Greetings, and welcome to the W.W. Grainger’s Second Quarter 2017 Earnings Conference Call. At this time, all participants are in a listen-only mode. A brief question-and-answer session will follow the formal presentation. [Operator Instructions] As a reminder, this conference is being recorded. It is now my pleasure to introduce your host Ms. Laura Brown, Senior Vice President of Communications and Investor Relations. Thank you. Ms. Brown, you may begin.

Thank you very much. Good morning, everyone, and welcome to Grainger’s Q2 quarterly earnings call. [Technical Difficulty] Good morning. This is Laura Brown and welcome to Grainger’s Q2 quarterly earnings call. With me are DG Macpherson, CEO; and Ron Jadin, Senior Vice President and CFO. As a reminder, some of our comments today maybe 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 the corresponding GAAP measures are at the end of this slide presentation and in our Q2 press release, which are available on our Investor Relations website. DG will begin by making some opening comments regarding the performance of the company with an update on our pricing actions in the U.S. and expense management. After that, we will open the call for questions. DG to you.

Thanks, Laura. So this quarter was about staying focused on creating value for customers, while executing our pricing initiatives in the U.S. and improving the economics of the portfolio. Before I go into detail on these activities, I’ll discuss overall company results. We’ll start with our reported results on page – on Slide 4, which were significantly impacted by restructuring. We began winding down the Columbia business in the quarter, which resulted in restructuring charges of $42 million. This business has struggled with sustaining profitability and we are moving quickly to ensure we have businesses with competitive advantage and strong returns in the portfolio. In the quarter, we also took steps to transform our Canadian business. We announced the closure of 59 branches and eliminated poorly performing assets, resulting in $20 million in restructuring for the quarter. I’ll discuss Canada in more detail in a few minutes. This morning’s call will focus on adjusted results, which exclude items outlined on page two of our press release. So turning to our adjusted results, our adjusted results were in line with expectations. Total company sales were up 2%. Volume for the company was up a healthy 7%, as many end market strengthened and our pricing actions started to take hold. Price was down 3% as expected and consistent with the first quarter. Gross profit declined 110 basis points in line with expectations that we had discussed in April. And we continue to get operating expense leverage on higher volume as operating expense as a percentage of cost was 50 basis points better than last year. Let me start with our other businesses. For our other businesses, which include our online model and our international businesses, sales were up a 11%. That included a 3% headwind from currency largely due to the British…

Thanks, D.G.

So now we’ll open it up for questions.

Thank you. We will now be conducting a question-and-answer session. [Operator Instructions] Our first question comes from the line of David Manthey with Robert W. Baird. Please proceed with your question.

Thank you. Good morning.

Good morning.

First off, have you been able to isolate the outgrowth from pricing effort versus the growth that would be driven by an improving market? And whether that’s looking at your growth versus comps or some other benchmark. How do you know that the growth you’re seeing right now was due to the pricing actions and not just the backdrop getting better?

It’s a great question, thanks. Let me just start by saying that, we think the market has grown this year and we have seen strengthening in many segments. And so part of the growth is certainly – part of the volume growth is certainly driven by strengthening in the market – of the marketplace. When we look at the pricing actions, we see growth that is significantly higher than we see in the past in areas that are directly affected by pricing and that’s what gets us comfortable, particularly midsized customers, where we were double-digit negative last year and that were positive. Large local customers that are not on contracts, which have turned positive and have been negative for a long time, and then just the spot buy with manufacturing commercial customers, which have turned positive as well. And so we see very strong growth in those areas and that gives us confidence that what we’re doing is working. And we – we’ve estimated the market to be growing a couple of percent this year with volume of 5% in the U.S. Certainly, we feel like we’re gaining volume share and most of that is probably reaction to our pricing at this point.

Okay. And then the follow-up would be, as it relates to the progression, does the lack of momentum into June concern you at all given the backdrop in sort of what the competitors have been reporting? And I know you mentioned government, but anything else we should know about there?

No. That – it’s really all government. In fact, government’s 100% of the slowdown. We saw state and local government holding funds. We saw federal government holding funds in many cases. There are rumors that that is easing up, but we’ll have to wait and see if that plays out, so it has been all government during the quarter.

All right. Thanks, D.G. Ron, congratulations.

Thanks, Dave.

Thank you. Our next question comes from the line of Ryan Merkel with William Blair. Please proceed with your question.

Thanks. Good morning, everyone.

Good morning.

Good morning.

So my first question is, have you seen margins come under pressure for the who cares items like lights and batteries and cleaning supplies? And I asked this, because investors are concerned, as you know, that you’re going to see margin pressure on these items. And I just wonder if there’s any evidence of it yet?

No. I guess, the short answer to that, Ryan, is not really. I mean, I think the industry is seeing pressure on margins across the Board the last few years. And certainly product and price transparency has increased as more customers Google items actually with two customers yesterday we were talking about our price changes. And their response was that’s fantastic, because we don’t feel like we should be negotiating every item with you. And if you’re in the ballpark, you’re going to get the business, given the service that you provide. And so really we’re seeing very strong response at very strong margins, where we’re getting the new price programs in place. So there hasn’t been a real change in the competitive environment necessarily on those items where we’re competitive.

Okay. And then for my follow-up question just on gross margin and pricing for the third quarter just to calibrate everyone. How much will U.S. prices be down in the third quarter? I was thinking down 5%, but I wanted to check. And then sequentially, maybe just help us, how much will gross margins be down sequentially into the third quarter?

So let me handle pricing first and then I’ll go and turn it over to Ron to handle gross profit. So we would expect July to be similar to what we’ve seen thus far this year, because there’s no change in July. For the rest of the year, we would expect to be price down – price to be down roughly 6, so we would expect kind of 5 to 6 in the quarter. And you asked GP as well, Ryan, is that right?

Yes, just sequentially just help us, I assume I would be down, I just was thinking just trying to help calibrate is how much?

Yes, I would say somewhere in the 100 basis points probably range, 100 to 130, sequentially.

Okay great. That’s helpful. Thank you.

Thank you. Our next question comes from the line of Adam Uhlman with Cleveland Research. Please proceed with your question.

Hi, good morning. I was wondering, could you spend a little bit more time about what you’re hearing in your large customer price negotiations that you’ve gone through the spot buy? Sales declines have gotten smaller, but they’re still down year-over-year. So maybe you could just give us a little bit more color about how those are going? How many contracts we retaining versus losing, that would be helpful? Thanks.

We – so we really haven’t lost any contracts that are meaningful to the negotiations. The negotiations have gone exceptionally well. I would say that, we still have to update a very small portion of those contracts on the new pricing, because most of that debt slips in the next month. So what you’re seeing was spot buy is encouraging, but it’s also relatively small base. Still we would expect to see better results as time goes on. So but so far we haven’t had. The conversations have gone well. Customers understand what’s going on in the marketplace. They really value the service that we provide – the services we provide in many cases. And so the conversations have gone very, very well and we’re going to create more value for customers and ourselves through these process.

Okay gotcha. And then could you talk to the branch closings in Canada? How should we think about the revenue impact from that here in the near-term?

Yes, so there will – so there will be some revenue impact obviously in the closed branches. Typically, we see revenue impact in the 20% roughly range, many of these branches. So to give you a sense, in the U.S. we have 250 branches. In Canada, we have 144 and the volumes attempt. So we’re over store in Canada right now until we are closing branches that are unprofitable, there’ll be some revenue impact, but it’s going to be positive OE impact. And we’ve taken a very closer look at where we want branches to be and where there’s foot traffic, where we can use those branches offer service to customers that they will stay open. And we will continue to provide actually better service to customers as products ships directly to customers, and we still provide services to customers twice the business. So some revenue lost certainly. We are really focused on getting the business reset to a place where it can grow profitably, that’s our focus right now.

Okay. Thank you.

Thank you. Our next question comes from Robert McCarthy with Stifel. Please proceed with your question.

Good morning, everyone. So first question just in terms of these trends you’ve been seeing, how do you think about just modeling for competitive response? I mean, obviously a lot of times, you’re dealing with a local where you’re losing out to a local mom and pop, or a local competitor on pricing and obviously lowering your price is going to help your volume. But how do you think about an environment maybe it’s obviously not across the Board.

Bob?

Yes.

Bob, we are having trouble. We are having trouble here, sorry. I’m not sure why.

Okay, can you hear me now?

You’re just breaking up.

You’re just breaking up, I’m not sure. But okay, let’s try, try again, I’m sorry.

Can you hear me now?

Yes.

Yes. Okay, sorry about that. So the question very simply is, how do you take into account competitive response in terms of your modeling in the back half of 2017?

Yes. And so I think the question is, how do you take competitive response to the model. I would say, we’re in an industry in the U.S. where the markets roughly $125 billion and competitors compete in very, very different ways. I was at a customer in Milwaukee yesterday and we were there, a lot of our competitors were there, serving different volume in different ways. And we have not seen direct response to the changes yet. It’s not obvious, given that some compete specialists, some compete online, some don’t compete online, it’s not obvious that how competitors will respond. And we feel like we get within range of the prices that we’re going to be very strong in terms of our growth. For the mom and pops, it’s not obvious that there’s a lot of room to respond really in terms of profit margins as well. So we’ll watch that closely. We’re watching it closely, and we will see what happens, but we haven’t seen much response yet.

Okay. And then Ron, congratulations on your career at Grainger. I guess the question I have in terms of launching for a new CFO search, it sounds like it’s external. Could you just comment on what you’re looking for and why there’s no internal candidates being vetted?

Our business has become more complex and we are – have looked at sort of the spec we want for a CFO, and we feel like we should cast away in that. So we’re going to look externally and find somebody who can handle the complexity of the regulatory environment, things have changed pretty substantially. And so we feel like that’s the right thing to do to look for the best candidate and we will find the best candidate we can find anywhere.

Thanks for your time.

Thank you. Our next question come from Andrew Buscaglia with Credit Suisse. Please proceed with your question.

Hi, guys. Can you update us on your free cash flow guidance? I don’t – I didn’t see an update there, and I would think it would have to come down relative to the restructuring charges you’re taking?

I’ll take it. This is Ron. Our free cash flow continues to be strong and it is kind of counterintuitive I suppose. There’s a lot of the restructuring that we’re doing at probably 80% of it is non-cash. So Colombia is a great example of that. So that has really affected our cash flow. And so while operationally there’s some pressure because of performance. There’s also a fair amount of cash flow we’re generating through the sale of the branches that we closed over the last two years. So, we expect free cash flow to continue to be strong and it’s up 10%, as we speak.

Okay, there’s no real change than I guess…

No. To give you a sense though, the Colombia is a $42 million charge and over $30 million of it’s actually non-cash. So that it’s not as big of a cash event as it is an earnings event.

Okay. Okay and then just as it relates to the whole industry, I know there’s definitely some skepticism in terms of where your pricing is relative to your competition. Can you give us, I don’t know some details or some confidence in that you’re not – you’re still not going to be the lowest price or in the industry, or I don’t know what it takes. It doesn’t seem a lot to be – the market doesn’t seem to be believing, but that’s the case. But at what point does the – to the price had stop, I guess is what we’re trying to gain confidence in?

So I can tell you, we’re looking at the competitive environment very closely. We’re not setting our web prices to be near the bottom on the stat. One thing I would say is, we actually spent a little bit of marketing money in the quarter on customer acquisition. At those put for items that we already changed on web prices and we had a very good response on small volume. And so I think we’ve shown and proved to ourselves that we can acquire customers at a price that is not low. It’s competitive, but it’s not low. And so, we don’t feel like we’re going to have to – we know we’re not going to have to be lowest price and we feel like we’re positioning the price virtually.

All right. Thanks, guys.

Thank you. Our next question comes from Matt Duncan with Stephens Inc. Please proceed with your question.

Hey, good morning, guys. This is Will Steinwart on the call for Matt.

Good morning.

On the relative success you’re getting with the medium customer volume response versus the large customer, what’s the one point sequential volume pickup with the large group in line with your expectations for the quarter as we’ve seen the backdrop improved throughout the last three months and the year overall?

Yes, it was in line with our expectations. So keep in mind that large customers most of their prices had always been competitive. And so the price change will have less of an impact initially with large customers and then well at midsized. And so we would expect shift in midsized to be much bigger than our – with larger customers, and so it was right at our expectations for the quarter.

Thank you. Our next question comes from the line of Chris Belfiore with UBS. Please proceed with your question.

Good morning, guys. So, yes, I just wanted to kind of go back to some of the earlier comments on – in terms of the trends in the quarter. But just kind of looking in the back of the slides, you kind of put the sales by end market. I mean and I understand like you’re saying that government kind of fell off. But it says it was flat for the quarter in some of the other pieces that are similar size or even lower. So I’m just kind of curious like – can you, is there – can you kind of provide some cadence on like, how government, like what government actually did from month-to-month? And then how light, I mean, how something like a light manufacturing, it sounds like it got better, because you’re saying that government was kind of thelot – the most – the biggest lagger in the quarter, but it was still down for the – light manufacturing was still down for the quarter?

Yes, so the back-half of the quarter the government was down and everything else, the trend stayed stable effectively is the way to think about. I think that’s your question is, we saw a significant year-over-year down with government as state, local, and federal in some cases health funding. But everything else just kind of continued on similar trends.

I think government was up low double-digit in the first-half of the quarter, I believe. So it was the big change that of a second-half.

Government started the quarter very strongly and ended very, very slowly. And these are all – just keep in mind these are all very large contracts that we have with the government, so it’s completely independent of our pricing action and really what they chose to spend or not spend.

Okay. And then just on the marketing that you guys will be able to do more thoroughly once you all of the SKUs were kind of on a web pricing in the second-half of the year. Just a lot of the sales are going through e-commerce. So I’m just kind of curious like if there are some kind of examples of like kind of what Grainger, the kind of marketing kind of Grainger’s like looking to be in terms of the stuff like click through rates in terms of like searches by customers and addressing kind of like that kind of part of the business?

Yes. So we have a lot of examples of doing this very well, particularly the online model with MonotaRO and Zoro. So lot of this is marketing spend online with a paid search of product listing ads. The dynamic we’ve had on the U.S. for a long time is that, if we had a customer click through as we paid – used paid search advertising, they would click through a price that was or they see a price the visible price that was much higher than the competition. So the difference now is when they click through, they’ll see something that is reasonable, and that marketing will have a much higher return than it had historically. We haven’t had great returns in the U.S., but particularly on new customer acquisition with marketing where we have with MonotaRO, for example. And so as we think about this, we’re going to spend marketing spend to acquire customers and then to acquire contacts within existing customers and the return on that should be much better than we see in the past because of our pricing.

And as a result, we’ll spend significantly more than we have in the past on that area.

Yes, it make more sense to spend more, the return is much better.

Thanks.

Thanks.

Thank you. Our next question comes from Patrick Baumann with JPMorgan. Please proceed with your question.

Hi, good morning, guys.

Good morning.

Just a question on volume. Just curious what your volume expectations are for the U.S. segment in the back half of the year? What kind of pick up you have embedded in the guidance? I’m getting to kind of high single digits versus the 5% you did in the second quarter and would look like maybe 4% in June. Just curious if that’s in the range. And then you mentioned July, you’re seeing some of the government issues loosen up, and just curious how July to-date is trending on volume for the U.S. segment?

Yes, in the back-half of the year, we’re expecting 6% to 8% of volume growth. And so fairly strong volume growth based on the price changes and some marketing ads. I think the government is probably a wildcard still in terms of what happens we – we’ve heard rumors of things easing up, but we will need to see it. So we’ll see what happens with the government.

And in July, how are things trending?

We are not talking about much at this point.

Okay. And second question would be just any update on the 2018 plus kind of margin progression for both gross and operating margin? Just a lot moving around as we exit this year with the price downs overlapping into next year and just trying to get a feel for the past 12% to 13% you still expect for 2019?

Yes, we are very focused on actually in the price – the pricing changes effectively on improving our cost structure. We will provide 2018 guidance at the Analyst Day in November.

Thank you. Our next question comes from Deane Dray with RBC Capital Markets. Please proceed with your question.

Thank you. Good morning, everyone, and my congrats to Ron also. Hey, my question is a bit to address your longer-term growth expectations in light of the new pricing. So if this quarter, we learned 4% down price drives 5% in volume, how do you hit a 6% to 8% revenue growth target out in 2018, 2019 without the benefit of further discounting? So is it a flat pricing environment? How do you get flat pricing environment and to drive 6% to 8% volume growth?

Well, when your prices are – your visible prices are much higher than the competition, and you do things like digital marketing, you don’t get the returns that you get. So this will enable us to spend on marketing dollars from midsized customer for customer acquisition like we have been able to do before. I would also say that when you sit down and talk with our customers, customers like as recently as yesterday, they are very excited if we are reasonably priced to give us a whole bunch of more volume. And so we’re pretty excited about – they’re pretty excited about the prospect and not having to come to us for negotiations for SKU level decisions. And so we feel like that’s going to change the game pretty substantially. Thus far, we’ve only changed partial prices. And so what you’ve seen so far is a partial response to the pricing changes and that will change start again in August.

What portion of your SKUs have had the reprice to web pricing? Can you size it by – either by customer base or by percent of SKUs?

So percent of SKUs online spend 400 some thousand, so it’s been 25% to 35% have been repriced or repriced at the beginning of the year and that that will be all of them soon. And at the percentage of volume, I think that the most important thing to recognize, it was large customer volume, large customer pricing was already competitive. So the impact has been fairly small thus far on large customers. We renegotiated a bunch of contracts in the last 60 days that will change that dynamic. But so far large customer prices really haven’t been all that different this year than they’ve been in the past in many cases.

Got it. And then just last question for me is on the buyback program. What would cause you to put the program on hold? And just the thought here is, do you see risks in continuing to lever up the balance sheet to fund buybacks when the business model is in such a state of change right now?

Yes, Deane, that’s a great question. I guess I go back to the strength of our cash flow generation through cycles is very strong. As you know, we reinvested about a third of our cash back in the business and the other two-thirds given back to shareholders. So there’s a lot of excess cash. So, that’s not a real concern of ours at all. We buy through the cycles. We’ll continue to buy back shares as we’ve given a guidance in the past. We’ll continue on that same path.

Got it. Thank you.

Thank you. Our next question comes from the line of Chris Dankert with Longbow Research. Please proceed with your question.

Good morning, guys. Thank you for taking my question. I guess just first off, you mentioned Cromwell was having some issues given the Brexit concerns and rolling out the new initiatives, I guess. Any update on what the growth rate look like there in the quarter and just kind of where profitability is at? I think last we knew was near break-even, is that still the case?

This is for which business are you trying to refer to Cromwell?

Cromwell, yes.

Yes. So, we think we gained a little bit of share in the first-half of the year. The market is down slightly, we’re up slightly. So that that’s our volume growth – our sales growth in Cromwell. The business is right around break-even now from a – from an earnings perspective. Keep in mind that that includes fairly significant investments we’ve made in the supply chain over the last nine months to go more to a direct-to-customer model. And we feel like that business will bounce back profitably wise fairly quickly and positive next year. So we’re not concerned about the long-term health of the business. We – but it has been a market challenge and the other thing has been a challenge is the currency change with the British pound has caused us to chase some price increases and the GP line has suffered..

Got it. And then just, any update on the status of the ERP transition in Canada? I mean, has that been more of a hindrance on trying to get those branches realigned or is that actually kind of help you identify opportunity at this point?

Well, I would say, for about a year, it was a big hindrance of doing any things. We had a bunch of service problems in the business. We are now a stable service, is good in the business. And we’re able to take a fresh look and really get after improving the fundamental operations and profitability of the business. It actually helps us now. We have more visibility into where there are – where there’s profitable portions of the business and where there isn’t. So right now it’s working well and stable.

Understood. Thanks so much.

Thank you.

Thank you. Our next question comes from Nigel Coe with Morgan Stanley. Please proceed with your question.

Yes, thanks. Hi, guys. Just going back to the government swing between the first portion of 2Q and the latter portion understanding that there were some budget pressures in certain states. But any sense on what would such a big swing? And also just to clarify, does that impact the spot purchases, because my impression was that the government sector had less spot purchases?

I don’t think in this case, it had much impact on spot purchases in the aggregate. So we have a very clear view to the pipeline and many of our government customers. And so the pipeline looks pretty good, but the money didn’t release at the end of the second quarter and that was – you can tie into very specific state and local governments and very specific federal agencies, it just did not release any money. So in this case, it’s pretty easy to see what’s going on, and assuming that you release the money, it will come back, but it’s very easy to see what’s going on from a pipeline perspective.

Okay. So just to clarify that the government sector did impact the slowdown in spot purchase between 2Q and the first-half of 2Q?

It would have been a little bit of a hindrance for that. Sure, yes, absolutely.

Okay. Okay, and then just maybe a follow on maybe for Ron. The accounts receivable seems quite high in relation to historical norms in 2Q? Anything driving that higher AR balance?

No, nothing unusual. Volume is up a fair amount. It’s just timing of collections and when the year-end closes off versus kind of the first-half of the year. This had a – it’s really just timing. There’s nothing unusual with DSO. The underlying DSO – that’s been – that’s remained stable.

Okay. Thanks, guys.

Yep.

Thank you. Our next question comes from Christopher Glynn with Oppenheimer. Please proceed with your question.

Thank you. Good morning, everyone, and Ron, congrats on your coming transition. I had a question on, the gross margin performance relative to the magnitude of the price resets is pretty impressive. I’m wondering, was there any reallocation of how costs get put into COGS versus SG&A along the way?

No, we see some COGS deflation, but there is no reallocation as just the actual performance.

Okay, great. That’s all I had. Thanks.

Thank you.

Thank you. Our next question comes from Scott Graham with BMO Capital Markets. Please proceed with your question.

Hey, good morning and congratulations, Ron. My first question is simply if we can go to chart 10, I’m trying to understand what sort of on the other side of the equal sign here. So we’ve got incremental expenses 2017 to 2019 listed. The cost takeout obviously goes the other way. Are you expecting mix to be the entire gap filler between what’s written here and the plus 100 basis points of operating margin expectation in 2019?

No, there’s a fair amount of volume leverage as well.

Yes.

So what…

What should happen is in 2019, our price should stabilize and so that volume growth in 2019 actually is positive for GP dollars. And then this – when you put this the expense picture below it, you get to the earnings guidance we’ve had before.

Okay. So what you’re saying here is that the WM&A percent of sales should start to more meaningfully come down than we saw in this quarter?

Yes. Yes, percent of sales should absolutely, yes.

Okay.

And I just wanted to make a comment earlier about the sequential GP rate. There’s nothing unusual in the quarter GP rate, but sequentially to the first quarter, there is an anomaly in the first quarter. And I’ll just go back to the press release from that, because it’s there year-over-year and it’s how our national sales meeting is accounted for and there are some costs that are moved between expenses and GP. So that does create a sequential difference from the first quarter to the second, and – but it’s just accounting-related, it’s not operational.

My follow up was simply, is it all possible that the U.S. June slowdown was maybe a function of customers maybe sitting on their hands a little bit, waiting for more price actions?

No, we don’t believe we’ve seen that behavior and talking to customers that doesn’t appear to be a behavior. Customers typically just buy. I mean, they’re not stockpiling inventory in our business and they buy when they need it. So given that’s kind of $300 at a time, we don’t expect to see much of that.

All right, very good. Thank you.

Thank you. Our next question comes from the line of Hamzah Mazari with Macquarie Capital. Please proceed with your question.

Good morning. Just first question, could you maybe give us some color as to what sort of a service premium you think on pricing is justified post your repricing actions? Is it 10%, 15%? And then what our customers think for? Is it product availability? It seems like technical support maybe a little bit in your portfolio part, just help us with some of that? Thank you.

Yes. So, Hamzah, I won’t talk about a specific percentage of them, actually that’s appropriate to talk about publicly. But – so let me tell you about the customer conversations we had. Yesterday, I was talking with a customer, and their perspective was, they get things the product availability, a wide range of products it comes quickly. But their perspective was also that, we provide them with a whole lot of support around safety service around inventory management services. We’ve embedded ourselves to help and manage our inventory. We understand how the business runs. We help them. I talked to somebody who places the orders. We talked about six people in the organization. And his view was, your orders are the easiest to place, easiest to get resolved, because you understand how our business operates and you link with our process very, very well. So there’s a whole range of the way we operate, which will allow us to command a premium in the market as long as that premium isn’t, so visible and so large.

And – thank you. And just a follow on, could you maybe update us on the current structure of the sales force? How much is insight sales now? And is there any opportunity on sales force efficiency remaining in – at the company? Thank you.

So we have – we’re mostly outside sellers calling on large complex customers. We have an inside sales team calling on midsized customers, but most of the numbers are in outside sales. We – there’s a couple of things going on. One is, we think pricing will allow those dollars to grow revenue, have better conversations and more conversations without having to talk about price as much and we feel like the revenue per sellers should increase. We should get more penetration at those account. So we look at revenue per seller pretty closely. Our expectation is we will get significant improvements based on the pricing actions, based on the tools we’re providing sellers, based on the number of factors and we are confident we’ll start to get more productivity out of the sales organization.

Great. Thank you. Best of luck, Ron. Thanks.

Thank you.

Thank you.

Thank you. Our next question comes from Robert Barry with Susquehanna Financial Group. Please proceed with your questions.

Hey, guys, good morning. Can you hear me?

Yes, thank you.

Great, lots of ground covered. So we’re halfway through the year, it sounds like the quarter was as expected. Should we be thinking the midpoint of the range as where you’re tracking at this point, still a pretty wide range out there?

I think based on the quarter, that would be a reasonable assumption. I would say that the quarter was as expected, given the changes going on in the business, given what’s going to happen in August 1. We’re very confident in the past, but there’s no reason to alter our guidance at this point. We feel like, we’re on the right path.

Kind of tracking to the middle, okay. And then just, I guess a question on price cost. What are you seeing in terms of COGS inflation on kind of a like-for-like product basis? It seems like we’re increasingly in an inflationary environment. And then what’s happening to pricing outside of spot buys and medium? Is there any place you think outside of those areas that you’re able to raise price? What’s the thought there? Thanks.

Yes, so we are – our COGS this year are likely going to be on the 0.5%, and we are not seeing huge inflationary pressure moving through, there is a little bit, but not much. If in fact, we got inflation, we would be able to get price in the number of places and number of customers. It works that way to see whether that happens, but we’re not – we have not seen any inflation in our COGS at this point.

Okay. It seems like a little bit of an outlier, because a lot of the others have been talking about starting to see inflation and having some challenges getting price. But I mean any reason why you’re not seeing inflation or actually seeing deflation?

Well, I think we have worked very hard putting processes to manage COGS. We work – we’ve put in new processes to really understand the competitive environment, understand what products should cost and build that into our work with suppliers. I think we’ve done a nice job of managing it.

Gotcha. Thank you.

Thank you.

Thank you. Our next question comes from Joe Ritchie with Goldman Sachs. Please proceed with your question.

Thank you. Good morning and congratulations, Ron, as well. My first question I guess just going back to Nigel’s question earlier on spot, it sounds like the government business didn’t really impact the spot performance as the quarter went on. So what specifically led to kind of weaker performance of spot as we progress through 2Q?

No government business did impacted and we saw for large customers spot buy x government was pretty stable throughout quarter.

Got it. And maybe thinking about spot longer-term, how – D.G., how are you thinking about the like mix of business moving forward? The spot remain 30% of your large customer base, or is – does that number just trend down over time?

We actually hope the trends up. I think when we’re talking to customers now about the new pricing structure, both us and they would like to get out of the situation where we have to negotiate every item. And so our hope is as we grow midsized customers as we grow long-contract customers, as we get the new contracts in with contract customers that actually spot buy will grow and we feel like we can make that happen.

Got it. And maybe one quick follow-up here. Just thinking about the guidance for the year, you guys have alluded to the price downs that are coming in the second-half to call it five to six point the price downs. How are we – how are you guys thinking about the gross margin the year-over-year change in the second-half? I think the guidance for the full-year is still down 160. What does that imply for 2H in your guidance?

It’s down. It’s a little bit more significantly third and fourth quarter over the prior years than it is in the first-half. So it’s worsening, but we haven’t given guidance on that per se. We’ve kind of stayed with the whole year. I think our total year guidance is still good, just a little – obviously a little bit worse in the second-half than the first-half on a year-over-year comp.

Okay. And maybe even more specifically then in terms of offsetting the pricing declines like I know that you’re thinking about 6% to 8% type volume growth. What are – what other items should we be thinking about as potential offsets to the pricing?

A product mix continues to be favorable for us. And what I mean by that is we’re – it’s not offsetting GP rate, but it’s at least mitigating some of it. And that’s the growth we’re seeing with the medium-sized customers in particular and the product they’re buying that even though their price reduced they’re still at margins above the company average. And so that does provide a partial mix offset.

Okay, got it. Thank you, guys.

Thank you. Our next question comes from Justin Bergner with Gabelli and Company. Please proceed with your question.

Good morning and thank you for taking my questions, D.G. and Ron.

Good morning.

On Cromwell, I’m trying to understand, it looks like it was a pretty sizable operating profit hit year-on-year in terms of dollars. Could you – is that going to disappear as we move into the second-half of the year, or is that a permanently sort of rebased margin for Cromwell?

Well, it’s not a permanently rebased margin. A lot of that has to do with the currency and the currency shifts having an impact on GP rate. And so we are working through pricing changes as a result of that. But when that happens typically, we like that and so we have to make that up. We’re also working on the plans to get back to where we need to be starting in 2018. So it’s not a permanent change. It’s just a pretty significant change given the currency translation.

And why did that mainly kick in the second quarter and not the first quarter on Cromwell?

I mean, commodity inflation we can often see right we have negotiations with suppliers. We can increase prices when we see true commodity inflation. But when a currency changes overnight, there is always a lag effect that’s going back to customers and repricing.

Okay. And then just one last question when we get to August and sort of the second round of pricing changes, I’m just would love some clarity as to what’s going to sort of change for large customers versus what’s going to differentially change for medium customers come August?

Well, for large customers, the biggest change will be more competitive prices in the items that they don’t buy frequently. So they will have – we will have renegotiated contracts in many cases. They will be more competitive in the tail of their purchases. For midsized customers, we will have price that will allow us to acquire customers now will be very, very new. So that will be very different than we’ve had historically. We talked about 50% of our volume at competitive prices of midsized customers, that’s part of the story. We don’t actually have business with most of midsized customers in the U.S. So we have a big football field to go out and try to acquire customers now. We’re going to go, go after that, so that will be very, very different.

And the change in the pricing book for large customers against what you described, as you know, fairly competitive pricing for more regular purchases, that’s all taken effect for large customers by now for the most part?

That will balance one for the most part. There are still some contracts that are having holding the same contracts, because they have renewals coming up in the next year. But for the most part it will have taken place.

Okay. Thank you.

Thank you.

Thank you. And our final question comes from the line of John Inch with Deutsche Bank. Please proceed with your question.

Thanks. Good morning, everyone. And Ron, I don’t – I forget if you mentioned this. But I know you guys typically have this customer sponsored trade show in the first quarter. Did you get where the reimbursement benefit that helped gross kind of second quarter versus first quarter versus last year, is it?

Yes, yes. John, there was and I was trying to – I probably didn’t say it well, but our national sales and service meeting in the first quarter….

Yes.

…is funded by suppliers, and so a lot of that expense gets moved up the COGS. And so that does create an anomaly for us between the first quarter and the second quarter for sequential GP rate. And I would just suggest you go back to how we explained on the first quarter. I don’t have that information with me, but it should be in our press release. That actually is in the first quarter and a little bit in the second quarter actually where we have to account for that, but…

I guess, my question, Ron is, was there any timing difference of the reimbursement year-over-year that benefited your GP in the second quarter versus last year? So in other words, last year you got more reimbursement in the first quarter than this year you got in the second quarter?

Just a few million dollars, nothing material of year-over-year variance.

Okay. I mean lot of questions around the growth. This is sort of the big picture question. Ron and D.G., how do you know that Zoro isn’t actually cannibalizing, purchasing at Grainger or sale took Grainger in some manner kind of obviously on an indirect basis? But is there anyway to kind of prove or disprove that hypothesis?

Yes. So we do a lot of analysis on Zoro. And the vast majority of the Zoro volume comes from small businesses that Grainger has not had a relationship with. So most of the customer file, we have no business with at all, the Zoro customer file. There’s a little bit of cannibalization that is very, very small. I would also say when you visit Orange customers, you don’t really hear Zoro come up at all. It is not a discussion point. So we don’t. We know the cannibalization rate is very, very small.

Okay. And then just finally, you mentioned that 80% of these charges right were non-cash. Why is that? Like, what – can you give me an example of what would be the nature of some non-cash write-down? And what would be the payback of the cash component of the $1.29 of charges, or of the cash component of that?

So and D.G. alluded to Colombia before, the big non-cash item there is foreign exchange.

Yes.

So cumulative translation adjustment, it’s on the balance sheet and it has to get flush through the P&L. That currency has weakened substantially in the last five years. And so, that’s a like $15 million by itself, that’s a pretty big non-cash item. So the things the typically would be cash would be severance right things like that. I don’t say a little bit of it is writing down some inventory at branches that were closing up in Canada. Most of the inventory we moved, but it becomes an opportunity to dispose some of the very slow moving items as opposed to handling it again and moving into another branch. So there’s some of that we sell. We actually generate cash on some of those, but we take some book accounting it.

It sounds like this would probably benefit your free cash next year then, all else equal?

Yes, for the branches that we own, I mean, this all depends on the market, right, the real estate market. But in the U.S. certainly, it has helped us. Now just to be clear from a P&L perspective, we have some gains and we pulled that out. So that the gains and/or losses, but it’s been gains, because gains are removed just like the restructuring costs are removed. So we talk about year-over-year adjusted results, none of that is in there, right. So it’s an apples-to-apples comparison. But it has helped us a little bit on cash flow the last couple of years and probably will next year as well.

Got it. Thank you.

Yes.

Thank you. There are no further questions at this time. I would like to turn the call back over to D.G. Macpherson for closing remarks.

So thanks for joining us this morning. Just to reiterate, we performed as we expected during the quarter. I think, the exciting points are that we’re starting to see growth in places that are really important for a long-term profitability, most notably midsized customers and large customers stop buy. We are continuing to make the portfolio stronger, making sure that the businesses we have are profitable and have profitable growth. Our actions in Canada, we are taking an eye towards improving profitability much faster there and took some significant actions in the quarter. We’ll keep talking about what we’re doing there. And we really believe that we are very well positioned to improve the customer experience. The conversations we have with customers around pricing have been fantastic. There has been no walking by customers. They’re very happy with what the direction we’re taking. They understand that we have a great service. They understand that we have a strong digital experience. They understand that we have a strong onsite experience. We’re going to continue to leverage those things to grow the business and we’re really excited about the path we’re on. So with that, thanks for joining us and take care.

Thank you. This concludes today’s teleconference. You may disconnect your lines at this time. Thank you for your participation and have a wonderful day.