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W.W. Grainger (NYSE:GWW)
Q2 2018 Earnings Conference Call
Jul. 18, 2018 11:00 a.m. ET

Contents:

  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:

Operator

Greetings, and welcome to the W. W. Grainger second-quarter 2018 earnings conference call. [Operator instructions] And as a reminder, this conference is being recorded.

I'd now like to turn the conference over to Irene Holman, vice president, investor relations. Please go ahead

Irene Holman -- Vice President Investor Relations

Good morning. Welcome to Grainger's Q2 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 statements 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 non-GAAP financial measures with their corresponding GAAP measures are at the end of the slide presentation and in our Q2 press release. Both are available on our Investor Relations website.

D.G. will cover our performance for the quarter, and Tom will give an update on our 2018 expectations. After that, we will open the call for questions.

D.G. MacPherson -- President and Chief Executive Officer

Thank you, Irene. Good morning, everybody, So the second quarter marked our third consecutive quarter of strong results, and the results certainly beat our expectations. Our volume growth significantly outpaced the market, driven by actions to consistently deliver value to our customers at relevant prices. The demand environment remained strong.

Our sales performance was driven largely by the strength of the U.S. business and our single-channel online businesses. In the U.S., we continue to see a solid response to our pricing actions with total volume growth of 11%. We saw growth across all of our major end markets, including manufacturing, commercial, healthcare and government.

We know that customers value the relationships they have with Grainger, our customer service, technical support and fulfillment capabilities. When you couple that with our relevant pricing, our offer is very compelling. And as a result, we're growing faster in more attractive parts of the U.S. business.

This is not only driving GP dollar growth but also resulted in better-than-expected gross profit margin for the quarter. In Canada, the execution of our turnaround is progressing as planned, and our actions there led to GP and operating earnings improvement. Our single-channel online and international businesses both had nice growth and expanded operating earnings in the quarter. Based on our performance and continuing momentum, we're raising our full-year guidance.

Tom will share the details of our updated guidance later in the presentation. Turning to reported results. Q2 2018 reported results include restructuring charges of $15 million and a $0.21 impact to EPS. Now, this morning's call will focus on adjusted results, which exclude the items outlined in our press release.

Total company sales in the quarter were up 9%. Volume was up 9%. Price was flat as price deflation in the U.S. was offset by price increases in Canada.

We had foreign exchange favorability of 1% in the quarter that was offset by negative 1% impact from the divestiture of Techni-Tool in the U.S. We have now lapped the Techni-Tool divestiture as of mid-July. Our normalized GP rate declined 30 basis points after adjusting for the revenue recognition accounting change and the timing of our annual sales meeting. We continue to realize operating expense leverage on higher volume.

This all led to operating earnings growth of 23% in the quarter. I'll cover our other businesses first. As a reminder, other businesses include our single-channel online model and our international businesses. Sales for these businesses were up 18% in the quarter.

14% was price volume and 4% was from currency. Our online businesses drove 25% sales growth and continue to be a profitable growth driver. Our international businesses had solid organic growth in the quarter and contributed to operating margin expansion. We are happy with where our international portfolio is today.

In Canada, sales were down 6% and down 10% in local currency. We introduced price increases in the fourth quarter of last year and are renegotiating pricing on large customer contracts. As a result, price was up 10% and contributed to GP rate expansion of 455 basis points in the quarter after adjusting for the revenue recognition accounting change. Volume was down 20% due to the planned price increases, branch closures and sales coverage optimization activities.

As we talked about before, this is going to be a smaller but more profitable business when we're through with the reset. Operating margin improved 290 basis points due to a higher GP rate and cost management. The turnaround is progressing as planned, with several of the activities running ahead of schedule. Much of the heavy lifting is behind us, and we're encouraged by the improvement in profitability.

We believe we'll be in a good position to exit the year profitably and go on offense in 2019. In the U.S., both the volume response to our pricing actions and the demand environment were strong. Sales were up 9% in the quarter. Total volume was up 11%, including seasonal sales and holiday timing of positive 1%.

Volume growth was partially offset by price deflation of 1% and a negative 1% impact from the Techni-Tool divestiture last July. Our normalized GP rate declined 65 basis points after adjusting for the revenue recognition accounting change and the timing of the sales meeting. Operating expenses in the U.S. were up 2% after adjusting for the revenue recognition accounting change.

Our operating margin was better than expected in the quarter as expense leverage on total volume growth of 11% more than offset the GP rate decline. Now as we look at growth in the U.S., we're continuing to see that our value proposition resonates with both large and mid-sized customers when we remove pricing as a barrier. We are gaining share and seeing volume growth with both customer groups. Our digital marketing activity is also having an impact.

And overall, our returns on both digital and off-line marketing are improving. U.S. large customer volume increased 9% in the quarter, above expectations. We're seeing increased share gains with large customers as they buy more infrequently purchased items and consolidate their purchases with Grainger.

U.S. mid-sized volume also exceeded expectations with growth of 29% over the prior year. We're seeing meaningful growth with both new and existing customers. Existing mid-sized customers, including lapsed customers, are buying more.

We're seeing that in our volume and the number of transactions per customer and in the number of customer contacts that are buying. We're also acquiring net new mid-sized customers for the first time in a long time. When we look at the mid-sized business growth, a meaningful portion of it is coming from new customer acquisitions. Overall, we remain optimistic about the U.S.

business in 2018. I'll now turn it over to Tom, who will discuss our expectations for the year.

Thomas Okray -- Chief Financial Officer

Thanks, D.G.. I want to start by adding some commentary on our results for the quarter. Let's take a closer look at gross profit. We normalized company gross profit rate in the quarter for two items.

One, a change in revenue recognition accounting standards; and two, the timing of our annual sales meeting. As a reminder, due to a change in accounting standards related to revenue recognition, we were required to reclassify certain KeepStock service costs from operating expense to cost of goods sold beginning in 2018. We have slides in the appendix that outline this change at the company and U.S. level.

Separately, suppliers provide funding for annual sales meeting. This funding benefits gross profit margin and is spread over three consecutive months, beginning in the month of the sales meeting. In 2017, the sales meeting occurred in March, and in 2018, the sales meeting occurred in February. The company normalized gross profit rate of 39.2% was down 30 basis points, which was better than our expectation.

This was driven by price-cost spread and mix favorability in the U.S. and the price increases in Canada. U.S. normalized gross profit rate of 39.8% declined 65 basis points.

As D.G. mentioned earlier, in the U.S., we're growing in areas we want to be growing. With large customers, price deflation is improving as we aren't deeply discounting infrequently purchased items and customers are more comfortable with our pricing level. Some of the gross profit favorability in the quarter was also due to the delayed timing of our large customer contract negotiation.

We're now through almost 90% of our contract revenue and expect to get through the majority of the remaining contracts by the end of this year. We did see some supplier inflation in the quarter, partially due to tariffs, and we're able to pass through price while maintaining market competitiveness. Company operating margin was 12.6%, up 150 basis points, driven largely by expense leverage on strong sales performance. Earnings per share of $4.37 in the quarter was up 59% versus the prior year, primarily driven by higher operating earnings and a lower corporate tax rate.

Operating cash flow of $248 million was up 30% versus the prior year, and free cash flow of $211 million was up 32% versus the prior year. The increase in both cash flow numbers was driven largely by higher earnings and a lower tax rate. Page 13 covers our updated guidance for the year. What we shared in April is on the left side of the chart, and our updated guidance is on the right.

We outperformed our internal expectations by about $0.60 in Q2. That flows through to the updated guidance for the year. In addition, we are also adding $0.15 of favorability to the second half, largely as a result of the momentum we are seeing, including lower-than-expected price deflation. As a result, we are taking both the high and the low end of the EPS range up $0.75.

We now expect revenue growth to be in the range of up 5.5% to 8.5%. We expect an operating margin of 11.5% to 11.9%, which is 50 to 90 basis points higher than the prior year. We expect EPS to be between $15.05 and $16.05 or 32% to 40% higher than the prior year. From a sales perspective, we continue to believe that our volume growth will outpace the market by 300-plus basis points this year.

With respect to gross profit margin, after normalizing for the 50 basis points related to the revenue recognition accounting change, the rate is expected to decline between 50 and 20 basis points versus the prior year. Further, we expect our gross profit rate to follow the normal sequential trend in 2018. For 2019, we expect the gross profit to be relatively stable versus 2018. I want to spend a moment on price-cost spread in the U.S.

We previously expected a price headwind of negative 1.5% for the year. That value was a net number comprised of negative 3% from our August 2017 pricing reset, partially offset by a positive 1.5% from favorable mix and market-based price increases. Today we are updating the total price headwind to be negative 1%. We now expect price deflation related to the reset to improve due in part to timing of contract negotiations.

We expect to complete a majority of the contracts this year. Our expectation for COGS deflation remains unchanged at 50 bps, driven by our internal product cost optimization initiatives. We expect that we will see some supplier inflation related to tariffs in the second half, and we are confident in our ability to pass on price increases. I think it's helpful to point out that the current market dynamic is similar to past periods of inflation.

Grainger has historically done well in managing costs and getting price realization through these periods. I'll now turn it back to D.G. for closing remarks.

D.G. MacPherson -- President and Chief Executive Officer

Thanks, Tom. So overall, we're very pleased with our continued strong momentum. Our value proposition is resonating in the U.S., resulting in strong growth, with gross margin rates above expectations. And we are developing stronger relationships with customers of all sizes.

We are executing our turnaround as planned in Canada and expect to exit the year profitably. Our online model continues to drive strong revenue growth and margin expansion, and our international businesses are contributing to earnings. We continue to get strong expense leverage across the business and are on track to achieve the productivity targets we laid out at Analyst Day in November. We're well-positioned to gain share and improve our economics going forward.

With that, I'll open it up for questions.

Questions and Answers:

Operator

Thank you. We will now begin the question-and-answer session. [Operator instructions] Our first question comes from the line of Ryan Merkel with William Blair. Please go ahead.

Ryan Merkel -- William Blair & Company -- Analyst

Thanks. Good morning and nice quarter.

D.G. MacPherson -- President and Chief Executive Officer

That's right.

Ryan Merkel -- William Blair & Company -- Analyst

So first question, a high-level question on the cycle, D.G.. There's been increasing talk and worry about peak cycle and what tariffs may do to demand. You just put up a very good quarter, obviously, but what are you hearing from customers about the second half? And are there any signs of slowdown anywhere that you can see?

D.G. MacPherson -- President and Chief Executive Officer

Well, through the quarter, we haven't seen any signs of a slowdown at this point. There's certainly conversations with the customers. I would say most of those conversations, tariff-related, tend to be longer-term. So questions about whether or not a product will actually be -- the end product will be made in China and then shipped over given the way the tariffs are structured, I've touched with a couple of customers about that.

But in the short term, we feel like there hasn't been a lot of action yet, and we don't see any slowdown at this point.

Ryan Merkel -- William Blair & Company -- Analyst

Perfect. That's helpful. And then secondly, opex growth has been very well controlled for a few quarters now, up low single digits. So two questions.

How long can this last? And then could you comment on what is normal opex growth?

D.G. MacPherson -- President and Chief Executive Officer

Well, I think if you looked over our history, normal probably would -- you have to have it in quotes. I'm not sure you have anything that's exactly normal. I would say we feel like for this year and next at least and in 2020, we have the opportunity to get pretty significant leverage. Our expectation is that our opex will cover merit for folks every year.

There's a built-in productivity every single year. And so if the market -- if we grow 6% volume, we would expect our opex to be 3 or something like that or less in general.

Ryan Merkel -- William Blair & Company -- Analyst

OK. Helpful. Thank you, I'll pass it on.

Operator

Our next question is from the line of Christopher Glynn with Oppenheimer.

Christopher Glynn -- Oppenheimer -- Analyst

Thanks. Good morning.

D.G. MacPherson -- President and Chief Executive Officer

Good morning.

Christopher Glynn -- Oppenheimer -- Analyst

Exciting results there. So as you talk about the U.S. large customers finishing their round of contract negotiations, just curious what happens next as you would envision it, assuming contracts renew on a rolling basis over time? You finish now, maybe it starts up again. Do subsequent rounds tend to include some additional price concession versus volume trade-offs?

D.G. MacPherson -- President and Chief Executive Officer

Any time you are in a negotiation for a contract, it's a competitive situation. That has not changed at all. That will continue to be the case moving forward. What we do feel like is off of the price reset, we are competitive.

I think what you're seeing with large customer GP is -- the gross profit is that it's not down very much because we've all been competitive with those customers, and we feel like we're well-positioned to go through whatever cycles come up in the future. And our focus through those negotiation is typically how do we save customers' time? How do we save them money? And if we focus on that, we have the ability to continue to have really strong economics on the other end if we do the right things.

Christopher Glynn -- Oppenheimer -- Analyst

OK. Thanks. And then on Canada, just wondering your comment, go on offense in 2019. You're clearly seeing a volume impact from the price resets.

But could you elaborate on what you mean by go on offense?

D.G. MacPherson -- President and Chief Executive Officer

Turn the situation from shrinking to growing. We are through teams that did a really nice job there, getting through the vast majority, if not all, of the restructuring and the changes we have to make. We're stabilizing the business with certain customers, and then we're going to grow. We're going to grow in a way that allows us to be profitable as we grow.

And so when we talk about going on offense, it's actually what we mean, grow profitably.

Christopher Glynn -- Oppenheimer -- Analyst

OK. Thank you.

D.G. MacPherson -- President and Chief Executive Officer

Thanks.

Operator

The next questions come from the line of David Manthey with Robert W. Baird.

David Manthey -- Robert W. Baird & Company -- Analyst

Thanks. Good morning.

D.G. MacPherson -- President and Chief Executive Officer

Good morning.

David Manthey -- Robert W. Baird & Company -- Analyst

D.G., about a year ago, you declined to refine your 2021 margin goals, and I assume that's still the case. But first off, the 12% to 13% overall operating margin target for 2019, should we assume that's still in effect?

D.G. MacPherson -- President and Chief Executive Officer

Until we change it, yes, you should assume that's still in effect.

David Manthey -- Robert W. Baird & Company -- Analyst

OK. Fair enough. Second, as we look at that prior 2021 range, especially for Canada, you were looking at 7% to 9%. And I believe your 2019 goal is 4% to 8%.

When we think about Canada, should we assume that structural operating margins are limited to high single digits? Or changes you've made to the footprint and the model here just recently -- can you ultimately start to approach double digits and maybe even get closer to U.S. levels?

D.G. MacPherson -- President and Chief Executive Officer

Well, I think I'd answer that with two comments. The first one is we don't believe there's anything structurally that should keep us from having double-digit margins in Canada if we do all the right things. So we do believe that. Given where we're sitting, we're really focused on getting to the improvement goals we set in the next year.

That's really, really important. And so we view that as a step on the path to improving growth and profitability in the business. But I don't think there's any reason why we couldn't be in the low double-digit earnings in Canada at some point.

David Manthey -- Robert W. Baird & Company -- Analyst

Thanks, D.G..

D.G. MacPherson -- President and Chief Executive Officer

Thank you.

Operator

Our next questions come from the line of Chris Dankert with Longbow. Please go ahead.

Chris Dankert -- Longbow Research -- Analyst

Hey. Thanks for taking my question. I guess, first off, D.G., would you mind kind of like highlighting what we've seen as far as the restructuring savings in the first half versus the back half? It seems like it should be a little bit back-half-weighted here. And just kind of your confidence in hitting those targets?

D.G. MacPherson -- President and Chief Executive Officer

Well, I'm really confident in hitting the targets, mostly because most of the actions that we have to take have already been taken or were just completed in the last quarter. So we feel like the Canada targets are going to be -- we're going to hit those. And the U.S. targets, most of the actions we've already taken.

So we are highly confident in what we're seeing.

Chris Dankert -- Longbow Research -- Analyst

Got it, got it. And then just kind of looking at 2Q here. It seems like the loss on your investment in clean energy was quite a bit lower 2Q versus last year-end and last quarter. I mean, anything that you'd speak out as far as expectations there going forward? Should we expect that the losses there just will be roughly smaller now?

Thomas Okray -- Chief Financial Officer

We've got no change in terms of our guidance on our coal investment. We're keeping with $0.05 to $0.10 EPS range.

Chris Dankert -- Longbow Research -- Analyst

That's even despite what we saw in the second quarter here?

D.G. MacPherson -- President and Chief Executive Officer

Yes.

Chris Dankert -- Longbow Research -- Analyst

OK. OK. Thanks. Thanks so much, guys.

D.G. MacPherson -- President and Chief Executive Officer

Thank you.

Operator

Our next question are from the line of Patrick Baumann with JPMorgan.

Patrick Baumann -- J.P.Morgan -- Analyst

Hi. Good morning, guys.

D.G. MacPherson -- President and Chief Executive Officer

Good morning.

Patrick Baumann -- J.P.Morgan -- Analyst

A quick question on the margins. You guys made 12.5% total company margins in the first half full-year guidance. I guess, 11.5% to 11.9% now. So it kind of implies -- the second half kind of implies margins that's a little bit worse-than-normal sequential deterioration versus one -- versus the first half.

Historically, it's about 100 basis points. This year, it seems like you're embedding 150 basis points of degradation versus the 12.5% you did in the first half. And I'm just curious if there's anything that stands out that's driving that. I know you mentioned large contract renegotiations, and maybe that's a factor.

I just -- want to help with the math there, if you can.

D.G. MacPherson -- President and Chief Executive Officer

Yes, yes. So it's a great question. Thanks for asking it. I think that the reality is that we still are, in many ways, in new waters in certain places.

So to the extent we saw our mid-sized customers continue to grow like we've seen them grow. We saw large local customers grow, like we've been seeing. Certainly, there's a chance for us to do better than what we've talked about. But it's so early on many things that we're seeing.

We're still getting a real handle on that. We felt like we wanted to stick with a wide range at this point. And we're optimistic about the path along.

Patrick Baumann -- J.P.Morgan -- Analyst

OK. Makes sense. Then can you talk about your direct exposure to China sourcing? I know it seems some of the private label products you sell come from there. I'm just not sure...

D.G. MacPherson -- President and Chief Executive Officer

Yeah.

Patrick Baumann -- J.P.Morgan -- Analyst

If you can quantify or -- and also how you're approaching kind of the tariff situation just from a risk-mitigation perspective for some of that stuff.

D.G. MacPherson -- President and Chief Executive Officer

Yes. So we -- the vast majority of our sourced items come from China, up to two thirds or even more than that, at this point. There's also -- so there's two things. One is our private brand products, they come from China.

The other is branded products that come from China. Both have the potential to be impacted here. If I focus on our private-branded products, though, we have -- we've been looking very closely at alternative sources and understanding what we can do and how we can shift. And so if you think about private brand, we have 22% private brand.

Most of that is China. For every item that is -- that you could, we have an alternate source effectively, and we can shift if we need to. We haven't seen yet the economics to make that work, but we are looking at it consistently. And we feel like we're in good shape to really understand what to do.

Patrick Baumann -- J.P.Morgan -- Analyst

Got it. Makes sense. Then last one for me, the buyback in the quarter slowed down a bit. Any reason for that? And is there any update to kind of cash flow expectations or buyback for the year?

Thomas Okray -- Chief Financial Officer

No, we're just looking at our model and opportunistically buying back. For the year to date, we bought back over 760,000 shares. Just really looking at the price of the stock in the market, no intentional slowdown.

Patrick Baumann -- J.P.Morgan -- Analyst

Thanks.

D.G. MacPherson -- President and Chief Executive Officer

Thank you.

Operator

And our next questions come from the line of Deane Dray with RBC.

Deane Dray -- RBC Capital Markets -- Analyst

Thank you. Good morning, everyone.

D.G. MacPherson -- President and Chief Executive Officer

Good morning.

Could you comment on your business with the U.S. government and specifically exposure on Section 846 of that NDA contract?

Yes. So 846 is still -- I think you know this is still under study. So there's absolutely no implementation of that at this point. Our business with the government -- the U.S.

government has been very strong this year. It continues to be strong. We have great relationships across a number of different organizations, the military organization and beyond. And we've seen really strong results with what we do.

In many cases, we are really helping military bases and other federal governments manage their inventory, and that's a big part of what we do for them. And so we haven't seen any impact yet from that bill, and I think there's uncertainty around what that bill will actually look like at the end.

Deane Dray -- RBC Capital Markets -- Analyst

Got it. And then just in terms of where we are in the cycle, are you seeing or feeling pressures, let's say, freight? Are you able to pass that types of incremental charges to your customers? And any issues with labor shortages in your organization?

D.G. MacPherson -- President and Chief Executive Officer

Well, certainly, I would say that the labor market is tight and the freight market is tight. So there's no question about that. We haven't seen labor shortages taken the second of those two. With freight, our team has done a really nice job of looking at alternatives.

Our initiatives have more than offset the pressure for price increases at this point. Certainly, there's pressure, particularly with truckload and LTL, where drivers are in a shortage and there's all kinds of issues that are challenging in that market. But so far, we've managed through that really well, Dean.

Deane Dray -- RBC Capital Markets -- Analyst

Got it. Thank you.

D.G. MacPherson -- President and Chief Executive Officer

Thank you.

Operator

And our next questions come from the line of Nigel Coe with Wolfe Research.

Nigel Coe -- Wolfe Research -- Analyst

Yes. Thanks. Good morning. I just wanted to go back to the OPEX control.

And appreciate the detail, D.G.. But can you just maybe give an update on where you are with the sales force expansion, sales force effectiveness and also your marketing strategies? And maybe just go into a little bit more detail. Obviously, you're investing in certain categories. Where are the offsets to SG&A to enable you to get that leverage into 2019?

D.G. MacPherson -- President and Chief Executive Officer

Nigel, I didn't understand. You said -- I didn't fully understand the question. You said sales force expansion, and you had another thing in there that I didn't understand.

Nigel Coe -- Wolfe Research -- Analyst

Yes, marketing. So online marketing and yes, traditional.

D.G. MacPherson -- President and Chief Executive Officer

Yes, yes. So when we think about OPEX control, we look at the entirety of our spend. We get very strong productivity, typically in pockets that have very big populations. That includes our distribution centers, our contact centers.

We continue to see that go well. We're continuing to get productivity in our sales force. And putting in the CRM has helped our sales force have the right conversations, go to the right customers, and it's improving. We expect to -- we're learning, and we expect that to continue going forward.

We've added some sellers, and we are adding sellers, I would say, at a modest level consistently. And the sellers that we do have are going to be more productive, and that's the way we think about that.

Nigel Coe -- Wolfe Research -- Analyst

Okay. Great. And then just picking up on the 301. I think you said 22% of your sales are white label -- are private label products.

Bulk of that comes from China. Is that right?

D.G. MacPherson -- President and Chief Executive Officer

Oh, that's correct.

Nigel Coe -- Wolfe Research -- Analyst

Yes. So based on the current tariff lifts that we have, the initial 50 and then the next 200, have you been in any way concerned with how much of that 20% is currently wrapped into those lifts?

D.G. MacPherson -- President and Chief Executive Officer

Yes. So far, it's a small portion of it, and our team is working very hard to make any changes we need to make with that portion. We'll have -- obviously, if this expands and the next tranche comes in, we'll have more to tell you about that as we learn more.

Nigel Coe -- Wolfe Research -- Analyst

Great. Thank you.

D.G. MacPherson -- President and Chief Executive Officer

Thank you.

Operator

Our next questions are the line of Evelyn Chow with Goldman Sachs. Please go ahead.

Evelyn Chow -- Goldman Sachs -- Analyst

Hi. Good morning, guys. Congrats on a great quarter.

D.G. MacPherson -- President and Chief Executive Officer

Thank you, Evelyn.

Evelyn Chow -- Goldman Sachs -- Analyst

In the first question, just thinking about the medium customer volume growth, still very strong. And you noted that you're finally seeing new customers acquired after a long time. What are those new customers responding to most out of your offerings and initiatives?

D.G. MacPherson -- President and Chief Executive Officer

Well -- so, I would say that the interesting thing about our performance in the last few years with mid-sized customers has been when we talk to them, they have been very positive about their perceptions of Grainger. But pricing has -- their comments have been, well, the price is not for me. You aren't for me. And so I think what we're seeing now is our technical product support, our assortment, our delivery performance, the basics that we provide customers are really, really valuable to mid-sized industrial customers.

We can help them find the right product. We have -- we're very easy to deal with. If they need to get somebody on the phone to understand things, they can. And so what we're seeing is price is not a barrier.

And so the things we've always done and we continue to do better are really resonating with those customers.

Evelyn Chow -- Goldman Sachs -- Analyst

It makes sense, D.G.. And then I just want to make sure I understand the components of the back half guidance raise. So I know of the roughly $0.75 raise that you put up today for the full year, you said $0.60 was from 2Q and then $0.15 in the back half. Am I correct in understanding that if a, OPEX performance is better than you expect, there's perhaps upside to that? And then secondarily, I think in your prior guide, there was about $0.10 of timing-related negative impact on the back half.

Could you just update that for us as well?

Thomas Okray -- Chief Financial Officer

Yes, Evelyn, you're correct. We basically took the $0.60, which was our forecast to -- versus our EPS and took that through to the guide and then put another $0.15 in the back half related to price volume in the U.S. And as D.G. said earlier, we're intentionally keeping the range wide.

It's early days dealing with customers we haven't dealt with in a while. So intentionally keeping the range wide. But as D.G. said, we're very optimistic in terms of how we're performing.

Evelyn Chow -- Goldman Sachs -- Analyst

All right. Thanks, Tom.

Thomas Okray -- Chief Financial Officer

Thank you.

Operator

Our next questions come from the line of Hamzah Mazari with Macquarie. Please go ahead.

Hamzah Mazari -- Macquarie Research -- Analyst

Good morning. Thank you. The first question is just around the medium customer business. D.G., is there anything preventing your market share in medium customer being similar to large customer? Is there any underlying dynamics in that medium customer market that either make it more competitive or different from the larger customer market? And any color there? Thank you.

D.G. MacPherson -- President and Chief Executive Officer

Well, I think the competitiveness is different. I think if you're serving large complex customers, the set of customers that can even do the things that you want to do -- or the set of competitors that can do the things you want to do are probably narrower. That said, I don't know that there's any gate to us achieving a similar share with mid-sized customers as we have with large primarily because of how much they value our assortment, our tech support, our search, our ability to help them get what they need. But that's an interesting question for the future, Hamzah.

We're looking at that really closely, and we'll see the trajectory we get on. And we will figure that out.

Hamzah Mazari -- Macquarie Research -- Analyst

Great. And just a follow-up. You talked about stable gross margin in '19. Maybe for Tom, did you assume that the COGS deflation that you guys are seeing, even though there's inflation in the market today, that that's structural and that's sustainable in '19 when you talk about stable gross margin?

Thomas Okray -- Chief Financial Officer

Yes. I think we've got many levers we can pull in '19 going forward. Our PPO organization really, I think, is a very good process and is going to enable us to have deflation going forward. So there's other opportunities as well as in the supply chain for gross margin.

And we're comfortable that the gross margin going forward is going to be stable.

Hamzah Mazari -- Macquarie Research -- Analyst

Great. Thank you.

Operator

Our next questions come from the line of Ryan Cieslak with Northcoast. Please go ahead.

Ryan Cieslak -- Northcoast Research -- Analyst

Hey, good morning. Congrats on another nice quarter. Just to take on that last question there. If price-cost is improving for you guys, and it certainly feels like mix is also moving in the right direction, I'm just trying to understand why you wouldn't be able to expand gross margins in 2019 or maybe you're just trying to be conservative just given the timing right now, as you said still early days.

But maybe talk a little bit about ultimately what would offset your ability to expand gross margins in 2019.

D.G. MacPherson -- President and Chief Executive Officer

Yes. I think that on a like-for-like basis, we would expect to have slight GP expansion in 2019. I think that what you're probably not accounting for is there are a number of contracts -- large contracts that are going to be implemented in the back half of this year that will have some impact on GP, and we've talked about that before. But it's 10% of the contracts or something that we still have to do roughly.

And some of those are fairly large. So that's going to be the drag in 2019 that we'll need to overcome.

Ryan Cieslak -- Northcoast Research -- Analyst

OK. And D.G., just sticking with the 2019 thought process. Is 6% to 8% volume growth still the range that we should be thinking about? Or is there any change in how to think about that, either from one, the fact that volumes are running ahead of your expectations but also that also makes the comp a little bit more difficult now going into '19?

D.G. MacPherson -- President and Chief Executive Officer

Yes. I mean, we haven't changed that. I think what I would say is that as we look at all the different sources of our growth right now, we're getting a better understanding what we think next year we'll be, and we'll talk about that as we get more refined in understanding. We will grow [Inaudible] faster grow with them.

Ryan Cieslak -- Northcoast Research -- Analyst

Okay. Great. And then my last question and I'll get back in line. The digital marketing initiatives you guys deployed, if I remember right, that was something that really was deployed more so in this past quarter.

Just can you help me -- thinking about the timing of that, maybe did you only have half of a benefit, do you think, from those initiatives, or meaning, did you get a bigger benefit as you go here into the third quarter as it relates to potential new customer growth in the back half of the year? Thanks.

D.G. MacPherson -- President and Chief Executive Officer

So we've been fairly consistent in the investments that we've made in digital marketing throughout the year. We've stepped it up a bit. I think we'll get more benefits because I think we're going to get better at it. And we're learning as we go.

And so I think it won't necessarily be because we spend a whole lot more. But as we understand what customers respond to, we're going to keep getting better, and the effectiveness of that will increase.

Ryan Cieslak -- Northcoast Research -- Analyst

Thanks.

Operator

Our next questions come from the line of Scott Graham with BMO. Please go ahead.

Scott Graham -- BMO Capital Markets -- Analyst

Hey, good morning. Nice quarter, all.

D.G. MacPherson -- President and Chief Executive Officer

Good morning.

Scott Graham -- BMO Capital Markets -- Analyst

I'm hoping -- and this is maybe a question for Tom, to maybe square my math here. Last quarter, the U.S. business price-mix was -- again away from the resets, was plus 1.5. And this quarter, it looks like it's plus 1.5 again.

Now I'm assuming that price was more of a component of the 1.5 in this past period, which would suggest that the mix actually deteriorated, if my math is square. Whereas the areas where you're getting the better volumes off of the price reset are mix-positive. Could you kind of maybe walk us through that?

Thomas Okray -- Chief Financial Officer

Yes. I'm not sure I fully understand the question. Can you take me back again and repeat, please?

Scott Graham -- BMO Capital Markets -- Analyst

Sure. So you're showing in your slide deck here, Page 14, that price-mix this past quarter thereabouts, was up 1.5 and last quarter, 1.5. Assuming that price increases have accelerated modestly as the years progress, so it would suggest that the mix component of that 1.5 has actually deteriorated. Yet the areas where you're lowering prices, including with large customers on the spot-buy business, and medium-sized customers, which are much higher gross margin sales, those are accelerating.

So where is the mix negative coming from? Because it doesn't appear to be coming from those areas. In fact, those areas are going the other way.

Thomas Okray -- Chief Financial Officer

Yes. I think your first assumption, in terms of the comparable -- I mean, the comparable price increase is not fully accurate for Q1 and Q2 because we are seeing favorable mix related to gross profit in terms of certainly our medium-sized customers, which have a higher gross profit. Now it's a much smaller amount of the total. We do see minor deterioration related to product mix, and that's probably a function of our customer mix.

But we're not seeing large deteriorations associated with customer mix. We're seeing favorable with customer mix.

Scott Graham -- BMO Capital Markets -- Analyst

Yes. As I would have thought. I guess, maybe I'm just still having trouble squaring the math. But I'll take that with Irene off-line.

My follow-up question is simply on the tariffs and how you source and what have you, and I guess, it's good news you're not seeing a lot of the proxy you source on the list. But I guess, what I'm wondering is, are you implying that -- and your competitors have said the same thing, we're ready to alternate source if needs be, this kind of thing. But that alternate sourcing would obviously come at a higher cost. So are you implying that you're not concerned about it because you'll get the price to compensate for that?

D.G. MacPherson -- President and Chief Executive Officer

Yes, that's exactly right. If the market price of items goes up because of the tariffs, we will be able to pass that through. And our history suggests that is true.

Scott Graham -- BMO Capital Markets -- Analyst

Thank you, D.G..

D.G. MacPherson -- President and Chief Executive Officer

Thank you.

Operator

Our next questions come from the line of Justin Bergner with Gabelli.

Justin Bergner -- Gabelli & Company -- Analyst

Hello. Good morning, D.G.. Good morning, Tom. Very great quarter.

D.G. MacPherson -- President and Chief Executive Officer

Thank you.

Justin Bergner -- Gabelli & Company -- Analyst

First off, I just want to make sure I understand that the $0.60, of I guess, better performance versus expectations doesn't include any sort of pull-forward from the second half in terms of the $0.15 that you're guiding better for the second half.

D.G. MacPherson -- President and Chief Executive Officer

It does not.

Justin Bergner -- Gabelli & Company -- Analyst

OK, great. And then on the cost inflation side, you're keeping that at negative 50 basis points. Is that because the cost of inflation won't really come through until 2019? Or is it because it's coming through in the second half but you're taking better actions to offset some of that?

D.G. MacPherson -- President and Chief Executive Officer

It's the latter. Yes, it's the latter. We're taking better actions to offset some of that.

Justin Bergner -- Gabelli & Company -- Analyst

Okay. And can you clarify sort of what you're able to do more on the cost side to improve the price-cost dynamic?

D.G. MacPherson -- President and Chief Executive Officer

Well, I mean, a lot of that has to do with the process that Tom mentioned, which is really understanding, working with suppliers to understand what the cost should be and making sure we get the right assortment, which can be at the right cost. So I would say that the processes we use consistently drive COGS improvement, and we continue to see that today.

Thomas Okray -- Chief Financial Officer

I mean, one of the things coming into Grainger, I was very pleasantly surprised looking at the clean sheet approach that they do related to working with the suppliers. I would think it would be up close to being an industry benchmark in terms of clean sheet and looking at replicating the suppliers' income statement, etc. So it's really a top-notch process in place.

Justin Bergner -- Gabelli & Company -- Analyst

OK. Thank you. And then just lastly, if I may. I assume that some of the higher earnings is going to translate into better free cash flow.

Any sort of comments on how you intend to deploy that better free cash flow versus sort of the views you set out at the end of last year?

Thomas Okray -- Chief Financial Officer

Yes. We'll have more to say about that at a later date. But I mean, just to touch on it briefly, I mean, obviously, we like our investment-grade credit rating, and that's important to us. Following that, we're going to invest in the operations.

We've got opportunities to have a lot of high-ROIC projects, which we're sorting through right now. And then third, we'll give the money back to shareholders, dividends and buybacks. I wouldn't expect any dramatic change in the current capital allocation process.

Justin Bergner -- Gabelli & Company -- Analyst

OK. Thank you.

Operator

And our next questions come from the line of Steve Winoker with UBS.

Steve Winoker -- UBS -- Analyst

Thanks, and good morning.

D.G. MacPherson -- President and Chief Executive Officer

Good morning.

Steve Winoker -- UBS -- Analyst

So I just wanted to follow up a couple of the questions. One is on the whole sourcing discussion and tariff. Just to be clear, the comments that you made were about the first $50 billion tranche in terms of what's effective to you, not this $200 billion, correct?

D.G. MacPherson -- President and Chief Executive Officer

That is correct. That is absolutely correct, yes.

Steve Winoker -- UBS -- Analyst

OK, OK. And then I mean, do you see in that, should this continue to escalate, and obviously, there's a lot of uncertainty around that, is there actually a share gain opportunity for you here as you look at customers? Or is this sort of hard to kind of see through some positives in this?

D.G. MacPherson -- President and Chief Executive Officer

Well, I'd have to ask you what you mean by share gain opportunity and how that would come about. But generally, as you know, it's just an inflationary action, and so we would expect that to be the outcome here.

Steve Winoker -- UBS -- Analyst

OK. All right. Well, let me take it off-line. On the medium customer comments that you made on the daily volume growth, and now that those are comping against difficult -- more difficult numbers, but still accelerating significantly or significantly higher, how much -- when you think about the reengagement versus the customer acquisition growth that you've been commenting on, where do you see this settling out over the next three or four quarters when you're past the tougher comp given the rate of growth that you're seeing on the customer acquisition side?

D.G. MacPherson -- President and Chief Executive Officer

Yes, I think we'll give a lot more detail on that as we move through the next couple of quarters. We've -- what we've said at this point is we are having a meaningful portion of this that is actually new customer acquisition. We're trying to understand exactly where we think that settles. We don't have enough months and quarters behind us to be completely sure yet.

But as we do and get more certainty, we will be sharing that.

Steve Winoker -- UBS -- Analyst

Right. But just again, back to some of the comments you've made versus your 2% versus your 4% share historically, even if it is a more competitive dynamic, I mean, that -- I mean, there's no reason to believe that 4% is really the ceiling there, I would assume.

D.G. MacPherson -- President and Chief Executive Officer

Right, right. Exactly.

Steve Winoker -- UBS -- Analyst

OK. Thanks.

D.G. MacPherson -- President and Chief Executive Officer

Thank you.

Operator

We've reached the end of our question-and-answer session. I'd like to turn the floor back to D.G. MacPherson for closing comments.

D.G. MacPherson -- President and Chief Executive Officer

All right. Thanks, everybody, for joining us today. As you probably gathered, we're very pleased with the momentum of the business and where we're headed. In the U.S., our value proposition is really resonating with customers of all sizes and types, and we're getting strong traction with those customers.

The turnaround in Canada is going as we expected it to go. Lots of reason to be optimistic there. Our online model continues to drive strong revenue growth and margin expansion. And our international portfolio is much stronger.

It's contributing to earnings, and we see decent growth there as well. And we continue to get strong expense leverage across the business, and we're on track to achieve the targets we set for ourself last November. So all in all, we feel very positive. We're well-positioned to gain share and improve the economics of the business going forward, and we appreciate your time today.

Thank you.

Operator

[Operator signoff]

Duration: 48 minutes

Call Participants:

Irene Holman -- Vice President Investor Relations

D.G. MacPherson -- President and Chief Executive Officer

Thomas Okray -- Chief Financial Officer

Ryan Merkel -- William Blair & Company -- Analyst

Christopher Glynn -- Oppenheimer -- Analyst

David Manthey -- Robert W. Baird & Company -- Analyst

Chris Dankert -- Longbow Research -- Analyst

Patrick Baumann -- J.P.Morgan -- Analyst

Deane Dray -- RBC Capital Markets -- Analyst

Nigel Coe -- Wolfe Research -- Analyst

Evelyn Chow -- Goldman Sachs -- Analyst

Hamzah Mazari -- Macquarie Research -- Analyst

Ryan Cieslak -- Northcoast Research -- Analyst

Scott Graham -- BMO Capital Markets -- Analyst

Justin Bergner -- Gabelli & Company -- Analyst

Steve Winoker -- UBS -- Analyst

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