Hello, and welcome to the W.W. Grainger First Quarter 2022 Earnings Conference Call and Webcast. [Operator Instructions] As a reminder, this conference is being recorded. It is now my pleasure to turn the call over to Kyle Bland, VP, Investor Relations. Please go ahead.

Good morning. Welcome to Grainger's first quarter 2022 earnings call. With me are DG 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 table at the end of this presentation and in our Q1 earnings release, both of which are available on our IR website. This morning's call will focus on our first quarter 2022 results, which are consistent on both the reported and adjusted basis for all periods presented. We will also share results related to MonotaRO. Please remember that MonotaRO is a public company and follows Japanese GAAP, which differs from U.S. GAAP, and is reported in our results 1 month in arrears. As a result, the numbers disclosed will differ somewhat from MonotaRO's public statements. Now, I'll turn it over to DG.

Thanks, Kyle. Good morning, and thank you for joining us. Today, I'll provide an overview of our first quarter performance, and then pass it to Dee to walk through the financials in detail. I'll begin by quickly highlighting our strategic operating framework, the Grainger Edge. I am proud of our team members as we embrace the edge at every level of the organization and in everything we do day in and day out. This framework serves as the basis for our culture and define how we work together to serve our customers and communities. I'm excited to share that earlier this month, we were recognized as one of Fortune 100's -- Fortune's 100 Best Companies to Work For. This award is attributed to team members across the organization. Turning to Slide 5. Not unlike the past 2 years, the first quarter of 2022 threw us some challenges, including the ongoing impacts of the pandemic, heightened inflationary pressures, supply chain and labor challenges and now the Russian war in Ukraine. I'd like to spend a few minutes on how we are managing through these challenges. First, we continue to manage through the highest inflationary period in our careers. On the cost side, we are leveraging our purchasing scale and working closely with our supplier partners to chart a shared path forward. Despite high inflation, our goal remains to be price competitive while targeting price/cost neutrality. On the supply chain front, we continue to work with our supplier and transportation partners to ensure products are available and delivered to customers on a timely basis. U.S. customer service levels are starting to improve as carrier capacity increases. Overseas freight remains pressured with delays, port congestion and container challenges and when coupled with increasing fuel prices, is pushing costs higher than historical trends. We…

Thanks, DG. I'd like to echo DG's sentiments. Our execution and teamwork in the first quarter drove very strong results. Turning to Slide 8. We covered revenue and margins at the total company level, and I'll get into more detail on the segments in a minute. Before we do, I'd like to highlight a few other key points. Our total company SG&A as a percentage of sales was 23.3%, gaining solid leverage over the prior-period first quarter. Given our investments in the DCs at MonotaRO and our continued strategic initiatives in High-Touch Solutions, I am proud of the way the team concurrently managed these investments as well as operating expenses to support strong top-line performance in the quarter. Finally, resulting EPS in the quarter was $7.07, up 58% versus the first quarter of 2021. Turning now to our High-Touch Solutions segment for the first quarter. We continue to see strong results with daily sales up 18.2%, compared to the first quarter of 2021. We saw impressive growth across the board with double-digit revenue growth across all of our North American geographies and both large and midsize customers. In the U.S., we saw a strong price realization from our recent pricing actions and delivered strong growth in every end market, with particular strength in commercial, transportation and heavy manufacturing. In Canada, the economy has rallied back, and the business saw year-over-year sales growth in nearly every end market, with manufacturing especially strong this quarter. Canadian daily sales were up 10% or 11.8% in local days and local currency. For the segment, GP finished the quarter at 40.4%, up 310 basis points versus the prior year. If we exclude the first quarter 2021 pandemic product inventory adjustment, we still achieved gross margin expansion of roughly 80 basis points. This expansion was largely…

Thank you, Dee. Before I open it up for questions, I would make just a few comments. First, we performed extremely well in the quarter. I'm proud of the team and the way we've executed, focused on serving customers well and navigated through some of the bigger challenges that we discussed at the beginning of the call. We continue to execute on our growth drivers, drive operational excellence and strengthen our culture. We are well positioned to continue serving customers well and they have a very strong 2022. As we shared last quarter, I'm excited to provide some information on our upcoming Investor Day. We will be hosting it on Wednesday, September 21 at our Northeast distribution center in Bordentown, New Jersey. We will be focused on providing more details on our strategic initiatives and longer-term outlook, as well as provide a tour of our DC, where we will highlight some of our automation and ESG investments at work. More detailed information will be available in the coming weeks, and we certainly look forward to an exciting day. With that, we will open up the lines for questions.

[Operator Instructions] Our first question today is coming from Jake Levinson from Melius Research.

I just wanted to see if we could get a little bit more color on what's happening with our neighbors in the North. I know you folks used to break that out a little bit separately, but maybe you can just give us an update on how things are progressing in Canada. It seems like the end markets have finally turned in your favor, but are we kind of on the sustainable path to profitability there?

Yes, yes. It's a great question. Thanks for asking. So I think the business is on a very sustainable path to profitability. We have reset the way the business operates over the last 3 or 4 years. We're seeing signs of share gain returning into that business. The cost structure is in a good place, and we're seeing growth with some attractive customer segments, most notably manufacturing in healthcare. And that business just continues to get better and better, from a profitability perspective, and it's steady, and it's going to continue to be a steady rise in profitability, but we feel pretty good about the path we're on.

Okay. That's helpful. And then, just as a quick follow-up, I'm looking at the safety side of the business. You mentioned that, that's back to kind of prepandemic levels as a percent of sales. I guess the question is, what does the new normal look like for your customers, in terms of buying those products? Obviously, the mandates seem to be changing or social norms around mask-wearing and what not, so are your customers still buying masks and hand sanitizer and things like that at elevated rates, I guess, you could say?

Yes. I think Dee talked about it. We're pretty much back to prepandemic mix. I'd say, there's a slight elevation in some of those products. I can't really predict what customer behavior is going to be around those products, given the way the virus proceeds. But what I will say is that we see most customers going back to some normalcy. I've been in a number of manufacturing plants the last couple of weeks. And in almost all cases, there isn't a lot of new PPE versus what was borne in 2019 being used. So we don't expect it to be hugely elevated, mask and sanitizer sales, going forward. And we're pretty much back to normal, still elevated, but not that much.

Our next question today is coming from Ryan Merkel from William Blair.

First off, I was hoping you could unpack the comment you made about speaking with customers and they expressed a lot of confidence about demand. In particular, I'm curious if you spoke with energy customers, if they're seeing a big uplift here?

I can give you my perspective and Dee, if you've talked to customers that have a different perspective. I have not talked to all that many energy customers. I have talked to a lot of heavy manufacturing, line manufacturing commercial customers. And despite -- we talked about -- a little bit about it despite sort of the uncertainty of the world, everybody right now would say super busy, just hanging on. If I can get the supply chain parts into my operation, I have the demand, and we see that through most of the customers that we're talking to, right now. So a lot of positivity. I haven't been -- I'm trying to think, it's been a while since I've been in an energy plant. So I don't have that perspective. But generally, customers are pretty bullish on demand, right now.

I was just going to concur. My time with customers is similar to DG's experience up to this point in the year.

All right. That's helpful. And then for my follow-up, what really stood out to me was the profit margin in the High-Touch business. And I'm curious, the guidance seems to imply that 1Q will be the high watermark. So can you just unpack why that might be the case?

Sure. Dee, do you want to take that one?

Yes. So when we talked about guidance last year, I think a lot of the underlying assumptions really stick, even with some strong performance up to this point. We, of course, had to lap for the E&O adjustments. The first quarter is the time when we work with our suppliers on some of our largest price increases in line with our cost cycle that we work with them. I know the cost cycle has been a little unusual, but I will say, the seasonality related to our price changes, we are assuming the same types of outcomes. So you are exactly right. We feel like Q1 will be a higher watermark as it relates to that, and we will moderate as we go through the year. Again, some of the tenants are the same. We're still focusing on price/cost neutrality and remaining price competitive in this market.

Our next question today is coming from Nigel Coe from Wolfe Research.

So I wanted to just return to Canada. That business, in days gone by, it was tracking low double digits until the oil and gas bubble burst in 2014, but any reason why it can't get back to those kinds of levels? I mean there's been some changes in the business profile and the cost base. So just curious on that. And then on the midsized customer margins, they used to be running, I think, about 10 points above the average in that segment. Are they still in that kind of zone?

I think, Nigel, your question on Canada is revenue growth, can we get back to sort of double-digit revenue growth, is that your question?

No, no, no. Margins, margins.

Oh, margins, yes. Yes. Structurally, we don't think there's any reason why we can't get there. Given the path of the business, we're focused on sequential improvement, and we do feel like we can build to that, but it's going to take multiple years to get back to that 10%. They're going on a good path. I am very confident that we will continue to improve margins in Canada. But structurally, there's no reason why we can't get back to double-digit margins there. And then Dee, do you want to take the second half of that?

Yes. Yes. And on midsized customers, I think it's a good assumption now to use high single-digit number.

Okay. That's great. And then just April, any comments on how April has been tracking relative to the strength to the 1Q?

Very well. It's -- Dee mentioned that it's 20%. It's, if anything, it's been slightly better than what we saw for 1Q revenue in April. But generally, it's very, very good.

Our next question is coming from David Manthey from Baird.

And congrats on the Fortune designation. It's a great honor. Could you please update us on High-Touch and some of your efforts there? I mean you had really nice outgrowth, and I'm trying to understand the factors there. I'm sure it's a combination of these things. But if you could talk about customer receptivity? And then, any idiosyncratic things that are going on there, in terms of a better offering or changes in incentives, anything that you're doing inside Grainger to drive those better results?

Yes. And we've talked about some of these things before. The primary initiatives for us are around continuing to improve our product assortment through merchandising efforts and making it easy for customers to find what they need. We continue to make great progress there. We see cause and effect in terms of driving share gain through that effort. Our marketing efforts, we're getting more capable in terms of marketing, spending money in the right places and getting really strong returns out of marketing, and that's a big piece of it. We see a nice expansion of our KeepStock offer, so becoming more integrated with our customers' inventory management practices and supporting their inventory management practices. Those are things that have been very consistent and are a bit evergreen for us at this point, in the sense that we're always getting better at those and we -- those -- cause actually drive significant share gain. I don't think there's really anything even idiosyncratic. I think the core thing that we are working on, I would add providing better insights to our customers to help them manage their business, they cost out, and I think we're getting better and better at that as well. But the only idiosyncratic thing would probably be supply chain related. I think, through this time, we've done a better job than most of managing, adding product of finding customers' substitute products, if we don't have products, and being able to serve them. And so we're probably getting some -- it's hard to quantify from just having inventory and being able to serve customers where others cannot.

Got it. That sounds good. And then just quickly, if you could zoom out on gross margin kind of 5-year plus sort of basis. Do you expect gross margin to continue to decline gradually over time, all else equal?

Yes, go ahead, Dee. You can take that.

I was going to add that -- DG, you can continue on. In the High-Touch business, we've kind of noted, specifically for this year, that we're focusing on gross margin stability around 40%. And DG, were you going to talk about the outlook?

Yes. Yes. I mean -- so what I would say is, we feel like we are price competitive at the gross margins we're at. We feel like within the High-Touch, the 40% number is going to be a fairly stable number over time. Our company gross margins are likely to go down slightly, just given the assortment growth continues to be -- to grow faster than the business, and then they tend to operate at a lower gross margin and lower SG&A. But in terms of the segment performance, we actually expect pretty stable gross margins over the next several years.

Your next question today is coming from Josh Pokrzywinski from Morgan Stanley.

Just first question, I guess, a clarification. Dee, you mentioned, I think, in some of your opening remarks about kind of a seasonal benefit in 1Q kind of tied into a sales event in February, I just -- starting to unpack -- hoping to unpack that a little bit more and maybe add some numbers to it.

Well, sure. Yes. We returned to an in-person Grainger show in Orlando in February. That's what I meant in my prepared remarks related to a show. It was really great to be back in person. Our show was well attended. We heard great feedback from our customers and from our team members. From a Q1 GP perspective, the show provides a modest tailwind for us year-over-year. And that's due to supplier funding, as you can imagine. And this favorable impact through the year will moderate versus prior year as we will go through the year.

Okay. Got it.

Verified [ph].

Understood. And then a competitor of yours, pretty recently, talked about some supply chain stabilization, maybe not seeing as much inbound inflation outside of freight-related items. What would the Grainger take on that be? I mean, obviously, the freight environment has gotten more difficult, and China has a bit more of wild COVID lockdowns. But would that be your take as well? Or do you see that differently?

We certainly have seen some improvement in -- particularly, domestic freight, in terms of service. And price increases have certainly moderated. They were starting to moderate a little bit on ocean freight as well with the lockdown in China. You know how that's going to play out. But yes, we would say something similar, where things were easing a little bit and continue to do that domestically, the overseas piece is probably the more complicated .

And your next question is coming from Chris Snyder from UBS.

I guess, so first, I kind of wanted to follow up on DG's prior commentary around the longer-term gross margin drivers. And certainly, I understand that Endless Assortment outgrowth is a structural gross margin, I don't have the consolidated level. But what gives the company confidence that it can hold business line, gross margin steady beyond '22? This is a pretty competitive business. So it is the midsized outgrowth. What gives you on that?

Yes. I think, just working with our customers, understanding the value we provide, the value we create, seeing some midsized outgrowth and having confidence as we continue to return to more industrial product as we've seen. We just feel like our price is in a competitive place. And we can continue to support our customers and provide what they need and sell on the value that we provide. And that's really what our business is based on. And we're going to continue to do that.

All right. And then I wanted to also follow up on the last question and commentary around potentially maybe easing some of the domestic freight costs or supply chain, and I understand that part of it. But has supply chains overall eased? Or has procurement gotten more difficult with the China shutdowns, even at -- some of the domestic freight market has opened up a little bit?

Yes. So I would first comment that the China shutdown is going to take weeks and maybe longer for that to flow through, in terms of understanding the impact. I would say that ex that, what we were seeing before was still significant supply chain challenges but more isolated to specific suppliers that were having trouble getting product to meet their manufacturing needs. And so it wasn't as widespread as transportation improved. And we do buy a lot domestically as well. And so for customers that have the materials that we haven't seen, labor has gotten a little bit better and transportation got a little bit better. There's still plenty of pockets of challenges though. And we still see -- it's still a challenged supply chain, from our suppliers' perspective, in many cases, but it is more isolated to specific suppliers rather than -- it was broad-based this time last year. You would have just said, it was kind of chaos, and it's less chaos now, but there's still plenty of challenges.

Our next question is coming from Hamzah Mazari from Jefferies.

This is Hans Hoffman filling in for Hamzah Mazari. My first question is just on the cyclicality of the portfolio today. Can you just walk us through how to think about how your business performed in a recession? And maybe any differences in the mix of the portfolio today versus past downturns?

You're talking about if there's a recession, how have we performed in past recessions? Is that your question?

Yes. Yes, yes. If there's any difference in the mix of the portfolio today versus past downturns.

I don't think -- so to answer the second part first, I don't think there's a significant change in the mix of the portfolio. We have more on those assortment business, but I don't -- that will probably perform similarly. The short answer is, we generally perform well in downturns. We look at share gain during downturns, and it's usually been very good. Part of that is because we are steadfast in maintaining service to customers in downturns, and that allows us to serve customers better than many others can. And we generally still generate a whole bunch of cash during downturns and still perform well. Obviously, everybody takes a hit. We take a financial -- you can go back and look at 2008, '09, is probably the most severe one we've had, and you can model what happened there. But we're -- one of the things that I would sort of say is, we are -- while we don't know when a recession will hit, we are certainly aware of the uncertainties of the world and we are being very mindful of the cost of running the business. So we are prepared for anything that happens. But in general, we performed well, and we would expect to do that again.

Great. And then, could you just walk us through where your market share is today with midsized customers? And what the total addressable market there is?

Yes. So -- and Dee, do you want to -- you may have the details. Roughly, if you go back over a kind of 10-, 12-year period, we were at about $2 billion of midsized customers. We dropped below $1 billion. We're now, I think, $1.5 billion or more, $1.6 billion, maybe this year, something like that, is the expectation. We're still to and change market share with midsized customers. We feel like we've got a long road ahead. And we continue to do a really nice job of reacquiring customers that left us, and then growing with existing customers and building solid relationships. So we think we've got a long runway, in terms of share gain, with midsized customers.

Our next question today is coming from Deane Dray from RBC Capital Markets.

But DG, I was hoping you could expand on what types of products are in short supply? Did you have any missed sales because you would blame it on the supply chain?

No, I wouldn't say we had many missed sales. We have -- I mentioned this a little bit before, more than ever, probably we're relying on some of our product information investments to make sure we can get customers to substitutes. But we wouldn't have any sort of things that wouldn't be in the news already. Obviously, if a product has a chip in it, that's been a challenge. There are certain commodity products that have been challenged. So I won't call out specific products, but I would say, we've done a nice job of finding alternatives in most cases, and it's hard to argue that we're missing too many sales. I'm sure we are missing some sales and they're just not occurring because nobody has those products.

That's helpful. And then just qualitatively, can you comment on the mix with regard to a typical reopening? Coming out of the pandemic, you've got a number of your customers opening up shop, back to work. And so that's when Grainger typically gets a nice lift as they haven't restocked their shelves but now they have to. So you typically get a bigger lift during the, like reopening or restarting process. Is that still reading across in your North America businesses? Or is this kind of the steady MRO run rate?

This is -- first of all, we have not had many customers that closed shop. I mean, we've been with our customers throughout. There were a few in certain categories that shut down. So if you said cruise lines, which we have cruise line customers, obviously, they shut down. And you'd see a little bit of that type of growth potentially there, but it's a very small portion. Hospitals, governments, manufacturing plants, retail organizations in terms of distribution centers have all been open the whole time. So one of the things that's been maybe surprising through the pandemic is just how consistent the growth has been. If you go back to 2019, we've seen substantial growth, and we saw really growth only in the front end of the pandemic in 2022 that we really see a drop because most customers actually kept operating. And so, I think it's just normal business. We don't see much restocking going on.

Our next question today is coming from Chris Dankert from Loop Capital.

I guess, and forgive me if I've missed it, but can we get a little bit more detail on the Zoro strategic pivot? I mean, it sounds like you're moving more into productive channels. I mean, does this merely change the TAM? Does it change the growth outlook for that business? Was it a margin-driven decision? Any color on that strategy change would be great.

Yes. We've been making a strategic pivot with that business for the last several years, dramatically expanding the product line, building new data analytics capabilities, getting that business independent from a technology stack. So there's been a lot of investment that's happened. In terms of the question specifically you're asking, we have done a whole bunch of analysis, working with the team in Japan, on customer profitability. And customer profitability, not in terms of the first transaction but in terms of lifetime value. And we are skewing our efforts to attractive business customers. And so what you've seen is dropped some volume that we certainly could have in the short term because it's just not helpful in terms of creating a profitable long-term business. I think, ultimately, it actually will accelerate our growth rate as we get better at acquiring and getting attractive customers to the second, third order, where they become more frequent buyers. But certainly, we have made a little bit of a shift in getting out of some channels that were lower lifetime.

Got it. That's really, really helpful. I guess, kind of, with that as a backdrop, any kind of color you're able to provide in terms of kind of price versus volume inside of the Zoro business this quarter?

I think the price volume wasn't much different than what we saw in the whole business that we talked about before. So high single-digit price and substantial volume growth is what we're seeing in that business at this point.

Our next question is coming from Christopher Glynn from Oppenheimer.

So I appreciate the comments that reopening isn't causing really episodic demand that you can really think of. But I think Dee maybe referred to some idiosyncratic benefit from competitors that are in relatively less supply chain wherewithal than you getting product through. I think, historically, when you accrue volumes in customers, it's pretty sticky base for continued scaling. So I just wanted to kind of revisit that there might be some reversion, once everyone has sort of democratic access to process or to procurement. But yes, just -- I'll listen from there.

Yes. It's a great question. I think what I'm hearing from customers is, most of the work that we've done has been highly valued to support their operations and to keep them up and running. And in many cases, we've actually added inventory management solutions to our KeepStock solutions or further embedded in customers really, really want to continue to have long-term relationships. So you could argue there may be some pullback, but that's really not the behavior we're seeing, and it's not what we're hearing from our customers. Our customers are saying, if anything, we've learned a whole lot about who we want to partner with and why we want to partner with them through this. And our ability to keep customers going is super valued, and I think it will continue to help us be sticky with those customers.

Our next question today is coming from Patrick Baumann from JPMorgan.

Can you talk about the approach to pricing this year? Should we assume the 8% in the first quarter is a good level to work from now? Or have you taken more actions that are providing another boost here in April and for the rest of the year?

Yes. Dee, why don't you -- do you want to jump in? I can not hear you, Dee. I can take it then. So what we basically have been looking at is, we took price, obviously, through some of the back half of last year as well, as everybody has. We think prices will moderate a bit. So we don't think the level we're at will be the full-year number year-over-year because we think that the price increases will moderate. That doesn't mean prices will go down, they won't. But relative to some of the changes that we made last year, you'll start to see a bit slower -- a lower difference. So we would expect them to moderate somewhat, still a pretty healthy price, obviously, this year.

Got it. And then with all this -- oh, sorry, Dee, go ahead.

Yes. Sorry, I don't know, there was a problem with my line, I apologize for that. Yes, we -- in High-Touch U.S., I know specifically, we usually talk a little bit about our pricing outlook. And so we're expecting price to be about 6 to 7 for the year.

Helpful. And then with all the pricing and the positive price/cost in the first quarter, just curious, why you aren't able to increase the gross margin guide? Can you just talk about the puts and takes there? And whether you may see some benefit if cost inflation moderates, given that the LIFO accounting dynamic you mentioned last quarter?

Yes. So we've kind of usually talked about the lumpiness of price for us and how it impacts gross margin through the year, with a large portion of our High-Touch U.S. business being contract based. So in light of still saying suppliers continue to come in, with cost inflation request and our ability to continue to work with them on that, when we look at the outlook, we believe that staying in line with our current gross margin is most feasible right now, knowing that we're going to have some lumpiness as we continue to appropriately pass through some inflation as it comes through off-cycle. As the year progresses, as you know, the math works, you have less months to push some of that through.

We reached end of our question-and-answer session. I'd like to turn the floor back over to DG for any further closing comments.

Sure. Thanks, everybody, for joining us. It is a pleasure to have you on and hope you're all doing well. I would just reiterate the fact that we're completely focused on what we can control, and that's making sure we advance our strategic initiatives to grow profitably. Building the culture, we think, is really, really important and making sure that we serve our customers well. And while there are many things going on, the market right now is very, very strong, and we feel good about the share gain performance we're getting. We feel good about what we're seeing in both models. And really optimistic for the future. So thanks. I hope you all have a great rest of the week, and take care.

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