W.W. Grainger, Inc.

Greetings and welcome to the WW Grainger first quarter 2020 earnings conference call. At this time, all participants are on 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. As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Ms. Irene Holman, Vice President of Investor Relations. Thank you, ma'am. You may begin.

Good morning. Welcome to Granger's first quarter 2020 earnings call. With me are D.J. McPherson, Chairman and CEO, and Tom Okre, SVP and CFO. As a reminder, some of our comments today may be forward-looking. 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 slide presentation and in our Q1 press release, both of which are available on our IR website. This morning's call will focus on adjusted results for the first quarter of 2020, which exclude restructuring and other items that are outlined in our press release. Now I'll turn it over to DG.

Thanks, Irene. Good morning and thank you for joining us today. I'll begin with an overview of our actions and experiences in response to the COVID-19 pandemic, as well as an overview of the quarter. Then Tom will get into more specifics about our financial response to the pandemic, as well as detailed information on our Q1 results. Before we start, I want to thank our 25,000 team members across the globe who continue to live our principles and are working hard to achieve our purpose, to keep the world working. We are an essential business supporting hospitals, governments, first responders, food manufacturers, distribution companies, and many others that are fighting this fight on the front lines. These are incredibly stressful times for all. From our team members who are on site with our customers, helping them work through day-to-day challenges, to those ensuring orders are picked, packed, and shipped properly, I'm proud of the work we're doing to keep our team members, customers, and community safe. I am also thankful for our supplier logistics partners' efforts to help us provide much needed products to our customers in this desperate time of need. To make this come to life, I thought I would share a photo I received from one of our leaders at a branch located in Brooklyn, New York. This particular branch and its Crossboro partner in Maspah, they're both situated in between a number of hospitals that are the epicenter of the pandemic fight. Each day, the teams at both locations dutifully come to work, hang the American flag and roll up their sleeves, and in their words, they do this to keep America running. It's this spirit that inspires me makes me truly proud to lead this company and gives all of us hope in our ability to get through this crisis. Turning to slide five, let me provide you with some color on the actions we have and continue to take in response to the pandemic. The biggest concern right now is our collective health and wellbeing. As a business, this is our absolute number one priority. When we look back on this crisis, it is how we will all be judged. With health as a primary focus, we have established three priorities during this challenge. First, we must continue to service our customers well. These are the customers that have so much to do with supporting the healthcare system and other critical industries in the US and other countries in which we operate. Second, we must support team members by providing a safe environment and as much job continuity as possible. During this period, everyone is scared and we are trying to provide team members stability and safety. And third, we must ensure that we remain in a strong financial position in order to execute on our first two priorities and remain positioned to thrive when we move beyond this pandemic. We have and will continue to ground our decision-making process with these three objectives in mind. Starting with the first, Grainger has been designated an essential business for all our locations around the globe, allowing us to continue to serve our customers and live out our purpose. In many cases, we are working side by side with hospitals, state and local governments, and critical manufacturing businesses to ensure that they can keep doing their critical work. This has been a challenging period. The virus has created significant supply-demand imbalances for PPE and other products, creating substantial challenges for our customers. We have had to make some tough choices about prioritization, and the challenge will continue into the near future. But our team is working very hard to find solutions to help our customers. In some cases, this has meant being creative with product solutions in the short term. We continue to be a valued partner to all our customers, even as we prioritize the healthcare system. We started planning and responding to the pandemic in late January and established an emergency preparedness task force shortly thereafter. In the early days, our focus was on product supply. We executed large pre-buys of non-pandemic product, leveraging our extra capacity in Louisville to ensure we could supply our customers through this period. Our service levels of non-pandemic supplies continue to be strong. As it became clear that the pandemic would have a significant impact on all developed markets, we developed business continuity plans following guidance from the CDC, the Public Health Agency of Canada, the World Health Organization, and federal and state governments. In many cases, we are going beyond that guidance, including temperature screening of all individuals prior to entering Grainger facilities. We have taken a number of preventative steps to protect our team members and customers including minimizing exposure of affected team members to other team members and customers, augmenting the cleaning procedures at our facilities, introducing mandatory curbside service at all our branches, providing personal protective equipment for team members working onsite with customers, and mandating work from home for all our team members who are able, including our phone service and technical support agents. We were able to pivot quickly to work from home for team members able to do that, and we have not missed a beat. In addition, we moved our national sales meeting to a virtual meeting after canceling the conference in Florida. We appreciate the flexibility our team members have demonstrated as we implement these solutions. Throughout this, I continue to receive many letters and calls of thanks from customers and am inspired with how the Grainger team is taking care of our customers and each other during this challenging time. I have also received many calls from customers who need solutions that we and no one else can fulfill right now. Stress in the system is extremely high, as you might imagine. On the supply chain front, our world-class supply chain has remained resilient. As I mentioned, we have had minimal disruptions to date on non-pandemic related items. We continue to maintain high levels of inventory and are leveraging our strong relationships with our suppliers and transportation partners to secure products and ensure we meet our same day ship complete delivery promise as regularly as possible. Like others around the globe, we continue to see shortages and stockouts of critical pandemic-related items, including N95 masks, sanitizers, and other PPE. We are working diligently with our suppliers alongside our government and healthcare customers to secure as much product as possible, as well as trying to identify and source suitable alternatives. To give you a sense of the magnitude of the problem, in several weeks' time, we received orders for the same quantity of safety masks that we usually receive over several years and, in some cases, even decades. This is truly an unprecedented challenge, and getting America back to work is essential. Let me assure you that Grainger is holding true to our values. We will continue to work with customers and supplier partners to find the best solutions. On all pandemic products, we are honoring our contracts and do not raise prices unless necessary to recover our increased costs. Moving to our second priority, we are committed to making decisions with team members' best interest in mind. Grainger is a sound business with a longstanding belief in the need to have a stable workforce to serve customers and keep the world working. When we emerge from the pandemic, we want to ensure that we are well positioned with an experienced team to accelerate growth through the recovery. While we don't yet know the full financial impact of COVID-19, we have contingency plans in place for any eventuality. In the short term, we have furloughed a small portion of our workforce and reduced hours for others. In both cases, With the enhanced CARES Act, we are focused on keeping our team members as close to whole as possible. Beyond this, we have delayed merit increases for salaried employees and have instituted short-term pay cuts for executives. Our incentive plans will adjust based on market conditions. Our goal is to keep our team members employed over the long haul, treated fairly, and working during this time. Our third priority, which Tom will cover in detail, is around maintaining our financial strength. In short, we are well positioned with an exceptionally strong balance sheet and a robust liquidity position. We are prepared for a multitude of scenarios and have already implemented changes focused on cashflow in the near term. Our strong financial position should enable us to withstand even the most challenging economic and market environments while allowing continued investment through the cycle. Stepping back, these three objectives do naturally create some tension. As you can imagine, given the size of our workforce, We have had cases of COVID-19 within our facilities. In each case, team member safety is our top priority. That means we have had to shift volumes across our network as we temporarily closed buildings to deep clean the facility and to quarantine any exposed team members. We are also paying DC branch and KeepStock team members a shift premium, recognizing their great work and commitment during this challenging time. As a result, we are running at higher unit costs than normal in our DCs and elsewhere. to ensure we serve our customers to our high standards and help get America and the world back on its feet. Lastly, and before we move on, given the uncertainty around the depth and duration of this pandemic and the related economic response, we are suspending guidance for 2020. As you might imagine, we have customers that are completely closed. We have customers who are operating under reduced volumes. We have customers operating normally, and we have customers who are running 24 seven. With all of these moving pieces, it doesn't make sense to forecast in this environment. While we can't guarantee the future, we've weathered storms in our long history before and have already started planning for the recovery whenever it may come. This will require us all to think differently as we and our customers are changed by this pandemic. There's a lot to learn and I believe much opportunity ahead. As we move forward, we will continue to evaluate all actions to ensure we are meeting our priorities to serve our customers, support our team members, and ensure we remain in a strong financial place. Turning to our quarterly results, we delivered strong top line growth in the quarter while navigating through this period of uncertainty. We achieved daily sales growth of 5.7%, underpinned by traction on our growth priorities and heightened sales of pandemic-related items. In the U.S. segment, we outgrew the MRO market by approximately 700 basis points, excluding estimated pandemic-related sales, which is an inherently messy calculation. we were in line with our goal of 300 to 400 basis points of outgrowth versus the market. So we had a strong top line outcome. Operating margins were pressured by factors, including the timing of certain SG&A investments, dynamically related mix impacts, business unit mix impacts, as well as the timing of year-over-year pricing and cost actions. Tom will cover the details in a bit. We produced strong cash flow in the first quarter, including $244 million of operating cash flow and $194 million of free cash flow, And finally, we continue to make progress on our 2020 priorities. Our re-merchandising efforts continued in the quarter as we worked to further improve product and search information. We continue to improve the efficacy of our marketing initiatives. Our endless assortment business grew 17% underpinned by resilient performance at Minotro and SKU additions at Zorro. Masaya Suzuki, our new leader of the endless assortment portfolio and his team are implementing the Minotro playback across Zorro and are closely looking at a number of areas for improvement. most notably around discounting strategy and other opportunities to improve profitability. Our turnaround efforts in both Canada and Cromwell performed in line with our expectations despite turbulent market conditions. And while we have curtailed non-essential spending in certain areas, we will continue to invest where it matters most. Most importantly, we continue to improve the user experience in our core businesses with customer feedback coming in extremely strong. As we look forward, we will focus on what we can control and make decisions based on facts. The business is well positioned to sustain through this pandemic, and I am confident we will come out stronger on the other side. With that, I will turn it over to Tom.

Thanks, DG. As DG mentioned, we have established three broad priorities that are serving as the backbone as we work through this unprecedented challenge. Our third decision-making tenet is to ensure we remain on a strong financial footing. In this regard, we've taken several actions to bolster an already strong financial position. From a balance sheet perspective, in the quarter, we increased the size of our revolver to $1.25 billion and executed a large-scale refinancing. Combined, these initiatives increased our available liquidity by roughly $625 million and eliminated all material near-term maturities. At the end of March, we proactively tapped $1 billion of the $1.25 billion revolving credit facility. As noted by our strong balance sheet and operating cash flow results, this was done solely out of an abundance of caution. In this low-rate environment, it's an inexpensive insurance policy. With the refinancing, we consolidated a majority of our foreign currency denominated debt, which pushed out any material maturities until 2025. Our revolver does not contain any financial covenants, and we continue to have strong A category ratings from both S&P and Moody's. All in, we exited the quarter with over $1.7 billion in available liquidity, including $1.5 billion in cash and only a 1.2 times net debt leverage ratio. When it became clear that we might be facing a serious economic downturn, we proactively began implementing initiatives that conserve cash and optimize profitability. To be clear, the initiatives strike a balance between short-term cost and cash savings and ensuring we come out of the gate strong when the crisis ends. Example of these baseline initiatives include temporarily furloughing team members to align with reduced volumes, short-term pay cuts for executives, delaying merit increases for our salaried workforce in North America, reducing outside professional service spend, scaling back advertising spend, eliminating nonessential travel, and delaying hiring decisions. We expect these baseline initiatives and the lapping of certain Q1 items will create $40 to $55 million of sequential cost savings in the second quarter of 2020, even when accounting for an increased level of cost to support our pandemic response. We have also identified several additional initiatives that can be implemented depending on volume levels. We are staying nimble in monitoring sales trends, cash position, and working capital closely. Additionally, we are deferring certain discretionary capital expenditures and now expect our full year 2020 CapEx spend to be between 150 and 175 million dollars. This is down from our previous expectation of 250 million dollars. With respect to working capital, we are working closely with our customers and suppliers to maintain our strong relationships while ensuring a manageable cash conversion cycle. To date, we haven't seen a material change in delinquencies or bad debt. Further, We remain committed to returning excess capital to our shareholders. However, to preserve financial flexibility, we have paused our share repurchase program. As for the dividend, we remain committed to the program and do not currently foresee where we would reduce or suspend its payment. We understand the importance of achieving our 49th consecutive year of dividend increases. While it's difficult in this environment to forecast the future, from a cash perspective, we have modeled multiple scenarios that reflect varying depth and duration cases of volume loss. Given what we are able to see now, we are confident that we will have adequate liquidity to support our business operations through this pandemic. We have a strong reputation of managing well through difficult times, and we expect this crisis will be no different. Based on what we know today, we are confident that we will emerge from this pandemic as a trusted partner to our customers and suppliers and are well-suited for the recovery. As we turn to our detailed quarterly results and think about the financial impact that COVID-19 pandemic has had on our business, it's very challenging to specifically quantify. There are numerous moving pieces, including sales of pandemic-related SKUs, determining substitute products, impact of customer capacity cuts or closures, and identification of customer pre-buying. All of these combined makes it challenging to pinpoint the specific impact of the pandemic on our financials. Therefore, as I go through our financial results, I will share estimated directional commentary on the impact. As noted on slide nine, for the total company, daily sales were up 5.5% in the quarter, 5.7% on a constant currency basis. This was driven by around a 7% increase in volume, offset by an approximately 2% headwind from price. Roughly half of the price headwind is due to product and customer mix, with the other half related to lapping of the 2019 price increase. For the total company, we estimate that pandemic-related product sales represented roughly half of our sales growth. Additionally, for perspective, it should be noted our core US and endless assortment businesses combined grew at 7.3% on a daily basis during the quarter. Gross profit margin for the total company was down 180 basis points versus the prior year quarter. This decline is driven by customer and product mix headwinds in our U.S. segment, largely related to sales of pandemic-related items, as well as business unit mix from higher growth in our lower margin endless assortment business. Gross margin rates are much more stable when we look sequentially. We gained 20 basis points of SG&A leverage with costs up $47 million versus prior year, as we continue to make investments to support our strategic priorities. As previously communicated, we generally expect SG&A spend to grow at approximately half the sales rate. For the quarter, our SG&A growth was higher than this annual target by approximately $20 million. This $20 million is driven by additional headcount that was added in the back half of 2019, incremental marketing investments, which will be reduced going forward, and heightened spend to support our pandemic response efforts. Additionally, we were impacted by non-recurring and timing items, including an extra payroll day and one-time costs for certain legal matters. These impacts more than offset lower travel and variable compensation costs, as well as favorable depreciation and amortization in the current year period. Excluding these non-recurring and unusual items, we were directionally in line with our plan from a cost perspective, which assumed elevated SG&A costs in the first quarter. We generated operating cash flow of $244 million which we use to invest in the business and return capital to shareholders. During the quarter, we used $178 million on share repurchases and dividends and had total capital expenditures of $50 million. Even in our current difficult economic times, we continue to invest prudently in our business all while maintaining a healthy 1.2 times net debt leverage ratio. Operating cash flow was 106% of net adjusted earnings, and return on invested capital was over 29%. Overall, U.S. segment daily sales grew 5.7% in the quarter, or about 700 basis points faster than the broader MRO market. Sales growth in the quarter included approximately 8% volume growth partially offset by unfavorable price of around 2%. Roughly half of the price headwind is due to customer and product mix, with the other half related to the lapping of 2019 price increase. In the U.S. segment, we estimate that pandemic-related product sales represented roughly half of our sales growth. Gross margin was 230 basis points unfavorable to the prior year, The variance was driven largely by two primary factors. About half is related to lapping of 2019 pricing and cost actions, and the other half is related to unfavorable product and customer mix. As we mentioned on the fourth quarter 2019 earnings call, we expected our Q1 2020 number to face difficult comparisons to the prior year. YEAR PERIOD AS WE AGGRESSIVELY RAISED PRICES TO COMBAT EXPECTED TARIFF INFLATION INCREASES IN THE FIRST QUARTER OF 2019. WE ACKNOWLEDGE THAT WE OVERSHOT THE MARK AND ROLLED BACK PRICES THROUGHOUT 2019. ADDITIONALLY, TARIFF COST RELATED INCREASES DIDN'T ACTUALLY TAKE EFFECT UNTIL LATER IN 2019 AND THUS CREATED A SECOND HALF headwind in Q1 2020. Looking sequentially, we did see positive price inflation in this quarter compared to Q4 2019. Going forward, we expect this tough year-over-year comparison will lessen in the back half of 2020. The remaining portion of the year-over-year gross margin decline resulted from customer and product mix headwinds. which were exacerbated by sales of lower margin pandemic related items to larger low margin customers. We expect these mixed related headwinds to continue during the pandemic as we sell increased levels of safety and cleaning products to our large healthcare, government, and critical manufacturing customers. This effect will become even more pronounced in the second quarter as we expect the more dramatic mix impact that we saw in the March to continue through Q2. In the quarter, we also had unfavorable mix related to our multi-site customer growth strategy. As we discussed on the Q4 call, this impact will be temporary and will continue throughout fiscal year 2020. From an SG&A perspective, we gained 30 basis points of leverage with cost increasing $30 million in the quarter. This level of increase was caused by many of the factors I outlined earlier, including incremental headcount added in the second quarter of 2019, as well as marketing investments, cost to support our pandemic response, and an extra payroll day. Operating margin was strong at 15%, but declined 200 basis points in the quarter on the decline in gross profit margin, which was offset by slight increase in SG&A leverage experienced in the quarter. Turning specifically to the US MRO market, while extremely difficult to predict in this environment, we estimate the US MRO market declined between 1 and 1.5% in the first quarter. Grainger was able to capture approximately 700 basis points of outgrowth in the quarter well above our objective to consistently grow 300 to 400 basis points above market aided by sales of pandemic related items. Even when excluding the pandemic sales contribution, we were still well within our targeted range, demonstrating consistent traction of our growth initiatives. Moving on to the other businesses. Daily sales increased 8.5% or 8.8% on a constant currency basis. Growth was driven by continued expansion of our endless assortment business, which was up a combined 17% on a daily basis between both Zorro and Monotaro. Both businesses continued to grow rapidly and benefited from an uptick in pandemic-related sales, albeit a much smaller impact than we saw with our U.S. business. Gross profit margin declined 60 basis points in the quarter, driven by business unit mix from the faster growing endless assortment businesses, as well as deeper discounting and a higher mix of dropship activity at Zorro U.S. We continue to achieve SG&A leverage in the first quarter, resulting in an operating margin increase of 80 basis points. This stems largely from decreased expenses at Cromwell and leverage in endless assortment. Cromwell performed unplanned in Q1 and was able to half its losses from the first quarter of 2019. These results were largely before the pandemic shut down activity across Europe. We took an impairment charge on our favorite business, reflecting continued gross profit and a flat to declining EBITDA against the backdrop of industrial sector declines across Europe. This was further amplified by the long-term implications of the COVID-19 pandemic, among other factors. Turning to slide 13, daily sales decreased 6.1% or 5% on a constant currency basis, comprised of roughly 4% decline in volume and price headwind, which includes customer mix of approximately 1%. Foreign exchange created 110 basis point headwind. Overall operating margins were up 110 basis points as gross profit margin was roughly flat to the prior year period, and SG&A was favorable 110 basis points as cost management drove significant leverage. Looking forward, in addition to the pandemic, Ranger Canada is also combating extremely low oil prices, given its more concentrated natural resource customer base, which will drive further headwinds into the second quarter. Before I turn it back to DG, I want to provide you with some insights into what we're seeing through the first few weeks of April. From a sales perspective, as of April 21st, we are seeing year-over-year declines of approximately 10% on a constant currency total company basis with dramatic differences by end market, product categories, and customer size. Not surprisingly, our healthcare essential manufacturing and pockets of government are growing significantly faster year over year, and we are seeing rapid declines elsewhere in areas such as hospitality and heavy manufacturing. On the product side, safety and cleaning supplies are significantly up year over year, with most other categories down, some dramatically. To be clear, this is what we are seeing through the first 15 business days of the month. and not meant to be construed as guidance for the quarter. As in Q1, these customer and product mix items will continue to impact our GP margins. Further, Q2 will be impacted by the change in format of our national sales meeting, which will create a year-over-year headwind to gross profit margin of approximately 40 to 50 basis points for the US segment in the second quarter. For the year, the national meeting impact will be a drag on gross profit margin, but will be roughly flat for the year on an operating margin basis given travel and event-related cost savings. With that, I will turn it back to DG for some final thoughts.

Thanks, Tom. We have a strong business and balance sheet as well as access to capital, and we're taking proactive steps to keep the company healthy and our workforce stable while continuing to serve our customers well. We take being an essential business very seriously and we're committed to living our purpose and being that critical partner for our customers throughout this pandemic and beyond. While this crisis is certainly different from any that we've experienced, I'm confident that Grainger will come away from this stronger than before and will be positioned to lead this industry for years to come. Now we will open it up for questions.

Thank you. The floor is now open for questions. If you would like to ask a question, please press star 1 on your telephone keypad. A confirmation tone will indicate your line is in the question queue. You may press star 2 if you would like to remove your question from the queue. For participants using speaker equipment, it may be necessary to pick up your handset before pressing the star key. In the interest of time, we ask that you please limit yourself to one question and one follow-up. Once again, that is star 1 to register a question. Our first question today is coming from Ryan Merkle of William Blair. Please go ahead.

Hey, good morning, everyone. Hope everyone is well.

Good morning. Good morning, Ryan.

So first off, thanks for the color on April. But I guess high level, and I realize that visibility is low and that you pull guidance, Anything you can help us with in terms of the outlook, maybe thoughts on a range of industry declines this year, or maybe comment on if 2019 is a good framework in your mind for 2020 or if there's major differences?

Well, I think it's, you know, as Tom said, it's forecasting right now is very difficult. I think we can say what we're seeing. And as I mentioned, we have some customers that are mostly shut down. We do do a lot of work with you know, airlines, which obviously aren't as busy, cruise lines, as you might guess. You know, as you get into some of the sub-industries, you see very big differences. Obviously, there's a bunch of customers that are very, very busy. You know, I think one thing I would say is that the world is not shut down necessarily, and you can see it in our daily volumes. We've been very consistent the last few weeks, and, you know, we've been fairly resilient. But it does take on different – numbers by different subsegments. I think the question for us is how long it's going to take to get back. And depending on who you talk to, whether it's an epidemiologist or an economist, that could be relatively short or really long. And so there's just uncertainty around that. And so, Ryan, I would not even try to forecast that. We feel like we're taking the right actions to make sure that we maintain profitability throughout any scenario. And we're confident in our ability to gain share. One thing that we didn't talk about, that's kind of interesting is we are seeing a very healthy flow of new customers, given the pandemic requests, and we feel like we're going to come out of this with a nice customer file increase as well. But, you know, right now it's really difficult to forecast beyond sort of this month, next month, and it'll just be how fast that's going to determine it.

Yeah, that's fair. Thought I'd ask. All right, and then second, you know, I was hoping SG&A was going to offset the decline in gross margins core a little bit better. You know, I know you talked about it a little bit, but just, you know, pinpoint for us what exactly happened. It seems to me like you're not making much profit on these pandemic sales. So maybe talk about that. And then, you know, is most of this a timing issue with the price cost and the higher SG&A? And then, you know, these trends should start to get a little bit better in 2Q. Just help us with that.

Yeah, yeah. So let me take both. I mean, so there's a gross profit and SG&A component to your question. And I'll turn it over to Tom in a minute. From a gross profit perspective, on the pandemic items, we made a decision, which is we're going to help the health care infrastructure. We're going to help government customers. That decision means in a scarce supply world, we're basically providing product to contract customers, and those products generally are lower margin to be in with. So that does have an impact on gross profit and a fairly significant one in the quarter. It's the right thing to do. It's absolutely the right thing to do. That's going to relieve over time a little bit because there's going to be more product and there's going to be more customers hopefully that open up and that we can serve. So on the gross profit side, that certainly was an impact, which we'll see in the second quarter, but I think over time that will relieve some. SG&A is a little bit simpler. Over half of our SG&A increase was basically one-timer and usual items, and we feel like growing SG&A half the rate of sales growth is a very comfortable place for us to be going forward, given what we know other than the one-timers. I'll turn it over to Tom to provide a few details on that one.

Yeah, so let me add just a little bit more color, Ryan. So let's first of all start with gross profit margin. As we said in our prepared remarks, you know, we went heavy on pricing in Q1 of fiscal year 19, and then we rolled that back throughout the year. So to your point, that pricing compare will get better throughout the year. Also, from a cost perspective, if you just look at how the tariffs behave on a year-over-year basis, the two big tariffs for us are Part 3 and Part 4A. And from a year-over-year impact for Part 3, in fiscal year 19, that tariff was 10% in Q1. It's 25% in Q1 this year. If we look at 4A, there was no tariff. and there's 15 or 7.5%. So that is the tariff impact that we saw in Q1. That also will get better throughout the year as we fully realize the lapping of our tariffs. It will also get better from the realization of our non-tariff cost increases. Let me move to SG&A and unpack it a little bit better than we did in the prepared remarks. We were up $47 million on a total company basis, which is a 6.4% increase. If you do look at the one-time items, and that includes one-time legal matters, the extra payroll day, we also had some benefits issue where we were lapping prior year adjustments, and some other one-time costs. You know, DG said over 50. It was actually closer to 60%. of the $47 million. So if you adjust that out, we really grew 2.7%, which gets into about half of the sales growth. The increase of the 2.7% is on items where we have said that we're investing related to advertising, technology, and adding headcount in the back half. Now, having said that, we noted in the prepared remarks that that we're scaling back on advertising. We're taking a stronger look on costs in terms of taking 40 to 55 million out sequentially versus Q1. And then the final thing I'll say is I want to be clear that we did also have additional costs to serve the pandemic in terms of overtime, pandemic pay, cleaning supplies, and those types of items. But the big story in SG&A is the one time as well as the investment costs, which we will roll back in the second quarter. Sorry for the long-winded answer, but it was a broad question. Thank you.

Thank you. Our next question is coming from David Manthe of Baird. Please go ahead.

Hi. Good morning, everyone. Granger used to give us growth ranges across customer end markets on a monthly basis? And just given the circumstances, is there any chance that we could get general growth rates for March across the end markets on slide 17?

We'll get back to that. It might be more valuable to give you ranges on April, frankly, than March. Yeah. Okay.

Sure.

Act on that and decide whether or not we're going to do any of that. You know, I would say if you saw it, it would not be all that surprising. As I mentioned before, there's certain segments, subsegments that are down tremendously and almost, you know, 90%, 70%. And there's certain that are up significantly. And they would be exactly the ones you think. So I don't think you'd be surprised by any of it. But we'll talk about whether or not we're going to provide that as we go through the pandemic.

I appreciate it. And second, you saw really nice growth in endless assortment, which was also an area of recent investment. Did you say that half of the 17% growth rate was COVID-related?

Yes, yes. Yeah, that's the U.S. That's Tesoro, yes. Now, let me just give a little bit of caveat to that. If you do it on a product basis, that's true. But even customers that are heavy COVID product buyers spent less on other things as the month went on. And so it's a bit of a rough estimate, so I don't want to over-index on that. We feel like we want to be very careful about saying how much was COVID. But certainly from a product perspective, that's true, David. Thank you.

Thank you. Our next question is coming from Nigel Coe of Wolf Research. Please go ahead.

Thanks, guys. Good morning. Really appreciate the details. I just wanted to just pick up on the SG&A. Obviously, you've provided a lot of good detail on that already. But, you know, as we go into 2Q and, you know, if sales continue to trend down 10%, I mean, who knows? But would you expect, you know, that 50% of sales growth or sales declines to hold? Gigi or Tom, or does the, you know, do the impacts of some of these sequential improvements in costs, such as the, I think you mentioned $40, $50 million in sequential declines in costs, does that mean that SG&A could be down a bit more than that? Just wondering how you should think about SG&A going forward for the rest of the year. Tom, do you want to take that one?

Sure. Yeah, it's a great question, Nigel. I think it depends, Nigel, on you know, how much we see the volume going down, quite frankly. If volume is going to stay where it's at in terms of 10%, we're probably not going to pull the more draconian levers in terms of cost reduction. You know, if it goes deeper than that, then we've got a number of initiatives in the playbook ready to pull it. If you look at the high side of the range we gave Nigel, You know, that $55 million sequentially would translate to year-over-year almost 3% reduction. We'd also get some volume variable cost reduction in addition to that. So I think it's going to be a meaningful SG&A reduction for Q2. But, you know, we're watching this on a daily basis and, you know, trying to really thread the needle in terms of which levers we pull related to the volume reduction.

Got it. No, that's helpful. And thread and needle is what we're all trying to do, so I understand that. And then just on the mix factor, again, you spent a lot of time talking about mix, but the one point of mix pressure you saw in one cue, we all get it. You all understand what's driving that. What would that normally be? Because obviously the national accounts outgrowth normally we're facing some mix pressures. What would that normally be? Where does that reside? Does it normally reside within the price bucket or the volume bucket? And then how does mix How do you think mix will trend into, again, I hate to be so short-term here, but do you think mix pressures accelerate into 2Q or remain steady?

Yeah, I mean, you're talking specifically, Nigel, about gross profit or you're talking about sales revenue?

Talking here about, well, I guess both. I mean, mix impacts mainly gross margin, but whatever is a better answer.

Yeah, if you look at it from a revenue perspective, we've actually got, you know, some customer mix component, which is in volume, but the majority of it is going to fall into price. You know, we mentioned in our prepared remarks the multi-site customers, but that was a much smaller part of the mix component. The primary component Part of it was our lower margin health care and government customers. That was the big driver of the customer mix.

Yeah, I would just add to that, Nigel, that we very recently, like the last few days, we started to get inquiries from midsize customers thinking about restarting. They've been on fairly hard shutdown. So that has been a negative mix, depending on how fast some of those midsize customers come back. The mix issues could be alleviated a bit. We would expect though for the next, certainly for April and probably for a lot of May, we would expect some of those mix pressures and then hopefully as everybody gets back to work, we would see those alleviated.

Thank you. Our next question is coming from Christopher Glenn of Oppenheimer. Please proceed with your question.

Thank you. Good morning. If we look at Zorro and or Zorro and Monotauro, I'm curious about the possibility of a net benefit this year with the, you know, online effect actually benefiting from distancing or, you know, otherwise if there's maybe a divergent experience of the COVID recession for the endless assortment versus the U.S. segment.

Yeah. So I can take that one. So Japan – has not had yet a hard shutdown like some of the other markets we've seen. Certainly we've seen the online model there do very, very well. In Zorro in the U.S., Zorro's done quite well as well, and in particular from a new customer acquisition as new customers look for different solutions that are digital, we're seeing a very strong new customer pipeline coming into Zorro. We also see a lot of that going on at the Grainger online as well on Grainger.com. So there is certainly a shift to digital, and we think we're well positioned for that shift, both with the Amazon solar model, but also with Grainger.com, which is an exceptional solution for industrial businesses. So we feel like we're well positioned for that shift.

Okay. And on the U.S. segment, you know, half of the growth was non-pandemic, and the absolute growth has gotten better as the benchmark sloped down, certainly the spread. I'm curious if you think more of that is due to the price-for-share dynamics on the large contracts enacted last year, or if it's more broadly the Granger system and market penetration tail on the heels of the 2017 resets.

I think it's everything that we're doing. I think it's the growth initiatives we've talked about. We're getting good results out of merchandising, nice results in more efficient marketing. We've added some focus to a keep stock, so we're providing more inventory management solutions for customers. I think very little of it is actually the price dynamic and more of it's the actions that we're taking to drive growth.

Yeah, I guess the one thing that I would add that might be helpful, Culler, is when you look at our share gain, we said it was 700 bps outgrowth in Q1. If you look at it in March, it was significantly higher than that, almost double share gain in terms of March, which would lead you to potentially conclude that when times get really tough, the good things that we're doing, the customers are coming to us and allowing us to take share.

Thank you. Our next question is coming from Adam Olman of Cleveland Research. Please proceed with your question.

Hi, guys. Good morning. Hope the whole team is healthy. I had a follow-up question on the gross margin discussion for the second quarter. You know, understanding there are a lot of moving pieces, and thanks for the detail on the national sales meeting for the headwind there, but any way that we could frame, you know, how much further down? We should be bracing for the gross margin to slip in the second quarter. I mean, we talked about a couple of hundred basis points of this next headwind we're seeing in April persist.

Yes, sure. It's really hard to predict, Adam, because we have good guys happening in terms of the compare of the price inflation going down materially in the second quarter. We've also got better lapping in terms of inflation, non-tariff inflation and tariff inflation. So those are really good things. It's just so hard to predict the pandemic of how much of an offset. And it really comes back to DG's point is when are the other non-pandemic businesses really going to start to come back to work? So we've got a big chunk of tailwinds. It's just we don't know how big the the headwind would be not trying to be evasive. It's just hard to call the ball right now.

Okay, gotcha. And then just to a different topic, any way to frame how much of your customer base is closed right now? And then secondly, there's probably some customers that are restricting access for vending or what have you. Any broad sense of how much your sales force is limited right now? Thanks.

Yeah, so we have a number of customers that we cannot get into to refill vending ourselves, but we flip most of them to customer-managed inventory. Most of those customers have people working. I would say it's very difficult to say how many are really closed, but certainly a portion of the business is really closed. As I said, if we looked into four groups, the ones that are really busy right now, you kind of say 10, 40, 40, 10, meaning 10% are really busy, 40 are less impacted essential businesses, 40 are nonessential, but they're really working on some sort of reduced schedule, and 10 roughly are what we would call disrupted. And so those are businesses that have a significant disruption right now that aren't doing a whole lot. They may not be fully closed, but for all intents and purposes, they are closed.

Thank you. Our next question is coming from Dean Dre of RBC Capital Markets. Please go ahead.

Thank you. Good morning, everyone. First question is for Tom, and it's the outlook on free cash flow for the year, just in terms of the playbook for industrial distributors, typically you'd be selling down from inventory with lower demand. That typically gives you a boost on free cash flow conversion. Maybe you're also pulling back some cap backs, but just kind of give us the dynamics there from a free cash flow perspective.

Yeah. Good morning, Dean. Yeah, we feel really good about our free cash flow. You know, if you look at our cash conversion cycle, you know, despite, you know, us working with customers to be constructive in terms of payment terms, we were actually, you know, better by four days versus the prior year quarter. So we feel that we're managing, you know, working capital really well. As it relates to, you know, stocking of inventory. Frankly, that's not the playbook we're running. We're positioned for the future here. When the recovery starts to happen and those customers start coming back, we want to make sure that we're able to provide the benefit to them. We feel that we're uniquely positioned with our our balance sheet and our liquidity to be able to really come out of the gate strong when the market takes off.

That's a helpful ending to that answer because that's what I'd like to ask DG about and not asking about the timing of the recovery because no one really knows at this stage. But DG, you suggested there be ways that Grainger would come out stronger. You've added customers. But I'd also be interested in what you think changes about the business in terms of your customer base, their inventory levels they'll carry. I mean, it used to be just in time. Now it's more some buffer inventory just in case. Maybe you have to do more cleaning of your DCs. Just the dynamics of what changes on the other side, both from customer behavior, maybe adding more customers, and maybe some incremental costs. as just standard business going forward. Thanks.

Yeah, so thanks, Dean. You know, since you can't predict what's going to happen, my assumption is that for a while we're going to be in a situation where we have to be careful around the virus on some level, even if businesses are back to work. And so over the short to midterm, I think there's going to be a lot of questions around do we have the right stock of cleaning supplies and PPE to make sure we can actually work And so we're already starting with customers, talking with customers about how to come back to work and how can we help them think about how to come back to work. And so that's going to be a big, big topic. You know, whether or not we turn to more buffer inventories or not is debatable. We've had shocks in the past and it hasn't changed behavior. This one feels like it could. So I'm guessing that we are going to be in a position where we're helping customers think more about inventory stocks than we have in the past for certain products. I still think that Us managing inventory and keeping their inventory levels down is going to be an important topic for most customers going forward. But certainly there's going to be some industries that are very, very different, and there's going to be some that are new, and we're going to have to navigate through that, and we've already started talking about that. In terms of our own business, I think we're all going to have to be more careful. We're thinking differently about how our buildings are configured. You know, most of our distribution centers have been designed to bring people into lunchrooms, for example, for camaraderie. Well, right now that doesn't make as much sense. And so we're talking about, well, how do we do, how do we have multiple lunch spots? There's just all kinds of details that we're working through that are going to change. And, you know, I think we're just going to have the same priorities, keep our team members safe, serve our customers well, do it responsibly, and that's going to be the focus. And we have a team, a pandemic team that's working on all of those operational issues right now and how to get back to work and how we operate in the future.

Thank you. Our next question is coming from John Inch of Gordon Haskett. Please go ahead.

Thanks very much. Good morning, everyone. T.G., I'm wondering, given the new Fabry write-downs, if you could update us on your strategic thoughts on retaining or divesting either Cromwell or Fabry, how are you thinking about that framework, particularly against what's happening in the economy?

Yeah, I mean, you know, we're always evaluating the portfolio and looking at whether or not we should be investing or not in businesses. Now is no different. We continue to look at all of our businesses, and, you know, we can't comment, obviously, on specific actions that we plan to take, but certainly we are We are looking at businesses. Those two businesses are important ones to look at. One thing I would point out is it's kind of interesting. Cromwell and Canada both, before the pandemic and the quarter, actually were on expectations, which was good to see. So we actually were getting a little bit of traction with both of those businesses, which was great. And then, of course, the world changed. And for Cromwell, we're excited to see if we can continue on a strong path. and Canada as well. So, you know, I would say we continue to look at the portfolio. We'll just do that consistently.

Yeah, no, that's fine. I appreciate the answer. I thought perhaps you had put them on kind of a timeline, if my memory serves. You know, you're going to sort of wait for the trend of profit or whatever. Just as a follow-up, I'm wondering if you could also comment on Zorro. Obviously, it's done really well in theory. It could take a lot of virtual share coming out of this. I'm just wondering, like, how you're thinking about the pandemic in the context of possibly, you know, maybe monetizing that business down the road, you know, maybe along with, you know, just like the whole endless assortment. Does this, in theory, push that out, or does it pull it forward, or does it not really have much of any impact thus far?

Yeah, I don't think it's going to have – you know, obviously, who knows, but I don't think in terms of how long this lasts. But I think that it doesn't have a lot of impact to our timing. So Masaya Suzuki is running – Manotro, he's been the CEO of Manotro. He now is in charge of Zorro in both the U.K. and the U.S. They are working very hard to improve the profitability and growth rates of both of those businesses. We're seeing good traction. At some point, that question may become more near term, but right now they're really focused on improving the business and working together to make sure we do that. So that's the focus right now.

Thank you very much. Thanks, John.

Thank you. Our next question is coming from Patrick Bauman of J.P. Morgan. Please go ahead.

Oh, thanks. Good morning, D.J. Good morning, Tom. Thanks for taking my questions. Hi, Patrick. Hi. Just the first one. Maybe within the 10% decline April to date, just curious if you could provide a range of growth you're seeing in the safety and cleaning supplies or whatever you consider to be pandemic-related, and then how long a tail you see on that demand if you look at the backlog of requests for those products. And then it would also be helpful along those lines to understand, like, what percentage of your business is pandemic-related products or would you consider to be that?

Yeah, so we haven't released those numbers. Pandemic-related items, though, are, I would say, way up. Silly numbers, and the backlog is even sillier than that, to be frank. So I mentioned it on the call. I mentioned it on the prepared remarks. We literally took orders for decades' worth of product in a few days in some cases. And so we continue to get product in. We continue to prioritize. We've had to change our processes for those items. And, you know, it depends how much, I guess, you feel. The length of time that we have increased sales of pandemic items depends in large part on whether or not you believe the backlog is real. In many cases, it is real. Depending on what happens, some of that might not happen, but certainly we have a big backlog of those products and we'll continue to sell those. You know, pandemic is a minority of the total product, but it's not a small minority. It's a significant portion of what we're selling normally, cleaning and safety and our big product categories for us in general.

Okay. And then just a follow-up would be on margins. In the first quarter, you had lower margins, you know, despite higher sales for all the reasons you discussed. Just wondering if you could give any color on what kind of range we should be thinking about for decremental margins if sales are down, say, 10%. I think last downturn, decrementals were only like 20%, but this one seems a little bit different. So just curious how you think about that.

Yeah.

Tom, you want to take that one? Sure, sure. You know, decremental margins, you know, an interesting calculation, especially in the pandemic, just because their assumptions are so related to volume deterioration and gross margin. You know, you referenced 08, 09. You know, there's a little bit of a nuance there where I don't think it's apples to oranges. As you said, we had big pricing impact back in 08 and 09, which wind aided, the decremental margin. If you're looking at 10% down with a range of, I guess, a reasonable gross margin, I could see a decremental margin being 45%, 45% to maybe 50% down. And that's largely driven by if it's only 10% down, we're probably not going to do those draconian cost initiatives. On the other hand, if we start to get for a more severe downturn with a longer duration, you know, then we would go to our cost initiative playbook that we've got ready and pull more of the SG&A cost initiatives in there and I could see the decremental margin being, you know, 35 to 40 percent. So, it's really highly sensitive on what you're assuming. Hopefully, that's helpful to give you a range.

Thank you. Our next question is from Stan Kurt of Longbow Research. Please go ahead.

Hi. Good morning, everyone. Apologies if I missed it. Did you stake out what national account growth was in the quarter? Just any update you can give on kind of the C-suite executive sales growth initiative? I assume you've had a lot more touch points in the midst of the virus, but maybe less access. So just any comments on that national accounts growth plan?

Yeah, I think we've seen solid growth. We've had a number of wins. You know, I think any first quarter number is going to be inflated due to the pandemic because all of our healthcare is basically on corporate accounts. But we continue to see good traction with our corporate accounts. And coming out of this, we think we're going to be in a position to get growth up and share gain up with those national accounts. I would say there's no real change in terms of the strategy. we have had a number of wins and we feel very confident about the path we're on with our corporate accounts.

Got it. Got it. And if we can just sneak one last one in here, circling back to Zorro really quickly, you know, Messiah has been on board for two, three months now, just any color on, you know, some of the biggest investment opportunities or optimization he may have highlighted, just does anything change there? Any just high level thoughts on where we're going strategically there?

Yeah, I think there's some significant changes. I think the team is thinking hard about discounting strategy, when to run targeted discounts versus big promotions. My guess is we will move to more targeted discounts, lower discount rates for acquisition, spending a lot of time thinking about which customers we're attracting and getting the attractive business customers and what actually it takes to win those and get those to be consistent purchasers. And so I think the team is really working hard on those things, and Messiah is certainly helping them think through a whole range of issues around how to grow and how to grow with improved profit.

Thank you. Our next question is coming from Hamza Mazzari of Jefferies. Please go ahead.

Good morning. Thank you. Hope you're all safe and healthy. My first question is just on medium customers. What are you hearing there? I know you referenced most of them are shut down, but any update on strategy to gain share there and whether in a downturn, you know, you had mentioned historically you've gained share. Does that also apply on the medium customer base, or is that sort of different versus large customers?

I think it really applies for midsize customers. I think that – so certainly we've seen – more impacted midsize customers, more of those customers have been closed. That said, we continue to see nice returns from our marketing activity with midsize customers, and our inventory position and our ability to provide strong service typically works very, very well in this situation, and we would expect as customers come back on that we will be able to acquire more, which we've been doing, and also increase volumes pretty significantly. So we're pretty excited about that path. As I mentioned, we're starting to get inquiries from midsize customers about, can you help us that are new midsize customers? Can you help us get back up and running? And that's really exciting to see, and so we're going to work very hard to capitalize on that.

Great. And my follow-up question is on Zorro, and you may have touched on this, so I apologize if it's repetition. But how independent is that supply chain today from parent company, GWW? And any thoughts on resegmenting that for more visibility? Is it sort of a different tech platform than sort of the parent business? Any thoughts as to, you know, independence of that business today versus years ago? And then sort of, I know it's buried in other businesses, but any thoughts on resegmentation? Thank you.

Yeah, so let me answer both of those. The first one, a lot of the investments we've made in the last year have gotten Zorro a lot more independence. And so while they still rely on Grainger's supply chain in many cases, they are becoming less and less reliant as they have other partners that provide delivery service for them to their customers. And so a lot of what we're doing is making that business more independent and operating it more similar to what Monotro does, which is to leverage multiple third parties for low volume items to really drive the growth. In terms of segments, we will follow SEC guidelines and we will think through segments during this year and we'll get back to you by the end of the year if there's going to be any difference.

Thank you. Our next question is coming from Michael McGinn of Wells Fargo. Please go ahead with your question.

Thanks. Appreciate the time. If I can go back to the margin discussion real quick. The $40 to $55 million of SG&A savings identified, is that a fixed number or does that include also some flexed down as a percent of sales?

It includes some amount of flex down, but not fully all of the flex down. So, you know, we would expect that we would get additional volume variable over and above the 40 to 55.

Okay. So, assuming the 40 to 55, they could get about a 728 base, plus you're saying the additional percentage of sales savings. So that would put us somewhere in, I think, my back of the envelope, Matt, an 8% operating margin, which is 200 basis points below the 09 trough. Is that the way to think about this for just this downturn as it stands without the additional actions phase two?

Well, I think the way to think about SG&A, let's just take the 55 million SG&A reduction at the high end. If you compare that, what we did in Q2 for SG&A, that would be, you know, roughly a 20 million reduction or about 3%. Now, depending on where volume tracks to, you're going to get some additional volume variables. So, you know, I would look at it as, you know, you're going to get three-plus percent in terms of SG&A reduction versus the prior year.

Okay. And then just quickly on the PP&E, you mentioned large sales, blanket purchase orders have You collected deposits for those, or are those cancelable, or how do you see those progressing throughout the year?

Well, it depends. I mean, for most orders in the backlog, we would not have deposits collected. For large special orders, we would often have deposits collected. But in terms of the backlog, we don't typically get payments until we actually ship and bill.

Thank you. Our final question today will be coming from Justin Bergner of GDOT Research. Please go ahead, sir.

Oh, hi, DG and Tom, and thanks for fitting me in. Good work on everything the company is doing. I guess what hasn't been covered, which stood out, was the retail sales up mid-20s. Are you seeing sort of an acceleration there besides the COVID-19 demand How large is the percentage of business is that? Again, are the margins there mixed dilutive when you normalize for sort of COVID-19 product, or are they mixed similar or mixed accretive?

Well, so retail for us typically is serving distribution centers that serve retail, and so we have very large customers that are e-commerce players typically that would fall in there. That is slightly mixed elutive as a customer group, certainly, but it's also a very important customer group. And so what we're talking about there is typically serving the industrial side of retail as opposed to retail stores. And most right now what we've seen is almost all e-commerce traffic, as you probably realize, is way up. And so our business to distribution centers that are serving that e-commerce traffic is way up.

Got it. Yeah, good work there. And then just a follow-up question is, on the SG&A cost being higher in the quarter, did some of that flow through corporate unallocated costs? Because that seems to be up, you know, materially year on year and quarter on quarter. Were there any other dynamics there in the corporate cost market? No. It was about, you know, half of that was flowing through the corporate – the corporate unallocated. And if you adjust for that, we're very comparable to last year in the corporate unallocated. And in terms of looking at it on a full year basis, we should not be materially different in the corporate unallocated. So it's a good question, Justin. Half of that was corporate unallocated.

Thank you. This brings us to the end of our question and answer session. I would like to turn the floor back over to DJ for closing comments.

Great. Well, thanks for joining us today. I really hope all of you are safe and healthy. I just want to reiterate that we are doing everything we can to help, and helping the health crisis first is the most important thing so we can all get back to work. We've taken a lot of action to ensure that we can continue to operate and serve our customers very well during this time to keep our team members safe and make sure we're in a strong financial position. We view this as certainly a short-term threat, but we view it as a long-term opportunity. We think we're going to come out of this stronger. We think we're going to gain customers. We think we're going to find all kinds of new opportunities coming out of this, and we are already starting to work those. And we already have some get-to-work plans already in place, so we're really excited about the future. Thank you for spending the time with us and really appreciate that. And please be safe, and we'll talk to you soon. Thank you.

Thank you for your participation. This concludes today's event. You may disconnect your lines or log off the webcast at this time, and have a wonderful day.