WESCO International, Inc.

Good morning and welcome to the WESCO Second Quarter 2021 Earnings Conference Call. All participants will be in listen-only mode. Should you need assistance, please signal a conference specialist by pressing the star key followed by zero. After today's presentation, there will be an opportunity to ask questions. To ask a question, you may press star then one on your telephone keypad. To withdraw your question, please press star then two. Please note this event is being recorded. I would now like to turn the conference over to Leslie Hunziker, the Senior Vice President of Investor Relations. Please go ahead.

Thank you, and good morning, everyone. Before we get started, I want to remind you that certain statements made on this call contain forward-looking information. Forward-looking statements are not guarantees of performance and by their nature are subject to inherent uncertainties. Actual results may differ materially. Please see our webcast slides as well as the company's SEC filings for additional risk factors and disclosures. Any forward-looking information relayed on this call speaks only as of this date and the company undertakes no obligation to update the information to reflect the changed circumstances. Today we'll use certain non-GAAP financial measures. Required information about these non-GAAP measures is available on our webcast slides and in our press release, both of which are posted on our website at Wesco.com. On the call this morning, we have John Engel, our CEO, and Dave Schultz, Wesco's Chief Financial Officer. Now I'll turn the call over to John.

Thank you, Leslie, and good morning, everyone. We had an exceptional quarter and delivered outstanding results across the board. In just one year after closing a transformational combination of Wesco and Anixter, the substantial value creation of the new Wesco is clear and powerful. We're capitalizing on our scale and industry-leading positions. We're generating significant integration synergies at a pace exceeding our initial expectations. As a result, our margin performance and backlog are records for the company. And we're de-levering our balance sheet at a rapid rate. Most importantly, we are only in the early stages of unlocking the power and performance of this new LESCO. Moving to page four. We are seeing accelerating sales and margin momentum across our entire business and delivered second quarter sales that are 4% above 2019 pre-pandemic levels and also delivered second quarter EBITDA margin that is up 110 basis points versus 2019 pre-pandemic levels as well. Each of our three business units is making strong contributions to the growth of our company. Our comprehensive product and value added service offerings, our broad and deep supplier relationships, and our technical expertise are proving to be critical differentiators for our customers. We're also ensuring continuity of supply to our customers, which is especially critical as the economic recovery accelerates. now shifting the margin and operating leverage we build a foundation for sustainable margin improvement through our increased global scale value-based pricing program and the realization of cost synergies at a pace and scale that continues to exceed our expectations increased earnings power that we're generating has been a key catalyst for rapidly delivering our balance sheet since our june 2020 acquisition of annixter In just one year since closing a transaction, we've improved our leverage ratio by 1.2 turns, which is well ahead of schedule and highlights the power of our business model. As a result, we now expect to reach our targeted leverage range of 2.0 to 3.5 times by the second half of 2022, which is significantly ahead of our original outlook. Year to date, we've experienced upside to our forecast on all of our key operating metrics, And as such, we've raised our sales, margin, and profit guidance for the second time this year. In addition, we've raised our three-year sales and cost synergy targets on the continuing strength of our integration execution. Our employees have done an absolutely outstanding job on delivering on our commitments in the first year of the transformational combination of Lesko and Anixter. I would like to recognize and thank each and every one of them for their drive, dedication, resilience, and strong results. Now moving to page five. Our dramatically increased scale and expanded portfolio positions us very well to capitalize on a secular growth trend that will sustain the current economic recovery and are foundational for the global economy in the years ahead. Our future growth opportunity is amplified by the six secular growth trends outlined on this page. You'll recall that we previously had a wheel of 12, and we've collapsed into these six major secular trend categories. I'd like to take a few moments to highlight two specific examples today. First, grid hardening. When it comes to power generation, transmission, and distribution, the overall infrastructure of that power chain, so to speak, today's utilities face numerous challenges from new environmental regulations, evolving technologies, and aging infrastructure and increased storm activity. Sixty percent of U.S. distribution lines have surpassed their 50-year life expectancy. and it's estimated that $1.5 to $2 trillion will need to be spent to modernize the grid just to maintain reliability. As ongoing and significant infrastructure upgrades are required, we're supporting our customers with advanced products and, more importantly, with integrated supply chain management services. We're onsite with many of our utility customers, helping with product selection. We're providing application and technical support. resourcing materials, and we're handling material staging and logistics. Through a single interface, our platforms are digitally integrated with our customer systems for efficient project management. As the leader in utility distribution, we are well positioned to continue to partner with all the major utilities as they implement the critical work for grid modernization. Second highlight area I wanted to highlight was rural broadband. World broadband network development is a huge growth opportunity for Westcom. Today, there are more than 30 million people in the U.S. who don't have access to broadband, or 30 million homes, that is, who don't have access to broadband. The pandemic put a spotlight on this challenge as working from home and learning from home became necessary. The FCC has committed $20 billion to support the broadband build-out in the U.S. through the Rural Digital Opportunity Fund, or better known as RDoS. There's another $65 billion within the proposed infrastructure bill. We're partnering with electric utilities, co-ops and municipals, as well as telecom providers to help bring broadband to these rural markets. Specifically, we're supplying end-to-end fiber solutions for the build-out of broadband networks and last-mile Internet access. Projections are that the build-out will take place over the next 10-plus years. We are in an absolutely outstanding position to leverage our broadband capabilities for customers as a leader in both utility and broadband supply chain management. So in summary, our mission is to build, connect, power, and protect the world. One year into this journey, we are confident that the results we are seeing are just the beginning of the value creation opportunity that the new Wesco represents. The value creation potential of WESCO plus annexure has started to emerge, but we have only just begun. With that, I'll turn it over to Dave to walk you through the details of the second quarter, as well as our updated guidance. Dave?

Thanks, John. Good morning, everyone, and thank you for joining our call. Starting on slide seven, this summary table compares our second quarter results to the pro forma results in the prior year. Compared with the prior year, sales were up 24%. Currency added three points to growth, and pricing was approximately a four-point benefit. During the quarter, we saw suppliers increase prices on average about 8%. As we have indicated in the past, pricing on our project-based bids are generally honored by our suppliers, and we don't see the full impact of supplier price increase notifications. Backlog reached another record level this quarter, up 36% from the prior year, and up 17% from the prior record level in March. Notably, each business unit posted backlog increases of more than 15%. Gross margin was 21% in the quarter, up 140 basis points compared to the prior year. The strong gross margin performance included a 20 basis point negative impact from an $8 million write-down to inventory of personal protective equipment. As we foreshadowed last quarter, we took additional inventory adjustments based on market prices and quantities in stock relative to expected demand. Business unit mix was a 20 basis point benefit to gross margin versus the prior year. Supplier volume rebates increased gross margin by 30 basis points, driven primarily by a year-to-date true up in the quarter, given our strong performance. The balance of the gross margin improvement, approximately 110 basis points, was driven by the benefits of the ramp-up of our combined company margin improvement program and inflationary pricing. Sequentially versus the first quarter, gross margin increased by 90 basis points. Mix contributed 10 basis points and supplier volume rebates 30 basis points, with the balance driven by the benefits of our margin improvement initiative and positive price costs. Adjusted EBITDA, which excludes the merger-related costs, stock-based compensation, and other net adjustments, was $309 million, $99 million higher than the prior year. This represented 6.7% of sales, 100 basis points above the prior year, and 110 basis points above the 2019 second quarter on a pro forma basis. Adjusted diluted EPS for the quarter was $2.64. Preliminary results for July are encouraging, with sales up mid-teens versus the prior year. Moving to slide eight, as I mentioned a moment ago, gross margin was 21% this quarter. This result was broad-based and a major driver was continued traction of the margin expansion program that we deployed across the entire organization. This slide lays out some of the aspects of the program, starting with capability building, which is the foundation of the program, and includes the interactive training sessions that the entire sales organization undergoes to become familiar with the program. Second is sales processes and playbook, which captures the focus on value-based pricing, the emphasis on solution selling, and the ongoing database coaching that our sales teams receive. Third, performance management captures the accountability aspect of the program and the alignment of our sales incentives to our margin expansion goals. Lastly, the systems and dashboards component of the program includes the access to dashboards that capture the most critical information our team needs and ultimately enables us to unlock the power of our big data. We are still in the early phases of the rollout and expansion of the program to the entire WESCO annexer organization and are confident we will see continued margin expansion from this effort. Turning to page 9, you can see the drivers of nearly $100 million increase to adjusted EBITDA driven by higher sales, expanded gross margin, and the benefit of synergies from the integration. Partially offsetting the positive drivers were higher volume-related operating costs, including variable compensation. The higher variable compensation is the function of both sales commissions and an increase to incentive compensation as we expect payouts for the year to exceed targets in the annual operating plan. Other headwinds to EBITDA in the quarter were higher benefit costs and the reversal of certain cost reduction actions we undertook in the prior year in response to the COVID pandemic. In total, adjusted EBITDA was up 47% from the prior year on sales growth of approximately 24%. Now let me walk you through the results by business unit beginning on slide 10. All the year-over-year comparisons shown in the next three slides are based on the pro forma results in the prior year. Sales in our EEF segment were up 34% with double-digit growth in all operating groups. This growth reflects construction sales that are continuing to recover faster than we had anticipated, momentum on our cross-sell initiatives, and demand driven by secular growth trends. This quarter, we continue to see a higher level of projects being released from backlog and shipped relative to our expectations at the beginning of the year. We continue to experience robust fitting activity levels that are driving an incremental increase to our backlog from its record level in the prior quarter, and we made further progress on our cross-sell initiatives that have capitalized on our ability to now offer a complete electrical package to our customers. We also continue to see increasing momentum in our industrial and OEM businesses in line with the broader industrial recovery. Adjusted EBITDA was up $85 million, representing 8.7% of sales, 290 basis points higher than the prior year level. This increase reflects the gross margin initiatives I discussed earlier, strong cost-synergy realization, and effective price-cost pass-through. Turning to slide 11, sales in our CSS segment were up 22% versus the prior year pro forma and up 17% sequentially. We saw strong growth in our security solutions, global accounts, data center, and hyperscale projects, partially offset by decline in safety-related products. In addition to our cross-sell programs, CSS benefited from several secular trends. The need for increased bandwidth, 24-7 connectivity, IP-based security solutions, and the demand related to remote work and school applications. Backlog increased almost 20% from March to a record level. Profitability was also strong, with adjusted EBITDA at 9% of sales, 30 basis points higher than the prior year, driven by operating leverage, integration cost synergies, and the execution of our margin improvement initiatives. Note that the majority of the $8 million inventory write-down was recorded in CSS, negatively impacting adjusted EBITDA margin by 40 basis points. Turning to slide 12, sales in our UBS segment were up 13% versus the prior year and up 13% compared to the prior quarter. Utility demand has remained consistently strong as our customers continue to invest in grid hardening and modernization, and we want new business due to our leading value proposition. Our broadband business was up double digits versus the prior year, driven by strong demand for data and high-speed connectivity that has never been greater due to the step change expansion and requirements for work from home and school from home applications. We are benefiting from sales activity due to the federal government's Rural Digital Opportunity Fund, which John mentioned earlier. Phase one of that project began at the end of 2020. For UBS, adjusted EBITDA on the quarter was $101 million, or 8.3% of sales, up 70 basis points, driven by synergy realization, gross margin expansion, and effective cost controls. Turning to slide 13, let me walk you through the updates to our integration and revised expectations for synergies. Starting with revenue, we originally estimated that we would generate sales synergies of approximately 1% of the pro forma sales of the combined company or a cumulative $170 million over three years based on 2019 pro forma sales of approximately $17 billion. This assumed we would see some customer attrition as we merged Wesco and Anixter. To date, we have not seen any revenue synergies and have realized $77 million of cross-sell benefit. The success of the cross-sell program to date has exceeded our expectations, and our pipeline of opportunities continues to build. Due to these factors, we are increasing our revenue synergies to a cumulative $500 million, or roughly 3% of 2019 pro forma sales to be achieved by the end of 2023. On this slide, we have provided examples of recent cross-sell wins for each business unit. In each case, we have been able to expand a legacy customer relationship of either Wesco or Anixter to sell additional products or capabilities. Each of these examples reflects a multi-year opportunity and combined represent future sales of more than $60 million in aggregate. You can see that they also cover a wide array of products and capabilities, including the wire and cable capabilities that Anixter is known for, and the LED lighting capabilities of LESCO, as well as reflecting the secular trends of electrification, bandwidth-driven fiber optic deployment, and the growing need for supply chain services. Turning to slide 14, last quarter we mentioned we would be reevaluating the Synergy Plan once we reach the one-year anniversary of the merger in June. Based on the results to date, the accelerated pace of integration and the size of cross-Synergy opportunities we are increasing the cumulative target by 20% to $300 million compared to the 2019 pro forma cost structure. This represents a 50% increase from our original cost synergy target of $200 million when the merger closed in June of last year. We expect one-time cost to generate these synergies will be approximately $225 million through the end of 2023. In total, we have generated approximately $117 million of cost synergies to date, or roughly 40% of our target through 2023. On the right side of this slide, we've outlined the target by synergy type, as well as an overlay of the synergies that have been realized to date. You can see as an example that most of the corporate overhead synergies have been generated, and a little more than half of the G&A synergies have been captured. primarily related to our organizational redesign, which is now essentially complete. The largest remaining synergies are those that take longer to execute, including the supply chain and field operations buckets. Moving to slide 15, we remain laser-focused on reducing our leverage. On this slide, you can see that this quarter we reduced leverage by 0.4 times trailing 12-month adjusted EBITDA for the second quarter in a row. and have reduced leverage by 1.2 times since closing the annexer acquisition 12 months ago. Net debt increased marginally in the quarter, primarily due to investment in working capital that we made to support the exceptionally strong sales growth we experienced across all of our strategic business units. We are gaining efficiencies and reduced working capital by three days in the quarter. One of the hallmarks of our business model is our ability to generate strong cash flow throughout the economic cycle, and we remain focused on reducing our leverage. We expect to continue the rapid pace of deleveraging and are accelerating our plan to return to our target leverage range of 2 to 3.5 times trailing 12 months adjusted EBITDA in the second half of 2022, at least six months earlier than our prior expectation of mid-2023. Turning to slide 16 in our outlook for 2021, we have increased our outlook for sales growth to a range of 10% to 13%, primarily due to the strong demand we have experienced in the first half of the year, execution of our cross-sell program, continued share gains, and a strong macroeconomic outlook for the remainder of the year. We now expect EES to be up at the high end of our range, driven by the faster than expected macro recovery of our end markets. Note that we do not participate in the residential construction market in a meaningful way. We expect CSS to be at the middle of our sales range due to its exposure to critical secular growth trends and its global footprint. Next, we expect UBS to be at the low to midpoint of our sales range. The utility market has been very stable, and we expect continued demand increases in the broadband market to contribute to growth as well. We've increased our outlook for adjusted EBITDA margin to a range of 6.1% to 6.4%, primarily driven by the strong profitability this quarter, the expectation for continued sales growth, and operating leverage in the second half of the year. Continuing down the income statement, we expect our effective tax rate to be approximately 23%. Due to the higher sales and profitability expectations, we are increasing our adjusted diluted EPS outlook to a range of $8.40 to $8.80. We are adjusting our expectation for free cash flow as a percentage of adjusted net income to 90% to reflect the investment in working capital to support the higher sales growth outlook. We still expect to deploy $100 to $120 million of cash for capital expenditures and investments in IT and digital. Note that many of our investments for IT will be cloud-based. Cloud-based and subscription services will be recorded as other assets and amortized over the term of its associated arrangement, rather than classified as the capital expenditure and depreciated over its useful life. Please note that we do not anticipate a change to the total depreciation and amortization related to this accounting. Turning to page 17, before opening the call to questions, I'd like to walk you through a quick summary of the key takeaways that we've covered this morning. We've had an exceptionally strong first half of the year, and the outlook calls for sequential growth in the back half. Results were again strong across the board this quarter, with sales up double digits in each of our three businesses. We are outperforming the market, capitalizing on our leadership position, and executing well on the tremendous cross-selling opportunity of our combined business. We are well positioned to continue benefiting from these trends in the years ahead. Each business reported higher adjusted EBITDA margin this quarter than the prior year pro forma. In total, EBITDA was up nearly 50%, with 100 basis points of EBITDA margin expansion. We are driving increased operating leverage across the enterprise and realizing the benefits of our strong execution of cost synergies. Our rapid pace of deleveraging continues. We reduced our leverage by 0.4 turns for the second consecutive quarter and delivered a total leverage reduction of 1.2 turns since closing the transaction just 12 months ago. These strong results have enabled us to make several significant adjustments to our outlook for the business. We increased the expectations for sales growth and profitability for the year. We increased our cost-energy target by $50 million to $300 million, in our sales synergy outlook by approximately threefold to be achieved by the end of 2023. And finally, we accelerated our anticipated deleveraging by at least six months to the back half of 2022. With that, I'd like to open the call to your questions.

We will now begin the question and answer session. To ask a question, you may press star then one on your telephone keypad. If you were using a speakerphone, please pick up your handset before pressing the keys. To withdraw your question, please press star, then two. And please also limit your questions to one question and one follow-up. At this time, we will pause momentarily to assemble our roster. Our first question comes from Dean Dre with RBC Capital Markets. Please go ahead.

Thank you. Good morning, everyone. Morning, Dean. Hey, maybe we can start with price cost. And as Dave was zipping through the prepared remarks, we heard four percentage point benefit the price, but then there was a reference to an 8% supplier input cost increase. Now, we don't know the timing of these and how they came through. But we did hear positive price costs several times. Can you pull it together? What was price cost for the total company in the quarter? And if you can give it by segment, that would be great. But we'd be happy with total company. And start there, please.

Yeah, sure, Dean. Again, appreciate the question. As we mentioned, what we saw from our suppliers were supplier price increase notifications that on average were 8% in the quarter. And one of the things that we highlighted was that, you know, we don't see all that impacting our business because of the bids and our suppliers will honor the bids. One of the things that's very difficult for us to do is to call out the exact basis point benefit that we get from price cost at this point. That is one of the key elements of our margin improvement program is making sure that we're pushing through price to our customers to the best of our ability. We do track that, but it's very difficult for us to break out the inflationary benefit that we're seeing in our gross margin relative to what we're seeing from the balance of our margin improvement program. So I hope that provides at least some perspective. In terms of the strategic business unit, we're seeing more of the price increases coming through on the EES side. And then I would say it's UBS followed by CSS, just based on the different types of businesses and the impact that suppliers are pushing through on price increases.

That's great. But just to clarify, the Westco that I know historically has always been quick to pass through input costs. I don't see where that changes. And just your degree of confidence on being able to keep up. These are extraordinary times right now on cost inflation. But just your degree of confidence that you're going to stay ahead of this during the course of the second half.

Good morning again. Yes, this is John. Great confidence. If you look at what's occurred, and I'll keep my comments with respect to Q2 and Q1, so the first half of this year, we're seeing we're clearly in an inflationary cycle. So versus what the company has done historically, I will tell you that we are passing through the price increases quicker than than we have historically the lag that we typically experience in other inflationary cycles is is much shorter i'm very encouraged by that it's really a function of two things the comprehensive margin improvement program the value-based selling and explicitly we're focused on moving that pricing through our our business in the customers the supply price increases that is through a whole array of techniques, and Dave laid out the key elements of that comprehensive program. In addition, we doubled the size of the company. and that increased scale and and global supply chain capability we're in a significantly better position to ensure continuity of supply if you look at our in markets across the board demand is still outstripping overall this is a market question uh the supply chain rebuild the rebuild underway but we're seeing the fact that we've added to our inventories consciously and using our newfound and increased scale and very strong global supply relationships, we're able to provide that continuity of supply as demand is ramping, which is also supportive of not only pricing and gross margins, but our sales growth, which is accelerating. So what they broke out was the 8% is a published, published supplier price increases, which is incredibly important. And I think, as you all know, that's not what's realized in the value chain. For the business that we provide that's direct shipped and is project-based, those are competitively bid. And we get special pricing authorizations in place from our suppliers that represent a more competitive price to support that project activity. And that gets locked in between our suppliers and us. So, again, that shows the difference. That's the delta between the eight, Dean, and the four.

Is that helpful? Oh, it is really helpful. And I just, you know, in reading the slides this morning before the call, there was no excuse, no complaining about price cost, which kind of was signaling that you had it handled. And I appreciate the specifics you provided just here. So I feel good about that. And just as my follow-up on the cross-selling target increase, I mean, that's a big bump. And I loved hearing that you're not seeing disenergies because that's kind of the one area we were holding our breath on in terms of the merger. So that's good news. Just talk about the rigor and how you're tracking these actual cross-selling wins. I mean, you gave good examples in the slide, but just is this a bucket of that we can have a high degree of confidence that, yes, that's a cross-selling that would not have existed prior to the integration?

yeah what we tried to do dean was spotlight three different types of examples you know to give a sense of the the categories one was where we had and dave spoke to this on that one page one is where we had the an existing lesco customer relationship and we were able to pull in and extra products and services I quote, the newfound capabilities as a result of the merger. The second was where there was an existing and extra customer relationship, and we did the reciprocal. We pulled in Wesco product service capabilities and capabilities. And the third was an existing Wesco customer where we did two things. where we pulled in Anixter products, but we also expanded the scope of supply and used some Anixter supply chain service capabilities to expand the business. So we wanted to show those three different types of examples. To the heart of your question, and we mentioned this before, we stood up a dedicated integration management office We pulled some of our top talent across both respective organizations and staffed it. That full-time, and we use the acronym IMO, that full-time integration management office is still in place and will be in place for the three-year integration period. We're still working with our external consulting partner across that integration period. And the integration execution, which includes detailed information, program management processes and tracking mechanisms and scorecards is incredibly rigorous, unlike anything either company had ever had in place prior to the merger. So great confidence, very high degree of confidence that we're going to go from the 1% cumulative incremental growth via cross-sell to 3 percentage points of growth. And it's really, we're in the very early inning to this. That's my final point. The opportunity pipeline that we're tracking, and it's rigorous again, grew substantially as we moved through the second quarter. And it's that coupled with the recent wins, we spotlighted three, and we're beginning to see the cross-selling results in our sales results. You put that all together, and we told you that we were going to take a very comprehensive look at our three-year-plus integration synergies at the one-year close. It gives me great confidence, Dean, to take up the 1% to 3%.

That's all good to hear. Thank you, and congrats.

Thanks, Dean. The next question is from Sam Darkash with Raymond James. Please go ahead.

Good morning, John. Good morning, Dave. How are you? Terrific performance, obviously. Two questions, and one of them, I guess, would be a piggyback on what Dean's prior inquiry was. As it relates to your implied second half guidance for this year, What specifically are you baking in for sequential pricing actions and sequential billing margin expansion within the guidance? And related to that, at what point does the PPE inventory write-down cease?

Yeah, Dean. I'm sorry, Sam. Let me address first on the pricing impact for the second half. Very, very difficult to forecast the impact of pricing on our revenue. So therefore, we don't include that. We know what we experienced in the first half. That's assumed in our four-year forecast, but we don't assume any incremental pricing benefit as we enter the second half of the year. related to the PPE write-downs. As we mentioned back in our first quarter call, that was a very fluid situation and we had indicated at that point back in May that we would continue to look at our inventory write-down requirements related to that safety equipment. We still do have some inventory. We think that any potential write-down would be immaterial. But again, that's something that we will continue to monitor and make sure we get the accounting correct as we report our results.

And your billing margin expectations in the second half versus the first half, are you expecting continued improvement in billing margins?

You know, we generally don't disclose any of the drivers or the forecast for our gross margin. So I don't want to get into too much detail on that. You know, obviously, one of the things that we're focused on is making sure that we continue to address the inflation. We continue to make sure that we're getting the value based pricing. through to our customers. So, again, I'm not going to comment specifically on the billing margin or the gross margin going forward. But as you can see from our implied second half, we are assuming adjusted EBITDA margin expansion in the second half.

And then my last question would be, I didn't note that year three free cash flow guidance had changed from the at least $600 million or so prior. despite the fact that you're obviously raising year three synergies? Now, I know there's going to be some incremental working capital needs, but theoretically, would it be more than $600 million at this point based on current trends and synergy expectations?

We're confident that we can deliver the $600 million of free cash flow by year three. We continue to recognize that one of the drivers to our ability to generate that free cash flow is continuing to become more effective on networking capital. And as we expect more sales synergies, that's going to require more networking capital. With that, the combination, we're very confident that we can deliver the $600 million by year three.

Thank you much. Thanks, Sam.

The next question is from Nigel Kerr with Wolf Research. Please go ahead.

Thanks. Good morning, everyone. So, yeah, look, the rebate disclosure, very helpful. I'm assuming that the bulk of that hits in the EEF segments. Maybe just confirm that. And then I'm actually more curious on the customer rebates that you're giving to your customers.

um you know the four percent price would that be net of rebates and i'm just wondering how the dynamic on you know the rebates that you're giving to your customers versus your supplier rebates how that's sort of that now it's here certainly nigel so let me address first on the supplier volume rebates uh we did do a true up in the second quarter again we we generally were looking at our expectations for the full year and of that 30 basis point improvement that we saw at the gross margin related to supplier buying rebates. The majority of that was just a true-up to get the front half where we thought it needed to be based on our performance and our expectations for the balance of the year. The supplier volume rebates are actually recognized in each of our businesses. So it would not be fair to say that the majority of that would be in EES. It is split out between the three businesses based on the agreements that we have with our suppliers. And on your comment about the customer rebates and the pricing impact, the customer rebates are netted. So, you know, generally it's the agreements that we have with customers that

on rebates is based on primarily what their spend pools are and how much they purchase from us so that would be a net against the inflationary impact on our revenue okay that's great um and then um on the on the comp headwind the variable comp uh headwinds uh that you mentioned that that stepped up in the bridge just curious you know where we sit on that on a dollar basis here and then as we think beyond this year in a sort of a more normalized uh you know plan What kind of tailwind can we expect into 22 from that reset?

Yeah, so at this point, we've accrued what we believe is the appropriate amount of incentive compensation for the front half of the year. Based on the performance of the company, we are above our targeted annual operating plan, so we will be expecting to pay out incentives at a higher level. If you think about what we outlined earlier in the year, relative to the headwinds that we had for both incentive compensation plus covid you know we recognize that and we've increased the accruals for the dollars that we expect to pay out for 2021 similar to what we had occurred for the current year if we accrue at a higher level versus target we would reset our plans for 2022 back to target. So there would be a potential tailwind in 2022 related to the incentive compensation.

Okay. We'll follow up offline on the actual qualification of that. Thanks, David.

The next question is from Steve Berger with KeyBank Capital Markets. Please go ahead.

Hey, good morning. Good morning, Steve. For a lot of companies this quarter, we've seen really solid increases to revenue and EPS, like you just put up, due to cycle recovery and inflation. I think some investors are just thinking about how the demand cycle plays out here. So I'm curious, to the extent you can talk about it, what is your view on cycle duration? And is there any reason to think that you can't drive further solid earnings upside as long as you're seeing revenue growth?

I think we're in the early innings. To answer your question directly on cycle, early innings. You know, you look at each of the three big business units. And I'll address cycle, but then also the secular growth trend, Steve, because I think those two you've got to look at in combination. Clearly the economic cycle, the overall economic cycle recovery is underway. For EES, Remember, exposed to industrial end markets, that's building. It includes OEM, that's building. So both of those are in recovery, and we're seeing real nice sequential growth. We're also outperforming that because we believe we're outperforming that and taking share, so it's kind of a double boost. Remember, we're not positioned to benefit directly from the resi cycle, but we benefit – uh on a second derivative basis when it drives subsequent non-resing cycle the non-resi cycle is recovery has begun but we're in the very early innings there's a bunch of clicks and takes depending on the end mark you know the end market type or the type of project but if you look at non-resi you know it's our view that as we kick into 2022 and 2023 that cycle recovery is well underway we're not really seeing the tailwind from the cycle yet But as evidenced by our improving sales growth momentum sequentially, particularly as noted in EES, plus the record backlog and the degree to which backlog grew, I'm going to put a very fine point on this. Normally, based on historical seasonality, we would eat into the backlog sequentially in the second quarter. We grew our backlog sequentially by a large margin. This is counter any normal historical seasonality or cyclicality. So in one of the early innings of the recovery, I think we're significantly outperforming in construction. So that's what's driving EES. Relative to UBS... we're benefiting just from a leading leadership position in the industry, leading value crop. And there are strong secular growth trends that are driving across the utility power chain. And that's why I cited that example in my opening comments about grid monetization as well as broadband. And then CSS is really benefiting from a global leadership position. It's tech-driven selling, technical-driven selling, and very strong secular growth trends. I think we're in the very early innings, because you had the cycle question, we're in the very early innings of a large capital deployment cycle across 5G plus FTTX, fiber to the X, including fiber to the home, and hyperscale data centers. The backlog for CSS is also at a record level by an extraordinarily large margin. When you look at how much backlog grew in CSS in Q1 and Q2, it's unlike anything we've ever seen, or let's say the Anixter team has ever seen in that business. And UBS is also sitting at a record backlog. So the cycle question is a great question. I'm glad you asked me. I think we're getting some benefits, but we're effectively in the early innings. I'll come back to the secular growth trends. You look at what we laid out there. I've touched upon those that benefit directly UBS and CSS. EES, we're in the very early innings of the electrification secular trend. And that has legs for the next decade and beyond. And green energy, we're in the very early stages. That has legs for the next decade and beyond. And obviously digitalization and supply chain reshoring in North America cut across our entire enterprise. So, you know, I feel really good about where we are, and I feel really good about our outperformance versus the current markets. You couple that with where we are in the cycle, that's what gave us the great confidence to increase three-year targets on top line and cost and bottom line effectively.

That is really great color. And, you know, now that we're a year or so into this and you're getting a better sense of the cost structure, obviously you're increasing those targets for sales and cost synergies. And you think about those secular trends and opportunities and what the mix impact of that is. How are you thinking about sustainable incremental operating contribution margin in an up cycle for however long that lasts?

So we, you know, I think the way I'd ask you to think about it, and Steve, you know us well, so I think with our three-year integration program, executing that and the targets that we've laid out for the three-year plus period through the end of 2023 post-close, We've given you good insights in terms of how we think of the next two years, because we're one year into this. I will tell you that this transformational combination is exceeding our expectations. I told you that the two businesses were more complementary than we thought when you looked at end markets, customers, and categories, products and services. Also, the cultural integration is exceeding our expectations. So those two elements together bear on the higher confidence we have relative to the sustainable value creation. You know, I do want to make the point we're above the 2019 pre-pandemic levels on sales, gross margin, EBITDA dollars and EBITDA margins. And that's without all the tailwinds of the cycle. So I'm not going to give you the longer-term construct right now, but we believe we're exceptionally well positioned to outperform the market on the top line, obviously leveraging the combined increased scale and the cross-selling. The cost synergies, you know, we've only delivered $117 million to date in our P&L of the $300 million. right, that we've outlined through January 2023, you know, gross margins at a record level, and we're in the early innings of our margin expansion program. On the West Coast side, that extra three years and still seeing margin expansion. And we're de-levering at a very rapid rate. And I would tell you that's probably the most, the strongest part of the story, is de-leveraging story. It's a major de-leveraging story that's well underway. You put that all together, I think we've got, you know, just an outstanding value creation opportunity in terms of top-line growth, above market, significant EBITDA margin expansion, de-leveraging, and outstanding cash flow generation. It can't redeployed to invest in the platform.

Great detail. Appreciate it.

The next question is from Christopher Grimm with Oppenheimer. Please go ahead.

Thanks. Good morning, and congratulations on all the success to date. Curious if you're seeing your volumes right now kind of augmented by overall supply chain disruptions globally and the influence that might have on customer buying patterns.

So that's a contributor, Chris. You know, we doubled the company in one move. So, you know, it's the inherent benefits of putting two strong leading companies together that increase scale. And I just mentioned the complementary nature of the combination. the overnight, the much stronger, broader, deeper relationship that we have with our global supply chain partners, that's having benefits across the entire operation, the entire company. And part of that is, as the demand is pulling on the supply chain that is rebuilding, we are able, we're in a position to provide high integrity supply chain management and continuity of supply. Look, we consciously increased our inventories because we're seeing very strong sales growth and we're focused on inventory availability and fill rates for what we're seeing demand and what our customers are giving us insight into. And we're able to, in conjunction with our supplier partners, provide a continuity of supply that we think is differentiated. I don't think that is... temporal i mean i think this is the result of this transformational combination and it's the benefit to scale of putting two leading companies together and what's still a fragmented value chain so i i see that i honestly see these benefits carrying on in the future in the perpetuity okay and then uh

If the third and fourth quarter produce similar earnings results as the second quarter, it puts you nicely above the range. So just curious, within the outlook, what part of the second quarter composition of the P&L might not repeat?

Hey, Chris. It's Dave Schultz. A couple things to look at that may not repeat in the second half. Obviously, the gross margin true-up, the SBR true-up that we got benefit from, we're at the right level in our forecasts. for supplier volume rebates, but we did get that extra benefit in Q2 that really should have been spread out between Q1 and Q2, knowing what we know now. So we did get an outsized benefit here in the second quarter. There's also the incentive compensation true-up. Again, going back to the discussion we had earlier around based on the progress that we've made relative to our annual operating plan, we do expect to pay higher incentives. There was a portion of a true-up that was included in Q2. So, again, that would be a little bit more level in the second half of the year. Okay. Thank you.

The next question is from David Manthe with Baird. Please go ahead.

Hey, thank you. Good morning. Good morning, Dave. Yeah, hi, John. inflation clearly had some positive effect on revenues, not very large in this quarter, but it sounds like you're telling us it's more like tens of basis points and a smaller impact than what you were able to achieve through organizational change. Is that the way to think about it?

I would say, Dave, and this is really an important point, which is why we include a page we had not done previously of the structure and and I'll use the term our recipe of our margin improvement program, you know, it was in Dave's prepared remarks, you know, focused on value-based selling and getting those price pass-throughs is an explicit element among other elements in that comprehensive program. And as I mentioned earlier to Dean, it was Dean's question, I see us passing through those more quickly than we have historically. as a result of this enterprise-wide margin execution program. You know, parsing out just that inflation benefit versus all the other initiatives that's embodied in that program that are positively impacting both billing and gross margins is, you know, impossible to do. Other than, you know, the explanation that, you know, that because of the mix of our business, you know, list prices that are published. I'll come back to that. And in our project part of our business, we're quoting competitively every day, and we're securing SPAs, special pricing authorizations, in conjunction with our suppliers to secure those project bids. And that represents pricing that does not match the list pricing that you're seeing that are published. and because we have a you know a sizable portion of our businesses direct ship that dynamic the pricing dynamic is different there we're getting special pricing authorizations that support winning those jobs in conjunction with our suppliers and then consequently you know we have a different sda structure too to execute that direction of business that's that's understandable if if you're if the suppliers though

are experiencing price increases across the board, it's not a net zero game. They're not going to sell it to you at lower than their cost. They're clearly passing through something. I guess I'm confused as to what you're saying about the special pricing.

Oh, no, no, sure, sure. And obviously they pass that to us and we work, they try to. And I'm just talking about the dynamic of the value chain and what prices realize. Because within our margin is the price we're realizing. That was my main point. And, you know, we're obviously working in conjunction with our supplier partners to push that through. And I think what I'm most encouraged about is, again, Anister had this two years running pre-merger close. They had a rigorous set of training materials around a whole series of margin improvement levers. price pass-through, doing it quickly, but value-based selling. And it's just a terrific set of materials. And if those materials we refined and expanded and now are driving enterprise-wide, effective really with the start of this year across the legacy Lesko portion of the combination that we're seeing the benefits on. So super encouraged with you know, what we're driving, the set of initiatives we're driving as part of our comprehensive margin improvement program and the benefit that's having on both our billing and gross margins.

Okay. Thank you for that, John. Second, As it relates to the sequentials and the seasonal pattern here at New Wesco, there's always a glide path on pricing. So I'd imagine you get a little more benefit met in third quarter than second quarter. You talked about the backlog build. The question is, should we just assume that the quarter-to-quarter growth from 2Q to 3Q should be at least as good as normal, maybe a little bit better than that?

Yeah, Dave, obviously you can do the math on our total back half versus where we are year-to-date with our outlook. As we think about the sequentials, you know, we do anticipate that we will see, you know, continued back half. I mean, at the midpoint of our guide, we're 7% growth on sales front half to back half. And obviously as we see increases in supplier price increase notifications, We're going to work really hard to get those passed through to our customers through our value-based pricing initiatives and our other margin improvement plans. But, you know, we are expecting EBITDA margin improvement front half to back half, as you can see from our outlook. And we're not going to break out the specifics between the gross margin line. Got it. Thank you both. Thank you.

The next question is from Chris Dankert with Loop Capital. Please go ahead.

Hey, morning, guys. Thanks for sneaking me in here. I guess, Dave, you know, you walked through some of the key drivers in that margin improvement program. And, John, you highlighted, you know, pricing for value specifically. But I guess more on the systems and data side, you know, what are we into when it comes to, you know, first, you know, the availability of that data to decision makers, and secondly, what kind of utilization and adoption of those actual tools? I assume some of that rolled out in New Year, but just kind of where are we in terms of actually getting that to people on the ground?

Great question, Chris. So one of the major activities that we've been working on, you know, literally started post-merger close, was getting both companies' respective data sets, complete big data sets, I'll call it, and figuring how to knit those together. So we've been working with one, you know, we have one new data lake that we've established as part of our foundational element of our digital transformation program, And we've been hydrating and porting that data, both legacy Anixter data and legacy Wesco data, into that new enterprise-wide data lake. As we've been doing that, we've also been, through our digital initiatives, under the leadership of our new CIO and CDO, Chief Information Officer, Chief Digital Officer, Kas Karana, who we hired six-plus months ago. Under his leadership and with that team, we've been developing our own digital applications to leverage that big data and unlock the power of that big data. There are several applications that we've stood up, Chris, specifically that are supporting that margin improvement program. With all that said, this is the new Wesco. I mean, we're in a multi-year digital transformation journey, and increasingly we will be standing up, building, using an agile development process, building our own digital apps to leverage our big data. Super excited about the long-term impact of this. I'm not going to go through the specific apps we've built. But I will tell you a few have been built already that are part of this comprehensive margin program. And we've also built some apps that are helping other parts of the front end sales management and order management and execution process. So we are in the very early innings of applying digital and unlocking the power of our big data. But thanks for that question.

No, no, and thank you for the response. Really helpful there, but glad you're moving fast. I guess the last follow-up from me, on the cross-selling, appreciate the examples. My curiosity, have we seen any cross-selling on an international space kind of bringing legacy Wesco into other markets? Any color there would be great.

Yes, we have. We've seen opportunities. a few opportunities both in EES and CSS. Now CSS brought to us very strong extensive global footprint. You know, global leadership capability, data communications, and IP security. So we've been able to, in a few opportunities already, leverage existing Anixter slash CSS customers and pulling some of the rest of their portfolio. But in addition, Anixter over the years, on the foundation of the leading position in wire and cable in North America, they also have been expanding globally. That capability. So we've been able to sell more of the complete electrical package, quote-unquote, globally as well. So, you know, examples in both of those business units. Okay.

Yeah, thank you so much for the caller. Much appreciated.

The next question is from Patrick Bowman with J.P. Morgan. Please go ahead.

Hi, good morning. Thanks for taking my question. Just going back to the pricing, I think you saw a 2% to 3% impact year over year in the first half of the year, but then you said something in response to a question about nothing incremental expected for the second half. Does that mean you have zero for price year over year in the second half, or does it mean that you have nothing incremental versus the first half but still up year over year? And then also, what is the assumption for foreign exchange in the guide, if there is any?

Yeah, so Patrick, it's Dave Schultz. For pricing, very, very difficult for us to pull out. what that pricing potential benefit or decrement would be to our overall revenue. So we don't include that as we think about the back half guide. Same thing with foreign exchange. Right now, we do look obviously at expected foreign exchange rate forwards, but we don't include any significant incremental delta for foreign exchange in the back half of the year.

Okay, understood. And then on free cash flow, you mentioned your capital spend target is unchanged, but so far this year you've only spent about $20 million. And then you also mentioned something about cloud investment. So I'm just wondering if you could flesh this out a bit, why the significant back half waiting on capital spend, and then maybe some examples of things you'll be investing the CapEx in from a digital perspective.

Certainly. So if you include some of the other expenditures from a cash flow perspective related to our IT and digital, we've spent approximately $40 million year to date, a combination of capital expenditure plus other cash spend on IT digital. We are, as John mentioned, we're still ramping up some of our digital initiatives and some of our platforms as we move forward. So we do expect to see an incremental spend in the second half of the year related to those IT and digital expenditures.

And then the other 20, is that in operating cash flow that we don't see? Correct. Understood. And then last one for me, why was Mix a benefits margin? Like, what drove that? I just would have thought with EES growing faster than the rest of the company, that mix would have been headwind.

Yeah, so when you think about the – we made the comment specifically around the gross margin. We did get a mixed benefit versus the prior year, and that was primarily driven by the strong gross margin in the EES business. So if you take a look at some of the historical pro forma numbers – You know, our EES business tends to have an above-average gross margin relative to the company. And when you take a look at that growth rate relative to where, like, our utility business grew, and our utility business does have a substantial portion of its businesses direct shift. So, therefore, though, you do get a mixed impact just based on the relative growth rates of the SBUs. Okay.

Thanks a lot. Appreciate the time. Good luck.

So I think we're at the top of the hour, so I'll bring the call to a wrap. Thank you all for your support. Much appreciated. We look forward to speaking with many of you in the coming days and throughout the quarter, as well as our upcoming investor events, including the RBC Global Industrial Conference next month. Have a great day, everyone.

The conference is now concluded. Thank you for attending today's presentation. You may now disconnect.