Greetings, and welcome to the W. W. Grainger First Quarter 2018 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, Laura Brown, Senior Vice President of Communications and Investor Relations for W. W. Grainger. Thank you, Ms.
Brown. You may begin.
Thank you. Good morning, everyone. This is Laura Brown. Welcome to Grainger's Q1 earnings call. With me are D.
G. Macpherson, Chairman and CEO and Tom O'Cray, who will assume the CFO role on May 2. As a reminder, some of our comments today 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 the slide presentation and in our Q1 press release, which is available on our Investor Relations website.
D. G. Will be covering the performance for the quarter as well as give you an update on our 2018 guidance. After that, we will open the call for questions. DG, to you.
Thank you, Laura. Good morning. Thanks for joining us, everyone. Earlier this month, we announced that we had concluded our CFO search, and I'm excited to welcome Tom O'Crayta Grainger. Tom brings great combination of finance and operations experience with him.
Knows our industry well, and we're glad to have him as part of the team. So moving on to the quarter, the momentum that we saw in the Q4 of 2017 continued into the Q1 of 2018. In the U. S, the volume response to our pricing reset was strong. The demand environment continued to improve.
We estimate market growth in the quarter was closer to 4% versus our expectations for 2% to 3% growth for the year. What's encouraging is we're strengthening relationships with both large and midsized customers. The pricing reset is allowing us to reestablish trust and gain share by focusing on creating value for our customers. In Canada, our actions related to the turnaround led to gross profit and operating earnings improvement, and our business model reset is on track. Finally, our single channel online and our international businesses expanded operating earnings in the quarter.
All this resulted in performance that was better than our expectations. We're raising our full year guidance based on our performance in the Q1 and our confidence moving forward. On Slide 4, let's take a look at our results. Q1 2018 reported results included restructuring charges of $8,000,000 and an $0.11 negative impact to EPS. This morning's call will focus on adjusted results, which exclude the items outlined in our press release.
Total company sales in the quarter were up 9%. Volume was up 8%. We had positive seasonal sales of 1%, mostly in the U. S, offset by a 1% decline due to our Technitool divestiture last July. Price was down 1% in the quarter, and we had currency favorability of 2% in the quarter, driven by strengthening of almost all international currencies in the markets that we participate.
Our normalized gross profit rate declined 30 basis points after adjusting for the revenue recognition accounting change and a benefit from the timing of our national sales meeting. GP rate was better than expected, driven by U. S. Mix, price cost spread and some Canada price increases, which I'll describe in a bit. We continue to realize operating expense leverage on higher volume.
This all led to operating earnings growth of 19% in the quarter. One note, despite the operating earnings growth in the quarter, operating cash flow declined approximately 19%. This was primarily due to full bonus and incentive payments relative to the prior year. This is specific to the Q1, and we expect cash flow to be strong throughout the balance of the year. I'll cover our other businesses category first.
As a reminder, other businesses includes our single channel online model and our international businesses. Sales for this group were up 18% in the quarter, 12% of that was price volume and 6% was currency. Our online business has continued to drive strong growth and profitability, and our international businesses performed ahead of our expectations as a group and continued operating margin expansion in the quarter. Turning to Canada. Sales were down 2% and down 6% in local currency.
We introduced price increases in the Q4 of last year, and as a result, price was up 7%. This helped gross profit by 400 basis points in the quarter. Volume was down 13% due to the planned price increases and branch closures. As we've talked about before, this is going to be a smaller but more profitable business when we're through with the reset and before we can start growing again. Operating margin was better than expected due primarily to a higher GP rate and cost management.
Everything that we've seen so far in Canada tells us we're on the right path. We're improving our large customer profitability. We've continued our restructuring actions, including closing 17 unproductive branches in the quarter, and we expect to see expenses come down more through the remainder of the year as we restructure and create North American centers of excellence. We're also improving service while doing this. Direct to customer shipping was at an all time high in March in Canada.
We are making strong progress on all of our initiatives. And while it's too early to declare victory, we remain committed to the plan that we laid out in November. Turning to the U. S, both the volume response to our pricing actions and the demand environment were better than we expected. Sales in the U.
S. Were up 8%. This included volume of 9%, intercompany sales of 1%, seasonal sales of positive 1% that was offset by the 1% decline due to the technical divestiture last July. Price deflation in the quarter was 2%. Our normalized gross profit rate in the U.
S. Declined 60 basis points after adjusting for the revenue recognition change and a benefit from the timing of our national sales meeting. Our gross profit rate benefited from volume mix and price cost spread in the quarter. Large customer gross profit was better than we expected. We're not having to deeply discount infrequently purchased items as much as customers get more comfortable with our pricing levels, and our customers are starting to trust that our prices are relevant and understand the value that we provide.
Operating expenses in the U. S. Were up 2% once we include the revenue recognition change, and operating margin was better than expected in the quarter as expense leverage on 9% volume growth more than offset the GP rate decline. So turning to our performance in the midsized customers. We are continuing to see that our value proposition resonates with both large and midsized customers when we remove pricing as a barrier.
We're gaining share and seeing volume growth with all customer groups. U. S. Large volume increased 7% versus the prior year, which was above our expectations. Midsize customer volume also exceeded expectations with growth of 30% over the prior year.
With midsized customers, we're seeing progress with our marketing efforts. We're further penetrating existing customers, reengaging lapsed customers and starting to acquire new customers. What's also encouraging is we're starting to see increased traffic in our branches and our sales reps are now having more value based conversations with customers, which helps us solidify our relationships. We remain optimistic for the U. S.
Business in 2018. Turning to guidance. Page 10 covers our updated guidance for the year. In January, we had shared what was on the left side of the chart. For the year, we had expected 3% to 7% sales growth, minus 2% to 6% operating earnings growth and 13% to 24% EPS growth.
We now expect sales growth of 5% to 8% for the year, operating earnings growth of 6% to 14% and EPS growth of 25% to 33%. The new revenue guidance is driven by better price deflation on market based price increases and better mix along with improved currency. The strong volume performance in the U. S. Will be offset by lower volume in Canada as we execute the turnaround.
Operating margin is now expected to be 11.1% to 11.5% on improved GP rate and expense productivity. I wanted to give a little bit more detail on our performance in Q1 versus our new guidance for the year. For simplicity, I'll refer to the midpoint of our guidance ranges. We expect momentum to continue in 2018. The shape of our growth curve hasn't changed.
We still expect higher growth in the first half of the year, although the whole curve has risen on a higher expected sales growth for the year. Some of the favorability that we saw with GP and expense in the Q1 was one off in nature, and we don't expect it to repeat. I'll talk about that in a minute. And we decided to maintain our expectations for Canada's 2018 operating margin despite better performance in Q1. We are cautiously optimistic about Canada, but it's too early to adjust our expectations.
So let's take a closer look at our performance in Q1. EPS exceeded our expectations by $0.75 in the quarter. Dollars 0.20 was U. S. Volume and price, and we expect that to repeat each of the next three quarters.
Another $0.45 was one off in nature, and we expect it not to repeat. That includes a tax benefit from stock based awards, some international business favorability, the timing of certain contract negotiations and a change in accounting estimate in the U. S. And finally, dollars 0.10 of our beat is timing related and will reverse in the year, and this includes Canada's favorability. So this gets us from the original $13.55 to $14.80 at the midpoint.
And finally, before opening up to questions, I wanted to spend just a moment on price cost spread in the U. S. We previously had expected a price headwind of 2% for the year. That 2% was a net number composed of negative 3% from the wraparound of our August 2017 pricing reset, which was offset by plus 1% from favorable mix and market based price increases. Today, we are updating the total price headwind to minus 1.5%.
The makeup is still minus 3% from our pricing actions, but we now expect the price mix to improve. We still expect 50 basis points of COGS deflation for the year driven by our internal product cost initiatives like PPO, is the same as we indicated with our prior guidance. COGS deflation was much more favorable in the quarter due in part to timing from our national sales meeting. We expect COGS deflation to moderate the remainder of the year. In summary, overall, we're very pleased with our progress.
Our pricing changes in the U. S. Are resulting in strong growth with gross margin rates above our expectations. We're developing strong relationships with customers of all sizes. We're moving very fast in Canada and seeing signs of progress.
Our online model continues to drive strong revenue growth and margin expansion, and our international businesses are contributing to earnings. We continue to get strong expense leverage across the business, and we are on track to achieve the productivity targets that we laid out at Analyst Day in November, and we are well positioned to gain share and improve our economics going forward. So with that, I'll open it up for any questions.
Thank you. Ladies and gentlemen, we will begin you. Our first question comes from the line of Christopher Glynn with Oppenheimer. Please proceed with your question. Thanks.
Good morning and congrats on the demand response and all that. Digging into the U. S. Medium customer was interested in the staging of the customer acquisition levers that you plan to pull? What's the traction there so far versus the kind of reengagement of what you've called dormant customers?
Yes. And as I thank you, Chris. As I mentioned, there are really three sources to that growth. One is getting more share with active customers. Another is reengaging Glass customers who have been customers in the past, and the third is the acquisition piece.
We're going to spend time talking about more of the details in the near future, but we're seeing growth across all three of those. I would say we're still fairly early days in the new customer acquisition piece, but we have dedicated some marketing dollars to acquire new customers and we've seen good response with that.
Okay. And then the U. S. Margin is up 120. Just wondering if you could disaggregate that beyond how we could triangulate from the slides just in terms of the ongoing upside versus the timing of the contract negotiations?
And I think you said the accounting change had a little more impact in the Q1.
So the accounting change does not have an impact on operating earnings. It just shifts from GP to expense. When we look at what we saw in the Q1, we're obviously happy with the expense leverage we're getting, and we're happy with what we're seeing from the customer response, both from a volume and from a price point level. So without going into too much detail, there were some elements that we talked about in detail that will not repeat, that are in that number, but a lot of the benefit we think is real from the U. S.
Thank you.
Our next question comes from the line of David Manthey from Baird. Please proceed with your question.
Yes. Hi, good morning, D. G. And Thomas, congratulations. Look forward to meeting you.
Am I understanding it right that your net pricing coming up a bit because market pricing is higher and some of your prices to your customers change contractually? Is that what you're saying?
Yes. So it's not all contractual. But what we've seen is, given some commodity price increase, we've seen some market prices creep up and we've been able to take those and our COGS performance has been better than those price increases. So effectively for us that shows up as price cost spread and we think we're going to have a little favorability for the year relative to what we originally expected.
Okay. And then, as it relates to your price reset parameters, if market prices more broadly inch up over the year, does that incrementally make your level of pricing more competitive? And could that be some of what we're seeing? Or is it just too early to say that that's what's going on here or too small in magnitude?
So just as a reminder, so our pricing philosophy is to price to market and we've gotten prices to what we think are the right market levels. If market prices go up, we will watch that closely and make some adjustments. We're seeing 2 benefits. 1 is a little bit of inflation and the other is from our customer mix, where we're seeing growth with attractive customers at higher margins and with attractive volume sources within existing customers as well. So there's really 2 things going on.
1 is the inflation benefit that we get and the other is customer mix benefit.
Got it. Thanks, T. G.
Thank you.
Our next question comes from the line of Ryan Merkel with William Blair. Please proceed with your question.
Thanks. A nice quarter.
Thanks, Eric.
So first question for me, just back to
the non repeating items that you called out. Can you just add a little more color to each piece? And then I'm hoping that you can quantify each component of the $0.45
dollars So let me just describe. So tax benefit from stock based awards, that's pretty clear. I think the one that's probably not maybe not as obvious is we had a change in accounting estimate. That's really we had a number of customers who have been on cash accounting because we were very conservative. And when we looked at their credit risk, it's similar to the rest of the business.
We made a change that's going to now be an accrual system. So that's a modest portion of the $0.45 But that's the one that probably is a little bit odd. The others are fairly self explanatory and we're not providing necessarily the detail on the each the impact of each of those at this point. Got it.
Okay. And then on gross margin, the quarterly cadence for the year is a little different than I was thinking. There's some noise, I guess, in the Q1's gross margin. But can you just clarify how much should gross margins decline sequentially into the Q2? And then could you also comment on the trend line?
Is it stable to slightly rising sequentially from the 2nd quarter?
Yes. So the things that were unusual in the quarter, Ryan, one is the timing of our sales meeting. And so we would expect the Q2 to be slightly lower because that benefit was in the Q1 and won't be in the Q2. It will be an offset effectively. Other than that, things are actually, I think, pretty stable with our GP rate.
All right. So just one more follow-up, I guess. So should mix and improving price help gross margins as we think about the second half of this year and entering 2019? Is that still the plan?
Well, that's in fact, that's why we've changed our expectations on GP because of the customer mix and the inflation. And that's why we've raised the U. S. 0.5 percentage point. So yes, that's absolutely the expectation for the year.
Perfect. Thank you.
Thanks.
Our next question comes from the line of Robert Barry from Susquehanna. Please proceed with your question.
Yes. Hi, good morning. I just wanted to actually follow-up on that. I mean, big picture, it doesn't seem like your view on the gross margin performance is changing that much. Is that right?
I mean, you still expect it down 110,000,000 I think that was 130,000,000 last quarter?
Yes, that's right.
And I think the math, if you were down $60,000,000 in the Q1 would actually imply a fair amount more pressure in the remaining quarters to be down 0.0.01 for the year. Your answer to the last question about just the modest what sounded like modest noise from the supplier accounting suggested that in fact it could be a lot better than that. So I'm just trying to understand, I guess, it's a clarification on the cadence.
Yes. We actually think it's going to be fairly stable. It's all really the sales meeting driving that difference. So it was a fairly significant benefit in the Q1. And so when you take that out, there's really not sequential down really.
Got it. So just to clarify, you do think the gross margin will be down a little bit in the Q2 versus or maybe a fair amount in the second quarter versus Q1 and then it will remain stable?
No, we're not and we're not giving quarterly guidance on GP. We don't do that. So we'll talk more about it as we go forward. But we would say that the one thing we wanted to highlight is the timing of the sales meeting. We also had some benefit from COGS deflation in the quarter that was better than we had expected.
Some of that is actually timing as well.
Got it. Okay. Thank you.
Thanks. Our next question comes from the line of Scott Graham from BMO Capital Markets. Please proceed with your question. Hi, good morning, DG.
Good morning.
I wanted to beat the dead horse here, the $0.45 How does timing of contract negotiations, how specifically does that translate into something positive? Is there some backdating there? Or how does that work?
Well, if the contracts push out and we don't get them completed, then we're we haven't lowered the price for our customer yet. And so that's why it's a benefit that we don't expect to continue because we will complete those contracts. I see.
And it looks to me like your revenue recognition change analysis in the back is exclusively about the revenue recognition. So the gross profit that you show here is not reflective of this whatever piece of the $0.45 is, yes?
So the So the Yes, right. Yes, right. We're only taught 2 separate things. We're talking about revenue recognition in the back. That's the accounting standard change that we've talked about before.
I think you're asking a question about the accounting change for revenue recognition for some form of the cash based customers. That's a very that's a small piece of the $0.45
Right. And I can okay,
I see. So that is a that's
a small piece, which would make the timing of the contract negotiations a larger piece?
There's a number of pieces that are that add up the $0.45 and those 4 all contribute.
I see. Okay. And my last question is, I don't know how closely you guys have looked at some of the tariffing, I'll call it, going on out there, U. S, China, even a little bit of Russia. But just kind of wondering if you guys are looking this as sort of a lay of the land, how this affects you?
Yes. So we have looked at it. We will continue to look at it. It's a little bit unclear yet at the impact it's going to have on some of the categories that we participate in. We look at it two ways.
1 is understand the financials. The other is making sure that we've got the right decision on sourcing. And depending on certain tariffs, we may move suppliers as well. So we don't have a conclusion. Obviously, certain tariffs would be very inflationary for the market and others might not.
And so we're looking at the specifics to understand what we need to do.
Very good. Thank you.
Thank you.
Our next question comes from the line of Robert McCarthy with Stifel. Please proceed with your question.
Good morning. Can you hear me?
Yes. Good morning.
Good morning. Well, what a difference a year makes. Good job on the quarter. And I don't want to be a Grinch, but I feel I got to ask some questions along those lines. I guess the question I would have is, how should we think about your embedded guidance in the back half of the year for revenue growth around you anniversarying these compares, particularly as your pricing reset?
And then I guess the question is, how do you think about the situation? Do you think you're going to have to have further price cuts as you get price discovery? Or what's embedded in your guidance with respect to further pricing actions if you sort of anniversary volumes and you don't see quite the demand response you saw through the first half of the year?
Yes. So let me break that in 2 buckets. I would say one of the things we're seeing is that for large contract customers, our pricing has always been competitive. And so we're not seeing substantial GP rate contraction with large customers. I think it's relatively business as usual.
I think we're going to execute well and we still have a lot of growth with large customers. Mid sized customers, what we're finding is the price points we're at are actually good for both acquiring customers and reengaging relapsed customers, and we have not reached yet a large portion of that market. So I feel like we have a fairly long runway to grow with midsized customers and certain large customers where we haven't historically had contracts. So, while we've always said the back half of the year will be lower revenue growth because of the comparisons, we feel like we have we're well positioned to continue to gain share.
And just as a follow-up in terms of brass tacks, I mean, what do you expect you can share about
the business, kind of the
EPG timeframe? Because I think you're not disclosing monthly sales anymore. You will be out at some of the conferences. But what can you what do you think will be kind of the mid quarter update topic around? Will it be traction at U.
S. Medium size? We'll be talking about Gamut. We will be talking about the back half. Just try to set the table for what are going to be the kind of key topics because we're kind of stuck because the submarine goes down for about a month and a half before we or a month before we speak with you again?
Yes. What are you going to do with your time? So I think the 2 topics are going to be 1, midsize customers understanding a little bit more detail what we're seeing with that group and the other will be around digital, broadly. So I think those will be the topics that we focus on that will be additive and new.
Thanks for your time.
Thank you.
Our next question comes from the line of Patrick Baumann with JPMorgan. Please proceed with your question.
Hi, good morning. Thanks for taking the question. Can you just talk about it looked like in the slides you pulled out the commentary on monthly volume or monthly daily sales by segment. I'm just curious how the U. S.
Segment progressed by month through the quarter? And really good question along the lines of your commentary around the expected second half volume slowing. And I'm guessing that's just comps, but I was just curious if you saw anything intra quarter that makes you kind of stick with that forecast?
No. I mean there's there really were very minor changes in terms of the demand environment and volume throughout the quarter throughout the entire business.
Okay. Fair enough. On the MRO market, you set up 3 to 4 now versus 2 to 3. Is that really what's driving the increase in the U. S.
Volume growth expectations from 6 to 7? It's the market.
Market, yes. So the market is a big portion of that and we're also seeing some higher share gain with midsized customers for sure than we expected and with large customers as well. So it's a bit of market and share gain.
Got it. And then on the price cost, the change from 1.5% to 1%. What's the U. S. Segment margin guidance now for the year?
Is it just 50 basis points better than it was before? And just curious on that price cost, is that going to exit the year in your current planning as a positive contributor in the 4th quarter?
Yes. So in terms of GPA, we're 20 basis points better than we were previously in terms of what we expect for the U. S.
In GP, I was talking total segment margins. So on earnings? Margin guidance for the year for the U. S. Segment, right?
You gave guidance.
Yes. We haven't given margin guidance for the year for the U. S.
U. S.
Segment. You're not asking No, we're not updating. No, no, we're obviously encouraged by what we've seen.
Got it. And then price cost for the year exiting 4Q, I mean, you think it will be positive?
Well, I mean, I think you may be asking 2 questions simultaneously. So, what we've talked about is our reset this year is going to be 300 basis point decrement. And then we talked about positive price cost above that. And so yes, price cost is going to be positive for the year for sure. What will happen as we go into next year, and we'll start talking about that later in the year, we would expect that 300 basis points to go because that will be much smaller.
And we won't talk about that really until November.
Our next question comes from the line of Deane Dray with RBC Capital Markets. Please proceed with your question.
Thank you. Good morning, everyone, and welcome to Tom and congratulations. Thanks, Tom. I wanted to follow-up what's also interesting in call, I feel a little badly for DG because you have to answer as a CEO and CFO at the same time. So I appreciate that it's a little more challenging, but a lot of good color here.
Just I want to go back to price cost, if I could. Just the reference early in your prepared remarks about mix has had a benefit here. And maybe give us some examples of how mix enters into this. I guess intuitively you would think that you're not selling as much as those products that had the deepest price discounts,
but maybe you could just clarify and provide
some color there, please? Discounts. But maybe you could just clarify and provide some color there, please? Yes. Dean, I think most of the benefit
we're actually seeing is customer mix. So the fact that midsized customers have generally higher GP rates and are less on negotiated prices than large customers. And so historically, the last 6 or 7 years, we've been growing large contract volume faster than midsized customers. That has reversed until you get some positive mix benefit on the GP loan.
Got it. That's helpful. And then in Canada, the ability to put a 7% price increase, how does that compare? Maybe it's a completely different market, but your pricing power in Canada compared to the market and versus pricing strategy in the U. S?
Where's the kind of the breaking point for you in Canada?
Yes. So I think it's really not even close to a comparison. The reality is that as we went through our ERP implementation in Canada, and the Canadian dollar a few years ago went down, we did not pass through price increases that the rest of the market did. So we got into a position where our prices are above market. And as we've improved our service and come out of that, we've been able to pass some of prices through.
So it's really not even analogous situation at all today.
Got it. Just let me if I can sneak one more in, any color on Cromwell?
Cromwell is performing as expected at this point. We've made a bunch of changes to that business. We've redone the supply chain, which is performing much better, put in a new website and that's performing better, but it's performing as expected.
Got it. Thank you. Thank you. Our next question comes from the line of Ryan Cieslak from Northcoast Research. Please proceed with your question.
Yes, thanks. Good morning and Tom congrats and welcome as well. My first question D. G, is when you look at the guidance on the price cost or the gross margin, I think you guys are looking at price deflation or cost deflation, excuse me, of around 50 basis points. It seems like that's consistent now for the balance of the year.
Is that the case? And if it is, can you just help us maybe understand maybe some of the offsets that you're able to deploy as it relates to maybe, as we're hearing more about inflation pressures throughout the industrial supply chain right now?
Sure. Yes. I mean, and I talked about this before, if we had not had the initiatives we had, we would have had COGS inflation this year of 2%, 3%, 4%, somewhere in that range. And so our own efforts around line reviews, managing COGS, PPO, we call PPO. With PPO, that's basically going through and understanding the cost of our products and working with suppliers to get the right assortment and the right cost.
Those efforts have had a significant impact and that's why we expect slightly negative COGS inflation this year.
And did you I mean, would it be fair to assume though you're having maybe better benefits from some of that stuff considering it seems like inflation even over the last couple of months has picked up more and certainly maybe some of the tariffs that could be rolling through as well?
Well, and so I think I would probably tease those into 2 groups. One is, I think we're getting the benefit we expected. I don't know that it's necessarily better than we expected. It's quite an important benefit and one that the team has done a nice job of. I think in terms of things like tariffs, that would be something the whole market would see and we would then be raising price to offset those if in fact those tariffs were to become reality.
So we're watching those closely. That would be a separate issue generally.
Okay. And then for my follow-up, in thinking about the incremental gross margin or gross profit contribution from medium size volume growth for you guys. Does that change at all going forward if you start to see new customer acquisition pick up in that overall mix of incremental volume, meaning maybe the cost to serve those new customers is going to be a little bit higher than gaining incremental volume from existing customers?
Thanks. We'll probably talk about that as we go forward. I think the incremental margins on that mid sized customer are strong, obviously, which is great. New customer acquisition does have a little bit different economics, although it will still be very positive to the business, we believe.
Our next question comes from the line of Chris Dankert with Longbow Research. Please proceed with your question.
Hi, good morning. Thanks for taking my question this morning. Good morning.
Just want to get
a quick update on Canada. I believe the expectation was getting margin to a positive number and exiting the year on a run rate basis. Is 4% still the bogey or just kind of given how that's rolled out, has that been pushed further to 2019 at this point?
No, that's still we had the exact same expectations we had in November for the Canadian business at this point. That has not changed.
Got it. Got it. Good news there. And then I guess, could you expound a bit on freight? Obviously, we've seen those numbers come up quite a bit.
Has any of the cost mitigation been on that aspect? How successful has that been? Just any color around freight would be really helpful.
So I think to understand freight impact, you have to understand sort of how our freight works. In the U. S, most of our orders actually go through parcel, although not necessarily most of the dollars. And we do not own our own fleet. So we use third parties.
We have contracts with 3rd parties. Certainly, for truckload and less than truckload volume, there's a lot of upward freight pressure right now. We don't do a whole lot of truckload and we do some LTL. And so we are actively managing that. Certainly, there's some upward pressure.
We probably have managed it well so far, I would say, and we're watching it very closely.
Understood. Thanks, DG. Thank you.
Our next question comes from the line of Joe Ritchie from Goldman Sachs. Please proceed with your question.
Hi, there. This is actually Evelyn Chow from Goldman.
Hi, Evelyn. I have
a question. Maybe just starting on 1Q, I just want to make sure we have a good handle on kind of the moving parts on gross margins. So specifically as it relates to the trade show and the COGS deflation, what benefit did you actually get in the quarter from that?
About 20 basis points in the quarter from that.
Okay, great. And then just turning to the timing of the contract renegotiations, it would be helpful to get some rationale as to kind of It Would be helpful just to understand, kind of what pushed that out?
Yes. This is not our decision at all. This is just customer processes potentially taking longer than we had thought they might take. So we aren't deferring anything. These are customer processes that are taking time to work through.
Got it. Thank you.
Thanks.
Our next question comes from the line of Justin Bergner from Gabelli and Company. Please proceed with your question.
Hi, good morning, DG, good morning, rest of the team at Grainger. Maybe you could just talk about the other businesses a bit. How is Zoro performing? Any sort of trends there in any of those sub components?
Yes, I would say that the online businesses continue to grow very strongly and continue to have strong margins. They're performing as we would expect. The international piece of the portfolio really is a much narrower piece of the portfolio. It's Cromwell Fabry, China, Mexico and some export business at this point. So we've gone through a fairly long process of cleaning up that portfolio.
And the good news is that is all profitable and contributing to profitability for the company. So we feel good about having the right portfolio at this time.
Okay, great. And then any change to your long term capital allocation or medium term capital allocation plans with this improved guidance? I noticed you continue to repurchase shares fairly actively, but any change there?
Well, I'm going to let Tom get more than 3 days under his belt before we dive into But we're not changing anything right now, but we will continue to talk to our Board about long term capital allocation as we move forward. Okay. Thank you. Thanks.
Our next question comes from the line of Hamzah Mazari from Macquarie Capital. Please proceed with your question.
Thank you. Good morning. The first question, D. G, is just you mentioned you have not reached a large portion of the medium customer market, which suggests you're in early innings of share gain. I was hoping you could maybe share some data points around maybe what was your market share in 2011 last time you grew with medium customers or maybe some other data points to sort of verify that you haven't reached a large portion of that market?
What's your customer count versus overall medium customer count? Any data points to sort of help us understand sustainability of share gains in that segment?
Yes. I mean, I think
I would point to a couple of things. One is we were $1,500,000,000 to $2,000,000,000 in mid sized customers at one point, which is probably 3% or 4% market share. We're down to 2% now. So that's it's small in either case, but we think we can certainly grow share. We think there are 500,000 or more attractive midsize customers.
We have relationships with 60,000 plus of them. So we feel like there's a long runway of midsized customers to acquire and to build relationships with.
Okay, great. That's very helpful. And then just on the COGS deflation, is the PPO project cover all your SKUs? Is that project sort of behind you? I know we didn't have this project in 2016.
I don't know if we had it last year. But just any color as to how is that project sort of behind you now and we're seeing the benefits of that? Or is there sort of more room to go in terms of other SKUs or revenue to cover?
So it has been ongoing for several years, and it was a little bit new way of thinking about how we manage our assortment in COGS. I would say that every year we run different processes for different parts of the portfolio. In some cases, it's a much simpler part of the process. In some cases, it's more involved like PPO. But we're certainly not done.
We're going to continue to work on the assortment, and we always start with the assortment and the cost of that assortment. And so that will be a consistent process for us.
Okay, great. And just a follow-up, did you guys have any impact from I know you don't get monthly sales, but any impact from Easter or weather in your Q1? Thank you.
So Easter would have been a very small impact and probably not worth talking about. I would say the weather, we had a 1% increase in seasonal sales. A lot of that was nor'easters just pounding, well, I guess, the East. So that was most of that in March. Okay, great.
Thank you. February, March.
Our next question comes from the line of Matt Duncan with Stephens. Please proceed with your question.
Hey, good morning guys. Congrats on a great quarter.
Good morning.
So first thing I've got, I'm hoping you can give us a little bit
of clarity here on gross margin. So
your guide before
had been 130 basis point decline with a 70 bp drag from the accounting change. It's now 110 basis point decline with only a 50 bps drag implying that the underlying gross margin hasn't really changed any yet. You're updating in a positive way the price cost spread in the U. S. So how do we reconcile those two things together?
So net net, the expectation is that the underlying GP will be 20 basis points better than we had set back in the Q4.
But there's a 50 better U. S. Price cost spread. So is there somewhere else in the business where gross margins are a little lower than you thought before?
No, no, no. That's just the impact of that 50 basis points of price equals 20 basis points of GP.
Okay, very helpful. And then just in terms of what you're seeing so far, DG, with Gamut, can you give us any update on where you are in the rollout of Gamut and what you're seeing there?
Well, if you recall, we're actually merging Gamut and Grainger dotcom and building a lot of those capabilities into Grainger dotcom at this point and the team is working to build those capabilities in. We'll provide a bit of an update in EPG in May.
Okay. Thank you much.
Thank you.
Our next question comes from the line of Steve Parker with KeyBanc Capital Markets. Please proceed with your question.
Hi, thanks.
With medium customer growth running the way it is, I'm curious if the incremental volumes coming through the digital channel or more through inside sales reps and how much room do you have in terms of inside sales capacity?
So it's coming in both places. We're seeing nice growth with the covered customers through inside sales, but we're seeing very high growth through digital channels as well. So it's really coming in both places. We have capacity in inside sales and we will add capacity if that makes sense. So we are not constrained if we're getting profitable growth.
But so far, it's we're seeing it in both places and really just continuing to dive in and understand the source of the benefit.
Okay. And based on the 4Q presentation, free cash flow guide is $810,000,000 to $850,000,000 for the year. 1Q came in at $97,000,000 even with less than 25% of the projected CapEx for the year. I know it typically ramps through the year. Can you talk about how you see free cash flow coming in given the early trends?
Yes. We expect it to be at the higher end of that range for the year, the range we talked about before.
All right. Thanks.
Thank you.
Our next question is a follow-up question from the line of Justin Bergner with Gabelli and Company. Please proceed with your question.
Thanks for my follow-up. On the gross margin 20 basis points improvement, is that almost all mix towards median customers or is some of that general price cost?
It's a little bit of both.
It's a combination of both.
And then what's driving the price cost, just the better end market environment that's allowing you to get a better spread there or are there other factors?
It's market price increases due to inflation and our ability to not take those in product costs, that difference. Great. Thanks.
Thank you.
We have a follow-up question from the line of Patrick Baumann with JPMorgan. Please proceed with your question.
Hi. I just have one more. I know this question has been asked a lot of times on the call and I don't I'm not sure I quite understood the answer yet. But so the U. S.
Segment margin in the Q1 was 16.7% and it does include, I guess, some favorability from items that you don't expect to repeat for the year or was timing related or something? What's the underlying margin in the Q1 ex those items? Can you give any color on that?
We don't give color on that typically. It was good though.
Okay. And maybe just last question just on the capital allocation priorities. Will there be a rework with the new CFO coming in? How does that typically work?
I would assume that the CFO will want to relook at pretty much everything. So yes, I would expect there to be a relook. I don't know when the timing will occur.
Okay. Thanks a lot. Have a great day.
Thank you. You too. All right.
I'm sorry.
Okay. Yes, go ahead. Go ahead.
Our next question comes from the line of Chris Belafur with UBS. Please proceed with your question.
Good morning. Good morning. So yes, I just wanted to kind of touch on a couple of things that we've talked a little bit about. So just in terms of the price increases versus mix and the 1.5% for the year, can you provide a little bit of color in terms of the mix portion of that versus the price?
No. I mean, both are significant contributors, but we're not providing that level of detail. Okay.
And then in terms of reaching a larger remaining portion of the medium customer base, what are the initiatives that gives you the confidence that that's achievable? And how much of that is factored into the longer term 6% plus volume growth that you guys are expecting?
Well, I mean, our expectation is that a lot of that will be through digital means initially, where we acquire customers to digital means and then figure out how to best serve them. I think what we're seeing with some of the digital efforts so far gives us confidence that, that will be a positive contributor. And certainly, we made the change with the idea of reengaging existing customers and driving more volume to existing customers and engaging lapsed customers and acquiring new customers. So all of that is important to our expectations going forward.
And that's factored into that the volume growth expectations that you guys have given or is that like above and beyond that?
It's factored in, although it's not a big portion of the 6% in the percent in the next couple of years. The expectation is longer term that will become a bigger portion of it.
Okay. Thank you.
Thank you.
That is all the time we have for questions. I'd like to hand the call back to Mr. MacPherson for closing comments.
All right. Thanks everybody for joining us. Obviously, we're very pleased with our progress. In the U. S, we're pleased that pricing changes are resulting in strong growth with gross margin rates above expectations.
I think we're probably most pleased with the fact that we're really developing stronger relationships with customers and all different types of customers. In Canada, we like the progress we've made to date. It's still a lot of work to go, but we really see signs of progress, and we're excited to get that business back to a profitable state. And then our online model continues to drive great revenue and profitable growth and international businesses are all contributing. And we're very happy with the expense leverage we've seen and continue to focus.
We will continue to focus on making sure that we spend money wisely to drive growth and to serve our customers and to improve our productivity. So we feel like we're really well positioned to gain share, improve our economics going forward, thanks for being with us today.
Ladies and gentlemen, this does conclude today's teleconference. Thank you for your participation. You may disconnect your lines at this time and have a wonderful day.