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Edited Transcript of GWW earnings conference call or presentation 24-Jul-19 3:00pm GMT

Q2 2019 W W Grainger Inc Earnings Call

LAKE FOREST Jul 26, 2019 (Thomson StreetEvents) -- Edited Transcript of W W Grainger Inc earnings conference call or presentation Wednesday, July 24, 2019 at 3:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Donald G. Macpherson

W.W. Grainger, Inc. - Chairman & CEO

* Irene Holman

W.W. Grainger, Inc. - VP of IR

* Thomas B. Okray

W.W. Grainger, Inc. - Senior VP & CFO

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Conference Call Participants

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* Bhupender Singh Bohra

Wolfe Research, LLC - Research Analyst

* Christopher D. Glynn

Oppenheimer & Co. Inc., Research Division - MD and Senior Analyst

* David John Manthey

Robert W. Baird & Co. Incorporated, Research Division - Senior Research Analyst

* Deane Michael Dray

RBC Capital Markets, LLC, Research Division - Analyst

* John George Inch

Gordon Haskett Research Advisors - MD & Senior Analyst of Multi-Industrials

* Joshua Charles Pokrzywinski

Morgan Stanley, Research Division - Equity Analyst

* Justin Laurence Bergner

G. Research, LLC - VP

* Patrick Michael Baumann

JP Morgan Chase & Co, Research Division - Analyst

* Robert Douglas Barry

The Buckingham Research Group Incorporated - Research Analyst

* Robert Stephen Barger

KeyBanc Capital Markets Inc., Research Division - MD and Equity Research Analyst

* Ryan James Merkel

William Blair & Company L.L.C., Research Division - Research Analyst

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Presentation

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Operator [1]

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Greetings. Welcome to the W.W. Grainger Second Quarter 2019 Earnings Conference Call. (Operator Instructions) Please note, this conference is being recorded.

I will now turn the conference over to our host, Irene Holman, Vice President of Investor Relations. Thank you. You may begin.

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Irene Holman, W.W. Grainger, Inc. - VP of IR [2]

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Good morning. Welcome to Grainger's Q2 earnings call. With me are DG Macpherson, Chairman and CEO; and Tom Okray, CFO. As a reminder, some of our comments 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. Reconciliations of any non-GAAP financial measures mentioned on today's call with their corresponding GAAP measures are at the end of this slide presentation and in our Q2 press release, which is available on the IR website.

Reported results in the second quarter included a $3 million benefit to operating earnings and a $0.03 benefit to EPS primarily related to a reduction in lease obligations in Canada. This morning's call will focus on adjusted results, which exclude the items outlined in our press release. Please also note, within our comments, we have removed the favorable timing impact of the North American sales meeting from gross profit margin and operating margin. The sales meeting had a positive 20 basis point impact on total company gross profit margin and operating margin and a positive 25 basis point impact on U.S. gross profit margin and operating margin.

Now I'll turn it over to DG.

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Donald G. Macpherson, W.W. Grainger, Inc. - Chairman & CEO [3]

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Thanks, Irene. Good morning, and thank you all for joining us today. I'm going to discuss our first half and second quarter results and share an overview of what we're doing to drive growth in the U.S. and through our endless assortment model. Then Tom will provide details on the quarter, and we'll open it up for questions.

The demand environment has softened throughout the year. Having said that, our strategy is grounding and have -- grounded at having a value proposition that resonates through economic cycles. Through our high-touch solutions model, we provide services and products to customers that help save them money. We help them consolidate MRO spend. We manage their inventory. We provide solutions to simplify their purchasing process. We offer product substitution recommendations. We enable standardization across sites, and we help them keep their operations running and their people safe.

In times of slower growth, we partner with our customers to lower their cost, which strengthens our relationships. We're confident in our ability to gain share in both up and down cycles with this model. With our endless assortment model, customers value our streamlined search experience and expansive assortment. We're investing for growth through this model and are bullish on the path ahead.

Turning to our performance so far this year. We delivered strong operating results in the first half of 2019 despite a slower global economy and significant investment in our endless assortment model. Year-to-date total company operating margin was 13%, up 50 basis points, and we've driven incremental margin of 42%. Operating cash flows through the first half of 2019 is up 14%.

We're through much of the heavy lifting on our cost takeout initiatives and are now focused squarely on driving profitable growth to our U.S. and endless assortment businesses. At AGI, the top line recovery has been slower than we anticipated. We made multiple changes in a short amount of time that caused disruption to our customer base, and we've seen more volume loss than we expected. Revenue dollars were stable from first quarter to the second quarter. Service is now once again strong when we started to win new business for the first time in a couple of years. We expect to see better performance in the second half of 2019.

At Cromwell, we had made many changes to position the business for growth. We redesigned the distribution center and launched Zoro U.K., leveraging the Cromwell supply chain. Performance has lagged in the short term, resulting from market conditions and our actions in the region. Performance at Zoro U.K. has been very strong. We remain committed to this market.

Our 2019 total company outlook remains the same for gross profit margins, operating margin and EPS based on our strong operating performance so far this year. We are lowering our estimate for market growth to minus 1% to 2% and lowering our revenue guidance to 2% to 5% growth due to the weaker demand environment and performance at AGI and Cromwell.

Moving to the quarterly sales performance in the U.S. The U.S. MRO market growth decelerated from 2% to 2.5% in Q1 to approximately 1% in Q2. We estimate U.S. market growth included about 1 point in price. As a reminder, these are internal estimates of market growth. The factors that determine market growth are finalized over the next 60 days. We expect the slow market growth to continue in the second half of 2019.

In the quarter, market growth slowed across all of our end markets with the exception of health care. The core Grainger business grew about 150 basis points faster than the market. U.S. large customer daily sales growth was 2% and 11% on a 2-year stack. U.S. midsize customer growth was 5% and 25% on a 2-year stack.

We got off to a slower start in the first half of the year for 2 reasons. First, as we've noted, we've seen a meaningful decline in the U.S. market growth from 2018. Second, we've implemented new initiatives to drive growth in 2019 and beyond, and these activities take time to yield results.

One example of this is our merchandising initiatives. We've completely revamped our category review process to include the voice of the customer more to ensure that we have the right assortment and that it is presented in the right way to our customers. This will lead to strategic product ads and improved product presentation.

To date, we've implemented this approach on a small portion of our assortment, and the early results are very promising. We expect to be through about $1 billion worth of the assortment in the second half of the year and to accelerate these changes in 2020.

We are confident in our ability to accelerate our share gain in the remainder of the year. Our updated sales guidance for 2019 implies U.S. share gain of about 300 basis points in the second half. And we are fully committed to 300 to 400 basis points of outgrowth versus the market on average over the next several years.

Let me spend a few minutes discussing our U.S. growth initiatives in the context of our value proposition. While we are in the early innings of these initiatives, which I first shared in May, we are encouraged by the results and remain committed to their implementation to drive the business forward. We generally think about them in 2 buckets. The first are improvements to our foundation that ensure that we stay competitive, and the second are incremental investments that contribute to our long-term goal of 300 to 400 basis points of growth above market.

In terms of what we call advantaged MRO solutions, we are investing in our foundation to allow us to offer better solutions for our customers. We are improving our product and customer information and building new data platforms so that we can suggest more relevant solutions online, over the phone, at the branch and through our sellers. We expect to start reaping the benefit of these efforts in early 2020. We are also investing in our website to make the search process easier. Feedback from our customers is positive and improving, and we will continue to make enhancements to our website throughout the back half of 2019.

To accelerate our growth, we are making incremental investments in marketing and merchandising. I've already talked about our merchandising initiatives. Our marketing investments are focused on both digital and media. This spend is spread evenly throughout 2019, and we're seeing strong returns from these efforts.

Moving to our second pillar, differentiated sales and services. From a foundation perspective, we are investing to refine our customer relationship management processes, increasing our efforts to serve specific markets more effectively and improving sales force effectiveness. In terms of inventory management, we've done some heavy lifting to realign our offer to drive profitability. KeepStock, which is the core piece of this offer, is now profitable and ready to drive growth.

Sales through this service represent 10% of revenue in 2018, and total sales with these customers represent about 30% of U.S. revenue. Over the long term, we expect sales through KeepStock to grow much faster than the overall business.

From an incremental perspective, we are expanding our service offering, which includes partnering with suppliers and utilizing our safety and other technical experts to help customers manage total cost and keep their facilities up and running and their people safe. We're also looking at targeted expansion of our sales force where it makes sense. We're planning to strategically add sellers to address changes in how customers buy and to be more relevant in select segments.

With corporate accounts, we have been very focused the last 2 years on communications around the price changes. We are now in a position to deepen those relationships to drive significant growth. These relationships start fresh from the plant floor to the C-suite, and we have a significant opportunity to gain share with these customers based on the service and the capabilities that we can provide.

Our last pillar is unparalleled customer service. Our first priority is always to deliver a seamless customer experience. We are known for this in the market and are focused on retaining this advantage through our order-to-cash work. We have implemented a number of initiatives in the past year that have resulted in an improved customer experience. Our metrics have improved, and customer feedback is at an all-time best and getting better.

In terms of fulfillment, we now have 600,000 products stocked in the U.S. It's very likely that when a customer places an order, we will have the products available for delivery next day and all in one box.

We're adding capacity and capability with the addition of our distribution center in Louisville, which we expect to go online in early 2020. Louisville will have the most capacity in our network and will enable us to stock up to 800,000 SKUs in the U.S. with potential for more. When we add stock to items, we tend to see significant lift in revenue.

Now historically, outside of the pricing reset, we've had anywhere from slightly negative share gain to up to 300 basis points. When we've had share gain in the higher end, it's been by adding customer touches or products. The initiatives, I've shared you both. Increased marketing and through product assortment and navigation, expanded services and sales force additions and the opening of our Louisville DC is expected to allow us to grow 300 to 400 basis points faster than the market over the midterm.

I also want to spend a few minutes on the investments we're making to our U.S. to drive long-term profitable growth. You've heard us talk about expanding the product assortment. We plan to add 1 million new items to the Zoro assortment this year. We've already added 400,000. Overall, we plan to add 10 million items over the next 3 to 5 years.

The product adds a driving revenue growth similar to what we've seen historically at MonotaRO. Our investments in systems and people to help drive this growth are also going well. We are going live with the new product information management system for Zoro this year, which will allow Zoro to add products at their own pace and to become less reliant on Grainger's supply chain. We're also improving our analytics platform, which will help us better market our assortment to customers online. We are investing in Zoro for success. We expect the bulk of the infrastructure investments to be complete this year. We are optimistic on the trajectory of this business going forward.

Now I'll turn it over to Tom, who will discuss the quarter's results in more detail.

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Thomas B. Okray, W.W. Grainger, Inc. - Senior VP & CFO [4]

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Thanks, DG. Looking at our total company adjusted results for the quarter. Sales were up 1% daily and up 2% on a constant currency basis. Volume was up 1.5% and price was up 0.5%. Year-to-date, price is up 1%.

For perspective, our U.S. and endless assortment businesses, which represents approximately 90% of total revenue, were up 5% but were offset by headwinds at AGI and Cromwell.

Moving to gross profit. Our GP rate declined 35 basis points. The decline in GP rate versus the prior year was primarily driven by the other businesses. We drove operating earnings growth of 5% in the quarter. Our operating margin grew 30 basis points versus the prior year due to gross margin in the U.S., our cost takeout initiatives at AGI and cost discipline in the U.S. and at the corporate level.

For the quarter, we generated incremental margin of 39%. Operating cash flow was $323 million in the second quarter of 2019, up 30%, driven by better operating earnings and favorable working capital versus the prior year period.

Now let's look at our performance in the U.S. As DG mentioned, the demand environment slowed sequentially from Q1 to Q2. Daily sales were up 2% composed of volume growth of 1.5% and price inflation of 0.5%. Intercompany sales to Zoro contributed 0.5%, which were completely offset by the decline in specialty brands.

Our GP rate increased 10 basis points. Excluding the remaining contract implementations, price/cost spread was neutral. Gross profit margin also included a benefit from supply chain cost primarily related to freight and inventory optimization and positive mix.

With respect to the remaining contract implementation, we are on track to complete this work in 2019 with only 5% remaining. In the quarter, we passed through a majority of tariff and nontariff-related cost inflation while ensuring that our pricing was market-based. We still expect price/cost to be neutral for the year, excluding the remaining contract implementations. And we've taken the following approach to mitigate any headwinds associated with price/cost.

With price, one of the main objectives of the reset was to ensure our pricing was market competitive. We can move web price fluidly throughout the year to ensure that we are priced appropriately. With contract customers, we can adjust price a few times during the year, and we manage these relationships in terms of total cost ownership to ensure that customers are getting the most value.

On the cost side, we've been very happy with our ability to navigate the tariff environment. As a reminder, we have a cross-functional team that meets regularly and has worked to minimize the impact. You may recall we originally expected about 2% COGS inflation related to tariffs. Our actual exposure through working with our supplier partners has proven to be much less.

More specifically, we leveraged our scale and maintain strong relationship with our suppliers, allowing us to better predict and manage cost headwind. Also, we continuously evaluate our product portfolio to ensure we have the best product at the best cost, which includes optimizing sources of supply.

Moving to operating earnings. Operating margin was up 60 basis points in the U.S. SG&A was flat on sales growth of 2%. Our continued cost discipline has enabled us to maintain SG&A while growing revenue. And we remain fully committed to growing SG&A at half the rate of sales on an ongoing basis.

In Canada, daily sales were down 23% and down 20% on a constant currency basis. Price was up 3% and volume was down 23%. Volume decline primarily resulted from the customer disruptions related to the turnaround activities we took last year.

Gross profit margin was down 150 basis points in the quarter due to negative price/cost spread. While we were able to pass through price in the quarter, cost was unfavorable due primarily to lower vendor rebates on softer volume and the foreign exchange impact of U.S.-denominated product purchases.

SG&A was down 26% versus the prior year driven by the cost takeout initiative. Operating margin was down 30 basis points in the quarter, reflecting lower gross profit margin, partially offset by favorable SG&A rate.

We expect performance in Canada to improve in the second half of the year. Late in the quarter, we saw encouraging data showing that service levels and web sales were improving. As DG mentioned, daily sales were flat from Q1 to Q2, indicating signs of stabilization on the top line.

Recall that most of the significant volume decline associated with the turnaround actions occurred in the second half of 2018. Therefore, we will have easier top line comparisons in the second half of 2019.

Moving on to Other Businesses. As a reminder, Other Businesses include our endless assortment model and our international portfolio.

Daily sales were up 6.5% in the second quarter and up 9.5% on a constant currency basis due to strong revenue from our endless assortment model. MonotaRO continues to grow significantly, and we're making good progress with our growth initiatives at Zoro.

Gross profit margin for the Other Businesses declined 220 basis points driven by promotional activities at Zoro, unfavorable customer mix at Cromwell and freight headwinds in Japan.

Operating margin declined 290 basis points for the Other Businesses primarily driven by investments in Zoro U.S. to drive long-term growth and performance at Cromwell.

Page 15 covers our guidance for 2019. At the total company level, we are reiterating our gross profit margin, operating margin and EPS guidance for the year. Our U.S. segment operating performance is strong and is more than offsetting slower performance at AGI and Cromwell. We expect U.S. segment operating margin to be at the high end of the guidance range, while AGI is expected to be towards the low end of the range. For Other Businesses, we are updating our operating margin guidance from 6% to 8% to 4% to 6% due primarily to performance at Cromwell.

Moving to our sales expectations. Our view of the MRO market has also changed from April. Instead of 1% to 4% growth, we now expect negative 1% to positive 2% market growth for 2019. Due to the slower demand environment, uncertain economic conditions, the early stages of our U.S. growth initiatives and performance at both AGI and Cromwell, we are lowering our top line guidance from 4% to 8.5% to 2% to 5%.

Now I'll turn it back to DG for closing remarks.

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Donald G. Macpherson, W.W. Grainger, Inc. - Chairman & CEO [5]

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Thanks, Tom. I would like to close by reminding you of our long-term performance expectations. We expect our initiatives in the U.S. to allow us to grow revenue 300 to 400 basis points faster than the market on average over the next several years. We believe Canada is an attractive market for Grainger to be in. It can grow faster than the market and be a double-digit operating margin business over the next 5 years. We expect continued strong growth with our endless assortment model through the strength of MonotaRO in Japan and the investments we're making in Zoro U.S. Overall, we expect to drive strong SG&A leverage and continued operating margin improvement, resulting from incremental margin of 20% to 25%.

Now I will open it up for questions.

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Questions and Answers

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Operator [1]

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(Operator Instructions) Our first question comes from David Manthey with Baird.

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David John Manthey, Robert W. Baird & Co. Incorporated, Research Division - Senior Research Analyst [2]

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Initially, you were targeting double-digit growth within the U.S. medium customer set, and now we're down to sort of a mid-single-digit growth rate this quarter. You mentioned the fluidity of pricing. I'm just wondering if there's anything you can talk about there as it relates to price refinements to try to reaccelerate the medium customer growth that you've made recently or you plan to make.

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Donald G. Macpherson, W.W. Grainger, Inc. - Chairman & CEO [3]

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Yes. Thanks. Thanks, Dave. So we still believe that we can grow midsized customers much faster than the market. We will need to grow them faster than 300 or 400 basis points faster than the market to be able to hit our overall targets. We have some good signs with our midsize customers. I would say that covered customers have continued to grow very strongly, which is a signal that the customers we've acquired are actually repeating at very strong rates, which is great to see. We feel like we have some efforts and initiatives going on with merchandising and marketing that can help us accelerate growth. I would point out that it's pretty new to us to be through the pricing changes and focusing on midsize customers, so we're learning everyday about what's working and what's not. And we're going to know more as we go forward, but we still feel confident we can really grow significantly with that customer group. And it's important for the overall economics of the company.

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David John Manthey, Robert W. Baird & Co. Incorporated, Research Division - Senior Research Analyst [4]

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Okay. And then as it relates to the reduction in the revenue outlook, I would assume that has more to do with your outlook for U.S. market growth just based on percentages than international or internal disruption. But if you run the numbers based on the full year guidance that, to some extent, it might imply flat to lower growth in the market in the second half of this year. And I'm just wondering your thoughts on how severe this slowdown might be. And is there a recession in your forecasting right now?

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Donald G. Macpherson, W.W. Grainger, Inc. - Chairman & CEO [5]

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So great question, one we talked about a lot. I would say, we're certainly not going to forecast a recession. And what we've seen in the market in the U.S. has been slow growth but pretty stable over the last several months, so we don't see anything that implies that we are heading off a cliff in the U.S. Obviously, internationally, there's pockets that are more problematic than others. But in general, we're not forecasting negative necessarily. We think it's a possibility but probably not a probability at this point.

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Operator [6]

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Our next question comes from Robert Barry with Buckingham Research Group.

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Robert Douglas Barry, The Buckingham Research Group Incorporated - Research Analyst [7]

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So I just wanted to circle back on the price. I mean I think the price slowed from 1.5 in the first quarter to 0.5 in 2Q. I think the tariff headwinds are kind of moving in the other direction. So just curious how you're thinking about kind of tariffs and other inflation and how price might track over the next couple of quarters kind of vis-à-vis what's happening with tariffs and inflation.

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Donald G. Macpherson, W.W. Grainger, Inc. - Chairman & CEO [8]

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Yes. I mean I would say that -- thanks, Rob. I would say that the tariff environment is still a significant uncertainty, and we'll see what happens in the next couple of months in terms of either resolving it or not. Our philosophy is to make sure that we are priced to the market. We will continue to make sure we are priced competitively to be able to serve our customers well. And we will take actions to make sure we will get it every day basically to make sure we're priced at the appropriate range. So that's really our philosophy, and that's what we'll focus on. Just some uncertainty as to whether or not the tariffs are going to come through in a bigger way, in which case price may go up or not, but our focus is really on making sure we're market competitive in terms of pricing.

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Robert Douglas Barry, The Buckingham Research Group Incorporated - Research Analyst [9]

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Got it. I mean just to clarify a couple of things. I mean since the List 3 did move up, I mean, is that going to be a bigger headwind for you in the back half? And if you're pricing the market, does the fact that the pricing moderated at Grainger mean that what you're seeing in the market, I guess, is, too, like, customers are not getting as much price?

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Thomas B. Okray, W.W. Grainger, Inc. - Senior VP & CFO [10]

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Yes. We've been planning for the List 3 change for quite some time. The way we've got it modeled is it's relatively small. As we said in the prepared remarks, we've been able to realize substantially less than the overall exposure. So we don't believe that the change in List 3 is going to be that material for us.

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Robert Douglas Barry, The Buckingham Research Group Incorporated - Research Analyst [11]

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Got it. Got it. Could I just clarify one more thing? When you were talking about getting the outgrowth from what was, I think, 1 point in 2Q to 3 points in the second half, is it all these items on Slide 8 that you think are driving it? And are they all just adding like 20 or 30 bps? Or is there 1 or 2 of them that's going to like drive the lion's share of the acceleration?

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Donald G. Macpherson, W.W. Grainger, Inc. - Chairman & CEO [12]

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So yes. Thanks for asking that. Yes. We will provide more detail going forward of how much we expect each to provide. I will say that this is a pretty big shift for us and mindset shift in the sense that we've tracked market share in the past, but we've never targeted market share growth. And we've never had a set of initiatives that we are expecting to align to that growth, at least not explicitly. And we do plan to become more explicit over time. I gave the example of merchandising in the prepared remarks, which I think in a good one where this is a little bit new to us. We are having to break down some barriers to execute faster and move faster on some things, and we're seeing good results. And we do expect that momentum to continue to build. And so we'll provide more of the specific details. But know that yes, that Page 8 is pretty important for us right now, I would say.

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Operator [13]

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Our next question comes from Christopher Glynn with Oppenheimer.

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Christopher D. Glynn, Oppenheimer & Co. Inc., Research Division - MD and Senior Analyst [14]

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Just had a couple of questions about the endless assortment strategy there. With the incremental investment you're putting in this year, is that investment in the cost base? Or does it tail off next year? And what are you thinking about time frame for that business to be stand-alone capable?

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Donald G. Macpherson, W.W. Grainger, Inc. - Chairman & CEO [15]

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Yes. So let me get to the last one second. Most of the investment that we're making in terms of getting platform and platform independent should be -- we should be through that by the end of this year. So we expect some of the cost we've added in terms of analytics and people to stay, but a lot of the cost will fall off next year as well. In terms of standalone, it will come in pieces. So one of the biggest things we're doing is developing the capability for that business to add their own items and to add items with third-party shippers, which will make that business less reliant on Grainger. Obviously, for the core Grainger items, Grainger will still fulfill. But that business will become less directly reliant on the Grainger supply chain over time. And so that should be -- we're going to implement that system in the third quarter. By the end of the year, we should have that capability. Similarly, the data analytics platform should be complete by the end of the year. So a lot of this should really be through this year in terms of getting that business more independent, and that's really what we're targeting.

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Christopher D. Glynn, Oppenheimer & Co. Inc., Research Division - MD and Senior Analyst [16]

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Okay. And then just a follow-up on the medium. If you go a little deeper into what you're seeing in terms of customer retention versus the pay positions and overall, how is the base holding on from the initial burst of growth there?

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Donald G. Macpherson, W.W. Grainger, Inc. - Chairman & CEO [17]

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So the base is holding on quite well. As I mentioned, we've taken a portion of that base. About half of the midsize customers are now in some sort of coverage model, and that has continued to grow at a pretty good clip. So the base has held on pretty well, and we are acquiring customers as well. But certainly, we're happy with what we see with the base.

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Operator [18]

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Our next question comes from Deane Dray with RBC Capital Markets.

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Deane Michael Dray, RBC Capital Markets, LLC, Research Division - Analyst [19]

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It was really interesting about what you did not say in your prepared remarks or in your Slides. There was no comment about weather. And we've seen all kinds of pressures on your peers, and you had to have felt some of the same pressures because this was a -- it's always an important HVAC opportunity for filters and refreshing refrigerants and so forth. But it didn't seem to impact you, and maybe you can clarify what sort of pressures you did see or did not see.

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Donald G. Macpherson, W.W. Grainger, Inc. - Chairman & CEO [20]

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Yes. I mean certainly the weather was not helpful, but it was very small impact to us. It's less than 0.5% impact. So we didn't call it out as a separate item.

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Deane Michael Dray, RBC Capital Markets, LLC, Research Division - Analyst [21]

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Good. Appreciate that. And then just to clarify and just make sure I'm clear on this. When you cut the sales high end of the guidance, you cut that more than what the market growth cut on the high end. So 3.5 points on the -- on your sales high end. So why are you cutting that more? Is that all Canada and Cromwell? Just to clarify that, please?

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Donald G. Macpherson, W.W. Grainger, Inc. - Chairman & CEO [22]

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Yes. It's a lot -- a lot of it is Cromwell and Canada, yes, being the [tricking] so that's a big part of it. Absolutely.

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Deane Michael Dray, RBC Capital Markets, LLC, Research Division - Analyst [23]

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Got it. And just one last quick one. Really it's helpful on the appendix where you give the monthly progression. And can you comment on how June ended as being their strongest month? And what sort of setup are you seeing in July so far?

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Donald G. Macpherson, W.W. Grainger, Inc. - Chairman & CEO [24]

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Yes. I mean we don't want to overindex on any monthly trends given some of the noise that can happen in the month. I would say that we do feel like we gained a little bit more share in June, and we do feel like the market, like I mentioned before, is not falling off a cliff. We expect to be in a slow growth market moving forward and it's been pretty stable from our perspective over the last several months.

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Operator [25]

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Our next question comes from Josh Pokrzywinki with Morgan Stanley.

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Joshua Charles Pokrzywinski, Morgan Stanley, Research Division - Equity Analyst [26]

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On the -- and I appreciate the color you guys gave on the tariff environment and the ability to navigate that a little bit better as we move into the 25% on the List 3. Maybe I missed it, but how would you kind of check that against the pricing environment out there? So maybe you have to ask for a little bit less price, but what's the appetite in the market? Some other folks in the space had mentioned that's gotten a bit more challenging. What would be your take on those?

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Thomas B. Okray, W.W. Grainger, Inc. - Senior VP & CFO [27]

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Yes. We're finding that we're able to pass on most of the tariffs-related price increases. The one thing that we called out in terms of price-neutral is the only thing impacting that, that we excluded was the price reset. We've had a great relationship since the tariff started working with our supplier partners. They want to sell their products with us, and it's been going extremely well as the results show.

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Joshua Charles Pokrzywinski, Morgan Stanley, Research Division - Equity Analyst [28]

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Got it. That's helpful. And then just coming back to endless assortment. Obviously, there's some kind of strategic synergy or operational playbook synergy from MonotaRO with Zoro. Once Zoro is further down the path and maybe has kind of learned all it can, is there a place for MonotaRO in the portfolio just given that it's a little bit more distant and probably doesn't give full credit from an external perspective given the strength of the business?

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Donald G. Macpherson, W.W. Grainger, Inc. - Chairman & CEO [29]

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Yes. So right now, we're learning a lot from MonotaRO. There's a lot to learn from their success. There's probably more leadership synergy than might be easy to recognize in the sense that the leaders of all of the businesses get together frequently and talk about what they're doing. We haven't talked much about Zoro U.K., but Zoro U.K. is on a terrific path and will be profitable in 2020. That's probably because of the linkages they have with MonotaRO and Zoro U.S. It's a fair question. But for now, we certainly feel like we're getting a lot of synergies out of the portfolio, and it's an important part of our portfolio going forward.

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Operator [30]

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Our next question comes from Ryan Merkel with William Blair.

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Ryan James Merkel, William Blair & Company L.L.C., Research Division - Research Analyst [31]

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So first off, really nice job on the U.S. margins. My question is what is surprising you positively to hit the high end of the operating margin guidance just given the slower sales trajectory?

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Thomas B. Okray, W.W. Grainger, Inc. - Senior VP & CFO [32]

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Well, I think it's been our ability to generate incremental margin. We know we're in a choppy slowing market, and our sales growth isn't going to be as great as we had planned. We're doing a lot of good work on COGS, as we described. I think managing the tariff environment very well. We're being very fiscally responsible on SG&A while also really continuing to invest in our priorities, advertising digital. So it really comes down to our ability to generate incremental margin. I mean we had very good results, as we called out.

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Ryan James Merkel, William Blair & Company L.L.C., Research Division - Research Analyst [33]

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Okay. That's helpful. And then moving to Canada. I hear what you're saying, average daily sales was stable from the first quarter, but the recovery still seems to be tracking a little bit slower. So what are the main issues? And then any change to getting to breakeven by the fourth quarter?

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Donald G. Macpherson, W.W. Grainger, Inc. - Chairman & CEO [34]

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So the main issues have been when we went through some of the changes, which were significant and there were many changes that we made, we had some customer interruption that we weren't fully expecting. I would say the most important sign for me is that the services improved in the business. We're hearing better things from our customers. We're starting to win back some customers, which is really, really important. I think the vision is that the business is very well positioned from a cost and business model perspective now, and we need to get the top line going. And that's taken a little bit longer than we thought. That's really the only thing that can start at this point is can we get the top line going.

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Ryan James Merkel, William Blair & Company L.L.C., Research Division - Research Analyst [35]

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And then breakeven by the fourth quarter of '19? Or is there any update that you can provide?

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Thomas B. Okray, W.W. Grainger, Inc. - Senior VP & CFO [36]

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Ryan, as we've said in our guidance, which is 1% to 5% for Canada, we believe it to be tracking to the low end. So the answer would be yes, breakeven -- better than breakeven for the year.

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Operator [37]

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Our next question comes from John Inch with Gordon Haskett.

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John George Inch, Gordon Haskett Research Advisors - MD & Senior Analyst of Multi-Industrials [38]

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Can we talk about the trajectory in the quarter? Was there a step-down from the first to second quarter as we hit April? And then how did sort of medium versus large play out sequentially? If there's any color you could provide there that gives us -- I know, DG, you've said that it's stable. But it seems like the number seems sort of low, but it looks like it picked up. Is there any color you can provide?

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Donald G. Macpherson, W.W. Grainger, Inc. - Chairman & CEO [39]

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Well, certainly, I would say May was lower across all segments, if that's what you're referring to, and June was better. I would say some of that are factors that are, frankly, not worth talking about from the last year or 2 in terms of setting the baseline that you're comparing to. But certainly, we don't see -- like I said before, we don't see anything falling off a cliff, and we do see midsized customers growing faster than the rest of the business. And we would expect to see that going forward.

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John George Inch, Gordon Haskett Research Advisors - MD & Senior Analyst of Multi-Industrials [40]

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But it sounds like you're sort of downplaying the significance of at least the monthly June tick back up to 3%. Is that a function in and of compares? Or is that just you don't want to get ahead of your skis by overpromising just based on 1 month?

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Donald G. Macpherson, W.W. Grainger, Inc. - Chairman & CEO [41]

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Well, I mean I guess I would downplay May being down as low as it was as well. So we would say that the quarter was, if you average out the quarter, that makes sense in terms of what we've seen for market growth.

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John George Inch, Gordon Haskett Research Advisors - MD & Senior Analyst of Multi-Industrials [42]

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And was there a disconnect between kind of the large versus the medium, going back to my prior question? And as you exited...

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Donald G. Macpherson, W.W. Grainger, Inc. - Chairman & CEO [43]

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No.

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John George Inch, Gordon Haskett Research Advisors - MD & Senior Analyst of Multi-Industrials [44]

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There wasn't really? So I mean...

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Donald G. Macpherson, W.W. Grainger, Inc. - Chairman & CEO [45]

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No. Not really.

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John George Inch, Gordon Haskett Research Advisors - MD & Senior Analyst of Multi-Industrials [46]

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It seems like medium then is going to pretty challenged to get back to double digit. Is that fair? Or do you see...

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Donald G. Macpherson, W.W. Grainger, Inc. - Chairman & CEO [47]

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In the short time, yes, that would be fair. Like I said, we're learning every day, and we're doing things to continue to improve the trajectory. And we like what we're thing. But certainly, in the short term, that's true.

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John George Inch, Gordon Haskett Research Advisors - MD & Senior Analyst of Multi-Industrials [48]

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And then your margin guidance for the year, right, implies a significant step-down from a really commendable performance in the growth and profit margin side, especially in the U.S., to sort of the total guide, which remains unchanged for the back half. What exactly is -- is that seasonality? Or are there other things going on there? Or are you just being conservative? Or why didn't you -- why the step-down, I guess, particularly at the midpoint?

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Thomas B. Okray, W.W. Grainger, Inc. - Senior VP & CFO [49]

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So there's -- you're referring to the U.S.? You're referring to the U.S.? Is that...

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John George Inch, Gordon Haskett Research Advisors - MD & Senior Analyst of Multi-Industrials [50]

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Well, kind of the whole thing, right? You look at the guide, but then you look at the -- with just the complexion of what's driving that, right?

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Thomas B. Okray, W.W. Grainger, Inc. - Senior VP & CFO [51]

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Right. Right. Okay. Yes. There is some seasonality as you look at the way we performed historically, the gross margin does go down over the year. Also, recognizing the uncertain economic environment we're in, we just thought it would be prudent to be cautious and as we measured in our guidance range.

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John George Inch, Gordon Haskett Research Advisors - MD & Senior Analyst of Multi-Industrials [52]

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But Tom, there's no price/cost dynamic. I mean I know you talked about tariffs. You feel like you're on top of it, but there's no other price/cost dynamic that's kind of playing out here that would be driving some of that disruption.

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Thomas B. Okray, W.W. Grainger, Inc. - Senior VP & CFO [53]

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No.

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John George Inch, Gordon Haskett Research Advisors - MD & Senior Analyst of Multi-Industrials [54]

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All right. Then it almost implies the guide could have a little cushion in it. Is that fair?

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Thomas B. Okray, W.W. Grainger, Inc. - Senior VP & CFO [55]

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It's seasonality and just the economic environment that we're in. I think it pays to be prudent.

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Operator [56]

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Our next question comes from Justin Bergner with G. Research.

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Justin Laurence Bergner, G. Research, LLC - VP [57]

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Just on the guide. Maintained margin guide, at least at the company level on 2% plus lower sales just mathematically would suggest that EPS would be 2% lower, but it seems like you're maintaining that. So should we also read that you're expecting operating margins to be a little bit above the midpoint of the guide at the company level to offset the lower sales?

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Thomas B. Okray, W.W. Grainger, Inc. - Senior VP & CFO [58]

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Well, I'm really not going to get into where we think we're going to land in the range other than what we've said in the prepared remarks. Where we've been running the play in the first half of not getting the sales we've wanted, generating very strong incremental margins. And we're going to continue to do that in the back half, and we think it will work out well for us. But I really don't want to get into going forward where we think we're going to land in the range.

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Justin Laurence Bergner, G. Research, LLC - VP [59]

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Understood. And then on repurchases, I guess you did a healthy amount of repurchases this quarter. You've done 400 million year-to-date that would put you tracking at or above the high end of your range if you sort of annualize that. Are you potentially going to do more repurchases in your earlier guide? Or were they just more weighted to the second quarter?

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Thomas B. Okray, W.W. Grainger, Inc. - Senior VP & CFO [60]

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I would go back to our capital structure tenets. One of the tenets that we have is we don't want to hold any excess cash. And we were in a good position where we had generated quite a bit of cash, and we just used that to return back to the shareholders. So really nothing to read into that. As it goes to our initial guide, we're sticking with that. And if it changes, we'll talk about it next quarter.

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Operator [61]

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(Operator Instructions) Our next question comes from Patrick Baumann with JPMorgan.

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Patrick Michael Baumann, JP Morgan Chase & Co, Research Division - Analyst [62]

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I just had a few follow-ups here. So a really good job on SG&A control in the first half of the year really. It looks like it was down year-over-year on a cumulative basis. Can you take it down again year-over-year in the second half? And I'm just trying to understand what the levers are for that, if you can. I ask because you said the cost actions are now, I guess, complete. So I'm just kind of curious what the levers are on SG&A.

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Thomas B. Okray, W.W. Grainger, Inc. - Senior VP & CFO [63]

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Yes. Our philosophy is that you can always optimize SG&A, and we will continue to look at that every day. The way we're looking at those is really trying to get to our 20% to 25% incremental margin. I mean that's the objective that the organization is focused on. But there's always ways to take out cost. I think in the prepared remarks, the cost takeout ending were primarily related to Canada.

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Donald G. Macpherson, W.W. Grainger, Inc. - Chairman & CEO [64]

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I would also just add that, I think, if you look at our cost structure, I think part of our cost structure is profit cost, the distribution centers, contact centers. We've made some pretty big changes, for example, in our contact centers. They are performing quite well now. They're going to continue to get better and better. So it's not -- so maybe the restructuring's done, but we expect every single year to get continuous improvement out of our big operations. And we continue to see that, and I would expect to see that going forward. So it's not like we're not going to improve our cost structure. It's just that we may not have as much restructuring type things going.

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Thomas B. Okray, W.W. Grainger, Inc. - Senior VP & CFO [65]

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Yes. Just finally, I would add one important thing is even in this down market because of what DG talked about, our focus on market share and our focus on growth, we are not backing off of any of our strategic initiative spending to hit an SG&A number. We're continuing to go forward full speed on that.

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Patrick Michael Baumann, JP Morgan Chase & Co, Research Division - Analyst [66]

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Do you think SG&A can decline in the second half year-over-year? And what drives the -- I think last year, you had some big profit share and headwinds in the second half that were impacting the numbers there. And I'm just -- so maybe that's an easy comp. I don't know. I'm just trying to kind of tie those -- all this stuff together here.

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Thomas B. Okray, W.W. Grainger, Inc. - Senior VP & CFO [67]

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Yes. We do have an easier comp as far as variable compensation. What I would say for the second half is we expect the SG&A rate to be lower than the previous year, for sure.

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Patrick Michael Baumann, JP Morgan Chase & Co, Research Division - Analyst [68]

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The -- as a percentage of sales? Or you're just saying the absolute number?

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Thomas B. Okray, W.W. Grainger, Inc. - Senior VP & CFO [69]

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Just percentage of sales. And we also expect the second half of the year to perform better than the first half of the year as it relates to favorability to the prior year.

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Patrick Michael Baumann, JP Morgan Chase & Co, Research Division - Analyst [70]

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From an absolute dollar perspective?

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Thomas B. Okray, W.W. Grainger, Inc. - Senior VP & CFO [71]

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From a rate respective.

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Patrick Michael Baumann, JP Morgan Chase & Co, Research Division - Analyst [72]

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From a rate perspective? Got it. Understood. And was that profit sharing expense line, was that a help in the second quarter year-over-year? Was it a tailwind?

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Thomas B. Okray, W.W. Grainger, Inc. - Senior VP & CFO [73]

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Sure. Yes.

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Patrick Michael Baumann, JP Morgan Chase & Co, Research Division - Analyst [74]

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And then just -- sorry, go ahead, I'm sorry. I didn't mean to interrupt.

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Thomas B. Okray, W.W. Grainger, Inc. - Senior VP & CFO [75]

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That's okay. That's okay. Yes.

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Patrick Michael Baumann, JP Morgan Chase & Co, Research Division - Analyst [76]

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And then D&A, looks like it's down year-to-date. What's driving that?

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Thomas B. Okray, W.W. Grainger, Inc. - Senior VP & CFO [77]

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That's a compare to last year. We had some issues in terms of KeepStock write-off some of the machines, older machines that we replaced. We also had some capital expenditures at 2 of our bigger DCs. So we were -- we had a favorable compare there to last quarter.

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Operator [78]

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Our next question comes from Bhupender Bohra with Wolfe Research.

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Bhupender Singh Bohra, Wolfe Research, LLC - Research Analyst [79]

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So just, Tom, I think you mentioned -- you gave some guidance with the Other Businesses margin here. Can you just give some more color on those margin targets and what your confidence is actually in the back half to achieve those targets for the year?

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Thomas B. Okray, W.W. Grainger, Inc. - Senior VP & CFO [80]

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Yes. We're -- we took down the Other Business unit operating margin target primarily due to the performance in our Cromwell business unit. Obviously, with the uncertainty of Brexit also that just combined with the transformation that we've got going on in that entity, where we're really changing the business model there in terms of being decentralized with the branch network and trying to have more centralization. Some of the things that we've noted on Canada we're seeing there where we disrupted the customer base, those types of things. So that's why we're taking down primarily for the other business unit.

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Bhupender Singh Bohra, Wolfe Research, LLC - Research Analyst [81]

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Okay. And is investment spending a big part of that? Or is it pretty small? I mean you guys are done with resource...

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Donald G. Macpherson, W.W. Grainger, Inc. - Chairman & CEO [82]

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Certainly, the investment spending in Zoro in the U.S. is a big part. That was planned at the beginning of the year, and we are spending that money and seeing what we want to see out of that. So we had always planned for the Zoro margins to come down in the year, and that's what we're seeing. So that's -- when we talk about investment spending, that's really what we're referring to.

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Bhupender Singh Bohra, Wolfe Research, LLC - Research Analyst [83]

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Okay. Got it. If I can, another one here on pricing. As we saw in the first quarter, pricing was 1.5%; second, 0.5%. How should we think about the back half? Because when you look at last year second half, I think we had pretty kind of close to 100 bps, actually pricing a bit, quarter. Are we going to see much more realization what we have seen in the quarter? Or as the kind of tariffs kick in like in the second half versus 3? So if you can give some color on that.

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Donald G. Macpherson, W.W. Grainger, Inc. - Chairman & CEO [84]

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Like we said before, I think our focus really is to make sure that we are market pricing everything that we do. Depending on how the tariffs play out, that could mean more price or less price, I think, and that there is some uncertainty around that. But we are tracking and watching this very, very closely. And our objective, always to make sure that we're priced competitively, and we will make sure we do that.

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Operator [85]

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Our next question comes from Steve Barger with KeyBanc Capital Markets.

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Robert Stephen Barger, KeyBanc Capital Markets Inc., Research Division - MD and Equity Research Analyst [86]

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Just looking at heavy manufacturing, down low single digit; and natural resources, down mid-single. In general, what are the customers or your sales force saying there? Is there an expectation for improvement in the back half of those segments?

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Thomas B. Okray, W.W. Grainger, Inc. - Senior VP & CFO [87]

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It's hard to tell. I mean heavy manufacturing was basically flat for the second quarter. Actually, in June, the overall market I'm referring to was actually negative. So it's hard to tell where that segment is going to go. Obviously, we've got a number of initiatives in play, which DG referenced in the prepared remarks and the Q&A. We think despite that down or slowing market, we're going to be able to gain share.

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Robert Stephen Barger, KeyBanc Capital Markets Inc., Research Division - MD and Equity Research Analyst [88]

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Right. And just more broadly, given softer markets, are customers leaning towards lowering reorder points or the amount of inventory they're willing to hold? And does that change how you think about inventories at DCs?

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Donald G. Macpherson, W.W. Grainger, Inc. - Chairman & CEO [89]

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Generally, not much. I mean the reality is that customers don't hold a whole bunch of our inventory anyway. And the way we've structured most of our large customer relationships we're helping them manage our inventory. We set MLQs that allow them to operate at a pretty lean level. So we don't feel a lot of channel loading or anything like that with our customers given the business model, and our business model is based almost entirely on helping them manage their inventory effectively.

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Operator [90]

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Our next question comes from John Inch with Gordon Haskett.

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John George Inch, Gordon Haskett Research Advisors - MD & Senior Analyst of Multi-Industrials [91]

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Yes. Just as a follow-up. I wanted to ask you about Europe. One of the things we've gleaned this quarter thus far from other companies is the European economies are actually starting to show up in a much more pronounced basis negatively. And it implied that the other business results were more U.K., Brexit-oriented maybe a little bit of your own affliction. What's going on actually with respect to Fabory and just what you're seeing in Continental Europe? And does that weigh on the results and have any sort of bearing on the second half in terms of your own expectations?

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Donald G. Macpherson, W.W. Grainger, Inc. - Chairman & CEO [92]

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I mean I think what we've seen over there is we've seen obviously the U.K. market has been struggling a bit. And we've seen some manufacturers ship some of their production from U.K. to the mainland of Europe. The Fabory business has had sort of consistent modest growth this year. We think the market in the Netherlands and Belgium where they are, it's been up combined but not that up significantly. Certainly, there are signs of some pressures in the European market, but what we've seen at Fabory hasn't really weighed on results. What we've seen in the U.K. has.

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John George Inch, Gordon Haskett Research Advisors - MD & Senior Analyst of Multi-Industrials [93]

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And the expectations, DG, do you think it's more of the same coming? Or are there reasons based on just exit-quarter trends or anything else that things get better or a little bit worse?

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Donald G. Macpherson, W.W. Grainger, Inc. - Chairman & CEO [94]

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Yes. I mean I would just remind you -- they may get a little bit worse. I would just remind you that we are very small in Fabory, so it might have had meaningful impact on us right now. So I also don't know that we have the best lens. I mean we have a lens of the Netherlands primarily and some Belgian business. So we don't have anything really in France to speak of, very little in Spain. So we don't really have much exposure to the big markets to have our position.

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Operator [95]

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Our next question comes from Justin Bergner with G. Research.

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Justin Laurence Bergner, G. Research, LLC - VP [96]

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With respect to neutral price/cost, are you seeing any different dynamic between sort of the industrial part of your portfolio and the nonindustrial part of your portfolio just given some of the comments from other MRO distributors earlier in the quarter?

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Donald G. Macpherson, W.W. Grainger, Inc. - Chairman & CEO [97]

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I'd have to go think about that. I'm not sure I have a great answer for you, to be honest. My inkling is probably not seeing much different, but I don't know that I could necessarily say that with certainty. I looked at the total, and I might have to go ask some questions about that specific question.

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Justin Laurence Bergner, G. Research, LLC - VP [98]

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Okay. Great. And then lastly, with respect to the endless assortment model, you used the term continuous growth versus accelerating growth. Does that just reflect more challenging end markets? Or is there anything sort of structural to be read into that change in language?

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Donald G. Macpherson, W.W. Grainger, Inc. - Chairman & CEO [99]

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I don't think it's anything structural. I think there's a sort of law of the universe, which is Zoro has been growing over 20 for the first 5 or 6 years. If we want to continue to grow in the 20s, we need to do something else given I think it gets bigger, that becomes harder and harder to do. We didn't want you to think that we're going to accelerate from the 20s to the 30s or 40s. We're going to try to continue to have a strong growth rate.

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Operator [100]

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Our final question comes from Patrick Baumann with JPMorgan.

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Patrick Michael Baumann, JP Morgan Chase & Co, Research Division - Analyst [101]

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I just wanted to follow up. You've mentioned KeepStock, and you said it's now profitable and was 10% of the business in 2018 and will grow faster, I guess, than the rest of the business going forward. There hasn't been a ton of visibility here in the last couple of years, so just curious if you could give a quick update on kind of what you've been doing there. Was it losing money last year? And kind of what changes have you made to improve profitability to make you feel like you can grow it better and more profitably in the future?

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Donald G. Macpherson, W.W. Grainger, Inc. - Chairman & CEO [102]

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Yes. We -- about 3 years -- or 2 or 3 years ago, we made some changes, and that's improved the profitability. We're now squarely in a place where we're building new capabilities. We've done some work on software. We've done some work on visibility and analytics and reporting to help customers understand the value that we're bringing, and we're going to continue to push on those things. The comment really around we had a -- for a couple for years, we hadn't to focus as much on capability building as we improve the profitability and now we're really focused on that. And so that's going to be our focus going forward.

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Thomas B. Okray, W.W. Grainger, Inc. - Senior VP & CFO [103]

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I think it's important to note that in June, we had our fastest growth rate that we've had in 2 years really to the KeepStock.

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Operator [104]

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I'll now turn the conference back over to Mr. DG Macpherson for closing remarks.

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Donald G. Macpherson, W.W. Grainger, Inc. - Chairman & CEO [105]

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All right. Well, good. Well, thanks for joining us. I would just reiterate a couple of points. One is in the U.S., given the profitability, we are really focused on growth and gaining share going forward. And it's a bit of a new orientation for us to say we're going to gain share on a consistent basis. But we are wiring ourselves up to be able to do that, and that's our primary focus, and the other is the online model continues to be very profitable and a fast grower. And so we're investing to make sure we can do that, if those 2 things go well. And we're pretty excited about the future, and I look forward to talking to you one-on-one. So thanks for your time today. Appreciate you on the phone.

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Operator [106]

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