Greetings. Welcome to the W.W. Grainger Fourth Quarter 2019 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]. Please note this conference is being recorded. I would now turn the conference over to our host, Irene Holman, Vice President, Investor Relations. Thank you. You may begin.

Good morning. Welcome to Grainger's fourth earnings and full-year 2019 earnings call. With me are D.G. Macpherson, Chairman and CEO; and Tom Okray, SVP and CFO. As a reminder, some of our comments today may be forward-looking. 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 with their corresponding GAAP measures are found in the tables of the end of the slide presentation and in our Q4 press release, both of which are available on our IR website. This morning's call will focus on adjusted results for the fourth quarter and full-year 2019 which exclude restructuring and other items that are outlined in our earnings press release. Now I will turn it over to DG.

Thanks Irene. Good morning. Thank you for joining us. On today’s call, I will talk about our 2019 performance and key accomplishments and discuss our growth priorities for 2020. Tom will then cover our financial performance for the quarter and the year in detail as well as our 2020 guidance. Late last year, we introduced our team members to the Grainger Edge, our new strategic framework that defines who we are, why we exist, and how we work together to achieve our objectives. At Grainger, our purpose is to keep the world working. Whether that means helping a hospital focus on patient care, a manufacturing plant focus on building great products, or school focus on teaching. The work we do in the background helps keep facilities running, so our customers can focus on what they do best. It's a purpose that we’re all very proud of as an organization. The framework also outlines a set of principles that define the behaviors we expect from our team members working with each other, our customers and our supplier partners. We are holding ourselves accountable to these principles and believe they will help us execute our strategy and create value for our shareholders. These are not just words on a page. We’re committed to making these principles come to life in everything that we do. The Grainger Edge provides a foundational framework for our strategies we work to consistently serve our customers and gain share. We gain share through two distinct business models that allow us to leverage our scale and supply chain to support customers with different needs. Our high-touch solutions model serves customers that have complex needs and are looking for more tailored solutions. Through this model, we develop powerful customer solutions, deliver a great customer experience, and develop deep customer…

Thanks, DG. I'll start with a recap of our 2019 total company adjusted results, then move forward to the fourth quarter results by segment. Overall, we're pleased with our 2019 performance despite a challenging environment. Sales were up 3% on a constant currency basis, driven by 2.5% from volume and price favorability of 0.5%. FX had a negative 0.5% impact. It should be noted that our core U.S. and endless assortment business combined grew at 5% in the full-year. Consistent with our guide, our gross profit margin was down 50 basis points versus the prior-year. The decline was primarily driven by our lower margin endless assortment business, which is growing at a faster rate than the rest of the company. Contributing to the decline, both MonotaRO and Zoro had lower gross margin. MonotaRO faced freight headwinds in Japan and Zoro’s lower gross margin was driven by unfavorable product mix and promotional activities. Elsewhere, slightly lower gross profit margins in the U.S. were offset by higher gross margins in Canada driven by supply chain favorability. Despite meaningful investments in advertising, technology, and Zoro, we drove SG&A leverage driven by continued cost management actions. SG&A as a percentage of sales improved 60 basis points year-over-year as our SG&A spend remained flat to 2018. As a result, total company operating margins for the year increased 10 basis points with a 20 basis point improvement in the U.S. Incremental margin for the total company was 17% aided by 22% U.S. incremental margin. We generated operating cash flow of over $1 billion, which we use to invest in the business and return capital to shareholders, returning north of $1 billion through dividends and share repurchases. We did this while maintaining a debt-to-adjusted EBITDA ratio of 1.4 times. Operating cash flow was 116% of net earnings;…

Thanks, Tom. As I look forward to 2020 and beyond, I'm excited about the opportunities that we have in front of us. And I want to thank the Grainger team for their hard work and dedication. We’re well-positioned to continue to gain share in the U.S, to continue to drive 20% growth profitably in the endless assortment model, and to improve the rest of our portfolio. I’m confident in our ability to drive long-term value for all stakeholders. And I'm confident that we're going to continue to extend our lead in the industry. So with that, I will open it up for questions.

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

Hey, thanks. So first-off, I'm a little surprised by the 2020 gross margin guide down about 80 basis points at the mid-point, I had thought that after the price reset, you were thinking that gross margins would start to stabilize. So I'm trying to figure out for 2020 is the big change to focus on the large accounts or what's really changing?

Well, Ryan, there is really two things happening. I mean, one, it's just -- it's just the algebra of our endless assortment business unit getting much larger and growing at 20% and the gross profit profiles that that business has. So that's a very big portion of it, which is getting bigger obviously. And then one of our key growth initiatives is going after the large customers. And maybe just unpack that with a little example. Right now, we've been heavily focused on location-by-location basis. As we stated as part of our growth initiatives, we’re working more with the C-suite to try to get a broader, broader range of locations in terms of going after a bigger piece of the company's pie. And with that, initially you'll have to do some sort of write-down usually to gross margin as it relates to product mix as it relates to your offer. But then over time, there's plenty of levers to increase that gross margin whether it be with product substitution, standardization, reducing overall buy. So we're confident over time that we will improve the gross margin with those customers, but for 2020, we're being prudent in putting that in the guide.

Okay, that makes sense. I guess for my follow-up, sort of related, I'm thinking about the long-term growth algorithm. And so maybe you can help us should we be assuming that gross margins are down sort of 50 to 60 basis points structurally because of its mix, but then you'll offset that with SG&A. So we should think about EBIT growth equaling sales growth. And then if you do better than mid-single-digits, you probably kind of do EBIT growth a little bit better. Is that right?

So Ryan, I guess this is DG. Yes, so in the U.S. business, let's start there, our assumption is that we gained share 300 to 400 basis points faster the market. So if the market grows 2% through cycle, we'd be at 5% to 6%. At that, so what you see this coming year is a projection of market down half a percent, at that you see operating margins flat for the U.S. business year-over-year, so 2.5% growth flat operating margins. At 5% through cycle, we'd expect to get a little more leverage than the slight pressure on GP over time and see some expanding margins in the U.S. So I think it's a good -- this is a good sort of guide on the economics of the business at 2%, 2.5%, 3%, you're probably flat on operating margin in the U.S. If you get more growth than that you’re probably positive.

Thank you. Our next question comes from David Manthey with Baird. Please state your question.

Hi, good morning, everyone. First question, when I look at Slide 5, you clearly made many meaningful upgrades here. And I'm trying to figure out how many of these were defensive versus offensive in nature. And essentially, how will we measure the success of all these changes over the next three to five years? It looks like maybe a little bit of sales outgrowth. But are there other metrics, you'll be tracking to see the success of these initiatives?

Well I think I mean these are, to be clear Dave these initiatives on the left hand side in the U.S. are mostly rearview mirror initiatives in the sense that centralizing the call centers has gotten us increased service and lower costs. So we expect to continue to get lower costs. So that's one that you'll see in the SG&A line. If I looked at our order to cash process and customer feedback in the U.S. right now it is, it is at an all-time high, it got better this year significantly relative to the competition. So some of these moves have been around continue to improve service and you see that in supply chain capacity. Verticalizing the Salesforce, we think you're going to see in terms of part contributing to that 300 to 400 basis point growth faster than the market. And so it's a mix. A lot of these have been done already. When we go forward, we're going to start talking about some of the initiatives that are on Page 7. We’re merchandising assortments. I mentioned we merchandised $1.2 billion this last year, that's far more than we've ever done in a single year and will do $1.6 billion this year. We see that directly leading to sales growth. And we measure that very tightly, marketing both effectiveness to marketing and increased marketing budget we measure that very, very tightly. We know how much that contributes to growth. But the large customer initiatives that Tom talked about, we know how much that's leading to growth and what impact that has. So we’re tracking -- we are tracking everything. We wanted to put Page 5 together to say, there's been a lot of change in the business and we feel like we're in a good position to really drive the growth initiatives we're talking about.

Okay, yes, that makes sense. As a follow-up, then and you partially answered this in your answer to the last question. Over the last couple of years, you clearly grow in SG&A at a rate slower than sales growth or even gross profit dollar growth. And your guidance seems to imply more of the same in line with your targets. As a distributor, there's obviously inherent inflation in some of the areas of your costs tag, can talk about the other major areas of expenses that you're keeping flat or reducing in order to keep SG&A in check so well in this lackluster environment. I'm just looking for the big two or three buckets that you think are really the drivers of that performance?

Yes. So if you look at the cost structure, and I'll focus on the U.S. again, there's some big buckets of cost, where our expectation is that we will get productivity on a consistent basis. So in our distribution centers, we continue to automate, we continue to get process improvement to drive dollars costs per line down. In our contact centers, we continue to get productivity; we continue to get productivity in our salesforce through revenue per seller increases. Our expectation is that the cost increases that you talk about will be covered by productivity in those areas. And we basically have developed a process and an expectation and a philosophy that we will continue to drive productivity in each of those areas mostly through continuous improvement to basically offset those costs increases.

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

Hey, I just want to say appreciate your level of clarity and context in describing some of the changes here on gross margin. That's really helpful. And just to clarify in Tom's answer when you talk about the mix shift to large customers, that you'll sacrifice over the short medium term, the gross margin, but once you build share with these customers longer term, you're better positioned for profitable growth. What's the timeframe on this? I know you say longer term, but are we talking multiple years? I don't think you mean it takes that long because if you're moving to standardization, okay, so just share with us more of the timing of this because it does make sense, just the short-term, long-term seems a little vague?

Yes, no first of all you've got to remember that we've got a ton of customers. So this initiative is in various stages of development by individual customers. So it's not like you snap the chalk line and you start everything at one-time. So when we're talking about short to medium-term, we're certainly talking about a lot of it will happen within 2021 timeframe. It's really building the trust embedding with the different large customers, so we can reach in mix, so we can have products, the substitution. So we can have standardization, those types of things. So I guess we would look at this as a transition year from 2020 for this initiative.

And Deane I guess I would add to that, when we look at large customers, we track what we call economic earnings, which is a more sort of holistic view of the profitability of customers. And our goal is to make sure that we drive growth and profitable growth through that metric as opposed to just gross profit. So at times, we will take gross profit. It’s in the short-term if we're improving the cost structure elsewhere to provide the ability to consolidate customers and then provide value for those customers.

I think another thing, important part to notice these are really large multi-site customers. So this is really hitting home runs versus hitting singles and doubles. So this is a very attractive business to get. And just launching off of DG’s comments, we can lever our SG&A at about 2.5% growth, so we can afford to take the time to develop these very important customers.

Great. And then just a follow-up, could you put this negative price in context because we're hearing elsewhere in the industrial distributors that not only are there some of it is delays in getting supplier price increases through but there's heightened competition within the distributors, how much of that is at play in the negative price that we're seeing?

I think the important thing when you talk about price is to look at it on the full-year basis. As we said in our prepared remarks, our pricing was very lumpy. You'll recall from previous calls, we were quite aggressive in Q1 and then we dialed that back in Q2 and Q3. We made a conscious decision not to raise price in the back half of the years as to not be disruptive to our customers. When you look at it on an entire basis of the full-year, our price cost was roughly neutral. So and we're happy with that.

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

Thanks. Good morning and just kind of following up on Deane's question, is there any defensive component value pricing with the large customers? Or is that really all emanating from your tactical execution by customer just for share independent of market dynamics?

I guess there's always some tactical but I would say the majority is the latter. Some of it’s product mix within a given customer, some of it’s customer specific mix.

I guess, I guess, Chris, I think maybe your question underneath the question is has the competitive environment heightened with large customers; I think it's always been competitive. And we will always be in a situation where we have to be effective in navigating that competitive environment. It doesn't feel like it's changed dramatically, but certainly it's competitive.

Okay. And then also, I think you talked about how it kind of is in -- by customer, did you suggest that this would be a 2020, 2021 process and then you might open up some gross margin headroom after 2021?

It's difficult -- it's difficult enough to predict 2020 to try to predict 2021. Ideally, 2021, we would get back to a more a lesser decline in gross margin on a year-over-year basis.

I would say, Chris, that we have a lot of confidence in the value proposition that we have, our service is exceptional. Our customers want to do business with us. Over time, we think that we should be in a position to get price as much as anybody and to be able to continue to have very strong operating margins with our customers. So we’re confident in what we’re doing. In the short-term with trade and with the environment, it's been a little bit lumpy and clearly but we're pretty confident in the long-term ability to improve our margins.

Our next question comes from Patrick Baughman with JPMorgan. Please state your question.

Well thanks. Good morning, DG, good morning Tom. Maybe just start-off on the mid-size versus large customers. Just wondering into next year or I guess this year into 2020 you’d expect mid-size customers to still outpace large or is that flip with some of these share gains initiatives -- share gain initiatives you’ve been talking about for large? And then somewhat related to that you described the U.S. outgrowth in the quarter as 300 basis points and then you said large was 350 and mid-size was 550. So I'm just wondering what drag down the total segment?

Sure. I’ll take the first part of the question first. Yes, definitely we would expect medium customers to grow faster than large. I guess the way we look at it is, large at about 300 bps faster than the market, mid-size about 500 bps faster than the market on the low-end. As it relates to the chart that shows large and mid-size, there's a service revenue component that is included in those charts for large and medium not to get too technical on you. But that is a very important part of our business. That is really embedding with the customer. On the U.S. segment that is reflected on a net basis meaning we adjust cost out. So that's the difference between the two numbers where you're always going to have large and medium be higher than the U.S. segment.

Okay. I can follow-up on that after -- just one more from you, just if you could talk about the path forward at Cromwell. And what's embedded in your other businesses guidance there in terms of losses for 2020? And then on the same topic for other businesses, the magnitude of Zoro investments made in 2019. And whether do you still expect most of that spending to falloff in 2020?

Yes. So let me focus on Zoro and Cromwell, I think other than Zoro and Cromwell, we expect continued improvement in the businesses and we see a nice path. Cromwell we would expect this year to cut the losses roughly in half for this year, that’s our expectation. And I would say there's a couple of things going on at Cromwell. One is certainly the market has not been great and a portion of it has been related to that, a lot of it has been some service issues we had that we have completely worked through. We're hearing much better things from the marketplace, our net promoter score has gone from not very good to quite good actually. And the team is pretty excited about what we're doing. We have a new team over there; we're comfortable with the actions they're taking. Cromwell is interesting. If you remember why we bought Cromwell was as a platform for the online business, and because we thought it was good business. Zoro UK is actually doing quite well. And we would expect it to be profitable in 2021. So really by the end of the year, we should have a view as to whether or not both of those businesses can be successful and profitable. And that's -- that's when we will really sort of evaluate what we think we need to do. So as I mentioned beyond that in the prepared remarks, we have taken a bunch of costs out of that business. We have seen great service improvement; we have won a few contracts with customers recently. It gives us some confidence that things are coming back. But it's a steep climb get better. The investments in Zoro most -- a lot of those investments start to come-off this year. We made significant investments in the fourth quarter, some systems investments that had a few glitches, but we through them we expect improvement this year and then significant improvement again in 2021 with that business. And as I mentioned, we're excited to have Masaya Suzuki lead that business. He has been through this at the same point with MonotaRO and really feel like he's going to help that business accelerate performance going forward.

Thanks a lot.

So there is no reason we can't see the margin profile longer-term for Zoro be consistent with MonotaRO.

Thank you. Our next question comes from Adam Uhlman with Cleveland Research Company. Please state your question.

Hey guys, good morning. Hey Tom, I guess could you expand a little bit more about your comments earlier about the cadence of earnings to the year, I'm just wondering the fourth quarter costs for Zoro were higher than expected, does that carry into the first quarter here as things are ironed out and then are those the moving pieces we should keep in mind like the customer show other investment spending for Louisville, I'm just trying to get a sense of, should we be bracing for larger earnings designs in the first quarter and then into the second and then recovery in the second half of the year?

We are talking specifically about SG&A I'll go back to DG’s answer on Zoro. 2019 was an investment year for Zoro where we spent heavily in SG&A related to adding people, technology and advertising that will be reduced significantly beginning in -- beginning in Q1, so that will be a material impact. The way I would think about SG&A is the way we've talked about it, we plan on growing SG&A at half the rate of sales. We will continue with the productivity that DG talked about in a previous answer. As it relates to gross profit, we’ve seen no difference than our normal seasonality. We expect Q1 to be greater -- greater gross margin than Q4 of this year. And then we expect it to decline throughout the year with Q4 being a relative uptick to Q3. Does that get answer to your question?

Yes, that helps. And then secondly, could you expand a little bit more about what you guys are seeing in the near-term from a customer spending and general environment perspective, it looked like most of the end-market, or the sales growth by end-market was relatively similar to last quarter, I guess today things stand out to you as notable and then as we think about the investments that are being made into the Salesforce and verticalization efforts from this past year, are there any vertical markets that we should look to see accelerating growth next year as evidence of a payoff on those investments?

Yes, Adam, so what I would say is that, we are privileged to see a very wide swath of the economy with our customers. We have not seen much, much change over the last eight months really; I would say we continue to see a market that is slow growth, but not trailing off in anything worse at this point. And the customer end market results that we've seen the last two quarters, our expectation is they won't be dissimilar to start the year and that they're likely to get a little better as the year goes along. That would be our expectation at this point, not much better, a little bit better as you're going along. So I don't -- we don't see anything all that is unusual in our end markets right now, we haven’t over the last couple of quarters.

Our next question comes from Chris Dankert with Longbow Research. Please state your question.

Just one question from me, thanks so much for the update on large customer prototypes swinging for the fences on volume there. I guess could you get a brief update on kind of medium customer strategy there's still some concern about this being more price competitive pieces of business just how are you balancing digital versus high-touch and what is the go-to-market look like in medium customer in 2020 here?

Yes, so midsize customers are actually less price sensitive and we continue to see much higher margins with midsize customers. We're trying to build -- build a growth so that can become a more meaningful portion of our portfolio. We continue to see the ability into the Grainger brand to acquire new customers. We continue to see growth with our existing customers through our inside sales team, and through fairly simple pricing actions. Our service model really sings things to midsize customers. We continue to get very loyal customers in through the funnel. We're digital first in the sense that most of our midsize customer acquisition comes through digital first touch. And then we do a lot of work to understand who the customer is, what their profile is and move them through the cycle in some cases to get them to coverage that makes sense for them. That has proven to be fairly successful. As Tom said, we expect it to go faster with midsize customers at higher gross profit than we will have with large.

Yes got it. Just one sort of follow-up on that. I mean the 400 to 500 basis points above market in medium customer, anything that helps kind of get our arms around what informs that or why that's kind of sustainable longer-term?

Well, I think the most obvious is we lost a lot of that business. If you remember we were kind of $1.6 billion in that business went down to 800 something million and now we're up over a $1 billion again. There's a lot of customers that we continue to reengage and a lot of our marketing efforts are proving to be very successful with these customers. And once we get customers back and they realize that we are not -- that we're reasonably priced, very high service solution, they are coming back and working with Grainger again.

Our next question comes from John Inch with Gordon Haskett. Please state your question.

Hi, good morning. It is Karen Lau dialing in for John. Thanks for taking the question. So DG I think in the past few years, you had mentioned that given after the price reset, pricing pressure from large accounts has kind of diminished because your prices are more competitive. It sounded like that is really changing a little bit into 2020. I wasn't obviously there's the defense versus offense components, but the whole thing sound a little reminiscent of what happened before you do the pricing reset. So my question is, can you compare the customer's behavior today versus how they were three years ago and then compare your ability to respond to that versus three years ago before the pricing reset?

Yes. So I mean I don't think -- I don't think the situations are at all now, I guess back then, we were losing share dramatically with higher margin customers. We’re not doing that now. Large customer business even back then was very competitive. Most of it was on custom pricing contracts that is still the same today. The large customer pricing -- the advantage we got through the price change was that some of the tailspin was easier to get large customers to sign-up for because they weren't buying things frequently then our prices then made sense that is still the case. We have super pricing discussions with our customers now. They are still competitive. They were competitive back then, they're still competitive now.

Okay. Maybe looking at it as sort of a different angle. So mid-size obviously has been a focus in the past two years and has been very successful for you guys. I guess the shift to large accounts and I guess the factor that’s kind of deemphasizing midsize account a little bit, is it just a function of you have been very successful and done what you could do with those accounts. So, it's hard to do more to further accelerate the outgrowth in that market. I mean how you are thinking about that?

I would say we are not deemphasizing midsize customers at all. We still think they will grow faster than large. We are making sure that we’re competitive with our large customers. And that's important, obviously given the size of that customer group for us. That is a bigger lever on growth at this point. And so we need to make sure that we are growing with both but we are not deemphasizing anything. We still think there's a long runway ahead from midsize customer.

Thank you. Our next question comes from Robert Barry with Buckingham Research. Please state your question.

I’m hearing from East Coast. Yes just a few follow-ups actually. Yes, it looks like prices assume neutral in the guide. Is that right?

Yes, basically we're looking at price cost to be relatively neutral. As we said in the prepared remarks, we've got the three variables that we're trying to balance, share growth, market competitiveness in terms of pricing, as well as passing on inflationary cost. And similar to this year, we're going to balance those, those three and we think we'll end up somewhere flattish from a price cost perspective.

Got it. And I think when you first did the price reset, the goal was to narrow what had become a very large premiums market but still maintain some modest premium to go-to-market as the premium provider and to price that way, is that still true? Or it almost sounds like kind of alluding to the earlier question that maybe you're getting a little more aggressive, more happy to err actually on the side of under versus overpricing the market.

Now, we still have a premium with our list prices, we will continue to do that. It's a modest premium. And we'll continue to have that. And then I think the comment earlier was when you're going after large contracts on a portion of volume; you need to get pretty aggressive. And we've always done that. We just have to continue that.

Yes, I think you're making too much about price as it relates to large customers versus just a normal business dynamic where you're going from individual locations to a much bigger piece of a total company. That's just -- there's going to be part of as DG says that you're going to have a certain part of the offer that's going to be priced aggressively to get your foot in the door.

Got it. And just lastly, Tom, on the gross margin cadence through the year I understand in absolute terms higher in 1Q and then down through the year but had you alluded earlier to the year-over-year decline in gross margin being larger in 1Q and then moderating as the year progressed, or did I mishear that?

Yes, no, no, you heard it correctly. The front half of the year is definitely going to be a larger year-over-year decline than the back half. And that just is a lapping consideration where again, we were heavy on price at the beginning of the year in 2019. Costs didn't kick in until the back half of the year. So yes, that's the correct way to model.

Thank you. Our next question comes from Hamzah Mazari with Jefferies. Please state your question.

Hi, this is Mario Cortellacci filling in for Hamzah. I know you guys already touched on the Zoro business and the new roll-off of the investments. I’m just curious, I guess as margins build in that business, do you think that you'll break out Zoro and MonotaRO as a separate segment? I mean some could argue that your multiple doesn't really represent that business at all given where other online marketplace assets trade at?

What I would say is that with Masaya now running this, we think we have a couple of years of really hard work to make sure that we are performing on a path like the MonotaRO businesses then in the U.S. and in the UK. That's our entire attention. We are fully aware of the question and but for right now, we're really focused on making sure we get the businesses to be as successful as possible.

And as it relates to reportable segments obviously will follow all SEC regulations in terms of doing that.

Got it. Okay. And then just one quick follow-up. I think your working capital has been a cash flow drag in 2018 and 2019. I just want to know what your assumptions were for 2020 and maybe just a little color on the reason for the headwinds, is it mostly the endless assortment portion?

No, no. You rightly point out that it has been a little bit of a drag in 2018 and 2019. I would be disappointed if it didn't become more of a tailwind in 2020.

Our next question comes from Michael McGinn with Wells Fargo. Please state your question.

Thanks. If I could lean in on the Zoro and MonotaRO discussion as your model continues to shift more towards a reseller base. What does the business look like today in terms of sourcing and along those lines, what kind of ballpark services are you targeting relative to similar BDC, e-commerce peers, is it something similar like Alibaba in Europe around mid-single-digits or higher something like Amazon is charging?

I'm sorry could you, I'm not sure I fully understand the question. So let me just tell you what we're doing and maybe that will help you help answer it. We are not creating a marketplace Ali Baba or Amazon, we actually will have supplier relationships that we have some of them direct ship to customers from Zoro, that's what we've done on MonotaRO. And so the GPs tend to be slightly less there but not dramatically less when you do that because we don't have big package ship, but it's not like it's a fee and that's all we're getting. So I think it's a different model describing.

Yes, it is going to be a win-win for the suppliers that are drop shipping and certainly for us.

Okay, asked it different way, is MonotaRO currently getting a service fee from Zoro and does that go up over time as the business expands?

Okay, that's a different question, sorry. Yes, there is a variable service fee that Zoro does pay to MonotaRO and it's based on their profitability.

Sorry is it based on Zoro’s profitability?

Yes.

Okay. And what is that currently and what do you expect that to trend to as you build to 10 million skews?

Yes, not going to go into those types of details.

They'll get bigger, as they're successful, it will get bigger in space. It’s very small, it's a very small portion.

Yes.

Our next question comes from Justin Bergner with Gabelli & Company. Please state your question.

Two quick ones here most have been answered. With respect to the Canadian gross margin improvement, is that sustainable or was there anything sort of one-time that benefited the fourth quarter?

Yes, as we said in our prepared remarks, some of that was win dated related to supply chain efficiencies. I guess if I were to score it roughly, I'd say half of it will continue, half of it will fall-off.

Okay, that's helpful. And then the retail customer segment improved dramatically in the quarter I guess, to mid-teens growth. Just curious if that sort of idiosyncratic or if there's initiatives there some underlying backdrop is favorable?

Just to be clear, retail for us typically does not mean retail stores; it means warehouses attached to retail. And as you would guess that has continued to be a growing business in the U.S. as more stuff shows up at your door. So that's what's driving that growth. That is a growing thing.

All right, thanks. I appreciate everybody being on the call. I would just reiterate we are really confident in our path. We feel good about sharing profitability in the U.S. We feel really good about the online model excited to have Masaya lead that and drive strong growth and profitability there. And we will get Canada and Cromwell right. But generally, I would say we're very excited about where we're going and appreciate you listening to call today. Thanks.

Thank you. This concludes today's conference. All parties may disconnect. Have a great day.