Q4 2022 W W Grainger Inc Earnings Call
Greetings and welcome to the W. W Grainger fourth quarter and full year 2022 earnings call.
At this time all participants are in a listen only mode.
A question and answer session will follow the formal 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 Kyle Bland, Vice President of Investor Relations. Thank you you may begin.
Good morning, welcome to <unk> fourth quarter and full year 2022 earnings call with me are D. G Macpherson, Chairman and CEO , Andy 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 Q4 earnings release.
Of which are available on our Investor Relations website.
This morning's call will focus on fourth quarter and full year 2022, adjusted results, which exclude the gain related to the divestiture of Cromwell's enterprise software business, which was sold in the fourth quarter.
We will also share results related to monetize.
Please remember that monitor with a public company and followed the Japanese GAAP, which differs from U S GAAP and as reported in our results one month in arrears.
As a result, the numbers disclosed will differ somewhat from monitoring public statements now ill turn it over to D. G.
Thanks, Kyle good morning, and thank you for joining us today I'm going to discuss some of our key accomplishments from 2022, and then I'll pass it to <unk> to walk through the specifics of our fourth quarter performance and our outlook for 2023.
Turning to slide four the Grainger edge framework has been instrumental in guiding our work in 2022.
We know that when we live our principles focussed on the things that matter and serve our customers well, we can achieve great things.
Our customer base is very broad I've been with customers that are seeing positive economic signs like aerospace and I've also been with other customers like some retailers that are seeing some concerning economic sites, but in general our customers continue to be busy and Grainger has and will remain a trusted partner by providing value to their operations everyday as.
We look to 2023 and beyond we are excited to continue living out the grainger edge, starting with the customer and serving as a valued partner through any cycle.
In 2022, the greater teams debuted meant mostly focused on what matters, most providing our customers exceptional service supporting each other and making a positive impact on our communities and the environment.
In both models, we made strategic investments to support customers and build the business for the future.
This included adding supply and capacity, including our new bold bulk warehouse in the U S and the startup of the <unk> distribution center in Japan.
Expanding our digital and data capabilities, including progress with our customer and product information systems, and our high touch business and improved account management tool and our endless assortment model.
And executing against our merchandising and marketing initiatives, including enhanced search and recommendations functionality.
During the year. We also continued to strengthen our purpose driven culture by ensuring granger as a place for our team members can be their true selves and fulfilling career.
We continue to receive external recognition for our workplace culture.
But what means the most to me and the rest of the leadership team is the positive feedback from team members about why they choose to build their career at Grainger.
And finally, we continued to make progress with our environmental social and governance objectives, both internally and in supporting our customers to help them achieve their old ESG goals.
Result of this focus was an outstanding year profitable growth.
We're extremely proud of our results, which surpassed our own expectations throughout the year.
Turning to slide six we finished the year with over 15 to the $15 2 billion in sales up 16, 5% daily basis, or 19, 3% and daily constant currency as demand across the business remain strong.
And our high touch business in North America, we focused on our growth engines and achieved approximately 775 basis points of U S market outgrowth in 2022 far exceeding our update updated target of 400 to 500 basis.
And the endless assortment model, both zoro and monetary made progress to achieve high teens growth in local currency and local days.
During the year, we drove 250 basis 15 basis points of gross margin improvement, which when coupled with 40 basis points of SG&A leverage resulted in 255 basis points of operating margin expansion and a nearly 50% increase in adjusted EPS.
We also generated over $1 3 billion in operating cash flow, an increase of 42% over 2021 and returned $949 million.
The grainger shareholders through dividends and share repurchases we.
We accomplished this while also improving our ROIC by 870 basis points.
46%.
The strong 2022 financials were the result of staying focused throughout the year on what truly matters to our customers our suppliers and our team members and we are well positioned to continue this momentum into 2023.
With that I will turn it over to <unk> to discuss the details of the fourth quarter and our outlook.
Thanks T D.
Turning to our fourth quarter 2022 results for the total company. It was a solid quarter to finish out this year and while you'll notice some noise as we walk through the financials at the end of the day, we delivered great results.
Sales growth in the quarter was 13, 2% or 17, 2% on a daily constant currency basis, which normalizes for the impact of the depreciating yen.
Our results this quarter included strong growth in both segments as we continue to execute well against our strategic priorities.
This includes approximately 800 basis points of share gain in the U S high touch business and high teens growth in local currency across endless assortment.
Total company gross profit margin in the quarter was 39, 6%.
Spending 230 basis points over the prior year fourth quarter.
And by increases in both segments, and including a favorable year over year impact from year end inventory adjustment, which I'll detail in a moment.
This strong gross margin performance was partially offset by a decrease in SG&A leverage in the quarter.
Continue to invest in our strategic initiatives and also incurred an aggregate 35 million nonrecurring items in the quarter.
This included a one time bonus to most hourly employees.
Within high touch to recognize their significant contributions towards our 2020 to perform it.
Excluding these onetime nonrecurring items.
It'll company SG&A as a percentage of sales would have been roughly flat year over year.
Despite these nonrecurring costs, we still finished the quarter with operating margin up 135 basis points over the prior year period.
This profitable growth resulted in diluted EPS of $7 in 2014 set for the fourth quarter, representing a 31% increase versus the fourth quarter 2021, another strong quarter of performance.
And our high touch solutions segment, we continued to see strong growth with daily sales up 16, 8% compared to the fourth quarter of 2021.
We saw continued positive growth in all major customer end markets across the segment, including over 20% growth in natural resources transportation and heavy manufacturing.
The daily sales increase in the U S of over 17%.
It was fueled by mid single digit volume growth and continued strong price realization over 11% in the quarter.
Canadian Daily sales were also strong up 7% or 17, 2% and local days in local currency.
For the segment GP margin finished the quarter at 41, 9%, achieving 225 basis points of margin expansion.
During the quarter the segment benefited from lower freight cost and continued improvement in product mix.
Margin was also favorably impacted by yearend inventory adjustment as we lap the unfavorable LIFO adjustment from the prior year period, and also recorded a positive net inventory adjustment in the current year period.
The net impact of these inventory adjustments was around 130 basis points for the segment.
Price cost spread in the quarter was also roughly neutral.
Moving to SG&A.
The segment de Levered by about 35 basis points, which was driven by continued investments in marketing and head count to support growth.
In addition, the segment incurred incurred 29 million nonrecurring items in the period, including the onetime bonus payment I previously discussed and some accounting true ups to close the year.
While we did modestly delever SG&A, we still expanded operating margins by 190 basis points year over year, finishing with a 15, 5% operating margin for the segment.
This is a strong finish for our high touch team.
Looking at market outgrowth on slide 10.
We estimate that the U S MRO market, including volume and price inflation grew between nine and 10%, implying we outpaced the market by roughly 800 basis points in the quarter.
This strong finish helped us deliver 775 basis points of market outgrowth for the full year 2022.
We continue to have great success in gaining share as we execute against our strategic growth engines and our high touch model.
We remain confident in our ability to deliver the four to 500 basis points of annual outgrowth going forward and are excited to continue partnering with our customers and our suppliers to drive value for all parties each and every day.
Moving to our endless assortment segment.
Reported in daily sales increased 9% or 18, 2% on a daily constant currency basis. After normalizing for the significant impact of the depreciating yen.
In local currency and local days monitor all achieved 19, 4% growth and all U S was up 19, 5%.
Revenue growth continues to be driven by strong new customer acquisition and repeat business for this segment as well as enterprise customer growth at Monotype.
Gross margin for this segment expanded 170 basis points versus the fourth quarter of 2022.
We saw strong price realization, coupled with continued freight efficiencies as average order values have increased year over year.
We also benefited from favorable business unit mix at Zoro grew faster than <unk> in the quarter.
Segment operating margin declined 180 basis point as favorable gross margin was more than offset by heightened SG&A costs.
While the world operating margins were roughly flat in the quarter Molotov was impacted by startup costs at the new and a gala D C. As.
As well as nonrecurring asset retirement costs related to the upcoming closure of the amagasaki facility.
As we lap these DC transition costs and ramp the new facility to Peach peak efficiency.
We expect profitability will begin trending towards more normal levels as we move through 2023.
On slide 12, we can see continue to see positive results with our key endless assortment operating metrics.
Total registered users are tracking nicely with zoro and monitor all combined up 17% over the prior year.
On the right. We show the continued growth of Zoro SKU portfolio now at over 11 million Skus and in 2022. The team successfully delivered on our stated goal to add 2 million skus per year over the next several years.
In summary, a great job of spending the endless assortment flywheel by both zoro and monitor all in 2022.
I also want to acknowledge the exciting news that are there.
Theyre all U S business surpassed 1 billion in annual sales in 2020 to the first time, they've exceeded that threshold in their history.
It's been an amazing success story since we launched this business back in 2011, and we remain excited about what Messiah, Kevin and the rest of the zoro team will accomplish going forward.
Moving to our outlook.
Despite the economic uncertainty uncertainty heading into 2023.
Our high level earnings algorithm remains intact.
Within our high Tech segment over the longer term economic cycle, we target growing four to 500 basis points faster than the U S MRO market and remain confident in our ability to do so.
And our endless assortment segment, we expect to continue our track record of strong growth both in the U S and in Japan.
At the total company level we.
Target generally stable gross margin performance over time, while sticking to our core pricing tenants.
And as we strive to grow SG&A slower than sales to.
To help expand operating margin.
Couple this with our balanced and consistent approach to capital allocation and we can drive attractive returns over the long term as we've done, especially well over the last few years.
So what does this mean for 2023.
At the total company, we expect revenue between 16.2 and $16 8 billion.
Daily sales growth between seven and 11% driven by strong top line performance in both segments.
Note that this range is 40 basis points lower on a reported basis when factoring in one less selling day in 2023.
Within our high Tech solutions segment, we expect daily sales growth between five and 9.5%.
In the U S. We're planning for MRO market growth between one and 5% comprised of a volume range.
Flat to down 3%.
Coupled with price inflation of between four and 5%.
Largely representing the rap of 2022 price increases.
On top of a one 5% market, we expect to continue executing against our strategic growth engine to achieve four to 500 basis points of U S market outgrowth in 2023.
And the endless assortment segment, we anticipate daily sales to grow between 16, and 18% or roughly 17% to 19% and daily constant currency with factor again, when factoring in a 100 basis points of foreign exchange headwind at the segment level from the Japanese yen.
Zoro is anticipated to grow within the segment range, reflecting further SKU expansion and a continued focus on acquiring and retaining high value business customers.
Monotype is also expected to grow within this segment range in local currency as they continue to grow with both small businesses and large enterprise customers.
Moving to our margin expectations.
We expect strong performance in both segments with stable to expanding performance in high Tech solutions and improving profitability in endless assortment.
And the high touch solutions segment, we expect gross profit in the year to be flat to slightly down as we anticipate some of the price cost favorability experienced in 2022 to unwind as we trend back to neutrality over the long term.
We expect this headwind will be partially offset by freight favorability given the improvement in container cost and the current outlook for diesel prices.
On the SG&A side, we will continue to make incremental investments toward our strategic initiatives as we view our growth algorithm.
We will also have some tailwind as we lap the nonrecurring items that hit in the fourth quarter and as certain expenses like variable compensation reset in the new year.
Overall in total we expect SG&A leverage to be favorable and therefore, when combined with our topline growth expectations. We anticipate operating margin of 16, three to 16, 8% and high touch for 2023.
And the endless assortment segment, we expect minus <unk> operating margins to improve year over year as they continued to benefit from favorable freight efficiency and strong price realization.
And they're all we expect operating margins to continue to ramp as they gain leverage on their cost base.
Overall this represents operating margin for the segment between eight six and 9% an improvement of 60 to 100 basis points compared to 2022.
Rolling this out for total company, we expect to gain SG&A leverage of 30 to 60 basis points to offset a modest decline in gross margin, resulting in operating margin between $14 four and 14, 9% for the full year.
Turning now to capital allocation, we expect the business will continue to generate strong cash flow in the year with an expected range of 145 to $1 $65 billion, an increase of over $215 million at the midpoint compared to 2022.
We expect to use this cash to invest in the business and return capital to shareholders.
As discussed at our Investor Day in September .
We plan to invest in our DC network over the next few years to support strong growth and to maintain industry leading service levels.
With this we anticipate capital spending in the range of 450 to 525 million in 2023.
This includes DC capacity investments to expand our service advantage in the U S as well as the startup of a new D C project in Tokyo.
We are also continuing to invest in technology to further our customer and product information advantage and we'll continue spending on accretive ESG investment across the portfolio.
We expect to continue to return a significant amount of cash to shareholders in line with our historical approach.
This will include share repurchases to the tune of $550 to $700 million and a strong cash dividend, which we've increased consistently for the past 51 years and expect to do so again here in 2023.
Summarizing the high level points on slide 17.
You can see these revenue profitability and capital allocation expectations translate to adjusted EPS of $32 to $34 50 per share.
Seven 9% to $16 three percentage increase over 2022.
And nearly double our pre pandemic 2019, adjusted EPS of $17 29.
We are off to a really strong start in January with preliminary total company daily sales up 16% or around 19% and daily constant currency.
We do expect growth rates will be stronger than the first half as results will benefit from a more pronounced price ramp.
In the second half, we will face tougher comps and have modeled a slower economic cycle.
On profitability, while every year is different we do expect gross margins will generally follow our traditional seasonal pattern with a high watermark in the first quarter and sequential decline in the second and third quarters.
We anticipate SG&A will be reasonably consistent over the course of the year.
With that I'll turn it back to D. G for some closing remarks.
Thank you D before I open it up for questions I want to first and foremost the grainger team as well as our customers and supplier partners, who have helped to drive such a successful year.
We truly kept working in 2022 and in turn achieved outstanding results for the year, both financially and operationally.
I am excited for what is to come in 2023 and remain confident in greater ability to create tangible value deliver flawless experience and drive profitable growth over the long haul.
With our team's continued commitment to focusing on the things that matter, we are well poised to deliver in any macro environment.
With that we will open up the line for questions.
Thank you and at this time, we will conduct a question and answer session.
Please limit yourself to one question and one follow up question.
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Our first question comes from Tommy Moll with Stephens. Please state your question.
Good morning, and thanks for taking my questions.
Good morning.
I'll ask two both on high touch.
Let's start on pricing there.
It looks like for 2023.
Four to five points of growth disciplined pricing.
I think you heard I think I heard you say that most but maybe not all of that as a rep.
But if you could comment there on the Rev versus any new initiatives and then also just a related point are there any areas of pricing pressure, that's something that's been picked up in the marketplace. This quarter elsewhere and I just wonder if you've seen any of that in your business.
So I'll start with the first part and then maybe <unk> can add in a little bit on.
What he's hearing from Chris what.
What are you hearing from some customers on his visit so yeah.
We've looked at the market outlook and includes both price and volume and so the some of that we believe will be somewhere in the range of 1% to 5% the total market.
We believe that volume will be down three to flat and as you know that price.
Four to five we have more visibility into our pricing than anyone and so when we look at price. We are also taking into account our rap which is basically the price increases that we took.
In 2022 and their full impact to 2023, so we still see a little bit more price coming our way. So it takes it takes that three ish percent up to about 4% to 5%.
For the price outlook.
Yeah, Tammi I would say most of the day.
Is there a deflationary pressure, it's mostly due to commodities. So there are we have we've taken prices up and down across the assortment and the ones that are down are almost always very commodity intensive so they're very steel intensive or very specific commodity intensive. So we do see we do see that broad broad market pressures, we don't see that much its more spin.
Civic commodities that we're seeing right now.
Thank you that's helpful.
And then I wanted to follow up on the volume.
Gives me the volume outlook for high touch flat to down three and did you you mentioned at least one area of strength and Aero in one area of relative weakness in retail, but I am just curious as you roll it all up into that full year outlook or are there other areas of weakness you're already seeing or is it more just.
Potentially some conservatism around the back half anything you can provide there would be helpful.
We're really sticking to what the market projections are at this point.
You heard the January results, we arent seeing a lot of weakness to be fair at this point, we do expect in the back half there to be more more challenges from a volume perspective.
What I would say is every every customer we have has a COVID-19 fueled story about what's happened to their volume over the past few years and where they've been determines whether they are facing pressures now or whether they're seeing optimism. So obviously with aerospace we shut down.
The airlines for a long time and they are now.
How have orders so they're starting to build up and that's going to take a couple more years to actually get to full speed, we think with aerospace.
With some they may at Florida forward loaded some of their volume because they were selling things that were very important during the pandemic and now they are faced with situations where things are slowing down. So I would say every customer has their own story net net we're not seeing any real softness as of yet and that's showing in the numbers.
Thank you. Our next question comes from Ryan Merkel of William Blair. Please state your question.
Thanks, and nice quarter.
I wanted to start with.
A couple of questions on price cost just wanted to dig in a little bit more so last quarter I think price cost helped by 60 basis points and then in the fourth quarter. It was flat I'm just curious why does it move around so much and then I think you are managing the price cost being neutral, but typically in the past when theres a lot of inflation right your gross margin.
That would expand I'm curious, how you are sort of managing to that price cost neutral.
Well if.
If you are specifically focused on GP in the U S. Our gross margins have expanded.
If you look over a longer period of time here and as it relates to price cost.
Just wanted to reiterate when we talk about <unk>.
Neutrality, we do talk about that over time, and we have continued to speak about the fact that price cost just like GPS lumpy.
We have a cost cycle, which we have traditionally have for years that really didn't hold last year because of how fast cost inflation was coming in to suppliers. So that makes the cost piece of that a little bit Lumpier and then if you recall, we have the opportunity based upon a percentage of revenue highly contracted.
We have the right to introduce price at different periods during the time.
We also have web price, which is also a good portion of our business and we can pass.
<unk> on web at any particular time, so that is the lumpiness is the timing of when we can actually price plus the timing of when costs actually come through and Thats why our focus is doing that over a period of time.
Time, and when it makes sense, both for our supply base as well as for our customer base.
Okay that makes sense.
Then my follow up I think you had 9% price mix in 'twenty two and.
My question is that is that 9% also included in your definition of the MRO market.
Really what I'm getting at is big.
The Grainger have more price in 'twenty two than the market and if so why.
Yes, maybe I'll, maybe I'll cover that first of all I think that the way you measure price inflation is probably not common across across everybody.
Dive into the details that we don't really know how others are talking about price inflation. So we wouldn't comment on that I think the thing I would point to as to <unk> point, we generally think of prices price into the market and we are very confident that what we have now is market competitive and we look at that very very.
Very closely given our history you might buy to understand why we would do that and so we are more wired on are we price competitive as you say.
There's really a lot of Lumpiness, we may have taken price later than others or so may have taken earlier, who knows but but the reality is that we're very competitive now until like when a good position on price.
Thank you.
Our next question comes from Deane Dray with RBC capital markets. Please state your question.
Thank you and good morning, everyone.
Good morning, good morning.
Can we touch on freight for a second it looked like that rate efficiencies helped you on price cost if I read that correctly, but it still sounds like there's freight inflation, so where does that stand today.
Yes, so so our price cost does not include freight the way we define it for you.
So freight is a separate issue obviously, we consider freight in everything we do.
Like everybody, we saw a huge rate increases.
During 2021, and 2022 that has certainly moderated.
It's still above 2019 levels fairly substantially and we have seen that come down quite a bit so and we've talked about for next for this year, we expect it to be a benefit in terms of some of the the moderating prices.
And yes. Some of that is sort of obvious places. They are containers from overseas are a lot cheaper than they were six months ago.
Quite a bit there's still you know.
Relatively higher than beginning closer other parts of the market are still tight so net net we still feel like it'll be a small benefit this year for sure.
That's helpful and then the <unk>.
Follow up on the supply chain, just where does it stand today and efficiencies.
What kind of lead times are you seeing any expectations about returning to normal.
Yeah, I mean, it's a great. It's a great question. So what I would say is that.
From our perspective once we have the product to when customers get at that part of the supply chain is all good.
We're basically clean every night.
Barring a storm in Dallas or something that we've seen the last couple of days, where people won't pick up but in general the supply chain on the outbound side both in our buildings and then and then our freight partners is very very good on the inbound side, we still have some elongated supply chain has gotten much better.
Past four or five months and we expect to continue to get better.
At normal thing I'd, probably say quotes now I do expect it to get closer to 2019 lead times, but maybe not quite all the way there as the year progresses, but we do expect it to continue to continue to get better.
Thank you and our next question comes from Chris Snyder with UBS. Please go ahead.
Thank you.
And congrats on a really great year.
Market outgrowth for the U S High touch business has continued to improve despite presumably better product availability across your smaller competitors. So it seems like the strategic initiatives are certainly taking hold so I guess my question with that does this change the way you think about the.
400 to 500 basis points of outgrowth.
And should we think about price as part of that outgrowth I'm. It sounds like a lot of the questioning seems to suggest that you guys are over pricing in the market, but it just feels like with the digital divide we're seeing and the increased importance that brings to customers.
I would suspect you guys should be able to price the smaller regional competitors, who do not offer that thank you.
Yeah, I mean, I guess I guess I would say just from a core sort of principle for us we think of outgrowth in terms of volume, we expect price to be relatively neutral.
We make it modest benefits over time that can happen, but it's but certainly what we're talking about is volume outgrowth.
The physician from last year, certainly, we got some benefit from supply chain.
Fairly modest in what we do is we sort of decouple analytically and look at what our initiatives are doing and Thats. How we came up with the four to 500 basis point target at the analyst day, we're still sticking with that I mean, obviously, we've done a little better than that but for now we're not changing that that's our expectation going forward.
Thank you and then for my follow up I wanted to talk about the high touch favorable mix during the quarter typically mixed screens as transitory, but on the last call. The company talked about the mix benefit coming from an increased focus on technical products and just given the strategic nature of that it sounds more.
Structural so just hoping for more color on how to think about mix going forward. Thank you.
Yes. So so we have a favorable mix mixed for us generally means product mix here and so.
You can imagine during 2020 in 2021 in particular, we had a very negative mix because we had we were selling.
Any masking the world we could finally, we're selling it and that is a lower margin product I would say we are more back to normal now in terms of the industrial products that we are typically sold and that's been a favorable mix for us.
And certainly we are working hard to make sure that we can compete with technical products or industrial products and that'll be a focus for us going forward, but most of the mixed benefit has been getting really getting back to normal is the way I describe it.
Thank you and our next question comes from Jake Levenson with Melius Research. Please go ahead.
Hi, good morning, everyone.
Good morning.
<unk> are you guys still experiencing.
Any kind of labor issues, either at the factory level or otherwise just thinking about kind of the mixed signals. We're seeing in the labor market is still good.
Wage inflation in the lower end.
Seemingly a lot of competition in.
Warehouses and factories and whatnot, but just curious what how that translates for you guys.
So a couple of things one is we.
Certainly we had wage.
Wage labor challenges.
18 months ago, a year ago, we have made adjustments in wages for our for our team members.
I would say we are in a much much better position.
Churn rates are back to normal basically in most parts of the business.
And we are in a much more stable staffing pattern than we've been in I mentioned sort of the outbound or our Dcs are performing well our call centers are performing well.
We don't have as much journey near as much churn as we did at the peak and we're really close to back to normal at this point.
Okay. That's helpful and just switching gears.
And I guess as a consumer when you got a lot of inflation.
You see people switching from from.
The premium product to the private label brand or are you seeing that kind of trend in your business where.
Customers.
One of them prefer your your Grainger brand over some of the.
The marquee brands, if you will.
No not we aren't seeing a big a big shift there I would say that most customers when they are buying industrial products. They need the product for the application that they're using it for and so if our private brand works that we use it and they always have.
But generally we arent seeing certainly a downshift to lower cost products, that's not what we're seeing right now.
Thank you and our next question comes from Christopher Glynn with Oppenheimer. Please state your question.
Thanks, Good morning, guys.
So I think last quarter another topic that came into the improved mix discussion for HTS was.
The result of the merchandising initiatives, so drilling into that is that trend kind of.
And put their full throttle now or still ramping up and is that kind of expect it to be.
Good guys driver for an indefinite number of years.
Yes, it's the latter Chris so we've.
We started this initiative three or four years ago, we've worked through sort of some initial category reviews, we get keep getting better at them and what we've discovered is that we.
We've learned a ton as we've gone and we're just getting better and better at it but there's still a lot of improvement to be made it will be a consistent benefit for us we believe going forward for the foreseeable future sort of that mid term three to five year timeframe, we still see a lot of benefit from improving the way we March quarter.
Core to what we do I mean, helping customers have confidence that they found the right product is kind of.
What we do so getting better at that seems to have good results and we're going to continue to really push hard on that and.
To be clear Thats, just highlighting higher value add products within categories for the most part.
No. We are I would say we are agnostic to two.
What.
Not not agnostic to the economics, but agnostic to sort of identify and higher value products, we're trying to make it super easy for customers to find what they need.
And so it's really all about do we have the right assortment can we presented in a way that makes it really easy for customers to find so they can have a lot of confidence that they are getting the product that they need to use for the right application.
Okay. Thank you.
Our next question comes from David Manthey with Baird. Please state your question.
Thank you good morning.
First of all.
Interested in understanding how you capture a LIFO benefit when both inventories and the LIFO reserve are up quarter to quarter and year to year extreme if you could go through the mechanics of that I'd appreciate it.
Sure sure Dave So I'll.
Go back to last year.
With that because it was.
Two things were lapping last year's unfair.
Favorable to last year and favorable this year adjustment and if you recall last year.
We had a sharp increase in costs.
And then we had an outsized amount of inventory kind of get delivered.
In the fourth quarter and that that combination of those two factors happening at the same time.
Wanted in us.
A recording a meaningful.
Our LIFO adjustment to our fourth quarter adjustments in 2021 now.
Looking at that and understanding that we were still in a <unk>.
Inflationary period as it relates to cost and we saw costs still coming in from our from our suppliers, we worked on improving our processes.
<unk>, our processes, making sure that we were booking.
Injuries and looking at the.
The process not just from the financials, but with the chain leaders to ensure our inventory valuation, we're staying up to par as we move through the year.
So I feel like we did a much better job. There. However, when you look at the inventory that was sold through in the last quarter of the year it required us to take a favorable adjust LIFO adjustment.
To correct for that because it would be it's something it's something as an increase.
For those that don't know something has an increase in the quarter.
<unk> sold it or the price changes that quarter from Glen change early in the year. The LIFO adjustment causes you to re factor all of those sales.
The latest costs, so that adjustment was favorable for us the combination of those two year over year in Q4 resulted in about 130 basis point of net 130 basis point.
Year over year impact to GP.
For the high touch business.
Okay. Thank you.
Second the share gains that you've been seeing is clearly been terrific.
Could you discuss the balance that you are seeing between new customer adds and selling more to existing customers I would imagine there is difference between high touch in endless assortment.
But could you just give us some color on that.
Yes in high touch so I would just say that in high touch that.
The vast majority of our share gain is existing customers the reality of the Grainger brand sells.
Something to most large and midsized customers business customers of the year and so vast majority of those are the share gains you're seeing or actually.
The share of wallet as opposed to new customer acquisition.
And the endless assortment, it's it's more balanced we're seeing in Japan, we're seeing a mix of new customers, but also significant growth with existing customers and zoro, we're seeing nice retention rates. So we are seeing.
A more balanced between new customer acquisition volume and existing customer volume and the endless assortment model.
Thank you and our next question comes from Ken Newman with Keybanc capital markets. Please state your question.
Hey, good morning, guys.
Morning.
D. I think I think the midpoint of guide implies SG&A leverage.
Probably high teens for 2023 at the midpoint.
Just remind me how much of the SG&A spend is fixed versus variable at this point.
And should we think about high teens is kind of the right way for SG&A leverage to progressive.
Sales stay at this.
At.
At or above mid single digit growth going forward.
Also.
If youre looking at our guide the guide is implying 30 to 60 basis points of SG&A leverage for next year.
And.
And as I think about that let's remember a couple of things.
We're continuing to invest in demand generation.
And we had some.
One time cost this year.
That we don't expect to impact US next year and I will say that one of the last things to consider is going into a new year, we get to reset our variable costs variable costs, such as variable compensation back to 100% of our planned and then we have some modest.
Productivity that we build into the plan because we focus our organization on looking at driving standard work.
Automation and productivity every day, so we don't have to have huge event.
We do that in times when things are going really well and then we can scale and also when things are tightening up so you know that.
Those are the numbers that I had related to the type of SG&A leverage we're looking to gain and remember that in the midst of us continuing to invest.
That's helpful.
For my follow up here.
It does look like inventories took a decent step up from the third quarter to fourth quarter.
Which makes sense given the the sales guide increase.
Can you just provide some color on what's embedded in the operating cash guide for how inventories and working capital trends throughout the year.
Can you repeat that question again could have a inventory levels next year in working capital next year also.
Was that investment. It also includes some investments in DC capacity. So we expect to continue to build inventory as we stand up some of those new building, we do expect to see some slight improvement.
And working capital.
As far as it is not diminishing as much as it has the last couple of years, because we were investing much more significantly.
Inventory say last year, and we're starting to see some improvement in our accounts receivable execution as well.
Thank you. Our next question comes from Chris Dankert with loop capital markets. Please state your question.
Hey, good morning, Thanks for taking the question.
I guess looking at the margin guide for endless assortment pretty impressive expansion 'twenty three expected here.
How do we think about kind of the long term path towards that 11% margin guide I mean does the DC investment in Tokyo, what else should we be thinking about in terms of costs and investments in 'twenty four and beyond maybe as we think about and assortment profitability overtime here.
Yes, so I think the two biggest portions of the endless assortment, our zoro U S and mortara.
Monetary.
Their profitability in the last year was due.
Deflated by operating two buildings at once in the.
And the Osaka area that goes away. So we'll see some improvement next year.
They will be investing in a building.
And the Tokyo region in the next several years.
But generally I think the pattern for them, we'll be getting closer back to where they were.
Prior to the dual DC Osaka situation. So we would expect them to improve over time.
And then we've talked a lot about zoro U S. We expect that to get to kind of high single digit operating margins over the next several years into that that combination gets you to sort of that long term guidance.
Got it and just to put a final point on that last piece about Tokyo, I mean will that have a similar impact as the standard of Osaka did in terms of operating two facilities at <unk> whenever that that investment comes through.
Right so.
We expect the <unk> DC that went up in getting out our Nagasaki in 2023, there the half first half they will there'll be incurring.
Some costs as well as ramping up to their full efficiency in the midst of that they're also launching phase two of the gala DC, which has additional costs. So our expectation is that they will end the year in 2023 or exit that year with <unk>.
Right similar to what you saw prior to both attract I think I think Chris was asking a different question, which you were asking about Tokyo and whether it's going to be a similar issue with Tokyo when that comes onboard.
Answer is who knows it depends on the pattern of the timing and when it when things open it may or may not be as impactful, but we'll comment on that as we get closer to okay. That's like three or four years out.
Thank you and our next question comes from Pat Baumann with Jpmorgan. Please go ahead state your question.
Hi, good morning.
Thanks for taking my questions. A quick one I think you were expecting on gross margin for the fourth quarter like 38% to 34%.
Can you just walk from from what you were expecting to that $39 six that you reported kind of like what surprised you.
You called out LIFO benefit, but that's like a year over year impact so I'm not sure if thats like.
The entire bridge to that 39, six to $1 30 year over year, but I'm not sure that that's like the difference in kind of where you came in that versus what you expected.
So any color on that thanks.
Sure. So admittedly, we did end stronger than what we expected as we continue to execute well and a number of things as you kind of know when our way. So we talked about one of them earlier, we got some tailwind from freight efficiencies with both fuel and container costs coming down over the last couple of months.
In addition to that we did get some price cost timing benefits.
As we look to implement some web prices, we implemented what prices in the quarter ahead of our January price increases that helped us a bit and then if you break away the inventory valuation adjustment. This year from what we saw last year that was more of something.
That wasn't anticipated.
So that inventory valuation adjustment that we booked in the quarter that was favorable and that was the third piece.
Okay is it kind of like in that order in terms of like the magnitude.
The difference.
I will say if you take all three it was about a third a third and a third from a value perspective.
Great and then my follow up is just on also on gross margin just the guide for 'twenty three.
Just wondering what the assumptions are kind of.
Behind that modest contraction for some of these moving parts like is it is price cost.
Negative, which is offset by freight kind of wash out and then kind of the decline is like just kind of segment mix related or is there anything in there for kind of the inventory adjustment dynamics to think about just wondering that year over year guide how to think about the moving parts for that.
I think you said it exactly right I can repeat what you said, but you know you know we have some price cost benefit timing some of that May fall away. We may have some freight efficiencies those may or may not cover that completely up and then you've got the business unit mix.
The endless assortment and high touch and the fact that endless assortment is going to grow faster. So it has a negative impact.
Thank you.
And we have reached the end of our question and answer session. Today I will now turn the call over to D. G. Macpherson for closing remarks.
Yes, thanks for joining us today really appreciate you jumping on the call.
Hopefully you get the sense that we feel pretty good about the path. We're on we've had a really good year, but we're more excited about the future.
Driving things to help our customers operate better and help them succeed.
So with that I'll, just say thanks for joining again and hope you stay safe you're going to get cold I think in the northeast so.
Hopefully you don't ice up too much because that doesn't affect us too but have ever great rest of the week. Thank you.
Thank you.
And this concludes today's conference you may disconnect. Your lines at this time. Thank you all for your participation.