Greetings, and welcome to the W. W. Grainger Third Quarter 2019 Earnings Conference Call. At this time, all participants are in a listen only mode. A question and answer session will follow the formal presentation.
As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Irene Holman, Vice President, Investor Relations. Please go ahead.
Good morning. Welcome to Grainger's Q3 earnings call. With me are D. J. McPherson, Chairman and CEO and Tom Okrae, CFO.
As a reminder, some of our comments may be forward looking based on our current view of future events. 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 mentioned on today's call with their corresponding GAAP measures are at the end of this slide presentation and in our Q3 press release, both of which are available on our IR website. This morning's call will focus on adjusted results. And now I'll turn it over to D.
G.
Thanks, Irene. Good morning. Thank you for joining us today. I'm going to discuss our Q3 results and share an update on the U. S.
And endless assortment growth initiatives that we introduced earlier this year. Then Tom will provide details on the quarter and we'll open it up for questions. We have had solid results so far this year as we manage through the uncertainty of the current environment. Despite softening global demand, we have accelerated our sequential share gain in the U. S.
Business and continue to invest for growth in our endless assortment business, Zoro. We've also been diligent in partnering with our suppliers to manage cost and driven expense leverage across our U. S. And Canadian businesses. Year to date, total company operating margin is up 30 basis points and we've driven incremental margin of 26 percent.
We've also maintained the guidance that we set on the Q4 call in January for total company gross profit margin, operating margin and earnings per share. I want to commend our team members for all the work they've done to strive during this environment. From our recent U. S. Customer visits, clear that demand has slowed, but it's also clear that things are not falling off a cliff and that we have great opportunities to continue to gain share.
Earlier this month, I spent time with a large manufacturer in the Southeast. They have seen strong growth due to their ability to innovate. Our team members have built solid relationships with their leadership and operations staff and are delivering solutions that matter. This customer views Grainger as providing exceptional service for part of their operation. We have leveraged our KeepStock inventory management system to make it easy for this customer to have what they need when they need it.
We only have a portion of this customer spend today. Because of our reliable partnership and our ability to deliver real value, we're exploring ways to expand our offer. This means finding ways for this customer to save more money by ensuring that they are using the right products at the right cost and managing usage and inventory effectively. When we do these things well, we gain share. I rarely visit a customer with the opportunity to create value and gain share is not significant.
And we do this across our business through 2 models. Through our high touch solutions model, we provide relevant products and services to customers to drive efficiencies and to save them money. Through our endless assortment model, we provide value through an expansive assortment that is easily accessed through a streamlined search experience. In these challenging times, we continue to focus on what matters. We're investing for growth in both business models.
Our strong balance sheet allows us to invest in good times and bad. And we are rigorous in our expense management. We've already achieved roughly $200,000,000 in savings the last 2 years and have expectations for continued productivity moving forward. With that, let's take a closer look at our performance in the U. S.
In Q3. Similar to what we are seeing from economic indicators, we estimate that U. S. Market growth decelerated from approximately 2% to 2.5% in Q1 and approximately 1% in Q2 to about flat in Q3. We are seeing softness across most end markets, including heavy manufacturing, natural resources, contractors and in pocket site manufacturing.
We have seen some of our customers, particularly in heavy manufacturing and natural resources, slow production. Healthcare market remains quite strong and we are seeing flat to modest growth in government and retail end markets. US segment share gain accelerated sequentially in the 3rd quarter with 250 basis points of outgrowth versus the market. US large business grew 2% 10% on a 2 year stack and US midsize grew 5% and 23% on a 2 year stack. Let me spend a few minutes providing an update on our U.
S. Growth initiatives, which we introduced in May of this year. As previously communicated, these initiatives fall into 2 buckets. The first are improvements to our foundation that ensure that we stay competitive. This includes improving the quality of our product and customer data, embedding our keep stock offer and enhancing the customer experience.
2nd bucket of initiatives are incremental investments that contribute to our long term goal of 300 to 400 basis points of growth above market. Initiatives are beginning to take hold as evidenced by our 2 50 basis points of share gain in the quarter. Our merchandising efforts are showing strong incremental revenue lift, driven by our comprehensive category review process. About $500,000,000 of product revenue has been remerchandised and we're seeing good results. We expect to get through about $1,000,000,000 for our assortment by year end.
We made incremental marketing investments in the 3rd quarter and our return on these investments has steadily improved throughout the year, which has exceeded our expectations. We have made solid progress in improving the customer experience and have increased the effectiveness of our order to cash process since the beginning of this year. Our customer feedback suggests that we provide the best experience in our space. We have re energized our corporate account work and have seen improvements in share gain with this group of customers. Finally, we are on track to start receiving inbound shipments to our Louisville DC in the Q4.
We are encouraged by our ability to accelerate sequential share gain in the U. S. And we remain fully committed to 300 to 400 basis points of power growth versus the market on an ongoing basis. I also want to spend a few minutes on our growth initiatives at Zoro US. You've heard us talk about expanding the product assortment at Zoro.
Our goal is to add 10,000,000 items over the next 3 to 5 years. In the Q3, we added about 350,000 SKUs, which brings us to 800,000 SKUs for the year. These product adds are driving incremental revenue growth on a per SKU basis that is similar to what we've seen historically at Monotro. Our investment in systems and people to help drive this growth are also going well. We launched a new marketing campaign in September and the results are promising, although early.
We are optimistic about the trajectory of Zoro going forward. The bulk of our investments in this business will be completed by the end of this year, and we expect strong growth in profitability moving forward. Now, the natural tendency would be to cut back on these type of investments during a soft market, but we are focused on long term growth of our business and we'll continue to make prudent investments while driving productivity. Now, I'll turn it over to Tom, who will discuss the quarter's results in more detail. Thanks, D.
G. Looking at our total company, adjusted results for the quarter, daily sales were up 2.5%, volume grew 2.5% and both price and the impact of FX were flat to the prior year. 2 of our businesses, AGI and Cromwell, are not only facing challenging end markets, but are also in the
middle of
turnarounds. Their results are adversely impacting the company's performance. For perspective, the U. S. Segment and endless assortment businesses combined were up 4.5% in the quarter and 5% year to date versus the prior year.
Moving to gross profit, our total company gross profit margin declined 80 basis points versus the prior year. The decline in gross profit margin was driven primarily by the timing of U. S. Price adjustments during the year, which resulted in negative price cost spread in the U. S.
In the 3rd quarter. Lower gross profit margin of our endless assortment businesses also contributed to the decline. Year to date, our total company gross profit margin is down 40 basis points versus the prior year. For the 4th quarter, we expect the company's gross profit margin to be higher than the 3rd quarter. We drove operating earnings growth of 2% in the quarter.
Our operating margin, however, declined 20 basis points versus the prior year due primarily to the investments we're making to drive growth at Zoro. Excluding the investments in Zoro, SG and A leverage completely offset the gross profit margin decline in the quarter. As expected, SG and A grew at half the rate of sales. As an organization, we will continue to rigorously manage expenses while ensuring we're providing the absolute best experience for our customers. Year to date, operating margin has expanded 30 basis points and we've driven incremental margin of 26%.
We are also focused on generating strong cash flow. While operating cash flow in the quarter decreased 8%, driven primarily by unfavorable timing of supplier payments, operating cash flow was up 3.5% year to date close to 100% of reported net income. Year to date, we've returned $842,000,000 to shareholders through $242,000,000 in dividends and $600,000,000 in share buybacks. We expect to continue to buy back shares in the Q4. Now, let's turn to our performance in the U.
S. The demand environment has slowed throughout the year and the market was flat in the Q3. Daily sales were up 2.5%, comprised of volume growth of 2.5%, flat price inflation, a 0.5% increase of intercompany sales to Zoro and a 0.5% decline in specialty brands. In the quarter, we grew 250 basis points faster than the market, driven by strong execution of our U. S.
Growth initiative. U. S. Gross profit margin declined 80 basis points in the quarter versus the prior year, driven primarily by product cost inflation outpacing price inflation, partially offset by favorability in the supply chain. At the beginning of 2019, we wanted to ensure that our pricing was sufficient to cover product cost increases related to tariffs and general inflation.
In retrospect, we were a little too aggressive. To ensure that our pricing was market based, we dialed pricing back in the 2nd quarter. While 3rd quarter gross profit margin was a little below our expectations, we estimate that gross profit margin will be higher in the 4th quarter than the 3rd quarter and the results for the entire year will be consistent with the expectations set at the start of the year. In an environment with uncertainty around tariffs and market demand, quarterly noise is commonplace. The year to date picture is often more useful in evaluating performance.
For perspective, on a year to date basis, excluding the write down of remaining contract negotiations, our price cost spread is favorable. Further, we continue to effectively manage product cost inflation related to both tariffs and general inflation. In the quarter, both improved sequentially and we expect that trend to continue in the 4th quarter. U. S.
Operating earnings increased 4% in the quarter. U. S. Operating margin was flat versus the prior year as lower gross profit margin was completely offset by SG and A leverage. SG and A was flat on sales growth of 4%.
In Canada, daily sales declined 14.5% on a constant currency basis. Price inflation was 1% in the quarter and volume declined 15.5%. Volume remains the main issue in Canada. While optimization of the cost structure is strong, it's taking time for us to stabilize top line performance. Operating margin was positive in the Q3 for the first time in 2019, driven by improvement to gross profit margin and continued diligence on the SG and A line.
Gross profit margin improved 50 basis points versus the prior year, largely due to supply chain efficiencies offsetting negative price cost spread. Moving to other businesses, which includes our endless assortment model and our international portfolio. Daily sales were up 9% in the 3rd quarter on a constant currency basis due to revenue growth from our endless assortment model. Together, Monachro and Zoro daily sales grew 19.5% in the quarter. Gross profit margin for the other businesses declined 130 basis points, driven by promotional activities at Zoro and freight headwinds at both Zoro and Monatro.
Operating margin declined 220 basis points for the other businesses, primarily driven by long term growth investments in Zoro US and performance at Cromwell. As we've mentioned in the past, the Cromwell business is facing operational challenges while also experiencing a difficult economic climate. The business is taking action to improve service and the customer experience to drive top line growth, while also At the total company level, we are reiterating all of our guided metrics. At the segment level, we expect the US segment and other businesses to be within their guided ranges. For AGI, we now expect to finish the year below the guided range.
Now, I'll turn it back to DG for closing remarks. Thanks, Tom. Performance so far this year has been solid even in a slower growth environment and with the added uncertainty around tariffs. While AGI and Cromwell continue to be challenged, customer feedback is much better in both businesses. We have done a lot of work to get the cost structure and service right at AGI and Cromwell and are well positioned to grow in the future.
I was at Cromwell early this month and even with the economic challenges customers were pleased with our improved service and we are exploring how to expand these relationships. We are happy with the growth of our endless assortment businesses and the progress we're seeing with our U. S. Growth initiatives. We've driven strong incremental margin year to date and are maintaining our total company guidance.
We are committed to delivering strong performance over the short term and long term. Our performance expectations remain the following. We expect our initiatives in the U. S. To drive 300 to 400 basis points of outgrowth versus the market on an ongoing basis.
We believe Canada is an attractive market for Grainger and we will continue our work to drive profitable growth in that business. We expect to accelerate growth with our endless assortment model through the strength of Monotro in Japan and the investments we're making in Zoro US. Overall, we expect to drive strong SG and A leverage and operating margin improvement for the year, resulting in incremental margin of 20% to 25%. Now, we'll open it up for questions.
Thank you. We'll now be conducting a question and answer session. Our first question today is coming from David Manthey from Baird. Your line is now live.
Thank you. Good morning. You mentioned the long term goal of growing SG and A at half the rate of sales growth and you've done a great job at that over the past several years. And clearly that equation is a lot easier when you're growing 8% than when you're growing 2%, but you've actually done it in both environments. What I'm wondering is, as we go forward here, we're looking ahead to the next year or so.
Do you have a specific plan in place that will keep that expense leverage going? Or at some point, do we just see natural low single digit inflation return to the cost stack in any case?
Thanks, Dave. I would say that we are constantly working on improving our expenses and our cost structure. We have built in an expectation that the functions in the business will cover things like merit going forward and we're working through plans for next year right now as you might guess. But we feel pretty confident that we can continue to get cost productivity throughout the business and we'll work hard to make sure that we continue to deliver the performance we've been delivering.
Okay. And then, DG, when you said that you expect a return to strong profitability in the endless assortment business or something along those lines, improved profitability. I'm just wondering if you can help us define that. Historically, when you look at segment contribution margins following periods of investment, you've gotten as high as maybe the mid or higher teens. Is that what we should be thinking about for contribution margins in the other business segment going forward?
So I would say that if you look at the online businesses, which are part of the other segment, our expectation is we will return Zoro to profitability and we'll begin the migration over the next several years up to very strong profitability like we see Monotro. And I think Monotro P and L gives you a sense for where we hope to be able to get with the Zoro business. So that's our objective. And it will take several years to get there as we come out of these investments, but we're pretty confident we can continue to grow profit.
Thank you. Our next question today is coming from Ryan Merkel from William Blair. Your line is now live.
Hey, thanks. Couple of questions. So first, I just want to clarify why gross margins are going to improve in the 4th quarter versus the 3rd quarter. I apologize if I missed it.
Yes. Gross margins typically improve sequentially Q3 versus Q4 this year. Q4 versus Q3, they typically will improve. And this quarter is going to be no different going into Q4. We are seeing general inflation and tariff inflation going down and that's the main driver for the gross profit going up in Q4.
Got it. Okay. And then you mentioned a price adjustment in the second quarter. Can you just tell us how much did you lower prices maybe on average? And was it broad based across all the SKUs or was it more targeted?
It was more targeted. And obviously, we're working on this on a continuous basis. As we said in the prepared remarks, coming up to Q one, we thought we overshot a little bit. So we went back and really scrubbed. Some SKUs we raised, some SKUs we lowered.
Overall though we lowered.
Got it. Okay. I'll pass it on. Thanks.
One other comment related to the first question on gross margin. We also expect some favorability in supply chain to help us out related to Q4. We see softening in the supply chain area, the transportation area. We expect that to also be a factor in Q4.
Thank you. Our next question is coming from Christopher Glynn from Oppenheimer. Your line is now live.
Hey, thanks. Good afternoon out there. So a lot of emphasis on the 300 to 400 basis points of long term sustainable outgrowth. I wanted to narrow that down into medium, get a little more detail on traction on your initiatives and prospects to kind of inflect that growth higher? I think last quarter, you talked about things like assortment sales coverage and digital experience.
So wondering how you're seeing those kind of discrete drivers kind of ramp on the ground level?
Yes. Thanks, Chris. We continue to expect our midsized customer growth and share gain to be higher than the overall U. S. Share gain.
We continue to see that. We certainly given the way we cover and interact with customers, things like merchandising and marketing have an outsized impact. They impact all of our customers, but they have an outsized impact on the midsized customers and that has continued to play out. And our expectation is that we will continue to grow significantly faster in the next several years with midsized customers than with the whole. So that and the initiatives are playing out pretty much as expected at this point.
Okay. And then with Canada, just want to I think you talked a little bit more about sales stabilization in prior quarters. Just wondering where is the cross section between the customer reengagement you've talked about with stabilized service levels versus kind of softening macro up above?
I'd say that when we have a number of our sales leaders in and we interact with them frequently and I've been talking to them and I've been hearing from customer feedback. We are now having conversations and getting permission to grow with our customers and that's it's been several years frankly since that's been the case. And so, we are right at the it feels like we're right at the precipice now of being able to start climbing again and grow based on the work we've done and it's been a long haul, but we feel like we're having the right conversations now. So we're a lot more confident now than we've been in several years.
Okay. Thank you. Thank
you. Our next question today is coming from Deane Dray from RBC Capital Markets. Your line is now live.
Thank you. Good morning, everyone. Hey, I know you're not in the giving of 2020 guidance yet, but just could you talk qualitatively what you're expecting the U. S. MRO market to look like?
1 of the other big industrial distributors talked about a flattish expectations for the first half. How do you think the operating environment for MRO will be? And then related to that, what caused you to step up into that 300 to 400 basis points of outgrowth? And what might the timeframe be for that? So 2 question.
Thanks.
Yes. Thanks, Dean. Yes. So I think we don't have any crystal ball that's different than others are seeing. We are planning for a wide range of potential market growth outcomes for next year and building plans around a wide range.
I think flattish is not a bad place to start probably and but anybody's guess, but that would not be a certainly a wrong estimate at this point, but we are planning for a fairly wide range. We actually are we have a set of initiatives that we've talked about that we believe are starting to build to getting us to that 300 to 400 points. If you look at the quarter, on a volume basis, we were significantly higher than 300 basis points of growth actually. So, we are starting to get confident that we have the right initiatives in place to grow 300 basis points to 400 basis points and the things we've been talking about with merchandising, marketing, adding sellers, corporate account growth, reenergizing things like our key stock program. So we feel like we've got the right initiatives and we're starting to some of that traction right now.
Terrific. And just as
a follow-up, can is there any update on Gamut? Looks like that Web site is in transition. You talked a bit about how that might be happening. And then maybe some update on the improvement of the search capability and the rollout there. Appreciate it.
Thank you.
Yes. So, Gamut is no longer a consumer facing a customer facing website. All those learnings have been built into the Grainger processes. We're building a new product information system that will be live in the Q4. We've actually when we talk about remerchandising $500,000,000 so far this year, a lot of the insights from Gamma are actually in those remerchandising.
So if you look at the categories that we've gone through, you see a lot of the lessons there. So, we've effectively built what we've learned from Gamut into granger.com. We are getting continue to get improved feedback from customers and that will only get better and better as continue to build out more categories and improve the product information. So we're pretty excited about the path we're on in terms of our search experience right now.
Thank you. Our next question is coming from Robert Barry from Buckingham Research. Your line is now live.
Hey, everyone. Good morning. Just a quick follow-up on Ryan's question. I think Tom, you mentioned seeing inflation going down. Was that just a comment on freight or is that broader comment on?
Broader, I mean sequentially, if you look at what we've experienced in Q3 versus Q2, we saw both tariff related inflation and general inflation go down. We expect that to continue in Q4 as well.
Okay. So do you expect to be price cost positive in 4Q?
Didn't say that. We'll come back to what we said for the entire year. We expect to be price cost neutral excluding our pricing write downs that we've done. Got it.
It just seems a little counterintuitive because the tariff headwinds seem to be growing.
Actually, if you look at the tariffs how we've experienced them throughout the year, they've been fairly constant. And now that we're starting to lap some of the tariffs, we're seeing improvement there. The other thing is you have to reconcile between stated tariffs and what we're actually able to negotiate in terms of realized tariffs. And we've got 2 buckets we work on. 1 is our own imported parts which come from largely from China, which are impacted directly and the other ones are national brands, which we work with our supplier partners.
So stated versus actually realized is a factor as well.
Got it. So just lastly, so does that mean in that context maybe seeing price at 0 is less of a concern to you, given you've been able to negotiate some of this deflation?
Well, I think what I would say is where we're at in terms of our share growth, where we're at in terms of our share growth objectives and our share growth initiatives, seeing flat pricing for the quarter doesn't get us overly exercised. As D. G. Mentioned, from a volume basis, we grew share quite a bit. And at this point, we're trying to get traction on our share gain initiatives.
That doesn't concern us that 1 quarter were priced flat. If you look at the entire year, we're price cost neutral when you adjust for the reset from the strategic write downs and we're happy with that. It's what our objective was at the beginning of the year.
Thank you. Our next question today is coming from Josh Pokrzywinski from Morgan Stanley. Your line is now live.
Hi, good morning guys.
Good morning.
Just want to follow-up, given that we're now past kind of fully past the price reset, just any observation with some of those customers, what percentage have kind of converted to being kind of more core customers versus those who are maybe transactional during the process. So I imagine you got a better grasp on that today than maybe you did 6 or 12 months ago. How satisfied are you with that? And I guess that will just lead out as first question.
So Josh, let me I will answer the question and interpret it. So tell me if I'm not answering it correctly. We tend to look at with our large customers, for sure, we had a lot of relationships that were not transactional relationships before. We still have a lot of those and we've expanded some of those. I think the biggest shift is then with midsized customers where we now have a whole lot more midsized customers who are buying frequently based on the price reset.
And the price reset was largely to make sure we were growing across the entire customer base consistently. And so we have liked the results we've seen with midsize customers. We still have a long way to go to acquire and turn those to many of those customers into regular purchasing customers. But we have made great progress with midsize customers.
Got it. Yes. And that was a midsize customer question. Okay.
I definitely have. I just want to picture. Yes.
Right, yes. Large wouldn't make as much sense. And then I guess on the price cost dynamic from here, is there anything that happens as a function of the calendar in terms of customers kind of reevaluating to start a year where the progression kind of post 4Q inflects or deflex one way or another. I think from a cost perspective, there's probably equal measures deflation and inflation, but probably a bit more deflation on the inputs. But just trying to understand how that conversation evolves over time on the pricing front and if there's anything that changes with the calendar flip?
Well, we have a long history of working with our customers to a lot of our contract customers to lock in prices at the beginning of the year. So we got through a process that we are going through now to make sure we've got the right competitive prices and that process always happens. So there's always a sort of beginning of the year sort of reset that happens and you see that in our results historically and that will be the same this year.
Thank you. Our next question today is coming from John Inch from Gordon Haskett. Your line is now live.
Hi, good morning. It's Karen Lau dialing in for John. So I just want to clarify on the 3Q gross margin dynamic. It sounded like given you said price inflation has sequentially come down, essentially out of that I guess part of it, I guess part of it, maybe you can confirm that the 5% of large accounts that still needs to get price adjusted and that is that done over the quarter and then is the rest of the pricing degradation coming from more broad based pricing adjustments?
Yes. It's largely done. We'll see a little bit in Q4 and then we won't have any in 2020.
Okay. Yes, it just sounds like I guess given the magnitude of the pricing and gross margin decrease, more of that has to do with broader based pricing adjustment. Maybe just follow-up on that point. I guess you guys have adjusted pricing since the start of the year, I guess a couple of times as you go through this exercise. Are you seeing sequentially similar well, I guess the ideal volume response that you would hope for or are we as you go through like these pricing exercise, are you starting to see throughout the year like a bit of a more diminishing return?
No, I think we're seeing good pricing response. Again, I'll go back to we see a flat MRO market in the 3rd quarter. Included in that flat market is a little over 1% in price, offset by a little bit over 1 in volume deterioration. We were up 2.5%. So that puts us well above 3 50 bps.
There's also some weather issues related to the hurricanes last year that we didn't put in our prepared remarks and some government lapping differences. So, yes, if you look at that, we're very happy with our volume response. Yes. I would just add that if you think about some of the pricing dynamic, Tom talked about this. We have we talked about being price cost neutral before the reset for the year.
We are effectively where we expect to be in aggregate. And we are careful we make pricing changes all the time, but we're very careful not to disrupt customers with large customers, particularly with changing prices around. So we are a little bit more careful with how many times we've changed with large customers. But overall, we've seen the exact response we expected this year.
Thank you. Our next question today is coming from Adam Uhlman from Cleveland Research Company. Your line is now live.
Hey, good morning guys.
Good morning. Good morning.
Had a few questions on Zoro. I guess, when should we expect the incremental investment spend to wrap up? Are we fully lapping that as we head into the Q1 and should expect profitability to recover there early in the year? Is this going to take a little bit more time and
then Yes. So we expect that and we expect profitability to recover some in the Q1. We did start investing pretty heavily in the Q1 of this year and it'll just grow from profitability to grow from there. So we will get some improvement in the Q1 is our expectation.
Okay. And then, of the 800,000 SKUs that have been added so far this year and as we add some more going forward. I'm just wondering if you could comment about if the gross margin profile of the business is changing, how you look at the categories that you're adding in? Is that more of a build out of the existing one? Or are there new product categories that are getting you into higher or lower margin categories?
Yes.
So, I mean, I think that we are first of all, we're adding a whole bunch of categories that we haven't had before. So, there's a mix of that in new categories and expanding the operating existing categories. In general, we are creating a fairly distinct value proposition for Zoro. And Zoro will become less reliant on the Granger supply chain moving forward. And so most of those products will be drop shipped.
So for the financials, the GP is lower when you have drop shipped items, so is the expense. But so you'll see that impact the GP slightly over time. And but we expect most of those items that we're adding, if we talk about $10,000,000 over the next 3 to 5 years, we expect most of those items to be 3rd party shipped. We're not going to be stocking those to those at Grainger.
Thank you. Our next question today is coming from Chris Dankert from Longbow Research. Your line is now live.
Hi, thanks for taking my question. You guys have given some really great color on gross margin. I guess kind of moving down to SG and A, typically we see a bit of a step up into the Q4 here, but your reiteration of the guidance suggests maybe you can hold that flat into the Q4. Is that the right way to be thinking about SG and A and just maybe some of how you can house some of the puts and takes that are in that line?
Yes, I think you're thinking about it the right way. Year to date, we're on a total company level, we're 70 bps favorable for SG and A. We expect that percentage to increase for the entire year. We do have a favorable lap related to variable compensation in addition to just a number of other cost productivity ideas and implementation that will hit in Q4.
Got it. Thank you. And then thinking about some of the rollback of the investment in the other business in Zoro and Monotaro, I think you guys had called out rolling back the vast majority of that into 2020. Is that still the plan? That is
if you think about it,
a number of the investments have been system investments. So we're going live with the new product information system, for example. We get through those this year and those do not repeat next year. So we have most of the investments behind us. We have added people analytics talent, marketing talent that will remain, obviously.
But a lot of the investments are kind of one timers that they're going to be gone this year. As you saw in the charts, we're really happy with the sales growth of both Zoro and Monitaro. Monitaro on a constant currency, local currency basis was up over 23% and Zoro was up big double digits. So, very happy with that.
Thank you. Our next question today is coming from Justin Bergner from G. Research. Your line is now live.
Good morning, DG. Good morning, Tom.
Good morning.
Just quickly on Zoro. Did I hear you say earlier in the call that Zoro is currently running unprofitable below breakeven?
No. They're actually made money in the quarter,
just not
as much as they will make on an ongoing run rate basis.
Okay. And is any of the investment price investment or is this all mainly on the SG and A
side? It's both. There are promotional spending, which we're undertaking when we're adding new SKUs and going into new verticals.
Okay.
On a dollar basis, most of it is expense as opposed to GP price of that.
Okay, great. My other question was just around the, I guess, price action you took that affected price cost in the Q3. Was that price action taken in the 2nd quarter such that you kind of expected the results that you ended up just reporting? Or was some of that taken in the Q3? And was that all sort of to correct for some of the pricing you took in the earlier part of the year?
Or was some of that more in response to current market conditions?
It was taken in the second quarter.
Our next question today is coming from Nigel Coe from Wolfe Research.
Wanted to just come back to the gross margin sequential guidance you gave. And certainly, when you go back in history, there's a very profound seasonal uplift in 4Q. Can you just remind us though what drives that? Is it a mix impact because normally revenues are down? So I'm just curious what drives that.
And then the second part of that question is, with the tariffs, list 3, 25% rolled in from May onwards and then list 4 from September. I think you talked about 10% of your U. S. Sales list 3, 10% of the 4. I'm just curious why we're not seeing some inflationary pressures coming from tariffs and perhaps that's offset by other deflationary tax, but maybe just address that as well, please.
Okay. Well, let me take the first one and I might have to get you to repeat the second one. It was breaking up on our phone here. There are many levers that we can pull in terms of gross margin for Q4. Why it historically goes up?
Traditionally, I think what we've seen is we've seen cost inflation work its way down throughout the year and we have better opportunities in terms of related to pricing terms, in terms of vendor rebates, customer support, those types of things which are quarter end settlements and we count those as cost obviously. Our pricing environment is fairly static throughout the year as D. G. Mentioned with the big pricing happening throughout the year. So the main driver in Q4 is really our vendor volume rebates and our customer rebate settlements that we have in Q4.
And if I could get you to repeat the second question, please.
Yes. It's really just about the impact of the tariff. So the step up from 10% to 25% on the List 3 tariffs, which was effective early May. And then List 4, which was, I think, September. And I think you previously disclosed the 10% of your U.
S. Sales on List 3, 10% on List 4. So I'm just wondering why we're not facing some inflationary pressures going into Q4 that would need to be offset with price?
Well, we've got Part 1 and Part 2, which arguably are a lower amount of our COGS, which are lapping in Q4. So we'll see less of an impact there. Q3, you're right, is moving from 10% to 25% or did move from 10% to 25% in May. Again, I will take you back to the actual stated tariff number versus the realized. We are experiencing much less than the stated tariff number on an actual basis.
So it's hard to just look at what's stated and look at the actual results. You really have to focus on the actual realized results. And our team is doing a very good job of working with our supplier partners to mitigate those increases.
Okay. I'll leave it there. Thank you very much.
Thank you. Our next question today is coming from Patrick Baumann from JPMorgan. Your line is now live.
Hi, D. G. Hi, Tom. Thanks for taking my question. Just on the Zoro business, if you could put a finer point on, you said it's making money.
Is it making money this year? Is it kind of like a mid single digit type operating margin? I know Monotro is in the low double digits. Just want to have a better sense of what the runway is there over the next several years, what the base is this year?
Yes. We're not going to go into specific breakout of Zoro. Let's leave it at it's making a small amount of money this year.
Okay, fair enough. And then how should we think about the Louisville facility coming online in the Q4 here and then into next year both from I guess what are your expectations for it I guess from a market outgrowth or cost perspective and I know you mentioned supply chain favorability that you expect in the Q4. I don't know if that's part of it or if that's something else. Just curious any color on that?
Yes. I think I would answer that 2 ways. One is long term, the Louisville facility provides capacity and helpful capacity a couple of ways. The first thing it does is it allows us to stock probably 200,000 more items in the network because it's a very good backup for Chicago, Greenville, New Jersey and even Dallas to some degree. So it allows us to stock more items and have more breadth which provides better experience.
And typically that does drive growth. The other thing it does is next to the Wolfport. So it gives you overnight capability for tail items, slow moving items in the network to get to customers who need them and that's a service that we will offer to our customers. We are working through exactly how to bring the building up. We're starting to receive in the Q4 And we'll talk more about that at the end of the Q4 in terms of what we're using the building for exactly next year and how we're bringing that building up.
Is huge. And it's going to take a couple of years to get to full capacity for sure, but we're going to leverage that building to provide better service to customers next year and improve our cost structure a bit as well. So, we'll talk about that at the end of the year.
Thank you. Our next question is coming from Michael McGinn from Wells Fargo. Your line is now live.
Thanks a lot for the time. If I could switch gears to more of a long term fundamental question regarding the endless assortment model. Having visited your new New Jersey DC, there was a distinct concerted effort on what shows up in a red box versus what shows up in a blue box. I'm just wondering, long term, what kind of thresholds are you putting on the 3rd party market to maintain branding? Are they going to get national account freight pricing?
How does that feed into your supplier rebate discussions longer term?
If you could just answer those quick questions, it would be great. So, we will have as we build out the endless assortment, we will have partners that provide distinct Zorro branding, whether or not it's an absolute box or a label is probably up for discussion at this point still. But the idea is we will make sure we retain the Zuora branding. Zuora will have more ownership for its own state. It will still leverage freight contracts that we have at Granger.
It will leverage some things at Granger. But in general, it will be more independent. The value proposition will be independent and the business will be more independent.
And the growth of that business, does that feed into the general Grainger supplier rebate conversation? Or is that something separate?
For stuff that we stock jointly, it definitely will. For stuff that we don't, it will not.
Thank you. We've reached the end of our question and answer session. I'd like to turn the floor back over to D. G. Macpherson for any further or closing comments.
Terrific. Thanks for joining us this morning. I'll just reiterate what we feel are really important about our expectations moving forward. In our U. S.
Business, we feel that scale really, really matters and gaining share is incredibly important. And so, our expectation is that we are going to grow revenue 300 to 400 basis points faster than the market. We feel like we have a great opportunity to do that with relatively stable gross profit and continuing leverage on the SG and A line going forward. In Canada, we have improved the customer experience. We are reengaging customers in a positive way.
And if we can get volume back into the business, which is our entire focus right now, we're going to be in a place to drive profitable growth. We're excited about the able to sort of model the investments we're making in the Zoro, excited about the growth path there. And we feel really, really good about a lot of the initiatives we have and the customer experience we're providing. So appreciate the time today and look forward to talking to you soon. Thank you.
Thank you. That does conclude today's teleconference. You may disconnect your line at this time and have a wonderful day. We thank you for your participation today.