W.W. Grainger, Inc. (GWW) Q3 2017 Earnings Report, Transcript and Summary

Greetings, and welcome to the W.W. Grainger Third Quarter 2017 Earnings Conference Call. At this time, all participants are in a listen-only mode. An interactive question-and-answer session will follow formal presentation [Operator Instructions]. As a reminder, this conference is being recorded. I'd now like to turn the conference over to your host, Ms. Laura Brown, Senior Vice President of Communications and Investor Relations. Thank you, you may begin.

Thank you. Good morning, everyone. Welcome to Grainger’s third quarter earnings call. With me are D. G. Macpherson, Chairman and CEO and Ron Jadin, Senior VP and CFO. As a reminder, some of our comments today maybe forward-looking based on our current view of future events, and 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 Q3 press release, which is available on our Investor Relations Web site. D. G. will be making some opening comments regarding performance of the Company with an update on our pricing actions in the U.S. After that, we will open the call for questions. D. G. to you.

Thank you, Laura. Good morning, and thanks for joining everybody. Before I begin, I wanted to acknowledge the many natural disasters that we have collectively faced in the third quarter to say that it has been an unusual period, would be a great understatement. Multiple hurricanes across Texas, the Southeast Florida, Puerto Rico and the Islands, the earthquakes in Mexico and the wildfires out west have all challenged our team members and our customers. We're relieved that all of our team members have stayed safe and we are really heartened by the support that we provided to these communities during this unusual period. Our team members have worked selflessly and diligently to help these communities. I've received countless personal notes of how our team members supported individuals and companies, and it makes me very proud to be a part of this organization with 23,000 team members. These natural disasters didn't have a material impact on our financial results this quarter, but the value that we bring to communities and customers during these times is really impressive. So let me move onto the quarter, and the quarter the message is pretty simply. Overall, it was a solid quarter and there were some positive signs. We continue to implement our pricing initiatives, which are driving solid growth as we expected. Removing pricing is a barrier in the U.S. allows us to do what we do best, which is to create value for our customers. We do that through our seller and onsite relationships, our fulfillment capabilities, our technical support and by helping customers take out cost. We continue to manage our expenses tightly and to make progress on improving our cost structure. We continue to make progress on resetting our Canadian business for profitability. Our single channel online model continues to drive solid growth and margin expansion. And we continue to invest for the future in critical areas. Most notably, with digital investments to measure that our digital capabilities are advantaged; in our supply chain, to make sure that we can handle the volume with great service; and by providing tools to help our front line team members to be more effective. And we are acting with urgency across the entire business to make sure that our business is set for profitable growth going forward. Now, before I go into details in some of these areas, I will discuss the overall Company results. We will start with our reported results on slide four, which include the impact of restructuring in the U.S. and Canada. The U.S. adjustments include restructuring primarily related to the consolidation of contact centers, partially offset by gains on sales of assets, branches and other items. Canada restructuring include the branch and headcount reductions. So this morning's call we will focus on adjusted results, which excludes the items outlined in our press release. So our adjusted results, which are on page five are in line with our expectations. Total Company sales were up 2% or 3% on a daily basis. Volume was up a strong 8%. Price was down 4% as the entire assortment went on web pricing August 1st in the U.S. Hurricane related sales growth was offset by lower seasonal sales in the quarter. Our gross profit declined 150 basis points, which was in line with our expectations. We continue to get strong operating expense leverage on higher volumes. Operating expenses increased 3%, volume up 8% in the quarter. And operating cash flow was up slightly despite the price write down as we focus our investments on the highest return areas. I’ll cover other businesses first. As a reminder, other business includes our online model and our international businesses. Sales in our other businesses were up 13%. That’s 15% excluding foreign exchange headwinds on a daily basis. The online businesses, which includes Zoro in the U.S. and the MonotaRO in Japan, continue to expand operating margins. Our international businesses performed in line with our expectations as a group. And operating margin, as of note, operating margin expanded versus the prior year excluding our investment in the digital platform. So we put our digital investments in the other business category. And if you excluded those, operating margins would have been 6.1% in the quarter. Let's move to Canada, and Canada sales were up 7%, which is 2% in local currency on a daily basis. Expenses in Canada were flat in local currency. And as you know, we're in the midst of a substantial transformation of the business in Canada. And we’ll discuss our plans in Canada and detail in a few weeks at our November Analyst Meeting. Turning to the U.S. We had encouraging results and trends from the volume response to pricing actions, and an improved demand environment. Sales for the quarter were up 1% on a daily basis. That included volume of 7% and price deflation of 5%. As a side note, this volume growth puts us in the 6% to 8% range that we’ve talked about for annual growth, volume growth in 2018 and 2019. We had a strong fiscal year end from the Federal government after several months of delayed spending. Hurricane related sales added 1% to sales as in inter-company in the U.S. They were completely offset by holiday timing and seasonal sales, so the 7% is really true volume in the quarter. Now, the growth was somewhat aided by demand tailwinds. Our current analysis suggests U.S. market will grow 2% to 3% for the year. Operating expenses in the U.S. were flat, demonstrating leverage on volume growth. We continue to be diligent in managing expenses, and are confident that we’re going to achieve the cost targets that we’ve outlined previously. Operating margin declined 220 basis points, driven by the GP impact of our pricing actions. So, taking a little closer look at large customers in the U. S. We continue to see sequential volume improvement with large customers. A note here of hurricanes effect large and mid size customers differently; hurricane related sales growth was more than offset by lower seasonal sales and holiday timing with our large customer, so this is really a pure volume. The benefit from the August 1 pricing rollout started in August, but really accelerated in September. Technically, what happened was we turned on the web prices on August 1st. We basically make sure that everything is working correctly and then we started investing in digital investments after that point about a week later. We talked last quarter about government slowing down in the second quarter. That continued into the quarter but then we saw a pick-up in activity at the end of the quarter. U. S. had two notable growth areas large spot by volume, which have been declining for years, grew in the quarter and large non-contract volume which have been declining for years also grew in the quarter. So, those are very positive signs looking forward. Turning to mid size customers. We had significant improvement year-over-year and versus the second quarter of 2017. All of this business is now competitively priced. We are acquiring customers digitally and we’re seeing strong drop due margins to the bottom line. For the first time in the long time, we have significant growth with midsize customers at attractive margins. Now, as a reminder, the actions of August 1st resulted in all prices for all customers being more competitive. This helps us speed up customer retention efforts, accelerates the acquisition of new customers. And it simplifies our pricing to make it much easier for customers to understand. And these actions are critical to achieving our 2019 operating margin objectives. Turning to guidance. In terms of 2017 guidance, we narrowed the range. We kept the mid-point the same. Our performance was in line with our expectations for the quarter. We would expect that given changes we’re making in Canada, which are significant, we would expect performance for that business to be challenged versus our expectations for the remainder of the year. And we would not be surprised if the U. S. was a bit stronger than expectations, given what we’ve seen. Sales midpoint is slightly lower because we divested a specialty business in the quarter. We’ve maintained our operating margin rate and our EPS midpoint. And of note, Q4 expenses are higher sequentially due to normal timing of expenses and investments we’re making in the single channel online business and digital marketing. So in close, we had a solid quarter. The U. S. volume growth was very encouraging. Digital marketing enables us now to acquire customers. The online model grew nicely and profitability expanded. We had solid expense management throughout the company. And we continue to work to turnaround Canada. The U. S. pricing actions remove a barrier. They allow us to focus on creating value for our customers. We do that by helping take cost out of the customers’ business. We help them manage our inventory and what is a very messy category. We provide exceptional fulfillments, and our sales and service teams help businesses succeed. So this is our first and third quarter call, which comes at an interesting time, given our Analyst Day is only a few weeks away. At our Analyst Meeting, we’ll cover a number of topics in more depth, including price and volume response in the U. S., the Canada turnaround, our digital strategy and our cost actions. So with that, I’ll open it up for questions.

[Operator Instructions] Our first question is from Ryan Merkel from William Blair. Please go ahead.

The first question I have is on U.S. sales in September, up 5%. What was the U.S. volume growth, ex-hurricanes and ex-divesting the specialty business?

For the large customers?

For the U.S.? I was thinking…

For volume, yes…

And that's relative to 7% for the quarter…

It was nine.

So that’s encouraging. And then my second question, in the fourth quarter do you expect U.S. volume growth to improve from the 7% that you did in the third quarter? Now you just did 9% in September. So I'm assuming the answer is, yes. And then also tell us what you think U.S. price will be down in the fourth quarter just to calibrate our model?

So I would say, Ryan that our volume expectations haven't changed. We would expect to see continued improvement, slight improvement in volume, and our GP expectations are what they were before. Sequentially, we expect our gross profits to be down 20 to 40, to 50 basis points, and that's just because we have the full effect of the pricing actions in the quarter. So that's our expectation.

Our next question is from Matt Duncan from Stephens. Please go ahead.

So, on the U.S. large customer business, you went from four in the 2Q to a five in the 3Q. I'm curious is there any way to sort through how much you think you were able to get from -- it sounds like the spot by volume did start to pick back up again, and how much of the benefit did that add? And then economically, were the tailwinds a little better in 3Q versus 2Q, or was it the same environment?

So, we've experienced modest tailwinds that continued to increase throughout the year, I'd say. So it's little better it seems at the quarter. In terms of the large customers, both the spot buy and large non-contract customers, which effectively are all spot buy, showed some growth for the first time in a long time, and that helps. And our contract customers continue to grow similarly to what we've seen, continue to improve slightly. So that's no real change there in terms of the path that we've been on.

And then shifting over to the medium sized customer base then, a three to a 15 is obviously a very big change. It sounds like maybe five points give or take of that was hurricane related, but still three to 10 is quite nice. Did you, did you kick in the digital marketing? How much volume would you attribute to that? And are there any correlations we can draw here in terms of timeline that when we started to see this volume really pick up as we look over to the U.S. large customer business and think about the timeline of how long it takes for the price actions to help with growth there?

So just to be clear, so the 15% is net of the hurricane impact. So the actual growth for mid size customers is higher when you include the hurricane impact. And I would say it’s a fairly clear path in terms of continued growth post the price changes. And mid-August, we really started digital marketing in earnest and so that certainly help the growth post that period.

Our next question is from Robert McCarthy from Stifel. Please go ahead.

Good morning, and congratulations on a better than expected quarter. I guess the first question I have is in terms of the gross margin, could you just talk about the walk in the U.S., because I think the total company was benefited by gross margin benefit in Canada in the quarter, lower inventory adjustment, something along those lines. Could you just talk about what was the pure compression in GP in the U.S.?

Well, in the U.S. the year-over-year compression was we're looking at 150 basis points in the U.S. and so that -- which is exactly what we expected. And sequentially, it was 180 basis points.

180 basis points from Q2, which was in line with your expectations, it sounds like…

Yes, it’s almost exact with our expectations.

Okay. And then just a follow up on Canada. Obviously, fairly dynamic there and obviously some updates for '17. But how do we think about, and you gave us some updates around '17 in terms of Canada being worse and U.S. being a little better versus your expectations. But how do we think about going into the targets for '19 in terms of where is the incremental pressure on '19 targets now, given the run rate of what you're seeing in your businesses?

So we’ll talk a lot about that in the few weeks, Rob. I would say that our expectation and in terms of the actions we're taking in Canada, we expect our profitability will be better. And we’ve talked about Canada being in 2019 and so we’re taking actions now to make that happen. It’s a messy process. There is a significant change that we're making to the business. But we’ll give more clarity on that in a few weeks.

Our next question is from Scott Graham from BMO Capital Markets. Please go ahead.

I have two questions for you, the first is hopefully easy. You note on page nine that the spot buy and large non-contract business volume was positive in the third quarter. And I'm just wondering, are we to read that your price actions went beyond spot buy and into large non-contract?

So keep in mind that a large non-contract customer would almost have the same price change or similar to mid size customers that they didn’t have pricing that they’ve gotten historically. And so non-contract large customers will have more of a price write down and better volume response similar to mid size customers not quite as severe because there are some large non contract customers that have price deals historically. So you should read that that -- the price change to have a very big impact on that group we would expect.

Okay, because that's a little different than your message previously, right? Or am I not understanding it?

Well, we lumped historically spot buying with large non-contract in some of what we shown. But there is a significant portion of the volume that’s non-contracted.

I understand that now. The other question that I have for you very simply is with spot buy better and midsize customers better, did we have a positive mix in the U.S.?

So not quite. Although, the trends would suggest that could happen is what I would say.

That should happen. Would you agree?

Yes, it should. Once we lap the price changes it should happen for sure.

I understand. Thank you.

Our next question is from Robert Barry from Susquehanna. Please go ahead.

Could I just clarify a couple of things you said earlier, the 15% growth in medium you said, is -- would have been higher?

Yes.

So, the hurricane…

So the way that works is we have a hurricane. Our branches we typically load the branches with hurricane type products and they skew more to midsize customers. So we see more midsize customer hurricane volume than we would see with large customers. We see a lot of it everywhere of course. But so it had a bigger impact but we’ve taken that out with the 15%.

So where is in the large, the hurricane was offset by the holiday timing and seasonal, it was a net benefit in the medium?

Yes, exactly.

And also to clarify, you said September in the U. S. was up nine on volume. Is that also a clean number, I would have thought the hurricane would have been mostly September or weather or maybe mostly August, that volume number…

It excludes it basically, yes.

And then if I could just ask quick question about what’s going on with inflation. I know there are lot of puts and takes impacting the gross margin this year. But if you just look at product cost inflation, how much of a headwind is that you’re observing this year. And are you getting any price to offset it, say in the large customer contract business?

So, our COGS inflation this year is going to be very slightly negative. And so we are seeing inflation. Now, we are starting to see inflationary pressures a little bit more than we’ve seen in the last few years of course. But so far, we have that is not shown up in our COGS line.

Why is that so minimal given what we’ve seen with commodity inflation headwinds?

Well, we’ve done a whole bunch of work at looking at product categories and optimizing our product categories and cost. So, we have a rigorous process where we’re following, we call it PPO, which basically helps us get the right assortment at the right cost.

Our next question is from Andrew Buscaglia from Credit Suisse. Please go ahead.

Can you just comment on that spot buy? You guys didn’t provide more data in the slide this time around. But can you provide us with a number relative to that negative 3% you saw in Q2?

It’s gone from -- it was negative three, and it’s low single-digit positive for the quarter.

And would you attribute that to some of the new -- I mean, first of all, how did that do relative to your expectations? And then do you attribute some of that to new things like Gamut, I mean we had Zoro been strong or continue to be strong. But what would you say [indiscernible]?

The spot buy is with large contract customers and that would not have anything to do with Gamut at this point. It would be just the pricing just that we make. And making sure that we’re actually selling the value and getting more of the customers’ pie.

And then if I could just squeeze one more in it, your OpEx was flat on that 7% volume number. But what can we expect in terms of -- I mean, I know that you probably talked more about this at the Analyst Day. But looking into ‘18, what that OpEx increase would be -- like what’s the framework to think about that for the long-term?

So we’ll talk about that at the Analyst Day. Obviously, we expect to get continued leverage and we expect expenses to grow slower than volume. But we'll talk more specifically in a few weeks.

Our next question is from Christopher Glynn from Oppenheimer. Please go ahead.

Just had a question about the price trend in the negotiated large customer contracts that you said are about done. I think long term that's still a percentage roll every year to a degree. So wondering your visibility conviction at price concession remains an incremental piece long term of those negotiations, or is that similarly off the table and stabilized?

We're expecting carryover impact next year on pricing probably minus 2% range, and we'd expect that to then flatten out in the following year and turn positive with inflation.

And then just curious fourth quarter tax rate and place holder for ongoing tax rate?

So we've guided for the balance of the year for tax rate already and we'll give a guide in our November Investor Day for next year. And I know there's been a number of ranges published already this morning from some of the sell side on taxes. And it's difficult for us to comment on third quarter taxes versus consensus. But I think it's a little bit more straight forward for us to talk about it year-over-year. And when we look at our reported tax rate in the third quarter of last year, it was about 34% and this year it's 31.7%, and that's in our press release. If you look at that and how we’re weighted to last year's earnings before taxes, it's an improvement of about $6 million in lower taxes or about $0.10 EPS. And about two thirds of that is driven by our clean energy investments and the other third is driven by some solar credits and foreign tax credits. So for us year-over-year normalized it's about $0.10 pickup. And about two thirds of that also would have been -- because this is done on a year-to-date trough, two thirds of that $0.10 is probably from the first half of the year. So a lot there to consume, but that's our perspective on a year-over-year basis.

Our next question is from Chris Belfiore from UBS. Please go ahead.

So, I just trying -- kind of go back to the mix a little bit. So if possible, trying to understand the benefit that you guys might have seen from any cost actions on the market improvement in the United States versus the mix? Given some of the numbers you kind of gave with the one you just gave of low single digit improvement on spot, it kind of implies that the recurring side kind of actually decelerated from 1Q to 2Q to 3Q. So the mix does seem better. So just trying to understand that a little bit kind of understand that how you have -- you still in negotiations with the recurring sites for the large contracts. So how that might change going forward a little bit?

So, I think maybe I can help, just talk about. So we renegotiated most of the contracts that we would want to at this point. There’s some that we can't because of contractual reasons, and we'll get to those over the next year. The way this works, it's a little bit odd to look at spot buy independent from the total volume or non-spot buy with large customer, because the goal here is to grow the entire customer and to have more of the share beyond spot buy. So the non spot buy basically has been fairly consistent in terms of the growth in the business, but we start to see that spot buy, that means more of the mix is non-negotiated, which just makes it easier for the customer and makes it easier for us and actually is helpful for everybody. So that’s the goal and changing this at this point.

And then I know you said that kind of give a lot of details in November. But in terms of Canada, I mean, you guys have been targeting breakeven operating margins by year end, and it seems likes that’s probably not the case. Just kind of any commentary around that or is there trends that you're seeing in the region from that from that stand point?

So we're seeing decent volume growth. We will come back, as I mentioned before, in about three weeks and talk through the plan for Canada. And the plan for Canada as we said it before is substantial, and I think get's us to a place that is much more profitable in 2019, which is what we’re looking for. So we will talk about that very shortly.

Next question is from Deane Dray from RBC Capital Markets. Please go ahead.

Like to get some color, further color on the hurricane impact. Specifically, what your sense of the mix for those medium customers relative to the segment average? And then what is expectation for fourth quarter impact from hurricane?

Fourth quarter impact, Deane, will probably be very small, if it is noticeable. In terms of mix, most of the time we have hurricanes I think this was no different. Product mix is similar in many ways to the rest of the mix. We end up spending a little bit more money frankly to deliver the product. So we do a lot of things that you wouldn’t naturally do. And so things like freight cost go up in the short-term to serve the customer. It's not really a big net benefit or decrement to the GP rate.

And just as a follow up, have you quantified what the digital investment in the quarter was? From a dollar amount, but also what is exactly we’re spending it on?

We have not quantified that. We’ll talk about that in a couple -- in a few weeks, that’s going to be a part of the discussion we have in the Analyst Day.

Our next is from Luke Junk from Robert W. Baird. Please go ahead.

First, D. G. just wondering if you could help size the benefit from higher government spending in September, is it in the same areas, the drag that you saw in June?

So, I would say fiscal year end, in general, was similar to past year it wasn’t either really strong or really weak. So it was similar fiscal year end to what we've seen before. Net-net there have been some bumps in terms of government procurement that happened from mid May through mid August, probably in the negative for the year so far. But year-end it was pretty good but not unusual.

And then second little bigger picture question. Just wondering as you're ramping up your efforts to acquire customers in the mid size area. I'm wondering is where and how your digital marketing activities that picked up in mid August here and inside sales efforts in your sack. So differently from a perspective range of your customer, how is that marketing effort can appear to me, and say if I do place an order, what kind of follow up or sale cycle expect to see?

So the basic funnel, and again we’ll talk about this in a few weeks. But we will use digital marketing in many cases to acquire customer, we learned who that customer is. We’ll figure out what the right price and service offering for that customer is. And then if they get big enough and attractive enough inside sales will cover them. And once an inside sales person is covering them most of the digital investments will be email digital as opposed to discounting digital. So there’s a funnel and a process for customers as they get more mature. That leaves them to inside sales if the characters fix with that customer make sense.

Our next question is from Joe Ritchie from Goldman Sachs. Please go ahead.

This is Evelyn Chow on for Joe. I would like to dig into the light spot buy acceleration, great to see very encouraging sign. Just wondering if there is any tilt this quarter towards certain customer or product categories that you’ve seen?

No, the growth has been pretty consistent across the board. So if you look at the overall customer growth, it’s been similar in the spot buy.

And then maybe turning to the divestiture of the U. S. specialty business, just wanted a little bit more clarification on the rationale and any potential impact to margins this year?

Well, it was a relatively small business that made a little bit of money. It was not core to what we do. And so some of our acquisitions we’ve integrated into the core, and this one never really made sense to integrate into the core. We brought some of the products into the business. But frankly this business ends up joining another business that’s similar and has a much better chance of success in that portfolio than it does with us.

Our next question is from Justin Bergner from Gabelli and Company. Please go ahead.

My first question is just similar to some other questions that have been asked, which is if the spot buy and non contract buy for the large customers drove the acceleration and the actual contractual buy was at a similar growth rate as last quarter. I mean, it would seem that with the market accelerating a bit holding the contract purchases similar growth rate might be under performing the improvement in the market. Is that true and if so why?

No, we actually don’t think that’s true. And if you look at the large customer results, what you’ll see is the spot buy and the non-contract customers went from negative to growing low single-digits which means the rest of it had to grow faster than the average. And so that is -- and we think that’s gaining share at a similar pace to what gain share before.

Okay, that’s great to know. And then on the acceleration in the other businesses, I guess the volume accelerated from second quarter a touch, but the single channel number decelerated fairly materially. So what’s offsetting the deceleration in the single channel business to hold the other business volume consistent with prior quarter growth?

Well, we’ve seen nice growth with the single channel online model even through this quarter the Japanese business grew in the 20s. But there are other businesses, Mexico grew strongly favorably strongly. So, we’re seeing growth in some of the other international but the UK grew a little bit. So we’re seeing nice growth in that portfolio as well.

Our next question is from Hamzah Mazari from Macquarie Securities. Please go ahead.

The first question is just on market share. D. G. large customer market share for you guys, and correct me if I’m wrong, is maybe 14%. Can you get to double-digit market share on the medium customer side? Or is there anything structural that prevents that? And then secondly, are you maxed out on large customer market share but that’s a pretty big number when you look at the overall industry?

I think we’re not maxed out on large customer market share. I think we have share opportunities to grow. When I do customer visits there, frequent discussions about how to expand the relationship find more context sell our value in the places where we don't have value -- add value today. So I'm not concerned that we've tapped out. Midsize customers, I guess, when you're as low shares where we'll see. When you talk to the midsize customers, they really love Grainger and the value that Grainger provides and they just haven't been buying from us largely because of price and we haven't actually been reaching out to them. So we'll see. I'm going to reserve that answer for time back. I think there's a long playfield for us to grow midsize customers.

And then just a follow-up. Any comments around the CFO search and what you're looking at there, I appreciate it?

Yes, so we have a search firm and a number of candidates that are -- that we are working through and we will get you an update when we have the CFO. We have very good pipeline.

Our next question is from Patrick Baumann from J. P. Morgan. Please go ahead.

I had a quick question on the pricing. You had a couple of months now under your belt with the new cuts, or price reductions. Are you seeing any noticeable competitive response on pricing and if so from where?

So, maybe I should start by what we've done with pricing, I think it was probably more unique to us than to the market where our prices were out of market the way we go to market. And so we expected modest reaction and that's pretty much what we've seen. There hasn't been much reaction. The reality in our space is that everybody goes to market differently, has their own strategy. And so we haven’t seen a lot of direct response to our actions, and our prices aren't lowest now and won't be.

And then just a clean-up question on tax rate, and I know you talked about the year-over-year change. But how much or did tax rate at all add to the midpoint of your EPS guidance relative to your prior guidance, and if so how much?

No. This is Ron. We stayed with the midpoint. We think the benefit overall on taxes is in the $0.05 to $0.10 range, and it’s really offsetting some little bit of loss earnings from the specialty business we sold very small and then just a cautious look at Canada for the year.

And then last one from me, just one more clean-up. The revenue guidance, the tightening around the low end and it seem like. Is that all because of...

That's because of the specialty business sale. I think that was your question so yes, specialty business sales.

Our next question is from Steve Barger from KeyBanc Capital Markets. Please go ahead.

Just back to the comment on working to get the right assortment at the right cost to offset inflation. Does that mean you're de-sourcing or resourcing some product to different vendors or how does that work?

Well, it typically is at a category level. And by category level, I would mean 500 SKUs, 200 SKUs. And effectively, we look at all the customer feedback and what customers care back. We look at the assortment we have and in some cases we're adding vendors, in some cases we consolidated vendors. It just depends on what the customers care about and then we try to get the lowest cost we can. And so there's not a single formula. You have to do it category-by-category.

And do you expect you can keep the lid on that inflation as you go through the end of this year into the first part of '18 based on your efforts?

Yes, we do. We think we'll keep a lid on inflation. I think if we didn't have that program, we would be seeing some inflation for sure. But that program helps us to offset that inflation.

And one more quick one sorry if I missed this. Are there any of those non-core business divestitures we should be looking for or is that portfolio where you want it now?

Portfolio is pretty much where we wanted now.

Our next question is from Jane Zhao from Morgan Stanley. Please go ahead.

So first one, I just want to understand little bit better the revenue and income for the specialty business, you guys divested. It was a one point headwind this quarter. But I think you guys sold the business in late July. So can you just give us some color, may be the potential impacting to 4Q?

We sold it in mid July and it was…

Revenue was in the $6 million to $7 million a month range, maybe…

So $70 million to $80 million businesses.

And is it slightly lower margin business compared to the rest of U.S.?

Yes.

And then on the pricing outlook. So pricing was down 5 points and it was I guess a full quarter of pricing impact. Are you guys still looking for like about 6 point of run rate in terms of price decline?

So keep in mind that the price changes happened mid quarter. For the last two months, the price changes were in effect. And so it's not a full, five is not a full quarter ex-U.S.

So six is still the number you guys are looking for on a run rate basis?

Five to six in the first quarter, five to six…

Our next question is from John Inch from Deutsche Bank. Please go ahead.

Just to circle back the tax issue, I don’t think we got the answer. What -- Ron or D. G., what is the effective tax rate you're guiding to in the fourth quarter to get to your implied 2013 midpoint EPS?

For the full year, it's 34.5 to 35.5 and for the quarter, it’s about 35 for the fourth quarter.

35 for the fourth quarter, okay…

Sorry, if I wasn’t clear enough on the other comment.

That’s okay, now I got the year. I just -- it's hard to triangulate because you’re excluding the 11 million, it’s just hard to triangulate. I was going to ask you, hurricanes were a percent of contribution in the quarter. What does that imply? Doesn’t that imply there were 3 points of contribution benefit in September? You're giving your numbers ex-hurricane. So I'm just trying to understand that.

John, I don’t understand the question. I didn’t track that.

So if hurricanes were a percent of benefit for the quarter, the impact of hurricane for your commentary happened in September. Does that imply the actual September results were boosted by about 3 points, just literally taking the one versus one month?

So it’s two in September.

And you said margins are slightly worse for these tails, is that correct?

Generally, it's not a major impact on the next I would say.

Our next question is from Robert McCarthy from Stifel. Please go ahead.

Just a quick follow up. As you think about the medium size business, going forward, how do we think about the pricing actions you’ve taken or contemplating? And the gross margin mix as we go into '18, what’s the embedded assumption there, given what we have new information now?

So we're going to have to wait three weeks for that one, Rob. We’ll talk at the Analyst Day about that.

And then just finally on Canada. Is there anything you can say about breakeven or not, or we would expect a small loss in the fourth quarter, seems these guys would imply loss given your comments around the narrowing in the range?

That would be our expectation and we’ll get a lot more detail in Analyst Day.

Our next question is from Justin Bergner from Gabelli and Company. Please go ahead.

Thanks for the quick follow up. On the corporate expenses, I guess, say we’re meaningfully down year-on-year and modestly down quarter-on-quarter. What’s -- is there any change to the view for the annual corporate expenses embedded in your narrowed guidance range?

And this is Ron. Not really we’ve some favorability in the third quarter driven by the low share price and stock compensation. The expensing of that and that will pride bounce back with a bit higher stock price in the fourth quarter. So there is some timing there. But that drive sequential variation. But for the year, we don’t expect anything unusual.

And we continue to work very hard to make sure that our costs are necessary. And so we’re really focused on making sure that our expenses are all well managed. And I think that this reflects that part.

Our next question is from Ryan Cieslak from Northcoast Research. Please go ahead.

Really quick just on the volume guidance in the back half of the year in the U. S., originally 6 to 8. Have you changed that guidance at this point based on what you saw here in the third quarter or your expectations, sorry if I miss that. I just wanted to make sure that was clear.

So, I would say in the U. S. we’re optimistic about what we’re seeing, but we’re not fairly short timeframe. So we’re not going to change our guidance per se that we are happy with what we’ve seen.

And then thinking about the longer-term operating margin targets you guys have out there for 12% to 13% by 2019. Can you just refresh us on what you guys are assuming for annual COGS inflation to get to that ’19 framework? Thanks.

So, we don’t typically view that. I would say, we don’t actually plan annual COGS inflation necessarily in that math. We look at price cost spread. So from our question is, when we manage COGS as well or better than our competitors and we will be able to perhaps pass through whatever the market COGS is overtime. So, we typically find our financials that way as opposed to sticking with the specific number, because that number can fluctuate pretty quickly. But we’ll talk about our expectations again in few weeks.

Okay, thanks.

All right. Well, thanks everybody. I think that’s our last caller. Just to summarize, we made a solid quarter, U. S. volume growth was encouraging, continued strong growth and profitability expansion in the online model, continue to really focus on cost management and we’re in the midst of a significant turnaround in Canada. Look forward to seeing most of you in a few weeks. And thanks for your time.

This concludes today’s teleconference. Thank you for your participation. You may disconnect your lines at this time.