固安捷 (GWW) 2018 Q1 法說會逐字稿

Greetings, and welcome to the W.W. Grainger First Quarter 2018 Earnings Conference Call. (Operator Instructions) 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 DG Macpherson, Chairman and CEO; and Tom Okray, 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.

DG 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 welcome Tom Okray to Grainger. Tom brings a great combination of finance and operations experience with him. He 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 fourth quarter of 2017 continued into the first quarter 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 expectation of 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 first quarter 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 million 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 Techni-Tool divestiture last July. Price was down 1% in the quarter, and we had currency favorability of 2% in the quarter, driven by the 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 continued 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 first quarter, 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 businesses continued to drive strong growth and profitability, and our international businesses performed ahead of our expectations as a group and contributed to 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 fourth quarter 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 Techni-Tool 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% excluding 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 U.S. and focusing on large and 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. Midsized 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 rates 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 first quarter was one-off in nature, and we don't expect it to repeat. I'll talk about that in a minute. Then 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. $0.20 was U.S. volume and price, and we expect that to repeat each of the next 3 quarters. Another $0.45 was one-off in nature, and we do not expect it repeat. That includes a tax benefit from stock-based awards, some international business favorability, the timing of certain contract negotiations and a change in counting estimate in the U.S. And finally, $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 expected a price headwind of negative 2% for the year. That negative 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. It's 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 through 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 stronger 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 the 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.

(Operator Instructions) Our first question comes from the line of Christopher Glynn with Oppenheimer.

Digging into the U.S. medium customer, I 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, thank you, Chris. As I mentioned, there are really 3 sources for that growth. One is getting more share with active customers; another is reengaging lapsed 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 3 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 bps. 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 first quarter.

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 first quarter, 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.

Our next question comes from the line of David Manthey from Baird.

Thomas, congratulations. Look forward to meeting you. Am I understanding it right that your net pricing is 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 had 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 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: one 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 margins sources within existing customers as well. So there's really 2 things going on: one is the inflation benefit that we get, and the other is customer mix benefit.

Our next question comes from the line of Ryan Merkel with William Blair.

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.

So let me just describe. So the 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 had 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, so we made a change. That's going to be now 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 first quarter's gross margin. But can you just clarify, how much did gross margins decline sequentially into the second quarter? And then could you also comment on the trend line? Is it stable to slightly rising sequentially from the second 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 second quarter to be slightly lower because that benefit was in the first quarter and won't be in the second quarter. 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 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.

Our next question comes from the line of Robert Barry from Susquehanna.

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 bps. I think that was 130 bps last quarter.

Yes, that's right.

And I think the math, if you were down 60 in the first quarter, would actually imply a fair amount more pressure in the remaining quarters to be down 110 bps for the year. Your answer to the last question about just a 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. It's -- 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 first quarter. 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 second quarter versus -- or maybe a fair amount in the second quarter versus the first quarter, 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, so...

Our next question comes from the line of Scott Graham from BMO Capital Markets.

I wanted to beat the dead horse here, the $0.45. [Hasn't] timing of contract negotiations -- how specifically does that translate into something positive? There's some backdating there? Or how does that work?

Well, if the contracts push out or 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 -- yes, right. Yes, right. We only thought -- 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 understand. 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 to the $0.45, and those 4 all contribute.

I see. Okay. And my last question is I don't know how close you guys have looked at some of the tariffing, I'll call it, going on out there. You've got China, even a little bit of Russia. But just kind of wondering if you guys have looked in this sort of 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 we participate in. We look at it 2 ways: one is understanding 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.

Our next question comes from the line of Robert McCarthy with Stifel.

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 anniversary-ing these compares, particularly [is] 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 some 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. Midsized customers, what we're finding is the price points we're at are actually good for both acquiring customers and then reengaging relapsed customers, and we have not reached yet a large portion of that market. So I feel that 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 -- what you can share about the business kind of an EPG time frame? 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 in U.S. medium-sized? We'll be talking about Gamut. We'll 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 1.5 months before we -- or a month before we speak with you again.

Yes, what do you do with your time? So I think the 2 topics are going to be: one, midsized 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.

Our next question comes from the line of Patrick Baumann with JPMorgan.

Can you just talk about, looking at 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, the 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 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 said 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 again.

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 then just curious on that price/cost. Is that going to exit the year in your current planning as a positive contributor in the fourth quarter?

Yes, yes. So -- oh, yes. So in terms of the GP rate, we're 20 basis points better than we were previously in terms of what we expect for the U.S.

In GP, but I was talking total segment margins.

Oh, on earnings?

Well, margin guidance for the year for the U.S. segment, right? You gave guidance...

Yes, yes. We haven't given. We haven't given margin guidance for the year for the U.S. segment.

You can kind of update then?

No, we're not updating.

You'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, do you think it will be positive?

Well, I mean, I think you may be asking 2 questions simultaneously. So what we talked about is our reset this year is going to be 300 basis point decrement. And then we've talked about positive price/cost above that. And so yes, price/cost is going to be positive for the year for sure. Then what will happen, as we go into next year and we'll start talking about that later in the year, is we would expect that 300 basis points to be like -- that will be much smaller. And we won't talk about that really till November.

Our next question comes from the line of Deane Dray with RBC Capital Markets.

Welcome to Tom, and congratulations. I wanted to follow up. What's also interesting from this 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 in 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 -- of those products that have the deepest price discounts. But maybe you can 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 line.

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 is the kind of the breaking point for you in Canada?

Yes, 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 to a position where our prices are well below market. And as we've improved our service and come out of that, we've been able to pass some of those prices through. So it's really not even an analogous situation at all today.

Got it. Just maybe if I can sneak one more in. Any color on Cromwell?

Cromwell is performing as expected at this point. We're -- 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.

Our next question comes from the line of Ryan Cieslak from Northcoast Research.

Tom, congrats and welcome as well. My first question, DG, 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 COGS inflation, excuse me, 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've talked about this before. If we had 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 -- 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 DG, I mean, would it be fair to assume, though, you're having maybe a better benefit 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 that 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-sized 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?

We'll probably talk about that as we go forward. I think the incremental margins on that midsized 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.

I 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 '19 at this point?

No, that's still -- we have 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 go up quite a bit. Has any of the cost negation been on that aspect? How successful that's 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 third 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. 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.

Our next question comes from the line of Joe Ritchie from Goldman Sachs.

This is actually Evelyn Chow from Goldman. 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 the decision to defer. Is it sort of a decision to maybe think about different customer accounts that you're targeting? Is it a reflection of the pricing or demand environment? 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.

Our next question comes from the line of Justin Bergner from Gabelli & Company.

Maybe you could just talk about the Other Businesses a bit. How is Zoro performing? Any sort of trends there on any of those subcomponents?

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, Fabory, 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 it's 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 that. 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.

Our next question comes from of the line of Hamzah Mazari from Macquarie Capital.

The first question, DG, 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 account versus overall medium customer account? Any data points to sort of help us understand sustainability of share gains in that segment?

Yes. I mean, I think I'll point to a couple of things. One is we were $1.5 billion to $2 billion in midsized 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 0.5 million or more attractive midsized 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 that 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 a sort of more room to grow 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 not -- 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 to follow up, do you guys have any impact from -- I know you don't give more details, but any impact from Easter or weather in your Q1?

So what -- 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 -- February, March.

Our next question comes from the line of Matt Duncan with Stephens.

So first thing I've got, I'm hoping you can give us a little bit of clarity here on gross margins. So your guide before it had been 130 basis point decline with a 70 bp drag from the accounting change. It's now a 110 basis point decline with only a 50 bp drag, implying that the underlying gross margin hasn't really changed, and yet you're updating in a positive way that price/costs spread in the U.S. So how do we reconcile those 2 things together?

So net-net, the expectation is that the underlying GP will be 20 basis points better than we had said back in the fourth quarter.

But there's a 50 bp 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 bp. 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 in there?

Well, if you recall, we're actually merging Gamut and grainger.com and building a lot of those capabilities into grainger.com at this point. The team is working to build those capabilities in, and we'll provide a bit of an update at EPG in May.

Our next question comes from the line of Steve Barger with KeyBanc Capital Markets.

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 and understand the source of the benefit.

Okay. And based on the 4Q presentation, free cash flow guide is 8 10 to 8 50 for the year. 1Q came in at $97 million 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.

Our next question is a follow-up question from the line of Justin Bergner with Gabelli & Company.

On the gross margin, 20 basis points improvement, is that almost all mix towards medium 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 cost, that difference.

We have a follow-up question from the line of Patrick Baumann with JPMorgan.

I just had one more, and I know this question has been asked a bunch of times in the call, and I'm not sure I quite understood the answer yet. So the U.S. segment margin in the first quarter 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 first quarter, 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 relook with the new CFO coming in? Or 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, so...

Our next question comes from the line of Chris Belfiore with UBS.

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 gives -- what are the initiatives that give 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 through digital means 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 dragging more volume through existing customers and reengaging lapsed customers and acquiring new customers. So all of that is important to our expectations going forward.

And that's factored into the volume growth expectation 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 next couple of years. The expectation is longer term, that will become a bigger portion of it.

That is all the time we have for questions. I'd like to hand the call back to Mr. McPherson 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 the 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. 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 our 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 still going forward, and 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.