Q3 2020 Wesco International Inc Earnings Call
Good day and welcome to the Watsco third quarter Twentytwenty earnings call.
All participants will be in listen only mode.
Should you need assistance, please signal like copper specialist.
I think star then zero on your telephone keypad. 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 too.
Please note this about just being recorded.
I would now like to turn the conference over to will.
Two of Investor Relations and corporate Communications. Please go ahead.
Thank you Andrew good morning, ladies and gentlemen, thank you for joining us joining.
Joining me on today's call are John Engel, Chairman, President and CEO, Dave Shull.
Executive Vice President and Chief Financial Officer.
This conference call includes forward looking statements and therefore actual results may differ materially expectations.
Please see the webcast slides for additional risk factors and disclosure.
For additional information on Wesco International please refer to the company's filings, including the risk factors described there right.
The following presentation includes a discussion of certain non-GAAP financial measures.
Nation required by regulation G of the Exchange Act with respect to such non-GAAP financial measures can be obtained via Wescos website at watsco Dot com.
Means to access this conference call via webcast was disclosed in the press release and was posted on our website <unk>.
Plays of this conference call will be archived and available for the next seven days with that I'll turn the call over to John Engel.
[music]. Thank you will.
Good morning, everyone and thank you for joining us for today's call.
Like to start out by saying on behalf of Wesco I hope that all of you have been staying safe and healthy.
I'll start with the third quarter highlights then I'll provide an introduction to our true to our three new strategic business units and I'll be emphasizing their strong positioning to deliver above market sales.
Margin and profit growth.
Dave will then take you through our third quarter results. The excellent progress, we're making on I can have commitments and synergy capture efforts and our increased synergy targets for the transformational combination of Lescott anixter.
So, let's first start with an update on our business in third quarter results.
Lets go lets go to new era is off to an absolutely exceptional start.
As our results exceeded our expectations across the board for sales.
Cost.
Margin.
Profit.
He P.S. free cash flow generator.
Generation and reduce financial leverage.
This was our first full quarter of results after completing the acquisition of Anixter in June and clearly highlight the substantial value creation potential of this transformational combination.
Our management actions and strong execution were effective in its kobin driven environment.
We expanded margin reduce cost and group profit both sequentially and versus prior year.
Business momentum improved through the quarter, if we took market share and built an all time record third quarter backlog.
Our positive momentum has continued into the fourth quarter with October.
October workday adjusted sales down just 3%.
Versus prior year, and a book to Bill ratio remaining above 1.0.
Free cash flow generation was exceptional at over 300% of net income and demonstrates our resilient business model and strength through the cycle.
Notably net debt was reduced by 280 million consistent with our capital allocation priority [laughter] more.
More importantly, the natural leverage was reduced to 4.8 times at the end of the third quarter, marking a reduction of about one half turns over the four month period since closing the anixter expiration.
Again, this quarter I'd like to recognize and thank all of our associates for their inspirational dedication commitment and hard work and and effectively managing holdco the drilling Oh no.
Procedure business unit or S. B use as as we as we call them outline.
Outlined on this page.
So first is electric electrical and electronic systems are EES, which is a little more than 40% of our accompanies total business <unk>.
Communications and security solutions are CSS, which is roughly one third of our company's total business.
And then a third utility and broadband solutions are UBS, which represents the remaining one quarter of our overall combined company business across the enterprise.
The respective industries and types of customer that these SBU serve.
Are outlined on this page we provide a high level summary for each of these businesses.
Including in our respective growth drivers and the additional information section of this webcast Street.
Yesterday, we also file an 8-K with pro forma operating performance for each each SBU on a quarterly and annual basis for 2019 and for the first two quarters of 2020.
As I mentioned last quarter, one of the most meaningful and positive discoveries posed clothes is how complimentary the <unk> anixter portfolios are.
The pie charts on this page to pick the legacy Wesco and legacy Anixter composition for each of the three businesses.
Yes. It is comprised of west coast leadership, and deep roots, and electrical coupled with anixter of depth and breadth and leadership position and wire and cable solutions.
And he brings the complete electrical package and best in class solution offer to customers.
She S. S includes anixter is leading global position capabilities and scale and communications and security and that's coupled with west coast data com.
A V and safety portfolio.
Combine css's is exceptionally well positioned in high growth markets with very attractive secular growth trends.
And finally, UBS, which combines west goes in anixter is leading utility and broadband businesses is also very well positioned to outperform the market with a strong execution track record and unmatched supply chain capabilities.
Organizing our company around the three global businesses enables us to leverage their industry, leading scale and highly complimentary portfolios and super serving our customers.
Each of these sbu's does between 4 billion, a 7 billion a business annually and they offer hundreds of thousands of products and industry leading services.
Which makes them highly valued partners to both our suppliers and our customers.
And what remains of highly fragmented distribution value chain. The combined company benefits from a step change in scale and capability.
And we're leveraging that to sell more products and more services.
Two more customers in more locations all around the world.
Finally, the leadership teams or the three businesses are comprised of the best of the best from each company and all possess decades of experience in our industry.
Nelson Squires, who was previously Wesker's, Chief operating officer, and head of the Canadian and international businesses is leading our Esfs business.
Bill Gary leaves are global CSS business and he previously was head of Anixter network and security business.
And Jim Cameron leaves are UBS business after running wesker's utility business since 2014, and West coast broadband business since 2016.
I'm very pleased that each of these leaders is off to a great start and delivering strong results in our first full quarter of Wesco plus anixter.
Now, let's move the page five.
Oh, that's b use.
Each and every one of them are extremely well positioned to benefit from a numerous sechler secular trends that will drive future growth for Alaska.
We share these 12 evolving secular growth trends with you previously, but today, we wanted to specifically highlight that they will drive growth across all of our businesses.
As we see an increase in automation machine to machine connections electrification of our infrastructure and demand for faster bandwidth in data center capacity, along with or coupled with the positive impact of the emerging trends such as relocation of supply.
In fact in North America, and increase remote connectivity all three of our strategic business units had the scale and the capabilities to capture the resultant secular growth.
Trying to call over today for his remarks, hey.
Thanks, John turning to slide seven during our second quarter earnings call. We outlined six second half priorities and we want to provide you with an update on the substantial progress on each of these goals starting with sales demand continued to improve and we believe we've taken sure.
Sales and a quarter were down versus prior year do the covid and up 8% on a pro forma basis from cute too.
We maintained our focus on cost management and exceeded expectations prior.
Prior to completing the merger with anixter, we laid out our expectation to deliver $50 million of covid related cost actions.
Between Q2 and Q3, we exceeded this target.
On a pro forma basis operating expenses were down $44 million in the third quarter versus the prior year.
On gross margin, we discussed the success Anixter had expanding gross margin to a targeted improvement program and we are deploying it to the legacy Wesco business.
Gross margin was up 20 basis points on a pro forma basis with broad based improvement across the combined company.
We are extremely pleased with the progress made on the integration.
As John mentioned, we have already initiated actions to achieve the full year, one synergy cost target of $68 million in the first four months of the integration and are increasing our cost synergy target.
One of the areas. We are most pleased with is cash generation free cash flow was extremely strong at $307 million in the quarter and we reduced net debt by $280 million.
Our leverage including near one synergies improved a four eight turns on and adjusted EBITDA basis.
Lastly, we are fully transitioned are reporting structure to our new strategic business units that John walk you through a moment ago.
We issued an 8-K yesterday, providing you with the historical Wesco only results recast the new segment reporting structure.
As well as a pro forma combining the historical wesco, an actual results, including the reconciliation of adjusted EBITDA.
Again, we're very pleased with the results in the quarter against a difficult operating environment due to covid.
Moving to slide eight we are increasing our three year cumulative cost synergy target to $250 million.
Two drivers to the increase first we said internal goals at our higher than we announce publicly and our teams are delivering.
Second there were specific areas, where it detailed information and analytics could not be completed until after we close the transaction.
We are finding upside to our initial estimates and all four buckets of synergies and are particularly excited about the incremental synergy opportunities in the areas of supply chain and SG&A, giving us confidence to take up or target.
And Q3, we realized $15 million of cost synergies and expect to achieve $100 million and the first year of the merger.
We still believe there is additional upside and we plan to build upon our successors to drive additional value capture in the areas of cost cross selling and networking capital synergies.
I'll also mention that we continue to make progress with a divestiture of the legacy Wesco Canadian utility and data com businesses, which represent less than $150 million in revenue.
We engaged in investment banking are working with potential buyers and are on track to complete the divestitures on a timely basis.
Turning to our third quarter results on page nine. This summary table compares our third quarter results to the West Elm plus an extra pro forma results for the prior year period and sequentially against the second quarter of this year.
Sales were down 5% versus the prior year and up 8% sequentially.
These sales improvements represent substantial growth above peers and indicate we are taking share.
October Workday adjusted sales were down just 3% versus prior year and as John mentioned are booked the bill ratio remains above one point.
Sequentially October workday adjusted sales versus September we're better than typical seasonality.
It just did gross margin, which excludes the effect of merger related fair value adjustments of $28 million was 19.6% up 20 basis points versus prior year and sequentially.
We are clearly seeing traction from our margin improvement initiatives and are just beginning to deploy anixter has proven gross margin improvement programs across the business.
Adjusted earnings before interest in taxes was $200 million in the quarter.
Reported EBIT was adjusted to remove the effect of merger related costs of $14 million the merger related fair value adjustments, an inventory of $28 million.
And again on the sale of an operating branch in the U S that was unrelated to the integration of $20 million.
Regarding the branch sale, we divested a single location that primarily sold Rockwell Allen Bradley automation equipment and a specific geography.
Compared to the prior year adjusted EBIT margin was up 30 basis points, reflecting the benefits of synergies and cost management actions in response to covid related demand declines.
On a sequential basis suggested that was up 60 basis points.
So I mentioned on the prior slide the legacy Wesco business expected to generate $50 million in total covid related cost savings in the last three quarters of the current year. This quarter, we delivered approximately $28 million of these savings.
Augusta, EBITDA, which excludes the effects of the adjustments I, just mentioned as well as stock based compensation in both the current and prior year periods and other net adjustments was $252 million, 5% higher than the prior year and 19% higher sequentially.
As a percentage of sales adjusted EBITDA margin was 6.1% 60 basis points higher than the prior year and sequentially.
These exceptional results, reflecting both year over year in sequential improvements of both adjusted EBIT and an adjusted EBITDA.
Reflect our continued strong execution disciplined cost management market share gains industry, leading value propositions across all of our business units and the acceleration of our synergy capture.
Are leading position and participation in the many secular trends discussed earlier.
As well as our track record of operational excellence sets us up exceptionally well to drive substantial value creation.
Augusta diluted EPS with a quarter was $1.66 a full reconciliation of adjusted EPS is included in our press release.
Turning to slide 10 R. E. S segment delivered sales that were down 10% versus prior year and up 13% sequentially.
The sequential growth reflects construction demand that continues to improve in North America, and which was up double digits in the U S and Canada.
Our backlog, which primarily reflects construction activity was the third quarter record consistent with the trend we have observed of project delays due to COVID-19, but not cancellations.
We continue to see increasing momentum in our OEM business as well as in many industrial verticals that we serve.
It is important to note that oil and gas, which previously represented approximately 7% of west coast business prior to the combination with anixter.
Is now a low single digit percentage of the combined company's revenue.
Adjusted EBITDA of 108 million was 6.5% of sales approximately in line with the pro forma prior year results and 70 basis points higher sequentially, which is an excellent result, given the lower sales versus the prior year.
During the quarter, we were pleased to be awarded multiple contracts to provide switch gear and electrical materials, including lighting for the upgrade of a water treatment facility in Ontario, Canada.
Turning to slide 11, or CSS segment delivered an exceptional quarter.
Sales were down 2% versus prior year against a broader market that was down substantially more and up 10% sequentially.
We are clearly taken share in these markets as would EES. We saw continued positive momentum throughout the quarter.
Security sales rep, low single digits versus a market that was down mid single digits in our global accounts activity was up low single digits, reflecting strong performance with Hyperscale data centers global security and system integrators.
Profitability was also strong adjusted EBITDA of $121 million was up more than 8% versus prior year and adjusted EBITDA margin improved 80 basis points above the prior year.
And the second quarter, we were pleased to be awarded a multi million dollar contract to provide a comprehensive solution of products and material management services for the construction of two data centers in Mexico.
Turning to slide 12 sales in our UBS segment were flat sequentially and down 2% versus the prior year.
This result reflect strong growth from broadband sales offset by weakness and the industrial focused areas of our integrated supply business.
Broadband sales were up mid single digits versus the prior year in high single digit sequentially driven by continued five <unk> five G build outs and fiber to the X deployments.
Utility sales were flat on a pro forma basis compared to the prior year.
Storm response activity contributed to this growth is there were a number of hurricanes and tropical storms that made landfall in the U S, especially in September.
Adjusted EBITDA of $86 million was up more than 11% versus prior year on a pro forma basis and represented seven 8% of sales 100 basis points above prior year, and 30 basis points above cute too.
As an example of our recent success, we were awarded a multiyear contract to provide electrical transmission and distribution materials and inventory management services for a public utility.
Moving to free cash flow and liquidity on slide 13, this quarter Wesco generated $307 million, a free cash flow or 315% of adjusted net income.
This exceptional result highlights are counter cyclical cashflow generation, which is one of the many reasons were highly confident in our ability to reduce leverage throughout all phases of the economic cycle.
Year to date, the company is generated $462 million, a free cash flow or 292% of adjusted net income.
R capital allocation priority remains unchanged, we will allocate capital support the integration and invest in our business. Our priority is to rapidly delever the balance sheet and be within our long term target leverage range of two to three and a half turns net debt to EBITDA by the end of the year three in June 2023.
We made substantial progress on this goldman the quarter as we reduced net debt by $280 million or leverage ratio, including the revised target of your one synergies was 4.8 turns about half a term below the comparable metric and Q2 of five three terms.
Our liquidity, which is comprised of invested cash and borrowing availability in our bank credit facilities is exceptionally strong and totaled approximately $1.1 billion at the end of the third quarter.
A reminder, that we will remit the first cash interest payments on the 2025 in 2000 2018 or notes and expect to pay the quarterly dividend on the preferred stock in December.
Exceptional free cash flow throughout the economic cycle remains a hallmark for wesco that along with strong liquidity supports our future growth.
Moving to slide 14 before.
Before opening the called your questions I'd like to just walk you through a quick summary.
We've also provided additional information about the business units and a slide that answers some faqs regarding the upcoming quarter.
This quarter was clearly an exceptional results on all fronts for wesco against a covid driven economic backdrop.
We increased margin across the board despite the challenge of Covid, driven 19 sales weakness.
This was driven in part by decisive actions to reduce costs given the uncertainty of demand.
We see core demand continuing to improve across our businesses, noting that we typically see a seasonal affect the queue for sales and have three fewer workday sequentially in the current quarter.
We restored salaries and benefits effective October 1st and we are incredibly proud of how our team has responded to the crisis and has continued to service our customers.
And just for months is closing the transaction we've initiated actions to meet the initial full year one cost synergies.
We have increased our year, one target from $68 million to $100 million and are increasing our total cost synergy target from $200 million to $250 million.
In addition to the substantial cost synergies you're already generating revenue synergies from our cross sell pilot program.
As a result of this excellent position and continue to integration of Anixter, we expect to exceed our value creation targets of sales growth margin expansion and cash generation.
Our free cash flow was also exceptional demonstrating are resilient business model and cash generation ability throughout the cycle.
Each of the new strategic business units that we reported on today are extremely well positioned to capitalize on several continued in emerging secular growth trends and with that we look forward to taking your questions.
We will now begin the question and answer session to ask a question you made correct Star then one on your telephone keypad.
If you were using a speaker phone please pick up your handset before pressing the keys if at any time. Your question has been address and you would like to withdraw your question. Please press Star then too.
Please limit yourself to one question and one follow up.
At this time, we will pause momentarily.
To assemble our roster.
The first question comes from Dean Dre of RBC capital markets. Please go ahead.
Yeah.
Thank you and good morning, everyone.
<unk> and I really like the new segmentation and all of these disclosures in the slide deck I mean, it's just it's very helpful to see the continuity like on page four where you show legacy Wesco combined with anixter like I say so.
Yeah, it's a big help to us.
And if we start I think the surprise for me is how much.
We're seeing Ah share games, and the quarter right out of the blocks. So maybe you referenced said it and the communications security as well as utility segment. So if we could just start there and frame for US how did you any specifics around the share games, but is it coming in the combined go to them.
Market Ah their new products and.
And if we can start there please.
Yeah, well, thanks for that yeah, I I would say that it's we're seeing the results of really.
Two things and I I I referred to one.
Both of these the last the last quarterly call. It remember we closed on June 22nd.
So we really couldn't get to look at all the details of the portfolio and so one major and meaningful positive surprise that we obviously became aware of post close with a complimentary nature of the portfolio team.
So I'll come back to that in a minute.
Yes, we thought we competed in the market and we did.
Predominantly in utility, but even even in your Tony either highly complimentary portfolios when you look at.
The array of services that each company had.
Secondly, if the cultural match, which I find to be you know also just a major.
Kind of new learning or a surprise and you know just as relentless focus on the customer and delivering value, but this specifically get at your point I you know I.
I think the team has come together exceptionally well, there's a spring and arched that we're very focused externally on the customer and taking this new broader and stronger portfolio of products and services the market.
And we did we did once we you know once we stood up the new organization. We launch this series of crust cell pilot.
And will report on these as we move forward isn't it's already typically proves to be the most elusive.
You know a loose of synergy to get when when companies come together, but we're we're really excited.
And encouraged by the initial results.
We launched a series of of Crossrail pilots in each of the three businesses.
So specifically in N E S.
We've we've we're taking our lighting capabilities, it's turnkey retrofit renovation and upgraded and applying that those capabilities, bringing that to the anixter customer base.
And we're taking the tremendous step breath and strengthen after hasn't water cable, which is where there can you restart and bring that to the west go customer base.
And as I mentioned in my prepared remarks, we have the complete electrical package now we can bring the customer so thrilled about that and C. S. S.
We're leveraging that global footprint and bringing additional categories to those customers.
That in terms of a V in terms of safety and fundamentally what we're realizing this is even without the the new secular trends that have been accelerating due to covid.
Five G.
Royal broadband Buildout datacenter growth in building wireless, we're just seeing really strong growth in the end markets and customer applications and now we have the most comprehensive and leading portfolio of products and services to bring the bear on that those applications and finally for utility and broadband.
We've got two very strongly <unk> companies coming together and so you know I think in conjunction with our supplier partners equal to offer even more value now even more value with the real key Ahah wise.
Array or a range of services that we have.
Services that we have a part of the overall solution offering is broader than we than we fully appreciate it pretty close so hopefully that gives you. Some some color game. It really does and just to clarify on that last point cause. It was really interesting you didn't highlight the the services that are part.
Of the sales offering in the combined entity and I know that was important to west coast before do you have a data point.
On how much services are attached to the revenues I remember you were saying before it's like 70 per cent or in that neighborhood before so what is it.
I'm buying company, yeah, what I'd like to do Dean is not answer that yet because I think what we we build out these businesses we are planning on.
You know some additional teacher and Investor day in 2021, and and what I think the best way to get to that is as opposed to one aggregated number and we will give you kind of insight business by business and what exactly those services are and and.
I will say that anixter also had a very similar to Alaska.
Just a tremendous service value proposition and some specific service offerings.
We're at the heart of their end user relationships. So.
At that level Dean to give you some answer to the question very similar but I I think the the entire portfolio is much more expensive.
As a result of the two coming together and if this will increasingly become one of our key value drivers I think going forward.
Right and then separate question for Dave.
It isn't often we see over 300% free cash flow conversion, especially in a corner, where 100% was considered to be good can you take us through the dynamics in that high cash conversion are there any one timers is or anything tax payment related so I'm just trying to get a sense.
Of what the run rate should be thanks.
Good morning, the probably the one thing to keep in mind as in our free cash flow statement. We we do have accruals and our income statement for the expected interest payments that will be making here in the fourth quarter. So that's the one thing to keep in mind as we do have those interest payments that will be coming out now that's in that other line on the free casual.
Statement, it's in our press release.
Terrific and you haven't do you have room to increase the free cash flow target and I know, we increase the cost synergy target, but what's your sense on free cash flow target three years.
Yeah, we've already gone out and we've talked about there being $75 million of net working capital improvement through the integration of the companies and as I mentioned during our prepared remarks, we are working on upside to that and that's one of the things that we're most pleased with us as we bought the companies together.
There's a John mentioned, a very very strong cultural alignment when it comes to our bringing accompanies together from a customer perspective, but also how we think about working capital and we do believe that there are you just going to be substantial upside across all three elements of our synergies, including networking capital going forward.
Great. Thank you and congrats to everyone.
<unk>.
The next question comes from Sam Dark passion of Raymond James. Please go ahead.
Good morning, John Good morning, Dave how are you.
Morning fan.
I had two observations.
Following the disclosures of your new segment reporting yesterday or if I can.
If we could explore them a little bit.
The first one had to do with corporate overhead.
Anixter, roughly the same size as wesco, but had and I'm looking specifically in 2019 had nearly twice the overhead.
Why why it it's kind of a big numbers of $80 million to $100 million or something.
Higher why is that and I'm wondering if your overhead synergies should be considerably higher than the $35 million to $40 million that you've highlighted based on just simply right sizing the overhead between the companies.
Well. Thank you for that question Sam [laughter] I Love. Your question about two two comments one is.
Yes, there's opportunity to if you get underneath the covers and look at the composition of that there. There were some there were some functions that were more centralized Sam then and distributed into the businesses. So so.
So I you know I I.
Answers you should take both of those into account there there were certain call it corporate level or administrative straight or processes that they they had centralized and it was in that corporate cost bucket.
But.
Your insights are right, we saw that as an opportunity for synergies.
We work the financial commitments and model well in advance of clothing, and we're we're beginning to realize that synergies already I mean, I think we're we're absolutely thrilled thrilled as the word with a prog integration private familiar with the integration teams on synergies why we've raised the 200 to 250.
But we also took the your one from 68 to 100 so.
And you know as Dave mentioned, that's in the G N a area and supply chain as well.
Really strong momentum with that said, we have we have increased confidence that that will will be able to deliver upside against these new higher targets and we are still running too, which I sent mentioned before to substantially higher targets internally. So the teams right now the numerous integration teams that are executing.
Have charges that are well above.
A new revised external targets.
Second question. The other observation I had I mean, obviously, John you've you've mentioned.
Heatedly that higher scale means higher margins and I think that's really intuitive for a distribution business. What else was interesting to me, though is anixter is E E S.
Business, clearly subscale versus you folks it's like half the size of your your folks.
<unk> half the size and yet it consistently had a point or two higher margin that legacy Wesco wondering why that is I'm guessing some of this wire and cable product mix, but I'm wondering if there's also some branch or labor productivity in there I'm just curious as to how.
Anixter could consistently get higher margins with it with a much smaller business and if there was any ear learnings or takeaways as to as to how to capture that more holistically.
The way you frame. The question you actually have the answer so they're they're absolutely undisputed leader and wire and cable if you go back and look at Anixter deep roots.
Wire cable connectivity solutions. This is pre fiber then they pivoted in the fiber organically and built out that business globally organically and now have the pre eminent leadership position and communications and security, but in that category wiring came on all that that means they are the industry leader lists.
Scale size scope and scale that garners higher margins.
Gives us the complete electrical package.
Balance of their electrical business, Sam is what they picked up through the Ht supply power solutions acquisition.
So the other categories that or I'll call more.
The more complete electrical package broadbased, electrical with really for all intensive purposes.
Kind of relegated to the southeastern portion of the U S.
And that's the legacy HD supply power solutions Broadbased electric businesses, the old who supply if you'd go back quite some time ago. They did not have a broader based electrical capabilities.
In other geographic region. So.
So you're inside correct. The way he has the questions right that.
Really wraps around that category and the way they actually the value added capability to have around wire cable connectivity solutions and the services.
It just that that delivered tremendous value to customers and they're seeing that and the resultant margins. So.
So I think at a combined basis the real important point is on a combined basis, though.
This one probably.
This was not probably this way competitively the weakest part of West Coast Broadbased, electrical offering we had strengthened wire and cable in some G. Local geography's, but we didn't have it besides scope of scale across the U S across Canada, we were not able to take it internationally and that's what anixter.
Gives us so that really is the leverage point Sam for the E S business I mean.
It's something I've always wanted and now we've got it on a combined basis, we've got the complete package.
And if I can sneak one more in real quick Dave not to forget about you can you help us on a pro forma basis in the fourth quarter as to how we should take about incremental detrimental margins.
Yeah, Sam that's something that we're not gonna get into too much detail over I mean, we're not providing any guidance for the fourth quarter. One of the things that I would point you back towards his prior to the the acquisition with Anixter during our first quarter call. We had targeted on a wesco only.
Basis at our queue, three <unk> or I'm, sorry, Q2, Q4 detrimental margins would be in the range of 10% and I would just highlight that we indicated back during our queue to call that we were well within that range. We were within that range again, no here in the third quarter, but we're not providing any spit.
Perfect for the fourth quarter, we're really focused on driving value for the shareholder on the combined company basis now.
Very helpful a terrific quarter folks.
Thanks Sam.
The next question comes from David Nancy up there. Please go ahead.
Yeah. Thank you good morning, everyone.
Or in a day.
Yeah, So I'm, hoping to understand the key factors behind the very strong gross margin and if the mid 19th is sustainable from here was the majority of the 15 million new achieved in synergies related to supply chain as the first question.
No no. The majority of what we're seeing in that $15 million is really related more to the S. G N a.
Just given some of the changes that we've made to the organization plus duplicative.
Corporate overhead costs, so that we have not really seen the full benefit of our supply chain initiated actions here in the third quarter work I would say the supply chain benefit we are in the very early days in terms of realization, Dave but based on the work we've done.
That was a factor they gave us increased confidence on why we raise the 68, two 100 and the 200 to 250.
Okay makes sense and just just.
But that on your gross margin classroom back the gross margin question look I.
Anixter now.
Going forward with these segments, we're not going to continue to talk legacy Annika Wesco, but I think it's really important with respect to this point and it probably a few other in this call with respect the margin. This would've been this was.
Eighth consecutive quarter.
Of gross margin expansion for legacy Anixter, and they alluded to in the last quarterly the last quarterly call earnings call. They had they put in place a very comprehensive gross margin.
Three years ago, and they're still seeing the benefit of that we are taking that enterprise wide.
And we are in the very early days of that that did not has not contributed yet.
To the park parked the legacy West go there now part of E. S. C. S. S M U B S.
Legacy Wesco expanded.
Expanded gross margins on a like for like basis.
And that's the result of a series of hard work and initiatives, we had going on last year into the first part of this year.
So and with that although that does not have.
The Anixter program with how we're going to drive it enterprise life.
Influencing are impacting those results yet so to answer your question, we were going to be very focused on operating prop.
Profit growth an operating margin expansion.
But ah highly confident that gross margin expansion will be part of that recipe going forward.
Okay. Thanks, John Yeah, it's pretty remarkable in this environment to keep that moving higher.
Second uhm construction.
No. It's a smaller percentage of your business today, but it's it's just surprising to me that you're seeing growth with no one else in the world seems to be seen growth and maybe you can just give us. Some examples maybe it's mix. That's that's driving that could you give us. Some examples of yeah, Yeah particular, construction verticals, you're seeing growth and.
Yeah.
Well I think that first let me start to go to the aggregate level.
You know.
The backlog in her record backlog exiting the third quarter.
And we came through October the momentum is improving overall for the business and are both the bill stayed above a 1.0 and we exited October and entered in November so.
And when you look at our sequential improvement of Q2 to Q3.
That was what was most notable so construction.
Was up double digit sequentially. The sales were in both U S and Canada.
Two two to Q3.
That's that's above normal seasonality. That's that's not typical you know typically as we move through two three.
Q3, typically a strong quarter like you too.
<unk> the construction season, but typically we start.
Trailing off and as we go into the queue for in in the winter the winter season.
We felt pretty good momentum crushed or construction branches and focus businesses, Dave from a product category standpoint, we had growth and distribution equipment, we had growth and wire and cable as I was referencing earlier.
The other ancillary electrical we had growth of motor and controls we had growth.
Some nice sequential growth and lighting, some nice sequential growth and solar so.
Yeah, I don't I mean, I share a view that at the aggregate level.
Non razee construction still has challenged.
With that said at a very very very large market and.
Some vertical with our more challenged than others.
Both the oil and gas and having it's very low it's low single digit percent of the combined business now so I think a big part of this is.
Like all of you would understand is we'd mix shifted up to higher growth markets and construction still an important and market and value value chain for us we have exceptional capabilities, but it disproportionately a much smaller part of the company and with that said when you get underneath construction.
Our our current momentum vectors encouraging.
And so look all that we can all that we can do is focus all we can control we haven't seen any meaningful cancellations of projects.
Only.
Some projects that slipped out earlier in the year that we mentioned and but net net sequential sales growth backlog holding up nicely.
Good position to be particularly given the backdrop in the end markets and the environment.
Okay. Thanks, a lot you.
The next question comes from Christopher Glen of Oppenheimer. Please go ahead.
Yeah. Thanks, Good morning, Congrats on the first started especially to cash statement on getting deleverage underway.
Thanks, Chris.
Yep had a question on the arrange some investment you're contemplating for the.
It'll be to be value chain initiatives is that included in the 140 million.
Costs to execute and also how are you thinking about guardrails around.
Complexity potential disruption of I T transitions.
Yeah. So there's a couple of questions and then if you could go back to the integration updated page in the deck.
Which was page a blood test that that is.
See what we did with cost synergies and right under that we've also increased their one time operating costs, one time operating costs to deliver the higher synergy.
So just I didn't want to call that out on that pay just as important comment.
But but let me let me talk about talk about.
Digital and I T first I'll say that and I I know I mentioned this last time.
We have a dedicated.
I T a.
Last digital team.
Both comprised of Lesko anixter as part of our integration office.
Has has our best minds and talent across both companies.
In addition.
We have a separate.
Dedicated consulting partner beyond the overall partner not does not the overall integration partner behalf.
I'm doing a terrific job is a separate world-class consulting firm that's helping you specifically on this effort.
And I mentioned last time, we're looking at.
We're looking at all the current state systems, identifying how to best leverage digital applications and our combined big data to create competitive advantage.
Or credit for completing that assessment of systems and digital investments.
Recall that we had been very clear in our original financial models of you know that we're gonna have about 120 million per year and capital expenditures.
For the first three years post clothes.
And typically are based capital was running at a 90 million dollar easy to look at the two companies combine so we laid in an additional 85 to 90 million of incremental capital.
On top of the run rate capital that was in the original.
And one time close up just slightly tangible.
To implement we so that.
Any.
Okay.
Okay.
And Angel.
Are amateurs, that's really important to understand.
I will tell you as a as a kind of a natural proof point.
We have two very interesting digital use cases underway.
I'm not going to describe what they are in this earnings call. This is something will want to do if you get into 2021 and and with our Investor day, another investor presentation begin.
But developed much better exactly what we're doing vis-a-vis digital but.
In both cases, we got agile development underway, we're standing up these days, you'll use cases in our current environment and leveraging our big data, we had taken anixter data and <unk> data and we now have combined it and we're using using aversion of essentially a data late.
Leverage that data to support.
The two digital use cases, I am I am thrilled with our initial progress and I expect it will have some interesting results as we move through Q4 and in the early Q1. This is rapid agile development on these two cases and I and I expect to have some really interesting and compel.
<unk>.
Results coming out of that so I'd, probably gave me a.
A bit more than you were asking I think it's it's just really important to understand that and I'll put this in context in the near to mid term.
This is an integration execution story.
Going about market leveraging cross selling opportunity that brought her products and services purple portfolio, expanding margins, reducing costs delivering those synergies exceeding a synergy target generating exceptional cashflow paying down depth 11.
In the mid to long term this the digital transformation.
And we've already begun with with the specific initiatives and activities to start standing up. These digital use cases, absolutely thrilled that we've got that underway only a few months post clothes. So hopefully that gives you a little insight.
Yeah no. Thanks, that's great I was asking all of that and.
Hello up as you're driving cost synergies and managing sales synergy strategies I wonder if you've seen any pockets or issues around key retention or you know worked for sun, we with the integration environment or any kind of.
Followed around those types of issues.
No no we have we've had no issues.
I am absolutely kind of thrilled with a cultural combination as I said and you know the kind of the extra effort being applied the customer focus.
We've come together terrifically.
So no issues, there I will say that you'll recall in our initial.
Targets that we outlined we had assumed some.
Some you know revenue disc synergies that was in the basic construct we have not seen any revenue synergies today. So it's our goal not to have any [laughter], but.
I thought I'd just answer that because I think your question was probably workforce plus also any disruption were saying so far.
[noise] exceeding expectations and uhm in both in both regards.
Thanks for that junk.
The next question comes from Chris Tankard of Longbow Research. Please go ahead.
Hey morning, everyone in again, congrats on on a really great quarter here can't help but notice with the increase synergy targets only 10 million more coming from field operations is that more a function of hey, we just have so much opportunity elsewhere, let's focus on those areas.
Or just being conservative on on the field operations savings just any commentary on kind of a mix it would be great yeah.
Yeah, Chris Good morning, I. Appreciate the question one of the things that I'd highlight here and we said this earlier in the year is well that as we started to come together, particularly in year. One we anticipated that the majority of the synergies and the first year would be coming from the SG&A in corporate overheads.
And that we would be working on the supply chain in the field operations initiatives as we get more information more data and we think about how we transform the company going forward. So.
We're actively working the synergies in those areas, we have gotten some additional synergies in the supply chain area of just based on what we've been seeing and what we've been able to to work against particularly in the indirect procurement area, but again most of what we're seeing here in the first year is related more.
To that G&A in the corporate overheads.
Got it got it and then we touched on it earlier, but I guess, just trying to pull the threat a bit more on the gross margin improvement front that cross pollination of of best practices I guess, if there's a way to kind of size you know how much of that knowledge has been disseminated how long, it's gonna really take to try and get those those.
Practice out into the field just any commentary on on timetable there would be great.
We are or in the process of of of implementing that now and you're the first part of that effort.
Organic store a couple of quarters, just a few quarters silly start seeing results as I said on the legacy basis as their eighth consecutive quarter gross margin expansion and look we all know what the environments. Then I'll have to I'll give credit where credit's due at they're exceptional results given the market environment over the last two years no down.
About it.
That did not drive the improvement of gross margin legacy Wesco in two three I think again, we're seeing the benefit of some of the actions in an issue we have going on.
So I would expect that that will be a contributor going forward. It could start as early as two four incrementally, but clearly it'll be a 2021 driver no doubt.
Got it got it thanks, so much for the color in January Congrats again.
Yep. Thank you.
The last question they will come from Nigel co a Wolf research. Please go ahead.
Hi, Good morning. This is a Christian ramos filling in for Nigel.
A lot of ground and covered but I really wanted to touch on the on costs interviews here and giving your assignments for for continued cost synergies.
Two more question, but first did you may decide to talk about you know what the pipeline potential pipeline across synergy is I mean, I know you raise it at 250 million total 200, but really interested in hearing with the with the pipeline sounds like and then too I think you've spoken about sales synergies.
100 basis points and again, it sounds like you're pretty confident about how you could accelerate that you just also touch on that as well.
So we're not gonna size the pipeline cause what that question is is how much what we it's not so much a pipeline we actually have targets that are substantially higher than that.
That had been work to a great. The tail in terms of what the potential opportunities are to hit those targets they've been detailed out they've been scheduled and that's what we're actually that's what the teams are executing too internally.
And again, yes, we went from two to 250, but the targets we had previously set.
Are the same targets that are in place and they're substantially above.
How about the Tuesday, so there that's that's the 0.1 0.2.
One of the one of the.
The the biggest pleasant surprises.
I think cause we had very high confidence we deliver the cost.
We also had had pretty good confidence that we get some margin improvement core margin improvement again anixter eight quarters in a row now they have seven in a row, we didn't think that wood and we actually could good confidence we'd step up margins on the west coast side.
So what was the biggest positive surprise topline.
I mean, you look at the top like if you really analyze the top line and what we delivered versus market versus other.
You know kind of alcohol quote unquote competitive comparator.
It was it was really strong topline results and we've got some initial success stories on the cross selling so you know as I said in as Dave said I'll, just put an exclamation point on it you know.
Our top line sales growth synergies are margin expansion synergies are cost reduction or cost synergies and.
Our free cash flow stepped up free cash flow generation all four buckets.
Very very high confidence and that confidence increased as we went through the quarter that will over deliver the three or target.
Gosh, that's very that's very helpful. John It and if I could just follow up and perhaps ask about the cadence of them.
Man throughout the throughout the quarter cause it sounds like where it seems like my my math here suggests that back half of September was it was really strong and so any increment to call. It or you can also be really helpful.
Yeah, we had given we have given we had given a.
Data point, you know partially through the quarter I think you know and so we did have a strong clothes and that momentum can as continued in October as I said I gave you may have that but I think that we are we have a positive momentum vector right now period in terms of opportunity pipeline bookings book the bills above one in sales.
Right and we also had indicated when we were you know through the quarter that we had talked about being.
Down year over year about 8% and we did get the benefit of an extra work day, but as John mentioned, we also finished strong and I think a lot of that goes back to.
When we combined with anixter, both companies has been working on how to grow sure.
And we saw that you'd be getting to take place here as we brought the companies together in the third quarter, we had a strong clothes in September.
Great. Thanks, Thanks, I don't either.
[noise]. This concludes our question and answer session I would like to turn the conference back over to John angle for any closing remarks.
Well. Thank you all for your time this morning, Brian and will are available to take your questions. I know, we have a number of follow up session scheduled already.
And we look forward to being able to.
Some additional time with you at our upcoming Investor events.
That includes our the bird Industrial conference next week and the Stephens Investor Conference later this month.
Thanks again in the meantime, please stay safe and healthy have a great day.
The conference has now concluded. Thank you for attending today's presentation you may now disconnect.
[noise] [noise].
[noise].