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Edited Transcript of GWW earnings conference call or presentation 25-Jan-17 4:00pm GMT

Thomson Reuters StreetEvents

Q4 2016 W W Grainger Inc Earnings Call

LAKE FOREST Jan 25, 2017 (Thomson StreetEvents) -- Edited Transcript of W W Grainger Inc earnings conference call or presentation Wednesday, January 25, 2017 at 4:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Laura Brown

W.W. Grainger, Inc. - SVP, Communications & IR

* DG Macpherson

W.W. Grainger, Inc. - CEO

* Ron Jadin

W.W. Grainger, Inc. - SVP & CFO

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Conference Call Participants

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* Ryan Merkel

William Blair - Analyst

* David Manthey

Robert W. Baird - Analyst

* Robert McCarthy

Stifel Nicolaus - Analyst

* Ryan Cieslak

KeyBanc Capital Markets - Analyst

* Deane Dray

RBC Capital Markets - Analyst

* Andrew Buscaglia

Credit Suisse - Analyst

* Scott Graham

BMO Capital Markets - Analyst

* Adam Uhlman

Cleveland Research - Analyst

* Christopher Glynn

Oppenheimer - Analyst

* Justin Bergner

Gabelli & Co. - Analyst

* Matt Duncan

Stephens Inc. - Analyst

* Hamzah Mazari

Macquarie - Analyst

* Shannon O'Callaghan

UBS - Analyst

* Robert Barry

Susquehanna Financial Group - Analyst

* Joseph Ritchie

Goldman Sachs - Analyst

* Nigel Coe

Morgan Stanley - Analyst

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Presentation

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Operator [1]

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Greetings and welcome to the W.W. Grainger fourth-quarter and full-year 2016 earnings conference call. (Operator Instructions). As a reminder, this conference is being recorded. I would now like to turn the conference over to Ms. Laura Brown, Senior Vice President, Communications and Investor Relations. Thank you, Ms. Brown, you may now begin.

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Laura Brown, W.W. Grainger, Inc. - SVP, Communications & IR [2]

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Good morning, everyone. This is Laura Brown, Senior Vice President of Communications and Investor Relations. Thank you for joining us this morning. With me is DG Macpherson, Grainger's CEO and Ron Jadin, Grainger's CFO.

Earlier this morning, we reported our results for the 2016 fourth quarter and full year. Included in today's press release were several large adjustments. We would like to take this opportunity to discuss these adjustments in further detail and thus the reason we decided to host a live call this quarter.

As a reminder, some of our comments today may be forward-looking based on our current view of future events. Actual results may differ materially as a result of various risks and uncertainties, including those detailed in our SEC filings. These documents are available on our Investor Relations website, together with reconciliations of any non-GAAP financial measures mentioned on today's call with their corresponding GAAP measures.

DG will begin by making some opening comments regarding the performance of the business, as well as provide additional color on a couple of the adjustments. He will then turn the call over to Ron to discuss the remaining adjustments. After closing remarks, we will open the call for questions. DG, to you.

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DG Macpherson, W.W. Grainger, Inc. - CEO [3]

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Thank you, Laura. Good morning, everyone and thank you for joining us. Even though our underlying operations performed as expected, given the number and the size of several fourth-quarter adjustments, I felt the need to discuss them more in open detail.

As Laura mentioned, Ron will cover several of the accounting adjustments as well, but before we do that, I would like to share my thoughts on the performance of the business for the quarter. The fourth quarter was operationally in line with the expectations we shared in November at our Analyst Day, both from a sales and an earnings perspective. Our US business performed slightly better than expected given stronger sales performance in December and solid expense management.

Our business in Canada, while still underperforming, is making progress and also met our expectations for the quarter with better-than-expected sales performance in the month of December. Both the US and Canada exceeded our sales expectation in the month of December, which we partially attribute to the favorable timing of the year-end holidays and some customer year-end spending. Our single channel online businesses, primarily Zoro in the US and MonotaRO in Japan, continue to perform quite well, growing revenue and earnings strongly in the quarter.

So far in January, we are seeing some softness, which we believe is related to extended vacations that occurred in early January due to the timing of the New Year's holiday. In addition, January has a tough comp both in the US and Canada and in Canada, especially in light of some pre-buying that occurred prior to the new system implementation of February 1 last year.

Now this past year, we made strong progress towards positioning the business for better growth and performance in the future. Several examples include further realignment of the large customer salesforce to focus on specific end markets, the launch of our inside sales team focused on medium-size customers; the opening of our 1.4 million square foot new DC in the Northeast. We made significant progress on e-commerce both with our core Grainger.com and online model with the customer experience. We continued previously announced restructuring in the US and Canada, including the closure of 69 branches and we also initiated new pricing in the US, which will provide a more relevant price for new and noncontract customers across all channels, including the Web.

Now with that overview of the quarter as a backdrop, I would like to now cover two of the adjustments that we reported today. First, our decision to write down a portion, roughly half, of the goodwill associated with the Fabory business, which was acquired in August 2011. The impact to EPS was $0.79. For those of you not familiar with Fabory, it is a fastener specialist primarily focused in the Netherlands and Belgium. We have restructured this business on several occasions and we are seeing improved revenue and stable margins resulting from the current initiatives. And while we believe the business has potential for growth in the future, our historical weak growth and margin performance caused us to revalue the long-term goodwill.

Secondly, we took an $0.08 EPS impairment charge for some intangible assets related to our business in Colombia. Both the Fabory and Colombia are fastener specialists and outside of our broadline MRO portfolio. We have been taking action the last couple of years to make sure that we focus on our core broad line MRO markets in developed economies.

So with that, I would like to turn it over to Ron to discuss the remaining adjustments.

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Ron Jadin, W.W. Grainger, Inc. - SVP & CFO [4]

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Thanks, DG. As we shared in this morning's release, we recognized a $36 million or $0.38 per share charge related to an accounting adjustment for unclaimed property. For Grainger, unclaimed property is defined primarily as aged customer debits and credits. Prior to 2013, the unclaimed property was recognized as income and no liability was established. The adjustment made in the fourth quarter reflects our best estimate of any unclaimed property prior to 2013. This issue was identified internally and the estimate has been validated by external third parties.

In 2013, we implemented a new process and began establishing a liability for unclaimed property. In addition, we recorded $9 million or a $0.10 per share charge to increase our reserve for contract dispute. We have been working with the General Services Administration, or GSA, auditors to resolve these issues from an ongoing audit. These issues relate to tax, freight and miscellaneous billing errors. This dispute relates to sales under a multi-award contract beginning in 1999. The GSA continues to be a great customer. We have done more than $2 billion in business with them since the beginning of the contract in 1999.

In addition, there were several small discrete tax items recorded in the quarter to true up estimated taxes versus taxes paid, primarily for US federal and state tax provisions. Combined, these had a negative $0.06 EPS impact, partially offsetting $0.21 in EPS favorability recorded in earlier quarters from the settlement of tax returns for the years 2009 through 2012. Now I will turn it back to DG for closing comments.

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DG Macpherson, W.W. Grainger, Inc. - CEO [5]

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Thanks, Ron. While I am certainly not pleased with the need to make these adjustments in 2016, the underlying business generally met our expectations. As a result, we reiterated our sales and EPS guidance for 2017. As I mentioned earlier, we've made significant changes to the business over the last year and I am excited about the future prospects for growth and profitability for the business.

We are focused on our core businesses in North America, the online model and the UK. We generated $1 billion in cash flow in 2017. We expect to see free cash flow continue to grow as we will not need to spend as much in the coming years on capital expenditures as we have in the recent past. So with that, I'd like to open the call for questions.

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Questions and Answers

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Operator [1]

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Thank you. (Operator Instructions). Ryan Merkel, William Blair.

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Ryan Merkel, William Blair - Analyst [2]

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Good morning, guys and congrats on beating the quarter. So first question for me is why are you reducing gross margins for the year? And then secondly and related, you also mentioned that OpEx is tracking a little bit lower and you are changing that, so what is underlying those two things?

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Ron Jadin, W.W. Grainger, Inc. - SVP & CFO [3]

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Sure. Ryan, it's really early to make a call on guidance for the year. Based on where we ended the fourth quarter really being right on our guidance. As we thought about it, our favorability in expenses we thought we should reflect slightly, but we didn't want to change the overall, so it was just kind of really at the fringe, just a minor tweak for recognizing a little bit of favorability and a little bit of risk on either expense or GP. I wouldn't read -- really probably we shouldn't have change anything in hindsight, it was such a small change and we really don't know anymore about the year now than when we said it in November.

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Ryan Merkel, William Blair - Analyst [4]

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Okay, so nothing really that dramatic changed with the gross margins?

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Ron Jadin, W.W. Grainger, Inc. - SVP & CFO [5]

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No, we don't intend any real signaling there. 10 basis points is pretty small.

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Ryan Merkel, William Blair - Analyst [6]

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Got it. Okay. And then secondly on pricing, are suppliers starting to talk about price increases and then you delayed the price increase in Canada, but remind us when you plan to push that through?

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DG Macpherson, W.W. Grainger, Inc. - CEO [7]

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Sure. We are constantly in communication with our suppliers on price increases from our supplier community. We've had some pressure in some categories, but overall the pressure has been relatively modest and we don't expect to have significant price increases throughout this year. So we expect things to be relatively stable on that front.

In terms of Canada, as we went through the transition with the system last year, given some of the service challenges, we did not pass through a price increase that otherwise we would have been passing through last year. We have started that process now and through the first half of the year, we will be increasing prices in Canada to reflect the market.

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Ryan Merkel, William Blair - Analyst [8]

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Perfect. And just one last follow-up. I am a little surprised to hear you say that you are not expecting suppliers to raise prices just given what we've seen with the commodities. So is there something else that -- is it demand is not strong enough, or you are just not having the negotiations right now to tell you or give you enough confidence that you would see suppliers raising price?

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DG Macpherson, W.W. Grainger, Inc. - CEO [9]

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Right. So given what we have seen, there is always a lag for us. So in terms of the commodities increasing, it takes a well for that to flow through the supply base. At some point, if commodities stay at elevated levels for a longer period of time, we typically will see some supplier cost increases and we will pass those through. But it hasn't been long enough yet to really force that to happen.

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Ryan Merkel, William Blair - Analyst [10]

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Got it. Okay. Thank you so much.

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Operator [11]

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David Manthey, Robert W. Baird.

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David Manthey, Robert W. Baird - Analyst [12]

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Good morning. First off, could you talk a little bit more about the unclaimed property contingency? I'm not sure I fully understand that. Could you give us more details on what the impact was historically because of how it was being handled and what it means going forward as well?

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DG Macpherson, W.W. Grainger, Inc. - CEO [13]

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I will turn that over to Ron.

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Ron Jadin, W.W. Grainger, Inc. - SVP & CFO [14]

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Sure. So the $36 million reserve covers -- I think we highlighted in there about $2 million or $3 million for potential interest costs, that sort of thing, but roughly the $33 million or so related to that is over a five-year period, so it's about $6 million or so a year and these are amounts owed to probably nearly 200,000, 170,000 to 200,000 customers in amounts that are typically less than $200 a piece. Some are adjustments on freight and tax. There's a variety of different debits and credits that can be issued by Grainger to a customer and in those years prior to 2013, after they aged significantly and were not applied, were taken to income by the Company. And we should have put a liability on the books for that prior to 2013, actually in 2013 and we didn't do it till now.

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David Manthey, Robert W. Baird - Analyst [15]

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Okay. So it's not that it increased anything, it just didn't decrease, whether it's sales or cost, as it should have. Is that what you are saying?

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Ron Jadin, W.W. Grainger, Inc. - SVP & CFO [16]

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I'm not sure I understand your question there.

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David Manthey, Robert W. Baird - Analyst [17]

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Well, if it was something that you had owed to a customer, but you didn't take through the P&L, say sales or your profitability was inflated historically, now you are just recognizing that, so bringing that down. Is that how I should think about it?

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Ron Jadin, W.W. Grainger, Inc. - SVP & CFO [18]

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Yes, we recognized it through the P&L up through 2012 and not since then, no. So everything's -- we are really just reflecting now the same process we've been going through since 2013. We are reflecting that back into prior years.

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David Manthey, Robert W. Baird - Analyst [19]

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Okay. And then second on pricing, if you could talk a little about the Red Pass Plus, the uptake there, how you are driving awareness and then as it relates to the pricing dynamic here, whether or not you're getting price increases or the cost side of your equation is changing? Are you still starting minus 1% price in 2017?

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DG Macpherson, W.W. Grainger, Inc. - CEO [20]

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Yes, so we have no change to our expectation at this point for pricing for the year. Red Pass Plus, for those unfamiliar, it's a program typically for midsize customers. Most of that activation has happened historically the last nine months through inside sales and it's been a program we have used to get reasonable prices for those customers. That continues to accelerate, that program. We are also offering it now online for the first time and we are also seeing some sign-ups online. So we would expect that to continue to be a key part of getting reasonable prices for all of our midsize customers, both online and through our inside sales organization and we have seen really good results when we get customers to sign on to that program thus far.

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Operator [21]

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Robert McCarthy, Stifel.

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Robert McCarthy, Stifel Nicolaus - Analyst [22]

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Good morning, everyone. I guess the first question is is this going to be a conference call that you are going to have every quarter, or is this just because of the nature of the charges and what's going on? Is this a one-off?

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DG Macpherson, W.W. Grainger, Inc. - CEO [23]

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We will continue to evaluate our investor outreach and we will continue to talk about it. At this point, this is a one-off, but if that changes we will certainly let you know.

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Robert McCarthy, Stifel Nicolaus - Analyst [24]

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All right. Not to be cynical, but obviously CEOs in the past when they get into the seat obviously have taken rather large sizable charges going forward. Now obviously this is a long-standing issue, so I understand that, but do you think that you could have done more in terms of perhaps calling out some more restructuring on your branch [base] footprint or do you think just more of that consistent with your message that you are just viewing that organically as you go forward?

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DG Macpherson, W.W. Grainger, Inc. - CEO [25]

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Let me make sure I understand the question, Rob. So on the branch organization, is that what you are asking?

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Robert McCarthy, Stifel Nicolaus - Analyst [26]

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Perhaps this could have been an opportunity while you had all these items to perhaps do some more maybe one-time issues in association with the branch consolidation or restructuring.

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DG Macpherson, W.W. Grainger, Inc. - CEO [27]

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Yes, sure. So we now have 252 branches in the US. I will focus on the US for this discussion. We have gone from 420 to 250. We have actually seen stability and even some growth in branches with those existing buildings and the volume that goes through them is quite profitable. So we will always evaluate the branch and the branch footprint, but right now we like what we are seeing out of the branches that remain open and so we right now wouldn't -- it wouldn't make sense for us to take any additional restructuring given what we are seeing in terms of volume through those branches.

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Robert McCarthy, Stifel Nicolaus - Analyst [28]

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Okay. Then this question is a bit of a stretch, but I guess that's what I am known for. The oil and gas and energy exposure in Canada, I think that broadly could be anywhere from 15% to 20% of the overall Company. Could you talk about what you are seeing both explicit energy exposure, the knock-on impact, the Canadian affect and could we see the prospects for a recovery going into 2018 or 2019, or what are you looking for to get a better sense of maybe we could start to see a return to positive growth across a sizable end-market perspective of your Company?

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DG Macpherson, W.W. Grainger, Inc. - CEO [29]

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So oil and gas for Canada, I think as you are familiar with, the direct exposure is high. The indirect is probably 30% plus I would say in terms of resources in just Alberta and what you see. What we have seen is the knock-on effects for oil and gas on construction companies in Alberta, so it's a big portion of the revenue in Canada. It's much less in the US. In the US, it's less than 5%.

So that said, we are watching very closely. You can look at oil rig counts. Obviously they've been up recently. We are also talking with a lot of our large customers about project business. Certainly things have stabilized with that customer base. They are not taking capacity out. This time last year, they were taking tens of thousands of people out of the operation. Right now, that has not happened. We don't see great activity yet, but certainly I would expect it could, to your timeline, 2018, 2019, we certainly could see a turnaround there; that is very possible if oil stays between $50 and $100.

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Robert McCarthy, Stifel Nicolaus - Analyst [30]

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Could you just touch briefly on your US exposure, excluding Canada, with respect to oil and gas, direct and indirect and what you are seeing there?

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Ron Jadin, W.W. Grainger, Inc. - SVP & CFO [31]

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US.

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Laura Brown, W.W. Grainger, Inc. - SVP, Communications & IR [32]

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US.

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Ron Jadin, W.W. Grainger, Inc. - SVP & CFO [33]

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For oil and gas.

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DG Macpherson, W.W. Grainger, Inc. - CEO [34]

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Oh, for oil and gas, oh.

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Ron Jadin, W.W. Grainger, Inc. - SVP & CFO [35]

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Direct and indirect.

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DG Macpherson, W.W. Grainger, Inc. - CEO [36]

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Direct is two. Arguably oil and gas has a fairly significant impact on heavy manufacturing, so I don't know that we fully know, but I would say organizations that produce large machinery given oil and gas have been very affected by that and so we have seen that heavy manufacturing get hit in the US as a result, probably less than 10% of our total US business and that probably is stabilizing now as well.

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Operator [37]

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Ryan Cieslak, KeyBanc Capital Markets.

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Ryan Cieslak, KeyBanc Capital Markets - Analyst [38]

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Good morning, guys. The first question is on just the gross margin guidance for the first quarter, down 80 to 130 basis points or so. That implies sequentially maybe the trend from the fourth to the first below the normal trend we have seen on the sequential basis. Is there anything going into the first quarter that might be impacting the gross margin, or something that maybe was unusual in the fourth quarter that is rolling off?

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Ron Jadin, W.W. Grainger, Inc. - SVP & CFO [39]

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Probably just Canada, the timing of the recovery and margins in Canada. Like DG said, the pricing actions are going to be over the first six months and so that's going to ramp up over a longer period of time than you would expect to see in the US from a pricing perspective.

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Ryan Cieslak, KeyBanc Capital Markets - Analyst [40]

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Okay. And then the pricing in Canada, you mentioned the price increase coming through. Is that something that just gradually rolls through in the first half of the year, or is there a specific date you guys will be implementing that price increase?

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DG Macpherson, W.W. Grainger, Inc. - CEO [41]

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We have already started the process. It hits a relatively small portion of the volume initially because you have to go through customer-level negotiations to get a broader increase and so that's the process that we have to follow through the first six months.

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Ryan Cieslak, KeyBanc Capital Markets - Analyst [42]

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Okay. And then my follow-up question -- and I will jump back in the queue -- when you look at the end-market breakout in the month of December, real nice pickup in commercial and government. Then you also highlighted heavy manufacturing as positive. Was there anything in particular within those end markets that you really saw in the month that gives you greater confidence that that is sustainable, or was it just a combination of maybe some easier comps and some other things? Thanks.

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DG Macpherson, W.W. Grainger, Inc. - CEO [43]

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So in December, everything was up and part of that is the holiday timing; part of that was some year-end buying. From an end-market perspective, we are seeing certainly manufacturing stabilize, even through the entire fourth quarter and then government has been strong, a consistent strong performer and we feel like we are well-positioned to continue to grow the government business.

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Operator [44]

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Deane Dray, RBC Capital Markets.

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Deane Dray, RBC Capital Markets - Analyst [45]

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Good morning, everyone. Was hoping to follow up on that last point on the strength in the government business in the fourth quarter and it is the term that you say it was project business and I always associate Grainger with more MRO-type business, stuff that wears out or has to be replaced and less about projects. So maybe you can just clarify when you talk about government projects what type of business is that?

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DG Macpherson, W.W. Grainger, Inc. - CEO [46]

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Yes, so it would be more small projects rather than large projects, Deane. It would still be MRO, but if people are doing maintenance cleanup projects in a bigger way, sometimes we will have somewhat larger orders. The order pattern had some of that, but it wasn't tremendously high volume. Generally, the volume was good across the board in December and so I wouldn't read too much into the project business. I think the government flow has been very, very consistent. We continue to do very well with the military, with the Federal Government and we saw some state government strength as well.

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Deane Dray, RBC Capital Markets - Analyst [47]

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Got it. And then for pricing in Canada, down 4 percentage points, was that across the board or was it mostly energy and natural resource-focused?

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DG Macpherson, W.W. Grainger, Inc. - CEO [48]

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Well, it is across the board, although the bigger hit is in the energy and resource business given where our volume is and that has been more challenged throughout the entire year last year. I would say that's true.

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Deane Dray, RBC Capital Markets - Analyst [49]

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Just last question from me if I could, maybe for Ron; really strong free cash flow conversion this quarter. Anything unusual in terms of timing of payments or anything like that?

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Ron Jadin, W.W. Grainger, Inc. - SVP & CFO [50]

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Yes, there was actually with regard to timing of payables, there was a lot of inventory purchased near the end of the year so our in-transit inventory balance increased quite a bit and as a result our payables did as well. So really just a timing thing there. Most of our favorability was driven by working capital. AR came down quite a bit in the fourth quarter versus the third, which it always does, but even more so this year and I think this time the timing of the holiday helped us in terms of when the holiday is on a weekend, we have more days to collect where our customers are open and we are in the office. So AR benefited as well.

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Deane Dray, RBC Capital Markets - Analyst [51]

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Got it. And then just lastly a comment the extent to which voice of the customer matters and like Rob McCarthy's question, it would be great if you guys would give consideration to doing these calls. I think it has gone very well and we appreciate the insight. Thank you.

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Operator [52]

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Andrew Buscaglia, Credit Suisse.

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Andrew Buscaglia, Credit Suisse - Analyst [53]

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Can you just talk a little bit about your Canada segment? I would have thought things would get a little bit better in Q4, but you had some things going on there. What's the trajectory of that business on the operating line through the year? Will we see a breakeven number by the end of 2017?

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DG Macpherson, W.W. Grainger, Inc. - CEO [54]

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Yes, our plan calls for fourth quarter to break even with the business in Canada. Just to give a little bit of history there, given the reliance on oil and gas, obviously, the downturn has had a big impact and the added challenge has been, we put the new system in and we had some service disruptions as well. We focused very hard the last half of the year on stabilizing the service and we are hearing very good things from customers right now in terms of providing service to them. And so we feel like we are in a better position now to be able to do things like take price increases and drive volume, but we would expect to be breakeven in the fourth quarter of next year -- of this year.

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Andrew Buscaglia, Credit Suisse - Analyst [55]

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Okay. Got it. Then just one other specific question. On the EBIT line in your unallocated expenses, it looks like you were helped by some restructuring there. What was that restructuring that specifically helped that line item, why would that go into that specific (multiple speakers)?

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Ron Jadin, W.W. Grainger, Inc. - SVP & CFO [56]

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Yes, we have easier comps in the fourth quarter this year than last year because, in the fourth quarter of 2015, we had quite a few expenditures relative to the SAP project, which went live in the first quarter of 2016. So from an expense perspective, if that's what you are referring to, we had easier comps, but we also were taking costs out of the business as well as we've been doing everywhere given the soft revenue.

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Andrew Buscaglia, Credit Suisse - Analyst [57]

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Okay, so that's the expense that helps you -- looks like it helps you about $0.09 or so for --?

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Ron Jadin, W.W. Grainger, Inc. - SVP & CFO [58]

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Are you looking at the adjustments page?

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Andrew Buscaglia, Credit Suisse - Analyst [59]

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Yes.

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Ron Jadin, W.W. Grainger, Inc. - SVP & CFO [60]

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Oh, the adjustment. That had to do earlier this year. That wasn't a fourth-quarter item. Earlier in the year, just to be clear, I was answering fourth quarter.

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Andrew Buscaglia, Credit Suisse - Analyst [61]

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Well, I was just looking at -- your unallocated expense usually is a little bit higher in Q4, but for some reason this quarter it seemed like it helped your EBIT line.

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Ron Jadin, W.W. Grainger, Inc. - SVP & CFO [62]

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No, I think I answered it. Yes. (multiple speakers). Easier comps. It's really easier comps.

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Andrew Buscaglia, Credit Suisse - Analyst [63]

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Okay, got it. All right, thanks, guys.

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Operator [64]

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Scott Graham, BMO Capital Markets.

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Scott Graham, BMO Capital Markets - Analyst [65]

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Good morning and thanks for having this call. I just wanted to really understand a little bit more about the price decreases that you are putting through for the midsize customers and also the spot buys with the latter being discussed a lot at the investor meeting back in November. And the simple question is, since you indicated at that time that you had begun that price reduction program or whatever you would like to call it, initiative, it was about 18 months ago. So just hoping you can tell us how is that going for both? How are the midsize customers reacting? How are the -- across the board selective stock price reductions to various customers doing on spot buys? Could you give us an idea of how that is going? Are you starting to see those sales respond?

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DG Macpherson, W.W. Grainger, Inc. - CEO [66]

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So I would make a few points. Thanks for the question. So with our large customers, they have had competitive prices for a long time. We have changed to some degree our price structure to try to give them more price incentives to buy slower moving items and that has gone reasonably well. When we give category discounts or other discounts, we do see volume increases so that has gone well.

On the midsize customer piece, we went through a fairly significant coverage change last year where we eliminated outside sales covering midsize customers and started inside sales and that team has been working to get the pricing programs in place for those customers and again, when we get the customers and we get them to sign up with the pricing program, which we talked about Red Pass Plus a minute ago, that has gone well. The broad changes on the Web have just started. So when we talked in November, we talked about at the beginning of the year starting those changes. It is too early to say how they are going and really what we've done so far is changed some prices to understand how the back-end systems would work and support those changes and so far that looks good.

You will see a lot more of that happening over the next couple of months and we will get a much better read on the impact of those changes; and just to remind everybody, the goal here is to provide a reasonable price for small, midsize customers and spot buys and that price will be higher GP than the average GP. So it is still going to be -- it's not cheap, but it's a reasonable price for those customers and those changes broadly are just starting now.

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Scott Graham, BMO Capital Markets - Analyst [67]

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Excellent. Just one other question, if I could. Your sales guidance for the year of plus 2% to plus 6% was given at a time when let's just say optimism was not where it is today. I think there is clearly a lot more optimism in the business community, particularly in Industrial Land. I was just wondering if you'd be able to give us an opinion -- I know it's only the first quarter, but I suspect that the plus 2% would be a little bit disappointing in that somewhere within that range we are thinking more at least the midpoint. Is there anything you could offer, DG, on what you are thinking now on that sales guidance range versus two months ago given the changes that have taken place?

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DG Macpherson, W.W. Grainger, Inc. - CEO [68]

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Yes. I don't know that we've got a different perspective. I would say to your point around optimism, I have been with a number of customers this year and there is some optimism, but that optimism hasn't yet translated into activity and in fact, some of the manufacturers have some concerns as well as optimism about the direction things could go. So I would say there is some optimism and if that were to bear fruit, certainly that would help us. So far, we haven't seen it, so I don't think our position has changed at all.

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Scott Graham, BMO Capital Markets - Analyst [69]

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Fair enough. Thank you.

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Operator [70]

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Adam Uhlman, Cleveland Research.

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Adam Uhlman, Cleveland Research - Analyst [71]

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Thanks again for hosting the call. Just to follow up on that last question I guess as this optimism has been building. At what point would the Company think about adding additional growth spending to the forecast for the year? Would we have to be above the high end of the sales guidance for -- or do you think you are pretty well set in terms of the additions that you have planned for salespeople regardless of the demand environment?

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DG Macpherson, W.W. Grainger, Inc. - CEO [72]

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I think we are mostly set. I think with the large-customer organization we are mostly set in terms of the coverage we have. We like the coverage we have and that group is going to get more productive given some of the tools we have given to them. I would say for midsize customers what would get us to increase spending is if the results were positive in a way that was better than we expected, then we would spend the money. And so I don't think it is necessarily external. It is more what happens to our own initiatives and if the initiatives bear fruit, we will spend more. We are not really locked into what happens in the economy for those actions.

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Adam Uhlman, Cleveland Research - Analyst [73]

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Great. That's helpful. Thanks. And then, Ron, have you made any changes to the cash flow assumptions for this year?

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Ron Jadin, W.W. Grainger, Inc. - SVP & CFO [74]

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No, no changes.

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Adam Uhlman, Cleveland Research - Analyst [75]

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Great. Thank you.

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Operator [76]

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Christopher Glynn, Oppenheimer.

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Christopher Glynn, Oppenheimer - Analyst [77]

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Good morning. Question on the OpEx line; OpEx to sales improved a little more than 70 basis points in 2016. And I know 2017, you have incentive comp restoration and the DC ramp costs. But notwithstanding that, is there an ongoing opportunity to manage OpEx there within the context of a nearly $3 billion spend line?

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DG Macpherson, W.W. Grainger, Inc. - CEO [78]

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Yes. I would say we are very focused on making sure that we get productivity out of our large pools of costs. We continue to get nice productivity out of our distribution centers, which is a big cost. We are making changes in our contact centers in 2017 to consolidate and take out some costs. We are working hard on the salesforce and the tools we provide them so that we can grow without having to add headcount in equal parts to our growth. Really at every point in the organization, we are focused on expense. We spend money where customers care about it and get productivity in every part of the organization.

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Christopher Glynn, Oppenheimer - Analyst [79]

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Okay. And within the key line items of your guidance, gross margin, revenue and SG&A, it would seem that that one is the most in your control to be able to guide conservatively. Have you in fact done that, again, the ramp costs notwithstanding?

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DG Macpherson, W.W. Grainger, Inc. - CEO [80]

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So our guidance is our expectation at this point. So I'm not sure if you are asking if we are sandbagging, but our guidance is our expectation.

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Christopher Glynn, Oppenheimer - Analyst [81]

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Fair enough. And then just, finally, you may have alluded to it, but just wondering if any 4Q budget flush was also seen in the manufacturing sector? January softer. It seems even -- January got softer even adjusting for the holiday timing.

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DG Macpherson, W.W. Grainger, Inc. - CEO [82]

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We are watching that closely. It's a little bit too early to tell and I think once we get through -- just as a reminder, January of last year was our second-highest growth month of the year after December, so there's some holiday timing. I think there's some weather. We did sell more cold-weather product in December than we are selling in January, for sure, given what we have seen in the weather. So there's a number of factors there. I wouldn't read too much into the first three weeks necessarily.

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Operator [83]

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Justin Bergner, Gabelli & Company.

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Justin Bergner, Gabelli & Co. - Analyst [84]

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Good morning and thank you for taking my questions. So the first question relates to I guess your comment that the US did a little bit better than you expected in the fourth quarter from a sales point of view. So could you just maybe clarify if the overall company was in line with your expectations, what part of the business came a little bit short of your expectations?

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DG Macpherson, W.W. Grainger, Inc. - CEO [85]

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So keep in mind we were comparing that to our Analyst Day, what we talked about at Analyst Day. December was a little stronger really across the board, Canada, the US, both were stronger. The rest of the business was basically on what we would've expected, so that's why we were a little bit better. Just slightly, slightly better than expectations. I wouldn't read too much into that and we've been talking about what happened in December and November and January and how much of that was holiday timing and other stuff. So I wouldn't necessarily read too much into that and really nothing was significantly below expectations for December.

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Justin Bergner, Gabelli & Co. - Analyst [86]

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Okay. And restructuring seemed to end the year around $45 million, which is a little bit light of your $50 million to $65 million guide. So should I make anything of that in terms of how that will affect 2017 restructuring spend, or did you find reasons to cut back on restructuring spend a bit?

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DG Macpherson, W.W. Grainger, Inc. - CEO [87]

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No, and some of that was estimates of what it would cost to restructure sometimes were higher than we landed and so that won't have any impact -- it shouldn't have any impact on 2017.

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Justin Bergner, Gabelli & Co. - Analyst [88]

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Thank you.

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Operator [89]

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Matt Duncan, Stephens.

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Matt Duncan, Stephens Inc. - Analyst [90]

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So first thing just want to try to dig in a little bit more on the sales trend and maybe look at some of the algebra here. My recollection is that January's comparison is 4.8 points harder than December and you had 2 points of holiday benefit in December and I guess there's, based on your comments, some chance that there has been a negative hit in January. So is the change from December to January simply the comparison and the difference in holiday timing and maybe the underlying demand is still where it was, if not improving? Just some thoughts there would be great.

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DG Macpherson, W.W. Grainger, Inc. - CEO [91]

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I think it is a little early to tell. I think some of the points you make are certainly on point. I think in the US, a lot of this may in fact be timing and seasonal. I think in Canada there is a specific issue for us, which is last January there was a lot of customer pre-by before we went live with the system and so Canada will look goofy in both January and February. February will be a very easy compare and January is a very hard compare given the flow of what happened around that. Other than that, I think we don't see any reason to think the underlying demand has changed dramatically.

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Matt Duncan, Stephens Inc. - Analyst [92]

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Okay. That helps. And then, Ron, on gross margin, the year-over-year decline there in the fourth quarter specifically was a lot less than what you guys had been experiencing. Can you walk us through what caused that?

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Ron Jadin, W.W. Grainger, Inc. - SVP & CFO [93]

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We had some easier comps essentially. There were some unfavorable GP rate items in the fourth quarter of 2015 that just gave us a bit of an easier comp and then some of the mix issues that we have with faster growth with some of our low margin businesses. While they continue to grow as they get bigger, they have a lower mix impact, a negative mix impact on GP. So as they mature and as their margins expand actually, the negative impact of those businesses diminishes over time.

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Matt Duncan, Stephens Inc. - Analyst [94]

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Is there anything going on there with rebate levels given how strong December closed out? You were flat at December 13 and came in up 6.5%. You mentioned that you had a lot of inventory in transit at the end of the year. So just curious if maybe you had a little bit better rebate accrual than you had been counting on previously?

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Ron Jadin, W.W. Grainger, Inc. - SVP & CFO [95]

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Not materially. A little bit better, but not material.

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Matt Duncan, Stephens Inc. - Analyst [96]

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Okay. And then last thing on Fabory --.

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Ron Jadin, W.W. Grainger, Inc. - SVP & CFO [97]

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Because the thing is, when you pre-buy, those rebates get capitalized. You don't take those to the P&L.

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Matt Duncan, Stephens Inc. - Analyst [98]

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Right. Okay. Last thing for me on Fabory, and I know it's a little bit of a difficult discussion, but it has been a while. You guys have had trouble -- you have made good progress in trying to get it improved and making money for you, but it continues to be a little bit of a problem child. Is there a point in time at which you start thinking about divesting that business, or is it a business that you feel like Grainger needs to be involved in going forward?

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DG Macpherson, W.W. Grainger, Inc. - CEO [99]

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So just to give you a little bit of history, the thesis when we bought that business, there were really two pieces to that thesis. One was we could expand into Central Europe through a branch expansion strategy. The other was that we could diversify its product portfolio and make it a broad liner. We really struggled with those to the first couple years we had the business. We ended up having to reverse course, refocus it on fasteners. It is a fastener specialist. I think there's benefits to having a specialist in the portfolio. I think we understand how specialists compete. Having Fabory in the portfolio, we certainly get benefits from fastener [buy] from the company.

But that said, it's not core to what we do right now. We need to get it performing. We need it performing better. We need to increase the profitability, get it growing, but we will always consider long term what to do with the business, but we are optimistic about the path it's on and we need to continue that path first before we consider alternatives.

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Operator [100]

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Hamzah Mazari, Macquarie.

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Hamzah Mazari, Macquarie - Analyst [101]

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Good morning. Thank you. Just the first question maybe for DG. DG, could you maybe talk about your supply chain and any issues you may be looking at given potential for tariffs and trade agreement changes as you look at your global supply chain?

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DG Macpherson, W.W. Grainger, Inc. - CEO [102]

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Yes, thanks Hamzah. So we do a lot of analysis on our supply chain just as a regular course of business to understand where we purchase, whether we have unique exposure relative to competitors through our purchasing activities. We don't have much. So trade agreements would certainly have an impact. We have alternative suppliers for many of those sources and we have those in place and plans if we need to go to those alternative sources. We don't feel like we would be unduly impacted by trade agreements. We don't buy more than our competitors do overseas as an example and we have alternatives for many of those suppliers.

I think the broader issue -- so for the sourcing that we own for our private brands that we globally source, I think we have a good sense. For the branded product, there are some categories that really are not made much in the US anymore, if at all. And so trade agreements on those, I don't know what would happen there and we would have to figure that out and we haven't historically focused too much of our energy there because that hasn't been under our control, but I think it's just an interesting thing for us. We probably need to spend a little more time thinking about that.

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Hamzah Mazari, Macquarie - Analyst [103]

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Great. And just last question, do you have a timeline around when the Zoro business margins can get closer to your Japanese business? Is that realistic? It seems like there may be a lot of investment spend rolling through the P&L on Zoro. Just trying to get a sense of whether that business can mirror the Japanese business or is there anything structural there. Thank you.

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DG Macpherson, W.W. Grainger, Inc. - CEO [104]

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Thanks. I think Zoro's business will be very close to MonotaRO's over time and we continue to see expansion. We think it's going to be in the 8s this year in terms of operating margin and it will continue to do get to that double-digit number. Really the difference is advertising spend as we grow, so we invest a bunch to grow the business. In Zoro, we are still acquiring customers that are really high rate and as that business becomes more modest in its growth, more like MonotaRO, we would expect the margins to be pretty much the same over time.

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Hamzah Mazari, Macquarie - Analyst [105]

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Great. Thank you.

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Operator [106]

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Shannon O'Callaghan, UBS.

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Shannon O'Callaghan, UBS - Analyst [107]

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Just, one, a question on some of the improvement trends in December versus what they were in November. All the areas got better, but the US was a little less improvement. So you had -- Canada went from down 13% to up 2%. That's a big move. Other went from up 7% to up 19%, so both of those had these double-digit moves. The US went from minus 2% to plus 1%. Any reason that would be more modest than the moves in the other areas?

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DG Macpherson, W.W. Grainger, Inc. - CEO [108]

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I think in general our US business is less variable. So in down times, it's down less and in up times, it's up a little bit less and that is just the way the US business works. We serve the entire economy in the US, so we are very diversified. We are not as diversified in Canada. So if you have big projects, it could have a bigger impact. I think that's probably the basic dynamic there.

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Shannon O'Callaghan, UBS - Analyst [109]

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Okay. And then just a follow-up on this first-quarter gross margin. You are down 30 in the fourth quarter and now we are going to be down 80 to 130 in the first quarter. You mentioned the tough comp, but I think you already changed the -- accounting for the tradeshow stuff last year. So can you remind me why the first quarter is a tough gross margin comp for this year?

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Ron Jadin, W.W. Grainger, Inc. - SVP & CFO [110]

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Well, it's really a combination of both. The fourth quarter was an easier comp and the first quarter is a tougher comp, so that's a couple of swings to account for, but I would just reiterate that, especially in Canada where we saw a real pressure on margins in this last year, the challenge will be recovering that through pricing actions in the first half of the year. Those won't happen just in the first quarter.

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Shannon O'Callaghan, UBS - Analyst [111]

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Okay, so you mentioned that before, so it is really about Canada?

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Ron Jadin, W.W. Grainger, Inc. - SVP & CFO [112]

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Yes, that's a big part of it. And then the comps, yes.

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Operator [113]

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Robert Barry, Susquehanna.

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Robert Barry, Susquehanna Financial Group - Analyst [114]

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Good morning. A lot of ground covered here. Maybe just a few follow-ups. First, on the much earlier commodity pricing question, when the commodities start to impact the pricing and I know it's not a precise dynamic, but just as a benchmark, the ISM prices component, which shows what OEMs are paying for inputs has been rising now for about 10 months. We've seen what's been happening with the spot prices. Does it typically take that long to trickle through and impact you, or might it be taking longer through this cycle for some reason?

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DG Macpherson, W.W. Grainger, Inc. - CEO [115]

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So it depends, I would say, where your starting position is. Given they went down so far and now they've been up for 10 months, I think it's probably taking a little bit longer, but if they continue to stabilize at higher levels, I think you will see it flow through. So I think what you are seeing now is just a function of how far they dropped before coming up and in many cases, they dropped a lot.

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Robert Barry, Susquehanna Financial Group - Analyst [116]

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And remind us what's in the gross margin outlook? Is there an assumption that you will start to get some benefit from pricing this year?

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DG Macpherson, W.W. Grainger, Inc. - CEO [117]

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It is minus 1% is the expectation. Now we also have expectation we will have negative cost inflation this year as well, about 50 basis points. So if there was significant commodity increases, that would help us if that happens, but we don't have anything baked in there.

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Robert Barry, Susquehanna Financial Group - Analyst [118]

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Got you. What is your thought on being able to put through pricing if it starts to come from your vendors just given a lot of the end markets are still pretty sluggish and there's a lot of small mom-and-pops cutting price to stay alive? Do you think you could get material pricing in this environment?

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DG Macpherson, W.W. Grainger, Inc. - CEO [119]

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Yes, if it is well-known that the commodity prices are up, we generally do pretty well and we are able to pass that through and I think that would still be the case here.

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Robert Barry, Susquehanna Financial Group - Analyst [120]

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Got you. And then maybe just a last one on this clean energy. I think in November you expected that would be a $0.10 benefit in 2016. I think it ended up being $0.15, so is all that $0.05 helping in the fourth quarter and was that just related to the weather?

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Ron Jadin, W.W. Grainger, Inc. - SVP & CFO [121]

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Right. A lot of it is weather. A lot of it is just whether the facilities are running at full capacity or not. It's a dynamic of both of those two. So we ended the year at about $0.15 and we think next year, 2017, we will be in the $0.10 to $0.15 range, so very similar.

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Operator [122]

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Joseph Ritchie, Goldman Sachs.

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Joseph Ritchie, Goldman Sachs - Analyst [123]

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Good morning, guys. Just a couple real quick ones. On the unclaimed property contingency, just to be clear, there is no cash impact, or is there a potential cash impact from that charge?

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Ron Jadin, W.W. Grainger, Inc. - SVP & CFO [124]

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There is none today, but over the next few years, we will make attempts to either return cash or issue credits to customers, so eventually over time there will be.

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Joseph Ritchie, Goldman Sachs - Analyst [125]

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Got it. And what would potentially trigger that? I'm just trying to understand it a little bit better.

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Ron Jadin, W.W. Grainger, Inc. - SVP & CFO [126]

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We will trigger it by actively pursuing many, many customers and then states -- and then states as well.

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Joseph Ritchie, Goldman Sachs - Analyst [127]

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Got it, okay. And then as it relates to -- I know typically we have talked about pricing a lot. I guess just asking it very specifically. Typically January, February timeframe, you've put through some time of pricing increase and so if I missed the answer earlier, is there an expectation that you are going to try to pass price through in January or February or is it just too difficult of a period of time to be able to do that today?

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DG Macpherson, W.W. Grainger, Inc. - CEO [128]

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We have gone through a process -- and I will focus on the US first -- we are certainly going to have a price increase in Canada, as we talked about, through the first half of the year. In the US, we have reset some of our prices. We certainly have raised some prices and lowered others. We look at the market pricing and we have adjusted to that. So there are some price increases in there and we would expect those to hold.

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Joseph Ritchie, Goldman Sachs - Analyst [129]

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Okay. And then, lastly, one quick one on your import position. What percentage of your COGS do you import? We have it at roughly 20% to 25%. I just wanted to make sure that we are ballpark correct.

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DG Macpherson, W.W. Grainger, Inc. - CEO [130]

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Well, I think that, to our earlier discussion, if you said what is the percentage that we import that is part of our private brand, which is what we have talked about historically, our private brand is 20% to 25%. Most of that is imported now, so probably 15% to 20% would be imported. And then if you included the brands, that goes way up. So the branded product, our estimate would be 40% roughly, but we have some work to do to really understand that.

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Operator [131]

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Nigel Coe, Morgan Stanley.

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Nigel Coe, Morgan Stanley - Analyst [132]

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Good morning. This call has been really helpful. Thanks a lot for doing it. So, Ron, just wanted to double check. All the one-timers came through SG&A, correct?

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Ron Jadin, W.W. Grainger, Inc. - SVP & CFO [133]

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Yes, that is correct.

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Nigel Coe, Morgan Stanley - Analyst [134]

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Okay, great. And then the uptick in December (multiple speakers).

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Ron Jadin, W.W. Grainger, Inc. - SVP & CFO [135]

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In the fourth quarter, they did. There were a few earlier in the year that were E&O, excess and obsolescence, for inventory. Those would have been up in that GP, so just to be clear, the fourth quarter, that is true, but earlier in the year, there's at least one or two.

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Nigel Coe, Morgan Stanley - Analyst [136]

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Okay, great. Yes, (multiple speakers).

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Ron Jadin, W.W. Grainger, Inc. - SVP & CFO [137]

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I'm sorry, one more thing. Also the discrete tax items, maybe it is obvious, but those are below the line, right? Those are in tax.

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Nigel Coe, Morgan Stanley - Analyst [138]

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Right. Okay, good. Thanks, Ron. Then the uptick in December, maybe this is getting a bit too down in the weeds, but did you see any differential between store versus direct? I'm just thinking about the margin differential between store and online. Was there any noticeable impact on either channel or nothing to call out there?

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DG Macpherson, W.W. Grainger, Inc. - CEO [139]

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It was fairly even across both, I would say, so we saw upticks in all the channels.

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Nigel Coe, Morgan Stanley - Analyst [140]

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Okay. And then going into January, the comments about slightly down January to date. Obviously Canada is a big part of that, but is the same read for the US just given the time of the holidays and the comp?

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DG Macpherson, W.W. Grainger, Inc. - CEO [141]

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Yes, I would say January started out sluggish based on some of the comps and the holiday discussion we had before, yes.

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Nigel Coe, Morgan Stanley - Analyst [142]

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Okay. And then just, finally, obviously big changes on some of the salesforce during 2016. How do we think about the productivity -- where we are in the productivity curve -- particularly on the inside sales channel?

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DG Macpherson, W.W. Grainger, Inc. - CEO [143]

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So we have installed completely new processes over the last year and a new system support for sellers to help make them more productive. On the inside sales team, we are giving them much more clarity on who to call, how frequently to call, what the returns are on those calls. I think we have got a long path for improvement here since we are very early in that process and figuring it out, but it's pretty exciting in terms of the data we have now and the ability to drive improvement going forward.

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Nigel Coe, Morgan Stanley - Analyst [144]

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So in terms of getting up to full productivity, is that a year, is it two years? How long is the timeline?

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DG Macpherson, W.W. Grainger, Inc. - CEO [145]

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On the inside sales team in particular?

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Nigel Coe, Morgan Stanley - Analyst [146]

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Yes, yes.

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DG Macpherson, W.W. Grainger, Inc. - CEO [147]

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Oh, yes, it's going to take probably 15 months to two years for any individual seller to get to full productivity, typically.

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Nigel Coe, Morgan Stanley - Analyst [148]

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Great. Thanks a lot.

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Operator [149]

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Thank you.

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DG Macpherson, W.W. Grainger, Inc. - CEO [150]

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So thanks for the time. I really appreciate everybody being on the call. I would just summarize the quarter, basically from an operating perspective, was at or maybe slightly above expectations. Hopefully we helped explain some of the unusual items that we had in the quarter and we are holding on guidance for 2017 and we are certainly excited about what we've done in 2016 to prepare ourselves to grow and gain profit going forward. So thanks for your time. Have a great day.

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Operator [151]

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Thank you. Ladies and gentlemen, this does conclude today's teleconference. You may disconnect your lines at this time. Thank you for your participation.