Greetings and welcome to W.W. Grainger's First Quarter 2024 Earnings Call. This conference is being recorded. I will now hand it over to Kyle Bland, Vice President of Investor Relations. Thank you. You may begin.

Good morning. Welcome to Grainger's first quarter earnings call. With me are D.G. Macpherson, Chairman and CEO; and Dee Merriwether, Senior Vice President and CFO. As a reminder, some of our comments today may include forward-looking statements that are subject to various risks and uncertainties. Additional information regarding factors that could cause actual results to differ materially is included in the company's most recent Form 8-K and other periodic reports filed with the SEC. This morning's call will focus on results for the first quarter of 2024, which are consistent on both a reported and adjusted basis. As a reminder, we have included a daily organic constant currency sales growth metric within these materials to normalize for the divestiture of our E&R Industrial Sales subsidiary, which was sold at the end of 2023. Definitions and full reconciliations of this and any other non-GAAP financial measures with their corresponding GAAP measures are found in the tables at the end of this presentation and in our earnings release, both of which are available on our IR website. We will also share results related to MonotaRO. Please remember that MonotaRO was a public company and followed Japanese GAAP, which differs from U.S. GAAP and is reported in our results 1 month in arrears. As a result, the numbers disclosed will differ from MonotaRO's public statements. With that, I'll turn it over to D.G.

Thanks, Kyle. Good morning and thanks for joining the call. 2024 started well. As we remain grounded in the Grainger Edge, we are focused on starting with the customer and staying focused on what matters most. I've seen this play out in several ways throughout the quarter. In February, we hosted the Grainger Show in Orlando. Over 10,000 of our customers, suppliers, and team members came together to showcase the products and solutions that Grainger offers. It remains a great opportunity to work together with our partners to solve customer problems. We've received great feedback on progress since the event. I've also had the opportunity to meet with a diverse set of customers from many industries. It has been great to see how the Grainger team continues to deliver value and further embed into our customers' operations. During a recent visit to a musical instrument manufacturer, I had the chance to see how our team partnered with the customer to help them standardize their product portfolio to lower costs and improve efficiency. This included leveraging our strong supplier relationships and expanding our KeepStock solution to ensure they have the right products in the right locations. I also spent time with a large public health system, which is in the process of building a new hospital. Throughout the project, we supported their operations as they transition to the new facility, ensuring products remain readily accessible across the campus. By supporting this customer throughout the significant change, we deepened their trust in Grainger and allowed them to focus on their area of expertise, patient care, while we took care of their MRO needs. Across all my visits, it's clear that we continue to show up well for our customers. Based on what I've seen, while each industry dynamic is different, overall demand for MRO products has remained soft but generally steady to start the year. Inflation remains a talking point with customers and suppliers and is turning out to be stickier than we had originally anticipated heading into 2024. Dee will provide details in a bit. Moving on to our first quarter performance. You can see we started the year largely as expected, delivering another quarter of solid results. Total company sales were up 3.5% or 4.9% on a daily organic constant currency basis with positive contributions from both segments. In High-Touch Solutions, we continue to advance our 5 key growth engines as we leverage our technology and data assets to unlock further value for customers. Within the Endless Assortment business, we remain focused on acquiring new customers and improving repeat purchase rates across the segment, and we made solid progress here in the quarter. From a profitability standpoint, total company operating margin was down as anticipated to 15.8%, a decrease of 80 basis points over the prior year. EPS finished the quarter roughly flat versus prior year at $9.62. Beyond the P&L, ROIC remained strong at 42.9%, and operating cash flow finished at record levels, which allowed us to return a total of $360 million to Grainger shareholders through dividends and share repurchases. Lastly, I want to mention that yesterday, we announced a 10% increase to our quarterly dividend, marking the 53rd consecutive year of expected dividend increases, something we are very proud of. In addition, the Board refreshed our repurchase authorization, enabling the buyback of up to 5 million shares of common stock. These combined actions reflect our continued commitment to returning cash to shareholders through a balanced and return-focused approach. Overall, 2024 started off largely as expected, and the business continues to perform well. With this, we are reiterating our full year 2024 guidance. We are set up to have strong year results for all stakeholders. I'll now pass it to Dee to go through the details.

Thanks, D.G. On Slide 7, you can see the high-level results for the total company, including 4.9% growth on the daily organic constant currency basis. The quarter played out as anticipated despite tough comps, continued rebaselining of the Endless Assortment business, and impact from holiday timing in the period. Operating margins were down 80 basis points year-over-year, finished largely as expected in the quarter. Gross margins were lower by 50 basis points as we lapped outsized favorability in the prior year period, and SG&A delevered 30 basis points as we ramped demand-generating investments to drive long-term, profitable share gain. In total, we delivered diluted EPS for the quarter of $9.62, up $0.01 over the prior year period and in line with our expectations to start the year. Moving on to segment-level results. The High-Touch Solutions segment continues to perform well with sales up 3.4% on a reported basis or 3.8% on a daily organic constant currency basis. Volume growth remained strong, which offset a slight contraction in price due to timing. All geographies saw growth in the period. In the first quarter, the U.S. continued to see strong growth with contractors, government, and health care customers. This growth offsets slowing demand in other end markets, including manufacturing and commercial services as well as the impact from holiday timing. Overall, demand remained soft but largely unchanged over the last few quarters. For the segment, gross profit finished the quarter at 41.8%, improving sequentially but below normal seasonality amidst a more muted pricing backdrop. On a year-over-year basis, gross margin was down 60 basis points primarily due to the timing of price/cost spread along with the lapse of a 20 basis point onetime favorable freight adjustment in the prior year. These headwinds were partially offset by continued freight and supply chain efficiencies, which began in the first quarter of 2023 and are now fully normalized. While the quarter finished in line with our expectations on the gross margin in total, we were a little more price/cost negative than anticipated as the timing of price and cost is never perfect. As the year progresses, we expect price/cost spread will recover and finish the year closer to neutral. SG&A delevered 40 basis points as we continue to invest in our demand-generating growth engines, including marketing and store headcount. We will continue to stay disciplined with our spending and rigorous in understanding cause and effect but feel it's prudent to invest through the cycle to gain share over the long term. Overall, these results position us well for another strong year within the high-touch segment. Looking at market outgrowth on Slide 9, we estimate that the U.S. MRO market, including volume and price, grew in the quarter between 2% and 3%, nearly all from continued price inflation. This indicates that the High-Touch Solutions U.S. business achieved roughly 150 basis points of market outgrowth in the first quarter in total. Similar to last quarter, this more muted quarterly outgrowth reflects the higher PPI-based price inflation in Grainger's first quarter price contribution. As we mentioned in the past, there is no perfect market for our business, and we're comparing a broader external metric of inflation to our MRO product mix. There can be noise, especially in quarterly periods. That being said, as D.G. alluded to earlier, inflation has been stickier than we originally anticipated, and we're taking some corrective actions in the second quarter to ensure we adhere to our two core pricing tenets: maintaining market-driven prices while ensuring price/cost neutrality over time. Importantly, on a pure volume basis, we're looking at our volume contributions versus the growth in industrial production. Our volume outgrowth is closer to 450 basis points, reflecting continued strong performance for our high-touch growth engine. Moving to our Endless Assortment segment, sales increased 3.7% or 10% on a daily constant currency basis, which adjusts for the impact of the depreciated Japanese yen. Zoro U.S. was up 5.1%, while MonotaRO achieved 13.1% growth in local days, local currency. At a business level, Zoro saw continued strong growth from B2B customers who remained up year-over-year in the high single digits. This helped offset continued declines with non-core B2C and B2C-light customers, which were down double digits year-over-year. We expect these B2C headwinds to subside as the year progresses. At MonotaRO, sales were strong from continued growth with enterprise customers, coupled with solid repeat purchase rates within their core B2B customer base. On a reported basis, however, these strong results are nearly all offset by continued foreign exchange rate pressures as the yen sinks to near all-time lows versus the dollar. Operating margins for the segment declined 20 basis points to 7.9% largely driven by gross margin favorability at MonotaRO from freight and supply chain efficiencies, which were more than offset by negative mix at Zoro as gross margins continue to normalize following the last few years of inflation. Overall, it was a good quarter for the Endless Assortment business. Now an update on the remainder of the year. Overall, we said Q1 played out much as we expected, and results aligned well within the guidance ranges we laid out at the beginning of the year. This has continued into April with daily organic constant currency sales up 5.7% month-to-date. This gives us confidence to reiterate our current full year 2024 guidance, which includes daily organic constant currency sales growth between 4% and 7% and EPS ranging between $38 and $40.50, up roughly 7% at the midpoint. On seasonality, top line comps get easier as we move through the year. Operating margin will dip down sequentially in the second quarter as gross margin moderated slightly, and SG&A leverage declines as merit increases go into effect and marketing investments continue to ramp. With that, we expect modest year-over-year EPS growth in the second quarter with earnings ramping from there in Q3 and Q4. Although we are maintaining our guidance ranges, I do want to call out the increasing headwind we're seeing from foreign exchange rates. As it stands today, the dollar to yen spot rate sits roughly at 1.55, well above the 1.44 we originally planned in January and still assumed in our current guidance. If rates remain at these elevated levels, this would cause roughly $140 million incremental headwind to our full year 2024 reported net sales guidance at an approximate $0.13 decrease to annual EPS. Overall, we're pleased with how the business is performing and remain confident in holding expectations for the year. With that, I'll pass it back to D.G.

Thanks, Dee. Grainger's ongoing success is made possible by our people. And I'm fortunate that I'm routinely able to spend time with our frontline team members. And it's clear that they are deeply connected to our customers, working side by side to help solve their most challenging problems. I believe this commitment to our customers is because of the emphasis we put on building a culture where every team member knows that they can make a difference. Earlier this month, Grainger was named to Fortune's Best Workplaces in 2024 for the third consecutive year. This is an exclusive recognition that honors companies with the best cultures and people, which is a perfect way to describe what we have at Grainger. I'm confident the team will continue to keep working towards our goals and delivering on the things that matter most for our customers, team members, and all stakeholders in 2024 and beyond. With that, we will open the line for questions.

Our first question is from David Manthey with Baird.

This is Quinn Fredrickson on behalf of Dave. First, could you provide an update on the pricing actions? Previously, you mentioned a 0% to 1% price increase in High-Touch for this year. Can you clarify that? Additionally, what are the gross margin implications moving forward?

Yes. I'll share a few comments, and then Dee can add any details. As you pointed out, inflation has been more persistent than we anticipated. Initially, we projected inflation at 0% to 1%, but it now seems likely to be in the 1% to 2% range. This forecast is lower than the overall PPI index because the factors affecting our industry differ from the PPI index, which has led to reduced market growth in recent quarters. We tend to notice these short-term discrepancies from time to time, similar to what we observed in 2022. However, these tend to balance out over time. We're a bit late in assessing the price increase this year, and as such, we are implementing changes effective May 1. We are adjusting pricing in a cycle set for May 1, and this adjustment is already well underway and will commence next week. Importantly, when excluding the inconsistencies from pricing, our volume growth has been quite strong, showing an increase of over 400 basis points. We continue to experience robust volume growth, and we believe the pricing adjustments will correct; it’s just a matter of timing.

That's helpful, D.G. Maybe on the Endless Assortment segment. Any color you can share just on that, the B2C portion? I guess, are you seeing that kind of progress as you would expect and still anticipating that inflecting positively in the back half of the year? And then, obviously, you reported that 10% segment growth even in spite of that. So any change to the 7% to 10% constant currency growth assumption for the year?

No, we don't have any change. I think we will still have a bit of a headwind for consumers, B2C and B2C-light customers through the second quarter. We think that will go away as the year moves on, and that could become a positive. But generally, that's all built into the 7% to 10%.

Our next question is from Nigel Coe with Wolfe Research.

So obviously, the yen is fairly small in the scheme of things, to be honest with you, but I'm curious how that impacts potentially MonotaRO's margins. Because I understand a fair amount of the product is imported into Japan from China and places so. Does that have any impact from a transactional basis as opposed to just translational? What is that $0.13, Dee? Does that cover both transactional and translational?

I'll start with the first part of your question. The majority of MonotaRO's cost of goods sold are in yen. They do have some expenses in U.S. dollars, but that accounts for a much smaller portion of their costs. Over the past several years, they have successfully managed to pass on inflation through pricing to address the differences between the yen and the dollar. Regarding the consolidation of the business, there is a tax effect that we need to consider, along with eliminating non-controlling interest, which leads to translation risk. Generally, we do not try to hedge translation risk because it does not represent real economic risk for us.

Right. Okay. That's helpful. And then just to tie boon in the second quarter kind of color, I guess. It seems like sales growth might be a little bit better year-over-year. Perhaps, margins a bit more contraction year-over-year than 1Q. How does price/cost look in 2Q versus 1Q in light of the pricing actions? And maybe just talk about how that price/cost develops from 1Q to 2Q. I know there's a lot there, but any more color on 2Q would be helpful.

Sure. Yes. I think the first two statements you made were correct. And as we look at the balance of the year, starting in the second quarter with the actions that D.G. noted that we are in the process of taking, we expect price/cost to continue to improve from here. And we expect to end the year close to price/cost-neutral. So that team is working really hard, making sure they're following our two core tenets, which is, first and foremost, remaining price-competitive, but then also looking through our assortment and estimating the continued cost increases that we're going to experience that we can time that as close to possible as we can so that we can end up price/cost-neutral.

D.G., I wanted to start on the core B2B Zoro customers where I think you said from a customer perspective, you're up high singles this quarter. What can you tell us about some of the initiatives internally? We've redoubled efforts to continue to drive that stickiness and repeat transaction rate among that cohort. And how are those initiatives progressing?

Yes. They're making good progress. Zoro is known for successfully acquiring new businesses, and they continue to excel in that area. When comparing Zoro to the Japanese business, we found that historically, repeat business at Zoro has been lower than in Japan. However, we have been steadily increasing that. This improvement involves a lot of marketing strategies, such as determining what to show customers after their first purchase, understanding who the customers are, and offering them the right products and deals. Most of our efforts are focused on these marketing actions. The Japanese and U.S. teams are collaborating closely to share best practices and enhance repeat purchase rates. We have observed positive results over the past six months with regard to improving those repeat rates.

And then a follow-up on inflation, which you've hit on a couple of times here. And it sounds like you're going to address some of the price/cost issues in early May. What are the factors that changed year-to-date? Was it more on the cost input side coming in little hotter than you expected? Or what did you see out there?

I would say there were a couple of factors. First, D.G. mentioned that we may have misjudged the trajectory of inflation. We began to lower prices toward the end of last year, possibly a bit prematurely. When we evaluated the price increases for 2024 in the first quarter, they were likely softer than expected. We plan for a range of outcomes, similar to others in the industry, and we are responding to an ever-changing market outlook. This is an annual challenge that we work hard to closely align with achievable goals. Additionally, we are seeing a range of cost outcomes from our suppliers, and these costs are coming in slightly higher than we had predicted.

Our next question is from Jacob Levinson with Melius Research.

Can you provide details on your recent investments, particularly regarding the visibility of Grainger ads? I'm curious about how you're allocating funds and whether there has been any change in the momentum of these investments. Are you consistently maintaining this approach, or do you see additional opportunities to invest more? I'll stop there.

I would say that it's all planned. There hasn't been any change in the path. And we invest in many ways, I'd say. But from a cash perspective, supply chain investments, we've talked about the new building in the Northwest and Houston. Those are in full swing. We also invest in technology. That's the other primary investment we make from a cash perspective. And then from an expense perspective, marketing is a big part of it. We invest up and down the marketing stack. We invest in advertising. We invest in paid search, of course. And then we invest in what we call mid-funnel, which is more targeted direct marketing with our customers. And what I would say is that we're constantly evaluating the returns on those and making minor tweaks, but what you're seeing today is just normal planned spend.

That makes sense. Moving on to a different topic, you have consistently repurchased your own stock for a long time, and the shares have performed exceptionally well over the last couple of years. Given that you have a potentially underlevered balance sheet, has that influenced your capital strategy and approach to external capital allocation priorities?

So we expect to maintain the course on our capital allocation strategy. We feel it's been working well for the investment community. It helps us maintain a good level of financial flexibility. But we're targeting to return any excess cash after we have invested to drive long-term growth back to shareholders in the form of the dividend and share repurchase. Those two vehicles, we feel, are both efficient for us and efficient for shareholders.

Our next question is from Christopher Glynn with Oppenheimer.

Was wondering about the utility and commercial services verticals down mid-single digits. If you could provide any complexion there, particularly maybe in the utility side. It seems like that should be a little stronger.

Yes. So what I would say is that they're both relatively small for us. And so in utilities in particular, there's a single customer that has had some challenges, and that has had a big impact there. So it isn't really a sector. We don't play big enough in utilities to really be a sector barometer. So I would say it's sort of noise there.

Okay. Great. And then wanted to ask about the medium customers parallel to, I think it was Jake's question on the small. But you're also developing some regional and vertical models there to support long-term penetration and accelerate the performance there relative to the large customers just given the share differentials and lower penetration with medium. So curious for kind of a diagnostic update on your action plans there with the medium and how you see that unfolding.

Yes. I mean a lot of the things that we're doing around the business, certainly, we have a supply chain that's built very effectively for both large and midsized customers. We have a lot of our resources attached to large customers, all of our sales force, our inventory management teams, and some of our support teams. And that is the lion's share of our revenue. Since we made the price change in 2017, we've recaptured virtually all of what we had lost in midsize customers. And certainly, the marketing initiatives have been helpful for that. The merchandising initiatives have been helpful for that in terms of helping us regain that share. We continue to grow faster with midsize customers than large, and we expect to do so for a long time. And there's a number of initiatives that we have that are supporting that. Although I would say most of our initiatives raise all boats, I mean, we do a lot of things that sort of scale across the entire business.

Our next question is from Deane Dray with RBC Capital Markets.

I joined a little bit late, so I apologize if you had gotten any of the specifics. But I know you called out the timing of the holiday. Just for Easter holiday, can you size that? And was there any impact on January weather that you could detect?

Yes, let me address the impact of January weather first. We started the month a bit slower than usual, which affected the quarter to some extent. However, by the end of the quarter, as we began to pick up pace, the impact became negligible for the overall performance. As for the Good Friday holiday, it resulted in approximately a $10 million effect in March. Currently, we are up 5.7% month-to-date, so we are feeling optimistic as we enter the second quarter.

That's real helpful. And then just second question, any change in the outgrowth dynamics, either what you saw this quarter and expectations for the year?

No, I don't think there's any change in outgrowth expectations. We discussed earlier that prices in our market have been slightly lower than the Producer Price Index. While broad metrics may not always align with our market, those discrepancies tend to balance out over time. However, our volume growth has remained robust throughout the quarter, and we are taking steps to enhance the pricing environment starting May 1. Therefore, we believe there is no significant change in dynamics.

Our next question is from Chris Dankert with Loop Capital Markets.

Apologies if I missed it, but on the step-up in SG&A in the first quarter here, was there anything onetime there? Maybe just if you could walk through some of the moving parts for the kind of drove that step-up.

Yes. There were no one-time items to mention. As we provide guidance, we've consistently indicated that throughout the year, we plan to keep investing in demand-generating growth engines. A significant portion of the increase this quarter was due to investments in areas mentioned earlier, such as marketing and capacity, which are reflected in the expense line rather than the marketing line. I want to emphasize that we are very careful with our spending on what we consider noncore expenses, which do not generate demand. Those costs remained relatively flat this quarter. We aim to support those teams in their growth, but they need to maintain a focus on growing at a much slower rate than sales.

Understood. And then just any kind of update on the development and deployment of that customer information tool and kind of how that's been impacting things?

We have been on a multi-year journey to enhance our customer information. The data available in our market is quite disorganized, with no reliable sources that provide clear insights into customer identities, their activities, or the size of their teams. As a result, we've been developing our own system. This effort has proven extremely beneficial, particularly with the recent changes we've made in seller coverage. We are now incorporating this into our marketing processes. The tool we have created has far-reaching implications for our business, and we are enthusiastic about its potential to enhance our customer service capabilities.

Our next question is from Patrick Baumann with JPMorgan.

Dee, I have a quick follow-up regarding April. The 5.7 number you mentioned excludes divestitures and foreign exchange, correct? Also, you mentioned a $10 million impact from holiday timing in March, which I believe is around 1% of sales. Was there a similar timing benefit for April?

Well, you would expect it to flow into April to the extent that we could pick that up, yes. And the answer is yes to your first question because I think you noted it excludes FX.

Okay. Yes, so that's organic. Yes. Okay. Sorry, I missed that comment.

Organic.

Okay. Great. And then on the follow-up is on SG&A again. So if we get later in the year and the top line isn't picking up from where we started the year, what's like the ability or desire to kind of toggle that SG&A growth back? I know you mentioned that you're diligent on spending if it's noncore. But what's your willingness to toggle back on some of the investment spending if growth doesn't pick up as the guidance expects?

Yes. Thanks. What I would say is that we are very focused on productivity improvements throughout the business. I think we are seeing productivity improve. The last few years have been a bit odd, to say the least, in terms of some of the challenges that everybody has had to deal with. And we have really sort of refocused our attention on getting better, getting more productive in every part of the operation. We're going to continue to do that. In terms of demand generation spending, I think you're asking specifically if it's worth spending in good times, it's probably worth spending in bad times, too. So we wouldn't typically pull back those things. We think that we exist for the long term and we're trying to win over the cycle, not just in the down cycle. So we would expect to not have dramatic changes in what we spend, but we do expect to continue to drive productivity.

We have reached the end of our question-and-answer session. I would like to turn the conference back over to D.G. for closing remarks.

All right. Thanks for joining, everybody. Really appreciate it. I would just highlight that in general, I would say everything in the quarter was as we expected, and we feel very confident in the path we're on. There's not a lot of new news in this quarter, but we do feel good about the path. We do feel good about our ability to gain share, to become more productive, and to make sure we remain price/cost-neutral over the long term. So all things point to really good results for the year. So appreciate the time. Thank you.

Thank you. This will conclude our conference. You may disconnect your lines at this time, and thank you for your participation.