Hello and welcome to WESCO's Second Quarter Earnings Call. I would like to remind you that all lines are in listen-only mode throughout the presentation. [Operator Instructions] Please note that this event is being recorded. I would now hand the call over to Scott Gaffner, Senior Vice President, Investor Relations to begin.

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

Thank you, Scott. Good morning, everyone, and thank you for joining the call today. The power of our portfolio and mix-shift into higher growth markets is clear in our record second quarter sales, although sales were below our expectations in the quarter due to our EES business. Continued strong growth and record sales in our CSS and UBS businesses more than offset a quarterly drop in our EES business. The decline in EES was largely the result of unprecedented supply chain rebalancing in the electrical industry, leading to customer destocking, along with weakness in certain sectors, including commercial construction and manufactured structures. Our long-term secular growth drivers remain intact and they are reflected in our continued sales growth in the utility, data center, security and industrial sectors. On the strength of our industry-leading customer value proposition, strong cross-sell execution continued in the quarter and we're now raising our sales synergy target again we've had a series of these, a string of these since we put the two companies together, we're raising it from $1.8 billion to $2 billion. Lead times for most product categories have returned to 2019 levels. The extraordinary supply chain disruptions and customer purchase patterns driven by the pandemic over the last few years are now correcting with the rapid reduction in supplier lead times. Against these supply chain rebalancing conditions, our gross margins remain healthy and stable. While economic conditions remain positive, consistent with the soft landing, we did see pockets of underperformance in certain end markets served by our EES business. Even with the increased overall sales in the second quarter, I'm very happy to say our free cash flow generation of $293 million was very strong and brought us back in the positive territory for the first half of 2023, and that's back in…

Thanks, John. I'll start on slide five with a summary of our second quarter results compared to the prior year. As John mentioned, the company delivered record second quarter sales. Year-over-year increases in our CSS and UBS businesses were partially offset by a decline in sales in certain EES markets. On an organic basis, sales were up 3% over the prior year, driven mostly by a low single-digit contribution from price as volume was flat. The flat volumes in the quarter represent a modest year-over-year decline in market volume that was fully offset by our strong cross-sell results. During the quarter, we experienced some negative impacts from supply chain rebalancing and the normalization of product lead times. As lead times extended at the start of the pandemic, customers increased purchases to offset the impact. As the supply chain heals, we are now seeing a rapid reversal of those behaviors, which has led to destocking and a temporary decline in our stock and flow activity levels in certain customer verticals, while underlying end market growth remain stable. Project backlog continues to be at historically high levels, supporting our outlook in the second half of 2023 into 2024 and beyond. In total, backlog was up 6% year-over-year and down approximately 2% sequentially from the end of March. Gross margin of 21.6% was stable year-over-year after adjusting for the impact of business unit mix during the quarter. We continue to prioritize profitable top line growth. And, as the industry leader, we intend to protect the progress we've made on gross margin with continued execution of our enterprise-wide margin improvement program. Adjusted EBITDA was flat with the prior year. Higher SG&A costs, which have been addressed through our cost-reduction actions was the primary driver of the reduction in EBITDA margins year-over-year. Adjusted diluted EPS…

Thank you. We will now begin the question-and-answer session. [Operator Instructions] Today's first question comes from Deane Dray at RBC Capital Markets. Please go ahead.

Thank you. Good morning, everyone.

Hello, Deane.

Maybe we can start with your expectations about the timing of the destocking process, how long do you think it takes in terms of quarters. Well, we've been asking the manufacturers, and many of them your suppliers, they're saying their releasing buffer inventory in a process of over several quarters. So would be interested in hearing your perspective how long do you think this process takes?

Well, thanks for that question, Deane. It started in CSS actually in the second half of last year. So you'll recall that as we move through last year, CSS' results were a little bit below what we thought momentum vector-wise compared to both EES and UBS. For CSS, it's -- I think by and large, the process is complete. Supplier lead times across the board are back to pre-pandemic levels. So we feel good about that. EES started at the very end of last year, but it really picked up momentum here moving into this year and especially in the second quarter. And so I think that, for EES, I do want to make a few comments specifically. Our EES comparisons are the most difficult from March to June of this year, I think we know that. If you look at EES last year, their strongest quarter was by far Q2. It is our expectations that we returned to growth in the second half of this year in EES based upon our view of the market conditions, and it gets to your question, Deane, as well as the strength of our backlog. We do believe strongly EES has outstanding long-term growth potential driven by the secular trends as Dave outlined in his prepared comments. So that's, EES, I'm sure we'll double-click on that some more in terms of the components of EES and UBS has both very strong results in the quarter for utility, the beat goes on, as well as our integrated supply business. Broadband, we saw -- as we expected, we saw some challenging conditions in the Broadband value chain in the second quarter. When we had our first quarter earnings call, we thought that would start to recover in the second half, but it's our view now that, that moves out to next year. So I think that gives you a sense being by business. Is that helpful?

Yes, it does give a sense of the calibration by segment. But the duration, most of it's happening in EES this quarter, any sense of the percent of that de-stocking that has happened so far?

Yes. So again, let's talk duration. I think the way to just think about this, and I'll take a moment to set the stage for the answer. Post-pandemic as the supply chain rebalances, we're experienced what I'll call that kind of a whipsaw or bullwhip effect, and that's occurring with this rapid reduction of supplier lead times. So it enables customers, and we're seeing it most acutely in EES, particularly contractor customers, to delay their purchases for our stock and flow business. That's what we saw in EES in Q2. Our project sales grew in the quarter, grew in the quarter, while the stock and flow sales were down, and it was principally in the wire and cable category. Also note that in EES, our backlog grew sequentially in Q2, which reflects recent wins of larger or more mega projects, I'll call it. And that bodes very well for 2024 and beyond. You'll recall the last several quarters, we've been getting questions about what -- when do we start seeing these bigger project wins, the mega projects, so to speak, that are tied to the two bills that were passed through Congress. We had been saying we originally thought we wouldn't see any meaningful wins until next year. But we're very encouraged with the recent wins that we had in this quarter, one of which we highlighted in our webcast materials. And I'll note that the shipments actually start in the second half of this year. So we would expect with that as a backdrop, Deane, we'd expect the rebalancing conditions to occur through the third quarter and return more normalized value chain in the fourth quarter. I gave you by segment, I think CSS is there. EES is moving in that direction despite the challenges we had in Q2 with respect to that. And so that's our view.

All right. John that was exactly what I was looking for. That's also the time frame that we're thinking. And just so we're clear, this idea of the shortening of lead times and normalization of supply chain, this is the risk that happens, all this buffer inventory gets released. You're at the end of that whip of this, we get it. And as long as end market demand stays strong, you've got to weather this period of destocking. We get that. We flagged that as a big risk for the whole sector this quarter. We're fine there. But I did want to touch on my follow-up question on the demand side, just the end market demand and the weaker commercial construction. And thank you for flagging that, that is the stock and flow business, not related to projects. So that is destocking related in the stock and flow business, it's not any sort of project delays or labor issues or weather or anything like that?

Correct. So again, I'll put an exclamation point on this, and it's important. Our project business, that's part of the business in EES, it's project and stock employment, right, two different business models. The project business grew year-over-year in Q2, while backlog also grew sequentially. So again I'll make the comment that with our EES business, true in our construction portion of it, solutions as well as the broader EES business unit, we think we're uniquely positioned to participate in the secular trends. And that's the good news with regards to the quarter. Now the stock and flow piece of the EES business was down, and it was down larger than the reported EES year-over-year decline because the project business grew. And that is the temporal or temporary effect that we just talked with. We're at the end of that bullwhip. We're seeing that. I did make a few comments about the overall supply chain, and it's important to understand because I think we'll write about this pandemic period for years and even decades to come. The level of supply chain disruption through this pandemic period is truly. I know this word is often overused, truly unprecedented. So when you analyze what happened in 2020 through '21, '22, '23, again, we're seeing -- we've only seen a bullwhip effect to a much smaller magnitude through an economic cycle, but this one is more pronounced due to what happened at the front end of the pandemic cycle. I also want to highlight, Deane, that there's some very strong growth engines that are driving other parts of EES. The industrial business was strongly up in the quarter, and we have a growing and record backlog with our industrial customers. Our bid activity levels are at record levels. So we're bidding tremendous number of opportunities. And I called out as well our integrated supply business. It is part of UBS, but recall the end markets there, their all industrial, was up double-digits in the quarter, grew double-digits. So the industrial, I think, portion of our portfolio, which is most represented in the EES, but also the list business in UBS, is a strong call out. And I mentioned this comment last quarter. I think we're at the front end of this industrial super cycle. And again driven by onshoring, the supply chain consolidation, it all manifests itself in these mega projects to support electrification and higher degrees of automation.

Okay. John, thank you. I appreciate all that color and context. And I'll hand it back. Thank you.

Thanks, Deane.

And our next question comes from Sam Darkatsh with Raymond James. Please go ahead.

Good morning, John. Good morning, Dave. How are you?

Hello, Sam.

Dave, a couple of questions for you. So at least if my math holds. So it looks like pricing was down about 2% sequentially from the first quarter on a two-year stack and your decremental margins implied with your lower sales guidance are also pretty high. They're like 20%, 30% or so. Now I'm guessing, at least if my math holds, the reason why the decremental margins on the lowered sales guide are so high is because of the SVR, the incremental SVR pressure, now 40 bps instead of 20 bps prior. But are you assuming any sequential pressure in pricing in the back half versus the second quarter also contemplated within the guide?

Sam, we are. It's -- if you take a look at what we've experienced year-to-date, we posted a 5% in Q1. We posted a 3% here in Q2. We do expect there to be still positive pricing in the back half of the year, but an additional step down in the back half. We're confident in the 3% to 4% for the full year. From an overall pricing perspective, we have continued to see the number of price increase notifications decrease sequentially as we've continued through this year. So as we take a look at what's known for the back half, the number of price increases, the rate increase, behind those increases is also lower than the prior year. And as I mentioned in the prepared remarks, we also do have some pure commodity categories where we do have a headwind when it comes to price.

I think you're talking year-on-year, though, I was talking sequentially. Are you expecting lower prices in the back half versus the second quarter?

No, no. And again, for the commodities, you're right, it was a year-over-year comment in the prepared remarks. We don't project or predict what the commodities are going to do. But as we think about the pure supplier price increase benefit to our top line, it will continue to be positive, but less than what we have in the first half.

Got you. And then my follow-up question. Can you remind us at this point what percentage of your overall backlog is EES versus UBS? And then same question as it relates to the inventory within your backlog, I'm guessing that's more overweight EES because a lot of UBS is direct ship. But can you put a little bit of help around the mix of your backlog right now between your segments?

Certainly. So the -- again, we've never broken out the specifics by strategic business unit within our backlog. There are varying levels of project business, and recall that only project business is in the backlog. So we've not provided that. But as you can see, what we've been seeing in our backlog over the last couple of quarters is we've been seeing the CSS backlog has continued to come down. That's primarily because their supply chains heal faster than the balance of the business. And within UBS, we've been relatively consistent. You've seen some slight moderation in their backlog versus the prior year. Where we continue to see the growing backlog within EES. I would characterize EES makes up about half of our total backlog. And again because of some of the supply chain issues that we've been dealing with, even though some product categories have gotten better, we still have some extended lead times in our backlog based on certain product categories, including switchgear within EES.

I mean that's an important point, Sam. I mentioned that lead times have come back to pre-pandemic level pretty much across the board in CSS. We've seen rapid reduction lead times for both UBS and EES as well across the majority of the portfolios. But we're still seeing well extended lead times for switchgear, which is part of EES, breakers and transformers in Utility, as well as rubber goods. So when you take those categories, we're talking about we're still seeing significant extended lead times. Think of it as more of the engineered components, the engineered subproducts and solutions.

That's all I was getting at, John. I was trying to figure out, all right, if we wave the magic wand and switchgear availability is normalized and transformer availability is normalized, how much of your inventory can you monetize, can you liquidate?

Yes, that will accelerate our ability to ship against that backlog. We've been saying we expect backlog to come down sequentially, right? We've been very clear about that, because, again, that's the other end of the supply chain cycle as the lead times of collect. We're seeing that effect in CSS, those backlogs are coming down sequentially. We haven't seen that in EES yet or in UBS materially. But again, you're on the right point. As switchgear and the engineered components and EES, transformers and other engineered components in UBS come back to equilibrium, well, that creates an acceleration effect in terms of us being able to ship against our backlog and relieving inventory. Correct?

But is there any quantification of that for some direct --

And I think it's completely a function, Sam, of how those lead times come in. We're still seeing a year-plus leads on gear and transformers.

Okay. I'll defer to others. Thank you for the help.

Thank you. And our next question today comes from Nigel Coe with Wolfe Research. Please go ahead.

Thanks. Good morning.

Hello, Nigel.

Can you hear me okay? Hey, guys.

Yes, we can hear you.

John, just want to go back to the bullwhip concept. Obviously, your suppliers are part of that bullwhip and arguably they should be more impacted by the sort of the inventory sequencing through the channel. So just would love your perspective on how some of your major suppliers like Schneider and Eaton, are showing mid to high teens growth in North America versus low single-digit growth for the use. So any perspective there would be really helpful. And there's been some questions coming in about some of your suppliers, you're using different channels or going direct to customers. Is there any change that you're seeing in the way the product is getting to customers?

On the latter part of the question is absolutely not. And I know that there's been some commentary out there, a little bit of noise around that. We're not seeing that. Because, again, our bid activity levels, Nigel, are at record levels. And we specifically spiked out one of the recent wins in EES, and showed it in our webcast deck, which is one of these newer, let's call it, mega project wins that just shows, and again, that's -- if you look at how we bid and won that, we did it by providing a combined solution across numerous product categories and the strength of the broader WESCO. So I think -- I can tell you, with our bid activity levels, our customer engagement, I couldn't be more pleased with. The opportunity pipeline that we're managing is at a record level. And that includes more complete solutions, where we're cross-selling inside each SBU intra, because of the WESCO Anixter combination, and increasingly across the SBUs. I think we're uniquely positioned with our portfolio to provide a complete solution and one-stop shop for these larger mega projects. So that's the last part of your question. I've seen no evidence of that as yet. And I don't expect to see it quite frankly. The reality is I've been in this industry over two decades. And for engineered components and products, there's always been a portion that has gone direct versus through distribution. That dynamic is not a new dynamic. So back to your first part of your question, I don't -- I typically won't go specifically -- talk about an individual supplier or competitor. I will say, I'd encourage you to look at the complete composite of our supplier base. We obviously have large suppliers for our Electrical business. We have…

Thanks, John. There's a few more pieces to the jigsaw there, so thanks for the help there. And then, Dave, just my follow-on is just look at the math you gave on the back half sequential, which is really helpful. It looks like you're implying sort of year-over-year growth in 3Q and 4Q of roughly 2%, 3% organic, I think it is. Number one, is that correct? And then thinking about that July prelim sales of 3%. If we take out Rahi, it looks like organic is closer to 1% to 2%. So just wondering the confidence that we have that organic accelerates from July into the back half of the year.

Very confident. We are -- first of all, the way that you frame that from the math is absolutely correct. When you take a look at the first half results from an organic sales relative to what we provided for our full year outlook, we do have the expectation, as we mentioned earlier, that we will see EPS growth in the back half of the year. We would still expect that we would see a continued performance from both our CSS business and our UBS business. Again, they've had very strong first half of the year. So from that perspective, we also indicate that July was a two-speed month. We saw things very, very slow the first couple of weeks. The second half of the month did pick up dramatically across all of our businesses. Again, from our perspective, we've incorporated the July results, along with our outlook for the performance by operating group to inform our outlook for the second half.

Okay. Thanks, Dave. Thanks, John.

Thank you. And our next question today comes from Christopher Glynn with Oppenheimer. Please go ahead.

Thanks. Good morning, guys. I had a question on free cash flow. A lot of times a little lower sales outlook enables a higher free cash flow in the distribution model and particularly with the past couple of years, investment in inventory growth. So curious what the rub is there.

Yes, Chris, it's Dave Schulz. So one of the things that we indicated was we do expect our fourth quarter to be sequentially stronger than the third quarter. So a lot of this will be the timing of the sales that we have in our outlook by quarter. And given the stronger sales that we would expect in the fourth quarter that would lead to a higher receivables balance. So that is a drag on our typical model where we would see seasonal declines in the fourth quarter, therefore releasing more net working capital. We've built into our outlook that we don't expect that to happen this year at the same level.

Okay. So would you expect that set up for a particularly strong free cash flow next year, again, given the backdrop of a couple of years of pretty pronounced working capital growth?

That is correct. Typically, we see our first quarter sales down sequentially versus the fourth quarter. Depending on the timing of projects, we would expect to release that accounts receivable build in the fourth quarter.

Okay. Thank you.

Thank you. And our next question today comes from Steve Volkmann with Jefferies. Please go ahead.

Great. Good morning, guys. Just a couple of kind of follow-ups here. Dave, how are you thinking about opportunities to pay down some of the sort of higher coupon debt? I know it's not due for a year or two. But are there ways to do that in the shorter term?

Yes, Steve. We're always looking at what are the opportunities for us to refinance. We do have a $1.5 billion note that is maturing in 2025. And we've talked about this previously that now that the break fees for calling that bond or further reduced, we're always looking at that. It's really the difference between the break fees versus the interest rate arbitrage. So that is something that we're looking at consistently.

Okay. Great. And then I'm curious how we should think about -- you've been talking about some of these project wins and mega projects that certainly -- I think we all see that opportunity. But how do we think about the margin mix as those start to come in? Maybe are they a little lower gross margin, but also lower SG&A? I'm just trying to think about how that plays out over the next couple of years.

That's a great, great question. So, yes, if the project -- there'll be portions of fulfilling the project demand, Steve, that will fill out of our stock and flow. But then there'll be other -- the engineered components, the engineered solutions that are part of that total solution, in some cases, not all, but in some cases, gets directly shipped from our supplier partner to the customer's job site where that construction is occurring or the build is occurring. So when the fulfillment method for that particular category is what we'll call direct ship, there's a portion of that project, we run, it's lower gross margins, inherently lower gross margins. But the operating cost to run that business model is also inherently lower. So we're relatively agnostic at the EBITDA margin line. So just I wanted to make that point. Second point I'll make, which is very important is -- and we didn't get this question at, but we typically get it, what's the backlog of what is -- what's the margin of what's sitting in backlog, what's the trend on that. And the trend on that remains strong. They're holding up. Up slightly. So call it very stable, actually up slightly. So that's a very good indicator of our value-based pricing, the margin improvement program as we're winning these bigger projects that have increased scope. Some are longer in duration. We're selling the value proposition just beyond the products that are prior to product solution. If they're services, hence the ability to execute that project consistent with all the customers' commitments, that we're doing a better job increasingly of getting paid for.

Great. That's helpful. And then just a final quick one. I think you laid out sort of a long-term target, 100% free cash flow to net income over sort of a longer period, and we can all sort of try to guesstimate sort of what's what quarter-to-quarter. But are you still committed to that sort of long-term 100% free cash flow target?

100% committed. If you look back at the company, let's just go kind of premerger close back in 2020, and you were to look back on a five or 10 year cumulative basis, legacy WESCO averaged over 100% of net income, free cash flow and Anixter was right in the same zip code. So the answer is absolutely, yes, together. I think, obviously, this pandemic has driven some unique, let's call it, some unique results in our business on how we had to manage the supply chain and our inventories through the most disruptive period, the front end of it. I mentioned as bullwhip effect at the back end of it. But as we get back to equilibrium, with the power of our portfolio, the scale in particular, and the digital transformation that we're executing that we haven't talked a lot about that, fundamentally, that will improve our ability to increase our working capital terms, in particular inventory. So I'm not raising the 100% of net income. I'll just tell you that we have shown with a long successful track record of consistently doing across the entire economic cycle. What's new is, as we put these two companies together with our scale and this digital transformation, we think we'll have increased cash generation opportunities versus what either company could do on a premerger basis once the digital transformation is complete. We'll leave that for a future discussion because that will be a bit out there. But in the short to medium, yes, the 100% were locked and loaded as a commitment.

Great. Appreciate the color. Thank you.

Thank you. And our next question comes from David Manthey with Baird. Please go ahead.

Thank you. Good morning, everyone.

Hello, David.

First off, John, you mentioned that you expect to return to growth in EES in the second half, and then you further said you expected to double-click on those EES trends. So just wondering if you can give us some color on trends within the three subsegments of EES and how you see those playing out in the back half, OEM, industrial construction.

Dave, could you repeat the last piece of that? I missed the very end of it, sorry.

Just wondering if you can give us color on how you see OEM, Industrial and Construction rolling out in the back half of the year.

Got you. Got you. Thank you. Okay. So I'll start with Industrial. Very strong momentum in the first half, very strong opportunity pipeline, increased backlog, we expect that continues. And I mentioned, Dave, that I think we're at the front end of an industrial super cycle. So I would say we remain, for the EES business, we remain very bullish on the industrial portion of that business. Relative to construction, again, look at the backlog that grew sequentially. So we're encouraged by the opportunity pipeline and the wins that we're putting on the board. As we shared with you in the last two quarters, we thought EES backlog would decline sequentially as we started to burn it off, we've not seen that yet. So I think we expect very strong contributions and strong growth from the project portion of EES that serves construction at value chain. And as I mentioned in response to Deane's question, we think these temporary supply chain whipsaw effects on the stock and flow business continue through Q3, but then have improved materially as we move into Q4. And then relative to OEM, the manufactured structures business is a very unique sector or value chain is cyclical. That will be a downturn through the second half of this year. But you look at the balance of OEMs, the balance of OEM is -- there's a [Technical Difficulty] we sell that into many different industrial end market verticals, including semiconductor. So I think as we move forward with OEM through the second half, but more importantly for next year, we remain very bullish on the solution capabilities that we have with our OEM business.

That's helpful. Thank you. And then just for completeness here. What percentage of EES segment revenue specifically or stock and flow?

David, it's Dave Schulz. So right now, our stock and flow business is running about 60% on our EES business.

Okay. Thanks very much.

Thank you. And ladies and gentlemen this concludes our question-and-answer session. I'd like to turn the conference back over to Mr. Engel for any closing remarks.

Well, thank you all. We are at the top of the hour. Thank you all for your support. It is much appreciated. We look forward to speaking with many of you. I know we have many calls scheduled over the next several days. And also, over the next two months, we have a robust schedule. We will be participating in the Jefferies Industrial Conference, the RBC Global Industrials Conference and the Morgan Stanley Laguna Conference during the third quarter. Thank you all for joining our call. Have a good day.

Thank you, sir. This concludes today's conference call. We thank you all for attending today's presentation. You may now disconnect your lines and have a wonderful day.