Q3 2020 W W Grainger Inc Earnings Call
[music].
Hello, and welcome to the W.W. Grainger third quarter 2020 earnings conference call. At this time, all participants are in listen only mode.
I did want to require operator assistance. Please press star zero on the telephone keypad. A question answer session will follow the formal presentation.
As a reminder, this conference is being recorded this call my pleasure to turn the call over to your host Irene Holeman VP Investor Relations. Please go ahead.
Good morning, welcome to Granger third quarter 2020 earnings call with me or DG, Macpherson, Chairman and CEO and Tom Okray, SVP and CFO as a reminder, some of our comments today, maybe forward looking statements actual results may differ materially as a route where it's out of various risks and uncertainties.
Including those detailed in our filings.
Filing reconciliations of any non-GAAP financial measures with their corresponding GAAP measures are found in the tables at the end of this slide presentation and in our Q3 press release, both of which are available on our IR website. This morning's call will focus on adjusted results for the third quarter up 20.
28, which excludes restructuring and other items that are outlined in our earnings release.
Now I'll turn it over to BP.
Thanks, Irene good morning, and thank you for joining us today.
Market conditions remain challenging in the third quarter EPS the pandemic conditions improved.
10 years away on many of our customers.
These challenges Granger performed while continuing to demonstrate our resilience and strength.
I'm, so proud of how great or team members have responded to the challenges of 2020, staying relentlessly focused on further deepening relationships with our customers and supporting each other.
I've shared with you our Granger etch framework, which includes our purpose exploration strategy and the principles that define the behaviors. We expect it from all team members these principles, including starting with the customer acting with intent and competing with urgency provide clarity and focus as we continue to execute on our purpose is to keep the world working.
And we'll continue to leverage the greater edge in all that we do throughout this kinda give me on it.
So let me start off with a brief business update and an overview of our third quarter performance before turning it over to Tom to dive into the details.
On the business side, we continue to serve our customers well support the needs of the safety of our team members and ensure we remain in a strong financial position a quick update on each point.
Grangers operated effectively throughout the pandemic first in support of the central businesses and now in serving all businesses. Each of our customers has unique story about how they had been impacted by and manage through the pandemic. We've been there for all of them self to health care government and ecommerce businesses remain strong in the quarter and we saw improving trends with manufacturing and commercial.
Customers I'll address the pattern of revenue in a moment.
Our world class integrated supply chain organization, which supports both our north American high touch businesses and are endless assortment platforms help find it secure products to meet customer demand.
Successfully worked down our backlog of orders for both pandemic related products, including mass and continue to work with suppliers to catch up on a few categories. It remains scarce, including some gloves enhanced appetizers, but.
The team remains laser focused on maintaining our high level of customer service.
Customer feedback has been strong and improving dropping down like.
For our team members, who continue to take steps to support not only their safety, but their overall well being during this uncertain time to date, we have managed the challenges of 2020 without major layoffs and currently have roughly 1% of a workforce still on furlough.
Importantly, weve made they maintained a strong financial position.
We've been diligent in controlling costs, while balancing the need to continue to serve our customers support our team members and invest where it matters most.
Strong performance over the last two quarters together with our solid cost containment haven't.
Have enabled us to relax a number of our short term cash preservation actions, we actually.
We exited the quarter with approximately 2.1 billion and available liquidity.
We continue to make strong progress on our strategic growth priorities during the short term hunter uncertainty.
We have continued to execute our transform merchandising process to drive significant user experience improvements to granger dot com, including our search and visualization capabilities and enriched product subscriptions and content.
By the end of 2020, we expect to have free merchandise 2.8 billion and product through this new process, including 1.6 billion in the year alone.
We intend to further accelerate these efforts moving forward as a result of our new product information management system that launched in the third quarter.
Customer feedback on our website as improved significantly over the past six quarters.
Marketing spend a large contributor of our U.S. share gain over the last few years, we have improved effectiveness in both media advertising and paid sure search and plan to further invest in marketing given the strong returns.
We continue to deepen relationships with our customers to our large customer multi site growth initiative.
Enhancements to our keep stock offering.
And improvements to our sales strategy and effectiveness.
We know that when we have had one or more of our service offerings with our customers, we foster deeper and longer lasting relationships.
Over 60% of our U.S. revenue is generated from customers with one or more embedded solutions.
And lastly, within our analyst assortment model, we are executing the successful inaugural play brackets oral here in the U.S. and are making strides in marketing effectiveness customer analytics and SKU additions. This year alone. We have added 1.5 billion excuses oral pushing its assortment is roughly 5 million products.
Turning to our quarterly performance, we pretty strong operating results in the third quarter organic daily sales finished up 4.6% in the quarter underpinned by growth in our U.S. high touch business and continued impressive performance of our endless assortment model in the U.
In the U.S., we realized strong outgrowth to the broader macro market as a whole, which was down 5% to 6% in the quarter or.
Our gains were supported by pandemic related demand sales to new customers and improve sales of non academic product as we started to see some stabilizing trends underlying business activity.
Overall business activity still trails pre pandemic levels, some customers remain disrupted by call it.
Yeah. This is sort of model continues to deliver 20% growth in the third quarter, while also generating meaningfully improve margins remains.
We remain very excited about the future of this business as we continue to adopt learnings from an intro to drive growth and profitability.
At the total company level, we expanded adjusted adjusted operating margins by 90 basis points as gross margins stabilize sequentially, we demonstrated strong cost control.
Tom will detail this in a bit.
The business continues to produce a durable cash flow stream with operating cash flow of 311 million and free cash flow of 252 million.
Looking at slide six I thought it would be important to again showed this chart to highlight the underlying trends with pandemic and all kinds of products based on our current categorization of skews our care.
Our characterization goes beyond traditional safety products to include product categories with substantial volume increases during the pandemic flexi.
Plexiglas barriers would be an example, as you can.
As you can see while sells a pandemic related products have decreased since may continue.
Continued demand for key products, including masks gloves and cleaning supplies has kept pandemic cells elevated year over year. This.
It's heightened demand has continued to come from a multitude of new and existing customers across numerous numerous industries has been this is reopened and adjust to the new operating protocols.
On the non pandemic side sales have improved since bottoming out in April, but don't panic sales now down about 7% year over year. This improvement has been seen across most industries are some of the obvious industries. Your many the furthest below they're pretty pathetic levels.
These include airlines hotels and cruise lines, but.
Based on Monday performance, we forecast October self to finish up around 2% for the U.S. segment continued trends of bad debt and not pandemic performance.
Addicting the recovery over the next few quarters is very challenging the path of the virus why the big impact on whether the recent improvements continue level off or reverse, but we feel well positioned to compete in any environment that comes our way.
With that I will turn it over to Tom to talk us through the quarters results in detail Tom.
Thanks DJ.
Starting on slide eight you can see we delivered strong results in the quarter organic daily sales, which adjusts for the divestitures of Sabri in China were up 4.6% on a constant currency basis.
This increase was primarily driven by share gains in our USA segment and continued impressive growth in our.
Our endless assortment business, which was up over 20% in the quarter.
These gains more than offset pandemic related softness in our Canada in kromm while businesses.
We saw a meaningfully higher sales sequentially.
But still remained well below pre pandemic level.
Gross margin for the total company was down 170 basis points versus the prior year quarter.
But represented a 120 basis point improvement from the second quarter year over year decline.
Margin pressure continues to be driven by pandemic related headwinds primarily in our USA segment as well as continued.
Unit business unit mix impact as we experienced significant growth in our endless assortment business.
Our EPS DNA came in at $700 million for the third quarter.
Better than our communicated range of $715 million to $730 million.
SGN, a cost was down $60 million year over year, and we captured 260 basis points of EPS DNA leverage in the period.
This result stems from prudent cost reduction actions across our high touch solutions model.
Including cost lower cost as a result of our fabry divestiture and leverage gains with her and whats the assortment business.
This EPS DNA performance more than overcame G.P. headwinds to drive a 90 basis point improvement in total company operating margins for the quarter.
Tremendous results in this environment.
Incremental margins were up 50% in the quarter as mentioned last quarter, the utility of the incremental in deck, where metal margin calculation is diminished in this uncertain environment as the metric can vary significantly given the magnitude of topline swings from quarter to quarter.
We generated operating cash flow of $311 million, which.
Which we used to continue to invest in the business the old appropriate inventory to support our customers and return capital to shareholders operator.
Operating cash flow was 126% added.
Net adjusted earnings in year to date adjusted return on invested capital is over 29%.
Given our solid results of the last couple of quarters combined with stabilizing trends in underlying business activity, we fully repaid our revolving credit facility in Korea.
We increased our dividend payment and our announcing today, our intent to restart our share repurchase program in the fourth quarter.
While we anticipate putting several hundred million dollars to work on repurchases in Q4, we will monitor market conditions and optimize the amount accordingly.
The favorable trends over the last several months give us confidence.
This is the right time to move forward with these actions.
Turning to our U.S. segment daily sales increased 3.1% in the quarter, driven primarily by volume, which is net of unfavorable product mix.
On the product side sales of pandemic related products remained elevated up 53% in the quarter there.
As shown earlier have tapered off from the peak in March.
Non pandemic products were down around 8% in the quarter, but continued to show meaningful improvement from April loves.
We've also seen a significant uptick in new customer acquisitions, with some really encouraging signs of repeat buying from.
From a customer perspective, we saw improved growth with both large and mid sized customers with the latter growing 6% in the quarter an improvement from the 6% decline year over year, we saw in Q2 2020.
Gross margins.
36.4% was down 160 basis points compared to the third quarter of 2019.
Improved sequentially from the 310 basis points year over year decline, we saw in the second quarter of 2020, yes.
The favorable variance in gross margin was driven by mainly by two factors that were similar to the second quarter.
Pandemic related product headwinds and tariffs yield cost inflation.
And Democrat related headwinds contributed about 140 basis points of the gross margin decline as.
As we continue to see on favorable product and customer mix due to elevated sales of lower margin pandemic product.
Beyond the pandemic intact, we continue to face pressure in the quarter due to the lapping of year over year cost inflation, which was driven partially by tariffs that went into effect in 2019.
This drove approximately 80 basis points of year over year margin decline.
Based on what we know now we expect that both of these gross margin headwinds will continue into the fourth quarter.
Should be noted that we anticipate the tariff headwinds will fully subside as we move into 2021.
Offsetting these two factors in the quarter was 60 basis points tailwind related to favorable freight costs, driven by nonrecurring shipping efficiencies and timing.
We do not expect these freight dynamics to continue in the fourth quarter.
From an EPS DNA perspective, we gained 160 basis points of leverage with costs decreasing approximately $22 million year over year.
The reduction was driven primarily by decreased travel expenses lower labor related costs in general operating efficiencies.
Operating margin remains flat to the prior year quarter at 15.1% as SGN, a leverage offset gross margin headwinds return on invested capital was a very healthy 38%.
Drilling into our U.S. sales performance on slide 10.
Well, we estimate the U.S. tomorrow market declined between five and 6% in the third quarter Ranger.
Ranger was able to capture roughly 850 basis points of outgrowth fueled by pandemic related sales selling to new customers and improving sales of non pandemic product.
Despite the challenges of 2020 U.S.
You Watch segment daily sales are up 2.1% year to date and we have.
And we have outgained the broad around MRO market by over 900 basis points through the first nine months of 2020.
Moving to our other businesses.
Organic daily sales increased 12.5%.
Our 12.3% on a constant currency basis.
Endless assortment business grew at approximately 20% fueled by strong results at both Monoprice ROE and zoro during the quarter Zoro continues to execute the menasha real playbook with improvements to marketing effectiveness.
Discounting strategies and better cost leverage all helping to drive improved performance.
Although we saw significant sequential improvement compared to the second quarter, our international high touch businesses continued to be impacted by pandemic related shutdowns with both Mexico and crime, while seeing year over year declines.
Operating margins for other businesses are up 190 basis points 35 basis points.
Which is due to the divestiture of our fabry and China businesses, which produced below system average profit ability in the prior year.
The remaining operating margin saver ability was driven by significant SGN they leverage across the portfolio a portfolio, most notably within our endless assortment business, which continues to do a nice job levering its cost base.
This leverage was only partially offset by gross profit headwinds from incremental freight cost at monoprice.
Turning to slide 12.
In Canada daily sales decreased 9.9% or 9.1% in constant currency.
Decline is comprised of roughly 8% decline in volume and price headwinds, including customer mix of approximately 1%.
While volumes in Canada continued to be impacted by the pandemic driven economic slow down the business did improve sequentially and is gaining traction with hospitals manufacturing and higher education customers.
As the Canadian business continues to integrate and leverage our U.S. resources, we are.
We are making progress with our customer diversification efforts and are pleased with the trajectory of this business going forward.
Gross profit margin at Granger, Canada declined 35 basis points year over year.
Driven by pandemic related mix headwinds, which were.
Which were offset partially by lower freight costs in the quarter.
Cost management remained strong with savings of $5 million year over year, resulting in a 110 basis points of SGN a leverage.
Total operating margins were up 75 basis points versus prior year. Despite the top line challenges.
Before I turn it back to DG similar to the last couple of quarters I want to give you a sense of how we're thinking about things in the fourth quarter.
From a sales perspective.
To date trends support our estimate.
For October year over year sales growth to be up over 4% at the total company level.
On an organic constant currency basis.
This October month and estimate.
Is reflective of continued solid growth in our U.S. segment, coupled with strong performance an endless assortment.
From a gross margin perspective as I previously mentioned, we anticipate gross margin pressure will continue as the pandemic related impacts.
And tariff field cost inflation headwinds will persist into the fourth quarter. So.
The one time freight tailwind we realized in the third quarter will fall off further.
Further we anticipate year over year cost headwinds in the fourth quarter EPS.
Yes, we already stretched global shipping providers pass through rates surcharges during the busy holiday season.
Given these factors and based on what we're currently seeing we anticipate gross margins will be down.
Over 200 basis points year over year.
With respect to SGN a week.
We expect to see sequential increases in a couple of the areas primarily related to some incremental technology investments to support growth in the U.S. and definitely no trial, which will push our estimated 's DNA to between 725 to 749.
In dollars for the fourth quarter.
As always we remain focused on managing near term headwinds, while continuing to invest in long term growth, particularly in people processes and technology, where and when it makes sense.
With that I'll turn it back to DG for some final thoughts.
Thanks, Tom.
So I'm proud of our results for the quarter I want to thank our team members for their commitment to safety and customer service. We have gained share improved our merchandising and marketing capabilities deepened our customer relationships expanded our assortment, while improving margins and zoro and have significant financial flexibility to support the business moving forward we were.
We remain committed to fulfilling our purpose of keeping the world working throughout this pandemic as well as continued to execute our strategies. We can achieve this purpose for years to come and with that we will open up the line for questions.
Thank you, we'll now be conducting a question and answer session if you'd like to be placed into question queue. Please press star one on your telephone keypad a confirmation code will indicate your line is in the question queue. You May press star two if he'd like to remove your question from the queue for participants using speaker equipment, maybe necessary to pick up the hill.
But before pressing star one.
One moment, please while we poll for questions.
Our first question today is coming from Chris Glynn from Oppenheimer. Your line is not a lot.
Hey, Thanks was curious you mention.
He mentioned the customer acquisition trends still going strong and conversions to some regular.
Regular customer.
Dynamics are going well just wonder if you could further.
Dive into that topic, and how informs early view Oh gosh.
Ah share outperformance for 21.
Great. Thanks, Chris So yes. So we've had as you might guess given inventory positions, we have had a whole bunch of new customers.
Sample Granger and sorrow eminent trail frankly.
As Weve had elevated customer acquisitions through this period the good news.
The good news is that are those who have repo.
Those who have repeated the numbers much higher than in the past the repeat rates are similar to the past, but we have got much bigger funnel and we're starting to get those customers to be regular purchasing customers. So we've seen really nice attractive customer acquisition through this period, and we think that really helps bode well for the future you know we feel very.
Confident and by our three to 400 basis point outgrowth of the U.S. smoke in the U.S. business in the 20% growth expectations for the animals assortment and we have no reason to change as right now this year.
This year, we've obviously the higher than that that number and in the U.S.
We expect to be in that range and shoot for higher but be in that range moving forward.
Okay, and then fought for follow up it take the.
Yeah would you anticipate the Threeq Q pandemic sales using October is a proxy might approximate the sustainable run rates as long as you know workplaces are very Jeremy phobic or is that still waits when flux.
I think that's a that's a very interesting question and I don't think anybody has the answer what we're seeing right. Now is elevated pandemic sales, we expect that to continue and certainly as as case rates rise, which we've seen recently, we would expect that to continue through the fall you know what what happens when we have better treat.
And so the vaccine is probably a question that that has on all of our mines and its probably impossible to answer we would expect some of that to moderate but we do think people are going to be more.
More conscious of safety and cleanliness for for some period after that as well, but for now we're seeing similar trends to what we've seen in the past we would expect that to you in the fall given that given that the rate of transmission.
Thank you. Thank you.
Thank you. Our next question today is coming from Chris Dankert from Longbow Research. Your line is not alive.
Hey, good morning, guys, if taking my question.
I guess first off what's the status of investment in Zoro I mean, as you know in the past would mention about $50 million investment to 19, largely rolls off this year I guess.
Are we still on pace to get to your mid single digit EBIT margin plus the other business and 21, just thoughts on investment that would be really helpful. I think.
Sure. So we had a very heavy investment period in the backend of 18 and 19.
With with Toro.
Any of those are good investments took several forms one was a technology.
Another was people and getting the talent to be able to have at their own destiny in terms of product ads and the like and so we made those investments.
Those investments are behind US we start to see those starting to see those leverage themselves now this year, we're getting improved operating margins in Toro, we think the long term path for zoro from a margin perspective is as we've discussed will talk about next year in January but we have no reason to believe that the positivity that we see.
And we'll continue that we still think that it's going to be a high single digit operating margin business in the next several years and so that that's the path for that business.
Got it got it I didn't think about SGN a., I mean compared to what the guidance was again coming in below that range. My apologies if I missed it but just what are the key moving parts on what helps you kind of cut that's getting number even lower in the third quarter here.
Yeah, Thanks, Scott I'll take that.
Yes sure. Thanks, Thanks, Chris.
You know first of all there was a little bit there was when data just with the the fabry divestiture and you know that takes the 60 million down two to about 40 million, but then we just had real good efficiency across the board everything from travel and Entertainment professional service says cleaning supplies.
Curiosity, you know just a real good focus by the team in terms of efficiency and cost control and one of the great things with the pandemic as you know we've always been cost conscious, but I think we've really upped our game and I I think it's going to continue going forward where we.
Where we're really and this this mode of operating this way. So you know too just to summarize really good cost control across the board, while continuing to spend in advertising and technology, which are important for us.
Got it okay glad to hear that the broad based savings certainly so well congrats again on the quarter and then thanks for my question again, Thank you since Chris.
Thank you. Our next question today is coming from Adam Olin from Cleveland Research. Your line is not a lot.
Hey, guys good morning.
Sticking with the Sq me question I guess, the freight dynamics that you pointed out for the the third quarter and the fourth quarter are pretty interesting as.
As the surcharge rate kind of transition into base rate increases I'm wondering if you could help us ballpark, just how meaningful of a headwind that that could be for 2021 or perhaps it's not a headwind and you have some other levers to pull to offset that.
And maybe you could just remind us about how you charge customers for freight I believe most.
Most customers don't pay but maybe discuss that as well so I.
So I would say that it's a great.
It's a great question I, most customers our largest customers in contract customers often don't pay for partial they often pay for LTL or large part shipments a the surcharge that Tom was referring to is really around large packages during the peak season.
And we will charge for some of that we expect to recoup some of that we don't expect to recoup all of that and that doesn't have much to do with what happens into next year so well.
We will talk about next year, obviously after this quarter I would say certainly the freight business given the membership and Scott a couple of houses has become strained and we've seen some some pressure.
That does not mean, though that the surcharge in the habit of default necessarily translate going forward and so we'll talk about that we think we we've got initiatives and actions to help mitigate that going forward, but we'll talk about that at the end it here.
Okay, Great. That's good to hear and then secondly.
The company's.
Building up inventory and I was curious one if you could talk about your inventory and working capital assumptions.
Here in the <unk> in the medium term and.
And then secondly, if you.
Youre concerned at all absorbing losses on any pandemic inventory that you might be taking a.
You know if we have some good luck and the pandemic that starts to roll off and market pricing.
Deteriorates further thanks, Yeah. So let me let me let me take those and Tom you could add to them. If you think I Miss anything so in term in terms of inventory, there's really two areas, where we built inventory and we'll continue to do so at you to ladder that are part of the year. The first one is sort of normal which is we are starting to level D.C. fall full.
Up in 2021, and so as that comes on we obviously stocked stocked at building that's partially stock now that becomes more fully stock as we go through an EPS at that that part of what you're seeing the other part is a pre buys for pandemic related product I would say to your question about do we have risk on excess obsolescence.
With with that product.
Part of what you see in terms of with US in terms of pandemic GP already embeds. Some some write downs, we obviously to make sure. We can serve our customers took positions at a whole bunch of products.
At the height of the pandemic and some of those the price cost is changed some of those.
Yeah, we haven't seen movement a lot of those we've seen movement and it's gone very well, but in that in that messing us to serve customers, which we think has been really really important you're already seeing that in some of the GP rates that you're seeing is us, let's take that we think that.
We're in good position most of the inventory build to be clear has been pre buys on products that has very low risk. We know suppliers. We know product we know product that will sell in any case, but trying to get out ahead of that in case the fall away.
In case the fall in the winter is really really bad so most of that is not higher risk than normal, but certainly in some of the the speculative buys and things we took in the in the heart of the pandemic you've already seen some of that come through in terms of GP.
Yeah, just just to add a little bit more color on an inventory and cash you know one of the things that we've we've been very efficient on as is our management of cash and you've seen that in this quarter.
More specifically our cash conversion cycle, our D.S.. So is actually down year over year, a couple of days and our D. P. O is actually favorable you know by by more than a few days, which has allowed us to to keep a overall cash conversion cycle that is.
He healthy versus last year and invest in the inventories. So we can you know play are.
Play our role as an essential business and support to customers the way we need to do so.
You're right inventories up since the beginning of the year, 8%. It's at 1.78 billion. We've we've invested in working capital. It's up 220 million yen, we did put pandemic inventories spend in the quarter of approximately 300 million and as DG said, I mean, you're you're not going up you're not going to be.
We had 1000 on all of that so we go through the normal and all process and I guess the way I would describe that is we're very aggressive operationally, but very conservative financially. So doing the right thing to to reserve. So thanks for the question.
Thank goodness question today from Chris Snyder from U.S. Your line is now live.
Thank you for the question I just wanted to follow up on enlist assortment margins I understand you know there's like a longer term you know kind of high single digit target out there for zoro, but you know with the back office investments slowing what kind of incremental margins could we expect for this business is the topline continues to ramp.
Yeah. It's a good question, we really don't look at incremental margins specifically on the endless assortment business just because the supply chain is so intertwined and the synergies with the broader business. So we.
So we really look at the business as the <unk> the incremental margin for the overall entity.
Sure Yeah, I mean, Tom I would just I would just add I mean, if you look at if you look at incremental margins with with Middle Georgia, typically you're talking about.
15% to 20%.
Which is GP minus the the variable marketing cost and so I would expect us to get to something like that over time.
Well, but that's that's typically we see I'm not sure I think.
I appreciate that and then just following up on Sinatra select the stock is up a 100% year to date in Tokyo last I checked.
Can you just talk about how you kind of view that business strategically add granger.
Well, we view I'm sure. So so we view both the.
Both the endless assortment of high Tech solutions model is absolutely core to what we do.
Besides suky, who is the leader of that business now also be tomorrow.
We are sharing best practices, and and analytics and working together to ensure.
To ensure that we're actually making progress across those two business center at our business in the UK as well.
So we view it is absolutely core to what we do right now and we're getting a whole lot of leverage from that and then I'm sure. Our team in terms of learnings and building the business its oral for the future. So.
So we are running those very tightly together because for.
Appreciate that thank you for the time.
Thank you. Our next question today is coming from Deane Dray from RBC capital markets. Your line is now live.
Thank you good morning, everyone I was hoping to get some color on the additional color on the gross margin guidance for the fourth quarter down 200, Bips is there any way you can parse out what the pandemic cells would be versus non pandemic cells, just trying to get a.
A sense of what the core gross margin trajectory might be thanks.
Yes, I think I think the way to look at it Dean as we said the pandemic impact is 140 basis points for this quarter and the the cost out there is 80 basis point unfavorable back.
Unfavorable bad Guy and we had the one time rate of 60, you know so if if you remove the 60 from the the one four D and the the 80 you get to 220.
Now, we think that the pandemic will likely improve obviously, it's very volatile you know lets say you get roughly a 20% improvement on your cost inflation as well as your pandemic.
That gets you to around 200 ish and then you throw in the freight headwinds that we think we might experience at the end of the year as D.G. discussed with the the surcharges and that gets yield about 200.
That's real helpful. And then I was hoping to get some additional color on the October sales or just.
Just the extent that you can anything that you think would be helpful regarding geographic.
Geographic customer size is anything else about the mix that'd be a big help here. Thank you.
I think I think Dean if you if you looked at the sales revenue performance July August September October you'd be hard pressed to see much of a difference across those months, we've seen a little tail off and pandemic in a little improvement in non pandemic, but pretty much. The trend has been very very similar across all of those.
So the trends we've seen and the performance we saw in the second quarter really just appears to be a third quarter picture appears to be continuing and in October at this point.
Got it and just lastly, an observation I've certainly heard the granger spot ads on business radio pretty frequently in the brand building. So I think it's pretty affect us. Thank you.
Thanks, Dan.
Thanks, Steve.
Thank you. Our next question today is coming from Joe Cole from Wolfe Research. Your line is now alive.
Oh, Thanks, Good morning, just a question [laughter].
On the Fourq.
Well Q gross margin guidance.
So roughly 10 basis points down from 30% last quarter gets you about the defense, which would be up from this quota. So just wanted to make sure that the that that kind of still holds that we're looking for what would be a fairly normal sequential pickup in gross margin percentage from from Threeq.
Bob you want to take that one.
Yes, sorry, I was on mute Nigel I think another way to look at it is our absolute gross margin should be very similar to Q3 and then when you just look at the comparison to prior year, Yeah, it's going to bump. It over 200, you know so that's the other way out.
Look at it.
Okay. That's fair and then you know the the midsize customer gross.
With with pretty impressive I swing from what we saw last quarter and I'm. Just curious are we seeing.
Oh, I see a lot of your competitors, especially the smaller competitors and one or two larger ones employ a very high touch.
The distribution model and I'm wondering if with see enough switch towards perhaps a more low touch direct ship E Commerce type sales.
And maybe some supply consolidation I mean anything you're seeing that in the market.
Well, Yeah, I would say, we certainly seen more more digital sales through through the pandemic.
I think we've seen that in almost every industry and ours has been has been no different.
Yes, what I would say is that's a you know we we are seeing improvements in mid size customer growth from digital actions, but also from inside sales actions. So that that is that as more of a touch but we're seeing nice growth across both both of those contact.
Right and so yeah, I would say its fair to characterize as more digital but not all digital we're also seeing some nice growth through some of our other actions that are more more high touch.
Okay. That's helpful. Thanks.
They could if question today is coming from Josh Pokrzywinski from Morgan Stanley. Your line is now alive.
Hi, good morning, guys.
Good morning.
Good morning couple of questions I know, we've covered a lot of ground already but one thing I want to be sure on if you don't mind, Tom on and what's the assortment clearly some good leverage happening there, but just wondering if anything is happening inside of zoro or monotaro for that matter with with mix.
Obviously in the middle of pandemic, we can talk about like pandemic Nexsan safety products, but I guess just more broadly we are people buying definitely stopped and that is normally tuned up for it and that have some benefit positive or negative that may not look like the ongoing model.
Yeah, I think the only thing that I would say and then DG. Please. Please add is we're probably seeing more b to C customers and b to b customers in the pandemic, but but other than that nothing out of the ordinary.
Yeah, I mean so.
One of the things that I would say that that's that's modeled the pandemic a little bit in terms of results as Ben with so many people working from home.
Sometimes it the business in the consumer tends to blur, you know I've listened to a bunch of contact center calls and.
It's a fascinating that there's a lot of people at home, maybe buying things for businesses, but also sometimes delivery to their home and so we think we've had more consumer acquisition than normal we don't remarket to consumers, whether in zorro or Granger and what we do know is that the business customer acquisition has been very.
Very solid very strong and and the attractiveness of those customers has been every bit as strong as we've seen in the past. So we're we're happy with <unk>, Besides having to sort of sift through consumer business. The business that we're sure as business has been very strong and that's been that sort of key for us.
Got it that's helpful. And then it sounds like Dean is going to be a future customer here based on the effect of this not marketing. So maybe you can you can close that lead.
[laughter] he's not he's not the target segment I can assure you that [laughter] [laughter] I understood and then just on the inventory question I know someone asked earlier about you know the the inventory build there anything on kind of a.
Seasonally I'm, Tom and liquidation in the fourth quarter that you're planning that that may be dragging that down are intact not at all I'm just thinking about historically, usually build a little inventory in the fourth quarter sequentially. That's something that happened earlier, but is that playing into into the that dynamic it on the gross margin.
It's it's playing into it it's playing into it a little bit you know as we said on the on the previous question. We've been we've been very aggressively operationally from an inventory perspective, because it's the right thing to do when we want to have the product available for our customers, but on the other he on we've been conservative financially.
So part of the gross margin deterioration that you've seen in Q3 is it isn't you know headwinds cleaning cleaning up some of the buys that didnt exactly thread. The needle. So we've tried to do most of that in Q3, we'll see a little bit in Q4 as well.
Oh, and then we believe that that's going to be behind us going into 2021 will have the right products to serve our customer and then if anything we'll have a tailwind as we unwind some of those reserves when the products that we have reserved potentially will be available for sale.
Got it that's helpful. Thanks, so much.
Thank you.
Thank you. Our next question today is coming from John inch from Gordon Haskett. Your line is that a lot.
Oh. Thank you good morning, everybody, Hey, I'm, assuming that P. fails, which you would assume right to happen as the markets been saturated naturally continue to trend lower as we roll into 2021, what kind of a you know kind of an absolute sales headwind, but this could just prospectively.
Represent and you guys have had very strong opex control kind of I don't think I've heard this in the discussion thus far I mean, what kind of costs are you thinking.
Are you thinking about are going to have to come back next year as you sort of flip from P. PE to kind of a more normalized volume trajectory for other products.
Well I think there's there's a lot in that question John I, Yeah, Yeah, I would say that we.
You know, it's hard it's really difficult to project the P.P. trend.
What we've seen since April and in April we saw PBT up almost 100%.
Well pandemic product, what we hope it never got includes more than GP, we saw sort of normal volumes down 20% in April and what we've seen is those two sort of just come together consistently since that since that time.
And there's there's lots of puts and takes with that so with pp. He comes down and we get a little bit better non pandemic product. It helps GP probably doesn't have any impact on SGN, a frankly, we think.
We think we can control last year day in any environment and you know what are the one of the good things about the pandemic in there haven't been many is it really forces a business to focus and I think it's we've really we've really been focused on what matters and I think that's something that we definitely need to take forward. It's how do we continue to focus on a few things.
Is that really matter, which helps drive results, but also help humana.
EPS humanitarian today. So we think we're going to be able to do that going forward I can't give you a crystal ball answer as to what's what's going to happen with with PB because it just all depends on the timing of the virus and People's behavior, We've never seen anything like this before.
Right, but do you have any sense TG of what may be the SG and they had a right I'm sorry, Tom They did what sort of EPS, you know headwinds you're facing kind of on a quantifiable basis. Because you do have the 1% people that are furloughed, presumably you're not to bleed back a little bit of travel and some.
Some merit increases and stuff like that is that is it too early to tell at this point or or anything yet or no.
No I mean, we'll talk about that certainly at year end as we as we talk about forward looking you know we took we had merit increases. This year you know such so that thought yeah. Clearly we have costs that will come back into the business travel will be modest Ah. We think for the next six months given given what we're seeing with the virus at some point that can come back.
Okay.
You know, but I think the I think that the.
The headline for me would be we've seen nice growth GP has been depressed given pandemic sales has been so elevated that's DNA has been down I think over time as that moderate should get better GP.
And and a little bit of costs back at it into the business and there's there's just the dynamic there that we can talk about there.
Yeah, do you I understand that I'm sorry.
I'm sorry, the only thing that I would reinforce is DG said, we're always going to be about SGN, a efficiency and control and you know we'll handle that the upside that I see which de de mentioned is we're going to see the gross margin pop from as the pandemic goes goes down.
And also I think on the sales front as the broader economy opens up we're going to be well positioned to ride that wave as well and I would have to imagine obviously, it's speculation that theres going to be a lot of P.P. any product that is going to come into those businesses opening up as well. So you know <unk>.
I see it more as a tailwind and then any sort of a headwind.
[laughter] DG, just lastly, implicit in your answer on Monotaro and monetizing Monotaro you indicated that zoro, it's still pretty important to the zoro business, that's intertwined and so forth at what point can zoro do you think stand on its own where you might strategically be in a position to say hey, we don't need to own happens auditoriums.
Stock has done fantastic, let's take our position down to 20, 30% something like that or even or even to zero.
I'd say a couple of things to that one is it's probably time with timing you probably need three more years, you know given given what we're projecting to get Toro to way.
To where we'd like to get it. So it's it's really got a the connective tissue to be a really strong performer for a long time and so that's that's what we're shooting for at that point you know, obviously, we could do things there.
There's all kinds of tax implications are that John and so we need that we can do to think through all that at that point for now.
For the next three years worth thinking out, but as you know we need to get its oral this is performing well, we're really excited about the middle east for a path and we think that's the right. That's the right focus for us.
Understood. Thanks, very much thank you.
Thank you. Our next question is coming from David Manthey from Baird. Your line is that a lot.
Thank you good morning, everyone.
It's Tom I'll have to go back and review your commentary, but when you were.
When you were talking about gross margin and you said above 200 I'm confused is that a fourth quarter statement of are you walking into 2021 four.
Fourth fourth quarter days, you know the way the way I'm looking at it is just simple math. If you look at if you look at Q3.
160, bad Guy or gross margin.
Gross margin with a 60 60 bips of onetime freight. So if you just take the 60 bips up that gets you to 220.
Now we assume the pandemic he is going to get better as his cost inflation, so bring that down to 200 or a little bit below but then going back to the freight surcharges, we see during the holiday season that will get us back above 200, which is the.
Framework that we talked about in the prepared remarks for Q4, now having said that I mean, it's it's very fluid it's hard to predict but we're just trying to give you guys. Some framework for your model.
Okay. Yeah, that's very helpful and so I'll ask the question gross margin is obviously extremely hard to model. These days and if were just thinking big picture moving parts from where.
Where will wind up in 20, Twond, which looks like I don't know 30 low 36 is if you just for thinking Big picture what are the main moving parts as we go from 2020 to 2021 that could move that up or down.
Yeah, well well have a lot more to say about that going forward I think I think so just to give you a couple of things to think about you know one would be how long is the pandemic going to laugh because obviously the longer the pandemic lasts the more we're gonna be depressed with pandemic related may.
Next and the type of customers, we're selling to so that's number one number two we should see a natural tailwind in terms of what we will have fully lapped the tariff related cost inflation as well.
As well as we'll probably see less spikes in terms of cost inflation related to the pandemic product you know so.
So those are those are the two big ones to think about and both of them should be tailwinds for 2021, but again, it's it's premature to talk in detail well plenty of time for that later.
Got it that's that's a great color and then second on the keep stock in these embedded solutions.
You talking about making up 60% of revenues just to put that in context, what percentage of customers would that represent and then recognize.
Recognizing that those customers obviously buy from via several mechanisms that you provide can you talk about what percentage of sales are directly via the embedded solutions today.
Well, so let me let me let me try to take that so most of our largest complex customers will have embedded solutions and typically they'll have.
Both a keep stock inventory management solution, and and eat <unk> pro sort of connected digital solution as well and so you know <unk> pro and keep stock would make up over 30% of our direct.
Direct revenue I believe you don't quote me on it's something like that I don't have the numbers right in front of it something like that in terms of number of customers. Obviously are midsize customers have fewer of those solutions, they're they're more to buying on greater dot com and and by the way that can be pseudo embedded below to call. It a better because they can have their own.
Hi, there on pricing they may have their own work flow and greater dot com, but typically they wouldn't have inventory management and so from a customer count.
The the number of customers will be much fewer in that 60% then than those in there, but the largest complex customers will have an embedded solution in general.
Okay. That's great. Thanks did you.
Thank you and next question today is coming from Michael begin from Wells Fargo. Your line is now live.
Thanks, if I could just moved to the low touch segment can you talk about the sell through rate of per site visit or any other tangible improvement first.
First you recommendations substitute or frequent packaged products and skew count what that's what's been the most impactful so far and what will be going forward.
I I mean are you talking about the enlist assortment business. This aura there yeah, yeah, yeah yeah.
Yeah, Yeah. So so I mean, I'd say, there's there's three things.
Three things that have been that had been really impactful one is skew count so we look at.
We look at.
The productivity of every skew AD and they look over kind of the last six seven years as Weve added skews, where now we've guided to 5 million flight.
The ads we've made in the last six months are as productive and and it looks like maybe even more productive than those that we've made in the past so that that bodes pretty well for future growth. So that's probably the most important piece of the growth.
The other one is is a customer analytics and marketing show getting customers customer acquisition.
The funnels pretty big but then getting customers to repeat is really the key.
And we're doing all kinds of things there with analytics and marketing to get that second third fourth order, that's starting to get real traction. There. So those are far and away. The two most important things with the analysis will revisit the business that we track.
And we're seeing we're seeing progress on both.
And how does that correlate to sales per site visit <unk>.
It's kind of been the trip trend there sales per site visits do you.
Do you mean customers coming onto the website and what's the revenue per site visit.
Yep.
I, what I guess, what what industry metrics are you benchmarking to within that assortment model and what's been.
What's the right improvement with this level of investment so we look at.
So we look at we look at things that other business with look I can return on return on AD spend that is interesting, but not sufficient the most important thing is looking at.
Customer value and so looking at customer acquisition and the customer lifetime value and so we we look at a new customer acquisition rates repeat rates and we like all that to a customer value model to understand the.
The NPV of each customer add into that that's what we track Holt.
Got it all right.
My second question Capex.
There are a lot of is there a normalized level of Capex that you would be targeting in the out years as you transition and more or less from branches more timeless assortment. There I mean, it looks like you're trending.
Pretty well this year just wondering if there's you under spent this year and there's a catch up into next year or beyond.
Yes.
Go ahead Tom.
Yeah, I I don't think theres going to be any big catch up I I mean, if you. Even if you look at we spent roughly 60 million in the quarter, which was similar to last year.
You know when the pandemic first hit we tightened our belts, a a little bit in deferred some things, but you know given the confidence that we've had and the cash generation. We're we're back.
We're we're back to normal spend levels. So I don't see any big waves, you know coming in future years, so would be anything out of the ordinary.
Got it thank you.
Thank you. Our next question today is coming from Hamzah Mazari from Jefferies. Your line is I live.
Hey, Good morning. My question was just on the.
Just on the other segment if you take out the endless assortment business are those other businesses, losing money today or are they profitable and then and then.
Is the endless assortment business now over 10% of revenue where are you where you have to sort of re segment third or is that not the right way to look at that.
So on your second on your second question, we are evaluating the need to think about about a segmentation and we'll talk about that in our press.
And our position on that at the end of the year or with the next year. So we have we are evaluating that and we work with our auditors to make sure we understand requirements. So that's that's still to come.
So there's different types of businesses that are in other when you take out unless assortment, but there's not a lot of them. So there's Mexico. That's profitable this Puerto Rico, that's off a profitable and there's kronwall Cromwell's unprofitable now.
But having a pretty good year in terms of customer a customer service experience and they're losing less money. This year than last so in total I believe those would be slightly unprofitable, but.
But two of them are profitable and one is not and and are working on now.
Got it I know where at the hours. So I'll just leave it there appreciate it all right. Thanks I'll re queue.
Thank goodness question is coming from Justin Bergner from GE Research. Your line is now live.
Oh, good morning, TJ good morning, Tom Thanks for fitting me in.
Right.
Morning.
Yeah good morning.
Quick clarification question then more open ended question the medium size customer growth going from negative 6% to 6% how much of that related to those businesses sort of being closed in the second quarter or been unable to get pandemic related product and then sort of catching up in the third quarter.
So two things there are two things going on one is that some of those businesses were more more impacted and may have been closed I think the bigger issue was in the heat of the pandemic in April may in particular, given the.
Given the way product supply happened for trying to make products and the customers we need to follow that product you. We didnt have product available for those customers and in the summer we relax that constraint as pandemic products became more available and we were able to open that up to their customer base and so weve seen very strong growth since that happened and I think that's probably the bigger issue.
Is just being able to release the product for midsize customers and we've seen nice growth as a result.
Great and then the open ended question I'm looking at it from a sort of customer grouping point of view Granger showed nice acceleration in the government and the retail channels, maybe you could just sort of talk about anything unusual or.
Unusual or potentially you know recurring that is going to sustain that trend and maybe in the context of just general outgrowth levers that you know may be materializing, a new as you look towards the end of this year and into 2021 data.
Yeah, I think it's important to understand where retail is retail is mostly distribution centers that go.
Direct to customer we don't do a lot of sort of walk in retail business, where we're more sort of the the distribution centers that obviously have more safety needs and other needs.
That is obviously been growing as an industry.
As the pandemic is happening so we've we've been there supporting our customers through that so that that is a trend that we believe will continue.
As as we move forward what was the other I'm sorry, what was the other segment you mentioned.
Governor government, accelerating which would sort of be surprising in light of pandemic sales being decelerating.
Well, yes, but government government sales have been have been strong and a lot of that has been pandemic as government to try to find product to support their community strain.
Their communities during this time and so that's a that's a lot of state government business.
Military has been okay as well for federal but certainly state governments have been very very busy at each of them has tried to fight the pandemic and we've been there try to help as much as possible.
Great. Thank you.
Thank you. Our next question today is coming from Patrick <unk> from JP Morgan. Your line is now live.
Hi, do you have time, a couple of quick ones here.
Fred.
Well next year.
[noise] I'm just wondering if there's a way for you to quantify you know.
On the revenue from a pandemic that could be a headwind for next year. It sounds like you still expect pretty good share gains that you said 300 400 basis points, but just wanted to check and see if there's any major issues on that front in terms of the pandemic or sales.
Sales into next year.
Well you know I think I think we're well like were definitely on to talk about that in January with our results.
Like I said before right now.
And as we head into the winter given what we're seeing with case counts, we expect pandemic sales to be elevated through the fall and the winter that would be our expectation we will.
We will reevaluate as we go forward to really understand what the what the.
What the what the puts and takes are but if pandemic sales go down we think non pandemic sale will go up because that would mean the pandemic isn't as much of a problem and again, that's that's it that helps our gross profit when that happens it and and probably over a profitability rates. So you know we we don't really know I think it's impossible to tell what's going to happen within and across.
At some point it will be a headwind, but other things and won't be a headwind and that's our that's our expectation.
Makes sense and then last one real quick I'm zero.
Or the edit skews year to date is that all third party related and since you're skewing mix more in that direction I just wanted to check and see if there are any big differences in how you report the revenue or the margin or the type of margin you get when you ship third party versus green around inventory.
Yeah. So so a lot of the new product ads or third party summer through the Granger, a greater supply chain.
Third party items tend to be lower SGN, a and slightly lower margin gross margin.
But but most most of the time, where we're working with high quality companies that have very good fulfillment capabilities and so that's that's one of our important sorts as we as we develop partners that actually add to our assortment. So it's really no different than our reported.
But it is going to be a bigger factor for us going forward, we're going to continue to to add third party shippers on that that's a big part of what we're doing.
Yes, the only thing I'd add Patrick is the accounting difference is whether you're in age and tour or not when you're doing third party, but but that's a minor nuance. So thanks for the question.
Thank you we reached end of our question and answer session I'd like to turn the floor back over to management for any further or closing comments.
All right. So this is easy so thanks, everyone for joining us really appreciate it we feel good about about our results in the quarter, we feel really good about our forward prospects. Obviously, there's a lot of uncertainty in terms of how the how the market is going to evolve and probably more than more than anybody we'd like for the pandemic to be behind us, but we know it's not.
So we're going to make sure we continue to support our customers through this that's the first and most important thing we're going to do we're not going to make sure. We take care of our team members and we're going to make sure. We do things that are prudent buffer that the current performance of the business, but for long term and we feel like we're taking the right actions at a very good position to succeed but during the pandemic and beyond so thanks for joining us today and.
And hope you all stay safe.
Thank you that does conclude today's teleconference. You may disconnect. Your line at this time and have a wonderful day, we thank you for your participation today.