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spk09: Greetings and welcome to the WW Granger third quarter 2023 earnings conference call. At this time, all participants are in a listen-only mode. A brief 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, Kyle Bland, Vice President of Investor Relations. Thank you. You may begin.
spk05: Good morning. Welcome to Grainger's third quarter 2023 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 IR website. This morning's call will focus on our third quarter 2023 results, which are consistent on both a reported and adjusted basis for all periods presented. We will also share results related to Monotauro. 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'll provide an overview of our third quarter performance and then pass it to D to walk through our results in detail. As I typically do, I'd like to start today's call with some reflections on how our Grainger Edge framework continues to drive our success. Unlike last year, our results in 2023 have not benefited from outsized macro tailwinds, and we don't expect this to change for the remainder of the year, as MRO market volume growth remains slightly negative. This means we must emphasize the value we bring through our customer experience and supply chain network to drive profitable share gains. I've recently had the opportunity to spend time with several manufacturing and government customers in California. While diverse in their operations, it was clear that our advantage supply chain, strong digital capabilities, and ability to solve complex problems is adding value for these customers. All of this is helping us to continue to gain share. Before we get into the results, I want to share a few examples of how our team members continually live our principles and improve the communities where we operate. Last month, our team members assembled more than 4,000 buckets to help natural disaster victims across the U.S. These buckets were strategically placed in regions vulnerable to hurricanes and flooding to ensure residents are prepared to quickly respond when a crisis hits. And for the second year in a row, Grainger has been recognized as one of Fortune's best places to work for women. This recognition is based on team member responses to key questions based on trust, respect, credibility, fairness, pride, and camaraderie. We know that when team members feel heard and recognized, we unlock the full potential of our team and the full potential of our business. Now let's dive into the quarter. On slide five, you can see we had another strong quarter as demand stayed reasonably steady as we continue to provide strong service and deliver tangible value to our customers. We finished the quarter with sales growth of 6.7% or 8.7% on a daily constant currency basis. Results again were driven by positive performance in both segments, most notably within the high-touch solution segment where we continue to drive profitable share gain. Total company operating margin was 15.9%, an increase of 60 basis points over the prior year, as improved gross margin performance driven by continued freight and supply chain efficiencies, along with favorable product mix, largely fell to the bottom line. Combine this with our strong top-line performance, and we delivered another quarter of robust EPS growth, record operating cash flow, and strong ROIC of over 44%. We also returned a total of $287 million to Grainger shareholders in the quarter through dividends and share repurchases. In the high-tech solution segment, we are advancing our five key growth engines as we continue to leverage our technology and data assets to unlock further value for customers. We remain focused on extending our service advantage and officially broke ground on our previously announced distribution center outside of Portland, which we expect will help enhance our service performance in the Pacific Northwest. Within the endless assortment business, While we continue to see a softer demand environment, we remain focused on acquiring new customers and improving repeat purchase rates across the segment, driving long-term profitable growth. Overall, 2023 is shaping up to be another great year as we follow the Granger edge, make progress on our strategy, and drive value for customers. We remain on track to deliver over 20% earnings growth for shareholders. And with that, I'll pass it to Dee to go through the details.
spk00: Thanks, D.G. On slide seven, you can see the high-level results for the total company, including strong sales growth of 8.7% on a daily constant currency basis, driven by growth across both segments. This is a relatively stable growth rate compared to the second quarter, even as price contribution declines as we wrap inflation past in the prior year period. Total company operating margin was up 60 basis points, primarily due to expanded growth margin and high touch, which more than offset lower EA growth margin and slight SG&AD leverage across the business. In total, we delivered diluted EPS for the quarter of $9.43, which was up over 14% versus the third quarter of 2022. Moving on to segment-level results, the high-tech solution segment continues to perform well, with sales up 8.5%, and daily constant currency, underpinned by growth across all geographies. Volume accelerated sequentially and contributed six percentage points of growth, exceeding price contribution for the first time in five quarters. In the U.S., we continue to drive year-over-year growth in all customer end segments, with government and transportation growing the fastest. Canadian daily sales were strong, up 9.1% in local days and local currency. For the segment, gross profit margin finished the quarter at 41.7%, up 110 basis points versus the prior year. We continue to benefit from improved product availability, which drove freight and supply chain efficiencies in the quarter. Product mix also remained a tailwind. partially driven by an outsized number of project-related value-added services in the current year period, a level which we don't expect to repeat going forward. As expected, price-cost spread was negative as the timing favorability captured in 2022 continues to unwind. This price-cost trend will continue in the fourth quarter, and we anticipate finishing nearly neutral on a two-year stack for the full year 2022 and 2023 combined. At the operating line, we saw improvement of 70 basis points year-over-year as GP favorability was partially offset by continued marketing and headcount investments to drive long-term growth. SG&A leverage was further impacted by one less selling day in the current year period. Overall, it was another strong quarter for the high-tech solutions North American segment. Looking at market outgrowth on slide 9, we estimate that the U.S. MRO market grew between 2.5% and 3.5%. indicating that we achieved roughly 550 basis points of outgrowth for the high-tech solution U.S. business in the quarter. Performance remains above our annual target to outgrow the market by 400 to 500 basis points, driven by consistent execution across our five growth engines. We continue to remain confident in our ability to achieve our annual outgrowth target through any economic cycle. Moving to our endless assortment segment, sales increased 4.3% or 9.2% on a daily constant currency basis, which adjusts for the impact of the depreciated Japanese yen. Zero U.S. was up 1.2%, while Monotaro achieved 12.6% growth in local days, local currency. At the business level, While we're seeing some signs of macro-related softness at Monotaro, the business still drove strong growth with new and enterprise customers and remains focused on growing repeat business with its core B2B customers. At Zorro, results reflect a continuation of headwinds discussed last quarter with tough prior year comps, declines with non-core B2C volumes, and a slowing macro environment all contributing to to more muted top-line growth. Non-core B2C customer performance was down nearly 20% year-over-year as we continue to focus our growth efforts on stickier B2B customers. Core B2B customer growth remains in the high single digits for the quarter and continues to reflect a slower macro for small businesses and in markets where Zorro is more skewed. We expect these pressures to persist for at least the balance of the year. From a profitability perspective, growth margin for the segment declined 20 basis points versus the prior year, as monetarial favorability was offset by year-over-year declines at Zorro. Monetarial results reflect continued great efficiencies and strong price realization in the quarter, while the Zorro decline was driven by negative product mix and the impact of unfavorable timing from prior year price increases. These gross margin headwinds, coupled with the continued demand generation investments and softer Zorro top line, drove a 70 basis points decline in operating margins for the segment. On slide 11, we continue to propel the Endless Assortment Flywheel as we add new users and grow our SKU count. Total registered users were up 15% in total across the segment, and we continued to grow our assortment at Zorro, having added roughly 600,000 SKUs in the quarter, pushing the portfolio total to over 12.8 million products offered. Now, looking forward to the rest of the year, You can see that we've narrowed our guidance ranges for the full year 2023. The new outlook includes total company daily sales growth between 8.5 and 9.5 percent, and an EPS range between $36 and $36.60. These updated figures imply a Q4 daily sales growth between 4.5 and 8.5 percent, which includes 4 percent month-to-date growth in October, which is in line with our expectations and reflects a tougher comparison given hurricane-related sales in the prior year. This month-to-date growth is roughly 100 basis points higher in constant currency. From a margin perspective, we are raising the lower end of our ranges and now expect operating margin for the full year to be between 15.6% and 15.7%. a record year for the total company. The new range implies fourth quarter operating margin will be lower sequentially as we anticipate product mix to normalize with fewer value-added service engagements and SG&A margin to deliver in line with typical seasonality in the fourth quarter. Supplemental guidance covering cash flow and share repurchase expectations, which have also been increased, can be found in the appendix of the presentation. All told, we're poised to achieve superior results that include historic highs for sales, profitability, and cash flow, further strengthening of our track record of delivering strong returns for Grainger shareholders. With that, I'll turn it back to DG for closing remarks.
spk05: Thanks, Dee. Before we close out, I wanted to quickly reflect on the tremendous progress that we've made over the years since our investor day last fall. As you may recall, we outlined an earnings framework that got us to some attractive three-year targets that included us delivering strong top-line growth, ramping to record operating margins, and producing double-digit EPS growth through 2025. With the 2023 guidance you just outlined, even if you were to normalize for some of the one-time benefits elevating our margins this year, we are trending favorably towards those 2025 targets. As we look beyond 2023, The core tenets of this earnings framework remain intact. We will continue to focus on maximizing earnings dollars generation by delivering strong top-line growth, maintaining healthy gross margins, which we expect are going to stabilize after adjusting for the one-time benefits we realized in 2023, and gaining expense leverage by growing SG&A slower than sales. Executing against this framework positions us well to deliver attractive returns and consistently produce double-digit EPS growth for our shareholders. With that, we will open up the line for questions.
spk09: Thank you. And ladies and gentlemen, at this time, we will conduct our question and answer session. Please limit yourself to one question and one follow-up question for each time you queue. To ask a question, press star 1 on your telephone keypad. 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. And our first question comes from Ryan Merkle with William Blair. Please state your question.
spk07: Thanks. Good morning and nice quarter. I wanted to start with a high-level question on gross margin, if I could. I think your guidance for gross margin 25 is 37%. and you're a good bit above that here, you know, 39% plus. Can you just tell us why your gross margins are so much higher than the expectation you laid out the investor day?
spk00: Hey, Ryan. This is Dee. Thanks for your question. Like, if you kind of go back in time and think about where we were about a year ago, You know, we were in the midst of kind of coming out of the pandemic. Product availability was not exactly where we wanted it to be, even though our relative performance was pretty good. And we were expecting to get back in line with product availability much later in this year. That snapped forward really quickly in Q1, and it helped us significantly improve our margins. That's one piece. The other piece I will point you to is we target price-cost neutrality over time. And last year around that time, we expected costs to come in a lot sooner than what they did this year. We had passed price earlier last year in anticipation of that cost. Costs really are now flowing through GP as we expected. So a lot of things are timing-related. we are performing better than what we had anticipated at that time, but really it's due to product availability, price-cost timing, as we continue to focus on neutrality. And then we've continued to do very well as it relates to freight and supply chain efficiencies. That was also another timing element.
spk07: Got it. Okay. That's helpful. And then just a question on trends. Government looks like it's performing very well. Transport, same thing. Maybe just unpack what the drivers are there. And then can you put a fine point on the October? I think you mentioned 4% month-to-date growth, and that's down from September. That's closer to nine. Just what's going on there?
spk05: Yeah, so government, I think a lot of that government has been very strong across the board. We have won some new contracts that have come on board that have helped us this year, and so that has been certainly a tailwind. When we say transportation, I think arguably we mean aerospace there. Aerospace has been very, very strong. I think that the aerospace companies can't pull enough airplanes now, so we're benefiting from that. And I would say the market in general remains stable. There's puts and takes, but those two have been certainly on the plus side for us. In terms of the 4% in growth that we've seen through October so far, there's a couple of things going on there. One is our market share gain, we think, is going to be pretty strong in October, but we did have a lot. Hurricane Ian basically generated a lot of tarp sales at other sales last year for us, and so that compare makes the month look a little worse than it actually is. The underlying volumes are actually still quite good.
spk00: And as it relates to the second part of your question related to the October month-to-date top line growth at 4% versus our implied for Q4 being in the range of 4.5 to 8.5, I'll point you to one thing. This time last year, we did support... sale through of products for the recovery related to the Hurricane Ian. And so we are in a period where we're cycling a tougher comp. But as the quarter moves on, comps will get easier. So we feel pretty good about the range that we've laid out for the quarter.
spk09: Thank you. Our next question comes from Tommy Mall with Stevens. Please state your question.
spk12: Good morning, and thank you for taking my questions. Good morning.
spk00: Good morning.
spk12: DG, you used the phrase reasonably steady to characterize the demand environment. So my question is if you could unpack that a little bit or offer any helpful anecdotes. The revenue guidance or the range was midpoint, rather moves slightly lower. I don't want to make a mountain out of a molehill, but is there anything behind that worth calling out or is it FX noise or something else?
spk05: Well, I think that the reality is the volume this year, the volume in the market has been near zero pretty much all year. And so all of our volume share gain, all volume pluses have been share gain. That will continue. I think the biggest difference is moving through the fourth quarter. We had price that happened last year that has been an increase in our revenue line for the first three quarters, but we lapped that. going into the fourth quarter. So we don't really see any changes, nothing to be made of it. This is exactly how we predicted the year to play out, and it's playing out pretty much exactly as we expected. So we are not at all concerned about the revenue line. It's exactly what we expected.
spk12: Great. Thank you. And then shifting back to gross margins and specifically around the high-touch segment, I know 40% is still the official long-term anchor there, and it may be prudent to wait to revise that, but could you even walk us maybe qualitatively from the 41.7 that you just reported in 3Q to how that may progress for 4Q and even into early next year?
spk00: Sure. You're right, it feels a little early for us to start resetting things, you know, at this point, which I've kind of reiterated the last couple quarters. But what I would say related to high touch, and if you compare really Q3 to where we think we're going to go sequentially Q4, I would call out, like in my prepared remarks, that we've mentioned our service-related or product mix. that happened as a benefit both in Q2 and in Q3. We don't expect that to continue into Q4. In addition to that, you know, there's some other pieces like that fall into the price cost related to rebates. You know, last year, both years were doing very good in volume as DG noted. But again, you know, volume was really strong last year, still very strong. And then that reset some of your some of your rebates and so that'll kind of fall off a little bit and then price costs will continue to unwind Q3 to Q4.
spk09: Thank you. Our next question comes from Jacob Levinson with Malleus Research. Please state your question.
spk01: Good morning, everyone.
spk00: Good morning.
spk01: Just touching on the margins, I know you talked about some favorable items you have this year and you're certainly trending well about those 2025 targets that you laid out, but DG or D for that matter, maybe you can just give us a sense of how you're thinking about operating leverage in the business going forward, because I would think at least if the growth is there, excuse me, if the growth is there, that you're probably not going to see margins contracting meaningfully, even if mix is a little bit worse or price cost is a little bit worse.
spk05: Yeah, I mean, so what I would say is that, you know, the adjustments that once you take out the adjustments that we talked about, we believe that in the high-touch model will be relatively stable moving forward. And, you know, we are trending favorable to the 25-type targets as we talked about. The earnings model is share gain and stable gross margins and grow SG&A slower than sales. That formula is not going to change. and we expect to be able to continue to do that moving forward.
spk01: Okay, that's helpful. And just switching gears, I think your balance sheet is probably the least levered maybe since you took over DG. Is that reflecting some conservatism in the macro, or is there an appetite for more aggressive share buybacks or a special dividend or something? otherwise returning more cash for shareholders.
spk00: So, you know, you are correct. You know, we are very fortunate to have a strong balance sheet. And at the time, based upon our cash flow generation, we don't see a significant need to further lever the business. So I use the word conservatism. You know, you can use that word consistently. But we don't see a big need right now for that. Now, you know, based upon our cash flow generation, our access to capital, if there ever becomes a need for that, you know, we feel like we are well positioned to go into the capital markets to help us with anything. But right now, based upon our operating cash flow and conversion, we feel like we're in a good place with leveraged.
spk09: Thank you. Our next question comes from Christopher Glynn with Oppenheimer. Please state your question.
spk14: Yeah, thanks. Good morning. So I was curious on HTS price-cost dynamics, a couple components. What was price in the quarter? And then is it holding well in the baseline, looking fine on market competitive pricing to expect neutral price costs? margin impact in 24, like the algorithm?
spk00: So just to answer your first question, price cost for high touch was 2.5% in the quarter. And again, we take a longer-term view of price competitiveness, remaining price competitive, and due to the lumpiness of all of the components of price and cost that impact the business, if you look at a two-year stack, we expect to be close to neutral if you include 22 and 23. I would say that would be, you know, looking ahead, we would not change that position. We are targeting price-cost neutrality over time. You know, when we get to early next year and set the 2024 guide, we'll talk in more detail about 2024.
spk05: And the only thing that I'd add to that is that we are not seeing a lot of product cost pressure relative to what we've seen the last few years, as you might expect. There's been a lot of puts and takes, but generally we're not expecting a lot of product cost inflation heading into the new year. True.
spk14: Okay. Thanks for that. And then on Zorro and Monotaro, just curious how you're thinking about path back to the kind of 16 to 18% long-term top line targets.
spk05: Yeah. So what I'd say is, you know, Zorro grew, I'm sorry, Monotaro grew about 13% in the quarter You know, the Japanese market has not been strong. They've been dealing with some inflation for the first time, really, in anybody's memory there. I have a lot of confidence that the team is going to be on the right track to continue to deliver strong growth. You know, whether that's approaching 20 like they've done for the last 20 years or something less than that is probably debatable, but there's absolutely no concerns about the performance of that business. In Zorro, we've seen some competitors to Zorro actually go negative the last couple of quarters in terms of revenue. And so that has had an impact. The market certainly has had an impact on Zorro. I think Dee talked about it. The core B2B sales are up high single digits at this point, which is not where we want to be, but not horrible. There's a lot of other factors going on, particularly consumer business that's falling off, and we want that to fall off. But there's a lot of things we're working on that business to continue to get more repeat business out of customers, and we need to get better and better at that, and the team is working hard to do that. That will be the real key to us being successful with growth long-term as well.
spk09: Thank you. Our next question comes from David Manthe with Baird. Please state your question.
spk04: Hi. Good morning, DGD. Good morning. Thank you. my question was along the same lines on Zorro. So I guess I'll, I'll try to refine it a bit here. Uh, DG, what you just said in terms of, um, the trends, it sounds like the, uh, what you're seeing there right now is, is primarily cyclical in nature. You're not concerned about this, the strategy there, but then you also said that you are implementing, um, strategic moves to, to grow that business. Could you just outline a couple of those for us? So we, we know, um, what the drivers are?
spk05: Yeah. So, so what I would say is that there's two pieces to, to growth at Zorro. One is that these are very simplified, but one is acquiring customers. Zorro has always been really good at acquiring customers. They've been a good, good customer acquisition engine. The other is developing a repeat business for those customers. So you become the place of choice to shop. We've had some success with that. We have a lot of long-term customers, but we need to get better at that piece. So most of what we're talking about doing is how to, how to make alterations. It's not really a strategy change, but we're testing a bunch of things to figure out how to improve that part of the business. And that'll be the big area of focus going forward.
spk04: Got it. Okay. And then on the high touch side, product and customer information tools have really been a key driver of the outperformance there. Can you update us? I don't know if you have statistics on Salesforce's use of those tools or if you've added any new capabilities lately to those applications.
spk05: Yeah, I mean, I think that, you know, let's start with, as you know, we are building some of our own software for the first time in a long time, and customer information and product information were early in the cycle. Product information in particular, with a core publishing system that we've developed, has helped the website, helped customer positivity on our website, and has helped really drive a lot of growth through both marketing and merchandising. The customer information system is supporting marketing efforts. It's also supporting seller coverage. which we have been adding sellers, and it's helped us understand where we can add and become more refined in that. So both of those have been a big driver of growth and will continue to be so going forward. And, you know, I think that we still have a long ways to go, particularly with customer information, to leverage it for all of our sales team and all of our marketing activities, but we continue to get better in those areas.
spk09: Thank you. Our next question comes from Nigel Coe with Wolf Research. Please state your questions.
spk08: Thanks. Good morning, everyone. Thanks for the question. So looking at this, the fourth quarter margin, he called out, I think, 50 basis points or thereabouts of sequential margin, you know, kind of this is third quarter. Is that math correct, first of all? And then how does that shake out between high touch and end of assortment? And then I've got to follow on the Zorro gross margins as well.
spk00: Yeah, so you're talking about sequential change from Q3 to Q4. Yeah, so total companies, you know, about 60 BIPs. And, again, I think, well, I know that the pieces are the same. And so the, you know, favorability that we saw, you know, in Q2 and Q3 related to some services, project-related revenue, which is accretive to the business, At the total company level, you know, that's about 40 BIPs. And at the high touch, that's about 60 BIPs. And then the other piece I called out, which is really related to some, you know, smaller headwinds related to price costs and some, you know, that falls through rebates, that's about another 20 basis points total company and round up to close to that on the high touch level as well.
spk08: Okay, and then just to calibrate the comments about price-cost normalization, we're no longer looking at 40% gross margin of high touch. Do you think you maintain a higher plateau than that?
spk00: You know, what we've said and what DG said, I'll reiterate that, is we've had some one-time benefits if you look at this year. Early in the year we had freight accrual related benefit, we had a supplier rebate benefit that we won't see going forward, and then this product mix which is related to services related project benefit. When you pull all that together, that's like a 40 basis points hit when year over year that we would expect. But outside of those things, we feel like, you know, we will be able to maintain relatively stable gross margins.
spk08: Okay. That's helpful. And then just a quick one on the Zorro gross margins because, you know, as you burn off B2C, focus on B2B, I would have thought B2B gross margins would have been higher than B2C, so therefore you actually get a gross margin mix-up. So I just want to understand that dynamic. Okay.
spk05: With Zorro, that's not the way it works. It's basically one price and spot discounts in some cases, but we don't have differentiated pricing for business and consumers.
spk08: I see. Okay. Thanks, DG.
spk05: Thanks.
spk09: Our next question comes from Steve Volkman with Jefferies. Please state your question.
spk10: Hi. Good morning, Stil. Mike, I want to go back to something you said, DG. I think you said you didn't expect any cost. increases or pressures in 24? I'm not sure exactly how you put that, but are we thinking that cost and price are sort of flat in 24?
spk05: Well, we haven't, we haven't really talked about that yet, but we do know that we're not seeing as much product cost pressure as we've seen the last two years. And there's certain categories where costs will be, will be down that are commodity related and certain will be up, but generally we're not seeing a lot of cost pressure. We'll talk about price costs and the actual numbers at the end of the year for next year.
spk10: Okay, fair enough. And in your long-term algo, you talked about leveraging on SG&A, but we didn't actually do that this quarter. I guess we're making some investments. Do those continue for a number of quarters, or how do we think about the sort of trajectory there?
spk05: Yeah, I mean, we're going to continue to invest in the business, but we do believe that we will have consistent over in any quarter. You may not see it, but over time, we will have SG&A leverage as we continue to find ways to improve our cost position while still investing in the business.
spk09: Thank you. Our next question comes from Chris Danker with Loop Capital Markets. Please set your question.
spk03: Hey, morning. I hate to keep harping on Zorro here, but I'm curious, again, you talked about a couple of different initiatives, but I mean, is there friction in that system that we need to pull out or kind of what can really get, you know, that customer acquisition up, you know, given you count has been moving up and doing well, what else kind of has to happen to the system perhaps on a more holistic basis?
spk05: Yeah, I would reiterate that. I think on the customer acquisition piece, which the product breadth really does help, we've actually done quite well. And it's after that where we're trying to get customers to become repeat customers, where we've done well in some cases, but we need to improve that part of the model. And again, not to oversimplify, but you use the product breadth to get new customers in, and then you have to become intimate with those customers in some way to get them to repeat buy, and that's really what we're focused on doing.
spk03: Got it. And just as far as, like, benchmarking, given the greater cyclicality in that business, how should we be thinking about, you know, growth there, maybe, you know, beyond just this year and some of the challenges we've seen?
spk05: Yeah, I mean, you know, we still think that it's going to be a real strong growth driver for the company. You know, we're We're going to, like I said, we're running some tests here in the fourth quarter. We're going to learn more, and we'll continue to communicate with you what we think the go-forward growth is as we answered before.
spk09: And our next question comes from Dean Dre with RBC Capital Markets. Please state your question.
spk02: Thank you. Good morning, everyone. Hi, Dean. Good morning. I have a question on destocking because it's, I'm not sure it's an issue for you. Certainly not. It's not coming up on the call here and in your remarks, any issues with customer D stocking, maybe they're lightening up on some of their working capitals, lead times on products and just all sort of the post COVID normalization. Is that at all impacting your volumes?
spk05: No, I, you know, I, that really never comes up in customer visits. You know, I was out in Northern California last week and I would say, um, for our types of products, customers just generally don't ever have like overstock of our inventory they're buying when they need it. And frankly, a lot of our value proposition is helping them not, not have too much. So we really pride ourselves in making sure that that customers have what they need to keep the business running and that, and that's really all they have.
spk02: Good. All right. That's, uh, I like hearing that. And then, uh, maybe I'm just more aware of it now, but, uh, Is there a bigger push on brand building both in advertising, TV, and radio? Because I'm certainly hearing it a lot more. And how do you measure the returns on that? Certainly, it helps on brand building. It helps on some of your outgrowth. But do you have any other precision around that?
spk05: Yeah, certainly. We've talked about it before. Marketing has been a big part of what's helping us gain share. In terms of media advertising, we generally measure returns based on A-B tests where we test in certain markets and understand what the actual pull-through is from those. And so I would say our marketing area is probably as well a measured area as you could possibly imagine. So we can tell you with a lot of precision what's working and what's not, and that helps us figure out what to do.
spk09: Thank you, Aaron. Our next question comes from Chris Snyder. From UBS, please state your question.
spk11: Thank you. I wanted to ask on the project-related value-added services. I guess first, just to confirm, it sounds like that was a 60 basis point boost to high-touch gross margin in Q3. And then I guess kind of, you know, just higher level, can you just talk a little bit about what are these project-related value-added services that the company is providing and And what makes them one-time or transitory in nature? Thank you.
spk00: So thanks for the question. So, you know, we go to market with our customers to help them solve problems, and those problems are solved with a combination of products, as you know, but also services. We have over 400 what we classify as value-added service providers that help us solve those customers' problems. And this is an ongoing revenue stream for us. However, what we have attempted to call out in this quarter and then also it impacted us in Q2 is that we had a larger number of projects in the services area that we do not believe will repeat. Some of those projects include things that are more steady state for us that we have been working with our customers on over the longer period of time are things like lighting retrofits, roofing projects, safety certifications to help them ensure that they are investing in the right products as well as capabilities to ensure that they can pass safety audits, etc.,
spk11: And then was I right, or did you say earlier it was a 60 basis point boost in Q3 to the high-touch gross margin? Yes, that is correct. Thank you. And then maybe staying on the topic of services, you know, DG, in your opening remarks, you talked a lot about, you know, the value-added services that Grainger is bringing to the table. I guess as we think about, you know, those going forward, you know, Do you view those services as a way for you guys to continue to drive price, even in, you know, a cost environment or environment called out going sideways or, or do you view those more as just, well, no, that's why we can outgrow the mark market by, you know, mid single digits on a volume basis. Uh, thank you.
spk05: Yeah. So, um, I'd probably frame that a little bit differently. So we are first and foremost, a product company. We do, we do two things for almost every customer. We help them simplify their purchasing process. We try to make it really easy for them to buy, receive, pay, return if they need to the products we have. And then we help customers manage their inventory. And so for almost all customers that are of any size, we're doing those two things. And those are not actually in the realm of what Adi would call value-added services, what she just described. Then there are a whole bunch of value-added things that we provide to our customers, often through our supplier partnerships, that are service-related. They are a minority of our business, but they are important when customers want them. So if a customer wants to do a safety audit, it's really important that we can help them understand what challenges they have and help them get better at safety. And so we provide that service through our partners. And we will continue to do those things. But generally, I think the thing that's different this quarter is there was, in particular, a couple of very large projects that probably are not likely to repeat that were driven by things that typically don't happen. And so we just wanted to call those out. But our fundamental business model and how we evaluate the customers is really around helping them get the products they need to keep their operations running, make sure they have the right inventory.
spk09: Thank you. And our next question comes from Patrick Baumann with J.P. Morgan. Please state your question.
spk13: Hi, good morning. Thanks for taking my questions. A lot of numbers like flying around on the gross margin side, so I just want to clarify. The 40 basis points, D, that you mentioned of gross margin, Um, on an annual basis.
spk00: Yeah. What I was calling out 23. Yeah. That is, if you are looking to normalize 23 and are thinking about gross margins on a go for it basis, that's the 40 basis points.
spk13: Right, right. So all else equal that's so if everything else is 40 basis points, uh, you know, comes out of, of your 23 number as kind of like a baseline. Correct. For next year. Okay. And then the follow-up is it sounds like maybe 2024 is a more normal year for pricing based on your comments that there is a lot of product cost pressure. Assuming that's the case and with the gross margin coming down a bit, do you see SG&A inflation slowing enough to be able to deliver a bottom line margin expansion? It looks like your fourth quarter guide there is flat year over year, but I think maybe there was some one-time benefit in SG&A last year that, or one-time cost, I think, in SG&A last year that inflated the prior year results. Just curious if you'd give any color on that.
spk00: Yeah. So, you know, I think when you look at our results quarter over quarter, you know, there are some timing things that happen. We continue to invest in demand generation to help us ensure that we can drive specifically in the U.S. long-term market outgrowth. When you look at prior year quarter, you know, we had a number of things happen. I think you recall in Q4 we had a LIFO benefit last year that we will also be cycling. But just, you know, zooming out a little bit, if you go back to our framework, You know, over time, we want to outgrow the market in the U.S. by 400 to 500 basis points. D.D. talked a little bit about the fact that while we're looking to invest in long-term growth, we also look to gain leverage. And if you really looked into how we're doing that, most of our SG&A investments are really targeted towards high return demand generating investments. And a lot of the SG&A productivity or leverage we are gaining is in our non-core SG&A expenses. And we accomplish that through really continuous improvement. So we're really targeting things that help us with achieving an improved customer experience, but also assist us with operating more efficiently and effectively. Our intent is to continue to invest in demand gen, but also, you know, look to offset as much of that as we reasonably can do through continuous improvement activities. If you look at that algorithm, you know, that we laid out for Investor Day, it talks about driving double-digit EPS growth over the cycle, and so we still expect to do that.
spk09: Thank you. And there are no further questions at this time. I'll hand the floor back to D.J. McPherson for closing remarks.
spk05: All right. Thanks, everyone. We recognize that today is a very busy day for all of you in terms of the number of people that are releasing results, and we appreciate you spending time with us. Yeah, I would just reiterate that we feel really good about the way the year's played out. It's played out pretty similar to what we expected. We continue to invest in the business to drive profitable share gain. That is our primary focus, and we continue to invest not only in that but in our team and in making sure that our customers are successful. So I appreciate you joining us, and I hope you have a great day. Thank you.
spk09: Thank you. This concludes today's conference. I hope parties may disconnect.
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