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Text: Actual results may differ materially as a result of various risks and uncertainties, including those detailed in our SEC filings.
Today, I'll provide an overview of our second quarter results and progress toward our goals as the economy recovers.
Before we get into details on the quarter, I'd like to spend a moment highlighting our Grainger Edge framework.
Two years ago, we launched this framework that defines who we are, why we exist and where we're going.
It covers our purpose, aspiration strategy and the principles that drive our actions.
It all starts with our purpose.
We keep the world working.
We shared this with all team members across the company in 2019.
While the concepts weren't new and many were already part of our operational DNA, the framework provided clarity at who we are and what we do as well as the common language for our team members.
The Grainger Edge has guided us through the pandemic, and I'm proud of how the Grainger team has continued to embrace it.
It's also been a strong foundation for how we serve our customers and helped us through the challenges of the last 18 months.
Speaking of challenges, 2021 has provided plenty.
The year has been characterized by strong demand but a very challenging supply chain environment.
Raw material shortages, labor shortages and transportation challenges have been the norm, particularly in the second quarter.
These challenges are industrywide.
And while we're not immune to them, we are uniquely positioned to leverage our scale and navigate through these ongoing difficulties.
Importantly, this year, the supply chain has become a competitive sport.
And while we've had obstacles and things are messier than normal, our customer research suggests we are navigating the obstacles well and providing very strong relative service during this time.
We are actively leveraging our network.
For example, for a customer located in New York, we would typically fulfill their entire order from our Northeast DC.
Due to supply constraints or product delays, now part of the order may only be available in Louisville.
In this case, the order may be fulfilled from Louisville, adding an extra day and incremental cost to the order.
But we are able to leverage our network to provide and protect our great service.
We are also leveraging our branches for more shipping in this environment.
In addition, we have accelerated the ramp of our Louisville DC, which has helped alleviate capacity constraints.
This building is a great asset for Grainger and will continue to ramp capacity through the next 18 months.
The good news is that we still have very high availability in our network even if the product comes from an alternate location.
I've had the opportunity to be in the field quite a bit this past quarter and have been excited to spend time with the customers and hear their feedback.
I'm hearing consistently that while we may be delivering a bit differently than the past, we are serving our customers better than the competition.
We have validated this through feedback on our recent customer surveys, and the vast majority said we were doing better than other distributors right now.
We are also investing in non-pandemic inventory and partnering closely with our suppliers to work through any supply constraints, inbound lead time challenges and any potential cost increases.
Additionally, shortage in the labor market have had a significant impact for all companies this year.
In response, we have increased our wages to attract and retain talent, especially in our distribution centers.
We've implemented robust training programs to onboard new team members and train existing team members to work throughout our buildings.
We have made great progress in closing staffing gaps and will continue to do so over the third quarter.
Finally, transportation has been very challenging.
That is clearly linked to the product and labor shortages.
While we have always prioritized optimal routes and cost efficiencies, over the last few months, we have partnered with our carriers in new ways to ensure we are meeting customer expectations.
We have also added new partners to our carrier mix to handle our volume and provide us flexibility.
It's important to note that the overall freight market is volatile and uncertain.
While we are confident in our current plans to manage these challenges, there are a lot of moving pieces and constraints across all modes, parcel, LTL and ocean freight.
For example, the ocean freight market has been uncertain as the pandemic surges again in Asia and container costs fluctuate.
We are ready to respond to any of these dynamics.
We expect the supply chain challenges to last through the end of the year and likely well into next year.
I have no doubt, as we continue to live the Grainger Edge and follow our principles, we'll not only get through these challenges, but we'll deliver strong results and take market share.
Turning to our financial highlights.
The bottom line is that our performance has been in line with our expectations and what we communicated on our last earnings call.
The only exception to this has been gross profit impacted primarily by the changes in May to the CDC mask guidelines halfway through the quarter.
Heading into the second quarter, all external factors were pointing to a reopening in the U.S. around or sometime after the 4th of July, giving us a full quarter to sell through as much of our remaining pandemic inventory as possible.
Based on our internal scenario planning, we thought that potential adjustments in Q2 would fall somewhere between $45 million and $50 million, while we couldn't predict precisely how far the demand curve would fall or when.
Then, when the CDC mask guidance changed in mid-May, we saw our demand for pandemic products, especially masks, declined rapidly.
As a result of the sudden weakening of demand, we had more pandemic inventory remaining than expected, and we took a $63 million adjustment, about $15 million more than our internal scenario planning.
We believe this completes any material pandemic-related inventory adjustments.
Without this incremental change, GP would have been roughly flat sequentially.
We understand that CDC has just changed guidance again this week.
While the situation is fluid, we do not expect any material change in our outlook as a result of this change.
Shifting to the other financial results.
We achieved strong organic daily sales growth of 15% for the company on a constant currency basis within our guided range.
When compared to 2019, Q2 was up about 14% on a daily organic basis, a positive indicator of our strong performance and recovery beyond the pandemic.
Our High-Touch Solutions North America segment grew 12.7% on a daily constant currency basis.
In the U.S., we lapped the most extreme volatility of 2020.
Looking at the two-year average in the second quarter of 2021, we drove approximately 275 basis points of average market outgrowth.
We remain very confident in our ability to grow 300 to 400 basis points faster than the market on an ongoing basis.
We expect the volatility of 2020 and 2021 to average out and get back to normal heading into 2022.
Our Canadian business drove positive operating earnings growth for the quarter and managed expenses well.
We are seeing continued momentum in targeted end markets, especially heavy manufacturing and higher education as schools prepare to reopen in the fall.
And we continue to diversify the business beyond natural resources.
The Endless Assortment model had another impressive quarter with 23.9% daily sales growth on a constant currency basis, fueled by strong customer acquisition.
Lastly, we generated $269 million in operating cash flow and achieved strong ROIC of 29.2%.
Turning to our quarterly results for the company.
I've discussed most of what's on this slide, but I wanted to point out two additional items.
First, our SG&A was $790 million, in line with the guided range provided on our first quarter call.
As expected, we increased SG&A for the quarter as we continued to invest in marketing and in our people through increased variable compensation and wage rates in the DCs.
This resulted in total company operating margin of 10.4%, down 70 basis points compared to the prior year.
Excluding the impact of the $15 million incremental inventory adjustment, GP would have been roughly flat sequentially and operating margin would have been 10.9%.
The resulting earnings per share would have been around $4.50.
We continue to see a robust recovery with daily sales up 13.7% compared to the second quarter of 2020 and up 9.5% compared to the second quarter of 2019.
In the U.S., we saw strong growth in our non-pandemic product category with product mix returning to more normal levels.
For the segment, GP finished the quarter at 36.9%, down 125 basis points versus the prior year.
I think it's important to note that without the $63 million of inventory adjustment, GP would have been up 125 basis points year-over-year.
This 250 basis point swing demonstrates that our underlying GP rate would have otherwise been a healthy 39.4%.
Coupled with our focus on achieving price/cost neutrality, we are confident that our run rate GP remains strong.
SG&A in the segment ramped as expected to $640 million, lapping the lowest point of SG&A spend in the second quarter of 2020.
Canada continued to make solid progress and expanded operating margin approximately 315 basis points year-over-year.
Consistent with last quarter, we have included a chart with details on the U.S. and the Canadian businesses on the first page of the appendix.
On slide 10, looking at pandemic product trends, I want to highlight two things before we dive into the Q2 numbers.
First, we lapped the extreme growth experienced last year and saw decreased demand for PPE products.
Accordingly, pandemic sales declined approximately 28% versus 2020.
However, that's an impressive 27% increase versus 2019.
We estimate July 2021 will be down about 28% over July 2020, in line with what we saw in the second quarter of this year.
More importantly, we see the trend in our non-dynamic sales as a positive sign of economic recovery.
During the quarter, we grew 31% versus 2020 and up 7% versus 2019.
We're seeing end markets like commercial, which include our severely disrupted customers in hospitality, along with heavy manufacturing, make a significant comeback.
We estimate that for the month of July 2021, non-pandemic sales growth of about 22%.
As it relates to pandemic product mix, while we expected it to taper off to near pre-pandemic levels to about 20% by year-end, we're seeing this happen more quickly now at about 22% of sales.
In total, our U.S. High-Touch Solutions business is up about 12% for the second quarter of 2021 and up 10% over 2019.
Looking at market outgrowth on slide 11, we are lapping the highest concentration of large pandemic purchases of the prior year.
At this time, the market declined between 14% and 15% and we saw outsized share gains of roughly 1,200 basis points.
For Q2 2021, we're seeing the opposite effect.
We estimate the U.S.
MRO market grew between 18.5% and 19.5%.
The U.S. High-Touch business grew 12.4%, about 650 basis points lower than the market.
To normalize for the volatility, we calculated the two-year average share gain to be 275 basis points over the market.
There's some noise in the market number because -- across industrials, given the dynamics and fluctuations over the last two years.
Therefore, the two-year average is a better estimate of what's really going on.
As I previously noted, our U.S. High-Touch business is up 10% over 2019.
As the impact of the pandemic subsides, coupled with our strong progress on key initiatives and our return on investments like marketing, we remain confident in our ability to achieve our share gain goals.
Now let's cover our U.S. GP rate.
As previously discussed, our second quarter GP decline resulted from the $63 million inventory adjustment.
This adjustment lowered U.S. GP by 270 basis points.
Without this, our underlying U.S. GP rate is 39.8% in the second quarter.
As we look to the remainder of 2021, it is important to note we are operating in a very challenging and fluid environment.
We're doing everything within our control to exit the year with a Q4 GP rate at or above the Q1 2020 levels or 40.1%.
We remain confident in our ability to achieve this target for a few reasons.
First, as noted earlier, we anticipate no further material pandemic-related inventory adjustments.
Excluding the inventory impacts, our GP rate is nearing this level already.
As we discussed on slide 10, our pandemic product mix is close to pre-pandemic levels, and we expect this to fully normalize in the second half.
And we've seen evidence that we can continue to maintain price/cost neutrality.
On the cost side, we have a robust process to partner with our suppliers and understand the specific raw material impacts as well as other conditions that may result in increased costs.
As it relates to price, our goal is to continue to maintain competitiveness in the market and pass what is applicable.
In the first half, we were slightly above neutrality and as we expect to take additional price increases in the second half to offset what we're expecting in costs.
Even in this inflationary environment, we are confident we will be able to execute and achieve neutrality through the remainder of the year.
Moving to our Endless Assortment segment.
Daily sales increased 23% or 23.9% on a constant currency basis, driven by continued strength in new customer acquisitions at both Zoro and MonotaRO as well as growth of larger enterprise customers in MonotaRO.
GP expanded 75 basis points year-over-year driven by positive trends at both businesses, and operating margin finished up 95 basis points over the prior year.
I'll go into more detail on the next slide as we provide further transparency on the results of both of these businesses.
Moving to slide 14.
Please remember that MonotaRO is a public company and follows Japanese GAAP, which differs from U.S. GAAP and is reported in our results one month in arrears.
As a result, the numbers we disclose will differ somewhat from MonotaRO's public statements.
In local currency and using Japan's local selling days, which occasionally differ from U.S. selling days, MonotaRO's daily sales grew 16.7% with GP finishing the quarter at 26.4%, 25 basis points above the prior year.
Operating margin decreased 15 basis points to 12% as they continue to ramp up operations at the Ibaraki DC.
Again, another strong quarter for MonotaRO.
Switching to Zoro U.S., daily sales grew 32.6% as it laps its softest quarter of 2020.
Zoro GP grew 95 basis points to 31.5% and achieved 320 basis points of operating margin expansion through substantial SG&A leverage in the quarter.
All in all, very impressive results.
Moving to slide 15.
In addition to the strong financial performance, we're seeing positive results with our key operating metrics.
As you saw in the first quarter, we've listed total registered users for both businesses, an important driver of top line performance.
Both MonotaRO and Zoro have shown progress and are up over 20% over the second quarter last year.
On the right, Zoro continues to actively add SKUs to the portfolio.
At the end of the second quarter of 2021, we had a total of 7.5 million SKUs available online, close to our goal of eight million for the year.
We remain encouraged by our progress with SKU additions beyond traditional MRO.
Now I'll provide commentary as it relates to the upcoming quarter and our expectations for the full year.
For the third quarter, on a total company level, we expect our revenue growth to be between 10% and 11% on a daily organic basis.
We believe any material pandemic-related inventory adjustments are complete, and we expect GP to be up between 100 and 120 basis points year-over-year and to improve sequentially.
SG&A is anticipated to fall between $805 million and $815 million as we continue to invest in marketing and wages in the DCs to remain competitive.
Transitioning to our total company guidance, I'd like to provide some brief commentary on how we're trending so far.
We expect strong sales to continue while GP, operating margin and earnings per share will face pressure as a result of the incremental inventory adjustments and freight costs, along with investments and increased DC wages and marketing.
While we are maintaining our guidance, we expect results will trend toward the low end of our range with the exception of revenue.
We expect revenue to be near the midpoint.
As it relates to our segment operating margins, we think that some of the supply chain challenges as well as the first half inventory adjustment will weigh more heavily on the High-Touch Solutions segment and therefore, High-Touch operating margin may trend at the low end of the range.
At the same time, we believe Endless Assortment, driven by strong performance and improving margins, may end the year at the high end, both helping to support delivery of total company results.
We are not adjusting guidance as we are confident in our ability to deliver results within our guidance ranges.
As we learn more, we'll continue to keep you apprised of any changes.
First, I'm proud to announce that earlier this month, Grainger was certified as a Great Place to Work, a true testament to the exceptional team member experience we've built and an important milestone in advancing the Grainger Edge.
Second, it's our 10th year of publicly reporting our ESG efforts.
I wanted to share highlights from our new corporate responsibility report.
At Grainger, we embrace our obligation to operate sustainably and with a long-term fact-based view of critical issues regarding the environment, society at large and corporate governance.
For example, in 2012, we became the first industrial distributor to publicly disclose our carbon footprint.
In 2013, we became the first in our industry to set a public greenhouse gas emissions reduction target, which we achieved two years early.
We just set a new goal last year to reduce the absolute Scope one and two greenhouse gas emissions by 30% by 2030.
We're also committed to helping our customers achieve their ESG goals through our products and services.
We now offer more than 100,000 environmentally friendly products.
Through this portfolio, we're able to help customers maintain sustainable facilities via efficient energy management, water conservation, waste reduction and improved indoor air quality.
And this year, we formed the ESG Leadership Council, which I chair.
The council is comprised of Grainger leaders who provide strategic direction and oversight on our ESG efforts.
You can find the new report at graingeresg.com.

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sees 2021 net sales $12.7 billion - $13.0 billion.

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