Q2 2021 W W Grainger Inc Earnings Call
Greetings and welcome to W. W. Grainger <unk> second quarter 2021 earnings conference call.
At this time all participants are in a listen only mode.
A question and answer session will follow the phone presentation.
If anyone should require operator assistance during the 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 VP of Investor Relations. Thank you you may begin good morning, welcome to Grainger second quarter 2021 earnings call with me are D. G. Macpherson.
<unk>, Chairman and CEO, Indeed, Meriwether senior Vice President and CFO as a reminder, some of our comments today may include forward looking statements actual results may differ materially as a result of various risks and uncertainties, including those detailed in our SEC filings.
Reconciliations of any non-GAAP financial measures with their corresponding GAAP measures are found in the tables at the end of this presentation and in our Q2 earnings release, both of which are available on our IR website. This morning's call will focus on adjusted results, which exclude restructuring.
<unk> 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 today I'll provide an overview of our second quarter results and progress toward our goals as the economy recovers before we get into details on the quarter I'd like to spend a moment highlighting a grainger edge framework.
Work too.
2 years ago, we launched this framework that defines who we are why we exist and where we're going it covers our purpose aspiration strategy and the principles that drive our actions. It all starts with our purpose we keep the world working we shared this with all team members across the company in 2019, while the concept work.
New and many were already part of our operational DNA. The framework provided clarity on who we are and what we do as well as a common language for our team members. The Grainger edge has guided us through the pandemic and I'm proud of how the Grainger team has continued to embrace it.
It's also been a strong foundation for how we serve our customers and helped us through the challenges of the last 18.
Speaking of challenges 2021 has provided plenty.
The year has been characterized by strong demand, but a very challenging supply chain environment raw material shortages labor shortages and transportation station challenges have been the norm, particularly in the second quarter. These.
These challenges are industry wide and while we're not immune to them.
We are uniquely positioned to leverage our scale and navigate through these ongoing difficulties.
Importantly, this year the supply chain has become a competitive sport.
And while we have had obstacles and things are messier than normal our customer research suggests we are navigating the obstacles well and providing very strong relative service. During this time.
We are.
<unk> leveraging our network for example for a customer located in New York, We would typically fulfill their entire order from our northeast D C.
On the supply constraints on product delays now part of the order it may only be available in Louisville. In this case, the order may be fulfilled from Louisville, adding an extra day and incremental cost to the order.
But we are able to leverage.
Our network to provide and protect our great service.
We are also leveraging our branches from our shipping in this environment.
In addition, we have accelerated the ramp of our Louisville, DC, which has helped alleviate capacity constraints. This building is a great asset for Grainger and will continue to ramp capacity through the next 18 months. The good news is that we still are very high.
In our network, even if the product comes from an alternate location.
I've had the opportunity to be in the field quite a bit this past quarter and are excited to spend time with customers and hear their feedback on.
Hearing consistently that while we may be delivering a bit differently from the past, we are serving our customers better than the competition.
We have validated this through feedback.
Ability from customer surveys and the vast majority said, we were doing better than other distributors right now.
We are also investing in non pandemic inventory on partnering closely with our suppliers to work through any supply constraints inbound lead time challenges and any potential cost increases.
Additionally, shortage in the labor market.
On a significant impact.
On a REIT all companies this year.
In response, we have increased our wages to attract and retain talent, especially in our distribution centers.
We are implementing with implemented robust training programs to onboard new team members and train existing team members to work throughout our buildings. We have made great progress in closing staffing gaps and we'll continue to do so over the third quarter.
Impact finally transportation has been very challenging.
That is clearly linked to the product and labor shortages.
We have always prioritized optimal routes and cost efficiencies over the last few months, we are partnering with our carriers and new ways to ensure we are meeting customer expectations.
We have also added new partners to our carrier mix to handle our volume and provide us flexibility.
It is important to note that the overall freight market is volatile and uncertain.
While we are confident in our current plans to manage these challenges there are a lot of moving pieces and constraints across all modes parcel L. T. L. On Ocean freight for example, the ocean freight market has been uncertain as the pandemic surges again in Asia and container costs fluctuate we are ready.
On to any of these dynamics.
We expect the supply chain challenges to last through the end of the year on likely well into next year.
I have no doubt as we continued to live the Grainger edge and follow our principles will not only get through these challenges, but will deliver strong results and take market share.
Turning to our financial highlights the bottom line is that our performance has been in line.
To respond vacations on what we communicated on our last earnings call. The only exception to this has been gross profit impacted primarily by the changes in may to the CDC mass guidelines halfway through the quarter.
Heading into the second quarter, all external factors were pointing to a reopening in the U S around or sometime after the fourth of July giving.
Giving us a full quarter to sell through as much.
Much of our remaining pandemic inventory as possible.
Based on our internal scenario planning, we thought the potential adjustments in Q2 would fall somewhere between 45 and $50 million, but.
But we couldnt predict precisely how far the demand curve with fall or winter.
Then when the CDC mask items change in mid May we saw demand for pandemic products, especially masks decline rapid.
As a result of the suddenly sudden weakening in demand we had more pandemic inventory remaining unexpected and we took a $63 million adjustment about $15 billion more than our internal scenario planning.
We believe this completes any material pandemic related inventory adjustments.
This incremental change GP would've been roughly flat sequentially.
We understand the CDC has just changed guidance again this week.
Situation is fluid, we do not expect any material change on our outlook as a result of this change.
Shifting to the other financial results, we achieved strong organic daily sales growth of 15% for the company on a constant currency basis within our guided range when.
When compared to 2009.
<unk> Q2 was up about 14% on a daily organic basis, a positive indicator of our strong performance and recovery beyond the pandemic.
Our high touch solutions North America segment grew 12, 7% on a daily constant currency basis.
In the U S. We lapped the most extreme extreme volatility of 2020 looking at.
Our average in the second quarter of 2021, we drove approximately 275 basis points of average market outgrowth.
We remain very confident in our ability to grow 300 to 400 basis points faster than the market on an ongoing basis, we expect the volatility of 2020 and 2021, the average out and get back to normal heading into 2022.
The 2 year Canadian business drove positive operating earnings growth for the quarter and manage expense as well. We are seeing continued momentum in targeted end markets, especially heavy manufacturing and higher education, our schools prepare to reopen in the fall and we continue to diversify the business beyond natural resources.
The endless assortment model had another impressive quarter with 23.9.
Daily sales growth on a constant currency basis fueled by strong customer acquisition.
Lastly, we generated 269 million on operating cash flow and achieve strong ROIC of 29, 2%.
Turning to our quarter quarterly results for the company I've discussed most of what's on this slide but I wanted to point out 2 additional items.
First our SG&A was $790 million in line with the guided range provided on our first quarter call as expected we increased SG&A for the quarter as we continued to invest in marketing and in our people through increased variable compensation and wage rates in the Dcs. This.
This resulted in total company operating margin of 10, 4% down 70 basis points compared.
<unk> the prior year.
Excluding the impact of the $15 million incremental inventory adjustment GP would've been roughly flat sequentially and operating margin would have been 10, 9%.
Total net EPS would've been around $4.50.
With that I will turn it over the day to take us through more detail on our 2 segments.
Thank.
Yes.
Turning to our high Tech solutions segment, we continued to see a robust recovery with daily sales up 13, 7% compared to the second quarter of 2020.
And up 9.5% compared to the second quarter of 2019.
In the U S. We saw.
So strong growth on our non pandemic product category with product mix returning to more normal levels.
For the segment G. P finished the quarter at 36, 9% down.
Down 125 basis points versus the prior year.
I think it's important to note that.
The $63 million of it.
Inventory adjustment GP would've been up 125 basis points year over year.
This 250 basis point swing demonstrates that our underlying GP rate would have otherwise been a healthy $39.
With the 5%.
Coupled with our focus on achieving price cost neutrality, we are confident that our run rate G. P remained strong.
SG&A in the segment ramped as expected to $640 million.
<unk> the lowest point of SG&A spend in the second quarter of.
For 'twenty.
Canada continued to make solid progress and expanded operating margins approximately 315 basis points year over year.
Insistent with last quarter. We have included a chart with details on the U S and the Canadian businesses on the first page of the appendix.
On slide 10, looking at pandemic product trends I want to highlight 2 things before we dive into the Q2 numbers first.
First we lap the extreme growth experienced last year and saw a decreased demand for PPE products.
Accordingly pandemic sales declined approximately 20.
28% versus 2020.
However, that's an impressive 27% increase versus 2019.
We estimate July 2021 will be down about 28% over July 2020.
In line with what we saw in the second quarter of this year.
More importantly, we see the trend in our non pandemic sales is a positive sign of economic recovery.
During the quarter, we grew 31% versus 2020 and up 7% versus 2019.
We're seeing in markets like commercial which include our severely.
Merely disrupted customers in hospitality, along with heavy manufacturing, making significant comeback.
We estimate that for the month of July 2021, non pandemic sales roles of about 22%.
As it relates to pandemic product mix.
Year, how we expected it to taper off to near pre pandemic levels to about 20% by year end. We're seeing this happen more quickly now at about 22% of sales.
In total our U S high touch solutions business is up about 12% for the second quarter of 2021 and up 10.
Percent over 2019.
Looking at market.
Growth on slide 11, we are lapping the highest concentration of large pandemic purchases of the prior year.
At this time the market declined between 14, and 15% and we saw outright.
Outsized share gains of roughly 1200 basis points.
For Q2, 2021 were seeing the opposite effect.
We estimate the U S. MRO market grew between 18, and a half and 19, 5%.
The U S high touch business grew 12.
We spent about 650 basis points lower than the market.
To normalize for the volatility we calculated the 2 year average share gain to be 275 basis points over the market.
There's some noise in the market number because across industrials given.
For financing and fluctuations over the last 2 years.
Therefore, the 2 year average is a better estimate of what's really going on.
As I previously noted our U S high touch business is up 10% over 2019.
As the impact of the pandemic subsides.
Even the doubled with our strong progress on key initiatives and our return on investments like marketing, we remain confident in our ability to achieve our share gain goals.
Now, let's cover our U S. G P rate.
As previously discussed our second quarter GP decline resulted from the $63 million.
Inventory adjustment.
This adjustment lowered U S. G P by 270 basis points.
Without this our underlying U S. G. P rate is 39, 8% in the second quarter.
As we look to the remainder of 2021 it is important to note we.
Writing in a very challenging and fluid environment.
We're doing everything within our control to exit the year with a Q4 GP rate at or above the Q1.2020 levels or 41%.
We remain confident in our ability to achieve this target bore fruit.
We are a burst.
As noted earlier, we anticipate no further material pandemic related inventory adjustments.
Excluding the inventory impact our GP rate is nearing this level already.
As we discussed on slide 10, our pandemic product mix is close to pre pandemic levels.
And we expect this to fully normalize in the second half.
And we've seen evidence that we can continue to maintain price cost neutrality.
On the cost side, we have a robust process to partner with our suppliers and understand the specific raw material impact as well as other conditions.
That may result in increased costs.
As it relates to price our goal is to continue to maintain competitiveness in the market and path what is applicable.
In the first half we were slightly above neutrality.
And as we expect to take additional price increases in the second half the offense.
What worked we're expecting in cost.
Even in this inflationary environment, we are confident we will be able to execute and achieve neutrality through the remainder of the year.
Moving to our endless assortment segment.
Daily sales increased 23%.
I'll say, a 23, 9% on a constant currency basis, driven by continued strength in new customer acquisitions at both zoro and monitor all as well as growth of larger enterprise customers amount of tomorrow.
D P expanded 75 basis points year over year, driven by positive trends in both businesses.
<unk> and operating margin finished up 95 basis points over the prior year.
I'll go into more detail on the next slide as we provide further transparency on the results of both of these businesses.
Moving to slide 14.
Please remember that monitor is a public.
Net with Honey and follows Japanese GAAP, which differs from the U S GAAP.
And as reported in our results 1 month in arrears.
As a result, the numbers, we disclosed will differ somewhat from monitoring public statements.
In local currency and using.
On Japan, local selling days, which occasionally differ from U S selling day.
Monetize daily sales grew 16, 7%.
P, finishing the quarter at 26.4% 25 basis points above the prior year.
Operating margin decreased 15 basis.
<unk> to 12% as they continued to ramp up operations at the Iraqi D C.
Again, another strong quarter for monitoring.
Switching to Zoro U S daily.
Daily sales grew 32, 6%.
As it lapses soft soft this quarter.
Order of 2020.
Zero G. P grew 95 basis points to 31, 5% and achieved 320 basis points of operating margin expansion through substantial SG&A leverage in the quarter.
All in all very impressive results.
Moving.
Moving to slide 15.
In addition to the strong financial performance, we're seeing positive results with our key operating metrics.
As you saw on the first quarter, we've lifted total registered users for both businesses and important driver of top line performance.
Both monetize loans are all have shown progress.
About 20 up over 20% over the second quarter last year.
On the right girl continues to actively add skus to the portfolio.
At the end of the second quarter of 2021, we had a total of $7.5 million Skus available online.
Close to our goal of 8 million for the year.
Here, we remain encouraged by our progress with SKU additions beyond traditional MRO.
Now I'll provide commentary as it relates to the upcoming quarter and our expectations for the full year.
For the third quarter on a total company level, we expect our revenue growth to.
To be between 10, and 11% on a daily organic basis.
We believe any material pandemic related inventory adjustments are complete and.
And we expect G P to be up between 100, and 120 basis points year over year and to improve sequentially.
SG&A as.
As anticipated to fall between 805, and 815 million as we continue to invest in marketing.
And wages in the D C to remain competitive.
Transitioning to our total company guidance I'd like to provide some brief commentary on how we're trending so far.
We expect strong sales to continue while G. P operating margin and EPS will face pressure as a result of the incremental inventory adjustment.
And freight costs, along with investments and create increased D C wages and marketing.
While we are maintaining our guidance we expect results were true.
Turning towards the low end of our range with the exception of revenue.
We expect revenue to be near the midpoint.
As it relates to our segment operating margins, we think that some of the supply chain challenges as well as the first half inventory adjustment.
Way more.
On the high touch solutions segment, and therefore high touch operating margin may trend at the low end of the range.
At the same time, we believe endless assortment driven by strong performance and improving margin.
End of the year at the high end, both helping to support delivery of total company.
Any results.
We are not adjusting guidance and we are confident in our ability to deliver results within our guidance ranges.
As we learn more we'll continue to keep you apprised of any changes.
With that I'll turn it back over to D. G for some closing remarks.
Thank you D before I open it up for questions I wanted to share 2 recent company accomplishments.
First I'm proud to announce debt earlier. This month Grainger was certified as a great place to work a true Testament to the exceptional team member experience, we built and an important milestone in advancing the grainger edge.
Second is our 10th year publicly reporting on ESG.
She efforts I wanted to share highlights from our new corporate responsibility report at Grainger, we embrace our obligation to operate sustainably and with a long term fact based on you are critical issues regarding the environment society at large and corporate governance.
For example in 2012, we became the first industrial distributor to publicly disclose our carbon footprint.
In 2013, we became the first in our industry to set a public greenhouse gas emissions reduction target, which we achieved 2 years early.
We just set a new goal last year to reduce the absolute scope, 1 and 2 greenhouse gas emissions by 30% by 2030.
We're also committed to helping our customers achieve their ESG goals.
Print products and services, we now offer more than 100000 environmentally friendly products.
Through this portfolio, we're able to help customers maintain sustainable facilities, the efficient energy management water conservation waste reduction and improved indoor air quality.
2017, Grainger signed the Chicago network equity pledge.
Focused on achieving 50% representation of women in leadership positions by 2030.
And this year, we formed the ESG leadership Council, which I chair.
<unk> comprised of Grainger leaders, who provide strategic direction and oversight on our ESG efforts you can find the new report at Grainger ESG Dot com.
With that we will open up the line for questions.
Thank you.
And ladies and gentlemen at this time, we'll be conducting a question and answer session.
Please note please limit yourself to 1 question and 1 follow up question.
If you would like to ask a question. Please press star 1 on your telephone keypad.
A confirmation tone will indicate that your line is on the question queue.
You May press the Star key followed by the number 2 if you would like to remove your question.
Once again, please limit yourself to 1 question and 1 follow up question.
Our first question comes from Christopher Glynn with Oppenheimer. Please go ahead with your question.
Yeah. Thanks, good morning.
Congratulations on the new adjustments.
Sure thing these days.
I'm curious on the large customer contracts you talked about having good price cost.
<unk> trends overall.
Just curious how that works with the large customer contracts.
Yeah.
Steve Why don't you why don't you take that 1.
Sure so.
You know as we've discussed on the path, we have about 70% of our business in the U S.
With large customers.
And.
That business runs through their contracts, we have the right to <unk>.
Pass on.
Price increases to those customers at different times in the year and so as you can imagine.
With cost increases coming in from our suppliers and the timing of when we can pass on price increases to those contract customers do not always line up perfectly so it ends up.
We ended up having some lumpiness as it relates to our G P. But overall those actions that we're taking.
Are those customers are going well and we have been able to pass on.
Cost increases to those customers I'd also like to remind you that you know the rest of the business.
30% is on a web price, which we have the ability ability to change.
In line with the Mark.
Taking when we do that to remain competitive with others in the market that have visible prices.
The only thing I'd add.
The only add on to that Chris and thanks for the question is is that.
We have a very and as he said a very robust process in their day managing cost this isn't an environment right now where.
Get anybody is raising price on everything and we are effectively working with our suppliers to mitigate the cost and so the conversation with customers are sort of well understood unexpected at this point. So I would say if we continue to do both of those things, where we feel like we can be in good shape.
Okay. Thanks for that.
<unk>.
On the.
The kind of guidance you know it kind of separately heard at the low end in the slide and then kind of towards the low end.
I don't know about other people I sort of read a little bit differently, just wanted to kind of clarify your intent.
So.
I think if you go back to our prepared remarks, we expect revenue to remain strong and and fall within the range.
And.
While G P <unk> operating margin and EPS will be pressured primarily due to some of the inventory adjustments that we have to.
<unk> taken this year, we're happy to be back past that.
But because of that and you know some other pressures related to from wage increases and things like that he noted.
We will we are saying now that GP operating margin and EPS will fall at the lower end of the guidance range that we provided in the.
The first quarter.
So we are maintaining our guidance and giving color related to revenue GP operating margins and EPS.
Thank you.
Our next question comes from Chris Snyder with UBS. Please state your question.
Thank you.
So you know the company has demonstrated a pathway to get back to pre pandemic gross margins on when we see the inventory adjustments were.
Almost already there.
But you know I guess, what's the outlook for either 22 or 22 and beyond once we get back.
You know is the expectation that we can get to pre pandemic levels and hold it or should we expect moderation thereafter on competition or is there an opportunity to improve it given what we're seeing with outgrowth from mid sized customers.
So thanks, Thanks for the question I think on if.
The back I think we find that comparisons to 2019 or or early 2020 are probably better than last year at this point because theres. So much messy. This on a year over year numbers, but our general thinking is we will exit the year with having gained significant share and in a better spot from a from an economic perspective.
With.
With similar G P and better SG&A leverage.
Leverage.
And that's kind of the model going forward, we feel like we're price competitively we feel like we can hold GP in each of our business units are fairly fairly consistently over time and get some SG&A leverage and so our whole model is based on.
He stepped on share gain and you know slightly expanding operating margins typically yeah. We would expect G. P to hold relatively flat as a percentage of moving forward with some SG&A leverage.
I appreciate that and then I wanted to follow up on the U S. Our 2 year outgrowth, which fell to a 270.
75 bps a bit below the 300 to 400 and the company is targeting them is there anything specific there to call out or is that just quarter to quarter Lumpiness and then I guess what gives you confidence that we will get back into that 300, 400 bip range at least on a multiyear basis into the back.
Consistent then.
Thereafter.
For the year, where we're still within our expectation.
Now I would say just to be to be Frank a lot of the comparisons we had the market around 18% to 19% in the second quarter.
It's tough to find sort of any any peers.
Back half on it that way.
It appears we think we're doing good and we look at both our own you know metric, which is based on it's on industrial production and we look at peers and so we feel very strong about our performance that's off a strong about the initiatives we have and the returns we're seeing we're tracking everything and we feel very good we think.
Right you know what you're seeing for the second quarter is a lot of messiness in metrics and pandemic driven sort of ups and downs, but you know through through cycle. We're very confident we're going to be able to achieve our target.
Thank you. Our next question comes from Deane Dray with RBC capital markets. Please state.
Thank you and good morning, everyone.
Good morning.
Hey, and I also join Chris and saying, it's great to see that you did flow through that inventory write down 3 of our operating results.
So we appreciate the transparency there and just did you you did say this is a fluid.
We recognize that there are some regions that are going to return to mass mandates would there be any potential scenario, where this inventory could eventually be sold.
Are you still carrying that inventory because I think the way the accounting works it would be sold at all profit since you've taken the costs out.
Your question is that the correct understanding yes, so to be clear on.
Our our accounting for the quarter was what happened at the end of the quarter on through the couple of weeks after that when we actually put the results together working with.
With our team on our external accounts and we just follow our process.
On the mass mandate.
Has that happened in the last couple of days I will say that every single external announcements and the pandemic has driven.
Behavior. So so you know we are expecting in the short term to get some increased mass sales.
We haven't flown that through Youre right Theres a potential oh, it's so early.
Any change hours worth of of of revenue would give us any indication and things are so fluid and change so fast it's really hard to tell.
If we went into full lockdowns with full mask usage, what you described could in fact.
Could in fact be true, but it's just really we really uncertain right now.
Of course I appreciate.
For that and then I may have missed the explanation, but on a toro the margin pressure. This quarter was the 15 basis points is that pandemic related whats the explanation there.
I think I think <unk> talked about it but basically startup starting up the Iraqi D C.
Which was in <unk>.
Did expected cost is a big part of that so given their growth. They have put significant investments into distribution centers and that has added some cost there is still very very profitable and still seeing very good growth relative to what it's been on a pretty challenged market in Japan.
Thank you and our next question.
Spectrum, David Manthey with Baird. Please go ahead.
David Manthey. Your line is open please on mute yourself.
Okay. Yeah. Thank you good morning.
First off I'm trying to understand the guidance.
And that comes with it to the low end not the lower end of the range when I run the numbers here from doing this right 15 million Bucks is maybe 20 <unk> after tax and relative to a Buck 50 range I mean, if youre originally at the mid point now you're maybe 1950 something.
I'm just wondering that excluding this write down have your expectations.
For the second half changed in the past 90 days and then you said its fluid, but it seems like to immediately go to the low end of the range seems a little bit much relative to the inventory adjustment.
That was unexpected.
Yeah, I'll start and then maybe you can add on if he wants to add any more color.
A couple of things have happened since the last time.
We talked and we talked about it in our repair remarks related to the messiness of the market and industry supply chain channel again.
And being able to make sure that we can hire and retain the right people in our D C, which is critical to our businesses. So we're seeing from labor inflation.
On that wasn't project debt you know.
At that time, so that that plays into it additional.
Marketing spend to continue to focus on our brand and improve on web conversion with our customers as well. So we talked about some of those things in our stated remarks as well.
And so again, we're guiding to the low end on the range as it relates to that plus the inventory actions we've taken.
Okay.
Got it thank you.
Thanks. Our next question comes from Ryan Merkel with William Blair. Please go ahead.
Thanks. My first question is on freight how much will freight hurt margins in.
Wine and then how are the conversations going with customers, where you're asking some of them debt pay freight where they had been getting free freight in the past.
Also you know starting last year as you can imagine trying to work through you.
You know somewhere north of <unk>.
22000 type customers with conversations with large customers those conversations have been going well.
But there's 2 things I think you have to take into account you know.
There are some freight rate changes that have come from you know from some from visible partners that are easier to talk through.
And so those things comes on.
Extremely well and continue to go well so no problems up to this point with being able to pass on some freight costs.
To our customers.
I would add Ryan.
There's a number of factors 1 is true.
The other is just the service challenges and you know we are we certainly added some cost we are going to recoup certainly some of that if on all of that but just just to be able to make sure that we have deliver reassured and this I can actually get product to customers right now is not as trivial.
Historically has been.
So we're having to prioritize loads more than we've ever prioritized loads.
Containers coming from Asia, or the cost is way way up and so we're navigating that.
Trying to avoid taking too much cost increase while still providing great service. So it's a it's challenging and certainly there's some uncertainty we do think.
Ultimately it will it will balance out but for right now it's relatively chaotic in the freight market.
Okay got it and then from my follow up just a question on gross margins. It sounds like you expect neutral price cost in the second half and but a high touch business at least so I'm just curious is it how much confidence.
Can we have in that I mean, it's crazy environment right now would you say, they're sort of above average risk versus normal debt. There there could be some downside or do I have it wrong and you feel pretty confident based on what you know.
You know I would say on and do you can add to this that if she she's like I you know I would tell you we're pretty confident on that we've we've actually had conversations.
Through the summer with most of our suppliers about cost expectations and we've already been managing those negotiations and getting to a place that we think makes sense.
And we have we have price set for some some increases in the back half of the year. So most of that is already set there are.
There are no surprises that happen and are likely to happen. This year, but typically we are able to manage those and either pushed those out or find ways to mitigate those so we're pretty confident that we're going to be within that within that sort of price cost neutrality range.
Thank you our next question comes from.
Cope with Wolfe Research. Please go ahead.
Thanks, Good morning.
Just.
A bit more detail on the <unk> guidance I think this is the.
So I think you said hundreds hundreds maybe basis points of gross margin expansion Q over Q, so that gives us flat year over year.
Nigel.
Number 1 is that correct.
The comment was full Q exit rates kind of consistent with.
<unk> feels like Thats now pushing to the right just maybe confirm that on.
The following comments, the SG&A and <unk>.
The <unk> 10, it seems like.
Full year guidance it seems that that could maybe go to the hiring of <unk> is that the right way to read on.
Yeah. So.
If you look at I think I'll start with your question just around.
Around the gross profit for a total company the guy.
Yes, we expect that to be up 100 to 120 basis points.
And so.
That's really being driven by a little bit other conversation, we just had achieving price cost neutrality, we're slightly above neutrality to occur through the first half, but we think that we're going on and maintain that would be neutral for them.
Full year.
And we believe that because of the pricing actions as D. G noted that we expect to continue to take our cost rigor with our supply base gives us confidence on what we've been able to do up to up to this point this year.
And as it relates to SG&A.
What day you know.
The range of 805 to 815 is pretty solid and in our mind on the Gulfport basis.
And it looks similar for Q4.
Okay.
And then longer term.
The customer bases for both of the monitor on.
SG&A on a very similar.
The off who is 2 ex from Ontario versus zoro.
Military was a much more mature business is there any reason why zero kind of op, who can't get closer to monetize over time.
Youre talking about Youre talking about our operating earnings.
I'm talking about.
On a customer.
Revenue per customer.
Right Gotcha.
Got you. Thank you.
So theres a couple a couple of things that will make that be.
Different going forward and I would expect <unk> to have much higher.
Sales per customer 1.1 is.
<unk> in the Japanese market. There is no. There is no industrial distributors brought on industrial distributors like there are in the U S that a director customer so actually the most of our businesses is starting to build a pretty strong enterprise customer solution.
And they are having some success there we don't expect zoro to do that.
Because the.
Recognition in the U S is much more stiff on on that front and so.
They have some larger customers that that zoro doesn't have zorro is focused on that small business more more.
More fully and really focus there. So I think that's probably the primary difference and I would expect that difference to continue.
We expect that.
The growth rates to be strong in both businesses and we expect our margins to improve to the high single digits Zoro.
Over the next couple of years and so we feel like it's a it's a great story, but I would expect that metric to be slightly different.
Thank you. Our next question comes from Tommy Moll with Stephens. Please go ahead.
Good morning, and thanks for taking my questions.
Good morning.
Just wanted to follow up on on the point you just made about the.
Continued margin progression for Zoro U.
Your leverage at the operating income line in the second quarter was impressive.
Can you take us through some of the drivers there.
And then looking forward how sustainable some of those might be.
Yeah. We think we think we think theyre very sustainable so just as a sort of a.
Reminder, we made a couple of years back we made pretty significant investments to give that business more independents and there are really 2 types of investments. We made 1 was in systems to allow them to have their own.
For example, they're on product management system.
So they're pretty much clean now in terms of their own systems infrastructure and the second 1 is building teams that can do things like add millions of millions of products a year.
Improving their marketing data analytics capabilities, improving there I T team a lot of those were onetime investments and now as we.
We grow we're starting to see the leverage and would expect to see that leverage.
Going forward.
We feel like the G.
<unk> is in a good place and we think that price points are a good place. So we don't see a.
Concerns there and we just see a world where we can continue to grow the business.
Fairly quickly and leverage the inverse.
So we've made.
Following up on your high touch business for the the gross margin trajectory versus what you talked about a quarter ago. It sounds like there's some incremental marketing spend that's in the budget now what what were the factors that changed over the last 90 days where.
You decided to go ahead, and lean and heavier there and as you look forward to Q4 does it does it feel like or I should say to the just the rest of the year or does it feel like you've now got a pretty good grip on what the budget looks like or could that shift higher again potentially yes.
We've got a really good handle on what the budget is going to look like on on marketing we.
Just look at returns on a periodic basis and the returns we're getting are really strong and we had some we had been running a number of tests and those test came back positive some did not but the ones that came back positive we decided to push on and so on.
That's what drove that incremental money.
Thank you. Our next question comes from Josh.
Josh <unk> with Morgan Stanley. Please state your question.
Hi, good morning, all.
So just on kind of your own kind of commercial initiatives getting out and from our customers things like that with the.
The market is being more open moving your customers being a little bit more receptive.
How do you expect some of those outgrowth metrics to sort of snapback from here I know that there is some a bit of a portion and in the metric right now because of the pandemic sales stuff, but are you able to kind of.
Commercialize or get out in the field more than you were 90 days ago, when does that kind of bearing.
True here in the in.
The medium term.
Yeah, so to it's a great question and the answer is yes, we're getting out and to our customers more if our customers are accepting visits from from US we are going with be the answer to that question I would say that the vast majority are.
And as you know our service.
Team members have been there every day of the pandemic basically we've been able to visit customers to fill inventory bins and do the things that we do on from a servicing side, but in terms of customer discussions we are pretty much running like normal there is still some customers that don't allow visits but I've been in front of probably 10 to 15 customers in the last 6.7.
<unk> weeks and those conversations feel very normal and we're talking about how to expand the business.
Leveraging the work we've done to help them stay up and running in the pandemic and keep their people safe to try to improve the relationship and grow and I think that's going to be.
A positive story moving forward.
Got it.
And then I guess sort of related to that.
Yes, I think there's a whole litany of end markets and business activities that are sort of post COVID-19 changed.
Is it whether it's a customer group or end market, where do you see sort of the biggest difference on that interaction someone buying differently.
Wanting you to handle a bigger scope of.
What they're doing but I would imagine that we go through 2020 and even early 'twenty 1 in the recovery everyone's just sort of too busy to make big sweeping structural changes, but maybe now with maybe the smoke clearing a bit more anything you've seen out there where someone who has just.
Said, here's how we're running this process differently again, it could be an end market could be you know kind of a customer practice, but just curious high level, where you guys have seen the biggest change.
Yes, I mean, I think I think the customer changes or trend changes. There are 2 I would point to 1 is on.
You.
The pandemic did teach a lot of our customers that debt, having a digital solution is it's pretty important and the other is having an inventory solution is pretty important and so.
Almost every conversation yet with customers now centers on.
How can we install processes, so that it's really easy to order and that we can help them.
Manage inventory and keep inventory levels, where they need to be those are the 2 biggest changes it doesn't really across across all customers. Obviously, there's differences by segment. There. So some segments that are pretty pretty significantly disrupted and some that are raging, but but I think from a from a customer interest standpoint, helping them manage their inventory and getting on the right.
Solution are the 2 things that are even more intense even though they've always been important they're really intense right now.
Thank you. Our next question comes from Michael Mcginn with Wells Fargo. Please go ahead.
Thank you.
I can go back from the SG&A and digital marker.
Right digitally you were discussing earlier if I'm looking at the Q3 guidance SG&A is going to take a 15% uptick year over year here on that it's about 500 bps greater than the.
Sales growth you're guiding to can you just give us an update on what the structural SG&A savings that were discussed last quarter and how much.
That is going to roll into 2022, and kind of what those initiatives look like.
First I will turn it over to David I think that we expect to have better SG&A leverage in the third quarter than we do the second quarter, but I'll turn it over to you talk about the details.
Yeah I'd agree so.
When we talked about.
At the highest level daily revenue ex.
Expectations on 10 to 11 in Q3 that you know on implies SG&A leverage will improve and so we expect that.
But again, we just talked about the fact that we are going to.
We continue to invest in marketing spend as.
Alas continues to see some uptick in the full quarter's worth of the some of the D. C labor changes in transportation changes.
That have happened we are working on a number of mitigating factors to continue to see how much we can offset that over time.
But we have laid into 2.3 as far as providing color on expectations that that's where we're going to get to when you take into account those increases.
Okay.
The color and on the freight conversation I guess my assumption.
Is there anything small standard would go on the contract rate and you guys are probably using your legacy relation.
Our legacy related relationships, the new carriers are you pushing.
The non standard product to those new channels, because theyre more market spot based freight costs and you know us.
Is this.
Something that youre going to lean into long term or how should we how should we think about that non standard product shipments.
Well the vast vast majority of our shipments due to a parcel and for those we have obviously very very big contracts and.
On contract rates and so that is that is correct.
In terms of in terms of.
Alternatives.
Right now the <unk> market is probably the most challenged.
From a service perspective from a driver shortage perspective.
And as a result from a cost perspective, and so there we've developed new solutions, we're working with.
We're working with some new carriers working.
Existing carriers and trying to find the right solution that would be where it is it is most messy right now I would say.
On the other place would be on on sort of ocean freight, which is mostly a container cost issue on a capacity issue right now.
Where we're prioritizing more than we ever had to make sure that we.
Working with the contracted rates and don't have to get outside those because if you get outside of those right now that's very expensive.
Okay.
Thank you.
Our next question comes from Justin Bergner with Gabelli and company. Please go ahead.
Good morning D G. Good morning day.
Good.
Good morning.
My first question was on the outgrowth I realize they're served from Squishiness to the market.
Growth rate of Palm, what's your outgrowth statistic was calculated but just generally speaking.
You know as we think about that.
The 300 to 400 basis points of outgrowth target.
Everything else being equal should the supply chain challenges favor grainger being on the high end of that range simply because you have more capabilities to meet customer demand and a supply chain challenged environment than some of your competitive set.
Yeah, I think that's absolutely right and I.
If we didn't have sort of our distribution center capacity right now things would be a lot more difficult finding customer solution. So we feel like the investments we've made which have been substantial over the last 12 years to get the network. We have is really helping us now make sure we can serve customers and we think.
That's a pretty significant advantage of the marketplace.
Okay, Great and then just.
A question on sort of free cash flow.
Is it still the case that sort of you're going to be focused on deploying the vast majority of your free cash flow to dividends and repurchases or has anything sort of.
Changed there.
So thanks for the question no nothing has really changed related to our capital allocation strategy.
And so we're still.
Sticking exactly to what we have debt and the path.
Thank you.
And our next question comes from Patrick Baumann with Jpmorgan. Please go ahead.
Hi, Good morning day, Thanks for taking my questions.
But on the zoro gross.
I mean, it looked really strong to me in the quarter.
I'm not sure what the comp was so I'm just kind of curious if you could tell us what it looked like on a 2 year stack basis.
And how should we think about growth there in the second half of the year, yes.
So I don't I don't remember the 2 year stack number on Zorro, but but what I will say is there is going to be a lot of lumpiness in every quarter to quarter comparison.
This year for for reasons that debt, mostly has to do with suppliers on last year in the second quarter.
Excuse me we.
Prioritize supply for.
For health care and government customers, a pandemic products and so we turned off a whole bunch of volume the zoro, probably could've sold so zoro did not have the kind of gross last year that.
Certainly it was used to in this years, we're very pleased with the trajectory there on there.
There are ahead of plan on doing very well, but this year's number in the second quarter.
I wouldn't assume that that's going to be the number we see going forward because that is often very low number.
Given the supply decisions that we made last year, we still on a lot of confidence in <unk> ability to grow.
20% going forward.
But theres going to be some lumpiness in the back half of the year theres going to be some bad compares.
And in the summer last year, we had a bunch of consumer businesses, we really only wants to have product.
We're going to compare against still be strong growth, but may not be quite as it quite as much as you're used to seeing that will all work its way out and we expect very.
Very consistent strong growth as our business.
That's helpful. Okay, and then my follow up is on.
Can you remind us where your freight costs are recognized and I'm not sure if it's inbound or outbound or.
Different areas of the P&L, maybe part of it to an SG&A part of it is in Cogs.
It's on target when you say price cost neutrality. It does this.
Include freight.
And then also does the neutrality means keeping profits neutral on margin rate neutral I know there was a bunch of questions in there, but just wanted to put them on.
So the freight costs are included in N J P for us and what was the you were you.
You were talking so fast can you repeat the second and third question again for me sorry.
Yes, so if I was saying if it's in G. P, which it is when you talk about price cost neutrality does this include freight in that comment and then when you talk about price cost neutrality also does does it mean keeping profits neutral or is it keeping the margin rate neutral.
So yes, so when we talk about price.
Tragedy it doesn't include.
The freight portion and then to answer the second question, we're talking about right.
GP rate.
No nothing that win rate.
Thank you.
And our next question comes from Kevin.
Kevin Merrick with Deutsche Bank. Please go ahead.
Hi, Thanks, good morning.
A lot's been Australia, maybe just 1 on Cromwell quickly.
Gross margins have improved this quarter can you talk about what's driving that and how sustainable the improvement is.
I'm kind of wondering if we should still think about chromo losses being half.
For the full year versus.
Constant here thanks.
Yeah. So so we do think from wells going to roughly half losses from last year to this year.
Market and Cromwell and the U K has been challenged as most people are aware, but that businesses that are really nice job of improving service and.
Starting.
Lastly, some growth now which is great and they.
Starting to bounce back a little bit and they're on a good position from a cost perspective and from a service perspective. So we start to set some of our expectations. We had the beginning of the year for how that's how that business will shake out through the balance of the year.
Okay.
Got it okay. Thank you.
Thank you there are no further questions in queue I'll turn it back to D. G Macpherson for closing remarks.
Great. Thanks, Thanks, everyone for joining the call I really appreciate it.
1 thing I will just leave you with is as we think about what has been a very strange periods last 18 months.
Our focus is clearly on the future.
We keep saying this but I will continue to repeat this our goal through this period is to exit the pandemic in better shape than we started on that means consistent share gains. We believe we will have done that and that means having better economics as we exit and we believe we will be there as well as we exit the year.
And head into hopefully with the pandemic behind us although of course.
That's no guarantee but that as debt is our goal.
<unk> and manage the business for long term.
Long term share gain and long term margin expansion. So we're going to continue to do that.
And we feel really good about where we're at and so I appreciate.
And look forward to talking to you soon thank you.
Thank you that concludes today's conference all parties may disconnect have a great day.