Operator: Our next question comes from David Manthey with Baird. Please state your question.
David Manthey: First off, I’m interested in understanding how you capture a LIFO benefit when both inventories and the LIFO reserve are up quarter-to-quarter and year-to-year. I just if you could go through the mechanics of that, I’d appreciate it.
Dee Merriwether: Sure, sure, Dave. So I’ll go back to last year, you just start with that because there was two things. We’re lapping last year’s — it was unfavorable last year, favorably this year adjustment. And if you recall last year, we had a sharp increase in cost, and then we had an outsized amount of inventory kind of get delivered in the fourth quarter. And that combination of those two factors happening at the same time, resulted in us recording a meaningful LIFO adjustment to our fourth quarter adjustments in 2021. Now looking at that and understanding that we were still in an inflationary period as it relates to cost and we saw costs still coming in. From our suppliers, we worked on improving our processes, tightening our processes, making sure that we were booking entries and looking at the process, not just from the financials, but with the chain leaders to ensure our inventory valuation was staying up to par as we move through the year.
So I feel like we did a much better job there. However, when you look at the inventory that was sold through in the last quarter of the year, it required us to take a favorable LIFO adjustment to correct for that. Because if something has an increase for those that don’t know, something has an increase in the quarter, it haven’t sold it or the price change in that quarter from when it changed early in the year, the LIFO adjustment causes you to refactor all of those sales to the latest cost. So that adjustment was favorable for us. The combination of those two year-over-year in Q4 resulted in about 130 basis points, a net 130 basis point year-over-year impact to GP for the High-Touch business.
David Manthey: Okay. And the second, the share gains that you’ve been seeing has clearly been terrific. Could you discuss the balance that you’re seeing between new customer adds and selling more to existing customers? I would imagine there’s a difference between High-Touch and Endless Assortment. But could you just give us some color on that.
D.G. Macpherson: Yes. I mean in High-Touch, so I would just say that in High-Touch that the vast majority of our share gain is the existing customers. The reality is that the Grainger brand sells something to most large and midsized customers’ business customers in a year. And so a vast majority of those are — the share gains we’re seeing are actually share of wallet as opposed to new customer acquisitions. In the Endless Assortment, it’s more balanced. We’re seeing in Japan, we’re seeing a mix of new customers, but also significant growth with existing customers. And at Zoro, we’re seeing nice retention rates. So we are seeing more balance between new customer acquisition and volume and existing customer volume in the Endless assortment model.
Operator: And our next question comes from Ken Newman with KeyBanc Capital Markets. Please state your question.
Ken Newman: I think the midpoint of guide implies SG&A leverage of, call it, high teens for 2023 at the midpoint. Just remind me how much of the SG&A spend is fixed versus variable at this point? And should we think about high teens as kind of the right way for SG&A leverage to progress if sales stay at this at or above mid-single-digit growth going forward?
Dee Merriwether: So the — if you’re looking at our guide, the guide is implying 30 to 60 basis points of SG&A leverage for next year. And as I think about that, let’s remember a couple of things. We’re continuing to invest in demand generation, and we had some one-time costs this year that we don’t expect to impact us next year. And I will say the — one of the last things to consider is going into a new year, we get to reset our variable cost like variable costs such as variable compensation back to a 100% of our plan. And then we have some modest productivity that we built into the plan because we focus our organization on looking at driving standard work automation and productivity every day. So, we don’t have to have huge events.
We do that in times when things are going really well, and we can scale and also when things are tightening up. So, those are the numbers that I had related to the type of SG&A leverage we’re looking to gain. And remember, that’s in the midst of us continuing to invest.
Ken Newman: That’s helpful. For my follow-up here, it does look like inventories took a decent step up from the third quarter to fourth quarter, which makes sense given the sales guide increase. Can you just provide some color on what’s embedded in the operating cash guide for how inventories and working capital trend throughout the year?
Dee Merriwether: Can you repeat that question again?
D.G. Macpherson: What can happen to have inventory levels next year and working capital next year?
Dee Merriwether: So with that investment, it also includes some investments in DC capacity. So we expect to continue to build inventory as we stand up some of those new buildings. We do expect to see some slight improvement in working capital as far as it is not diminishing as much as it has in the last couple of years because we were investing much more significantly in inventory, say, last year, and we’re starting to see some improvement and our accounts receivable execution as well.
Operator: Our next question comes from Chris Dankert with Loop Capital Markets. Please state your question.
Chris Dankert: I guess looking at the margin guide for analyst assortment, pretty impressive expansion in ’23 expected here. How do we think about kind of the long-term path towards that 11% margin guide? I mean does the DC investment in Tokyo, what else should we be thinking about in terms of cost and investments in ’24 and beyond maybe as we think about Endless Assortment profitability over time here?
D.G. Macpherson: Yes. So I mean the two biggest portions of the Endless Assortment are on our Zoro U.S. and MonotaRO. MonotaRO, their profitability in the last year was deflated by operating two buildings at once in the in the Osaka area. That goes away. So they’ll see some improvement next year. They will be investing in a building in the Tokyo region in the next several years. But generally, I think the pattern for them will be getting closer back to where they were prior to the dual DC Osaka situation. So, we would expect them to improve over time. And then we talked a lot about Zoro U.S. We expect that to get a kind of high single-digit operating margins over the next several years. And so that combination gets you to sort of that long-term guidance.
Chris Dankert: Okay. And just to put a finer point on that last piece about Tokyo. I mean, will that have a similar impact as the stand of Osaka did in terms of operating two facilities that once whenever that investment comes through?
Dee Merriwether: So, we expect — so, the Anegawa DC that went up and getting out of Amagasaki in 2023, the first half, they will still be incurring some costs as well as wrapping up to their full efficiency. In the midst of that, they’re also launching Phase 2 of the Anegawa DC, which has additional cost — so our expectation is that they will end the year in 2023 or exit that year with op margin rate similar to what you saw prior to both product.
D.G. Macpherson: I think Chris was asking a different question, which you were asking about Tokyo, whether it’s going to be a similar issue with Tokyo when that comes on board. The answer is who knows. It depends on the pattern of the timing and when things open. It may or may not be as impactful, but we’ll comment on that as we get closer to that’s three or four years out so.
Operator: And our next question comes from Pat Baumann with JPMorgan. Please go ahead and state your question.
Pat Baumann: A quick one, I think you’re expecting on gross margin for the fourth quarter, like 38% to 34%. Can you just walk from what you were expecting to that 39.6% that you reported kind of like what surprised you? You called out LIFO benefit, but that’s like a year-over-year impact. So I’m not sure if that’s like the entire bridge to that 39.6%. I know, it’s 1/3 year-over-year, but I’m not sure that that’s like the difference in kind of where you came in at versus what you expected. So maybe color on that.
Dee Merriwether: Sure. So admittedly, we did end stronger than what we expected as we continue to execute well. And a number of things as you kind of note went our way. So we talked about one of them earlier. We got some tailwind from freight efficiencies with both fuel and container costs coming down over the last couple of months. In addition to that, we did get some price/cost timing benefits as we look to implement some web prices, we implemented some web prices in the quarter ahead of our January price increases, so that helped us a bit. And then if you break away the inventory valuation adjustment this year from what we saw last year that was more something that wasn’t anticipated. So that inventory valuation adjustment that we booked in the quarter that was favorable, that was the third piece.
Pat Baumann: Okay. Is it kind of like in that order in terms of like the magnitude of difference?
Dee Merriwether: I would say, if you take all three, it was about 1/3, 1/3 and 1/3 from a value perspective.
