Q2 2019 Earnings Call
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Thank you Chuck good morning, ladies and gentlemen, thank you for joining us.
Joining me on today's call are John Engel, Chairman, President and CEO , Dave Schulz, Senior Vice President and Chief Financial Officer.
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Thank you will good morning, everyone and thank you for joining us for today's call.
I'll lead off with a few high level remarks, and then Dave will take you through our second quarter results and our 2019 outlook before we open the call for questions.
We achieved record sales in the second quarter and all of our end markets grew on both a year over year and sequential basis. However sales growth came in below our outlook range.
Continued strengthening in Canada utility and Datacom were partially offset by slower than anticipated overall growth in the U.S.
After a slow start in April and May in the United States, our sales growth strengthened in June but was impacted by slowing momentum and increased uncertainty in our end markets.
Operating margin expanded 30 basis points versus prior year on strong operating profit pull through driving our operating profit to its highest level in the past 15 quarters.
Net income grew 10% at healthy double digit rate and he P.S. grew 19%.
Versus prior year.
We also repurchased $150 million of our common stock, which was above our share repurchase forecast for the second quarter.
Finally.
That you saw in our release earlier. This morning, we have revised our full year outlook for sales growth operating margin effect of tax rate, Andy P.S. to reflect our first half results and our expectation for lower market growth rates in our end markets in the second half.
With that I will now turn the call over to Dave to provide further details on our second quarter results as well as our third quarter and full year financial outlook Dave.
Thank you John and good morning, everyone.
I'll start with an overview beginning on page four.
As John mentioned reported sales in the quarter were up 2.2%.
Your outlook range of 3% to 6%.
On an organic basis sales were up 1.9% with 6% growth in Canada, 2% growth in the U.S. and a decrease of 8% in our international markets.
During our Investor day on June 30.
We indicated that sales were trending to the low end of our outlook range.
Relative to our expectation at that time, we missed by about half a day in the back half of June .
Pricing provided a favorable impact of approximately 2%.
Sales were strong in Canada. We're all end markets were up mid to high single digits in local currency with the exception of utility which was down due to the contract non renewal that we discussed previously.
Outside of Canada, our utility business grew exceptionally well be consolidated sales were up more than 22%.
On a two year stack basis.
Beginning in 2019, we made some changes to our go to market team for Datacom.
Datacom sales were up mid single digits in the second quarter.
Following a similar performance in the first quarter.
The lower overall sales growth relative to our expectations.
It was primarily due to pockets of weakness that we're seeing in the U.S. with some industrial and OEM customers.
As well as with industrial oriented contractors.
Gross margin was 19% in the quarter flat with the prior year and down 50 basis points sequentially.
Relative to the prior year gross margin this quarter was negatively impacted by mix, which reduced gross margin by approximately 20 basis points.
We had significant growth in our utility end market, which as we discussed at our Investor day.
As the lower than line average gross margin rate.
Additionally, some of our businesses with short cycle exposure and high gross margins declined versus the prior year.
This impact was offset by the gross margins benefited from the SLS acquisition that closed in March.
Sequentially gross margin was down 50 basis points.
Approximately half of the decrease was driven by mix as we had significant sequential growth in both our utility and construction end markets.
The balance of the decline was driven primarily by the high number of supplier price increases.
We are confident we are passing supplier price increases through to our customers water, but are experiencing the normal lag between when we receive price increases from suppliers and when we see the impact on our gross margin rate.
SDMA expenses were 1% higher than the prior year on a consolidated basis.
The increase in expense was primarily driven by the SLS acquisition, partially offset by the absence of a two and a half million dollar bad debt charge incurred in the prior year period, and lower variable compensation expenses.
Operating profit in the first quarter was $97.9 million or 4.6% of sales within our outlook range for the quarter.
Moving to the diluted EPS walk on page five.
We reported diluted earnings per share of $1.45 up 19% from the prior year.
This reflected 13 cents from core operations and 11 cents from a lower share count following our repurchase activity in 2018 and 29.
Foreign exchange rates reduced EPS by two cents and the SLS acquisition contributed one cents EPS in the quarter.
There was no impact from taxes, the effective rate was approximately equal to the prior year.
We've also provided you the reconciliation of organic and reported sales growth.
Foreign exchange was about a one percentage point drag to reported sales, but more than offset by the benefit of the SLS acquisition.
Moving to our end market results beginning on page six.
Industrial sales were up 1% overall and up 2% and 6% in us and Canada, respectively.
Industrial sales were up 2% sequentially from the first quarter.
Overall momentum with industrial customers improved over Q1 levels.
It was not as strong as we expected.
Among our global account market verticals petrochemical metals and mining and food processing were all up from prior year levels and sequentially.
The areas, where we experienced weakness were technology, and OEM, which were down versus the prior year.
We continue to expect growth in the industrial end market in 2019.
In our supported by strong production levels and capacity utilization rates in the USA and Canada.
We see continued opportunities to benefit from our customers deploying capital to drive productivity improvements.
During the quarter, we were awarded a new three year contract with a medical device manufacturer to provide an integrated supply solution for MRO and OEM materials in the U.S. and Mexican operations with estimated total revenue of $30 million.
Turning to page seven sales in the construction end market were up 3% in the quarter, reflecting sales that were down 1% in the us and up 9% in Canada in local currency.
Sales were up 9% sequentially from the first quarter.
In line with typical seasonality.
On a two year stack basis construction sales were up 11%, reflecting incremental growth on top of 8% growth in the prior year quarter.
Project activity levels remain robust and many of our customers remain bullish on your outlook for the balance of the year, but we are seeing some project delays with industrial contractors due to budget constraints and uncertainty partially caused by tariff driven price increases.
Sales to commercial commercial construction contractors were up mid single digits in the us, but were offset by declines with industrial oriented contractors.
We expect moderate growth for the balance of 2019.
The skilled labor shortages that our customers are facing represent opportunities for Wesco project management and construction services that help our customers meet these challenges.
Reducing supply chain complexity, and increasing construction job site productivity.
Backlog in constant currency was down versus prior year and sequentially, reflecting normal seasonality.
We ended the quarter with the second highest Q2 backlog in our history.
As an example of our recent success. This quarter, we were awarded a multi million dollar contract to provide electrical equipment in lighting for the construction of a new healthcare manufacturing facility in Canada.
Moving to page eight our utility sales continued to be exceptionally strong.
On a global basis sales were up 3% for the quarter after delivering 19% growth in the prior year.
This result was despite a 28% decrease in our Canadian business due to the non renewal of a contract at an unacceptable margin that we've discussed previously.
We expect one more negative comparison in our Canadian utility sales to occur next quarter, after which there will be no longer any impact from the absence of this contract.
We also expect to begin servicing the new utility lines customer highlighted on our last call late in the third quarter.
Wesco is benefiting from secular trends in the utility sector, including construction market growth.
Increased industrial output grid, hardening and reliability projects and higher demand for renewable energy.
In addition to these trends we continue to expand our scope of services with investor owned utility public power and utility contractor customers.
After seven years of growth in utility, we expect the balance of 2019 to remain strong.
Bidding activity levels are high and we have a robust opportunity pipeline.
This quarter, we renewed our contract with the US investor owned utility to provide electrical and MRO materials fourth generation transmission and distribution operations for three years with estimated total revenues of more than $400 million.
Finally, turning to commercial institutional and government or C.G. on page nine.
Sales were up 1% with us up 1% and Canada up 10% in local currency.
Sequentially sales improved 14% led by 19% growth in us driven by a bounce back of government spending following the federal government shutdown that ended in late January as well as certain small and medium project wins.
Sales to Datacom and security customers were up high single digits.
On a two year stack basis.
Sales were up 11% in the quarter, marking the fifth consecutive quarter in which sales increased by double digits on a two year basis.
This performance was again driven by our strong capabilities and value added services in led lighting renovation retrofit applications fiber to the X deployments broadband build up in Canada and network and security solutions.
As an example of the continued strength we are seeing anti gene. This quarter. We were awarded a multi million dollar order for data communications material and supported a new data center for a large us public University.
Turning to page 10.
Operating cash was an outflow of approximately $38 million in the quarter, which caused year to date free cash flow to be negative.
This cash usage was primarily attributable to an increase in working capital driven by an increase in accounts receivable from sales volume in June and slow payment by certain large public companies at the end of the quarter.
The net use of cash is expected to unwind itself in the coming quarter and we continue to expect free cash flow of approximately 90% of net income for the full year.
We have already seen a bounce back in our cash collections in July .
Debt leverage net of cash was 3.2 times trailing 12 months EBITDA.
Up from the prior quarter, driven by borrowing to support our share repurchase program.
Leverage is within our target range of two to 3.5 times trailing 12 month EBITDA.
As a result of adopting the new lease accounting standard at the beginning of the year our balance sheet at the end of the period includes operating lease assets and liabilities of approximately $230 million.
The adoption of the lease accounting standard did not have a material impact on the income statement or the statement of cash flows.
We maintain strong liquidity defined as available cash plus committed borrowing capacity of $587 million at the end of the quarter.
Our weighted average borrowing rate was 4.5% for the quarter.
Fixed rate debt is approximately 59% of total debt consistent with historical averages.
Capital expenditures were $11 million in the quarter in line with the first quarter, reflecting investments to digitize, our business, including information technology tools digital applications and facilities.
As we mentioned at our Investor Day, we entered into an accelerated share repurchase transaction in may for $150 million.
When this program settle later this year, we will have completed $275 million of the $400 million share buyback authorization that expires at the end of 2020.
Wesco has a history of generating strong free cash flow throughout the entire business cycle and we expect this to continue.
Our capital allocation priorities remain consistent.
The first priority is to invest in organic growth initiatives and accretive acquisitions, including large core electrical distributors that consolidate the market or transactions that provide a new strategic capability.
Second we seek to maintain a targeted financial leverage ratio of between two to 3.5 times EBITDA.
Third we return cash to shareholders through share repurchase under our three year $400 million share buyback authorization.
As we said at our Investor day, we expect to initiate a dividend at some point over the next several years and we will analyze that option as we complete the current repurchase authorization.
Now, let's turn to our outlook for the third quarter and full year on slide 11.
For the third quarter, we are projecting sales growth to be in the range of 3% to 5%.
And operating margin to be 4.3% to 4.7%.
We are expecting an effective tax rate of approximately 22% in the third quarter in line with the expectations for the full year.
Preliminary July sales are up mid single digits. The continuation of the strong sales momentum that we experienced in June .
For the full year, we are lowering the midpoint of our outlook to reflect the impact of weakness in certain markets in the first half as well as economic data that now point the slower end market growth in the second half of the year.
We expect our industrial construction and key end markets to be up low single digits for the full year.
And our utility end market to be up low to mid single digits.
We expect to use to be up low single digits in sales in Canada to be up low to mid single digits for the year.
Operating margin of 4.2% to 4.5%.
And effective tax rate of 21% to 23%.
And diluted EPS of $5 to $5.60.
At the midpoint the outlook for operating profit would represent the highest operating profit in four years and the highest earnings per share in Wesco history.
We still expect to generate free cash flow of approximately 90% of net income as the increase in accounts receivable that impacted the first half will be converted to cash in the next two quarters.
With that let's open the call to your questions.
We will now begin the question and answer session to actually a question you May Press Star then one on your Touchtone phone.
The first question comes from Deane Dray with RBC capital markets. Please go ahead.
Thank you good morning, everyone.
Good morning, James.
Air pockets it seems on.
Industrial short cycle slowing as well as some project push outs and delays so.
John you always give really good end market color and the pulse of what the customers are doing and thinking so take us through those two primary headwinds and with July having an uptick.
How much do you think that that improves in the third quarter and if you could take us through that I would appreciate it.
Yes, Thanks Deane.
Yeah the.
The slowing momentum and you used the term short cycle, but also kind of daily activity the MRO.
We're seeing that in terms of directional pressure and I'm using those words purposely.
And then the project.
For industrial.
And marketing customer applications, we're seeing.
Some selected push outs as well as a re locked in.
To kind of initiate or move those along.
Versus what we had originally expected it kind of going through Q2 and at the midpoint of this year. So I would say overall given.
Our exposure our mix our customer base, we're seeing a slowing momentum vector in terms of end market customer activity levels. It is all tied around the slowing global economic growth uncertainty around the trade situation, primarily and that giving pause to the CFO is in our company in terms of.
Capital spending we had expected that would step up as we move through this year. So I would I would say that's the primary difference.
When you look at our results in Q2.
We did improve in industrial so we did grow sequentially.
Remember the us didn't grow in the first quarter, neither to Canada and in the second quarter. The U.S. grew 2% I mean, not a strong number but its still growth in Canada grew 6% international was down double digits after being down very low single digits in Q1 and that international industrial decline is specifically around capital projects in oil and gas.
So ill just spend a moment on that oil and gas for us.
In the in the first half it was roughly flattish in Q1 and it was down a percentage point in Q2.
And oil and gas, we're getting we're seeing low growth, but it is growth in Canada and us and the declines are in international.
And again around this project activity so.
I.
Clearly the markets have some slowing momentum and.
Theres, a pause and in terms of capital spending and such.
Our momentum vector against that backdrop actually im encouraged that we began to step it up in Q2 versus Q1, and then the momentum vector inside the quarter.
You know showed a nice step up in June it did come to come in a little bit below where we thought but we're not as Dave mentioned, we're talking about a half a day of sales from the low end. So in July to your pointing isn't that we haven't.
We got to Flash report, we haven't closed July fully yet so it's in the mid single digit growth range, though and that's encouraging because it's not like there isn't a lot of pull pull forward.
Right from July into June .
You know the guide that we've given for the balance of the year does reflect.
And Dave shared this kind of a more historical seasonality first half second half, we got 49% of our sales roughly in the first half 51 in the second half.
So what does that imply that implies that you know we continue our relatively positive sequential performance versus the market, that's a little bit tougher.
I think the wildcard is going to be you know how does the market shape up as we move in particularly industrial as we move through Q3.
And and into Q4 and.
I will just say this I think business spending could be a real stabilizing factor if the trade uncertainty.
Yes get gets better resolve begins to get resolved and that's really the way we're looking at and that's what we're hearing from our customers. So to the extent that happens the capital starts getting spent again.
Production levels in the industrial manufacturing space is still relatively high capital utilization healthy, but it really is around the confidence in spending the capital.
That does that help it really does and just.
Follow up on the guidance and so we have an implied for Q guide here as well.
And if we take third quarter mid point, and see where that puts us in for Q. It really does look like the implied guidance is well above consensus or you are you baking in this you know the trade resolution rebounder just yet.
It does look like.
And in flex.
Stronger and for Q, so what's seasonal and are there any.
Macro assumptions there.
Yes, great Great question.
I think what I think what the way we look at it.
First I will go back to kind of first half second half we look more we look more in line with.
With the kind of typical seasonality with the 40 951. The other thing that is definitely different in three versus four is our year over year comparable.
So as we mentioned earlier, our first have comparable we're very really challenging because we delivered double digit growth in Q1, and Q2 really through the whole first half last year and then when you get the Q3. Those comparables are are stronger than Q4, So I would say that that's the way to think about it.
We've given we've given the guide I would say that July start is the is a supportive and encouraging.
Start to and does support the guide.
The implied for Q guide has a wider range kind of by definition.
So what we're trying to do Dean as we move through Q3 is build off the momentum relative to market that we think that we built in Q2.
And continue to sell the value proposition and kind of outtake kind of outperformed the market and again it again I'm going to come back to that because this is I think is the key issue.
And to the extent that the conditions in the global economy, and the trade uncertainties resolve that that would represent a nice positive catalyst.
Yes, thanks team.
The next question comes from David Manthey with Baird. Please go ahead.
Good morning.
John you just went through a lot of this stuff.
At two after reporting what looks like a really strong June .
And now you're sort of guiding the third quarter and the full year lower on the uncertainty and slowing momentum, but your growth just went from 1% to mid single digit I can you can you help me.
Justify those things.
Yes, I mean, I again, I think it's the same commentary that I just just shared with.
With Dean in respect to overall first half second half.
The only thing I'll add to that because that was really focusing on industrial I'll make I didn't talk about the other end markets explicitly. So let me hit them quickly and then Dave you may want to tag on to that if we look at.
Utility.
Also our comparable there again.
Measurably easier as we go through the second half.
Due to the.
The non renewal that we walked away from in Canada previously disclosed so overall utility get easier comps and then we'd be again as Dave mentioned in his prepared remarks, we begin to see the contribution of those of the of the previously announced utility wins. So we think we have really strong momentum Dave in utility versus underlying end markets. All three portions of utility grew in the quarter.
I O U.S.
It is a big piece of our sales direct to them that was up that was actually up really strongly public power also grew and utility contractors. So.
And that's all.
More double clicking into the U.S. so.
You asked was really we think really strong number at the plus six the Canada down over 20% is really due to that nonrenewal, so but that comparable gets measurably easier as we go through.
Through the second half.
Before if you go into C.G. and this is this is really important and I don't think we made this point in our Q1 results. So which is why we wanted to amplified a bit here.
We made some changes in how we kind of manage the front end of our Datacom business. We did that the latter part of last year, we weren't pleased with the execution that we are getting.
And we've got terrific supplier support I feel really good about our Datacom and security in the first half were up very high single digits close to a double digit rate really nice results from that.
And in Canada, the strength of Canada in General we think is.
The Canadian economy the.
Incrementally a bit stronger, but I think our own performance against it continues to be a positive a real bright spot really proud of our Canadian team. Their execution. Then the final then the final.
And we got our second highest backlog ever.
At the end of Q2.
And when you when you double click into construction really good results in Canada. Obviously, so I think we are really performing well above market there, but when you look if you look at the U.S.
As Dave mentioned again in his prepared remarks.
The commercial construction piece of construction the sales the contractor for commercial projects with mid single digit growth.
And it really is the industrial projects I think that they were down and offset effectively slightly more than offset the growth. We're seeing the KMR for commercial projects in construction. So if you kind of add that all up by.
If the comments I made in response to Dean's question, plus I wanted to take you through the on the other end markets and in Canada. Overall, hopefully that's helpful. Dave you may want to add on exactly on Investor Day commentary and then relative to how we closed out sure. So so clearly what we said during Investor day was we were trending towards the lower end of our range that was after on an organic basis, putting up a plus one in may against a difficult base period comparison as we mentioned in the prepared remarks relative to what we thought which was based on the 11th of June at the time of the data that we had we mis spine sales might not have today.
We put together what we believe is the appropriate outlook by quarter. Obviously, you can imply with the fourth quarter. It looks like based on the full year, but one of the keys for US is last year on a reported sales basis, we're comparing against a plus two in the first half of 2018, we did a plus 11. So the comparisons are getting easier. We've included that in how we think about our front half back half split and from a 40 951 split front half back half revenue that includes the SLS acquisition in the back half will have the full benefit in all six months. So again, we feel that this is the right outlook given the macroeconomic indicators and then some of the things that we can see internally relative to backlog in contracts that we expect to continue and contracts that we have that will start generating revenue in the back half of the year.
Okay. Thanks for that and just as a follow up on the.
Maybe there's some commentary in there that relates to gross margin I think.
Answers the questions that.
Utility is growing well and industrial is seeing some slowing.
Is that part of what's going on here too is that maybe there's a little bit more downward pressure on gross margin than you previously expected.
So I Wouldnt, Dave you may want to add to that too I would say the mix piece as you just outlined which again Dave shared in his prepared comments, it's clearly a factor I think the other factor let me expand on was in.
And Hey, Mike spoke to this at our Investor Day, our recent Investor day.
The first half we've seen a record number of price increases over prior year and you'll recall as we close out 18, we shared at those increases in 18 were more than the previous several years combined.
So now 19 first half is above 18, which was.
Kind of at a very much elevated level. The other thing we're hearing from our suppliers and those announcements.
That have occurred throughout the first half the particularly in Q2.
His tariffs are being mentioned as the as kind of the driver or the cause of the trigger.
And approximately two thirds of the announcements that went into effect in Q2, that's across the whole supply base. So.
And so and the magnitude of these price increases are in the double digit range. We're seeing 15 18 than the light for some schemes for some of our suppliers categories. So we're we're actually kind of caught in that same time lag that that we do experience I think maybe disproportionately at a higher level than others because of our.
What percent of our business is global accounts integrated supply utility alliances. So we can't there's always a time lag when we get the price increase obviously any price increase we try to put a bump on it.
If we only pass it through on a strict percentage basis, we'd have contracting margins. So.
Yes, so we try to put the bump on it but it takes time to work it through as opposed to just normal spot business that we're quoting today that can be worked through instantaneously virtually instantaneously, we change the pricing system thats exposed to the branches real time every day. So that's part of the factor as well so the way I look at it we were pleased with the 19 five in Q1.
I I thought we'd have some pressure sequentially. We don't guide to gross margin as you know now we got to the EBIT margin in Q1 to Q2 sequentially. The fact that it's still flattish versus prior year, given the supplier price increase impact and the lag.
Actually I am I am still feel on the margin.
US momentum foundation still stable and in place and.
Obviously, we're going to we're applying all our efforts continue in those initiatives to try to set those up sequentially as we move through the second half.
All right. Thank you.
The next question comes from Sam Darkatsh with Raymond James. Please go ahead.
Good morning, John Good morning, Dave how are you.
Right.
Just wanted to follow up on Dave Matthews last question hair, So and I apologize if I'm, putting words in your mouth, but.
Because of the time lag should we then.
Assume that pricing in the second half.
Go is higher than the plus 2% that you saw in the first half and if so is that enough to offset.
The 20 to 30 basis points or billing margin pressure that you saw sequentially in the second quarter I, just want to make sure I'm understanding that dynamic.
Well I want to be very clear I'm, giving you kind of the general trends, we do not we don't guide and I'm not going to start guiding in the call.
Question and answer sand pricing as well and we're not guiding we don't guide gross margins right. So we guide operating margin.
I just wanted to give you a sense of.
Kind of a headwind tailwind in aggregate that we experienced Dave in his prepared commentary kind of took you through the walk year over year and sequentially and mix was a factor right and then.
All that I wanted to speak to you again was.
We see the tariffs had had in the headlines every day.
The.
Our suppliers are trying to work those through and and using that as an opportunity to work through price increases because they're experiencing that on the input side of their cost equation right and so.
We weren't normal process, we work that aggressively but when we get that announced price increase and then we proceed to try to drive it across our into our customer base for that again the spot market activity, we're factoring that in.
How were bidding.
Effectively real time, but where we have you know the global account.
Relationships as multiyear contracts or utility alliances integrated supply contracts.
Where we have construction projects that are already bid and there may be some dynamic there was more contractors try and do so it's those kinds of things that there is a normal timeline we've experienced historically.
I think those of you that you view that we've had this discussion over the years and and were feeling that so we saw that in Q2. So.
Does it so the short answer though to your question is does that manifest itself in terms of improved gross margins in the second is we're not going to guide that but that will also be a function.
What are all the headwinds tailwinds in the pricing environment, and where our mix it ends up.
We clearly a guide operating margins.
And when you step back and think about how the first half ended up bottom line is that.
Sales came in lower than expected.
Gross margins are higher than last year's first half and that's in the face of.
A tougher supplier price increase environment right and we continue to have very good effective cost management, we're getting good pull through very good pull through as demonstrated in Q2, and so I think we've got the cost structure, it's always been well under control now the effort and on all the efforts are focused on margin improvement initiatives and getting that sales top line given.
Some stiffer headwinds and uncertainties in the end markets in the second half that's that's where we are at the midyear point.
And then my second question. Thank you by the way John My second question Dave.
At least by my math it looks like in order to get your free cash flow guidance, you'll have to take about a $100 million out of.
Working capital in the back half and you mentioned it was receivables.
A number of your vendors have noted that they're expecting.
Inventory.
Drawdowns in the channel at distribution it Doesnt sound like Thats, what you're anticipating or expecting that youre going to be keeping inventory levels fairly.
Static.
Is that strategic in terms of picking up some market share and or to make sure that your rebates are going to be at a level that you originally perspective, our projected or how should I read the lack of an inventory drawdown from you folks strategically.
Certainly so clearly our inventory levels are much higher than we experienced in the prior year Theres a couple of factors driving that one the SLS acquisition added inventory versus the prior year.
Second as we said during Investor day, and I know some of you are well aware of this we opened up a new distribution center. So we've been building inventory for that the combination of those two factors and we would anticipate.
Continued focus on managing our inventory level and I would anticipate that our inventory levels would come down in the back half of the year because of those two factors were still going to make sure. We have the right inventory to service our customers. The real driver of our 90% free cash flow of net income is going to be accounts receivable, we saw a significant uptick.
Our accounts receivable balance at the latter half of the second quarter, we anticipate that we will get that back under control.
As we were walking in here, we looked at collections our collections are well above our run rate for July . So we know that we had.
Some receivables due in June that were held and we've already received them. So that will unwind here as we go through the balance of the year.
Hey, Sam the only thing I would add is.
We always look at availability and fill rate.
Being able to serve customer demand.
Both the demand that we understand and are planning for the.
Global accounts utility lines related or new contracts that weve won ramp up of those new wins, but as well as kind of the walk in business. We're in real good shape in terms of rail building fill rates coming out of the first half.
And that that's those are the key metrics that we kind of watching and manage very carefully.
We had late in some inventory, though in addition to what things that we have laid in some inventory originally to support what we thought would be higher sell them. Some new wins in the first half. So we've got that dialed in pretty tightly.
You know and.
If the demand is not manifesting the inventories are going to get.
Trued up a bit and as Dave mentioned, there will be some downward trend there.
Thank you both.
Thank you Sam.
The next question comes from Robert Barry with Buckingham Research. Please go ahead.
Hey, guys good morning.
Good morning.
I was curious to understand better what was going on with SGN. A did you give or could you give a kind of same store basis SGN a number.
Oh or performance because I guess, you have some that sell SSG in there.
Rob Thats correct, so our sq nay versus the prior year was up 1%.
So when you take a look at it on a consolidated basis were up roughly $3 million. A couple of factors that drove that the first is in the base period, we had that bad debt charge. So we didn't have that same level of bad debt expense in the current year, obviously SLS has a much higher as seen as a percentage of sales and so that was a negative impact to profitability year over year.
We've had the typical inflation on wages and other expenses, but these were offset by cost controls. So as we saw some of the decline in our Q2 results.
We began a series of cost control the other factor quite frankly is that.
Was our variable compensation.
So we are below our expectations relative to our fiscal year operating plan and we've reduced the accruals for variable compensation.
Got it yeah, I was going to follow up with that I mean, so what's a good expectation I mean do you think on like the same store basis, you can keep best unit growth in the back half at around 1% or is that what's in the plan.
I think the 1% would be tougher relative to the prior year.
Again, we want to make sure that we are continuing to invest in the right areas of our business.
We've also got a couple of onetime events in the back half of last year, including a property sale that reduced our SG nay in Q3.
So I think if you take a look at our Q2 results.
I think that that would be a good starting point for overall s., United but I wouldn't call that just a 1% given we had a couple of items in the base period that we wouldn't expect to repeat.
Got it got it I guess, just lastly on mix I mean, big picture Directionally, given it sounds like you're expecting a lot of the growth improvement in back half in addition to comps to come from utility and construction.
Just mixed as this mix headwind probably get worse in the back half.
You know, where we obviously have laid out what our full year expectations are for those end markets. We do expect a higher growth rate opportunity in utility and we wouldnt anticipate.
That construction would would continue to be a key driver of our sales growth sequentially.
I think the way that that I would suggest that you take a look at this is even if there is an impact on the gross margins because of that mix.
Generally that is agnostic at the operating margin level.
Right fair enough and just lastly, a housekeeping item what would the share count be now in the guide given you've done more on the repos.
Sure. So you've seen the numbers that we reported for the second quarter I would say that we're still executing against our $150 million share repurchase I think for Q3, you should expect about 43 million shares outstanding on a diluted basis.
Okay and for the year, maybe 42 or.
Uh huh.
Right now I would anticipate the fourth quarter to be similar to the to the third quarter. So you're probably in that 43, and a half the $44 million diluted share count for the full year share share count.
All right great. Thanks, a lot.
The next question comes from Steve.
Bargar with Keybanc capital markets. Please go ahead.
Good morning, guys. This is Ryan mills on for Steve.
Hey, Ryan warning.
I just wanted to focus in on the guide back cast implying more topline growth in the first half.
But at the same time guidance implies EBIT margins flat to down slightly year over year.
And weaker incrementals compared to the 14% you put up in this quarter. So can you just help me wrap my head around what's driving that I know, Dave you talked about some of the onetime items in the back half of last year that might be affecting it but is there anything else that we should be thinking about.
Sure so relative to the prior year back half the one thing to keep in mind is that SLS as we had $28 million of SLS sales.
In the second quarter, that's about the runway run rate that we've been describing for SLS on an annualized basis and remember that we said that that basically comes with no profit.
And so the SLS acquisition on the total company is going to be roughly a 10 basis point drag at the operating margin line. So when you are comparing back half of 18 versus back half of 19, Thats one factor to keep in mind.
Clearly there are other investments that we talked about back in June with our Investor day, we want to continue to invest in those strategies, particularly the digital plays and some of the digital initiatives that we shared with investors and so that is some incremental costs relative to the prior year.
Okay. Thank you for that.
And then just sticking with the guide.
They did topline guidance and your updated end market outlook.
When I think about that and also considering your SLS acquisition.
To me it kind of implies that your market outperformance, an expectation of 1% to 2%.
The updated outlook kind of implies you're tracking at the low end or maybe below.
Is that a right assumption and if so what's driving the lower market outperformance.
Expectation.
So Ryan as we take a look at it clearly there has been some pressure in the first half on our sales rates.
But we're still comfortable that we are growing share I mean, we obviously are looking at that very closely we've looked at what some of the competitors have put out as we mentioned there has been some pressure on our business specific specifically in certain pockets of our U.S., but overall, we still are confident that we're going to be able to grow share relative to competition. During the full year I mean, what I would add is I think the where what has occurred.
The end market growth rates, we're expecting I mean, there are materially lower in the second half.
I mean that.
There there are some that's the pressure that is kind of ripple through our outlook et cetera, now our performance versus them I don't see that degrading I see that kind of.
Maintaining slash improve.
And you know we've got again I kind of took took you through earlier in this call each of the segments.
And you know kind of gave you a sense of how I think we are performing and what some of the headwinds or so and the wild card is going to be I think again as I as I answered in response to Dean's question and Dave Matthews question, you know what what the the end how did it end markets develop as we move through Q3, and Q4, principally around industrial and Capex spending.
Thank you. Thank you and then just one last one for me can you talk about your capital allocation priorities I know a good focus has been on share buybacks, but with leverage creeping up to the high end of your targeted range will you start to focus more on debt reduction.
Right as we think about the priorities they are not change to so we're investing in the business. We're still actively looking for the acquisitions the ones that we specifically talked about being large transformational acquisitions and then the strategic capabilities that we can acquire.
We want to make sure that we're managing our our debt leverage.
But we will continue to be opportunistic on share repurchase we have the program available. So we will continue to focus on those priorities going forward.
Thank you for taking my questions.
Thank you.
The next question comes from Nigel Coe with Wolfe Research. Please go ahead.
Thanks, guys good morning.
Good morning, Joe.
Hey, Dave.
Just wanted to.
Sorry, John [laughter], it's been on day.
Hello, everybody I'm just wanted to go back to the Okay. Nigel Okay. No problem. So it equally you can call me, David you ones as well.
So what does it go back to the investment momentum and you called out metals Kodak.
Petrochem and these are obviously capex focused projects and but then you referred to some of the projects getting.
You know sort of pushed to the right. So I'm just.
Kind of just wanted to dig into that a little bit more in terms of are we seeing overseas projects in place will can progress getting done and that's a source of strength, but we've seen some of the new projects getting pushed and that's what we might see the pivot.
Okay, and capex towards the back half of the year is that it was number one and then the second part would be equal to OEM weakness and.
Is that construction focus does it just manufactured in general how do you define OEM.
No.
Great question, I guess because I.
I want to come back and it's really important that we.
You know that it's clear in terms of what we're seeing and what parts of our business. So I'm glad you raised there.
And Dave when Daves commentary when you talked about.
What pieces of industrial we're growing he was looking at it from global account relationship standpoint, remember with a global account customer. The foundation of that relationship is principally MRO and then where we do capital projects directly directly with that global account end user customer it would show up in those sales if we're selling through a big contractor with a large construction projects through NEPC it will be categorized as construction.
And then also can include some selective Oems so when Dave commented about Petrochem overall metals and mining and food processing is being.
Three of the areas in global accounts, where we have strength you can think about that as being a combination of MRM, though.
Okay plus.
Key projects that are direct with their customers and users in those verticals and by very definition. Those projects are more small to mid size because when they get larger they typically are managed through the construction value chain upwards to a big VPC at time, Okay. So hopefully that's helpful.
And Dave talked about.
Some of the divert the two verticals that we had headwinds in.
In global accounts.
And one was OEM.
And so you'll remember that we bought a business back in 2005, Carlton Bates and then we made a few other acquisitions along the way RF electronics, the Hawaii electric so we've got a terrific OEM.
Business model and platform and so thats selling value added assemblies.
Kitted parts and value added assemblies that get incorporated into our customers' products.
Truly feed into the manufacturing.
Process flow because it's true OEM.
We're seeing some that's where we're seeing the slowdown.
With select OEM customers. So that's more customer by customer and also with the broader I'd say broader customers across global brands in that vertical.
And for technology, we serve a number of tech companies directly.
Through a global accounts relationship and that's.
Typically not exclusively but typically has a higher datacom.
Content because its wrapped around.
In most cases their enterprise class data centers, and we did call out as a comparable challenging comparable in Q2 of last year, we had significant growth with those tech companies supporting.
Several of them one in particular with global expansion of their enterprise captive data data centers to run their their their business. So.
Thank you for that question. It was important to kind of raise that back to the air pocket question I, we're not saying that we're forecasting an air pocket again, the way to think about project activity. Overall is what's our what I would ask you to look to think about as well as our overall backlog level were the second highest Q2 ending backlog level ever.
And you know we're starting out.
Q3, with us with a really solid July .
And we've got a first half second half guide that is somewhat consistent with historical seasonality, 49% of sales in the first half 51 in the second so we're not we're not foreshadowing we're forecasting an air pocket. The question on is there you know if there are further headwind for capital spending or or if some of the uncertainties are kind of resolved the business spending become is stabilizing factor in catalyst that that remains to be seen but we're delivering solid performance and not seeing an air pocket for say, yet even given those challenges hopefully that hopefully that helps Nigel does that get to your question.
Yeah kinda, thanks, Jon that everybody does.
I do have a quick follow on this time full days.
On cash flow and it sounds like you don't see accounts receivable is the biggest driver of second half cash improvement in the back half of the year would you expect the or the I guess, the dsos to get back to where they were at year end 18 bye-bye by year end and then on the inventory you talked about some some work down in the back half of the year normally we do see to fool low than Q2 roughly 510%.
Is that sort of magnitude of inventory declined you'd expect to see.
That's correct. So again, our key driver in our lever will be the accounts receivable and getting back to a reasonable DSL and then we do have opportunities on inventory basic seasonality, but also some of the investments we made in the front half to set up that Chicago DC. So we do anticipate and inventory balance sheet declined through the balance of the year.
And then dsos or days.
DSL, we would get back to our typical historical range at a minimum.
Okay. Thanks very much.
This concludes our question and answer session.
I would like to turn the conference back over to John Engel for any closing remarks. Please go ahead.
Thank you all again for your time. This morning, we really appreciate it.
Brian and we'll are available to take your questions and we look forward to seeing many of you at one of our investor marketing events that we will be participating in during the third quarter. Thanks again have a great day.
The conference has now concluded. Thank you for attending today's presentation you may now disconnect.