Q2 2022 Wesco International Inc Earnings Call
President and Chief Financial Officer.
And now I'll turn it over to John .
Thank you Scott good morning, everyone, it's a pleasure to be with you today.
As you saw our earnings release earlier. This morning, the beat goes on in terms of the value creation of Western New business model as we passed the second anniversary of our transformational combination with anixter.
Our second quarter results were exceptional we once again set new company records for sales backlog margin and profitability.
Importantly, leverages now back within our target range and it's a full year earlier than what we guided the market to expect after we completed the anixter merger in June of 2020.
Our momentum continues to build as we outperformed the market and deliver superior value to our customers. The power of our newfound scale expanded portfolio and industry, leading positions is 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 gross margin improvement programs.
Overall, we delivered impressive organic sales growth of 21%.
Record profitability of eight plus percent adjusted EBITDA margin, which is the first for wesco Dow 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.
Before I hand, it off to gaming by plan to address our transformation our 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.
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 our new of the new lessor is best measured all 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 the pro forma firsthand pre pandemic results from 2019 as you can see clearly we've 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 the transformational combination of electrical and anixter and we're confident in the future of sustained growth and market outperformance.
Now moving to page six providing our global customers with end to end solution that is including the product 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 are exceptionally well positioned to capitalize on our 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 key months of sales synergy target again this quarter now 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 slowing our market outperformance and growth and as I've said before the new western is transforming into a growth company, we have a record backlog and spanning cross sell program, a growing opportunity pipeline and very positive momentum overall, but.
And this is an important but we are only in the early stages of unlocking our total growth potential.
With that I'll now turn the call over to Dave.
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 anixter products and services.
<unk> more than $200 million of sales in the quarter and we continued 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 EES and UBS businesses too.
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.
We estimate that the lack of availability of certain products from our suppliers reduced 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.
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.
<unk> pass through of supplier price increases and the absence of a COVID-19 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 eight 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 scale benefit of higher sales and realized cost synergies from our merger with Anixter 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 <unk> 39 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 nine 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 in an inflationary environment, we continued 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 recognized an incremental $8 million of expense associated with our long term incentive programs, which we also anticipate we 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 EES 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 nonresidential market.
We also continue to see increased momentum in our industrial and OEM businesses supported by broad end market demand.
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 are capturing demand driven by the secular growth trends that John discussed earlier.
Adjusted EBITDA was.
Ladies and gentlemen, please remain calm and the call will resume momentarily.
Okay.
Uh huh.
[music].
You may resume.
Hey, good morning, everyone. It's Dave Schulz, 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.
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 nine 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 <unk>.
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 and EPS 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 have 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, EES $112 million award to provide electrical cable switch gear and miscellaneous electrical equipment to support the construction of a 900000 square foot data center from our legacy anixter customer and end user relationship.
Our complete EES product offering and ability to provide an end to end solution drove this win.
In the second example, CSS leveraged our legacy Anixter product set and west coast TBC expertise to support a middle mile broadband build out initiatives.
And then the third example, UBS generated $10 million of initial sales to support our fiber network expansion project with our legacy anixter customer by leveraging the unified sales team and legacy West Coast comprehensive supply chain solutions.
Our customer momentum is building and clearly highlights the power of the combined portfolio.
Turning to slide 15.
On the left side of the slide you can see in the gray boxes that we realized cumulative run rate cost synergies of $188 million in 2021 60.
$63 million in Q1 to $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 350 $15 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 had 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.
And 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 on to three four times.
This represents a decrease of two three leverage turn since closing the acquisition in June 2020.
Three five times and returns.
Leverage.
To that range, a full 12 months faster.
Investors prior to the closing of the <unk>.
Anixter merger.
This accelerated pace of deleveraging reflects the strength of our <unk> distribution.
Operating model.
Moving to page 18, we are again updating our full year outlook based on this quarter's results.
This is a strong demand trends we are seeing the continued expansion of our backlog a significant growth of our cross sell synergies we.
We are increasing our full year outlook for sales growth to 18%.
Our assumption for market growth is 12% to 14%, including the benefit of price.
The demand environment for our products services and solutions to continue to be strong. However, we.
We recognize that supply chain constraints and the pace of inflation presents some uncertainties for the <unk>.
Due to the strength of our cross sell program, we are increasing our estimate for share gains in crop.
We had a 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 work day in 2021 that occurred in the first quarter, which we estimate will add one five points.
With regard to our business units.
We continue to expect that EES and UBS.
Those businesses will be at or above the upper end of our sales rate that should be below the lower end of the range due to their experiencing less of a benefit from price relative to EES.
Yes, and UBS as well as a larger impact to sales from supply chain disruption.
Okay.
Also recall that included in our outlook is a contract with a 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.
Fair range primarily reflects.
I think increased operating leverage.
The higher sales as well as continued benefit from our gross margin improvement program.
At the midpoint of this sales and EBITA margin range, our full year outlook.
$8 billion and represents a substantial increase versus the midpoint of our prior outlook range of $1 mid point of one three.
$3 billion.
We're 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 discreet 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 expectations 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.
The quality of our net working capital. It has not degraded 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.
This outlook reflects a handful of them.
And an above target payout.
We have also included the impact of the increase in transportation and logistics.
The fixed costs that we mentioned last quarter.
On cash flow, we still expect to spend approximately $120 million in combined capital expenditures and digital investments on our statement of cash flows approximately $45 million will flow through capital expenditures and approximately 75.
$10 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.
Call that in 2021, we realized approximately $2 million of the $418 million annual benefit activity. This year that is taken into account higher short term interest rates.
Our outlook assumes an average diluted 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 margins are steady.
Moving to slide 19, and before opening the call for what we've covered this morning.
This was an exceptional start to.
For the year, and we have strong momentum across our business.
We delivered very strong financial.
Financial results across the board, including record level sales operating profit adjusted EBITDA and adjusted EPS and the strongest quarter since the anixter transaction closed in June 2020.
For each segment of our business grew versus the prior year and sequentially in the quarter as well as compared to 2019 levels.
We delivered adjusted EBITA 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 dealer eight quarters after closing the acquisition of Anixter.
And lastly.
We're making excellent progress on our it and digital roadmap and are exceptionally well positioned.
Since the benefit from the secular growth trends and increasing public sector investments that John discussed earlier and with that let's open the call to your questions.
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 or.
Our first question today comes from it.
Deane dray of RBC capital markets.
Please proceed.
Hey, good morning, everyone can you hear me okay.
Interestingly in the morning, Hey, good morning, first broadband upgrade with the rural digital opportunity fund.
Okay.
I Love your sales lean event.
Yep.
Okay, and then secondly, a big welcome to Scott, Scott and I have a lot of history together I've seen them in action I'm confident.
It will be successful so congrats Scott.
Thanks, Dave.
Alright.
A slowing going on in.
Because the other financial markets are swearing attack at any of the metrics you are putting up.
Youre not seeing any sign of it.
Page six slide tells you all these long term drivers that you benefit in that it's not just a.
Our post COVID-19 burst of activity, but just.
A long ramp here.
US through at at the margin kind of real time, what's going on in terms of product availability project delays anything that youre seeing any of the daily stock and flow business any kind of real time color would be helpful. Thanks.
Yes.
This incident.
It's a great question Joan.
We are not seeing.
Any indication.
Any of that.
Array of leaning in.
Indicators and Kpis for us in terms of.
Slowdown occurring with.
With respect to the new western over the Wesco Anixter combination.
Look at our backlog you look at it right.
Our opportunity pipeline.
This comprised.
Large the large degree of cross sell synergies.
Look at our daily sales.
Our margin momentum you look at it sequentially versus normal seasonality.
We are just everything.
The one word I would use our user subscribed Q1 improvements is the strongest quarter.
Western ever delivered that in Q1, we delivered an encore in Q2.
If we fast forward to July .
Preliminary sales numbers as Dave outlined is still exceptionally strong.
Book to Bill ratio is about one point.
So again the latest set of data we are seeing although fashion I'll just reported this morning.
Daily sales in July versus June .
Yes, we are seeing again, just very strong.
Ill call it momentum and it's really the power of the combination and terminal.
Moving your supply chain question.
Stock and flow specifically.
I would say, we still will have.
Few areas its gotten incrementally better, but I would say in a minute here working with correct.
Categories that were more.
The challenge there as a result of supply chain.
After a bit encouraging.
With that said as Dave outlined in his commentary earlier.
We still saw a couple of points.
Consistent with Q2 a lot of.
Supply chain throttling, our topline through it would have been that much better.
And so that's that's kind of what I would signal.
<unk>.
The supply chain is healing blood analyzer.
Sure. This the last few quarters, we thought it would take a protracted period for.
That hearing to occur.
And demand is still outstripping supply from our perspective.
So.
Hopefully I addressed your question absolutely Thats, great really good to hear and then just as a follow up for Dave on free.
Free cash flow and look we are seeing this.
Yes everywhere across the industrials.
In order to fill.
There's big demand, you've got 80% of our more inventory, we get that and then higher sales higher payables. So two questions one is <unk>.
Anything in the payables that is unusual like past due or anything like I just wanted to get some assurances there and then secondly on the inventory Theres. Some misperception I just want to put this to rest.
That somehow west coast, a bit like target that you put inventory on the shelves will you hold customers comp Youre project base.
And the inventory that has been committed to by the customers for these projects.
Customers around the hoop for that Youre, not adding speculative inventory and just maybe just address that in terms of the certainty of that inventory that you're carrying.
Yeah. Thanks, Steve Let me address your second question. There on inventory you are absolutely right. So we have been taking in inventory.
Given the strong backlog, 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 net working capital, including the payables, we actually improved about half a day versus the prior year quarter.
Not seen any degradation in the quality of the payables, we run our consistent process yes.
Yes, 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 expected in the second half of the year.
We call that a high quality problem. Thank you.
Thanks, Dan.
Thank you. The next question comes from David Manthey of Baird.
Please proceed.
Got it thank you and good morning, everyone.
Good morning, Dave.
You noted, 8% inflation and there are some differences in how different companies measure.
The price benefit to revenues.
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, the CSS and seeing the least.
Is it right to think Youre seeing it mostly in the heavy gauge wire and steel conduit and less in finished goods.
Switch gear general supplies that sort of thing.
Yes, Okay, let me start with that 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 one of the suppliers passing on to us.
Then again take a look at that and how do we pass that through to ensure that we are 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 at our suppliers are seeing.
Out of just the commodities so very clearly on some of the more commodity base, that's going to move with the market at all.
All of our suppliers are also passing through now the increases that they're seeing on labor increases youre 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.
But for the most part we're seeing broad based.
Inflation.
The board is being passed through to us from the suppliers.
Sure.
Okay, Thanks, and just to be clear, Dave are you, saying that.
If you look at specific Skus this year versus last year is it just the same skus same SKU same product and then there's different methodologies people use of just trying to understand how to read that 8% number.
Yes, we're looking at it by product category, because we don't always tell the same SKU consistently from quarter to quarter year over year. So we're looking at the group of product categories within skew family in order to calculate that 8% number this quarter.
Great. Okay. Thank you very much.
Thank you.
Next question comes from Sam <unk>.
<unk> from Raymond James.
Please proceed.
Good morning, John Good morning, Dave can you hear me okay.
Yeah, Hi, good morning terrific good morning too.
Broad topics if I could.
The first would be about the new $1 billion repo authorization I don't recall.
Staying in your prepared remarks or at least certainly wasn't accentuated.
Your own equity is considerably more attractive than any perspective, M&A opportunities and then secondly.
Rightly or wrongly the market generally perceived three turns of debt leverage I guess, the point at which the stock becomes high beta.
Knowing this and knowing the broad concerns of an industrial slowdown are you you're really looking to do more substantial repo when you get under three turns or will your repo plans be more based on simply.
What are the absolute value of the equity.
Yes, Sam it's Dave So I appreciate the question and as you mentioned, we did 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 are at three four turns for our borrowings against our facilities to support that networking capital and our 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 would expect our leverage to be closer to the middle of that.
Two to three five turn range. 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 will continue to evaluate those opportunities.
And what we believe will drive most value for our shareholders.
My second question topic.
Kind of a piggyback of what being with <unk>.
Working your inventories lower you may not have inventory risk.
Hey, Budd.
Yes.
At drawdown theres 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.
No longer seeing announced price increases from your suppliers going forward.
Sam.
We have been through numerous cycles.
<unk> got a very seasoned management team and when you look at the operating leaders of the three businesses sales in day would have been through numerous cycles.
I think we know how to manage this company through all phases of the cycle or conceptually.
Exceptionally high confidence in the cash generation characteristics of our model.
Through all phases of the cycle and just touch on that earlier point Hey.
We looked at all of our working capital growth.
For the first half.
We are all sitting in accounts receivable.
We're confident we'll collect from customers relative to margins, we have an enterprise wide.
Gross margin improvement program that's underway.
As we noted several years, leading up to the merger close anixter closed it consistently across.
<unk>.
Allowing the 10 quarters gross margin expansion against the backdrop that was very challenging and trying to get a margin. When you look at the other publicly traded distributors. They were at the aerospace margin compression.
And that will continue and we took that enterprise wide growth larger program is a top priority in the first six months post merger close.
I wanted to make some refinements, we looked across wesco relation of additional assignments and we now have in executing that enterprise wide and logic thats been in place.
And for the better part of 2021, and so far here in 2022 and take a look at our gross margins. We're building very strong momentum on the gross margins.
And so.
We've got confidence that there's a lot there's a long runway left in terms of gross margin expansion in all we don't guide to that anymore.
But we clearly see.
Strong combinatorial contributions of gross margin expansion.
Operating cost leverage both of those.
It's Don.
And laser focused on driving both of those to drive further operating margin expansion.
And the recipe is working.
Let's take a look again at this quarter the gross margin improved sequentially to a new all time record level and thats with some commodity prices starting to rollover significantly in the quarter. So I think again.
Some are of our gross margin improved enterprise wide improvement program is really focused on value creation.
We're selling the value of oxide selling the value creation that we're delivering.
Through our customers operations and our supply chain.
I could not be more pleased with them.
With the exceptional job of our sales and account management teams are doing in terms of selling that value to the customers.
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 our strongest for our highest performing supplier even more.
I've said before.
Supply chain now is a strategic issue at the top of the C suite.
And at a broader level in terms of the priority and added supply chain integrity supply chain resilience and we provide a high degree of supply chain integrity resilience, that's core to our value prop in terms of what we deliver to customers. So look I know this is the question.
Everyone has an extensive things starting to slowdown, but we are high and the short answer is we're highly confident that we've got tremendous runway left in terms of our margin expansion.
So to paraphrase gross margins in the back half contingent continue on its favorable trajectory despite.
Yes.
Inventory drawdowns.
We're not seeing any answer yet our margin as Dave mentioned net of our margins in July the <unk>.
Not very.
Consistent with that would run through second quarter, so well.
As I mentioned earlier, Kevin Yost, specifically we.
We made some changes as part of the gross margin improvement, it's enterprise wide in terms of proppant system for our sales force so does the.
The addition of all of it or paying for performance. There I think is bearing significant fruit.
Thereby optically focused on selling the value and benefiting from that.
Continuing to drive the margin expansion.
Terrific to hear in a terrific performance in the quarter. Thanks, so much and onward and upward.
Thank you Jim.
Thank you. The next question comes from Nigel Coe of Wolfe Research.
Please proceed.
Good morning, everyone.
Yeah.
So yes. It just had a question just on <unk>.
Is that a company accrue.
So make sure I understand how this works so obviously you've talked up the full year payout. So you have a.
Catch up for <unk>, and <unk>, and then third quarter fourth quarter with them better run rate.
<unk> would be a catch up for <unk> is that right.
Nigel in 2022, we true 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.
Okay, and then can you help us.
When does that in dollar terms now running so the full year compared to where we were back in January .
So 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 on that.
Tailwind has essentially gone away I mean, we are performing much better and therefore, we are accruing appropriately for that short term incentive compensation the $1 year over year are not materially different than what we experienced in 2021.
Okay. So it is seen in the phase III is more back on targets.
The 30 basis point tailwind into 2023.
And that's my real question is if you go into FY 'twenty three.
<unk> volumes are positive and 23 vessels at a big ask but based on the backlog doesn't seem unreasonable.
Is there a scenario where margins could be down in and train three and I'm thinking here about maybe some price cost headwinds.
I don't know what else but.
Is that a is that a scenario that's even on the table.
Well I would tell you Nigel is similar to what John said before I mean, we've been through these cycles in the past we know how to operate theres 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 topline growth to offset that and hold the margin.
Clearly in a volatile economic environment of one was to take place.
We'd have to pull the appropriate levers in order to protect our margins going forward. We've done it before we're focused on making sure that we continue to drive value long term for the shareholder but again, we think that we've got a good setup for 2023 as you mentioned the incentive compensation will be adjusted back to target as we think about our plan.
For next year.
It was $1 1 billion.
I would say really the setup for.
Quantifying for is excellent as we sit here in the early part of the second half or Jason functionally running with our full year guidance for the second time for 2022.
We have very strong momentum.
We've raised the sale of synergy targets substantially again at.
At $1 2 billion, our sales synergies in the second quarter.
$200 million exceeding our original target set pre merger close. This is the breakout growth opportunity I think that is really showing itself as we establish a track record of success over the last eight quarters, our backlog continue with us any normal seasonality.
New all time record level sequentially, which is a great set up not just for 2020 can put in particular for 2023, our opportunity pipeline as evidenced by raising across South Park and it's the largest we've ever seen continues to grow over time, we think we're outperforming the market significantly we're the market leader undisputed Mark.
And leader in our core markets.
To the extent depth.
The cycle gets a bit more challenging customers will want to double down even more with their strongly supplier partners.
Supply chain integrity, and resilience demand is still outstripping supply.
A really important point and love.
Inflation continues I think inflation continues at a meaningful level through 2023, because of the sources of inflation and demand outstripping supply first and foremost secondly, everyone's missing that labor is a constraint it's not just the materials and the supply and the supply chain It's lane.
Well I think.
You have public infrastructure spending plan that will Stoke demand, even further and we've seen none of that in our numbers yet again.
I did want to touch upon is really important take a look at where we are in our full year guide.
Our full year guide for 2022 now.
As above.
Current analyst consensus for 2023.
On the topline.
First 0.2nd point, we expect to grow in 2023.
That's the answer.
Okay, that's great John Thanks, a lot for the detail.
<unk>.
Thank you. The next question comes from Tommy Moll Stephens, Inc.
Please proceed.
Good morning, and thanks for taking my questions.
Good morning.
John I wanted to start on the big data theme.
You've given some transparency and of the digital and invest.
Investment.
Recently.
So I'm curious what inning, we're in for that investment cycle, and then on the flip side when you start to monetize and unlock some of the revenue and margin benefits from these investments.
Have you even started to see some of those benefits yet or when do you anticipate that those would show up in a meaningful way, where we will see it in the P&L.
Yes, Thanks for that question and still outstanding we are.
In the.
Are you a baseball analogy the 8 million of it we're in the very very early innings.
The balances I'll start with the benefits we've highlighted a few areas we're already applying digital for our business.
In terms of digital products, new products and applications over the last couple of quarters I will tell you that we plan on.
Kind of.
The Warner expressive with respect to our total digital transformation at our upcoming Investor day in early September we're very excited about that that will be our first investor day.
So back to digital.
And we also said we're in the midst of the digital transformation that we embarked upon in this quite frankly, the catalyst and the ability to put these two large companies together gave us the opportunity to invest in a digital transformation like neither individually neither company could individually.
That was a long time.
As 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 period.
The investments are laid out phase spotlighted, a gap in his commentary what was what were investing in China.
Capital spending in a different in different areas of the P&L statement.
Any of our centers, even if the top line results allows us to flow into investments.
I'm incredibly bullish on.
Not long term mid to long term growth prospect and the transformative nature of what.
What we're doing in digital what it will do for us and our ability to serve customers more efficiently more effectively unlock other avenues of growth and other areas of monetization.
That forms the basis of a new business model is increasingly tap our big data Super excited about it here's the great news is not in our results yet.
The investments are in our results.
Any results in terms of meaningful sales growth and margin expansion are not in our results yet and improve.
A dramatic acceleration of working capital that's not in our results yet so stay tuned plenty of that Investor day joined us and Youll get a much better sense of.
Our five year digital transformation journey.
As strong as the story has been thus far.
I think I think it's been exceptional linked quarter. Since we came together worthy one to two years of the three year integration period, a client as a result of exceptional.
With a series of increases along the way.
Digital transformation story.
Whole hire another order of magnitude.
We'll launch futures that are.
Exceptionally exciting.
Thank you I appreciate that.
Follow up I, just wanted to ask on on CSS organic.
Sales trended quite.
The trend was quite strong in the quarter, although it was.
Well below the other two segments you called out supply chain is one headwind there.
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.
Let's look at the number the another great question, let's look at business over a really let's say the last four to six quarters.
Versus the other three businesses.
Outstanding secular growth trend, leading value proposition global footprint.
Truly outstanding business as a franchise.
Terrific.
It has been supply chain constraints it has been supply chain constraint.
No.
My comments in Daves comments have been very positive and bullish on the on the mid Atlantic for the long term prospects of that business, that's unchanged I'm as bullish as ever.
In terms of.
Applications that we have access to our total solution offering.
Typically with respect to the momentum vector I couldnt be more pleased with how QSS picked up everything is relative and life of business I would ask you to look at this sequentially.
See momentum building in CSS the backlog growth is exceptional.
At a higher rate than EES, not quite the UBS backlog growth rate, but it is exceptional and now the sales and margin is beginning to accelerate.
As the supply chain continues to heal.
That is the story here and.
Again, it's an it is an accelerating factor that we're on with CSS and I'm very pleased with with the pick up again, now dilemma and 12% growth in the quarter.
Thanks, I appreciate it and we will turn it back.
Okay.
Thank you and the final question of today's Q&A session.
Will come from the line of Ken Newman of Keybanc.
Please proceed.
Hey, good morning, everybody. Thanks for squeezing me in.
Good morning, John .
Good morning, gentlemen, and thank you touched on it briefly in a prior question.
The increase in the cross sell and share gain synergy capture for 2022.
Have a sense of just how much of those benefits have already been realized within the current guidance I'm just trying to get a sense of how conservative that portion of the sales guide increase is.
Where do you see the momentum for those synergies coming up even further.
I'll, let Dave handle that so.
So when we think about are the bridge in our sales outlook from our previous quarter call.
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 five and.
I think that as we look at Q2, we're confident that we increased share.
We believe that we are taking share, but really the benefit of the cross sell we're now expecting that to be come off 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.
Understood.
And just for my follow up here, you talked about the balance between share repurchases and working capital needs and keeping the balance sheet and 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 common shares understanding that there are some caveats on how much you can repurchase from that.
Referred bucket.
Yes.
Very clearly there are some constraints on repurchasing the preferred and we will come back down to best value and if we take a look at where the preferred is trading and the premium that would be required to to buyback. Those shares there are some make whole provisions on that.
We take a look at that just from a pure economic 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.
I think what's important to understand that I know, we foreshadowed this earlier in the year.
I want to foreshadow oil again.
We think we have a new company, we've created clearly fundamentally different characteristics as mix shifted to higher growth markets the execution.
It's showing up in the execution and the results thus far.
And we think we fundamentally shifted shifted this company.
So a different value creation trajectory looks like and in their car company as a robot in their history in terms of cash utilization cash generation capability.
Over the mid to long term and cash utilization priorities at <unk>.
<unk> non outlined with a longer term view.
Since we put these two great companies together and that is something we are going to absolutely addressed at our upcoming Investor day, we foreshadowed that earlier.
And we will do that and I think it's important getting the authorization in place for the share repurchase with final because we did not have an approved authorization in place and we got to put that in place ahead of being back within our target range and we did that purposely.
We will always need to make sure we have an ongoing share repurchase authorization in place.
The bottom line.
Cash generation of this new western is exceptional I'm not going to address this earnings call.
Take a look at western.
When we outline that for you at Investor day, the Optionality.
In terms of the value creation levers of that going forward.
Anything either company had in the past.
And that represents a clinical breakout off the table for us, which we'll share with you.
Looking forward to it thank you.
Okay with that.
We did go a little bit longer avnet, our rapid and because we had again a technical difficulty.
Lost connection here for a few minutes.
That's why we were in a few minutes server.
I'll bring the call to a close thank you for your support very much appreciated as I. Just mentioned, we look forward to figure as many of you in the coming days months at our upcoming Investor Day that David has been SaaS September seven in New York City.
And as I mentioned earlier this will be our first investor day since closing the anixter.
Merger.
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.
Currently we are going to be participating in the Raymond James diversified Industrials conference in August and both the RBC Global Industrials at Morgan Stanley conferences in September so with that.
Let me call scheduled this afternoon and tomorrow.
<unk> have a great day and thanks again.
That concludes the conference call. Thank you for your participation you may now disconnect your lines.