Greetings, and welcome to W.W. Grainger’s Fourth Quarter 2018 Earnings Conference Call. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. [Operator Instructions] As a reminder, this conference is being recorded. I would now like to turn the conference over to your host, Irene Holman, Vice President, Investor Relations. Thank you. You may begin.

Good morning. Welcome to Grainger's Q4 earnings call. With me are D.G. Macpherson, Chairman and CEO; and Tom Okray, Senior Vice President and CFO. As a reminder, some of our comments today may be forward-looking based on our current view of future events. Actual results may differ materially as a result of various risks and uncertainties, including those detailed in our SEC filings. Reconciliations of any non-GAAP financial measures mentioned on today’s call with their corresponding GAAP measures are at the end of the slide presentation and in our Q4 press release which is available on our IR website. Looking at reported results for the year, we had adjustments resulting in $186 million impact to operating earnings and a $2.97 impact to EPS, adjustments included $139 million of non-cash impairment charges related to the Cromwell business and restructuring primarily related to Canada. This morning's call, we'll focus on adjusted results which exclude the items outlined in our press release. Now I'll turn it over to D.G. to discuss our 2018 performance. D.G., to you.

Thanks, Irene. Good morning. Thanks all of you for joining us this morning. 2018 was a strong year for Grainger, both in terms of our performance and in building the path for our long-term success. I am extremely proud of our team members and what they accomplished. Across the business, we remained laser-focused on enhancing our relationships with customers, which has put us in a better position to consistently gain share moving forward. Let's take a look at what we accomplished in 2018. We drove significant share gains across large and midsize customers in the U.S., as our value proposition continue to resonate on more relevant pricing. Our strong sales performance and favorable customer mix help drive gross margin performance that was better than expected for the year, and our diligence in managing costs resulted in significant operating expense leverage. We continue to enhance the customer experience with the Grainger brand in the U.S. to better search capabilities, best-in-class fulfillment, and by improving the end-to-end customer experience from order to delivery. Feedback from customers has been very strong and improving over the last two years. In Canada, the structural reset of the business is complete and we exited the year with a profitable fourth quarter. This has been a tough road for our team members in Canada. I want to acknowledge all the work that they and our team members in the U.S. put in to get Canada to profitability. We still have work ahead of us to stabilize volume performance, which I will talk about in a minute. Our single-channel businesses, mainly MonotaRO and Zoro, continued to drive profitable growth. Daily sales grew 23% for our single-channel model in 2018. For our international businesses, the portfolio performed well and contributed to operating margin expansion in the year. Across the…

Thanks, D.G. I'll start with a recap of our 2018 total company-adjusted results then move to the fourth quarter results by segment. For the full-year, revenue was up 8%, 7% on a daily basis driven entirely by volume. Our normalized gross profit rate was down 20 basis points versus the prior year after adjusting for revenue recognition consistent with the U.S. businesses. We continue to realize operating expense leverage on higher volume. For the full-year, operating expenses normalized for revenue recognition grew 3% on 8% revenue growth. Our strong sales growth, gross margin performance, and diligence in driving operating expense leverage resulted in incremental margin of 25%, operating earnings growth of 17%, and then operating margin of 12%, which is 100 basis points higher than the prior year. EPS grew 46% for the year. We generated operating cash flow of $1.1 billion, representing a 110% of net earnings after adjusting for the non-cash impairments for the Cromwell business. This result was flat to the prior year as positive earnings were offset by higher working capital, primarily driven by the timing of trade and other payables which we do not expect to repeat and the investment in inventory, including some opportunistic pre-buys. In addition, we returned $741 million in cash to shareholders through dividends and share repurchases. Looking at the quarter, sales increased 5% including a 1% unfavorable impact from foreign exchange. On a constant currency basis, sales grew 6%, 4% on a daily basis. Sales were comprised of volume growth of 4% and price inflation of 1%, partially offset by a 1% impact for holiday timing. Our normalized gross profit margin was down 20 basis points as margin growth in the U.S. and Canada was more than offset by gross profit declines in our other businesses, driven primarily by Cromwell…

Thanks, Tom. We are very pleased with our performance in 2018. More importantly, we are excited about the actions we've taken to position us for success moving forward. We look forward to maintaining this momentum in 2019 and beyond. Now we will open it up for questions.

Thank you. At this time, we will be conducting a question-and-answer session. [Operator Instructions] Our first question is from Ryan Merkel with William Blair. Please proceed with your question.

Great. Thanks. So first of all, U.S. EBIT margin guidance for 2019, up 10 basis points at the midpoint. I guess two-part question. First, just to clarify your thinking about flat gross margins, and then, it is offset by investment. Is that why there's not more margin expansion? And then, well, I'll let you answer that then I’ll ask the second part.

Thanks, Ryan. This is D.G. So a couple things. One is on the gross profit line. Our expectation is that we will be down 60 basis points to flat for the year. There's a couple things going on there. One is, we talked about being roughly flat in 2019 before. What has happened is some of our contracts have not actually been implemented yet, so we got some benefit in 2018 and that benefit will turn into a slight negative in 2019. So at the midpoint, we're slightly down. We still expect to get strong operating leverage in the year. We are making some additional investments in digital capability certainly, but we still expect to get strong operating leverage and slightly down GP at the midpoint and that's because of that contract timing.

Okay, got it. All right. And then are we through some of these one-off items, sticking with U.S. EBIT margin in the fourth quarter? I guess what I'm asking is once we get into first quarter 2019, does year-over-year operating margins in the U.S. start to expand again? Or is this something that might be more of a second half progression?

Yes. Let me take this. This is Tom. As we alluded to in our prepared remarks, there's three main items there. Let me give you a little bit more granularity to help you size that. For the U.S. segment in Q4, SG&A expenses grew 6%. We said 5%. That's related to the additional payday. If you normalize for three buckets, which is variable compensation, the additional payroll day and items that aren't expected to recur, the 6% increase actually goes to flat or 9% associated with revenue recognition, goes to a 3% increase. This clearly had a material impact on our Q4 U.S. segment on the operating margin, and we don't expect this profile to be representative going forward.

Got it. Okay. That's helpful.

Who's next?

[Operator Instructions] Our next question comes from David Manthey with Baird. Please proceed with your question.

Thank you. Dramatic pause there. Hi, guys, good morning. First off, as it relates to your outlook, it appears to contemplate something of a soft landing. Could you just talk about the 1% to 4% market growth? What of that do you assume is price versus volume for the market? And then are you assuming that Grainger is going to be in the same ballpark of maybe a low single-digit growth rate of price?

Yes. So we have 1% price in there. We have volume of 0% to 3%. We would expect to be somewhere in that ballpark generally. So yes, that's what we've embedded in there. And it is a bit of a soft landing. We don't have any. We've got the same economic advisors that everybody else does and so we're hearing the same things you are. So that's where we're at right now.

Okay. Sounds good, D.G. And then on these investments in the digital in the Other Businesses, including Zoro, could you talk about the nature of those investments? What broadly, what type of investments those are? And then if you could talk about maybe by how much those investments depressed the EBIT margin forecast that you've given us?

Sure. So the investments are largely – if you think about our business in MonotaRO which has been so successful. They now have 20 million items on their website and we are making investments in Zoro to be able to expand our offering dramatically over the next several years. Those investments are in systems and people to make sure that we can be successful in doing that. We're also investing in analytics capabilities and marketing capabilities and really taking the lessons we've learned from MonotaRO to go ahead and push that. Those investments are significant for Zoro. The business will remain profitable through the transition and most of those investments will be done by the end of the year. So we should be in better shape going into 2020 from a margin perspective, but we expect several hundred basis points or more to be down relative to where we were this year.

Sounds good. Thank you.

Thank you.

Our next question is from Christopher Glynn with Oppenheimer. Please proceed with your question.

Yes. Thanks. Good morning. Just wanted to ask a little bit about the sequential momentum and the medium strategy. In terms of your path to get back above 5% share long-term, obviously good momentum right now. Wondering if there are any market penetration levers that are just getting started there and how that compounding sensitivity is shaping up? You're introducing new levers at Zoro, sounds interesting. How would you describe how you sustain the compounding at the medium?

Sure. So with midsize customers, and we've talked about some of this before. We've seen growth both with existing customers. We've reengaged some last customers and we've acquired new customers. I would say the new customer acquisition has been very solid over the last quarter, and we expect that to continue. So most of that is acquiring new customers digitally and then getting – building a relationship with those customers. We still have a fairly small customer file with midsize customers relative to the entire universe. So with the Grainger brand, midsize customers, we expect consistent strong growth over the next couple of years at a minimum. And a lot of that's going to be new customer acquisition in addition to some of the existing customer growth.

Okay. Great. And I just want to get a better understanding of the impact of the contract negotiations on U.S. gross margin outlook because the U.S. large revenue base about 80% of the segment and you're talking about 10% of those, so maybe 8% of the U.S. segment. It doesn't seem like that approach is the magnitude of mix that would have such a pronounced impact on your gross margin outlook given volume and mix should be good guys?

Yes. So it actually does approach the number that we're talking about, if – that's going to be in the 10s of basis points of impact for next year. So if we're down 60 to flat if that were not the case, we’d be sort of centered – much closer to zero for next year. So that's the impact and a lot of this is just implementation of contracts that are already signed. And in particular, one very, very large contract that that still needs to be implemented fully.

Okay. Thank you.

Thanks.

Our next question comes from Stephen Volkmann with Jefferies. Please proceed with your question.

Hi, good morning. I wonder if we could go back to the midsize sort of large customer breakdown and obviously the midsize growing a lot faster, great to see that. I assume that has some positive margin implications and I'm curious if you could ballpark sort of how much tailwind that gives you and then sort of what's offsetting that to leave us with sort of flat to down and gross margin?

Yes, I mean like we said it's an impact. It's certainly 10 basis points to 20 basis points roughly have an impact in terms of mix that we've seen if we continue to grow midsize customers much faster than large. So it's a small impact, but a real one.

Okay. All right, that's helpful. Thanks. And then just with respect to – I think you laid in a little bit of extra inventory and I'm curious if that benefits maybe the first half of 2019, I'm sort of a price cost basis?

Yes. We added inventory as you saw including some opportunistic pre-buys that we made in Q4, preparing us for what we expect to be strong growth in 2019.

Thank you.

Our next question is from Hamzah Mazari with Macquarie Group. Please proceed with your question.

Mario Cortellacci filling in for Hamzah. Actually, just kind of hitting on the medium customers again. I mean, could you walk us through what kind of market share you think you guys could get in the medium customers? And maybe you could talk about how your go-to-market or your sales strategy is different from that of large customers or maybe it's the same?

No, it's fairly significantly different. So we have less than 2% market share today. At our peak, we had significantly more than that. Without contemplating a specific number, we know we've got a lot of runway with midsize customers. In terms of how we go-to-market, we acquire customers typically digitally with the midsized customer group. We then develop a relationship in some cases that will stay digital and some cases that becomes an inside seller relationship where there will be someone on the phone that talks to them on a consistent basis. We provide significant technical product support to that group, which is a big value to that group. And what we find is that those customers really value what Grainger has to offer the technical product support, the products themselves and the quality of the products, and the fulfillment all mean a whole lot to that that midsize customer group. So we're seeing great response as we acquire new customers and build those relationships.

Great. And just a quick follow-up. I mean, could you talk about, I guess, how you guys differ from Amazon industrial supply in your distribution or your products or even your service levels, and maybe where you guys bump up with them head-to-head and – just competition-wise?

So I'm assuming you're talking about Amazon business, is that…?

Yes.

Yes. Okay. Yes, so I would say that we are skewed a very much more industrial. We developed personal relationships with customers. We provide services with customers. We provide onsite services with customers. We have sellers. Our fulfillment is designed to make sure that we get complete orders to customers next day. So our buildings are completely different design. I would say on almost every dimension we are different. And so without going into too much detail on the call, we've built our machine to be able to really be very attractive to industrial businesses and that's our customer base and that's what we're trying to gauge here with.

Gotcha. Thank you so much.

Thanks.

Our next question is from Patrick Baumann with JPMorgan. Please proceed with your question.

Hey guys, thanks for taking my call. I just had a couple of questions here. First one is just an SG&A growth. The profile for 2019 sounds pretty similar to what you did in 2018? Just curious as you look beyond 2019, what this might look like on more of a normalized basis after you're through with all your costs savings plans?

So I would just say that we have – we think built a muscle in a process to make sure that we're very disciplined with SG&A going forward. Our expectation is that we will continue to get SG&A leverage to 2020 and beyond. So without talking about specific numbers, our expectation is that the process we built, the way we look at our expenses, the way we drive improvement throughout the business, efficiency and effectiveness will continue to do to perform well going forward.

Okay. On Zoro, what did the business grow in the quarter and for the year? And just curious if you could provide some context on what's driving the change in kind of the assortment strategy there? Is the growth kind of slowing down a little bit? Or you guys just…

Yes. The Zoro business continued to grow very, very strongly throughout the year. If you look at the history of our business in Japan, about this time in the history, they really stepped on the accelerator with the assortment strategy, and we're at the point now where creating some real differentiation with the Zoro business in the marketplace. We think is important and we think we've got an opportunity to do that based on what we've learned. And so we're investing for the future. It doesn't mean that have seen slower growth at Zoro at this point.

Got it. And then last one just really quick on restructuring expense for 2019, do you guys expect you’re restructuring? I haven’t seen anything on the slides here or the press release?

Yes. We expect our restructuring expenses obviously to go down with most of the heavy lifting in U.S. and in Canada behind us, so it will be significantly less than we've seen in the past couple of years.

Okay. Thanks. Good luck guys.

Thanks.

Thank you.

Our next question is from Robert Barry with Buckingham Research Group. Please proceed with your question.

Hey guys. Good morning.

Good morning.

Good morning.

I apologize, I was dropped from the call for the first couple of questions, so if you touched on this already, we can skip it. But did you talk about what you've assumed in the guide vis-à-vis the tariffs versus what you outlined at 3Q? Any change there?

No change at all. And just to clarify our contemplation in the guide, assume the 10% tariff being at 25%, so that's already included in the guide.

Got it. So if it stays at 10% and there'd be some upside there, I guess?

Correct.

Yes.

Got it. And then just wanted to follow-up on the question about – I think there was a question about the U.S. operating margin. I think it's implied about flattish, is that right? And I'm just curious what's driving that especially because it sounds like you'll be lapping some headwinds in 3Q and 4Q that seemed to be non-recurring?

You're referring to the guide for 2019 for the U.S. segment?

Yes, the 15.5% to 16.1%, I think it came in at 15.7% for the year.

Yes. Sure. As D.G. mentioned earlier, maybe you had dropped off the call. Our GP, we expect to be flat to minus 60 down and with the big impact there being freight as well as the contracts, which still have to be closed for this year are implemented for this year. So yes, we've got opportunity on the high-end to grow 100 bps in terms of operating margin, but we're being prudent on the low-end given the uncertainty we see in terms of the freight issues as well as the overall economic environment.

Got it. Just finally, what is the messaging on the end market demand in your momentum? I mean the 4% adjusted in December, it looks like a deceleration and I think the 4Q overall is the deceleration versus recent quarters. Just any color on what you're seeing out there from the demand perspective? Thanks.

Yes. I'd point to a couple of things. One is, certainly the market growth was still reasonably strong in the fourth quarter, a little less than it was in Q2 and Q3 it appears. That's said, we think our performance was very similar on a comparison basis to the market in the fourth quarter. We talked a little bit about the last week of the year being very slow. But fortunately people showed up, back up to work to start the year. And so our expectation is that there's going to be very modest growth at this point. That's our expectation and we will continue to gain share at a similar pace to what we've done.

Got it. Thank you.

Thanks.

Our next question is from Nigel Coe with Wolfe Research. Please proceed with your question.

Thanks. Good Morning. D.G., could you maybe just kind of go back to your comments on tariffs, because you expressed confidence in your ability to price through both inflation and tabs. So if we end up with a 10% or 0% on less 3% compared to 25 in your plan. Should we assume that's a wash with pricing a little less than you would otherwise have gone with?

Nigel, I think your question is what happen is with the tariffs stay at – go back to 10%. Is that your question?

Yes. And then what pricing not be as great as it would have otherwise have been?

Over time that would be the case, I mean typically when if that were to happen there would be some legs. So there might be some benefit during that light period is what we typically have seen historically, but generally our philosophy is we want to make sure we're pricing to market and getting the best cost we can. And so presumably the market price would adjust adjusted some point in the future as well.

Okay. And then I hate to ask the obvious question, but can you maybe just touch on your government sales obviously still very strong through 4Q, but with the shutdown, how would that tracking maybe just remind us in terms of your exposure to state versus federal and the proportion of sales.

Yes, great. So we're about 70% stay local about 30% federal. The federal business for us tends to SKU industrial and by that we mean things like the military. Some of those are funded. So far I would say the impact on us has been certainly it's calculable, but not big. It's a small impact for us right now. I would say, we get a little more concerned if the shutdown goes longer because it has knock on effects to other things. But for us the shutdown in its current form, we don't have huge volume with customers that are shutdown right now. So it's a pretty small impact on us so far. That's it. Obviously if it goes longer we get, we get concerned about some other things.

And then total governments about 14% of your sales

Yes. That's about right.

Great. Thank you.

Thank you.

The next question is from Chris Dankert with Longbow Research. Please proceed with your question.

Hi, good morning, guys. Thanks for taking my question here.

Good morning.

I guess just to take another slice at medium, kind of what gives you confidence in maintaining it looks like medium – mid-teens growth in that business. I mean is – anything you could share with us, whether it's your number of new customer acquisitions, new users’ size? Any other metrics we can see as far as giving you confidence in maintaining that growth rate?

Yes. We haven't shared this specific. I would say that the new customer acquisition rate gives us confidence. I would say that that the lapse customer return rate continues to be strong. We continue to get customers who have been customers before. And just our numbers through the fourth quarter give us confidence that there's still a lot of momentum to go as we've lapped the price decreases.

Got it, got it. And then thinking about productivity and cost savings beyond 2019 here, obviously you already commented on Zoro in the single channel kind of getting a little bit improvement from lower investment. I guess any other way of think about normalized incremental margins for the U.S. or the other businesses here?

I'm sorry. You're talking about in 2019 or beyond 2019?

Beyond, once we kind a get the cost cuts.

Yes. So our expectation has been that we will grow expenses and about half the rate we grow sales in that that's been kind of our expectation. We don't see anything that would change that at this point going forward. We still feel like we've got a lot of opportunity to improve our cost structure go forward.

Understood. Thanks guys.

Thank you.

Our next question is from Evelyn Chow with Goldman Sachs. Please proceed with your question.

Good morning, guys. I wanted to touch on Canada for a moment. I know Tom when we met back in November. You had said there's some potential green shoots in the volume inflection in that business. Could you just give us an update on what you're seeing on the ground and how the market is progressing and any line of sight you have into your own inflection?

Just to clarify, we had a really hard reset of that business. I think when you look at the cost, takeout numbers, they're bigger than we had talked about taking and as we got into it, we felt like we needed to reset, pretty much everything, everything in the business. That has had a fairly significant impact on volume in the business. We are now doing some things to improve the customer experience that we think are going to help us grow going forward, adding products to the assortment. Again, we're training our sellers and really working on getting a high performing sales and services team in that business. Our fulfillment performance is actually pretty good. We're hearing from customers’ that is pretty good and we're starting to see a few wins for the first time in a long time. There, I think what we're starting to get some volume. Now it's going to take a while. The reality is this was a very hard reset and that's why we're backing off of the margin targets for 2019 because it's going to take a little bit longer than we had hoped. It's been a very complicated and challenging process. I would say we're still confident in the underlying market. The market has been performing reasonably well. We have a business that’s sort of separate out there that we know has been performing reasonably well, so the market has been growing, and most of this has been us resetting that business.

That makes sense. And then thanks for framing the gross margin guidance with your comments and contract negotiations and tariffs. It sounds like freight is the other big piece of that, so any sense of the magnitude that's baked into the guide currently?

Well, obviously freight market has been tight. I think I make a lot of the uncertainty on where we land probably is freight going into the year, whether or not that market stays is tighter, gets tighter or gets looser. It builds in some of the uncertainty. We feel like we are effectively managing freight. We feel like we've got a really good process to improve both our operational freight costs, and our overall freight cost. So I would say its modest impact, but it is an impact.

Thank you, guys.

Thanks.

Our next question is from Ryan Cieslak with Northcoast Research. Please proceed with your question.

Hey, good morning, guys. My first question, I think you'd mentioned that supplier rebates had a positive impact on your gross margins within the U.S. business in 2018. Is there any way you could maybe quantify that or provide some directional color of how much of an impact that was. And then what is the 2019 guidance for your gross margins in the U.S. segment assume for the supplier, rebate dynamics, certainly relative to what you guys saw in 2018?

So our supplier rebates are largely based on volume. We don't disclose how much of what the magnitude of those are. And I would say their supplier rebates for 2019 bake in, an assumption around our volume, which you see in there. So they're linked to the revenue expectations for the business.

Is it fair to say D.G., though that the supplier rebate benefit is smaller than what you saw in 2018?

To the extent that our volume is slightly smaller, that would be fair to say.

And then when you think about the ability to maintain the medium size customer growth, I know this question was asked a couple of different ways, but is there anything specific that you guys are going to do differently this year as it relates to digital actions or some sort of investments that you're making that would potentially be a catalyst or recapitalize sort of where the level is? Or are you saying basically you're seeing good momentum and you expect that momentum to continue here into 2019?

I think it's both. We're seeing good momentum and we're actually increasing our digital investments to acquire more customers. So we are doing, but that's part of the digital investment that Tom talked about earlier.

Okay. Appreciate it guys.

Thanks.

Our next question is from Deane Dray with RBC Capital Markets. Please proceed with your question.

Thank you. Good morning, everyone.

Good morning.

I just want to make sure I understand how you could get to the higher end of your 2019 sales guidance. Just from what I see you coming out of the fourth quarter, exit rate is a bit softer. You're baking in some soft landing assumptions here. Maybe we'll see how long the government shutdown pinches you, at least for the first quarter. But based upon that, where do you get an acceleration of growth? And might you have to go and consider further price cuts?

Well, first of all, let me adjust the price cut issue first. Our prices are competitive from a market base perspective, so that – no is the answer to that question. Our perspective is we don't actually see a shift in the share gain we have. So the way you think about it is if the market growth rate is at the top end of what we're saying, then we feel like we will be at the top end of that that revenue perspective. And so there's all kinds of opinions out there about what happens with market activity. Some of them actually have a little bit of a slowdown now and acceleration later. I don't know whether any of that's true, but certainly there are projections out there that are at the top end of our range. If that comes through, then we will be the top end of our sales range.

Got it. And then for Tom, just some color around the tax for the fourth quarter, a lot lower. We've heard some companies discuss further clarity on tax reform? Was there any dynamic there? And what was it that drove the decision to exit your clean energy tax program?

Yes. I mean, first of all on the tax rate, if you put in the stock-based compensation, then that puts us squarely at the low-end of our guide. So that's the story on that. In terms of exiting the clean energy, it was a nice $0.09 per share pickup for this year and just made the decision that we're going to conclude it.

So that was at your discretion it's not that the program went away.

That's correct.

Got it. Thank you.

Our next question is from Justin Bergner with Gabelli and Company. Please proceed with your question.

Good morning, D.G. Good morning, Tom.

Good morning.

As you look at sort of your outgrowth going forward and I realized only guiding to 2019 today, but just generally speaking, is it going to shift more towards medium customers driving your outgrowth? I know that large customers have also been a strong contributor, but as meaning customers become a larger base, is that going to become a larger contributor to your outgrowth? Or is it going to stay large contribution as well?

Over the next several years, we expect midsize customers to go faster than large, but we expect the dollar impact of large customer growth to be much higher given that the base of large customer revenue. So we don't feel like we are close to maxed out with any customer segment. We feel like we have strong opportunity really with our customer groups, but we would expect the percentage growth with midsize customers to be higher this year, next year, probably for the next three years at a minimum.

Okay. Thank you. And then I'm surprised that price is only modeled or expected to be 100 basis points. I mean, help me understand why all sort of the inflationary and tariff headwinds don't require greater than 1% price to sort of keep up with cost pressures?

Yes. Just to clarify, in the 1% to 4% market growth, we've got 1% is assumed in that, so it'd be 0% to 3% in terms of volume. With respect to our own range in our guide, we've got 1% to 2%.

Okay. That makes sense. Thank you.

Thanks.

Our next question is from Scott Graham with BMO Capital Markets. Please proceed with your question.

Hey, good morning.

Good morning.

Similar to – I think it was a question at the top about the 2019 guidance range for the U.S. I guess, I was expecting to hear a tinge of conservatism, and I don't think I'm hearing that from you all. And if I'm wrong in that, please let me know. And by extension, that does mean that the Other Businesses, that goal of 6% to 8% with a midpoint of 7%, that's roughly 100 basis points on a 6% margin from 2018 is a pretty big needle move on a business whose margins have really not moved even though we've kind of targeted higher. So it does seem that if in fact, the U.S. margin range is kind of going to be what it's going to be, that there's a lot of reliance in an area where we haven't seen a lot of success in reaching to a higher level of margin. Can you maybe give us what the drivers are behind that business to give us some comfort on that?

Sure. So just to be clear, we have seen pretty significant margin expansion in our other category over the last couple of years. And what gives us more confidence as we've actually closed some unprofitable businesses. That portfolio is now much more squarely the tune to the online model and the margins there are much higher than that 6% in aggregate. So as we go forward, we would expect to have continued margin expansion even with the investments in Zoro that we're going to make largely just the math of having a much stronger portfolio at this point. So we expect that. I would also say, we do expect slight margin expansion in the U.S., although it's modest at least for the guide.

Okay. We are talking to the as reported 6%, right? Not the sort of stripped down version, right?

I’m not sure. Scott, I’m not sure.

In other words, the business is – I think you were referring – they're through your other, your inter segment, you run some things that could potentially change the dynamic of the Other Businesses margin. We are talking about the Other Businesses margin as reported, right?

Sure, yes. Absolutely, absolutely we are. Yes.

Okay. Secondly, I know it was some time ago that you set forth your 2019 margin goals. Any reason why now that we're in 2019, we don't maybe take a look at a couple of years and kind of go to higher aspirations?

Well, I mean I would assume that we have higher aspirations. We have not – right now we're just talking about 2019. If we decide to put out margin guidance going forward, we would do that separately. But yes, I mean obviously we don't – we're not saying that we're going to stop.

No. For sure, I would definitely be hearing that message. Last question is this, the slowdown that we maybe saw in the fourth quarter, could you maybe give us a little bit of a feel for the tone of business in January so far?

Well, like I said, I mean it was – we're happy to see that people came back to work in January and we feel good about our ability to gain share in any market. There's obviously a lot of uncertainty. Most of that is uncertainty around things that we don't control and I don't think we know where to land. I would say that the fourth quarter up until sort of the last week of December, things were very, very, very good. And so the slowdown was a very, very short period of time. And so we were looking to see if people came back to work, and they did, which is good.

Understood. Thanks.

Thanks.

Our next question is from John Inch with Gordon Haskett. Please proceed with your question.

D.G., I want to ask you just about the national accounts. If you go back prior to your pricing initiatives, they would traditionally drag gross margins, and I'm curious if we were to normalize for these contracts sort of implementation the 10%, are they still relatively dragging year-over-year on the trend? Or are they flat, up? Like what's going on there?

So are you asking about – I think you're asking the question on national account. Are their GPs flat year-over-year? Or are you talking about their impact on the company's GP?

Yes. Are they flat year-over-year? And just – I guess if were to normalize for the contracts…

Yes. With the exception of the contract resets that we've talked about, the answer is, yes. They're pretty stable.

They are pretty stable. Okay.

Yes.

And that's a change right, from what…

Yes. It is actually post reset. What we've seen with all of our large customers is a bit of an opportunity to simplify pricing. They're more willing to buy spot-buys at the prices that they see because they're competitive, and so that’s simplifying things as well.

Okay. The other question I had is, it goes back to tariffs. If the tariffs are rolled back or we actually achieve a trade deal, I mean what actually happens to pricing? Does pricing have to get reversed? And how do you – look, how do you guys think about this dynamic over the next few months?

Well, so for us we actually separate price cost in terms of how we think about it. We're pricing to the market, and we try to get the best cost we can. I think I mentioned this before, typically when there's been things like that that have happened, price will change, but there maybe some lag. So there might be some period where you have some short-term benefit. Ultimately you would expect if tariffs will roll back, that prices would eventually sort of moderate. But typically we get some period of benefit then.

You mean, in Grainger prices moderate, so you would actually have to take your list prices down? Is that – or your contract pricing down or whatever?

Well, so over time the market price will change, and we will be aligned in the market price.

Understood. Just lastly, your Zoro investments, I think you said that you were expanding your SKUs. What are the SKUs now? And how much do they expand? And I'm curious, is there an impact if Zoro gets bigger with respect to potentially cannibalizing medium accounts or do you really think they can sort of stick to discrete tracks?

Yes. They're pretty discrete today. There is very little cannibalization. Actually, today, there's several million SKUs that Zoro has. We will go to double-digit million SKUs eventually. Doing that actually creates a little bit more differentiation between a Grainger model, which is very industrial, very MRO-focused versus what Zoro has. And we feel that that will actually mitigate cannibalization to some degree as well. But obviously there's some, but it's very minimal today.

Got it. Okay. Appreciate it. Thank you.

Thank you.

Ladies and gentlemen, we have reached the end of the question-and-answer session. I'd now like to turn the call back to D.G. Macpherson for closing comments.

All right. Thanks everyone again for joining us. I would just reiterate a couple of points. One is we're very happy with the performance that we had in 2018. I think we've focused on the right things. Our results were strong and we've got a lot of momentum heading into the future. So I really appreciate all your time, and I hope you are off to a great new year. Thank you.

This concludes today's conference. You may disconnect your lines at this time, and we thank you for your participation.