Q4 2020 W W Grainger Inc Earnings Call
[music].
Greetings and welcome to the W. W. Grainger fourth quarter 2020 earnings conference call.
At this time all participants are in a listen only mode.
Question and answer session will follow the presentation, if anyone should require operator assistance. During this conference. Please press star zero on your telephone keypad.
Please note that this conference is being recorded.
I will now turn the conference over to our host Irene Holman Vice President of Investor Relations. Thank you you may begin.
Good morning, welcome to Grainger, Inc, fourth quarter and full year 'twenty 'twenty earnings call with me are D. G Macpherson, Chairman and CEO, Andy Grove, Meriwether, Senior Vice President and CFO.
As a reminder, some of our comments today may be forward looking statements actual results may differ materially as a result on various risks and uncertainties, including those detailed in our SEC filings reconciliations of any non-GAAP financial measures with their corresponding GAAP measures are found in the tables at the end.
The slide presentation and in our Q4 earnings release, both of which are available on our IR website. This morning's call will focus on adjusted results for the fourth quarter, 2020, which exclude restructuring and other items that are outlined in our earnings release now I'll turn it over to D. G.
Thanks, Irene good morning, and thank you for joining us I'm excited that our new CFO Merriweather is here with me he brings a wealth of financial and operational expertise and a deep understanding of Grainger business that will serve us well.
He's been with Grainger for eight years in finance pricing and sales leadership roles.
Great to have her as our new CFO.
For the call today I'd like to provide an overview of 2020, highlighting accomplishments and challenges.
Much of the year has been shaped by the epidemic, but I'll also highlight our progress on key strategic initiatives, then I'll turn it over to day to review the details of our fourth quarter results.
Those by discussing how we will reshape the business to more closely reflect how we think about the company and will also touch on our high level opportunities and priorities for both the high touch and endless assortment businesses.
2020 was obviously one of the most challenging and intense years in history through.
Through it all we demonstrated agility resilience and a steadfast focus on supporting our customers and team members.
At the start of the pandemic, we laid out three basic priorities to serve our customers well support our team members and ensure we remain strong financially.
I can confidently say, we've been able to accomplish all three and I'm proud of how the team has continued to execute on our purpose to keep the world working by living our principles every day.
Over the last year, we persevered through the pandemic, while continuing to deliver an exceptional customer experience.
We've deepened relationships with existing customers and develop new relationships. Many of which are returned for multiple purchases. We helped our customers secure product manage your inventory and solve their problems as we further embedded keep stock and our other solutions in their facilities.
Grainger is sometimes the only vendor our customers about on their sites to support their operations, a testament to our deep customer relationships.
Another priority was to support our team members, we operated with a perspective that the pandemic would be challenging and longer duration than we wanted but that it would eventually and.
As such we maintain a stable workforce deployed personnel to safely and effectively serve customers and support team members to ensure their safety and wellbeing.
Pandemic is first and foremost a humanitarian crisis and supporting our team members for the remainder huge priority.
Finally, we have remained very strong financially generating over $1 1 billion in operating cash flow in this difficult year as it became clear that our business model will be resilient throughout the pandemic, we reverted from a temporary focus on cash preservation for our longer term strategic priority of growing our business profitably.
The Grainger team has been active in serving our communities through this time of need.
We have great team members, who value getting back to others.
Company, we provided monetary and product donations to organizations like the Red Cross and the children first fund to support the pandemic response.
The key leadership challenge this year was balancing our pandemic response, while continuing to build the company for the future.
We remain focused on executing against our strategic initiatives.
On our high touch solutions model, we improved the way customers find the products. They need we know this is core to our growth in 2020, we launched our product information management system, which provides the foundation for our merchandising efforts. We now have over $2 8 billion of our product assortment Remerchandised, one 6 billion completed in 2020 along well.
We also made enhancements to our search functionality and mobile app, resulting in a better user experience. We added features like search by image, where you can take a picture of the product you are looking for.
Accurate matches to relevant items quickly and easily.
We took a significant step forward with our marketing capabilities in 2020.
We brought more capabilities in house to develop the competitive advantage on industry specific knowledge.
These efforts helped us gain share and increase customer acquisition with the Grainger brand.
We develop new capabilities to support onside inventory management, including vending solutions and technology, allowing us to remotely upgrade for altra installations to better serve customers during the pandemic.
We also opened a new distribution center in Louisville earlier this year now our largest facility with the capacity to stock 700000 products and our strategic geographic location, we leveraged the building for test product expansion on a set of new categories with very strong results.
We also made strong progress with our endless assortment businesses zoro continued to expand its product portfolio, adding $2 5 million items in 2020 to bring the total skus to over $6 million.
<unk> also improved its marketing capabilities, resulting in improved ROI and higher customer repeat rates. They are leveraging the minnow true a playbook to improve the fundamental growth and profitability of the business.
<unk> continued its exceptional growth and profitability performance.
On a great year for the endless assortment team.
Now before I review, our 2020 results I think it's helpful to step back and take a look at the impact the pandemic has had on our operating performance.
From a revenue perspective, we started to see a shift to pandemic related products starting in mid February of last year.
In late March as pandemic pandemic product demand surge, we saw a significant decline in other non pandemic product as lockdowns to COVID-19 since that point. We are seeing continued strong sales of pandemic products, which is ebb and flow based on the buyers, including another surge in the fourth quarter, which mirrored the increase in case counts non.
Non pandemic products are slowly coming back and we're not yet at pre pandemic levels. They have improved quite a bit from April lows. We expect the pandemic to continue to impact revenue through at least for first half of 'twenty 'twenty, one and then start to moderate as vaccinations take hold.
Taylor forward looking thoughts in a bit.
The pandemic has also had a big impact on gross profit driven by two main factors for.
First we were impacted by product and customer mix pandemic products are generally lower margin and we sold large quantities to health care and government customers.
Which typically receive more favorable pricing. This was exasperated early on as we initially prioritize product allocation to those most in need like health systems and those on the front lines. So sell through margins have been negatively affected by these mix impacts the second drivers that we have been aggressive in supporting our customers by trying to anticipate the needs they might have.
As a result, we placed large orders for certain products in Q2 of last year as.
As we have gone through the pandemic surge as the supply demand picture has changed rapidly for some products and we had to revalue our inventory to reflect this reality the vast majority of our purchases have worked well for you. That's not we have reverted to our normal purchasing processes and we'll continue to monitor market dynamics as the situation unfolds.
The impact on GP is easier to understand sequentially. Our G. P dropped significantly in Q2, and it's been impacted the remainder of the year moving forward, we expect U S. G P to improve sequentially and to exit 2021 as high or higher and we started in Q1 2020.
Finally, as we look at SG&A overall net costs were lower despite some increased costs for enhanced safety and cleaning protocols and workforce disruptions. The team was able to tightly control costs, while also continuing to invest for the long term.
Despite these unique and challenging circumstances, we were still able to deliver strong overall performance in 2020 fueled.
A few of the highlights we delivered organic constant currency daily sales growth of three 5% at the total company level driven by our above market growth 800 basis points in the U S. Due in part to pandemic related sales also we achieved over 18% daily sales growth in the endless assortment businesses.
We delivered operating margin of 11, 2%, reflecting strong SG&A leverage which helped to offset the previously mentioned pandemic fueled GP headwinds.
<unk> of $1 1 billion in operating cash flow, we're returning $939 million to shareholders through dividends and buybacks.
And we remain disciplined in our capital deployment, maintaining strong adjusted ROIC over 28% for the company.
In order to focus on our core high touch on endless assortment businesses, we divested fabry in China, two non core businesses abroad.
Overall I am confident in the direction, we are heading and very excited about the future. We have gained significant share in built strong capabilities. We are in a very good position to deliver strong performance this year and for years to come as the pandemic loses its grip with that I will turn it over to D to take us through the fourth quarter results D.
Thanks D G.
Turning to our quarterly performance.
Organic daily sales would suggest whether that divestiture of fabry in China finished up five 6% on a constant currency basis on the fourth quarter.
Underpinned by growth on our U S segment and continued impressive performance unless department.
In the U S. We realized strong outgrowth for the broader market, which can drive for about one and a half to two per cent persons prior year.
Gains were driven by pandemic related demand, which remain at elevated level.
Now to new customers and growth with net.
Yeah, unless assortment model continues to deliver with 20 per well and daily sales again in the fourth quarter, while also generating improved operating margin.
We remain very excited about the theater on this bill will discuss our plans to provide further transparency as we introduce our new GAAP reportable segments for 2021.
At the total company level margin pressure continues to be driven by pandemic related headwind primarily in the U S segment.
I will detail the pandemic makes more than if you buy.
In addition, we continue to see business unit.
As we experienced significant growth from our endless assortment business.
SG&A costs were favorable by 42 million net year over year as we captured 235 basis points for SG&A leverage in the period through prudent cost control from Canada.
And we've got strong thanks, a lot much less assortment.
This resulted in Q4 operating margin per se.
75 basis points from the fourth quarter last year.
From a cash flow perspective, the business continues to produce robust cash flow.
Operating cash flow of 336 million.
At 170 per se.
Net adjusted earnings for.
Free cash flow of $291 million.
We restarted our share repurchase program on the fourth quarter and completed 500 million of repurchase theory.
Finally, we delivered strong return on invested capital at over 28 per cent for the full year.
Turning to our U S segment.
Daily sales increased three seven per second quarter compared to the fourth quarter of 2019.
On the product side sales.
Pandemic related products remained elevated up.
49 per se.
Quarter.
But a tapered off from the peak in the second quarter.
We continue to see meaningful improvement non tender.
Pandemic product strength.
Total day down 7% on a quarter.
Exiting the year with December at lowest decline.
On 5%.
We've also seen a significant uptick in new customer acquisitions month over month with encouraging signs of repeat buy.
From a customer perspective, with the improved growth with both large and mid size customers with a lot of growing about 6% on the quarter.
I wanted to show signs of improvement from earlier on the year.
Gross margin of 35, 7% was down 290 basis points compared to the fourth quarter of 2019.
Yeah on the favorable variance in gross margin was driven most notably in day like related headwinds, which accounted for nearly 90 per cent of the G. P decline.
And then the impact was driven by continued product and customer mix.
And mark to market inventory adjustment, which D. G outlined earlier as well as freight related surcharges.
Net of pass through shipping charges for customers.
In the second half of 2020, we started gaining solid traction on price realization, which nearly offset continued cost headwinds as we exited the year.
From an SG&A perspective, we gained 155 basis points of leverage with cost increasing approximately $14 million year over year.
The reduction was driven primarily by decreased travel expenses, lower depreciation and general operating efficiencies.
Operating margin declined to 12, 8% in the fourth quarter.
As the pandemic impact on gross margin weighted more heavily on the SG&A leverage gained.
Adjusted return on invested capital with a very healthy 36.5%, whereas the full year of 2020.
Now looking at pandemic product trend, while sales of pandemic related products.
Second quarter through October.
Continued demand for key products, including masks gloves and cleaning supplies has kept net sales elevated year over year.
We saw this pick up again in the last few months of the year as cases spiked headed into the winter.
We've also think customers across industries per for the vaccine distribution moving.
Related but slightly different products like those required to work in refrigerated storage units.
January sales remain elevated but have tapered off from Q4.
On the margin side things continue to get better.
We exited the year with the someone's out five per cent and have continued to see improvement with January roughly flat year over year.
Looking at share gain on slide 10.
We estimate U S MRO market declined between 1.5% to 2% in the fourth quarter saw a strong improvement from the mid teens decline we saw on the second quarter.
Angela was able to capture roughly 550 basis points of outgrowth fueled by pandemic related sales and our growth initiatives.
On a full year basis, we estimate that we have outgrown the broader MRO market by roughly 800 basis points.
This outgrowth was aided by significant pandemic related volume some of which particularly in the second and third quarters was related to a large one time orders that are unlikely to reoccur.
We estimate that approximately 250 basis points of the market growth in 2020 was a result of these non repeating pandemic transaction.
Accordingly, as we move into 'twenty 'twenty, one and last these pandemic sales side, we expect to see some volatility in our year over year share gain metric.
That being said we are.
Confidence in our ability to serve new and existing customers during these challenging times.
We believe we are doing on the right things in merchandising marketing and sales effectiveness to drive repeat purchases and produced 300 to 400 basis points.
Payable outgrowth in our U S high touch business.
Moving to our other businesses.
Organic daily sales increased $14 six per cent or 13% on a constant currency basis.
The endless assortment business grew at an approximately 20% with strong results in bolt on that.
And they're all during the quarter.
For International High touch business from both Mexico on Crown or well, we saw continued sequential improvement. However, both businesses remain impacted by pandemic related shutdowns.
Overall operating margins for other businesses were up 210 basis points.
The favorability was driven by significant SG&A leverage and endless assortment, notably at rural what's left heavy investment spend in the prior year period.
So I'll continue to execute the monitor all playbook and delivered low single digit results for the year.
Turning to slide 12.
The Canadian market has seen an overall economic slowdown during the pandemic, which has notably impacted our natural resource and export customers.
Throughout the pandemic our team in Canada has remained focused on serving new and existing customers well, while also accelerating our customer diversification efforts.
In Canada sales.
<unk> decreased three 2% or for 4% on constant currency basis.
Volume in Canada reflects the pandemic given slowdown however, the business continued to improve sequentially.
Positive sales growth in the month of December and we believe the business is well suited for a post pandemic world.
Gross margin at Grainger, Canada declined 1040 basis points year over year. This is primarily driven by lapping significant one time supply chain efficiencies and to a lesser extent the impact of pandemic related headwinds.
Cost management and the benefit of pandemic related subsidies resulted in 315 basis points of SG&A leverage.
Given the continued uncertainty surrounding the pandemic on the subsequent path of economic recovery, we will not be providing formal guidance at this time.
This picture remains fluid as off the shape of the pandemic on our customer demand for pandemic profit.
So look for the last few quarters, we want to continue providing some insight into how we're thinking about the current quarter's performance.
From a sales perspective, our preliminary results for January So you open yourself up about 9%.
On a company level on a daily organic constant currency basis.
While this was a strong start for the quarter, we face more difficult comps in February and March when pandemic sales started to spike.
With this we expect daily sales for.
On moderate and in the first quarter up between three and 5% organically.
Note. We will also have one less selling day this quarter.
From a gross margin perspective, we expect GP improvement of around 50 to 100 basis points sequentially versus Q4 2020.
This anticipated lifts underpinned by slowdown in pandemic demand.
Continued price cost recovery and the lapping of freight headwinds for Q.
For 2020.
On a year over year basis, with what implied G. P will be down between hugging 50 to 200 basis points in the quarter.
With respect to SG&A, we expect Cogs will inch up sequentially as business activity progressing and if things like variable comp reset with the start of the new year.
With this we anticipate SG&A of between 732 $750 million for the first quarter of 2021.
Bob This is up slightly versus Q4, 2020, we will still be down meaningfully year over year.
As always we remain focused on managing near term headwinds, while continuing to invest in the business for the long time.
From a capital allocation perspective, we remain committed to our balance framework for.
For 2021, we anticipate investing for 2225 and $275 million back into the vehicle.
These capex investments include D C expansion in Japan for team.
T and keeps back investment from the U S at normal level of maintenance capital.
Beyond that we anticipate executing a similar dividend and share repurchase strategy put in between 600 for $700 million to work on.
On repurchases on 2021.
Although we are not providing 2021 guidance I thought it might be helpful to provide some insights into how it post pandemic recovery could play out for the year.
As it's the largest portion of our business and one of the most impacted by the pandemic we have charges on our U S segment on slides 14 and 15.
Give me some context.
If we have for continued progress on vaccine distribution and a return to near full economic activity as we enter into the second half of 2021, we.
We would expect our results to trend back towards more normalized levels.
On slide 14.
We map out year over year sales growth in Dallas.
Similar to our pandemic non pandemic sales chart, you can see the quarter to quarter sales spikes from pandemic related product.
Most pronounced in the second quarter, which remained elevated through the year and finished up $835 million for 54% from 2020.
This drove pandemic product mix as a percent of total sales for 28% in large increase compared to 19 per se in 2019.
Conversely, non pandemic sales were down dramatically from the second quarter and remain depressed through the balance of the year, finishing down $540 million for 8% in 2020.
These trends did improve sequentially.
In 'twenty and 'twenty, one we expect to faithfully I think headwinds as pandemic sales continue to moderate from spikes, we saw last year.
That makes it I think it's important to remember that more than 70% of our sales comes from non pandemic product.
And as the economy recovers and these sales rebound on it should more than offset the lapping headwind from pandemic related product.
This will also help to normalize on product mix back towards pre COVID-19 level.
Accordingly, we would expect to see year over year growth in 2021, but the magnitude will be determined by the pace of the economic recovery.
Related to gross profit margin is product mix trends towards pre pandemic levels, we would expect to see improved GP rates throughout the year.
This includes sequential improvement from Q4 2020, beginning in Q1 'twenty 'twenty one.
We expect to exit the year with U S. G P rate as high or higher than Q1 2020 levels.
I want to reiterate.
While this commentary relates to the business, we showcased it because it represents more than 70 per cent of the total company result, and was the most heavily impacted by depends on it.
With that I will turn it back over to D. G.
Thank you D. Turning to slide 17, I am excited to announce changes to our GAAP reporting structure, which will better align our financial disclosure to the way we manage the company now that's for providing increased transparency for the investment community.
Getting a 2021, we will shift our segment.
Segments to high Tech North America, and endless assortment.
Thinking about these businesses under two new segments is consistent with our strategic priorities for each segment and how our teams are organized internally.
Our new high Tech North America segment is comprised of our Grainger branded businesses in the U S, Canada, Mexico, and Puerto Rico. This further solidifies. The work we had done over the last couple of years to create a consistent go to market approach across the region. While also merging the commercial functions of these businesses into a single organization.
It also reflects the fact that we run the supply chain as one entity across the region.
We feel confident that these businesses are well situated to support our customers with quicker for coordinated decisions drive profitable share gains and exceptional customer solutions across North America.
Given the growing size and importance of our endless assortment model. The timing is right to begin providing standalone disclosures for this important business. Our endless assortment segment will consist of our mono true zoro businesses, which operate primarily in Japan Korea, the U S and the U K.
We continue to work closely align the operations of these businesses, taking the lead from the success we've had at Minto true.
Alongside these changes we will also take the opportunity to simplify our corporate cost allocation and intercompany sales methodologies to better align with industry best practices.
Given the amount of change we wanted to preview the re segmentation. This morning in preparation of shifting to the new structure, starting with the first quarter of 2021 results.
Between now and our Q1 earnings call. The team will be working to file our 2020 10-K in normal course under our historical presentation.
And then shortly thereafter, we expect to file an 8-K with three year recapped summary, financials, reflecting the new segmentation.
<unk> quarterly information for the 2020 period.
On March 9th we then plan to host day modeling call to help you fully understand the change and to answer any additional questions that you may have this should position us well for our Q1 call on April 30, which I would point out is a week later or so than normal going forward, giving our new endless assortment reportable segment, we will be pushing back on earnings call calendar.
For align with <unk> schedule.
Shifting gears, we continue to execute against our business priorities.
Touch solutions model, we remain focused on re merchandising our product line to ensure customers and team members can find the right solutions quickly, we know that re merchandize categories to increase sell through rates were also significantly improving the user experience. So this work is an important pillar in our share gain efforts, we expect to re merchandise and additional $1 $5 billion of product in 2021.
This process has become embedded in the way we work it will be a constant moving forward.
We will continue to invest in and improve our marketing efforts, which supports all customers and us.
Delivered proven share gainer for the past few years, we will continue to deepen customer relationships keep stock and further strengthen our keep stock offer to create more value for customers and ensure we have for competitive advantage.
We'll continue to improve our offer and sales strategy with both large multi site customers as well as mid size customers and lastly, we will continue to improve the path that we're on with our Canada operations as part of the North American Grainger business unit.
Our improved cost position exceptional service and early success in expanding into new customer segments gives us confidence that we're on the right path in Canada. We will update you on Canada's performance as part of the Nord High touch on North America segment.
In our endless assortment model, we expect to add over 2 million items zoro in the U S. In 2021, pushing us to over 8 million Skus on our site.
We will work to continue improving profitability through enhanced marketing efforts, we will further leverage analytics to refine our customer acquisition funnel and to improve customer repeat rates at zoro.
<unk> reflects this resilience in 2020, and we will look to continue momentum in 2021, the business expects to launch new product and order management systems in the first half of the year to further improve internal processing and shortened lead times. Additionally work continues on two new fulfillment centers with Ibaraki facility expected to be completed in mid 2021.
So a lot of great work being done across the organization and I am excited about the opportunities in front of us in 2021 on beyond.
On slide 19, I just wanted to reiterate our earnings growth algorithm as we've shed non core businesses over the last few years and move forward with more streamlined reportable segments. The path to long term growth comes into clearer focus on the operational side. We feel we are well situated to gain share profitably in our North American high touch business. This includes 300 to 400 basis.
Points of sustainable annual outgrowth in the U S improving topline performance in Canada, and operating margin expansion as GP rates recover and we continue to gain SG&A leverage in the on.
For this assortment, we expect to continue to produce 20% annual top line growth, but also ramping margin Zoro U S into the mid <unk> into the high single digits over the next three to five years. These.
These strong growth drivers alongside a business that generates consistent free cash flow and has significant capital allocation flexibility gives us confidence in our ability to deliver strong returns for our shareholders.
I am proud of our results for the quarter on the full year and want to thank our team members for their commitment to safety and customer service I also want to thank our customers and suppliers have been great partners. Throughout this challenging time, we have needed to work together more than ever over the past year on those relationships have been crucial.
We have gained share in <unk>.
Proved our merchandising and marketing capabilities, deepen our customer relationships and expanded our assortment, while improving margin zoro.
We are in a strong financial position to grow the business profitably moving forward.
We remain committed to fulfilling our purpose of keeping the world working throughout this pandemic.
Sales continuing to execute our strategy. So we can achieve this purpose for years to come.
And with that we will open the lineup for questions.
Thank you ladies and gentlemen at this time, we will conduct our question and answer session.
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Once again to ask a question press star one on your telephone keypad.
Our first question comes from Ryan Merkel with William Blair. Please state your question.
Hey, good morning, all.
Good morning.
So first off can you explain slide 14 in the deck a little bit more how much are you assuming pandemic sales could be down in 'twenty, one and I guess I'm just trying to get a sense of what the safety search headwind could be for 2021.
Yeah sure. So you know that.
On the headwind will largely depend on how long. The pandemic goes if you think about sort of 10 months of over 10 months of pandemic sales, we sold about 100 million incremental pandemic product.
We feel like.
Well, we know that the pandemic sales are very strong right now and will continue to be so in.
In the year, we would expect you know several hundred million something like that to be a headwind. We also expect to more than recover that in non pandemic.
And Ryan I would also comment that given given the relationships, we have with government health care customers.
The way pandemic sales were throughout the year, our incremental margins on pandemic sales were a lot lower than what we lost on the smaller loss of revenue from non pandemic. So we do expect profitability improve and we expect to have have growth as non pandemic recovery.
Okay. That's helpful and then.
The next slide the gross margin framework, it's really helpful. Thanks for that I guess my question is on the 250 basis points of ramp from for <unk> 'twenty do you expect it to be gradual like youre, showing because I would think in <unk> you could see a bigger jump just based on the comps and then as part of the answer can you just tell us how to think about freight and inventory adjustments.
Because I would think those impacts would be falling off.
So we expect a freight impact to fall off.
And in the first quarter in some ways and certainly the second quarter as well, although the freight environment remains tight I mean, the reality is that more people are shipping product to their homes than ever as you're probably aware of and that has driven.
On a fairly tight freight market, but we don't expect to be impacted all that much by that in terms of inventory adjustments just to be clear.
In the second quarter of 2020, we took a number of actions to try to get product for our customers to protect service. Many of those worked out some did not work out as we as we expected and we received that product in most of the Q3 I'd say.
So you know every every week that goes by we learn more we expect it to match anything we've taken inventory.
Two the actual pandemic sales as we learn more so we would expect that to be theres still to be some of those inventory adjustments in the first half of the year, but just to solely from the fall off after that basically.
So you have a ramp we show is more like what we would expect to see Ryan.
Thank you our.
Our next question comes from David Manthey with Baird. Please state your question.
Alright, Thank you and good morning.
So in the in the fourth quarter, you reported 70 basis points on a sequential degradation in.
Gross margin I think your outlook was more for.
For a flat outcome can you quantify approximately the material factors that affected the fourth quarter gross margin working from the third quarter levels.
Yes, sure I'll turn it over to D roughly.
The surgeon pandemic, Canada had a modest impact.
Inventory adjustments had a bigger impact and was that was with a large part of that so D. Do you want to provide a little bit of color.
Yeah. Thanks, David So yeah, I would say if you look at that the U S segment, which I think if you're talking about 515 debt you know over 90 per cent of the impact the sequential impact from.
Q3 for Q4 was all pandemic related headwind and did you talked about.
And I spoke a little bit about our mark to market adjustments I would say if you look at the full year I know you asked for sequential question, but if you looked at the full year for the U S. I would say about half.
Of our for pandemic impact was related to our inventory adjustments.
With a take or pay with a bigger portion of the fourth quarter.
Correct Okay.
And then second.
As the fourth quarter gross margin didn't play out exactly as you expected relative to your outlook last quarter.
When you look at the gross margin outlook here, what factors could prevent you from achieving the anticipated levels that you have outlined here for 2021.
Yeah.
Well I mean, I think I think that.
Most of what we have is pretty well understood and known at this point, though if if we ate to a point where the vaccinations work in the third quarter starts to look better economically and theres less pandemic product. That's generally true that's generally the shape of how it will play out.
Obviously, if the pandemic doesn't get better and we're still on really elevated pandemic states and pandemic is still a huge portion of our of our business it would be somewhat less and still improve over the year, but they'd be somewhat less and as we exit the year then as shown on that slide.
Thank you.
Our next question comes from Christopher Glynn with Oppenheimer. Please state your question.
Thanks, Good morning, and welcome Jay Congrats on the new role.
Thank you.
I'm curious did you you kind of left us.
With the.
Affirming the 3% to 4% outgrowth is your long term algorithm.
For 'twenty, one is it reasonable to net debt.
Kind of 2.5% of callout large pandemic orders against that as a thought as we kind of model out the year, yeah on the U S. I think the way to think about it is we gained 800 basis points of share in.
In 2020.
250 of that we think is non repeating so you'd say $5 50.
Is what we think is real share gain if we gained 400 basis points of real share gain ex those orders you to track $2 50 from that and we'd be at $1 50 in the year on across the two years we'd be.
950, I think the two year story.
The main point here is that.
And I hear it from customers you know every time I talk to them and I talk to customers every week at a minimum.
We are viewed very favorably in terms of how we've handled this and certainly we took extra risk with inventory and it certainly had an impact on on our G. P. But we are in a great position from a relationship perspective, and we will have a very strong two year share gain period, and we will exit those two years.
Very strong economics, and so for US that's really the main the main point and that's what we've always been trying to do and so yes, you do have to subtract the $2 50.
But in any case, it's going to be a very strong share gain over those years.
Okay that makes sense and then.
On the.
Again to kind of affirming.
Exit.
Catch there the high single digit margin at Zoro.
If you said it I missed it but where was that in 2020 and directionally. It is zoro scale profitability a bit in 'twenty. One yeah. We expect it to go it was it was low single digits, we expect closer to mid single digits in 2021 on high single digit from three to four years.
Three to five years that temporary time range.
Thank you.
Our next question comes from Deane Dray with RBC capital markets. Please state your question.
Thank you and good morning, everyone add my congrats to D in her new role.
Thank you.
D. G. I don't mean to put you on the spot, but just be interested in hearing maybe just the description of the product category of what product purchase did not work out or categories that did not work out those were just to replay that was really a scary time.
And I know you were scrambling to get P. P. E. So I'm kind of anticipating that's going to be an example, but just what didnt go right. There just from like a history lesson.
Yeah, I mean, so I mean, a lot a lot did go right, but there are certain categories, where our supply demand has changed dramatically since that point. When if you wanted to byproduct for your customers you had to pay you had to buy in very large quantities of inflated cost.
I would say there is a very narrow range of skus that fall into that category, they're all PPE day.
On that fall into that category that have have become.
The reason for the inventory every statement, it's not like it's hundreds of Skus, it's a very narrow set of skus.
And if you asked me what I'd do it again I would say, yes, I think it was the right decision.
A lot of those products are sold to customers and kept them safe.
But certainly you are seeing the impact.
In terms of the inventory adjustments at this point.
I fully appreciate that and that's that was the answer I was expecting that was P. P related so.
And then second question is maybe you were getting a little better feel for post pandemic.
And how the sales will ramp back up and what I'm trying to do is get a sense of how will the recovery have a different look and feel versus previous recoveries from recessions, where you typically get this big restock.
Phenomenon, where our customers had run down their own inventory and now as they restart theres a big burst of restocking that goes on it just doesn't feel that's the way it is going to happen. This time.
But any color just to give us a sense of what you're expecting that ramp looks like.
Yeah, you know I think it's not going to happen that way, primarily because it's not a broad based.
Sort of all segment impact so I think what youre going to see a certain segments turned on we've already seen manufacturing come back.
Eloquently strongly as the year progressed and enter into 2021.
So we've certainly seen some.
Restocked, we don't get a lot of restock you are and what we sell but we certainly have seen volumes pick up on manufacturing we saw.
Still earn a very challenged state with.
Hospitality Airlines cruise lines those types of things and so I think what's going to happen is certain segments seem to turn on.
As we recover here and they don't alternate once so you probably don't see a huge sort of restock you see more of it.
Paste restocking as we go that would be my expectation, although you've got some experts and they may have a different answer.
Thank you.
Our next question comes from Chris Dankert with Longbow Research. Please state your question.
Hi, good morning, and congratulations again.
I guess D. G. I know we've gone over this this territory before but I guess with the re segmentation happening now.
Can we come back to Canada.
It's been about five years and Thats really been positive contributor here, what's the logic in keeping it around what's the the long term profit for getting this thing back to a real contributor to growth and profitability for Grainger here.
Yes, I mean, it's I think it's a great question. So first of all let me be clear, we expect to provide as much transparency into Canada as we did before the recent mutation it's quite easy to provide you with the numbers you need to understand what's going on in Canada.
Secondly, though I would say the performance in Canada last year was pretty good we've seen growth now in December.
And in January it was good for Canada, which is the first time, we've seen that in for five years, we have very good customer feedback when I talk to customers they're the.
The feedback is very very good our cost structures in the right place.
We have stabilization and in gross profit.
Ex some of the inventory.
Efficiency issues, we've talked about this quarter, which are not operational.
So we feel like the business was roughly breakeven last year in in the midst of a pandemic.
We actually think it's on a very good path and we think in the next several years, it's gonna be profitable growing part of the portfolio.
We've taken all the hard action now and we are grinding out customers, we aren't losing contracts anymore. I mean, it just it just feels very very different and I think we'd also built some deep customer relationships through the pandemic. So it's going to be a profitable part of the north American portfolio, albeit not as big as it once was but it will start growing now is for.
Sure.
Got it got it thanks for that and then again just thinking about.
Price mix in the U S specifically pretty nice results in the fourth quarter I know, we're not guiding but just how do you think about pricing into the new year as we started to see.
Good number of vendors really come out with pretty significant increases just any commentary on the pricing environment as we move into 'twenty one.
Yes, I mean, well so.
And I think I think this is one where.
You really need the segment there have been a few categories that have been where supply demand has been impacted by the pandemic COVID-19 have had very large cost increases and everybody's taken price increases on those categories and we are no different than general inflation is still fairly modest and we think that price cost mix will be.
Neutral.
Over time, and maybe a little better.
Given our given our starting position so.
No we arent seeing we're seeing in some categories huge huge cost increases and everybody's adjusting prices on those and then for the rest for seeing modest price inflation and we are seeing some early signs of a pretty decent price cost mix.
Thank you.
Our next question comes from Nigel Coe with Wolfe Research. Please state your question.
Thanks, Good morning, everyone.
So we've been talking about the inventory amongst the months.
I'm just wondering if there's any way you could quantify in dollar terms, how much inventory is still kind of being held out trying to help us think about the the risk.
Okay.
The real question is more on the the growth algorithm for non timed on our sales in 'twenty. One on the obviously you provided some detail on slides 14 15.
If we think about.
It is a proxy for MRO, let's call it for.
Perhaps on recovery in 'twenty one.
You expect to grow 30 basis points over that number is that from us.
Yeah that is that is generally the right framework.
Again, we would year over year be hampered a little bit because of some of the outgrowth. We said 250 basis point out growth that was really one time orders.
But yes, that's generally the long term framework.
Okay.
And then I'll ask the question is from getting there.
The short answer is that the the curve that we showed on <unk> on slide 15.
It takes into account.
What we think the risk score with any inventory so that is already embedded in that in that curve.
Okay.
And then just on on zone.
Margin improvements on that.
It would be merchandising just so I understand this kind of model.
Do you basically on a commission on that.
So she doesn't sales so essentially the more volume you need to be merchandising.
<unk> better youll kind of fixed cost absorption SG&A absorption and that's what drives the margin expansion.
Well, let me let me let me, let me clarify a few things there and I think I can answer the question in the process. So when we've talked about re merchandising as prior as a priority that is mostly in the Grainger brand. So that is that is.
Mostly making sure that we have very highly curated product data. So it is easier for our customers and team members to find product than anybody else on the.
Roughly 2 million items, we would have in the U S with zoro.
We're expanding the off for you don't have as much curation with that model you couldn't possibly given the number of Skus we have.
Hmm.
What happens when you add skus as you get growth.
And you get customer acquisition first and then Youre able to get repeat buy.
That does that does not add much expenses for the business that you do as you grow get fixed cost leverage with that debt investment and product skus.
That isn't the full story part of the full story is we're also growing with existing customers and getting repeat buying and that that adds to just some of the fixed cost leverage as well.
Hopefully that answers your question.
Thank you.
Our next question comes from Adam Uhlman with Cleveland Research. Please state your question.
Hey, guys. Good morning, Congrats D.
I wanted to start on SG&A expense and thanks for providing all the detail on the first quarter. That's very helpful. I guess.
No, we're still going to be youre expecting to be down meaningfully in the in the first quarter.
But then we start to cycle some.
Pretty easy comps from the temporary savings I guess could you help us dimension, how we should be thinking about the rest of the day.
The year, how big is the reset of incentive comp and then.
Presumably we will be traveling on at some point in the second half of the year should we expect a big step up in <unk>.
<unk> expenses related to that maybe just flush out the.
SG&A outlook, Yeah, I think I'll turn it over to D. In a minute I think in general.
We don't expect to have sort of a big step up through the year the comps may look.
Unfavorable as a reminder, we.
We went into this with the opinion that the virus was going to be a little longer lived on we want it for sure but that we would come out of it.
Need to operate so we did not take a whole bunch of draconian actions, we prioritize what we did.
We I think we will continue to prioritize more tightly we're working on which is taken some cost out obviously travel some of the travel budget will come back maybe the second half maybe not hard to hard to really tell given where we're at right now.
But not all of it and so we feel like we're still going to have very tight cost control.
And be able to achieve leverage but D. Do you want to do you want to provide any any color on that yeah.
Yeah I think.
And you said most of it there, but I would just say generally I think our long term view to have SG&A at half the rate of sales will be the continued focus but this year is going to be.
Kind of a wait and see and as <unk> noted, we're very focused on.
On being very prudent with our cost and I think it's all going to really depend upon how this pandemic progresses, but I think we will slowly start to see expenses tick up as we get closer to normal levels, but of.
<unk>.
On the overall market with our customers, but if we don't see.
Getting back to normal we will still be very prudent.
With our expenses.
Okay got you Thanks and then.
I guess <unk> you were mentioning the like kind of new customer wins, it sounds like a lot of more sticky relationships is there any way that you can dimension.
Retention of new customers that you've got like repeat buyers folks that have done business with or.
Any data you could share on like active account growth that could help us better understand.
Kind of this.
The market outgrowth that you delivered this past year.
Yes, I mean, so so just to.
In terms of contribution to revenue I would say new customers.
<unk> rates were good.
There's still a fairly small portion of the outgrowth, but we think it gives us a chance to we certainly grew the customer file.
We don't typically provide that information was or with Grainger, we don't often provide two.
To meet each other on that I will say that customer file is bigger and we get more.
Repeat by customers that were new in 2020 than we've had in years. So I don't I'd also say to be honest, we're getting a handle on on what that means and how to how to make and convert them to be consistently buying customers.
It's a little early to understand sort of along the long term impact for them.
Thank you. Our next question comes from Chris Snyder with UBS. Please state your question.
Thank you. So just following up on safety or pandemic. This was a very sizable $1 $6 billion business prior to the pandemic. So I guess my question is how did this legacy business trend in 2020, just so we can try to separate out the underlying business from the surge or new business that came on line over the last year.
Just to help model out the trajectory because I would assume that the underlying business carries.
More leverage to the industrial economy than the surge business that came on.
[laughter], that's a that's a great question and mostly unanswerable I would say so let me give you some customer examples.
To give you a sense so when the pandemic hit in Q2 of 2020.
We are the largest industrial safety supplier we.
We are used to selling things like N 95. So we are not used to selling at 95 for hospitals just to be clear hospitals haven't historically been big users of N 95, and 95 typically go into places like grain elevators and dirty manufacturing processes.
Oh, all of a sudden all of our product was being shifted to hospitals and governments.
We have gotten back to a more normal.
Mix across what we call pandemic product.
Than we did before but I think there's still a lot of Messiness theres still a lot of our customers in industrial economy that haven't come back and aren't using safety products, maybe like they did before if they don't have the activity. So I think it's a really interesting question and one that is super hard to get out and I would also point out debt.
You know theres a lot of safety products, even in hospital systems Hospital systems. This year have done incredible things to protect people to save people. They have been unable to do a lot of the historical safety maintenance things that they might have done. They just have been full out many of them had been full out on COVID-19 and there's a backlog of things that they will need to do.
You know funding funding.
Fundings available that they just haven't done so I think it's a really interesting question and one that is really hard and I'm sorry to give you some anecdotes, but certainly I have a lot of them were.
There is some pent up demand for it from normal pandemic product.
No I appreciate all of that and then just kind of following up could you provide some color on numbers around the margin difference between pandemic and non pandemic revenues just as we try to model out this margin trajectory into 'twenty or 'twenty one is that.
Ship normalizes, Yeah, I mean, you know if.
We havent provided that I will say that.
For the half a billion in non pandemic debt.
We're short in 2020.
That probably has normal increments decrement numbers that you've seen from us the 800 million on pandemic that we sold above normal would have a lot lower incremental margins are quite a bit lower maybe less than half.
As you think about it which sort of gets you to what happened to our overall.
Slight decline in operating earnings for the for the full year. So that may be a way just sort of take to allow you to sort of on think about it.
Thank you on next question comes from Patrick Baumann with Jpmorgan. Please state your question.
Oh, Hi, good morning, Thanks for taking my question.
You covered a lot of ground on the short term I just wanted to move on to the <unk>.
Long term growth algorithm for a second on where you are targeting I think low double digit earnings growth and high single digit revenue growth.
Can you give us a high level view on the moving parts on margins within this particularly how we should think about gross margins over the medium term. Once this mixed dynamic from pandemic normalizes and then just kind of the puts and takes within that.
For the for the company and I you know you cannot you can keep me honest, if I say anything that doesn't make any sense.
For the company, we expect the the U S business the high touch model to have fairly consistent if not for.
Consistent margins gross margins over time, we expect to have SG&A growing at half the rate of growth and that's kind of the the earnings earnings algorithm for that model. We expect the b on the server model to continue to grow much faster than the than the rest of it something like 20%.
If you just include the fact that those gross profits are lower.
On than the average that has a roughly 20 basis point impact on the overall, so you might see a slight decline in overall GP.
And a slight decline in overall SG&A given the debt that business also has lower SG&A, but it should be fairly stable once we get through this.
And then as a follow up to that.
I'm sorry no.
Again, I was just gonna Applebee's is that I I would agree with that and then coming out of the pandemic I think we would look for a much more stable and potentially more accretive margin zone.
Hi debt.
Then we understand that over depend on it.
And just as a follow up to that I guess I'm, a little surprised that you would expect the high touch too.
Just given some of the.
The growth initiatives relative to <unk>.
Yeah, maybe keep stacking onsite and stuff like that where margins tend to be lower maybe just talk about how you're positioned competitively to expand those parts of the business and kind of hold your margins.
Good morning.
I'd point out debt.
We continue to see and even even the last quarter. We continue to see very strong results from our mid sized customers. So.
Even even if there's some pressure with large customers, we expect growth with midsize customers.
To continue to do that.
And so that should help us there too.
And they use less services like yes on them.
Mike keeps on both.
Those kinds of services higher GP, lower certain less services and so higher margins.
Yeah.
Thank you our net.
Question comes from hands on Missouri with Jefferies. Please state your question.
Thank you good morning.
Just just sticking with the medium customer initiative D. G. Maybe you could talk about sort of what what.
What kind of growth to expect an end in 2021, I know I guess it was 6% in Q4, and whether that's sort of baked into your gross margin.
Assumption of exiting sort of pre pandemic levels in Q4 2021.
I guess, just what's baked into your assumption on medium customer growth within that gross margin sort of trajectory.
Yeah, I think I think there's a few a few dynamics. One is one is that in 2020 I think it's important to recognize that.
In the second quarter, we because of how we prioritize supporting health care systems and governments.
We had less product for a while there with midsize customers starting with dice customer business took a bit of a debt. They were also more closed mid sized businesses during that period.
Net slowly come back not fully back yet, but we do expect.
Normalcy with mid sized customers that we have baked in significant share gain with that group.
We don't have huge outgrowth in 2021.
The pandemic, we think is going to be a factor in the first half for the year, but we think we will exit the year with the midsize customers growing faster than large, which does which is baked into our gross profit assumptions.
Okay.
Got it.
And just my follow up question and congrats again on the new role I'm.
Just on on Zoro UK is is that a business that can scale up I know, we've talked a lot about zoro U S book, but just any thoughts there. Thank you yeah, I mean I'd say.
Yes is the answer for.
The business has done well in terms of customer acquisition revenue path.
It's got a healthy gross profit.
For a business thats relatively new.
And Messiah on the team are working hard to make that a scalable business and we still have.
Some some some positive expectation there that that is going to be a success story as you know the U K market was probably more impacted this year than than some others, but certainly we've seen continued growth through the cycle with our UK business and a lot of good signs.
So good well, thanks, I really appreciate everybody's questions.
Questions.
Just close by reiterating what we're doing.
<unk> is a.
Likely to your events and we expect to gain a lot of share during those two years and we expect to have very strong economics exiting out of that and you know I want to thank our team members.
And our customers for for all we've worked together on to really put ourselves on a good position to have great relationships.
Moving forward and it's been it's been an all hands on deck effort.
So thanks to everybody and I hope you stay safe and I hope to see you at some point in person.
Thank you. This concludes today's conference all parties may disconnect have a good day.