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spk03: Hello and welcome to West Coast second quarter earnings call. I would like to remind you that all lines are on listening only mode through the presentation. If you would like to ask a question, please press star followed by one on your telephone keypad. Please note that this event is being recorded. I would now hand the call over to Scott Gaffner, Senior Vice President of Investor Relations to begin.
spk07: Thank you, and good morning, everyone. Before we get started, I wanted to remind you that certain statements made on this call contain forward-looking information. Forward-looking statements are not guaranteed 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 state the information. to reflect the changed circumstances. Additionally, today we will 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 this call this morning, we have John Engle, Wesco's Chairman, President, and Chief Executive Officer, and Dave Schultz, Executive Vice President and Chief Financial Officer. And now I'll turn it over to John.
spk06: Thank you, Scott. Good morning, everyone. It's a pleasure to be with you today. As you saw from the earnings release earlier this morning, the beat goes on in terms of the value creation of Westcote's new business model as we pass the second anniversary of our transformational combination with Amnesty. Our second quarter results were exceptional. We once again set new company records for sales, backlogs, margin, and profitability. Importantly, leverage is now back within our target range, and it's a full year earlier than what we got as a market to expect after we completed the Onyxer merger in June of 2020. Our momentum continues to build as we outperform the market and deliver superior value to our customers. The power of our newfound scale, expanded portfolio, and industry-leading positions is made clear each and every quarter. Strong demand in our end markets continues. Each of our three strategic business units again delivered double-digit sales and profit growth in the quarter, driven by the ongoing success of our enterprise-wide cross-selling and growth margin improvement programs. Overall, we delivered impressive organic sales growth of 21%, record profitability of 8-plus percent adjusted EBITDA margin, which is a first for Wesco now to deliver above 8%, a very important mark. and adjusted EPS growth of 59% versus the prior year. You will recall that we substantially raised our outlook for the year after our excellent first quarter results. As a result of our outstanding second quarter results and the strong execution across our business, we are again raising our outlook for 2022. Along with this raise, I want to highlight that our increased profitability continues to fuel our investment in advanced digital capabilities, which is expected to result in an even higher level of performance, operating efficiency, and customer loyalty. Dave will review our financial results and address our higher full-year outlook in more detail shortly. But before I hand it off to Dave, I plan to address our transformational results versus our pre-pandemic levels, as well as our uniquely strong position to capitalize on the attractive secular growth trends in our end markets. Now turning to page five. The demonstrated strength of our business model and the success of our integration efforts over the last two years have established a track record of superior results for the new WESCO. The strength of the new WESCO is best measured by the value we have created since the merger closed in June of 2020. This page highlights our record first half 2022 results as compared to our pro forma first half pre-pandemic results in 2019. As you can see clearly, we have outperformed the market, delivered impressive sales growth and margin expansion, and achieved record profitability, all while rapidly deleveraging our balance sheet. While we're pleased with this progress, we're even more excited because there's still substantial value to be generated from a transformational combination of Let's Go and Adixter. And we were confident in a future of sustained growth and market outperformance. Now moving to page six. Providing our global customers with end-to-end solutions, that is including the products and supply chain services that make our customers more efficient and more effective, is what drives us each and every day. We are executing at a very high level, and we're exceptionally well positioned to capitalize on the strong secular growth trends and increasing investments in public sector infrastructure outlined on this page. These long-term trends are driving secular growth in each of our three global business units and across our entire global enterprise. We raised our cumulative sales synergy target again this quarter, now up to $1.2 billion. It's important to note that this is seven times the original target we set prior to the merger close. Our accelerating cross-selling momentum is fueling our market outperformance and growth. And as I've said before, the new rescue is transforming into a growth company. We have a record backlog and expanding cross-sell program, a growing opportunity pipeline, and very positive momentum overall. But... And this is important, but we are only in the early stages of unlocking our total growth and potential. With that, I'll now turn the call over to Dave.
spk09: Thanks, John, and good morning, everyone. Thank you for joining our call. I'll start on slide eight with a summary of our second quarter results compared to the prior year. As John mentioned, second quarter sales were a record, and cross-sell in the quarter exceeded our expectations. Our ability to cross-sell Wesco and Annex for products and services contributed more than $200 million of sales in the quarter and we continue to benefit from price. On a reported basis, sales were up 19% over the prior year. On an organic basis, sales were up 21% as differences in foreign exchange rates represented a 160 basis point headwind in the quarter. We estimate pricing added approximately eight points to sales growth in line with the first quarter with the benefit primarily in our EDS and UBS businesses. The CSS business saw a low single-digit benefit from price and improved sequentially. Supply chain challenges have continued to impact certain pockets of our business. We estimate that the lack of availability of certain products from our suppliers reduce sales by approximately the same amount as in the first quarter of the year. We continue to strategically invest in inventory in the quarter to address these challenges, as well as support our strong backlog of future sales growth opportunities. Backlog reached another record level this quarter and was up more than 10% sequentially from March and up more than 80% from the prior year. Each business unit posted backlog increases of more than 60% above the prior year. As we start the third quarter, demand has continued to be strong. Preliminary July results are encouraging, with sales up approximately 17% year over year. Gross margin was our highest ever at 21.7% in the quarter, up 70 basis points versus the prior year, and up 40 basis points sequentially. This result was primarily driven by our gross margin improvement program, the affected pass-through of supplier price increases, and the absence of a COVID-related PPE inventory write-down in the prior year period. Recall the impact of the PPE write-down was 20 basis points in the prior year quarter. Adjusted EBITDA, which excludes merger-related and integration costs, stock-based compensation, and other net adjustments, was 44% higher than the prior year, and represented 8.1% of sales, an all-time high watermark for the company, and 140 basis points higher than the prior year. This result was driven by the combination of increased gross margin, a scaled benefit of higher sales, and realized cost synergies from our merger with Aniston. I'll walk you through the main drivers of this improvement in a moment. Adjusted diluted earnings per share for the quarter was $4.19, also an all-time record, and up nearly 60% from the prior year. The primary driver of this increase was core operations, but included headwinds related to foreign exchange rates, interest expense, the effective tax rate, and a higher share count, which collectively reduced adjusted diluted EPS by 39 cents in the quarter. The adjusted effective tax rate in the quarter was higher than our fiscal year outlook due to lower benefits from intercompany financing and discrete tax items. Turning to page 9, you can see that the higher sales and expanded gross margin drove the $135 million increase in adjusted EBITDA. We also recognize the benefit of incremental cost synergies of $66 million in the quarter on a run rate basis, or $22 million incremental to the prior year quarter. As you would expect in a strong demand and an inflationary environment, we continue to experience higher volume-related operating costs, including shipping and sales commissions, as well as higher expenses for employee benefits and incentive compensation. Given our strong results, we continue to accrue short-term incentive compensation above target. Additionally, we recognize an incremental $8 million of expense associated with our long-term incentive programs, which we also anticipate will pay out above target. Finally, in accordance with our plan, we incurred higher expenses related to our investment in systems and digital tools that offset a portion of the growth of adjusted EBITDA. Overall, we delivered strong operating leverage as we generated a 44% increase in adjusted EBITDA, more than two times our organic sales growth of 21%. Moving to slide 10. Sales in our EEF segment were up 23% year over year in the second quarter on an organic basis. This growth reflects continued strong construction sales that were up double digits with the ongoing recovery of the non-residential market. We also continue to see increased momentum in our industrial and OEM businesses supported by broad end market demands. Elevated bidding activity drove a further increase in our EES backlog from its record level in the prior quarter. We also made progress on our cross-sell initiatives and our capture and demand driven by the secular growth trends that John discussed earlier. Adjusted EBITDA was...
spk03: Ladies and gentlemen, please remain holding. The call will resume momentarily. You may resume.
spk09: Good morning, everyone. It's Dave Schultz. We apologize. There was some technical difficulties with our service providers, so I'm going to point you back towards slide 11 of our webcast deck. So turning to slide 11, sales in our CSS segment were up 12% versus the prior year on an organic basis. We saw strong growth in both network infrastructure and security solutions operating groups. driven by growth with security integrators, cloud applications and wireless, as well as data center and hyperscale projects. While pleased with these results, CSS sales growth was not as robust as EES and UBS, primarily due to ongoing supply chain constraints in certain pockets of the industry that we discussed last quarter. We are helping our customers effectively navigate these challenges and additionally, Pricing in CSS was a low single-digit benefit versus the prior year but did improve sequentially. Backlog in CSS increased 7% sequentially from March to another record level, reflecting continued strong demand driven by the secular growth trends in our end markets. Profitability was also strong with adjusted EBITDA of 9.4% of sales in the quarter, 40 basis points higher than the prior year, driven by operating leverage, integration cost synergies, and the execution of our margin improvement program. Turning to slide 12, organic sales in our UBS segment were exceptionally strong, up 29% versus the prior year on an organic basis. Utility demand has remained consistently strong as both our investor-owned utility and public power customers continue to invest in grid hardening and modernization. Sales growth in our broadband business was also strong again this quarter, driven by continued demand for data and high-speed connectivity, including requirements for home-based applications. We continue to benefit from sales activity related to the federal government's Rural Digital Opportunity Fund. Backlog in UBS was up 25% sequentially and 140% versus the prior year, reflecting future benefit from strong end market demand. Adjusted EBITDA in the quarter was up 68% for UBS, and adjusted EBITDA margin expanded 260 basis points to nearly 11% of sales. This growth was driven by the scale benefit of sales and gross margin expansion. Now moving to page 13. The size of the cross-sell opportunity of combining Wesco and Anixter continues to exceed our expectations. In Q2, we recognized more than $200 million of cross-sell revenue, our largest quarter to date, and up nearly 30% sequentially from Q1. Our pipeline of sales opportunities continues to expand, and our cross-sell momentum continues to build. We are capitalizing on the complementary portfolio of products and services, as well as the minimal overlap between legacy Wesco and legacy Anixter customers. The size of this opportunity has turned out to be one of the most significant value drivers of the combination of Wesco plus Anixter. Recall that two quarters ago, we increased our cumulative cross-sell target to $600 million, and last quarter we increased it again to $850 million. Due to the continued strength of this program, we are increasing our target again by 40% to $1.2 billion cumulatively by the end of 2023. To date, we have generated $729 million of that target. Turning to page 14, on this slide, we've highlighted three recent cross-sell awards. These wins represent approximately $50 million of year one sales. However, all three are multi-year projects that extend as far as 2026. Collectively, these wins represent more than $165 million in total potential sales value over the next five years. In the first example, PES won a $12 million award to provide electrical cable, switchgear, and miscellaneous electrical equipment to support the construction of a 900,000-square-foot data center from a legacy Anixter customer and end-user relationship. Our complete EES product offering and ability to provide an end-to-end solution drove this wing. In the second example, CSS leveraged the legacy Anixter product set and Wesco's TBC expertise to support a middle-mile broadband build-out initiative. And in the third example, UBS generated $10 million of initial sales to support a fiber network expansion project with a legacy Anixr customer by leveraging the unified sales team and legacy Wesco's comprehensive supply chain solutions. Our cost and momentum is building and clearly highlights the power of the combined portfolio. Turning to slide 15. On the left side of this slide, you can see in the gray boxes that we realized cumulative run rate cost synergies of $188 million in 2021, $63 million in Q1, and $66 million in Q2. Due to this progress, we are increasing our 2022 target by 15 million and now expect to realize $265 million of cost synergies in 2022. We remain on track to meet our expected target of $315 million by the end of 2023. Recall that these savings are relative to the 2019 pro forma base. On the right side of the slide, we've outlined the $315 million of cost savings by synergy type, and in the chart, you can get a sense for the synergies that have been realized to date in each category. For example, the estimated $45 million in corporate overhead savings have now been fully realized. The largest remaining synergies are those that take longer to execute, including those related to supply chain and field operations. Turning to page 16. On this page, you will see a year-to-date bridge for the free cash flow, which was a cash draw of $293 million. Starting with adjusted net income and moving right, the $40 million source of cash primarily reflects a combination of depreciation and amortization, interest and income taxes. In total, working capital has been a $714 million use of cash in the first half, driven almost exclusively by increases in receivables due to our exceptionally strong sales growth, which has far exceeded normal seasonality. Inventory and payables offset each other in the first half as we continue to invest in inventory to support our backlog and manage through supply chain challenges. Lastly, the CapEx and IT spend reflects the investments related to our ongoing digital transformation consistent with our plan. Moving to slide 17, reducing our leverage has been a top priority since we announced the acquisition of Anixter. In the second quarter, we reduced leverage by 0.2 times trailing 12-month adjusted EBITDA and brought our leverage ratio down to 3.4 times. This represents a decrease of 2.3 leverage turns since closing the acquisition in June 2020. We are now within our target range of 2 to 3.5 times investors prior to the closing of the annex to merger. This accelerated pace of deleveraging reflects the strength of our B2B distribution operating model.
spk10: Moving to page 18, we are again updating our four-year outlook based on this quarter's results.
spk09: These are the strong demand trends we are seeing, the continued expansion of our backlog, significant growth of our cross-sell synergies, we are increasing our four-year outlook for sales growth to 18%. Our assumption for market growth is 12% to 14%, including the benefit of price, to demand environment for our products, services, and solutions to continue to be strong. However, we recognize that supply chain constraints and the pace of inflation present some uncertainties for the supply chain. Due to the strength of our cross-sell program, we are increasing our estimate for share gains and crosses from 4% to approximately 5%. We are also updating our outlook to reflect a headwind of approximately 1%. Lastly, keep in mind that 2022 has one more workday than 2021 that occurred in the first quarter, which we estimate will add one half point of With regard to our business units, we continue to expect that EES and UBS businesses will be at or above the upper end of our sales range.
spk10: CSS should be below relative to EES and UBS as well as a larger chain disruptions.
spk09: Also recall that included in our outlook is a contract with the utility customer that will shift from a full revenue model to a service fee model, which will negatively impact sales by approximately half a point with no impact to EBITDA. For adjusted EBITDA margin, we are increasing our outlook to a range of 7.8% to 8.0% of sales, fully above our prior range. primarily reflecting increased operating leverage on higher sales, as well as continued benefit from our gross margin improvement program. At the midpoint of this sales and EBITDA margin range, our full-year outlook for $8 billion represents a substantial increase versus the midpoint of our prior outlook range of $1.33 billion. We are also slightly increasing our effective tax rate outlook to a range of 24% to 25% for 2022 based on the effective rate in the first half of the year. Our outlook does not assume any additional benefit from discrete items that we experienced in the first quarter. We are also increasing our adjusted EPS outlook to a range of $15.60 to $16.40 which represents growth versus the prior year of approximately 55% to 65%. Lastly, we are adjusting our expectation for free cash flow to approximately 50% of adjusted net income, which reflects the need for higher investment in working capital to support our increased sales outlook. As noted earlier, the primary driver of our net working capital increase is accounts receivable, driven by our strong sales growth. We are adjusting our free cash flow forecast to reflect continued strength on sales, including through the fourth quarter.
spk10: The quality of our networking capital has not degraded.
spk09: We are confident we will collect this cash, and there is no change to the long-term free cash flow conversion capability of the company.
spk10: This outlook reflects a handful of of assumptions that I would like to remind you of.
spk09: Based on our first half results and outlook for the year, our short-term compensation structure is reflected in our margin outlook at an above-target payout. We have also included the impact of an increase in transportation and logistics costs that we mentioned last quarter. On cash flow, we still expect to spend approximately $120 million in combined capital expenditures and IT digital approximately $75 million will flow through changes in other assets. We expect to realize the full $18 million of annual interest savings related to the redemption of our 2024 notes that we completed in June of last year. Recall that in 2021, we realized approximately $2 million of the full $18 million annual benefit activity this year but has taken into account higher short-term interest rates. Our outlook assumes an average alluded share count of approximately 53 million shares for the year. And lastly, this outlook does not reflect any potential changes to applicable tax laws. As it relates to the third quarter, as I mentioned earlier, preliminary July sales were up 17% versus the prior year, and margins are steady. Moving to slide 19, and before opening the call for questions, let me provide a brief summary of what we've covered this morning. Very strong financial results across the board, including record-level sales, operating profit, adjusted EBITDA, and adjusted EPS, and the strongest quarter since the annex or transaction closed in June 2020. Three segments of our business grew versus the prior year and sequentially in the quarter, as well as compared to 2019 levels. We delivered adjusted EBITDA margin expansion of 140 basis points over the prior year, driven by our value-based pricing execution, accelerated cross-sell, and continued cost synergy generation. Our pace of deleveraging has exceeded our expectations, and we are now back within our target leverage range, just eight quarters after closing the acquisition of Anixter.
spk10: And lastly, we're making excellent progress on our IT and digital roadmap and are exceptionally well positioned to benefit from the secular growth trends and increasing public sector investments that John discussed earlier.
spk09: And with that, let's open the call to your questions.
spk03: We will now begin the question and answer session. If you would like to ask a question, please press star followed by one on your telephone keypad. Please limit your questions to one question and one follow-up. Our first question today comes from... Hey, good morning, everyone.
spk09: You hear me okay?
spk06: Yes, Dean, good morning.
spk09: Hey, good morning. First, a broadband upgrade with a rural digital opportunity fund.
spk10: I love your sales lead, Dean.
spk00: Good.
spk09: And then secondly, a big welcome to Scott. I've seen him in action. I'm confident he'll be successful. So congrats, Scott. John, maybe just to start off, there's such anxiety right now about a slowing at any of the metrics you're putting up you're not seeing any sign of us page six slide tells you all these long-term drivers that you benefit and it's not just a uh a post-covid burst of activity but there's just you know we see a long ramp here take us through at at the margin kind of real time what's going on in terms of product availability, project delays, anything that you're seeing of the daily stock and flow business, any kind of real-time caller would be helpful.
spk10: Yeah. It's a great question, Gene. We are not seeing any indications in any of the array of meetings.
spk06: Indicators and KPIs we use in terms of slowdown occurring with respect to the new WESCO, the WESCO-ANISR combination.
spk10: You look at our backlog.
spk06: You look at our opportunity pipeline that's comprised, you know, of a large degree of cross-sell synergies. You look at our daily sales and margin momentum. You look at it sequentially versus normal seasonality. We are just everything. The one word I would use, I use this to describe Q1. This is the strongest quarter that Wesker has ever delivered. I said that in Q1. We delivered an encore in Q2. If we fast forward to July, our preliminary sales number that Dave outlined is still exceptionally strong. Our book-to-bill ratio is above a 1.0. So, again, that's the latest set of data we're sending to you. I know Fastenal just reported this morning, and their daily sales in July versus June. So we are seeing, again, just very strong momentum, and it's really the power of the combination.
spk10: Still have an array of supply chain challenges we're managing through. I'm very proud of how the team is doing that. A few areas, it's gotten interesting. incrementally better, but I would say, and I'll use your words, Dean, it was kind of categories that were more challenged as a result of supply chain. That's a bit encouraging.
spk06: With that said, as Dave outlined in his commentary earlier, we still saw a couple points you know, consistent with Q1 of supply chain throttling our top line, so it would have been that much better. And so that's kind of what I would signal. I just, you know, the supply chain is healing, but it's, and I did share this the last few quarters, we thought it would take a protracted period for that healing to occur. I mean, and demand is still outstripping supply from our perspective. So that hopefully addressed your question.
spk09: Absolutely. That's great. Really good to hear. And then just as a follow-up for Dave on free cash flow.
spk10: And look, we are seeing this everywhere across the industrials.
spk09: In order to fill this big demand, you've got 80% more inventory. We get that. And then higher sales, higher payables. So two questions. One is, Anything in the payables that is unusual, like past due or anything like that, there's some assurances there. And then secondly, on the inventory, there's some misperception, I just want you to put this to rest, that somehow Wesco is a bit like Target, that you put inventory on the shelves and you hope customers come. You're project-based. And the inventory that has been committed to by the customers for these projects is The customers are on the hook for that. You're not adding speculative inventory. Maybe just address that in terms of the certainty of that inventory that you're carrying. Thanks. Yeah, thanks, Dean. Let me address your second question there on inventory. You're absolutely right. So we have been taking in inventory. given the strong backlogs, which are committed orders. And we do have terms and conditions. So that inventory will be shipped to a customer. We have not seen any cancellations in the backlog, so we're very confident in the quality of the inventory. Going back to your first question about the quality of our network and capital including payables, we actually improved about half a day versus the prior year quarter. We've not seen any degradation in the quality of the payables. We run our consistent process. So, again, nothing out of the ordinary in terms of our networking capital or the quality of our networking capital. Again, our free cash flow guide coming down specifically for the accounts receivable impact that we expect going forward and the strong sales that we expect in the second half of the year. Great. We call that a high-quality problem. Thank you. Thank you.
spk03: Thank you. The next question comes from David Mante of Baird. Please proceed.
spk08: David Mante of Baird Thank you. Good morning, everyone. You noted 8 percent inflation, and there are some differences in how different companies measure the price benefit to revenues. Could you, first of all, could you tell us, Dave, what is your methodology? And then second, could you talk about which product lines where you're seeing the most inflation? You mentioned CSS and seeing the least, but is it right to think you're seeing it mostly in the heavy gauge wire and steel conduit and less in finished goods and switchgear and general supplies, that sort of thing?
spk09: Let me start with the calculation. I mean, we essentially looked at changes to the pricing and what we've been able to pass through to our customers to calculate that 8%. So it really does start with what are the suppliers passing on to us. We then, again, take a look at that and how do we pass that through to ensure that we're appropriately getting paid for not only the product but the services attached to the product that we're delivering to our customers. In terms of the overall inflation, we have seen spikes over the last, call it 12 months, that are pure commodity-related. But I would tell you that a lot of the price increases that we're seeing are relatively consistent across all product categories, primarily given the inflation that our suppliers are seeing outside of just the commodities. So very clearly on some of the more commodity-based, that's going to move with the market. All of our suppliers are also passing through the increases that they're seeing on labor, increases they're seeing on logistics, transportation, and their ability to service the orders to us. So I would tell you that it's across all the product categories. The one area that we called out was we're not seeing the same level of inflation in some of the suppliers to our CSS. For the most part, we're seeing broad-based inflation. inflation across the board being passed through to us from the suppliers.
spk10: Okay, thanks. And just to be clear, Dave, are you saying that you look at specific skews this year versus last year?
spk08: Is it just the same skews, same skew, same product? I mean, there's different methodologies people use. I'm just trying to understand how to read that 8% number.
spk09: Yeah, we're looking at it by product category because we don't always sell the same SKU consistently from quarter to quarter year over year. So we're looking at the group of product categories within a SKU family in order to calculate that 8% number this quarter.
spk03: Great.
spk09: Okay.
spk08: Thank you very much.
spk03: Thank you. The next question comes from Sam from Raymond James. Please proceed.
spk04: Good morning, John. Good morning, Dave. Can you hear me okay?
spk03: Yes, Sam.
spk04: Good morning. Terrific. Good morning. Yeah, two broad topics, if I could. First would be about the new billion-dollar repo authorization. I don't recall it being in your prepared remarks, or at least certainly wasn't accentuated, that your own equity is considerably more attractive than any prospective M&A opportunities. And then, secondly... You know, rightly or wrongly, the market generally perceives three turns of debt leverage as, I guess, the point at which a stock becomes high beta. And knowing this and knowing the broad concerns of an industrial slowdown, are you really looking to do more substantial repo when you get under three turns, or will your repo plans be more based on simply the absolute value of the equity?
spk09: Sam, it's Dave. So I appreciate the question. And as you mentioned, you know, we do take a look at multiple factors when we make decisions. We did not purchase any shares. In the second quarter, we do have the authorization that was approved by the board back during our May board meeting. In terms of how we're thinking about this right now, we just got under the target leverage range. So we're at 3.4 turns. Our borrowings against our facilities to support that networking capital and the strong sales growth. So right now, we're still focused on being able to drive down that leverage in the near term. Over the long term, we'd expect our leverage to be closer to the middle of that two to three and a half turn range. And so, again, we want to continue to focus on that. In the immediate term, we always are looking at the equity value against other uses of our capital. And right now we have been focused on making sure that we get that leverage down within the target range, and then from there we'll continue to evaluate those opportunities and what we believe will drive most value for our shareholders.
spk04: My second question topic is kind of a piggyback on what Dean was getting. working your inventories lower you may not have inventory risk per se but you know that drawdown is going to pressure your vendors volumes it's going to pressure their pricing saying it's going to pressure your rebates and so on and so forth so at what point do you believe that your gross margin expansion will end And how do you manage price cost if you lose the air cover of no longer seeing announced price increases from your suppliers going forward?
spk06: Sam, we've been through numerous cycles. We've got a very seasoned management team, and you look at the operating leaders of the three businesses, and myself and Dave, we've been through numerous cycles. I think we know how to manage this company through all phases of the cycle. We're exceptionally high confidence in the cash generation characteristics of our model through all phases of the cycle. And just to touch on that earlier point, you look at all the working capital growth through the first half, it's really all sitting in accounts receivable that we are confident we'll collect from customers. Relative to margin, we have an enterprise-wide gross margin improvement program that's underway. If you look several years leading up to the merger close, and it's been posted consistently across, you know, a nine to ten quarters gross margin expansion. Against the backdrop, it was very challenging in terms of getting margin. When you look at the other publicly traded distributors, they were facing margin compressions. And that's continued. And we took that enterprise-wide gross margin program as a top priority in the first six months post-margin close. I still wanted to make some refinements. We looked across WESCO. We made some additional refinements. And we now have been executing that enterprise-wide. And that's been in place for the better part of 2021 and so far here in 2022. You take a look at our gross margins. we're building very strong momentum on the gross margins. And so, you know, we've got confidence that there's a lot, there's a long runway left in terms of gross margin expansion. You know, we don't guide you to that anymore, but we clearly see the strong combinatorial contributions of gross margin expansion plus operating cost leverage. Both of those were focused on, you know, laser focused on driving both of those to drive further operating margin expansion. And the recipe is working. And, you know, look again at this quarter, the gross margin improved sequentially to a new all-time record level. And that's with some commodity prices starting to roll over significantly in the quarter. So I think, again, the essence of our gross margin enterprise-wide improvement program is really focused on value creation. We're selling the value of, say, selling the value creation that we're delivering to our customers' operations in their supply chains. And I could not be more pleased with the exceptional job our sales and account management teams are doing in terms of selling that value to customers. Yes, we did invest in working capital, but more importantly, we are a one-stop shop. We provide a complete solution for customers. And as the markets get more volatile and the customers have more challenges, they lean on their strongest, broadest, highest-performing suppliers even more. And as I've said before, supply chain now is a strategic issue. It's at the top of the C-suite, and it's at a boardroom level in terms of priority. And that is supply chain integrity, supply chain resilience, and we provide priority. high degree of supply chain integrity or resilience, that's core to our value prop in terms of what we deliver to customers. So, look, I know this is the question that everyone has to the extent that things start to slow down, but we are highly confident that we've got tremendous runaway left in terms of our margin expansion.
spk04: So, to paraphrase, gross margins in the back half continue on its favorable trajectory despite the inventory drawdowns?
spk06: We're not seeing any issue yet. I mean, in our margins, Dave mentioned it. I'll amplify it. Our margins in July, the beat goes up very consistently with how we ran through the second quarter. So, as I mentioned earlier, Sam, and you'll recall this specifically, You know, we made some core changes as part of the gross margin improvement program at Enterprise One in terms of compensations for the sales force. So the additional element of pain for performance there, I think, is they're actually having to improve. And they're biopically focused on selling the value and benefiting from, you know, continuing to drive the margin expansion.
spk04: Terrific to hear and a terrific performance in the quarter. Thanks much. And onward and upward.
spk09: Thank you, Jim.
spk03: Thank you. The next question comes from Nigel Coe of Wolf Research. Please proceed.
spk01: Good morning, everyone. So, yeah, I just had a question. Just maybe to start off on your debit comp and your accruals. I just want to make sure I understand how this works. So, obviously, you've topped up the full-year payout, so you have a catch-up for 1Q and 2Q, and then third quarter, fourth quarter, we'll then get a run rate, but... 2Q would be a catch-up to 1Q.
spk09: Is that right, Dave? Yeah, Nigel, in 2022, we trued up incentive comp above target payouts in Q1 as well as in Q2. So there's only a slight increase sequentially on that short-term incentive plan accrual.
spk01: Okay. Can you help us, you know, where is that in dollar terms now running for the full year compared to where we were, you know, back in January?
spk09: Back in January when we provided our initial guide, we called out that if we pay at target for 2022 against 2021 where we did pay out above target, that it was roughly a 30 basis point tailwind. well, that tailwind has essentially, you know, gone away. I mean, we are performing much better. Therefore, you know, we are accruing appropriately for that short-term incentive compensation. The dollars year over year are not materially different than what we experienced in 2021.
spk01: Okay, but it's seen in 2023 as more back on target. We got a 30-base point tailwind into 2023. And that's sort of my real question is, you know, if you go into FY23, Assuming that volumes are positive in 23, that's obviously a big if, but based on the backlog, it doesn't seem unreasonable. Is there a scenario where margins could be down in 23? And I'm thinking here about maybe some price-cost headwinds. I don't know what else, but is that a scenario that's even on the table?
spk09: Well, I would tell you, Nigel, similar to what John said before, we've been through these cycles in the past. We know how to operate. There's always things that are going to be impacting the overall margin. As we've said in previous years, we're going to be looking at market inflation rates on our people cost. So we've got to have enough top line. So clearly, in a volatile economic environment, if one was to take place, we would have to pull the appropriate just on making sure that we continue to drive value long-term for the shareholder. But, again, you know, we think that we've got a good setup for 2023, as you mentioned. The incentive compensation would be adjusted back to target as we think about our plan for next year.
spk10: I mean, I would just add to Dave's point.
spk06: I would say the setup, you know, for 2023, you know, would just substantially range with our full-year guidance. for the second time for 2022. We have very strong momentum. We raised the sales synergy target substantially again at $1.2 billion. Our sales synergies in the second quarter of $200 million exceed our original target. This is the breakout for this opportunity, I think, that is really showing itself as we establish this track record of success over the last eight quarters. Our backlog continues to fuck any normal seasonality, and it's in a new all-time record level sequentially, which is a great setup, not just for 2023, but in particular for 2023. by raising the cross-sell target, it's the largest we've ever seen, continues to grow. We think we're outperforming the market significantly. We're the market leader in our core markets.
spk10: And, you know, to the extent that customers will want to double down even more with their strongest supplier partners, supply chain and tech,
spk06: demand is still outstripping supply. And so really, inflation continues. I think inflation continues at a meaningful level through 2023 because the sources of inflation is demand outstripping supply, first and foremost. Secondly, everyone's missing that labor is a constraint. It's not just the materials in the supply chain. It's labor as well. And then you have public interest and even further, and we've seen none of that in our numbers yet. So I did want to touch upon this. It's really where we are ending.
spk10: Our full year guide, our full year guide for 2022 now is above current analyst consensus for 2023. on the top line.
spk06: Third point. Second point, we expect to grow in 2023. That's the answer.
spk03: Thank you. The next question comes from Tommy Maul of Stevens Inc.
spk10: Good morning and thanks for taking the time. Good morning.
spk02: John, I wanted to start on the big data theme. You've given some transparency into the digital and IT investment. So I'm curious what cycle.
spk10: And then on the flip side, when you start to some of the revenue and margin benefits from these started to see some of those benefits yet, or when do you anticipate that those would show up in a meaningful way where we'll see it in the P&L?
spk06: Thanks for that question. It's outstanding. We are in the baseball now. We're in the very, very early innings of seeing the benefits. I'll start with the benefits. We've highlighted a few over the last couple quarters.
spk10: I will tell you that we plan on kind of being more expressive with respect. We're very excited about that.
spk06: That'll be your first investor day since Anister and Lester came together and since the pandemic.
spk10: When we brought these two strong back in June of 2020.
spk06: of a digital transformation that we embarked upon. And this was quite frankly the catalyst and the ability to put these two large companies together gave us the opportunity to make a transformation like neither individual.
spk10: That is a longer time.
spk06: And that is roughly a five-year process. And so we're two years into the three-year integration period. We're two years into the five-year digital transformation. The investments are laid out.
spk10: Dave spotlighted again in his commentary what we're investing in and showing them, you know, both in capital spending and different areas of the P&L statement.
spk06: But, you know, any of our synergy is a top-line result.
spk10: Mid, not long term, mid-term, that's been a transformative, we're doing in digital, what it will do for us and our ability to serve customers more efficiently, more effectively, unlock monetization for increasingly tap our big data. Super excited about it. Here's the great news. It's not in our results yet. We
spk06: The investments are in our results, but the results in terms of meaningful sales growth and margin expansion are not in our results yet, and improved, and a dramatic acceleration of working capital. That's not in our results yet. So stay tuned.
spk10: As strong as this story's been thus far, and I think ever since we came together, we're going to be
spk06: What are the two years or the three-year integration period of point? And the results are exceptional with a series of increases along the way.
spk10: The digital transformation story is a whole higher, another order of magnitude.
spk06: And that's futures that are exceptionally exciting.
spk02: Thank you. I appreciate that. As a follow-up, I just wanted to ask on CSS. Organic sales trended quite the other two segments. You called out supply chain as one headwind there. So I wonder if you could comment on that. Was that the primary delta in that segment's growth rate versus the others, or would there be an effect?
spk10: Let's look at CS as the other two businesses. Outstanding secular growth trend. leading value proposition, global footprint, an absolutely outstanding business.
spk06: It's a franchise. It's terrific. It has been supply chain constrained. It has been supply chain constrained.
spk10: You know, my comments and Dave's comments have been very positive and bullish on the mid and long-term prospects of that business.
spk06: That's unchanged. I'm as bullish as ever. in terms of the applications that we have access to and our total solution offering. Specifically with respect to the momentum vector, I couldn't be more pleased with how CSS picked up. Everything is relative in life of business. I'd ask you to look at this sequentially. You see momentum building in CSS.
spk10: The backlog growth is exceptional.
spk06: It's at a higher rate than EDS, not quite the UBS backlog growth rate, but it's exceptional. And now the sales and margin is beginning to accelerate as the supply chain continues to heal. So that is the story here. And, again, it is an accelerating vector that we're on with CSS, and I'm very pleased with the pickup again.
spk03: Thank you. And the final question of today's Q&A session will come from the line of Ken Newman of KeyBank. Please proceed.
spk05: Hey, good morning, everybody.
spk10: Thanks for squeezing me in. Morning, Ken. John, good morning.
spk05: John, I think you touched on it briefly in a prior question, but Regarding the increase in the cross-sell and share gain synergy capture for 2022, do you have a sense of just how much of those benefits is, where do you see the momentum for those synergies coming up even further?
spk09: I'll let Dave handle that. Yeah, so when we think about the bridge in our sales outlook from our previous quarter call, Now, the success that we're seeing in share gain and cross-sell, we called it out as 3% to 4% of the growth previously. It's now approximately 5%. And I think that as we look at Q2, we're confident that we increased share. So we believe that we are taking care, but really the benefit of the cross-sell, we're now expecting that to be combined approximately five points of the growth within our outlook for 2022. So, again, really pleased with the results. As we mentioned earlier, it exceeded our expectations in the second quarter. We're also very diligent about looking at not just the pipeline but the backlog of the cross-sell, which is one of the reasons we had confidence in taking the number up for the target this quarter.
spk05: Understood. And then just for my follow-up here, you talked about the balance between share repurchases and working capital needs and keeping the balance sheet in that target leverage. But I'm curious if you have any comments on just how you look at the priorities between repurchasing the preferred shares and the common shares, understanding that there are some caveats on how much you can repurchase from that preferred bucket.
spk09: Yeah, very clearly there are some constraints on repurchasing the preferred. It will come back down to best value, trading in the premium that would be required to buy back those shares. There are some make-hold provisions on that.
spk10: We take a look at that just from the pure economic perspective.
spk09: perspective, whether it would make more sense to buy back common stock or preferred, and we are able to buy back both classes within the authorization. It purely will come down to the economics at the time.
spk06: You know, we think we have a new company. We've created it clearly. It has fundamentally different characteristics. It's mixed, shifted up. market, the execution, it's showing up in the execution and the results thus far, and we think we've fundamentally shifted this company to a different value creation trajectory, let's say, than either prior company ever was on in their history. In terms of cash utilization, cash generation capability over the mid to long term and cash utilization
spk10: priorities.
spk06: It's something that we've not outlined with a longer-term view since we put these two great companies together, and that is something we are going to absolutely address in our upcoming investor day. We foreshadowed that earlier, and we'll do that, and I think it's important. You know, getting the authorization in place for the share repurchase was vital because we did not have an approved authorization in place. And we did that purposely.
spk10: We will always need to make sure we have it. The new Westcom is exceptional. I'm not going to address it in this earnings call, but you've got to take a look at, you know, when we outline this for you in a
spk06: Yesterday, the optionality in terms of the value creation levers that I'm going forward is unlike anything either company had in the past. Okay, with that, I think we did go a little bit longer. I'm going to wrap it because we had, again, a technical difficulty where we lost connection here for a few minutes. That's why we went a few minutes over. I'll bring the call to a close. Thank you for all your support. Very much appreciated. As I just mentioned, we look forward to speaking with many of you in the coming days as well as our upcoming investor day. That date has been set. It's September 7th in New York City. And as I mentioned earlier, this will be our first investor day since closing the Anister merger. And it will be an excellent opportunity to learn more about our combined business and get to know our entire senior management team better. I hope all of you will be able to join us, hopefully in person or at least virtually. Additionally, we're going to be participating in the Raymond James Diversified Industrials Conference in August and both the RBC Global Industrial and Morgan Stanley Conferences in September. So with that, I know we've got many calls scheduled this afternoon and tomorrow. I'll bring you to a wrap. Have a great day. Thanks again.
spk03: That concludes the conference call. Thank you for your participation. You may now disconnect your lines.
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