer mix, and MonotaRO has some different strategies around customer demographics that have been a bit in flux as well. So, curious how – what might be a practical update on that metric.

Christopher Glynn:

Okay. Great. And then I was just curious on the SG&A spend rate in the second quarter, is that a kind of good benchmark to think about stability in that kind of dollar rate range for the second half?

Operator:

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

D.G. Macpherson:

Good morning.

Jacob Levinson:

If you will humor one more price-related question and then we can move on just high level, trying to get a sense of whether your suppliers are talking about or have already put through midyear price increases or if they are talking about further price increases in the latter half of the year or whether with inflation coming down, we are really just past that cycle, if you will?

D.G. Macpherson:

Yes. And we talked about this at the beginning of the year, Jake. I think that almost all of the inflation we are going to see this year is wrapped from last year. And so we are seeing puts and takes, ups and downs with suppliers. But in general, there is just not a lot of additional inflation coming in from our suppliers.

D.G. Macpherson:

Yes. I mean – so what I would say is we generally have two premises when we think about inventory levels. The first one is to stock see service levels. So, based on the velocity of items, we have set targets for the service we want to provide on those items that is competitively advantaged. And we basically stock to that. The other is we look at wasteful inventory, inventory that isn’t productive and make sure to manage that down. I don’t think we are necessarily in a new world. We still have some elongated supplier lead times now. Those have mostly come down. And as those continue to come down, I suspect we can be mostly back to where we were historically from an inventory perspective to revenue.

Patrick Baumann:

Hi. Good morning. Just I got one more on price. Sorry about that. The – is there an update to how you think you are going to finish the year on price at High-Touch? And just curious if you are seeing any changes in like demand you will have to see with respect to – I think you make changes with your web pricing ahead of like making changes in the CRP. Just curious if you’re seeing any changes to velocity [ph] related to moves you are making there? And then on Zoro within the price discussion, has that been holding up as well as it has in the High-Touch segment?

Patrick Baumann:

And then the price for the year there at High-Touch, prices at High-Touch for the year, do you have an update on that? That was part of the question.

Patrick Baumann:

Okay. And my follow-up is on inventory again. I guess I am just curious what drove the better-than-expected cash guide, the upgrade to the guidance? Was it you are planning to hold a little bit less inventory than you previously planned, or is there something else?

Patrick Baumann:

Okay. Thank you.

D.G. Macpherson:

We think it’s probably Deane Dray since we know…

D.G. Macpherson:

Alright. Thanks for joining the call today. What I would say is the year is playing out pretty much as we expected. We talked a lot about price/cost. It’s actually played out almost exactly like we expected at the beginning of the year. So, there are really no surprises generally in the market at this point. We continue to feel good about our performance, our share gain, our profitability and feel like we are well positioned to have a really strong second half relative to the market. And so we are going to continue to work on that. And I just appreciate you being on the call, and we look forward to seeing you and talking to you down the line. Thanks so much.

Kyle Bland:

Good morning. Welcome to Grainger's First Quarter 2023 Earnings Call. With me are D.G. Macpherson, Chairman and CEO; and Dee Merriwether, Senior Vice President and CFO. As a reminder, some of our comments today may include forward-looking statements. Actual results may differ materially as a result of 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 Q1 earnings release, both of which are available on our IR website. This morning's call will focus on our first quarter 2023 results, which are consistent on both a reported and adjusted basis for all periods presented. We will also share results related to MonotaRO. Please remember that MonotaRO was a public company and filed Japanese gap which differs from US GAAP and is reported in our results one month in arrears. As a result, the numbers disclosed will differ somewhat from MonotaRO's public statements. Now I'll turn it over to D.G.

Dee Merriwether:

Thanks, DG. I'd like to echo DG's sentiment – execution on our growth strategy and improved service from a return to more normal supply chain performance helped drive excellent results in the quarter. Starting on slide 7, you can see the high-level results, including strong sales growth of 14. 5% in daily constant currency, driven by double-digit growth locally in both segments. Although year-over-year growth rates decelerated as we moved through the quarter on tougher comps, daily sales dollars remained strong and were reasonably in line with historical sequential growth trend. Total company operating margin was up 200 basis points as expanded gross margins in both segments dropped to the bottom line. SG&A margin was flat year-over-year as investments in headcount, marketing and technology were offset by revenue growth. In total, we delivered diluted EPS in the quarter of $9.61 up 36% versus the first quarter of 2022. Diving into segment level details. For the first quarter, we continued to see strong results within our Hi-tech segment with daily sales of 14.5%, fueled by revenue growth in all geographies. Customer demand was generally in line with expectations for the quarter and continues to remain resilient as a whole despite certain areas of softness. In the US, we are seeing broad-based strength across most of the manufacturing with contractors and government customers to name a few. Retail and warehousing are slowing the most, but still up high single digits. In Canada, the economy remains stable, and we are seeing good results across most end markets with Canadian daily sales up 11% and local days and local currency. For this segment, GP margin finished the quarter at 42.4%, up 195 basis points versus the prior year. This expansion was largely driven by freight and supply chain efficiencies as well as product mix favorability. As DG mentioned, improved product availability and short of supplier lead times drove improved stocking positions in our DCs. This availability improvement resulted in more efficient shipping routes, which helped reduce freight expense and lower our handling costs. Freight expense was further aided by a onetime adjustment, which drove 20 basis points of improvement in the period. Product mix was also a tailwind and partially due to improved product availability and partially from lapping the pandemic fuel spike in safety sales from last year's Omicron variant. For the quarter, price cost per ad was neutral and trended largely as anticipated as price/cost favorability we captured in 2022 began to unwind and offset the structural timing benefit we typically see as we passed price early in the first quarter each year. At the operating margin line, we saw improvement of 215 basis points year-over-year. The strong gross margin in the quarter was fully aided by 20 basis points of SG&A leverage as marketing and headcount investments were more than offset by revenue growth. Overall, it was a very strong quarter for the High-Tech Solutions North American segment. Looking at market outgrowth on Slide 9, we estimate that the US MRO market grew between 7% and 8%, indicating that we achieved roughly 750 basis points of outgrowth in the quarter. As we continue to build strong partnerships and make progress with our growth engines, our customers continue to turn to Grainger to help them solve their MRO challenges. Coupled this with our supply chain service advantage, we continue to have a high degree of confidence in delivering against our goal to consistently outgrow the US MRO market by 400 to 500 basis points in any economic cycle. Moving to the endless assortment segment. Sales increased 3.8% or 14% on a daily constant currency basis, which adjusts for the impact of the depreciated Japanese hand. So US was up 13.5%, while MonotaRO achieved 12% growth in local stains and local currency. While Zoro generated solid growth, they are off to a slower start than anticipated predominantly due to noncore B2C business, which was down in the mid-teens year-over-year. For small B2B customers who make up a majority of the world's business were up nicely in the first quarter but are softening a bit in April give Zoro more diversified end market customer mix outside of the industrial economy. At MonotaRO, sales were impacted by adverse weather as well as slower return to work patterns with the New Year holiday following midweek. Sales have ramped back over the last several weeks, and we expect results to be more in line with our expectations for the balance of the year. From a profitability perspective, gross margin for this segment expanded 140 basis points versus the prior year due to strong price realization and continued freight efficiencies across both businesses as well as favorable business unit mix for the segment. Operating margins expanded by 15 basis points year-over-year to 8.1% and primarily due to gross margin favorability offsetting investments in marketing and headcount to drive customer acquisition and assortment expansion. On slide 11, we continue to see positive results with our key endless assortment operating metrics. Total registered users are tracking nicely with Zoro and MonotaRO combined up 16% over the prior year. On the right, we show the continued growth of Zoro SKU portfolio, which grew by 900,000 SKUs in Q1 and stands at around $12 million in total. We are well on our way to achieving an annual goal of 2 million SKU additions in 2023. Now looking forward to the rest of the year, given the unexpected sharp improvement in profitability and continued resilient demand environment, we are updating our total company guidance for 2023. In our revised outlook, we are holding top line expectations with daily sales expected to be up 7% to 11% for the total company. This reflects solid Q1 performance in high touch offsetting a slightly slower start across inlets assortment with expected softness to continue for the balance of the year at Zoro. High Touch is trending slightly higher than originally expected on a similar 1% to 5% total US MRO market outlook, which continued strong share gains. And this assortment is trending slightly lower, however, we expect daily sales for this segment to be up low double digits, which is a couple of hundred basis points higher when translated to constant currency. Note that April sales growth for the total company is holding firm with month-to-date sales up 10% year-over-year or nearly 11% in daily constant currency. The larger changes to our guide come on the profitability side. More improved product availability and the resulting step change in service levels is driving better freight dynamics, lower handling costs and improved product mix. With this, we are raising our gross margin range to 39.1% in to 39.4%, up 70 to 100 basis points year-over-year. While we still expect to be price/cost negative over the next few quarters as we unwind prior year favorability. The supply chain improvement is flowing through our P&L much faster than anticipated and is fueling the predominance of our revised outlook. The increase in gross margin largely falls through the op margin improvement and resulting EPS, which we now expect to be between $34.25 and $36.75 and nearly 20% increase year-over-year at the midpoint. We have updated our supplemental guidance, which can be found in the appendix and includes revised segment margins and improved operating cash flow outlook and increased expectations for share repurchases for the year. Our execution has put us on a great path. We are serving customers well -- we're remaining focused on the things that matter and are positioned to continue to take share. I exit the quarter very confident in our ability to continue to deliver on our commitment to shareholders. With that, I'll turn it back to DG for some closing remarks.

Operator:

Thank you. We are now conducting a question-and-answer session. [Operator Instructions] Our first question today is coming from Chris Snyder from UBS.

D.G. Macpherson:

Sure. Thanks, Chris. Yes. We are certainly seeing supply chains improve. I do think that a lot of the work we've done through the pandemic in the last three years has helped build some stickiness with our customers. I was -- every customer I go into, we've expanded our KeepStock operation if there of any size. We're filling bins, we're doing more and supporting customers to make sure that they have the right inventory in the right place. And I think that's been a big part of it. We continue to see really good results from merchandising, from marketing, from KeepStock and from our supply chain performance. All those things continue to be an advantage for us and helping us gain share.

Dee Merriwether:

So yeah, Chris. How you doing? I would talk about the -- the last part of your question, I believe, first, which was you asked about producer price push. That has, of course, become less and less over a period of time. So it's basically modest as what we have seen of late. However, as you know, in the first quarter is when we implemented some of those costs are pulled them through to our system. And so for Q1, it's traditionally a high watermark for us for price cost. And as you noted, we expect to unwind some of our price cost positivity from 2022 as a result through the next couple of quarters.

Operator:

Thank you. Your next question is coming from Tommy Moll from Stephens. Your line is now live.

D.G. Macpherson:

Good morning.

Dee Merriwether:

So thanks for the question. Obviously, we've had a really strong start to the year. And as I noted, we really feel like from a GP specifically in high touch, we're at a high watermark based upon the unwind that we're going to experience with price costs. A lot of the favorability that we experienced this quarter relates to our availability improving and some of the friction costs coming out faster and probably a little bit more pronounced then we would expect that is driving our results up. We did have a, I would say, a non-comparable freight impact of about 20 bps as you look at the outlook for the rest of the year. But other than that, we feel pretty confident in staying at this level based upon what we see right now.

D.G. Macpherson:

Yeah. So roughly 80% of Zoro's business is business to business customers that are small businesses and midsized businesses those, while they continue to perform pretty well in the first quarter. We are seeing sort of across everything smaller businesses and consumer-facing businesses slow down relative to certainly large and industrial-type businesses. So there's a mix here thing that's going on. And then the 20% that is not business to business, some of that came through the pandemic, as you might imagine. That has been down fairly substantially in the first quarter. So that's been a drag. Net-net, we still expect the endless assortment to be low double-digit growth, and we expect the segment to perform well during the year, but we do expect our -- to be below what we expected at the begin of the year.

Ryan Merkel:

Hey, everyone. Nice quarter.

Ryan Merkel:

I wanted to start on the freight and supply chain dynamic. Can you just talk about maybe take us from November, December to today? And just talk about how you got surprised by supply chain sort of normalizing? And what sort of happened? Did everyone start to have the lead times improve it at one time in the quarter?

Ryan Merkel:

Got it. Okay. That's clear. And then, DG, I wanted to ask your opinion on AI. How do you think that might help Grainger? And what could the impact be to the industry?

Operator:

Your next question is coming from Jacob Levinson from Melius Research. Your line is now live.

D.G. Macpherson:

Good morning.

Jacob Levinson:

DG, maybe you can just give us a sense of how things are going north of the border in Canada. And I know that, that business has been on a long journey to get back on track. But maybe if you put in innings, what inning are all the in that way.

Jacob Levinson:

Okay. Great. And just shifting gears on the balance sheet for a second. Look, we've put positive commentary from quite a few other companies about M&A valuations coming in and maybe being one of the better markets for buyers in a long time. You've obviously got a maybe even an underlevered balance sheet and recall you talking about M&A for the first time, quite a while back at the Investor Day in the fall. I mean, is that -- is M&A is something that you see factoring in over the next months or so.

Operator:

Thank you. [Operator Instructions] Our next question today is coming from David Manthey from Baird. Your line is now live.

Dee Merriwether:

Sure. Just to roll up what you said a little bit, we really focus on PPI and IP to -- as a predictor or outlook of the MRO market. And our estimates about where it stood as we put together our guide, which is showing volume down 3% to flat in the US and price between 4% and 5%. So that's where we were at the end of the year as we look at the latest updates of IP and PPI there about there. And so underlying a lot of our assumptions is the MRO market growth, including price and volume of about 1% to 5%.

D.G. Macpherson:

Yeah. I mean it's a really interesting question. We -- Grainger has always had a wonderful culture, one where people really wanted to do the right thing for customers and very highly ethical company. About six years ago, we went through a process to say what needed to change. And we outlined a set of principles that we talk about at every meeting at every, every day basically and say are we in, in those principles. I think the things that have probably moved the most have been making sure we're starting with the customer, making sure we're competing with urgency and making sure we're acting with intent, meaning working on the things that really matter. I think our culture historically might have not always been as focused on a few things that matter and stay on them as long as needed to make them really great. And I think that's been a big focus for us as a leadership team. And I think that's probably a shift. I mean the shift is slow, to be fair, cultures don't change overnight, and so we're constantly working on it. The business I think we've been most focused on that have been a little bit different from the past.

Steve Volkmann:

Yeah. Thanks for taking the question. This one is a little bit lucy as well. But it feels like on the logistics and freight costs that there's sort of two things going on. Obviously, the cost of those things has come down, but then you're also managing it much better. And I guess I'm curious if there's more opportunity as we go forward just in terms of how you manage it to continue to see some gains in that area.

Steve Volkmann:

Great. And then my follow-up is just your long-term kind of EPS targets from the Analyst Day. It seems like you're already pretty much there or getting close anyway. How do you think about revisiting those targets over time?

Operator:

Thank you. Your next question is coming from Pat Baumann from JPMorgan. Your line is now live.

D.G. Macpherson:

Yes. So as we built the plan for this year, we knew that our comparison would get harder as the year went along because we came out of the pandemic in every month last year, we effectively got better. So I'd say we're right where we expect to be right now. The 11% is seasonality-wise, is normal. And the relative growth rate is only down slightly because we continue to improve through the year last year. So we're basically on what we expected to see at this point.

D.G. Macpherson:

Yes. So the Masaya Suzuki, who is the CEO of MonotaRO also leads that business and the person reporting to him Kevin he's been with us for 15 years left to take a CEO job, which was great for him. And Sandy Mattison who Officer has moved in, I don't expect to see big shifts Sandy knows the business well, and we're just continuing to push on the core initiatives and Masaya is still supporting her and we're supporting her to make sure we can continue to improve that business and grow.

Unidentified Analyst:

This is Tyler Boyd on for Deane Dray. Just looking at Slide 21, it looks like was fairly broad-based across end markets. Maybe you noted a little bit of slowing maybe in consumer retail end markets. Is there anything else that you'd call out where demand is waning particularly strong?

Unidentified Analyst:

Great. That's it for me. Thank you.

Katie Fleischer:

Hi. Kind of going off of the prior question, can you just talk about if you've seen any divergence between your small- and medium-sized customers versus the national accounts?

Katie Fleischer:

Okay. And then just for my follow-up. So one of your competitors recently talked about a slowing cadence of manufacturing activity through the month of March. I was just wondering if you've seen any sort of similar dynamic or any demand issues that you're concerned about?

Operator:

Thank you. We reach the end of our question-and-answer session. I'd like to turn the floor back over to D.G. for any further closing comments.

Operator:

Thank you. That does conclude today's teleconference and webcast. You may disconnect your line at this time, and have a wonderful day. We thank you for your participation today.

Kyle Bland:

Good morning. Welcome to Grainger's fourth quarter and full year 2022 earnings call. With me are D.G. Macpherson, Chairman and CEO; and Dee Merriwether, Senior Vice President and CFO. As a reminder, some of our comments today may include forward-looking statements. Actual results may differ materially as a result of 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 Q4 earnings release, both of which are available on our Investor Relations website. This morning's call will focus on fourth quarter and full year 2022 adjusted results, which exclude the gain related to the divestiture of Cromwell's enterprise software business, which was sold in the fourth quarter. We will also share results related to MonotaRO. Please remember that MonotaRO was 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 will differ somewhat from MonotaRO's public statements. Now I'll turn it over to D.G.

Dee Merriwether:

Thanks, D.G. Turning to our fourth quarter 2022 results for the total company, it was a solid quarter to finish out this year. And while you'll notice some noise as we walk through the financials, at the end of the day, we delivered great results. Sales growth in the quarter was 13.2% or 17.2% on a daily constant currency basis, which normalizes for the impact of the depreciating yen. Our results this quarter included strong growth in both segments as we continue to execute well against our strategic priorities. This includes approximately 800 basis points of share gain in the U.S. high-touch business and high-teens growth in local currency across endless assortment. Total company gross profit margin in the quarter was 39.6%, expanding 230 basis points over the prior year fourth quarter driven by increases in both segments and including a favorable year-over-year impact from year-end inventory adjustments, which I'll detail in a moment. The strong gross margin performance was partially offset by a decrease in SG&A leverage in the quarter. We continue to invest in our strategic initiatives and also incurred an aggregate $35 million in non-recurring items in the quarter. This includes a one-time bonus to most hourly employees within high touch to recognize their significant contributions towards our 2022 performance. Excluding these one-time non-recurring items, total company SG&A as a percentage of sales would have been roughly flat year-over-year. Despite these non-recurring costs, we still finished the quarter with operating margin up 135 basis points over the prior year period. This profitable growth resulted in diluted EPS of $7.14 for the fourth quarter, representing a 31% increase versus the fourth quarter 2021, another strong quarter of performance. In our High-Touch Solutions segment, we continue to see strong growth with daily sales up 16.8% compared to the fourth quarter of 2021. We saw continued positive growth in all major customer end markets across the segment, including over 20% growth in natural resources, transportation and heavy manufacturing. The daily sales increase in the U.S. of over 17% was fueled by mid-single-digit volume growth and continued strong price realization of over 11% in the quarter. Canadian daily sales were also strong, up 7% or 17.2% in local days in local currency. For the segment, GP margin finished the quarter at 41.9%, achieving 225 basis points of margin expansion. During the quarter, the segment benefited from lower freight costs and continued improvement in product mix. Margin was also favorably impacted by year-end inventory adjustments as we lap the unfavorable LIFO adjustment from the prior year period and also recorded a positive net inventory adjustment in the current year period. The net impact of these inventory adjustments was around 130 basis points for the segment. Price/cost spread in the quarter was also roughly neutral. Moving to SG&A. The segment delevered by about 35 basis points, which was driven by continued investments in marketing and headcount to support growth. In addition, the segment incurred $29 million in non-recurring items in the period, including the one-time bonus payment previously discussed and some accounting true-ups to close the year. While we did modestly delever SG&A, we still expanded operating margins by 190 basis points year-over-year, finishing with a 15.5% operating margin for the segment. This is a strong finish for our High-Touch team. Looking at market outgrowth on Slide 10, we estimate that the U.S. MRO market, including volume and price inflation, grew between 9% and 10%, implying we outpaced the market by roughly 800 basis points in the quarter. This strong finish helped us deliver 775 basis points of market outgrowth for the full year 2022. We continue to have great success in gaining share as we execute against our strategic growth engines in our High-Touch model. We remain confident in our ability to deliver the 400 to 500 basis points of annual outgrowth going forward and are excited to continue partnering with our customers and our suppliers to drive value for all parties each and every day. Moving to our Endless Assortment segment, reported and daily sales increased 0.9% or 18.2% on a daily constant currency basis after normalizing for the significant impact of the depreciating yen. In local currency and local days, MonotaRO achieved 19.4% growth and Zoro U.S. was up 19.5%. Revenue growth continues to be driven by strong new customer acquisition and repeat business for the segment as well as enterprise customer growth at MonotaRO. Gross margin for this segment expanded 170 basis points versus the fourth quarter of 2022 as we saw strong price realization, coupled with continued freight efficiencies as average order values have increased year-over-year. We also benefited from favorable business unit mix as Zoro grew faster than MonotaRO in the quarter. Segment operating margin declined 180 basis points as favorable gross margin was more than offset by heightened SG&A costs. While Zoro's operating margins were roughly flat in the quarter, MonotaRO was impacted by start-up costs at the new Anegawa DC as well as non-recurring asset retirement costs related to the upcoming closure of the Amagasaki facility. As we lap the DC transition costs and ramp a new facility to peak efficiency, we expect profitability will begin trending towards more normal levels as we move through 2023. On Slide 12, we continue to see positive results with our key Endless Assortment operating metrics. Total registered users are tracking nicely with Zoro and MonotaRO combined, up 17% over the prior year. On the right, we show the continued growth of Zoro SKU portfolio, now at over 11 million SKUs. And in 2022, the team successfully delivered on our stated goal to add 2 million SKUs per year over the next several years. In summary, a great job of spending the Endless Assortment flywheel by both Zoro and MonotaRO in 2022. I also want to acknowledge the exciting news that our Zoro U.S. business surpassed $1 billion in annual sales in 2022, the first time they exceeded that threshold in their history. It's been an amazing success story since we launched this business back in 2011, and we remain excited about what Masaya, Kevin and the rest of the Zoro team will accomplish going forward. Moving to our outlook. Despite the economic uncertainty heading into 2023, our high-level earnings algorithm remains intact. Within our High-Touch segment, over the longer-term economic cycle, we target growing 400 to 500 basis points faster than the U.S. MRO market and remain confident in our ability to do so. In our Endless Assortment segment, we expect to continue our track record of strong growth, both in the U.S. and in Japan. At the total company level, we target generally stable gross margin performance over time while sticking to our core pricing tenant, and as we strive to grow SG&A slower than sales to help expand operating margin. Couple this with our balanced and consistent approach to capital allocation, and we can drive attractive returns over the long term as we've done especially well over the last few years. So what does this mean for 2023? At the total company, we expect revenue between $16.2 billion and $16.8 billion, with daily sales growth between 7% and 11%, driven by strong top line performance in both segments. Note that this range is 40 basis points lower on a reported basis when factoring in one less selling day in 2023. Within our High-Touch Solutions segment, we expect daily sales growth between 5% and 9.5%. In the U.S., we're planning for MRO market growth between 1% and 5%, comprised of a volume range of flat to down 3% coupled with price inflation between 4% and 5%, largely representing the wrap of 2022 price increases. On top of a 1% to 5% market, we expect to continue executing against our strategic growth engines to achieve 400 to 500 basis points of U.S. market outgrowth in 2023. In the Endless Assortment segment, we anticipate daily sales to grow between 16% and 18% or roughly 17% to 19% in daily constant currency when factoring in 100 basis points of foreign exchange headwind at the segment level from the Japanese yen. Zoro is anticipated to grow within the segment range, reflecting further SKU expansion and a continued focus on acquiring and retaining high-value business customers. MonotaRO is also expected to grow within the segment range and local currency as they continue to grow with both small businesses and large enterprise customers. Moving to our margin expectations. We expect strong performance in both segments with stable to expanding performance in High-Touch Solutions and improving profitability in Endless Assortment. In the High-Touch Solutions segment, we expect gross profit in the year to be flat to slightly down as we anticipate some of the price/cost favorability experienced in 2022 to unwind as we trend back to neutrality over the long term. We expect this headwind will be partially offset by freight favorability given the improvement in container cost and the current outlook for diesel prices. On the SG&A side, we will continue to make incremental investments toward our strategic initiatives as we fuel our growth algorithm. We will also have some tailwinds as we lap the non-recurring items that hit in the fourth quarter and a certain expenses like variable compensation reset in the new year. Overall, in total, we expect SG&A leverage to be favorable, and therefore, when combined with our top line growth expectations, we anticipate operating margin of 16.3% to 16.8% in High-Touch for 2023. In the Endless Assortment segment, we expect MonotaRO's operating margins to improve year-over-year as they continue to benefit from favorable freight efficiencies and strong price realization. At Zoro, we expect operating margins to continue to ramp as they gain leverage on their cost base. Overall, this represents operating margin for the segment between 8.6% and 9%, an improvement of 60 to 100 basis points compared to 2022. Growing this up for total company, we expect to gain SG&A leverage of 30 to 60 basis points to offset a modest decline in gross margin, resulting in operating margin between 14.4% and 14.9% for the full year. Turning now to capital allocation, we expect the business will continue to generate strong cash flow in the year with an expected range of $1.45 billion to $1.65 billion, an increase of over $215 million at the midpoint compared to 2022. We expect to use this cash to invest in the business and return capital to shareholders. As discussed at our Investor Day in September, we plan to invest in our DC network over the next few years to support strong growth and to maintain industry-leading service levels. With this, we anticipate capital spending in the range of $450 million to $525 million in 2023. This includes DC capacity investments to expand our service advantage in the U.S. as well as the start of a new DC project in Tokyo. We are also continuing to invest in technology to further our customer and product information advantage and we'll continue spending on accretive ESG investment across the portfolio. We expect to continue to return a significant amount of cash to shareholders in line with our historical approach. This will include share repurchases to the tune of $550 million to $700 million and a strong cash dividend, which we've increased consistently for the past 51 years and expect to do so again here in 2023. Summarizing the high-level points on Slide 17, you can see these revenue, profitability and capital allocation expectations translate to adjusted EPS of $32 to $34.50 per share, a 7.9 to 16.3 percentage increase over 2022, and nearly double our pre-pandemic 2019 adjusted EPS of $17.29. We are off to a really strong start in January with preliminary total company daily sales of 16% or around 19% in daily constant currency. We do expect growth rates will be stronger in the first half as results will benefit from a more pronounced price wrap. In the second half, we will face tougher comps and have modeled a slower economic cycle. On profitability, while every year is different, we do expect gross margins will generally follow our traditional seasonal pattern with a high water mark in the first quarter and sequential declines in the second and third quarters. We anticipate SG&A will be reasonably consistent over the course of the year. With that, I'll turn it back to D.G. for some closing remarks.

Operator:

Thank you. And at this time, we will conduct a question-and-answer session. Please limit yourself to one question and one follow-up question. [Operator Instructions] Our first question comes from Tommy Moll with Stephens. Please state your question.

Dee Merriwether:

So I'll start with the first part and then maybe D.G. can add in a little bit on what he's hearing from -- what he's hearing from some customers on the visit. So, yes, when we look at the market outlook, it includes both price and volume. And so the sum of that, we believe, will be somewhere in the range of 1% to 5% of the total market. We believe that volume will be down 3% to flat. And as you know, at price, up 4% to up 5%, we have more visibility into our pricing than anyone. And so when we look at price, we are also taking into account our wrap, which is basically the price increases that we took in 2022 and their full impact to 2023. So, we still see a little bit more price coming our way. So, it takes that three-ish percent up to about 4% to 5% from for the price outlook.

Tommy Moll:

That's helpful. And then I wanted to follow up on the volume -- the volume outlook for High-Touch flat to down three. And D.G., you mentioned at least one area of strength in aero and one area of relative weakness in retail. But I'm just curious, as you roll it all up into that full year outlook, are there other areas of weakness you're already seeing? Or is it more just potentially some conservatism around the back half? Anything you could provide there would be helpful.

Operator:

Our next question comes from Ryan Merkel of William Blair. Please state your question.

Dee Merriwether:

Well, if you're specifically focused on GP in the U.S., our gross margins have expanded, if you look over a longer period of time here. And as it relates to price cost, just want to reiterate, when we talk about neutrality, we do talk about that over time. And we have continued to speak about the fact that price cost just like GP is lumpy. We have a cost cycle, which we have traditionally had for years that really didn't hold last year because of how fast cost inflation was coming in to suppliers. So that makes the cost piece of that a little bit lumpier. And then if you recall, we have the opportunity based upon our percentage of revenue, highly contracted. We have the right to introduce price at different periods during the time. We also have web price, which is also a good portion of our business, and we can pass price on web at any particular time. So that is the lumpiness. It's the timing of when we can actually price plus the timing of when cost actually comes through. And that's why our focus is doing that over a period of time and when it makes sense, both for our supply base as well as for our customer base.

D.G. Macpherson:

Yes. Maybe I'll cover that. First of all, I think that the way you measure price inflation is probably not common across everybody. So you dive into the details that we don't really know how others are talking about price inflation, so we wouldn't comment on that. I think the thing I would point to is, to Dee's point, we generally think of price as pricing to the market, and we are very confident that what we have now is market competitive, and we look at that very, very, very closely, given our history, you might understand why we would do that. And so we are more wired on how we price competitive. As you said, there's really a lot of lumpiness. We may have taken price later than others or some may have taken earlier who knows. But the reality is that we are very competitive now and feel like we're in a good position on pricing.

Deane Dray:

Could we touch on freight for a second? It looked like that rate efficiencies helped you on price cost, if I read that correctly, but it still sounds like there's freight inflation. So where does that stand today?

Deane Dray:

That's helpful. And then a follow-up on the supply chain. Just where does it stand today in efficiencies? What kind of lead times are you seeing and expectations about returning to normal?

Operator:

And our next question comes from Chris Snyder with UBS. Please go ahead.

D.G. Macpherson:

Yes. I mean I guess I would say just from a core sort of principle for us, we think of outgrowth in terms of volume, we expect price to be relatively neutral. You're right, we make it modest benefits over time that can happen. But certainly, what we're talking about is volume outgrowth. The position from last year, certainly, we got some benefit from supply chain fairly modest. And what we do is we sort of decouple that analytically and look at what our initiatives are doing, and that's how we came up with the 400 to 500 basis point target at the Analyst Day, we're still sticking with that. I mean, obviously, we've done a little better than that. But for now, we're not changing that. That's our expectation going forward.

D.G. Macpherson:

Yes. So we have a favorable mix. Mix for us generally means product mix here. And so you can imagine during 2020 and 2021, in particular, we had a very negative mix because we had -- we were selling any mask in the world we could find, we're selling it, and that is a lower margin product. I would say we are more back to normal now in terms of the industrial products that we have typically sold, and that's been a favorable mix for us. And certainly, we are working hard to make sure that we can compete with technical products or industrial products, and that will be a focus for us going forward. But most of the mix benefit has been getting -- really getting back to normal is the way I describe it.

Jake Levinson:

D.G., are you guys still experiencing any kind of labor issues either at the factory level or otherwise? Just thinking about kind of the mix signals we're seeing in the labor market. You still got wage inflation at the lower end and seemingly a lot of competition and warehouses and factories and whatnot, but just curious what -- how that translates for you guys.

Jake Levinson:

That's helpful. And just switching gears, I guess, as a consumer when you get a lot of inflation, you see people switching from the premium product to the private label brand. Are you seeing that kind of trend in your business where customers that might want to prefer your Grainger brand over some of the marquee brands, if you will.

Operator:

And our next question comes from Christopher Glynn with Oppenheimer. Please state your question.

D.G. Macpherson:

Yes, it's the latter, Chris. So we've -- we started this initiative three or four years ago. We've worked through sort of some initial category reviews. We keep getting better at them. What we've discovered is that we've learned a ton as we've gone, and we're just getting better and better at it and there's still a lot of improvement to be made. It will be a consistent benefit for us, we believe, going forward for the foreseeable future, sort of that midterm three- to five-year time frame. We still see a lot of benefit from improving the way we merge. And it's core to what we do. I mean helping customers have confidence that they found the right product, it's kind of what we do. So getting better at that seems to have a good result, and we're going to continue to really push hard on that.

D.G. Macpherson:

No. We are -- I would say we are agnostic to what the -- not agnostic to the economics, but agnostic to sort of identifying higher-value products. We're trying to make it super easy for customers to find what they need. And so it's really all about, do we have the right assortment, can we present it in a way that makes it really easy for customers to find so they can have a lot of confidence that they're getting the product that they need to use for the right application.

David Manthey:

First off, I'm interested in understanding how you capture a LIFO benefit when both inventories and the LIFO reserve are up quarter-to-quarter and year-to-year. I just if you could go through the mechanics of that, I'd appreciate it.

David Manthey:

Okay. And the second, the share gains that you've been seeing has clearly been terrific. Could you discuss the balance that you're seeing between new customer adds and selling more to existing customers? I would imagine there's a difference between High-Touch and Endless Assortment. But could you just give us some color on that.

Operator:

And our next question comes from Ken Newman with KeyBanc Capital Markets. Please state your question.

Dee Merriwether:

So the -- if you're looking at our guide, the guide is implying 30 to 60 basis points of SG&A leverage for next year. And as I think about that, let's remember a couple of things. We're continuing to invest in demand generation, and we had some one-time costs this year that we don't expect to impact us next year. And I will say the -- one of the last things to consider is going into a new year, we get to reset our variable cost like variable costs such as variable compensation back to a 100% of our plan. And then we have some modest productivity that we built into the plan because we focus our organization on looking at driving standard work automation and productivity every day. So, we don't have to have huge events. We do that in times when things are going really well, and we can scale and also when things are tightening up. So, those are the numbers that I had related to the type of SG&A leverage we're looking to gain. And remember, that's in the midst of us continuing to invest.

Dee Merriwether:

Can you repeat that question again?

Dee Merriwether:

So with that investment, it also includes some investments in DC capacity. So we expect to continue to build inventory as we stand up some of those new buildings. We do expect to see some slight improvement in working capital as far as it is not diminishing as much as it has in the last couple of years because we were investing much more significantly in inventory, say, last year, and we're starting to see some improvement and our accounts receivable execution as well.

Chris Dankert:

I guess looking at the margin guide for analyst assortment, pretty impressive expansion in '23 expected here. How do we think about kind of the long-term path towards that 11% margin guide? I mean does the DC investment in Tokyo, what else should we be thinking about in terms of cost and investments in '24 and beyond maybe as we think about Endless Assortment profitability over time here?

Chris Dankert:

Okay. And just to put a finer point on that last piece about Tokyo. I mean, will that have a similar impact as the stand of Osaka did in terms of operating two facilities that once whenever that investment comes through?

D.G. Macpherson:

I think Chris was asking a different question, which you were asking about Tokyo, whether it's going to be a similar issue with Tokyo when that comes on board. The answer is who knows. It depends on the pattern of the timing and when things open. It may or may not be as impactful, but we'll comment on that as we get closer to that's three or four years out so.

Pat Baumann:

A quick one, I think you're expecting on gross margin for the fourth quarter, like 38% to 34%. Can you just walk from what you were expecting to that 39.6% that you reported kind of like what surprised you? You called out LIFO benefit, but that's like a year-over-year impact. So I'm not sure if that's like the entire bridge to that 39.6%. I know, it's 1/3 year-over-year, but I'm not sure that that's like the difference in kind of where you came in at versus what you expected. So maybe color on that.

Pat Baumann:

Okay. Is it kind of like in that order in terms of like the magnitude of difference?

Pat Baumann:

Great. And then my follow-up is just on -- it's also on gross margin, just to guide for '23. Just wondering what the assumptions are kind of behind that modest contraction for some of these moving parts? Like is it price/cost negative which is offset by freight kind of those wash out and then kind of the decline is like just kind of segment mix related? Or is there anything in there for kind of the inventory adjustment dynamics to think about? Just wondering that year-over-year guide, how to think about the moving parts for that.

Operator:

And we have reached the end of our question-and-answer session today. I will now turn the call over to D.G. Macpherson for closing remarks.

Operator:

Thank you. And this concludes today's conference. You may disconnect your lines at this time. Thank you all for your participation.

Kyle Bland:

Good morning. Welcome to Grainger’s third quarter 2022 earnings call. With me are D.G. Macpherson, Chairman and CEO; and Dee Merriwether, Senior Vice President and CFO. As a reminder, some of our comments today may include forward-looking statements. Actual results may differ materially as a result of 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 our third quarter 2022 results, which are consistent on both a reported and adjusted basis for the respective quarterly periods presented. We will also share results related to MonotaRO. Please remember that MonotaRO is a public company and follows Japanese GAAP, which differs from US GAAP, and is reported in our results one month in arrears. As a result, the numbers disclosed will differ somewhat from MonotaRO’s public statements. Now, I’ll turn it over to D.G.

Dee Merriwether:

Thanks, D.G. As D.G. highlighted, it was another quarter of exceptional results, which are summarized at the total company level on Slide 7. We delivered strong growth and gross margin performance across both segments and also manage our SG&A well, driving 85 basis points of leverage in the quarter as we continue to stay disciplined, while investing to support long-term sustainable growth. This growth in profitability resulted in diluted EPS for the quarter of $8.27, up 46.4% versus third quarter of 2021. Turning now to our High-Touch Solutions segment for the third quarter. We continue to see strong results with daily sales up 19.4% compared to the third quarter of 2021. We saw a broad-based double-digit growth across all geographies and over 20% growth with both midsized and large customers in the US. Daily sales growth in the US of 20% was fueled by broad-based volume growth and strong price realization of over 12% in the quarter. Canadian daily sales were also strong, up 11.4% or 15.5% in local days and local currency. For this segment, GP margin finished the quarter at 40.6%, achieving 125 basis points of margin expansion. The increase is primarily due to product mix as well as favorable price/cost spread, realizing a timing benefit as we continue to work through cost discussions with our suppliers. Price/cost was also aided by some targeted customer and product actions as we work to ensure we are receiving the right economics for the value we provide to customers. These favorable contributors to gross margin were partially offset by heightened freight costs in the quarter. Our pricing team continues to do a really nice job managing through this highly inflationary environment. And while the timing will always be choppy from quarter-to-quarter, we remain focused on our core pricing tenets of achieving price/cost neutrality over time while ensuring our prices remain market competitive. Increased SG&A spend in this segment was driven primarily by higher headcount to support growth and compensation costs as well as continued investments in marketing. Even with the increased investment, we delivered 150 basis points of SG&A leverage year-over-year, and we're combined with the continued gross margin expansion, Q3 operating margin of 17.3% was up 275 basis points versus the prior year. Overall, a very strong quarter for the High-Touch Solutions business. Looking at market outgrowth on Slide 9, we estimate that the US MRO market, including volume and price inflation, grew between 12.5% and 13.5%, indicating that we achieved roughly 700 basis points of market outgrowth in the quarter. As you heard at Investor Day last month, we're having great success gaining share as we execute against our strategic growth engine. Given our recent performance and go-forward expectations, as announced at Investor Day, we are now targeting 400 to 500 basis points of annual outgrowth going forward, a 100 basis point increase from our previous outlook target. The strength of our initiatives, coupled with our supply chain advantage, gives us confidence in our ability to deliver against this commitment. Moving to our Endless Assortment segment. Reported and daily sales increased 8.6% or up 23.7% on a daily constant currency basis after normalizing for the significant impact of the depreciating Japanese yen, which is down over 23% versus last year. In local currency and local days, MonotaRO achieved 19.8% growth and Zoro US was up 27.4%. Revenue growth continues to be driven by strong new customer acquisition and repeat business for this segment as well as enterprise customer growth at MonotaRO. Gross margin expanded 130 basis points versus the third quarter of 2021 as we continue to see freight efficiencies from increased average order value. We also benefited from favorable business unit mix as Zoro grew faster than MonotaRO in the quarter. Segment operating margin declined 95 basis points in the quarter as favorable gross margins were offset by continued investments to support growth in both businesses as well as DC start-up costs at MonotaRO for the new Inagawa DC. The new facility is ramping nicely. As we exit our legacy facility in the first quarter of 2023, we anticipate that the business will return to normal operating margins thereafter. On Slide 11, we continue to see positive results with our key Endless Assortment operating metrics. Total registered users are tracking nicely with Zoro and MonotaRO combined, up 17% over the prior year period. On the right, we show the continued growth of the Zoro SKU portfolio, now at over 10.3 million SKUs. You'll see a more modest increase between the second and third quarter as Zoro -- is offering of SKUs that could not meet our service level expectations. We continue to target around 2 million SKU additions in 2022 and have a robust pipeline to meet that goal as we finish the year. Turning to guidance. With another very strong quarter and with sales in October trending up over 16% on a daily reported basis or over 21% in constant currency, we are raising our 2022 full year outlook. While we acknowledge that the broader market conditions remain uncertain and the risk of a potential recession has certainly increased, we have not seen any meaningful slowdown in our business and continue to outperform our normal seasonal trends. Our updated outlook for the full year 2022 includes

Operator:

Thank you. And at this time, we'll conduct our question-and-answer session [Operator Instructions] Our first question comes from Tommy Moll with Stephens. Please state your question.

D.G. Macpherson:

Good morning.

Tommy Moll:

Dee, I wanted to circle back to your comments on High-Touch profit in the third quarter. You called out price/cost was a tailwind in the period, and there were some timing impacts, I think, related to discussions with suppliers, but if you could elaborate on what you were referencing there around the timing and whether that implies that it may look different next quarter or at some point in the future, that'd be helpful. Thank you.

Tommy Moll:

That's helpful. Thank you, Dee. Shifting gears to capital allocation. If I'm looking at your guidance for this year correctly, I think in terms of operating cash flow, there's no update to your prior guidance, but it looks like CapEx and share repurchases have been pulled in a little bit. So I'm curious for any commentary you can give there. And then also as you think about CapEx for next year and some of the capacity expansion initiatives you talked about at Investor Day, if there's any early peak you can give us about priorities for 2023, that'd be helpful as well. Thank you.

Operator:

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

D.G. Macpherson:

Yes. Sure. So thanks, Dave. We have -- we talked at Investor Day, based on our improved customer information, we have been able to identify a potential to add some sellers. We've added them relatively small percentages overall to a couple of pilot areas that we're running now, and we expect to have results of that early in the year, and that will inform what we do going forward. We do think we're going to have the ability to consistently add sellers and also improve the effectiveness of sellers based on the information we've now built and have on customers. And so that's a pretty exciting path. We won't have details for you in terms of what that looks like in the aggregate probably until second quarter next year when we start to hear -- get all the results back from the pilots.

D.G. Macpherson:

Sure. I was over there--

D.G. Macpherson:

I was over there four weeks ago. I'll let Dee answer the sort of exact timing. But just to give you sort of a magnitude, they're operating two buildings in the Osaka area. The new ones, a six-story enormous building that is coming up to speed and getting up to the line volumes to take over entirely, and they expect that to happen mostly by the end of the year. The other one has been running at the same time. So, that's a duplicate cost. And Dee, I'll turn it over to you for the numbers.

Operator:

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

Dee Merriwether:

Good morning.

D.G. Macpherson:

I think that there's been a fairly significant increased attention to supply assuredness given what's happened in the last few years. And supply chain is improving. They've improved. They aren't fully back, but they are improving for sure, hasn't really changed those discussions. Customers still want to understand how they can make sure that they have what they need to get their jobs done. Obviously, we've always done that through different ways, whether having inventory in a branch or managing inventory on site or having next day delivery, all those things help customers. but we're still having a lot of conversations with customers about -- based on our ability to serve them during these challenging times, how can we continue to help them. And we think a lot of the performance we've had in our supply chain is going to be pretty sticky moving forward based on what we're hearing.

Dee Merriwether:

Yes, I wouldn't think about it so much as rebates, but just we're constantly negotiating on price take timing with our supplier partners. And some of that timing, some has moved up, some has slipped out. And that's why we continually and talk about the lumpiness of GP because it's very difficult to time everything perfectly both from a price perspective and a cost actualization perspective. So, it's nothing more than that. It isn't. We really aren't focused on supplier rebates as a reason for this.

Dee Merriwether:

Thank you.

Jake Levinson:

Good morning, everyone.

Jake Levinson:

D.G., if we did a postmortem, if you will, on the pandemic period over the last couple of years, do you have a sense of how many of these new customers that you picked up during COVID are still buying from you, or maybe just any color you have on kind of the retention rates?

Jake Levinson:

Okay. That's helpful. And just shifting gears on price. Are your suppliers -- I mean, certainly, you're still seeing price increases for you folks, well after that on a year-over-year basis. Are your suppliers still putting through broad-based increases, or is what we're seeing in the P&L today mostly just reflecting what's already been actioned?

Operator:

Thank you. And our next question comes from Deane Dray with RBC Capital Markets. Please state your question.

D.G. Macpherson:

Deane, what do you -- what are you trying to understand? Go ahead. Go ahead, Dee. You can take that one.

Deane Dray:

It's more of a holistic question, but just give us a sense on pricing traditionally, historically with distributors was much more of a standard markup. And what you've seen is with the advent of more services being added and then understanding exactly the kind of value that Grainger is providing, you're actually able to gain more pricing and, under this umbrella, value-based pricing and wanted to get a sense of where you are in that transition. Do you feel like you've done as much as you can? Are you halfway through? Just any color there would be helpful.

Deane Dray:

Okay, that's helpful. And then, look, supply chain has come up a number of times. How would you characterize it in terms of product availability, lead-time, stock outs? And just also, if you could weave in if that's been the same for your private label offerings.

Operator:

Thank you. Our next question comes from Ryan Merkel with William Blair. Please state your question.

Dee Merriwether:

Sure. Well, if you look at -- maybe if I take it to the over in the US, gross margin was up like in the 125 basis points. About half of that, I would call it the price costs of benefit and again, we see that price costs benefit normalizing as we get into 2023 or during the fourth quarter.

Dee Merriwether:

Well, let me start 2021. Like when you look at this quarter here, it's going to be -- especially November and December, we'll be lapping 2021. That's our first, I would say, significant price inflation period. So that's why it's going to be a little bit tougher comps for us, we believe, the last two months of this year. Our rep for price, we're thinking it will be in the single -- mid-single-digits, low to mid-single-digits will -- looks like what the rent will be heading into 2023.

Operator:

Our next question comes from Chris Snyder with UBS. Please state your question.

Dee Merriwether:

Yes.

Chris Snyder:

Appreciate that. Thanks for all that color. And then my follow-up on that outgrowth in the US. So obviously, the company raised the target to 400 to 500 bps, and it's really substantially above kind of the pre-COVID run rate for the business. But I guess my question is, year-to-date, the outgrowth is running in the 700 or so bp range. When we think about that compression from, say, 700 down to 400 or 500, what does that reflect? Is it just maybe some level of conservatism? Is it the fact that maybe 2022 is seeing outsized pricing versus the market, or that some -- maybe some of the product availability share gains that the company has realized is going away? What's that kind of delta, that compression back? Thank you.

Operator:

Thank you. Our next question comes from Christopher Glynn with Oppenheimer.

D.G. Macpherson:

What I would say is that we think we can grow midsize customers faster than large customers through the cycle. A lot of that has to do with the lower share we have, but also some of the actions we're taking are allowing us to acquire and penetrate midsized customers. Whether that's 20% or not, I won't comment on that. But I'll just -- if you recall, we were in the high 1.5 billion -- 1.8 billion number 10, 15 years ago, and we're going to break through 1.5 billion here in the next year or so, we think. And so we're getting back to where we were, but there's still long ways to go. So, we do feel comfortable that there's going to be faster outgrowth of midsized customers than there are for.

Dee Merriwether:

Are you talking about the GP mix effect?

Dee Merriwether:

Not necessarily. I think the only thing that's probably changed on a consolidated basis is the yen continues to depreciate, but that's going to impact on the topline. The GP rate should be the same algorithm that we've discussed.

Patrick Baumann:

Can you hear me?

Patrick Baumann:

Sorry about that. So, you mentioned product mix as a favorable factor in the quarter year-over-year. Can you elaborate on that at all? I thought we'd move past kind of the pandemic versus non-pandemic stuff. So I'm just wondering what that might be now related to.

Patrick Baumann:

I'm sorry. What are some examples of that, technical product? What is that?

Patrick Baumann:

Do you view that piece of the expansion that you're seeing as more sustainable? Like is that a function of like maybe some of your remerchandising efforts or anything else, or is that temporary?

Patrick Baumann:

Okay. Thanks. And my follow-up is on Zoro. Can you give a sense of how fast you think that market for Endless Assortment, that, that business model is growing in the US? The Zoro growth in kind of the 27% range this quarter, obviously very strong. Just curious like how you think that market itself is growing. It's obviously taking share from, like, I think, traditional distribution. But I don't really have a good sense of how fast it's growing.

Operator:

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

Dee Merriwether:

No. What were you -- you're talking about how much the price/cost one versus...

Dee Merriwether:

Yes. Well, I noted was the US over make year-over-year was about 125 basis points, and I said about half of that -- roughly half of that, so call it, 50 basis points – 50 so basis points is what we're saying is the price/ cost favorability that we believe will normalize heading into...

D.G. Macpherson:

So what I would say is that as we think about next year, as we think about any year, we try to think about the total cost we're going to see and the -- make sure we're pricing the market and get the best cost we can get. In many ways, those cost improvements will be embedded in price/cost because we will understand how those movements, and everybody else is going to have similar movements. The portion of product that comes from China is actually pretty similar across major competitors today. And so we don't think we are disadvantaged or advantaged necessarily on that. So we would expect that to sort of flow through in sort of normal ways from the competitive environment.

D.G. Macpherson:

All right. Thanks for joining us today. We really appreciate you being on the call. As we said, we're certainly happy with the quarter, probably happier with sort of our longer-term ability to consistently gain share and do it in a profitable way and feel really good about the things we're doing in -- as we face into an uncertain market. I hope all of you have a great weekend and a great rest of the year and look forward to talking to you in 2023. Thank you.

Kyle Bland:

Good morning. Welcome to Grainger's Second Quarter 2022 Earnings Call. With me are D.G. Macpherson, Chairman and CEO; and Dee Merriwether, Senior Vice President and CFO. As a reminder, some of our comments today may include forward-looking statements. Actual results may differ materially as a result of 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 Q2 earnings release, both of which are available on our IR website. This morning's call will focus on our second quarter 2022 results, which are consistent on both a reported and adjusted basis for the respective quarterly periods presented. We will also share results related to MonotaRO. Please remember that MonotaRO is a public company and follows Japanese GAAP, which differs from US GAAP, and is reported in our results one month in arrears. As a result, the numbers disclosed will differ somewhat from MonotaRO's public statements. Now, I'll turn it over to D.G.

Dee Merriwether:

Thanks, D.G. Turning to Slide 8. We covered revenue and margins at a total company level, but I'd like to highlight a few other key points. Our total company SG&A as a percent of sales was 23.7%, a 95 basis point improvement over the prior year second quarter as we drove leverage from our top line performance. We continue to invest in our strategic initiatives but remain committed to not adding unnecessary cost to the business. And our resulting EPS in the quarter was $7.19, up 68% versus the second quarter of 2021. Turning to our High-Touch Solutions segment for the second quarter. We continue to see strong results with daily sales up 22.2% compared to the second quarter of 2021. We saw broad-based double-digit growth across all geographies and over 20% growth in both midsized and large customers in the US. In the US, we continue to see strong double-digit volume growth and price realization of around 11%, all helping fuel 23.1% daily sales growth. Canadian daily sales were also strong, up 11.1% or 15.5% in local days in local currency. It's been a long journey, and we are proud of the traction the Canadian team has gained with their now fifth consecutive quarter of profitability. For the segment, GP margins finished the quarter at 39.7%, up 275 basis points versus the prior year, driven primarily by lapping of a $63 million pandemic product inventory adjustment in the prior year period. Excluding this inventory adjustment, we achieved gross margin expansion of over 25 basis points as favorable product mix and largely neutral price cost spread were partially offset by heightened freight costs. As we manage through this highly inflationary period, while there will be quarter-to-quarter fluctuations due to timing, our goal is to remain price competitive, while achieving price/cost neutrality. Increased SG&A spend was driven primarily by higher variable compensation expense as well as continued investments in marketing, payroll, and benefits to support growth. Even with the increased investment, we delivered 150 basis points of SG&A leverage year-over-year and when combined with strong growth margin recovery, Q2 operating margin of 15.6% was up 425 basis points versus the prior year period. Overall, the performance in our High-Touch Solutions business remains strong as our powerful value proposition continues to resonate with customers. Looking at market outgrowth on slide 10, and we estimate that the US MRO market, including both volume and price inflation, grew between 12.5% and 13.5%, indicating that we achieved roughly 1,000 basis points of market outgrowth in the quarter. While we know that our advantaged supply chain contributes to our success, we also continue to see strong growth with our strategic investments. We are excited about the returns that we are seeing on these investments, most notably with our remerchandising and our data-driven marketing programs. Our continued success gives us confidence in our ability to consistently achieve 300 to 400 basis points of annual market outgrowth on an ongoing basis and through the cycle. Moving to our Endless Assortment segment, reported and daily sales increased 11.4%, up 21.1% on a daily constant currency basis after normalizing for significant impact of the depreciating Japanese yen. In local currency and local days, MonotaRO achieved 21.9% growth and Zoro US daily sales were up 23.2%. The segment growth continues to be driven by new customer acquisition at both Zoro and MonotaRO and enterprise and repeat customer growth at MonotaRO, an impressive quarter of growth across the segment. Gross margin expanded 100 basis points versus the second quarter 2021 and was primarily driven by freight efficiencies as average order values increased at both Zoro and MonotaRO as both continue to focus on B2B customers. As planned, segment operating margin declined 25 basis points in the quarter, consistent with the first quarter. This decline was primarily a result of the new DC at MonotaRO coupled with continued investment in technology, marketing, and payroll costs to support growth at Zoro. Despite the increased investment, Zoro operating margins still improved 85 basis points over the second quarter of 2021 as strong GP -- on strong GP improvement. As a reminder, the increased cost at MonotaRO will continue for the remainder of 2022 as they transition to their new Inagala DC. We anticipate that the business will return to more normal operating margins in 2023. In addition, we also continue to see positive results with our key Endless Assortment operating metrics. On slide 12, you can see total registered users across MonotaRO and Zoro combined are up 18% over the prior year period. On the right, we show the continued growth of Zoro key portfolio. We are targeting about 2 million SKU additions in 2022 and will likely exceed that given our progress after the first six months. At the end of the second quarter, we have around 10.2 million active SKUs on the website. Now looking to the back half of the year. With another very strong quarter and with July total company daily sales of 19% or 21% in constant currency, we are raising our 2022 full year outlook. While we acknowledge that the broader market conditions remain uncertain, we have not seen a slowdown in demand in our business and continue to hear positive sentiment from our customers, further supporting our revised outlook. Our updated outlook for the full year 2022 includes expected daily sales growth between 14.5% and 16.5%, and EPS between $27.25 and $28.75, a 41% increase year-over-year at the midpoint. We've also updated our supplemental guidance in the appendix, which reflects improved segment operating margins and net ranges for all other metrics. While it is not typical for us to change our guidance this frequently, our objective is to provide our most up-to-date view with each earnings cycle. Given the strong revenue and profitability performance to date, we felt it was necessary to update our segment metric again this quarter. With that, I will turn it back to DG for some closing remarks.

Operator:

Thank you. And ladies and gentlemen, at this time we will be conducting our question-and-answer session. [Operator Instructions] Our first question comes from Ryan Merkel with William Blair. Please state your question.

D.G. Macpherson:

Thank you, Ryan.

D.G. Macpherson:

Yes. It's a great question. Thanks for asking. Yes, the initiatives have added more than 300 to 400 basis points, we do on many of the initiatives we do A/B tests and we're able to track what the initiatives are bringing and they've been very, very effective in the last year or so. So we continue to see very strong gain from the initiatives. We are getting some tailwind from our inventory position as well. But the initiatives have been very strong in terms of their performance.

D.G. Macpherson:

Yes. I think more time will help us understand if this is going to be -- if we're going to get to a new norm in terms of higher share gain. Thus far, we've committed to the share gain targets and we'll continue to talk to you about what we expect going forward.

D.G. Macpherson:

Thanks.

Tommy Moll:

Good morning. And thanks for taking my questions.

Tommy Moll:

I was going to ask if you'd seen any slowdown in demand and Dee beat me to the punch. So I guess I'll ask it a different way. Is there any end market or customer anecdote that's not as positive as you could even hope for at this point? Is there anything at all that's changed? I just want to circle back on that, because your comment, you haven't yet seen a slowdown. It was pretty clear at the same time, investors are searching closely for any sign of anything that's changed and there have been at least a few macro indicators that have been met.

Tommy Moll:

Yes. That's great. Thank you. Pivoting to a question on your technology investment for high touch. D.G., you've talked for some time about some of the investments you made in the website, the product information systems, customer database, et cetera. Can you bring us up to speed on those initiatives? What inning are we in for this investment cycle? And I was going to ask --

Tommy Moll:

-- if you could identify any of the fruit that's been borne out of these initiatives, which you've already touched on a little bit, but maybe you could give a few more examples.

Operator:

Thank you. And our next question comes from Deane Dray with RBC Capital Markets. Please go ahead.

Dee Merriwether:

So that is on product cost. And so -- if you kind of go back, when we've talked over a period of time, we try to focus on the inflation that comes through product versus what comes through like transportation. And what we have noted is that we -- our goal over the cycle, any cycle is to be price cost neutral as it relates to our product costs, and to cover a majority of any incremental freight costs on a go-forward basis. And as you all probably know, we saw a significant acceleration of fuel pricing during the quarter. And we are working very hard to look for ways to cover some of that incremental freight costs. So it is not -- when we say price/cost neutrality, we're not talking about overall gross margin. It is a component within gross margin.

Dee Merriwether:

Yeah. So thanks for the question. And we are generally always in the market from a repurchase perspective. We're not specifically looking to attempt to try to time the market with our repurchases. And we really try to balance that with our cash generation. And so it was nothing more than Q1 and Q2, we have some large cash payouts during those periods as it relates to our bonuses, some tax payments. So it's generally just timing for us.

Operator:

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

Dee Merriwether:

Well, I'll start D.G. Well, generally, we're continuing as it relates to MonotaRO to ramp up our investments there and fund those investments for carrying two DCs Anegawa and Amagasaki at the same time. So those ramp costs continue to have an impact on us. And similar to the High-Touch segment, the Zoro business is continuing to invest in marketing, payroll costs, as well as technology to drive their long-term revenue growth. So it is just investments during the period of time. And as we get to 2023, specifically for MonotaRO, we expect their operating margins to normalize back to historic levels. And so we'll see some settling out at that point.

Dee Merriwether:

Sure. We generally speak to or share our LIFO impact on an annual basis. So what I will say is that with us being in an inflationary period is very important as you can imagine, to stay on top of standard cost increases with product. And so we are doing that. And so we continue to have increased cost inflation within our inventory and COGS related to LIFO, but we feel like we're fairly on top of that now that we've been in this situation for going on two -- well, I won't say two years, close to a year, a year now. So materially, in the quarter, it was a really immaterial impact, but because we continue to update our standard costs on our inventory and cover that LIFO impact with price.

Hans Hoffman:

Hi. This is Hans Hoffman filling in for Hamza. On the endless assortment segment, specifically Zoro, where do you think profitability can go longer term from where we sit today and where SKU count can go? And then just what does the competitive set or competition look like for Zoro? Thanks.

Hans Hoffman:

Got it. Thanks. And then could you just talk about how you're thinking about headcount additions going forward? What you're seeing in terms of labor inflation, turnover and labor availability?

Operator:

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

Dee Merriwether:

Yeah. Price and volume, the 12%.

Dee Merriwether:

Well, are you talking about price inflation?

Dee Merriwether:

Yeah.

D.G. Macpherson:

Yeah. So what I would say is the typical customer that we acquire is a small business customer. We have actually gotten out of some of the lower-value marketplaces where we weren't getting business users as frequently as you want. So mostly business customers and relatively small business customers. We are then really focused on getting those customers to repeat. And we've seen really nice results through MonotaRO or over the last year in terms of increasing repeat rates for existing customers. And so that's been a nice trend and a very positive trend. In terms of a downturn, we would expect the underlying growth to be able to sort of power through the downturn, we would be affected by the downturn, but we still think we'd have significant outgrowth from the Zoro model given the way the model works and what we've seen in other downturns in MonotaRO and other places.

Christopher Glynn:

Thank you. Great first half. And curious on the second half outlook, the HTS margin guide implies a little bit of a softer sort of tail off on the margin versus normal seasonality. I know last year was bent a little differently. So looking past that, but I think the tape is usually a little more than what's implied here. So curious if you could comment on that?

Christopher Glynn:

Great. And just on this price level getting 10%, 11%, what scenarios within reason, would you see maybe price giving back and reversing a little bit, or are you pretty confident this is a new baseline?

Operator:

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

D.G. Macpherson:

Good morning.

D.G. Macpherson:

So, do you mean inbound transportation or amount product cost or all of it?

D.G. Macpherson:

Okay, yeah. Yeah. So we have not -- we've seen a stabilizing of purchase prices from our suppliers. We have had fewer requests for price increases in the last several weeks than we had several months ago, for sure. But we really haven't seen any backtracking at this point. So it's stabilized, but still not -- not going down, going up slightly, going up less than it was going up.

D.G. Macpherson:

Well, of course, we don't know exactly what our competitors can get. So this is all speculation. It's still a pretty challenging availability market. There still is certainly, the China shutdown didn't help anything and there's still areas of supply that are challenged. So I suspect we still have an advantage on some level. And I think some of the things we've done with our product information, management system has helped us get to crosses, which has been very important in the last 1.5 years to be able to cross to a functional equivalent, so we can get -- if a product is not in stock, we can actually get customer solutions. So I think we have some advantages. And I would say that we are not out of the woods from a global supply chain in our industry yet. It's going to take some while to get out of this.

Jacob Levinson:

Good morning, everyone.

D.G. Macpherson:

Good morning.

D.G. Macpherson:

Well, I think one thing I would say is that, it's -- there's -- the signal to noise in some cases is probably lower than you'd like, if you're looking from the outside, because some competitors are taking price at different times. And so what's changed is, we know we are market price competitive now. And we spend a lot more time focused on that. And the pricing changes we've made have been in line with market. Now we may have taken them at different times, later, earlier, depending on how things go, but we we're very confident that we are market priced at this point. And that's our primary tenant for pricing.

D.G. Macpherson:

Yes. I think few additions are a big part of it. I also think that the customers we're going after are business customers. And so, I think, most of what you would see as compares in the digital space would not be business focused, so we think business customers are probably doing better than consumers online right now. And so that's a big part of it too.

Chris Snyder:

Thank you. I wanted to ask about customer inventory levels. One of the concerns that investors have on the distributors is that industrial companies are reporting outsized inventory levels. Obviously, a good chunk of that is price. But I would appreciate any color or views you have on MRO inventory at your customer base?

Chris Snyder:

I appreciate that color. I guess, I wanted to follow-up for my second question on previous commentary around product availability across the industry, so at your competitors. I guess as industry-wide product availability gets better and starts to normalize. What do you think that means for your business? It sounds like some of the market outgrowth could compress back to the target range. Do you think that carries any risk of price cost, as I'd imagine maybe some of those smaller competitors will look to get back to their market share? Any thoughts on that would be helpful. Thank you.

Operator:

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

Dee Merriwether:

Well, I mean, as you can kind of see our working capital needs have kind of grown with trying to ensure we have the right inventory in stock to meet demand, and to support our customer sales. And so we see that trend continuing. I will say some of the AR growth is starting to stabilize here for us a little bit. And just inside, collections are strong, so we have no issues with collecting from our customers. But it's more a matter of ensuring that we have the right inventory on a go-forward basis. We still will have strong growth, as you know, in the back half that's implied by the guidance. So no big material changes. I would just say a little bit more stability as it relates to working capital needs.

Dee Merriwether:

Well, I mean, based on what you just heard, D.G. say, we still -- as our customers continue to operate, they will still need MRO product. And we're building inventory on some SKUs. And on some SKUs, we still can't quite build inventory. So we will continue to attempt to get inventory back -- levels back to where we feel they need to be to meet demand.

D.G. Macpherson:

We see nice increases in average order value for the Zoro business. And I think a lot of that has to do with whom we're targeting. We're targeting only business customers. And we found ways to avoid acquiring consumers, I would say, through that process that helps average order value. We expect that to continue to get a little bit better as we continue to refine our processes and continue to get more repeat business from these business customers. But we feel like we're on a trend. It's been a little bit better than we expected actually this year from an average order value. So, probably a little better than expected, but we're basically on the path we want to be.

Ken Newman:

Hi, good morning.

Ken Newman:

I just wanted to follow-up on the comments you made earlier in the call about your retail and e-commerce sales. I think they were up mid-single-digits in the quarter, but -- can you just talk a little bit about what's embedded in the sales outlook for that portfolio? And maybe just a little bit more color on how customer behavior has changed through the quarter and into July?

D.G. Macpherson:

No, no, I got it.