W.W. Grainger, Inc.

Greetings and welcome to the WW Granger third quarter 2022 earnings conference call. At this time, all participants are in a listen-only mode. A question and answer session will follow the formal presentation. If anyone should require operator assistance during the conference, please press star zero on your telephone keypad. Please note that this conference is being recorded. I will now turn the conference over to our host, Kyle Bland, Vice President of Investor Relations. Thank you. You may begin.

Good morning. Welcome to Grainger's third quarter 2022 earnings call. With me are D.J. McPherson, Chairman and CEO, and D. Merriweather, Senior Vice President and CFO. As a reminder, some of our comments today may include forward-looking statements. Actual results may differ materially as a result of various risks and uncertainties, including those detailed in our SEC filings. Reconciliations of any non-GAAP financial measures with their corresponding GAAP measures are found in the tables at the end of this presentation and in our Q3 earnings release, both of which are available on our investor relations website. This morning's call will focus on our third quarter 2022 results, which are consistent on both a reported and adjusted basis for the respective quarterly periods presented. We will also share results related to Monotaro. Please remember that Monotaro is a public company and follows Japanese GAAP, which differs from U.S. GAAP, and is reported in our results one month in arrears. As a result, the numbers disclosed will differ somewhat from Monotaro's public statements. Now, I'll turn it over to DG.

Thanks, Kyle. Good morning, and thank you for joining us today. I'm going to provide an overview of our third quarter performance, and I'll pass it to D to walk through the financials. As I typically do, I'd like to start with our Grainger Edge framework, which guides our strategy and behaviors across the company and with our customer and supplier partners. One of our Granger Edge principles is to do the right thing. Nowhere is that commitment more obvious than when we respond to natural disasters. Granger has a long history of being there for our customers before, during, and after a crisis strikes. Last month, Hurricane Ian destroyed parts of the U.S., most notably in southwest Florida. Our team spent days, nights, and weekends on the front lines, working long hours to get essential products like generators, sandbags, and tarps to our customers. After the storm passed, our sellers, onsite service representatives, and branch team members were on the ground making sure we served our customers. And many of them did this while balancing their own personal recovery efforts. We know the road ahead will not be easy, but the Grainger team will continue to be there to support the community as they recover and rebuild. Before I get into the financial highlights from the quarter, I want to talk a little bit about what I've seen and heard during my market visits with customers. I recently visited an outdoor equipment manufacturer that experienced a surge in demand during the pandemic. As consumers had excess cash and a desire to spend more time outside during COVID, they saw a major uptick in revenue. They're now facing a dip in demand as consumers begin to pull back on spending. I've also visited some of our aerospace customers where it's clear that business activity has picked up, especially in 2022 as COVID impacts have diminished. The industry is now making investments in new airplanes and other equipment to meet ongoing changes in business and leisure travel demands. All told, we continue to experience a dynamic market, with some industries still on the upswing, some that have stabilized, and others that are trending down. And while our customers will face different levels of impact as we navigate through this inflationary period, we know that Grainger wins because of our ability to add tangible value to our customers' operations through inventory management, digital solutions, and product substitutes. This has been true in past economic cycles, and we expect it to continue as more and more customers turn to us for solutions thanks to our relevant product offering, know-how, and advantage supply chain. Turning now to our results, we performed very well in the third quarter with sales growth of 16.9% or 20.3% on a daily constant currency basis. This normalizes for the impact of the significantly depreciating Japanese yen. Our results this quarter include strong growth in both segments as we continue to execute well against our strategic priorities. We outgrew the U.S. MRO market by 700 basis points in our U.S. high-touch business and delivered over 22% sales growth and endless assortment on a daily cost-to-currency basis. Total company gross profit margin finished the quarter at 38.5%, expanding 145 basis points over the prior year third quarter. Profitability, while strong throughout the quarter, was especially strong in the month of September as we benefited from a confluence of factors, including some timing benefits that provided a tailwind to gross margin. Dee will outline the details in a few minutes. The strong gross margin performance coupled with solid SG&A leverage helped us achieve 15.3 percent operating margin, an increase of 230 basis points over the prior year third quarter. We delivered adjusted ROIC of nearly 42 percent, up over 1,000 basis points compared to the same period last year. We also generated $380 million in operating cash flow and returned $286 million to shareholders to share repurchases and dividends. Due to the strong results achieved in the quarter and continued strong trends in October, we are again raising our 2022 full-year guidance. Starting with the customer and living our Grainger Edge principles is helping us deliver value to all of our stakeholders. With that, I will turn it over to Dee to discuss the details.

Thanks, DG. As DG highlighted, it was another quarter of exceptional results, which are summarized at the total company level on slide 7. We delivered strong growth and gross margin performance across both segments and also managed our SG&A well, driving 85 basis points of leverage in the quarter as we continue to stay disciplined while investing to support long-term sustainable growth. This growth in profitability resulted in diluted EPS for the quarter of $8.27, up 46.4% versus the third quarter of 2021. Turning now to our high-tech solution segment for the third quarter, we continue to see strong results with daily sales up 19.4% compared to the third quarter of 2021. We saw broad-based, double-digit growth across all geographies and over 20% growth with both midsize and large customers in the U.S. Daily sales growth in the U.S. of 20% was fueled by broad-based volume growth and strong price realization of over 12% in the quarter. Canadian daily sales were also strong, up 11.4% or 15.5% in local days and local currency. For the segment, GP margins finished the quarter at 40.6%, achieving 125 basis points of margin expansion. The increase is primarily due to product mix as well as favorable price-cost spread, realizing a timing benefit as we continue to work through cost discussions with our suppliers. Price-cost was also aided by some targeted customer and product action as we work to ensure we are receiving the right economics for the value we provide to customers. These favorable contributors to gross margin were partially offset by heightened freight costs in the quarter. Our pricing team continues to do a really nice job managing through this highly inflationary environment, and while the timing will always be choppy from quarter to quarter, we remain focused on our core pricing tenets of achieving price-cost neutrality over time while ensuring our prices remain market competitive. Increased SG&A spend in the segment was driven primarily by higher headcount to support growth and compensation costs, as well as continued investments in marketing. Even with the increased investment, we delivered 150 basis points of SG&A leverage year over year, and when combined with the continued growth margin expansion, Q3 operating margin of 17.3% was up 275 basis points. versus the prior year. Overall, a very strong quarter for the high-tech solutions business. Looking at market outgrowth on slide nine, we estimate that the U.S. MRO market, including volume and price inflation, grew between 12.5 and 13.5 percent, indicating that we achieved roughly 700 basis points of market outgrowth in the quarter. As you heard at Investor Day last month, we're having great success gaining share as we execute against our strategic growth engines. Given our recent performance and go-forward expectations, as announced at Investor Day, we are now targeting 400 to 500 basis points of annual outgrowth going forward, a hundred basis points increase from our previous outgrowth target. The strength of our initiative coupled with our supply chain advantage, gives us confidence in our ability to deliver against this commitment. Moving to our endless assortment segment. Reported and daily sales increased 8.6% or up 23.7% on a daily constant currency basis after normalizing for the significant impact of the depreciating Japanese yen, which is down over 23% versus last year. In local currency and local days, Monotauro achieved 19.8% growth and Zorro US was up 27.4%. Revenue growth continues to be driven by strong new customer acquisition and repeat business for this segment, as well as enterprise customer growth at Monotauro. Growth margin expanded 130 basis points versus the third quarter of 2021. as we continue to see freight efficiencies from increased average order value. We also benefited from favorable business unit mix as Zorro grew faster than Monataro in the quarter. Segment operating margins declined 95 basis points in the quarter as favorable gross margins were offset by continued investments to support growth in both businesses as well as DC startup costs at Monte Charles for the new Inagawa DC. The new facility is ramping nicely. As we exit our legacy facility in the first quarter of 2023, we anticipate that the business will return to normal operating margins thereafter. On slide 11, we continue to see positive results with our key endless assortment operating metrics. Total registered users are tracking nicely with Zorro and Monotaro combined up 17% over the prior year period. On the right, we show the continued growth of the Zorro SKU portfolio, now at over 10.3 million SKUs. You'll see a more modest increase between the second and third quarter as Zorro pair back its offering of SKUs that could not meet our service level expectations. We continue to target around 2 million SKU additions in 2022 and have a robust pipeline to meet that goal as we finish the year. Turning to guidance. With another very strong quarter and with sales in October trending up over 16% on a daily reported basis or over 21% in constant currency, we are raising our 2022 full year outlook. While we acknowledge that the broader market conditions remain uncertain and the risk of a potential recession has certainly increased, we have not seen any meaningful slowdown in our business and continue to outperform our normal seasonal trends. Our updated outlook for the full year 2022 includes expected daily sales growth between 15.5 and 16.5 percent, and EPS between 29.10 and 29.70, a 48% increase year over year at the midpoint. This implies Q4 daily sales, which normally slow due to seasonality, will grow roughly 9 to 13% as we face into difficult comps over the fourth quarter of 2021, especially in November and December. We also continue to see further FX headwinds from the depreciation of the Japanese yen. We've included updates to our supplemental guidance as well, which can be found in the appendix. While it is not our typical practice to change guidance each quarter, doing so provides our most up-to-date expectations in light of the current economic environment. With that, I'll turn it back to Digi for some closing remarks.

Thank you, Dee. Before I open it up for questions, I would make just a few comments. While this quarter brought more market fluctuation and potential uncertainty broadly, both our market and our performance was strong. I remain confident in Grainger's ability to create tangible value, deliver a flawless experience, and gain share profitably over the long haul. We are grateful for our customers' continued confidence in Grainger. No matter what comes next, we will remain their trusted resource, ready to help them navigate any cycle. I would also like to thank the Grainger team for all they've done and continue to do to support our customers. With our team's continued commitment to focusing on the things that matter, we are well poised to deliver a very strong finish to the year. And with that, we will open the line for questions.

Thank you. And at this time, we'll conduct our question and answer session. If you would like to ask a question, please press star 1 on your telephone keypad. Please limit yourselves to one question and one follow-up question. A confirmation tone will indicate that 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 keys. One moment, please, while we poll for questions. Our first question comes from Tommy Moll with Stevens. Please state your question.

Good morning, and thanks for taking my questions.

Good morning. Good morning.

Dee, I wanted to circle back to your comments on high-touch gross profit in third quarter. You called out price cost was a tailwind in the period, and there were some timing impacts, I think, related to discussions with suppliers, but if you could elaborate on what you were referencing there around the timing and whether that implies that it may look different next quarter or at some point in the future. That would be helpful. Thank you.

Thanks for the question, Tommy. So, yes, we did perform well in the quarter, you know, both top and bottom line, and specifically related to the gross margin expectations. We did experience significant product mix tailwinds. as well as favorable price-cost spread. And I did note that that was due to a couple of factors. Price-cost being favorably as we realize the timing benefit that we, as we continue to work through cost negotiations with our suppliers, we do expect that benefit to normalize over the next couple of quarters. And so that really aided aided in some of the outperformance. In addition to that, you know, from time to time and good hygiene, we continue to work with customers to make sure that we are receiving the value that we provide to them from an economic perspective. And so we also receive some benefits in the quarter for that. We also expect that to continue.

That's helpful. Thank you, Dee. Shifting gears to capital allocation. If I'm looking at your guidance for this year correctly, I think in terms of operating cash flow, there's no update to your prior guidance. But it looks like CapEx and share repurchases have been pulled in a little bit. So I'm curious for any commentary you can give there. And then also, as you think about CapEx for next year and some of the capacity expansion initiatives, you talked about it yesterday. If there's any early peak you can give us about priorities for 2023, that'd be helpful as well. Thank you.

Sure. Yeah, that is correct. We did, based upon the range we had out there for operating cash flow, left that as is. And just based upon where we were trending with share repurchases, as well as as we looked at what we thought would fall through CapEx by the end of the year, we made some tweaks in those numbers as well because we had the opportunity to do so. As it relates to 2025, we'll talk a little bit more about what we expect CapEx to look like in February.

Thank you. Our next question comes from David Manthe with Baird. Please state your question.

Thank you. Good morning. At the Investor Day, you discussed seller coverage and seller effectiveness as two of your strategic growth engines. I'm wondering if you can talk about the trajectory there, just how many outside sellers you have today versus what you had last year and what is the plan for 2023? Yeah, sure.

So, thanks, Dave. You know, we talked at Investor Day about Based on our improved customer information, we have been able to identify a potential to add some sellers. We've added them relatively small percentages overall to a couple of pilot areas that we're running now, and we expect to have results of that early in the year, and that will inform what we do going forward. We do think we're going to have the ability to consistently add sellers and also improve the effectiveness of sellers based on the information we've now built and have on customers. And so that's a pretty exciting path. We won't have details for you in terms of what that looks like in the aggregate probably until first, second quarter next year when we start to get all the results back from the pilots.

Okay. So TBD. And then as a follow-up, could you tell us specifically when the Monotauro occupancy expenses that are

duplicate today drop-off and approximately with the magnitude of that overages right now sure I was over there about yeah I was over there four weeks ago let D answer the the sort of exact timing but just just to give you sort of a magnitude you know they're they're operating to bit two buildings in the Osaka area the new ones a six-story enormous building that is coming up to speed and getting a up to the line volumes to take over entirely, and they expect that to happen mostly by the end of the year. The other one's been running at the same time, so that's a duplicate cost and the alternative for the numbers.

Yes, so just to add on to what DG said, we expect the duplicative cost to drop off after Q1 of 2023. Thank you.

Our next question comes from Josh Perserinsky with Morgan Stanley. Please state your question. Good morning, folks.

Good morning. So I just wanted to focus in a little bit more on the outgrowth. I mean, I think we've sort of transitioned here from a period of time with, you know, kind of more hyperinflation and a little bit more scarcity supply chain-wise to to what sounds like it's sort of an improving supply chain environment today, just based on what some of your peers and broader industrial cohort have said. Any sort of change in the way customers or competitors are sort of interacting with the marketplace? Clearly, the background circumstances are changing. Just wondering if their needs or their priorities are changing as well.

You know, I think that there's been a fairly significant increase increased attention to supply assuredness given what's happened the last few years and supply chains improving, you know, they've improved. They aren't fully back, but they are improving for sure. Hasn't really changed those discussions. Customers still want to understand how they can make sure that they have what they need to get their jobs done. Obviously, we've always done that through different ways, whether having inventory in a branch or managing inventory on site or having next day delivery. All those things help customers But we're still having a lot of conversations with customers about, you know, based on our ability to serve them during these challenging times, how can we continue to help them? And we think a lot of the performance we've had in our supply chain is going to be pretty sticky moving forward based on what we're hearing.

Got it. That's helpful. And then, Dee, just a follow-up question for you on the gross margin tailwinds and those, you know, kind of I'll call it extra conversations you're having with your suppliers about that economic value, which, It sort of sounds like a different way of saying rebate. Maybe I'm mischaracterizing it, but is that something that's on more of an annual cycle where that normalizes when the calendar flips, or what's the timeline that we should think about there?

Yeah, I wouldn't think about it so much as rebates, but just, you know, we're constantly negotiating on price take timing with our supplier partners, And some of that timing, some has moved up, some has slipped out. And that's why we continually, I know I do, talk about the lumpiness of GP because it's very difficult to time everything perfectly, both from a price perspective and a cost actualization perspective. So it's nothing more than that. We really aren't focused on supplier rebates as a reason for this.

Got it. That's helpful. And a nice quarter. I'll leave it there.

Thank you.

Our next question comes from Jake Levinson with Mellius Research. Please state your question.

Good morning, everyone. Good morning. DJ, if we did a postmortem, if you will, on the pandemic period over the last couple of years, do you have a sense of how many of these new customers that you picked up during COVID are still buying from you or maybe just any color you have on, on kind of the retention rates?

Yeah, sure. So, um, it's inherently a tricky, uh, tricky thing to, to figure out what I would say is that our customer file has increased substantially versus 2019. So a lot of the, a lot of the new customers have stuck around. Uh, it, our customer file was at its peak in, uh, the heart of the pandemic in 2020. both for Granger and for Toro and for Montoro, they all had sort of a similar pattern. And what was going on there was there was a lot of, you know, consumers buying and just trying to find whatever they could find for safety reasons. That's all gone back to normal. And so we think that what we see now is all of the business customers that we were able to acquire during the pandemic, either for pandemic reasons or other reasons, and we've had really healthy growth of the customer file, and I think that's probably the biggest signal that matters the most.

Okay, that's helpful. And just shifting gears on price, are your suppliers, I mean, certainly you're still seeing price increases for you folks latch it up on a year-over-year basis. Are your suppliers still putting through broad-based increases, or is what we're seeing in the P&L today mostly just reflecting what's already been actioned?

Yeah, so, and, you know, Dee may have other adds to this. You know, we continued to see through our cost cycle this year increases from a number of suppliers. I would say it's less intense now than it was certainly, you know, in the first half of the year. But, you know, most, and what you're going to see in terms of price increase, a lot of it's sort of what's already been taken before. And so, you know, you're just seeing the impact of that. But we do expect some increases to continue to flow in as things continue to roll forward, but just not as intense.

Thank you. And our next question comes from Dean Dre with RBC Capital Markets. Please state your question.

Thank you. Good morning, everyone. I want to touch back on price realization. And DG, can you give us a sense of how much of your price now is being driven by what you would call the value-based pricing as opposed to standard markup?

Dean, what do you want me to say? Go ahead, Dean. You can take that one.

Yeah, Dean, first I want to clarify, I want to make sure I understand the question. So do you want to add a little bit more color?

Is there a question behind it? It's more of a holistic question, but just give us a sense on – Pricing, you know, traditionally, historically with distributors was much more of a standard markup. And what you've seen is with the advent of more services being added and then understanding exactly the kind of value that Grainger is providing, you're actually able to gain more pricing and under this umbrella of value-based pricing and wanted to get a sense of where you are in that transition. Do you feel like you've done as much as you can? Are you halfway through? Just any color there would be helpful.

Sure. Well, I would say I think if you go back, you know, back several years to the pricing strategy change to ensure that we could provide competitive pricing to all size customers, you know, we're through that cycle. Now we're in more of a cycle, I would say, with higher sophistication related to using, you know, our own internal information, product information, and coupling that with market information to get to the best price for customers. And if it's high-touch business, as you kind of articulated, it's making sure we get to the best price based upon the value we provide those customers. And if it's like a mid-sized customer that has less, you know, gets less services from us, then the price is relevant for them as well. So I will say we are there. However, we always have opportunities with the broad assortment that we have, you know, over 1.7 million, excuse me, 2 million, you know, things are constantly changing, the market is changing, costs are changing, and market price is changing. So I will say our pricing sophistication continues to get better. From time to time, that leads to us being able to, you know, have some pricing levers in our benefit while we still remain competitive.

Okay, that's helpful. And then, look, supply chain has come up a number of times. How would you characterize it in terms of product availability, lead time, stock outs? And just, you know, also if you could weave in if that's been the same for your private label offerings.

Yeah, so what I would say is that certainly portions of the supply chain, I would say, are pretty much back to normal. But the portions that we control being able to pick back and ship and get things out were clean pretty much every night. A year ago, we had labor challenges and all kinds of challenges. Those have pretty much gone away in terms of our own supply chain. And then the outbound transportation is also pretty strong at this point and less of a problem. From a supplier standpoint, there's still suppliers that are catching up to a challenge that they've had, and so lead times are elongated in some cases. What I would say is that our service levels in terms of having product and being able to get it to customers are high. on a relative basis, and getting back, moving back towards what we'd expect to have from an absolute basis. So we do see a lot of improvement. There's still a long ways to go. I mean, this has been quite a shock to the supply chain, and there's still a long ways to go from our suppliers and from transportation entities. Coming from, I think, your question on global source product, certainly we're seeing it become much more year to get sailings from from Asia into the US and the cost of that is coming down substantially from from its peak not maybe back to where it was but certainly coming down and so we do see that starting to flow much better than it had earlier earlier in the year thank you our next question comes from Ryan Merkel with William Blair please state your question hey everyone I had a follow-up on gross margin

Can you help quantify the price, cost, timing benefit in 3Q and just speak to sustainability into 4Q?

Sure. Well, if you look at, maybe if I take you to the over make in the U.S., gross margin was up like 125 basis points. About half of that, I would call it the price, cost, um uh benefit and um again we see that price cost benefit normalizing as we get into 2023 so through the fourth quarter got it that's helpful and then i had a follow-up on price really i'm trying to get at how much price is going to carry over into 23 just based on what you've passed through so far

And, you know, when do you lap sort of the bigger price increases that you took in 22?

Well, let me start at 21. Like, when you look at this quarter here, it's going to be, especially in November and December, we'll be lapping 2021. That's our first, I would say, significant price inflation period. So that's why it's going to be a little bit tougher comp for us. we believe, the last two months of this year. Our wrap for price, you know, we're thinking it will be in the single, you know, mid-single digits, low to mid-single digits will look like is what the wrap will be heading into 2023. Very helpful. Thank you.

Our next question comes from Chris Snyder with UBS. Please state your question.

Thank you. So in the past, the company has spoken to an ability to hold North American high touch gross margins. So does the fact that 2022 is running a bit hotter than expected, you know, change that at all? Should we expect maybe some slight easing or normalization lower in 2023?

You know, yeah, maybe just let me just talk about philosophy here, and if you want to add to it, you can. I think that, you know, we, as Dee mentioned, there have been some tailwinds that are probably, you know, modest and might come back, you know, drop down a little bit. I think the overall algorithm hasn't changed at all. There's been a lot of messiness the last two years. You know, obviously, we had... deflated GP given all the pandemic product and challenges with that, which was all the right things and right things to do to serve our customers. And now you're seeing sort of the normal GP with probably a little bit of tailwinds that may bleed off. But the algorithm is still the same. Our plan is to grow faster than the market in the high-touch model, 400 to 500 basis points, to have consistent GP and, and, and, you know, slight SG&A leverage as we go forward. And that's, that's a, that's the algorithm and the algorithm for the high tech that the end of the survey model is exactly the same as well.

Appreciate that. Thanks for all the color. And then my follow-up on, on that outgrowth in the US. So, you know, obviously the company raised the target to four to 500 bps and it's really substantially above, you know, kind of the pre COVID run rate for the business. But I guess my question is, You know, year to date, the outgrowth is running in the 700 or so bit range. You know, when we think about that compression from, say, 700 down to 400 or 500, you know, what does that reflect? Is it just maybe some level of conservatism? Is it the fact that maybe 2022 is seeing outsized pricing versus the market or that, you know, maybe some of the product availability share gains that the company has realized is going away? Like, what's that kind of delta, that compression back? Thank you.

Yeah, it's a great question. So I think we mentioned this at Investor Day, but just to put maybe a finer point on it, when we look at what we get from a share gain perspective, we're looking at cause and effect for the actions that we take. This year is higher, obviously, than our target. And we've actually been able to determine that we think some of that might be availability related, just having product when others didn't. And some of that becomes sticky, as we've mentioned before. But when we look at the 400 to 500 basis points, that's looking at the actions we take around merchandising and marketing and seller coverage and seller effectiveness and keep stock to drive share gain. And that's where that number comes from. So we've had a little bit of benefit, we think, this year that's due just to having a better execution around the supply chain than maybe others have had.

Thank you. Our next question comes from Christopher Glenn with Oppenheimer.

Thanks. Thanks. Good morning. Um, so DG building off the, uh, immediately prior question for Chris, um, I want to kind of bridge that to the medium customer discreetly. The large customer is obviously a bigger revenue base, but you have lower share there. You're doing, you know, 20% on 20%. Uh, and a lot of your capabilities do seem to be, uh, you know, ramping as you've hit on some nice algorithms. Um, And you have a long-term CAGR for the MLS assortment. Should we start to think about medium customer along those lines? Can you hold a 20 with that lower share demographic?

What I would say is that we think we can grow midsize customers faster than large customers through the cycle. A lot of that has to do with the lower share we have, but also some of the actions we're taking are allowing us to acquire and penetrate mid-sized customers. Whether that's 20 or not, you know, I won't comment on that. But I'll just, if you recall, we were in the high, you know, 1.5, 1.8 billion number, you know, 10, 15 years ago. And, you know, we're going to break through 1.5 billion here in the next year or so, we think. And so we're getting back to where we were, but there's still a long way to go. So we do feel comfortable that there's going to be faster outgrowth of mid-sized customers than there are at large.

Okay, and then just to revisit the gross margin algorithm, you had the 37% target in 2025. It was based on a 30 basis point kind of tiny mix impact over the interim, you know, based on kind of a 37.3 this year. Should we just shift that algorithm, thinking about the multi-year target?

Are you talking about the GP?

Yeah, using the minus 30 basis points as the driving force, and maybe you want to shift my thought relative to that.

Not necessarily. I think the only thing that's probably changed on a consolidated basis is that the yen continues to depreciate, but that's going to impact the top line. The GP rate should be the same algorithm that we've discussed previously.

Thank you. Our next question comes from Patrick Bauman with J.P. Morgan. Please state your question. Patrick Bauman, your line is open. Please state your question. Unmute yourself.

Hello? Can you hear me?

Yes, go ahead.

Sorry about that. So you mentioned product mix as a favorable factor in the quarter year over year. Can you elaborate on that at all? Because I thought we'd moved past kind of the pandemic versus non-pandemic stuff. So I'm just wondering, you know, what that might be now related to.

So that is true. But don't forget that the pandemic stuff, that was also safety equipment, which is a significant piece of our business. And we continue to, you know, sell more safety. But the other piece is that, you know, We're also selling a whole lot more technical product, and technical product, that's also product mix for us, and generally those SKUs have a little bit better margin rate for us.

I'm sorry, what are some examples of that? Technical product? What is that?

General handling products, things that are more technical that help in manufacturing processes, pieces and parts as it relates to... assembly lines and things like that are the more technical product. When we say safety product, I think a lot of people think about, you know, vests and gloves and things of that nature. So these are more products that are utilized or adjacent to manufacturing.

Do you view that piece of the expansion that you're seeing as more sustainable? Like is that a function of like maybe some of your re-merchandising efforts or anything else? Or is that temporary?

Absolutely. You know, you hit it on the head. Our re-merchandising efforts are making sure that those products are much easier for our customers to find and are helping them solve their business problems.

Okay, thanks. And my follow-up is on Zorro. Can you give a sense of how fast you think that market for endless assortment, that business model is growing in the U.S.? You know, the Zorro growth in kind of the 27% range this quarter, obviously very strong. Just curious, like, how you think that market itself is growing? It's obviously taking share from, like, I think, traditional distribution. But I don't really have a good, you know, sense of how fast it's growing.

Yeah, I mean, we think that market's growing similar to what the whole market's growing, which would be sort of low double digits, 10% to 13% in the quarter is kind of the market growth that we saw.

Thank you. And our next question comes from Nigel Coe with Wolf Research. Please, to your question.

Yeah, thanks. Good morning, everyone. So I'm guessing, you know, the mix of, you know, obviously manufacturing has grown high 20s, light manufacturing mid-20s, commercial up low 20s, government up mid-teens. I'm guessing that's, you know, when you talk about technical products and paper mix, I'm guessing that's what it comes down to. But I do want to go back to this kind of mix or temporary kind of gross margin benefit. Did you say 25-50? Did I get that right?

No. No. What were you – you were talking about how much the price cost was versus – Yeah, this is, you know, temporary supplier negotiation benefit. Yeah, what I noted, you know, what I noted was the U.S. over May year-over-year was about 125 basis points, and I said about half of that, roughly half of that, so call it 60 basis points, 60-some basis points is what we're saying – is the price cost favorability that we believe will normalize.

So about $20 million. Okay, got it. That makes a lot more sense. And then just thinking about, you know, your sort of APAC supply chain, you know, we're seeing some big movements in currencies, the Chinese yuan. So to the extent that you still manufacture, sorry, still source white label products from China, Given the move in the yuan, given the move in ocean freight rates, what kind of benefit do you realize, or does that benefit get fully captured by your suppliers?

You know, so what I would say is that, you know, as we think about next year, as we think about any year, we try to think about the total cost we're going to see and make sure we're pricing the market and getting the best cost we can get. In many ways, those cost improvements will be embedded in price cost because we will understand how those movements and everybody else is going to have similar movements. The portion of product that comes from China is actually pretty similar across major competitors today. And so we don't think we are disadvantaged or advantaged necessarily on that. So we would expect that to sort of flow through in sort of normal ways from the competitive environment.

Thank you. And we have reached the end of the question and answer session. I will now turn the call over to DG McPherson for closing remarks.

All right. Thanks for joining us today. We really appreciate you being on the call. As we said, we're certainly happy with the quarter, probably happier with sort of our longer-term ability to consistently gain share and do it in a profitable way. and feel really good about the things we're doing as we face into an uncertain market. I hope all of you have a great weekend and a great rest of the year. I look forward to talking to you in 2023. Thank you.

Thank you. This concludes today's conference. All parties may disconnect. Have a good day.