Greetings, and welcome to the W.W. Grainger Fourth Quarter 2021 Earnings Conference Call. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. [Operator Instructions] As a reminder, this conference is being recorded. I would now like to turn the conference over to your host, Irene Holman, Vice President of Investor Relations. You may proceed.

Good morning, and welcome to Grainger’s fourth quarter and full year 2021 earnings call. With me are D.G. Macpherson, Chairman and CEO; and Dee Merriwether, Senior Vice President and CFO. As a reminder, some of our comments today may include forward-looking statements. Actual results may differ materially as a result of various risks and uncertainties, including those detailed in our SEC filings. Reconciliations of any non-GAAP financial measures with their corresponding GAAP measures are found in the tables at the end of this presentation and in our Q4 earnings release, both of which are available on our IR website. This morning’s call will focus on adjusted results, which exclude restructuring and other items that are outlined in our release. We will also share results related to MonotaRO. Please remember that MonotaRO is a public company and follows Japanese GAAP, which differs from U.S. GAAP, and is reported in our results one month in arrears. As a result, the numbers disclosed will differ somewhat from MonotaRO’s public statements. Now, I’ll turn it over to D.G.

Thanks, Irene. Good morning, and thank you for joining us. Today, I’m going to provide an overview of our full year highlights and fourth quarter results, and I’ll begin, as we always do, with the Grainger Edge, our strategic framework that defines who we are, why we exist and where we’re going, as well as how we’ll get there using our operating principles. This framework has been foundational for our team to work through another challenging year with resilience and strength. We remain relentlessly focused on our customers and building the company for the future. I am tremendously proud of what we’ve achieved and want to thank our team members for their commitment as well as our suppliers and transportation partners for their shared passion to support our customers throughout the year. It is always a privilege to help customers keep their people safe and their operations running, and even more so over the last two years. While 2021 was our second year navigating the impacts of the pandemic, it certainly brought us some unique challenges. Labor material shortages train supply chains throughout the industry. We demonstrated our agility and leveraged our supply chain scale to deliver strong service. Our customer satisfaction remained high. And in my regular interactions with customers, I continue to hear appreciation for our ability to deliver over the last two years. We invested in inventory, which enabled us to improve our availability and meet growing demand, especially in the back half of the year. We’ve also invested in our team members with increased wages to make sure that our DCs are staffed and able to get orders out the door. I can confidently say that the Grainger team navigated these challenges extremely well and put us in a good position as we enter 2022. While…

Thank you, D.G. Turning to our High-Touch Solutions segment. For the fourth quarter, we continue to see strong results with daily sales up 16.5% compared to the fourth quarter of 2020, and up 21.5% compared to the fourth quarter of 2019. In the U.S., we saw continued strong growth of our core non-pandemic category. And as a result of our growth investments, we’re seeing continued growth with both large and midsized customers at 16% and 25%, respectively. The U.S. business also had strong price realization in the quarter. We’re encouraged by how Canada and Mexico finished the year both with positive daily sales growth in the fourth quarter. In Canada, the business saw a year-over-year sales growth with 11 of its 14 industries, most notably in our targeted in segments like manufacturing and higher education. Canadian daily sales were up 12.2% or 6.8% in local days local currency. For the segment, GP finished the quarter at 39.6%, up 250 basis points versus the prior year, a very strong quarter for our High-Touch Solutions segment. We once again achieved price cost spreads slightly above neutral, and our pandemic product mix returned to near pre-pandemic levels, both driving positive improvement in gross profit. At the operating margin line, we saw an improvement of 230 basis points year-over-year, overall, a solid quarter for High-Touch Solutions. I’d like to go into a bit more detail specifically on our U.S. GP run rate. During the quarter, we achieved a gross margin rate of 40%. We’re encouraged by these results and the GP stabilization achieved in the fourth quarter. The pandemic product mix, our pricing actions and our ability to navigate supply chain challenges supported this achievement and will be the foundation for our GP expectations in 2022. As you’re aware, Grainger follows the LIFO accounting…

Thank you, Dee. Before I open it up for questions, I want to really reiterate my appreciation for the Grainger team and our partnership with our customers and suppliers in this challenging year. While we all hope that 2021 will bring more normalcy than it in fact did, the team remained steadfast in our purpose of keeping the world working and in turn achieved outstanding results for the year, both financially and operationally. In the coming year, we will continue to focus on serving our customers better than anyone else, profitably growing market share and making Grainger a great place to work. We have three core priorities: first, execute on our growth drivers that provide customers with a flawless experience and tangible value to help them operate safely and effectively; second, drive operational excellence and productivity in all that we do to support our growth investments; and third, strengthen our culture and focus on talent development at all levels of the organization. We will execute these efforts with our long-term environmental, social and governance objectives in mind. Finally, I'm excited to announce that we'll be hosting an Analyst Day in the fall of this year, where we will be focused on providing more details on our strategic initiatives and longer-term outlook. With that, we will open the line, up for questions.

[Operator Instructions] Our first question is from Nigel Coe with Wolfe Research. Please proceed with your question.

Hey guys, this is Sophia [ph] on of for Nigel Coe. Congrats on the blockbuster quarter. It was amazing.

Thank you.

So, my question was really on like the 2022 guide, you've kind of put forth HTS U.S., you see 300 bps of market outgrowth. How much of that do you really see volume versus the 3% price, I think, you've quoted in that particular segment?

So just to be clear, thanks for the question, and that's a good clarification point. And I can turn it over to Dee for specific. But in general, we talk about share gain, we're talking all about volume. So, our philosophy is to price to market, and then we expect to get volume share gain. That's how we think.

Yes. So, as it relates to the components for the U.S. market, we anticipate low single-digit volume growth at about 4% to 5% in price, which results in a market of about 4% to 7%. And there we expect to grow 300 basis points above the market which gets you to high-touch U.S. guide of between 7% to 10% growth.

Got it. That’s all for me.

Thank you.

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

Thank you. So I also want to follow up on the U.S. 2% outgrowth guidance. So certainly a positive level when we compare to the long-term outgrowth that the company has achieved. But it is below, I believe, 2021 came in at 4.5% outlook on the two year. In Q4, you guys add a very strong at over 6%. Is there anything specific that is kind of pushing that guidance down to just 3% in 2022?

Yes. We expect 300. We’re really confident – at a minimum, we’re really confident in the first half outlook, and we anticipate robust growth and some price inflation there. But the second half remains really harder to predict for us. And so based upon having better visibility, we feel pretty confident in the outlook that we’ve stated right now. And know that as things change, we’ll be more than want to talk about that and talk about the changes in the future how does impact our results.

Appreciate that. And for my follow-up, I wanted to talk about Zoro margins. Previously, the company has communicated a pathway to getting sort of to high single-digit margins over three years. But over the last couple of quarters, Zoro gross margin has really surprised and impressed to the upside. Does that change the operating margin outlook for Zoro? And if you could just kind of refresh us on what’s the latest expectations for there? Thank you.

Yes. I guess I can start with that one. So we have not changed our expectations for Zoro operating margin. We still are on the same path. We talked about. We have gotten strong gross profit improvement in the business. Some of that – most of that is squarely focused on quality growth, so making sure we are acquiring business customers that have long-term positive value and really focusing our efforts there, which means we’ve gotten out of some lower quality growth avenues that we’ve had in the past. And that has shown a pop. That pop is going to stick, but you’re not going to see similar growth in the gross profit line like we’ve seen. That has been very specifically towards actions to improve the quality of our growth, and we think we’re on a good path now. But we’re still on the same operating margin.

Our next question is from Deane Dray with RBC. Please proceed with your question.

Thank you. Good morning everyone.

Good morning.

Look, I fully respect that you guys are not a manufacturer, and that’s part – that’s a big advantage in this environment for sure. But you do have some manufacturing exposure with your private label. Just any update there, how you’ve been holding up in terms of supply chain issues there?

Yes. Yes. It’s a great question. So it’s – there’s a lot of chaos in the supply chain for sure. It has been very costly to get containers out of Asia. We have been prioritizing what we can get in. I think we’ve done a nice job of navigating the things that we can control. I think the other thing I would point to is we’ve done a really nice job of crossing items to more locally sourced items to help support customers during this time. And I think our ability to improve our product information has helped us navigate this. We are starting to see some loosening coming from Asia now, and we do expect things to get at least modestly better through the next couple of quarters. And so it’s been a challenge. I think it has been a constant seed if you’re working in the supply chain, certainly, the last year, our team has done a great job with navigating it. I think relatively, we’re doing well, but it’s challenging for sure.

Yes, it really does look like you’re holding up well, so congrats there. And then second question, maybe some color on the CapEx plans. It’s an uptick from last year pretty noticeably. We’ve heard some companies say, Hey, look, they couldn’t – because of supply chain issues, they couldn’t do as much in the way of projects. There were delays there. So was this a catch-up and maybe some color on where that money is being spent? Thanks.

Yes, I’ll turn it over to Dee in a second. I mean so it’s not necessarily a catch up. I’d say our CapEx is almost always in supply chain investments and in technology, and that will continue to be the case. I’ll turn it over to Dee to talk about specifics.

Yes. Just a little bit more to add to that, D.G. I agree, really not a catch-up. We’re really focused on maintenance capital in the DC. The DC have been running hard. As you can expect, we’re trying to keep up with demand. And so we’re making sure that we’re spending the right amount of capital there. In addition to that, you hear us continue to talk about continued capacity investment in Japan. So that is a portion of that as well. We mentioned our focus on ESG. So that’s about 10% of our capital spend going into next year. So really just getting back to what we would call normal levels of capital as we come out of the recovery.

Our next question is from David Manthey with Baird. Please proceed with your question.

Thank you. Good morning everyone. Could you share with us the amount of the LIFO adjustment? And just to be clear, is that – is it still in the adjusted results you present here in the slides? Or is that factored out?

So yes, the LIFO adjustment is in the adjusted results. And just want to remind everyone again that this is a noncash accounting entry and really is not reflective of operational performance. And so this year, at the end of the year, because we invested heavily in growing our inventory, so that it set us up well for the start of this year. That, coupled with cost inflation is the result of a larger adjustment than normal. And that adjustment, which you'll see in the 10-K is more than two times what it's historically been. So you'll see the net of tax around $49 million.

Okay. And I was under the impression that Grainger historically at least, was something like 30% FIFO in part of your business as well. And I'm just wondering, was there any kind of an offset from FIFO to offset some of that LIFO gain? Not explicitly in that number you just mentioned, Dee, but just operationally if you have some business on pipe when that might have benefited from the inflation.

So you're correct. It's about 25%. That is factored into our numbers. We really didn't get a benefit from that this year. We don't expect to on a go forward basis unless inflation changes materially.

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

Good morning. And thanks for all the details and guidance. My first question was on gross margin for 2022. Could you just unpack it a little bit more 4Q is exiting at 37.3%, but the low end of guidance for 2022 is 36.8%. Is that the LIFO impact? Or just what are the puts and takes?

So if I just start back with the U.S. GP probably be a good place to start there. Our goal was to exit the year in line with pre-pandemic levels for high-touch U.S., and so we achieved that around 40%. We will expect high-touch U.S. GP to stabilize into 2022, but we're also expecting a little bit more normal seasonality for our plan this year. We do expect to continue to manage price cost were added to 2022. And then we'll have a little bit of compression potentially from EA. Even though the high touch business is growing much faster than it has historically been, it is still a little bit lighter than the EA business, so that causes a little bit of compression for us.

Got it. Okay. That's helpful. And then pandemic sales flat in January, it's been negative, so the trend is looking good. I'm just wondering on the outlook there because I think you said it's still 40% above 2019. Just wonder, is there any give back as things sort of normalize? Or what's your feelings there?

No, I don't see that. I think we're about where we expect to be. If you look at our January results sequentially, we're still up a little bit on pandemic sales, but – so we have a little way to go that we hope will help us in our current outlook. We've embedded that we get back to normal levels in 2022. So we've embedded that in our plan and in our guide.

Our next question comes from Christopher Glynn with Oppenheimer. Please proceed with your question.

Thanks. Good morning everyone. Looking at the six points compound to your market outperformance in the fourth quarter, as everyone is talking about supplychain has got worse and tighter in the quarter. Are you a net beneficiary of that dynamic that everyone else is more bothered by just strictly from a volume perspective?

Well, I think there's a number of factors that go into that. We think we probably had some net benefit in the sense that we have product there, there's probably we don't have. And we've been able to navigate the challenge as well. And I talked about it before, but almost every customer call I have now talks about finding alternates that are in stock as opposed to waiting to get received from Asia, and we are aggressively helping our customers find solutions to keep them up and running. And I think that – all of that in our scale and the inventory pools we have help. We did build inventory in the back half of the year pretty significantly, and that has been a help as well. So I'd say we're a net beneficiary. And I think it's also helped us develop stronger relationships with our customers because we've been able to serve them during this time.

That makes sense. And how do you assess the risk, if any, of that 4Q volume strength with being a net beneficiary on how you process the transition to the expected 2022 volume growth?

Well, I think Dee talked about this a little bit before. We have a lot more clarity about what we'd expect in the first half of the year. Just on compares, we would expect the first half of the year to be stronger in terms of revenue growth. That said, we look at run rate volumes, and we understand how our initiatives impact volume and we're confident in at this point and what we've talked about from a range and feel pretty good about the year in terms of our ability to grow.

Our next question is from Hamzah Mazari with Jefferies. Please proceed with your question.

Good morning, thank you. My first question would just be just coming back medium customer strategy. We saw the growth numbers were pretty good. Could you maybe just remind us where you are in the process of gaining market share with medium customers? And is that number – could that number be similar to your large customer wallet share over time? Just any thoughts on where that's trending?

Yes. So just as a reminder for everybody, I think we've talked about this before. At our peak, we had about $2 billion worth of midsized customer sales. We went down to $800 million. We have recovered a portion of that, but we still have a long ways to go. And our share with midsized customers is still smaller. We are getting smarter in terms of our ability to acquire and develop relationships with midsized customers. It's hard to argue that we'd ever get to the wallet share in any reasonable time horizon that we have with large customers, we do think we can grow it faster than we grow large customers for years to come. So we're pretty confident in the growth path that we expect.

Got it. And just my follow-up question, and I'll turn it over, is just – as you think about MonotaRO, you had strong enterprise customer growth. Is there an opportunity for enterprise customers at Zoro? Or is the market just different where you service that through the high-touch brand? Just any thoughts there would be great, too. Thank you.

Yes. And I think it's a really good question. The short answer is the competitive market is very, very different. In Japan, the market typically goes through wholesalers to local distributors to customers versus what we have in the U.S. with the big distributors that serve customers with all kinds of services today. And so we don't see an opportunity for Zoro and our enterprise customer business. We see that squarely on the shoulders the Grainger brand and the high-tech solutions and the competitive environment makes that very different in the U.S. And so that's our growth path there.

Our next question comes from Josh Pokrzywinski with Morgan Stanley. Please proceed with your question.

Hi, good morning.

Good morning.

So just a follow-up on some of the market share dynamics. Maybe if you could talk about how kind of supply chain inconsistency has helped Grainger. I got to imagine that for maybe your smallest competitors, those guys are still having a hard time getting product and or maybe the most likely to use price as sort of a competitive weapon. How do you think share gains sort of attributable to that have trended here kind of through the second half? And what do you expect as we kind of continue in this tighter supply chain environment at least through the first half of this year?

Yes. I mean, I think through the last two years, we have done well in terms of navigating the supply chain. At first, it was pandemic product. And this past year, it was mostly non-pandemic product, where we have been able to find solutions and work with our customers and our suppliers to figure out how to get the right solutions for our customers. I don't see that changing at all in the first half of the year. I think we're going to be constrained. I know we're constrained now and we'll continue to be constrained as an industry. So I think the things we've been working on figuring out how to help customers find the right solutions in a constrained world will continue to be beneficial. And certainly, we don't really know how every distributor is doing. But having the inventory pools we have, having the information we have, having the data, having the deep customer relationships all helps us help our customers navigate through these really challenging times.

Got it. That's helpful. And then just from an end market perspective, what percentage of the portfolio, if any, because I know you have some important customer groups and maybe some hospitality, airlines, things like that, is still below pre-pandemic levels.

I'm not sure if I've got the exact numbers. It's – I would say most industries are above pre-pandemic levels for us now. Pretty much all manufacturing would be – there might be some sub-segments. We mentioned aerospace in the UK, aerospace has been challenged, for sure. And then there are certainly industries that we supported like cruise lines and hotels and airlines that are still below. It's a small portion of our total, and we continue to support those customers well and expect to continue to support those customers. But I think it's sort of we aren't talking as if the large portion of our customer base is challenged right now. We're seeing very strong demand in general, and we know there are sub-segments that are still struggling. We would expect those to recover over the next couple of years.

Our next question comes from Michael McGinn with Wells Fargo. Please proceed with your question.

Hey, good morning, everybody. I wanted to go back to the cash flow conversation. It seems like it's a little heavy on working capital or at least the conversion is a little bit below historic levels. Any comments on the timing of the MonotaRo DC load-in process, also general inventory, how you're preparing for pre and post Chinese New Year?

Well, you want me to start, D.G. and then maybe you can talk about operations?

Yes.

So when you look at our operating cash flow for the year, really two components contribute to that. And neither reasons – neither of them is really a reason for concern for us. And so the major factor was really our decision to invest in inventory later in the year, so we could have a strong start. And the second one was we had a very robust sales growth in the U.S. in December, really exceptionally strong. And so accounts receivable – our accounts receivable balance increased based upon the number of orders, but most of those payments are going to come due early in the year. So we're already seeing a consistent trend to what we've seen in prior years related to AR developed. However, as long as we continue to drive very strong sales, our AR balance would be higher than what it has traditionally been, and we expect to continue to support growth with inventory investment. I know you have a question specifically about inventory related to Chinese New Year. So I'll turn it back to D.G. for that.

Yes. I mean without going into too many details, we always look at Chinese New Year and try to get out in front of it. Part of the inventory build that we had was being able to pull full containers in earlier, clearly, things are still backed up coming out of China. The Chinese New Year, we're in the midst of it. When it comes out, it typically takes two to four months for things to get totally back to normal. We do expect some ease of supply chain, some more flow to come in. We're starting to see signs that, that is likely to occur. But certainly, this year, we – it wasn't just Chinese New Year. We're just managing constrained supply chains, and so that was part of it.

Great. And then somewhat more of a longer-term question with Zoro SKUs fast approaching the $10 million benchmark. Can you talk about the addition and curation process? And are you now able to leverage search on the platform to target potentially high-volume value-add SKUs that would benefit or versus using external search dynamics in the past? And then also maybe the general learnings and mix improvement from last quarter, where I think you mentioned some channels were turned off.

Yes, yes. So we expect to have a strong SKU count addition this year, the team is working on analytics and works with the team in Japan as well to understand which customers and which product pairs we want to go after. So we do most of that analytically. We use some platform, artificial intelligence type tools to help with that. But a lot of it's good old-fashioned analytics and understanding which target segments we want to go after small business segments we want to go after and which products to add. We continue to have a lot of success with getting those products in and having them be a source of growth for those customer segments.

Our next question is from Pat Baumann with JPMorgan. Please proceed with your question.

Hi, good morning. Thanks for taking my question. I wanted to go at the share gain thing in the High-Touch business from a little bit different vantage point. Can you talk about the revenue growth you saw for the year in that segment broken down between like the digital piece, whether that's EDI or website? And then how that compares to kind of the growth rates you're seeing in KeepStock and the branches. Just curious where you're seeing the most growth across those different channels and then how you see that playing out into this year?

I'm sorry, just to clarify the question. Did you say Endless Assortment or?

No, no, no, specifically High-Touch, just thinking about the different channels in High-Touch that you touch the customer with.

Yes. Yes. So we had strong growth through almost all the channels. I would say that KeepStock grew faster than the core business last year, continues to be a really core driver of growth in serving customers on site. As does ePro, which is typically connecting our systems directly to purchasing systems. So we continue to have a lot of large complex customers that have multiple points of stickiness and helps the customer manage their purchasing process and their inventory. We have seen, obviously, strong growth with digital, grainger.com has continued to grow very quickly. I think if you looked at it with midsized customers, you'd see digital as the primary source of growth. And if you look at it with large complex customers, you'd see more balance with strong growth in cube stock and ePro is what you typically see.

Understood. So that would mean that if those are all growing faster than branches are growing slower, I guess, than the rest?

Yes. I think over the last two years, branches have grown slower than e-commerce. That doesn't mean they aren't growing. They've actually had solid growth. But yes, I think Dee, you correct me, I think I'm pretty sure that branch, if you look over the last few years, walk-in traffic has been down, and the pandemic is probably contributed to that. We saw a nice bounce back this year after a pretty significant down in 2020.

That's correct, D.G. Right.

Our next question comes from Steve Barger with KeyBanc Capital. Please proceed with your question.

Hey, good morning, guys. This is Ken Newman on for Steve. Thanks for taking the question.

Good morning.

Good morning. I just wanted to circle back on the December ADS number. I think you guys had mentioned. It did see a pretty decent sized jump up from October, November despite it looks like it would be a slightly more difficult comp. Can you just talk through what drove that jump? And where is ADS kind of trending now through January?

So again, you've also Slide 11, you'll see in High-Touch U.S., our January estimate up about 15%, and that's posed by the pandemic and non-pandemic sales at answers your trending for January question.

Sure. That makes sense. Okay.

And then for December sales, I think I'd go back to like what D.G. has articulated, a lot of customers are finding our product availability to be appealing, and we believe that led to a lot of our growth in the U.S. later in the December time frame driven by core pandemic or non-pandemic products.

Understood. And then for my follow-up, I'm just curious if you can give a little more color on the capacity investments in Zoro and MonotaRO. Any color on the timing of when you expect the margin trends to kind of return back to normalized levels? Or how do you view the ramp of more normalized ROIC for those investments?

Yes, that's a good question. So it affects MonotaRO only. Zoro is not having unusual investments at this point, and we expect the operating margin to continue to expand for Zoro the next several years. MonotaRO has – given the Japanese geographic footprint, it's not as broad or as big as the U.S., obviously. And they have very high-volume DCs but very few of them. And so what you're seeing right now is expansion – capacity expansion around Tokyo and Osaka, which are the two primary places where you need distribution capacity. And you're going to see a lot of redundant assets this year, which is why costs go up, and you're basically running two buildings and doing the transfer. That falls off in 2023. So in 2023, you'll see more of a normal return to SG&A for the MonotaRO business. It's just the – I think they're going from a 1.1 million square foot building to 1.7 million or something like that around the socket. These are very large buildings. And when you're running both of them at the same time, you have a lot of redundant costs during the transition.

Ladies and gentlemen, we have reached the end of the question-and-answer session, and I would like to turn the call back over to D.G. Macpherson for closing remarks.

All right. Well, thank you. I appreciate everybody's questions, and thanks for the time today. We obviously feel good about the way the year ended and are excited about 2022. We're going to stay focused on making sure we provide the right solutions to our customers, and investing in things that I think the thing I'm most excited about is we have a lot of things we can still get a lot better at. And so it does feel like we are working on the right things, and we'll stay committed to making sure that we build the right systems and processes to support our customers and win for the future. So I hope you all stay warm and you're not getting hit too hard by the storm and look forward to talking to you soon. Thank you.

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