Wesco International Inc Q2 FY2020 Earnings Call

Good morning, and welcome to the WESCO Second Quarter 2020 Earnings Conference Call. All participants will be in listen-only mode. After today's presentation, there will be an opportunity to ask questions. Please note, this event is being recorded. I would now like to turn the conference over to Brian Begg, Treasurer. Please go ahead.

Thank you, Kate. Good morning, ladies and gentlemen. Thank you for joining us. Joining me on today's call are John Engel, Chairman, President and CEO; and Dave Schulz, Executive Vice President and Chief Financial Officer. This conference call includes forward-looking statements and therefore, actual results may differ materially from expectations. Please see the webcast slides for additional risk factors and disclosures. For additional information on WESCO International, please refer to the company's SEC filings, including the risk factors described therein. The following presentation includes a discussion of certain non-GAAP financial measures. Information required by Regulation G of the Exchange Act with respect to such non-GAAP financial measures can be obtained via WESCO's website at wesco.com. Means to access this conference call via webcast was disclosed in the press release and was posted on our corporate website. Replays of this conference call will be archived and available for the next seven days. With that, I'll turn the call over to John Engel.

Thank you, Brian. Well, good morning, everyone, and thanks for joining us for today's call. On behalf of WESCO, I hope that all of you have been staying healthy and safe in these challenging times. We've prepared a very thorough update for you today. I'll lead off with a few introductory remarks and then Dave will take you through our second quarter results. And then, we'll provide a review of the excellent progress we're making on the Anixter integration, as well as the outstanding value creation that our transformational combination of WESCO and Anixter will create. So, first, for an update on our business in the second quarter, results exceeded our expectations across the board. That is for sales, operating margin, operating profit, EPS and free cash flow. Business momentum improved through the quarter as we outperformed the market and built an all-time record backlog for the legacy WESCO business. Importantly, sales improved sequentially each month and we saw continued growth in our Utility business. Anixter also delivered a strong performance to close out the second quarter. Our positive momentum has continued into the third quarter. We're very encouraged by that with quarter-to-date sales through workday 28, that's quarter-to-date, down 8% versus prior year, but up 11% sequentially, with a book-to-bill ratio above 1.0. As we have done in prior economic cycles, we aggressively managed our business and took significant cost reduction and cash management actions, which enabled us to achieve a decremental margin of only 10% and generate exceptionally strong free cash flow of $140 million or 250% of adjusted net income. As you know, we increased debt to complete the Anixter combination. We expect our consistently strong and countercyclical free cash flow generation to enable us to rapidly delever and get back within our financial target leverage levels within 36 months. In closing out the first half of 2020, I would like to take this time to recognize and thank all of our associates for their inspirational dedication, commitment and hard work in effectively managing through this COVID-19 driven crisis. Now turning to Anixter, the second quarter will prove to be a watershed period in our WESCO history, as we successfully closed on our industry-shaping merger of WESCO and Anixter. In combining two industry-leading Fortune 500 companies with successful track records, we are creating the premier electrical, communications and utility distribution and supply chain solutions company in the world. In May, we completed a well oversubscribed and highly successful capital raise of approximately $5 billion in bonds and bank debt, all with very favorable terms. We satisfied the remaining closing condition when the waiting period for the Canadian Competition Bureau expired on June 18 and then successfully closed the Anixter transaction on June 22. This timing met our commitment to close this transaction in the second or third quarter. Against the challenges imposed by the global pandemic, the extraordinary determination of our WESCO and Anixter associates to execute a flawless day one closing just five months after signing the merger agreement was very impressive. I could not be more proud or more appreciative of the entire team and their extraordinary efforts in achieving this noteworthy milestone. As I mentioned before, we've been executing a detailed rigorous and process-oriented integration planning effort over the last several months. Now, all of our integration efforts and organizational focus shift from planning to execution and synergy realization. I'm happy to say we are off to an excellent start in integrating the two businesses in our first six weeks since closing, and have already completed actions to deliver over 50% of our year one cost synergy target of $68 million. We have also begun to realize our first sales synergies through leveraging our expanded global footprint and cross-selling what is now our broader product and services portfolio. The strong cultural alignment between WESCO and Anixter is proving to be a key driver of our initial success. We are building on these early successes and we remain highly confident in capturing the significant upside potential and exceeding our three-year cost savings, sales growth, margin expansion and cash generation synergy targets. With that, I will now turn the call over to Dave. He's going to walk you through our second quarter results and then discuss our integration, execution and synergy capture plan in more detail. Dave?

Thank you, John, and good morning, everyone. I'll start with an overview of results, beginning on page 4. This slide presents our second quarter, walking you from our reported GAAP results to the legacy WESCO results. The column on the left shows our reported GAAP numbers and to the right of that column are the various adjustments to our reported results to remove the transaction-related impacts. The third column subtracts the merger-related adjustments from the reported results to show the underlying results of the business adjusted for all deal-related costs and activities. To the right of that are the Anixter and WESCO components of these adjusted results, respectively. Reported sales in the quarter were down 3% and down 12% organically, driven by lower demand due to the COVID-19 pandemic. I'll walk you through our sales results in more detail in a moment. The legacy WESCO business generated approximate operating profit of $70 million, approximately $28 million lower than the prior year on a sales decline of approximately $285 million, representing a decremental margin of 10%. SG&A was down $33 million compared to the prior year quarter, reflecting COVID-related cost actions and lower volume. Legacy WESCO adjusted operating margin was 3.8% for the quarter and adjusted EPS was $1.04. The legacy Anixter results for the period following the merger had gross margin of 20.3% and operating margin of 8.3%. This result was driven by the strong Anixter sales during the nine-day ownership period in the second quarter, continued gross margin expansion and cost reduction actions initiated by Anixter in response to COVID-19. On an adjusted basis, the combined WESCO and Anixter business generated operating margin of 4.2% and diluted EPS of $1.36. A brief comment on the merger related adjustments. The $73 million of SG&A primarily represents investment banking, legal and integration management fees. Additionally, we recognized the one-time expense associated with the change in control provisions of the transaction. You'll also note several impacts below the operating profit line, including interest expense of $45 million. This includes interest paid on the bonds issued and non-amortized financing fees. We also recognized preferred dividends expense of just over $1 million in the quarter related to the preferred stock consideration to Anixter stockholders. We will provide a detailed update on the Anixter acquisition a bit later in the call as we have made substantial progress on the integration of the businesses and the generation of synergies. Turning to slide 5, this summarizes the organic sales growth by end market and geography for the legacy WESCO business and does not include any contribution from Anixter. You can see on the right-hand side that monthly organic sales in the quarter were down 16%, 10% and 13% in April, May and June, respectively, versus the prior year. As John mentioned, sales improved sequentially through the quarter on a same workday basis with April down 13%, followed by increases of 9% and 5% in May and June, respectively. Differences in foreign exchange rates reduced growth by 90 basis points, primarily reflecting unfavorable Canadian dollar exchange rates. Looking at the sales results by geography, the US, which is roughly 75% of legacy WESCO overall revenue, was down 12%. Canada was down 17% organically. Both the US and Canada results were driven by declines in our industrial and construction end markets as many projects were delayed beginning in March. Industrial sales were down 21% organically in the US and 22% in Canada as we saw broad-based weakness in market verticals we serve due to COVID-19. Bidding and project activity remained strong, however, and a number of industrial markets improved sequentially from Q1. Construction sales were down 16% in the US and 21% in Canada, reflecting the project delays due to COVID-19. Our legacy WESCO backlog reached a new company record and was up 17% versus the prior year and up 4% sequentially from Q1. Consistent with what we saw through the end of April, construction projects have been delayed rather than canceled. Utility sales continued to be exceptionally strong in the quarter, with the US up 6% organically and Canada up 36%. Sequentially, US Utility sales were up 8% and Canada Utility sales were up 27% versus Q1. This was our 12th consecutive quarter of organic growth in the US Utility business. Commercial, institutional and government, or CIG, organic sales ended down approximately 5% for the quarter. This end market exhibited positive momentum in the quarter as sales were up 13% and 11% sequentially from Q1 in the US and Canada, respectively. Projects related to data center builds, security and cloud computing projects with large technology customers continue to provide significant sales growth opportunities. Moving to slide six, let me take a moment to remind you of our liquidity and some features of our new borrowing facilities that we closed on in June as they position us to meet the challenges related to the economic impact of the coronavirus. Our liquidity, which is comprised of invested cash and borrowing availability on our bank credit facilities, is strong at $819 million. We have maintained sufficient cash on the balance sheet of $265 million. Collections throughout the quarter and into August have performed at or above historical trends. Bad debt reserves are also tracking consistent with historical levels. In connection with our closing the Anixter merger, we raised new senior unsecured notes of approximately $2.8 billion, a portion of which was used to refinance Anixter's 2021, 2023 and 2025 notes. We also entered into a new $1.1 billion ABL facility and increased the AR facility commitment to $1.025 billion in June. Our bank credit facilities are low-cost LIBOR-based agreements and mature in June 2023 and 2025. We expected our ratio of fixed rate debt to variable rate debt to be approximately 70% at closing and it ended up at 72% at the end of June. Our credit facilities include limited operating covenants and we easily pass some liquidity thresholds by which compliance is measured by a very large margin. Having completed the Anixter merger, our capital allocation priority will be to support the integration, organic sales growth opportunities and to rapidly retire debt. We do not expect to utilize any remaining amounts available under our board-authorized share repurchase program that expires on December 31 of this year. Turning to slide seven, let me recap our second half priorities. Our first priority is to build on the improving sales momentum we experienced this quarter. Despite weakness in certain markets in Q2, we capitalized on improving momentum within our business and are well-positioned to leverage our broad portfolio of products and services to drive sales ahead of the market. We will maintain our cost discipline to meet or exceed the $50 million in cost savings generated by the actions that we took in April in response to COVID-19. We are planning to reinstate full compensation on October 1 for legacy WESCO employees that was temporarily reduced between 12% and 25% effective May 1. We will be deploying across the legacy WESCO business, Anixter's gross margin improvement programs that enabled Anixter to deliver seven consecutive quarters of year-over-year improvement. We will continue to rapidly execute our integration plan and deliver the year one merger synergies with a high confidence of delivering substantial upside. As we generate cash, our priority will be to retire debt, consistent with our objective return to our target leverage of 2 to 3.5 times debt to adjusted EBITDA within 36 months post close of the transaction. Finally, beginning in the third quarter, we will begin reporting results for the three strategic business units announced as part of our new organizational structure in early June. With that, let me turn the call back to John as we will provide an update on the Anixter merger.

Thank you, Dave. So I'd now like to reemphasize the outstanding value creation that our transformational combination of WESCO and Anixter will create. There are seven key highlights regarding this industry shaping merger. Number one, the merger is a transformational combination that creates the industry leader in electrical, communications and utility distribution and supply chain services. Number two, the combined company benefits from a step change in scale and capabilities in what remains a highly fragmented electrical and communications distribution space. On a combined basis, we're the industry leader in North America with approximately $17 billion in sales revenues and over $1 billion in adjusted EBITDA on a pro forma basis, including the identified cost synergies. Number three, the two businesses are highly complementary in terms of products, industries and geographies, which enables us to sell more products to more customers in more locations around the world, and, more importantly, accelerate our sales growth by more than 100 basis points versus standalone projections. This is an extraordinary combination of two successful companies where one plus one is equal to three. Number four, we're executing an integration plan to deliver well over $200 million worth of cost synergies. As I mentioned previously, we're off to an excellent start, only six weeks since closing this acquisition in late June. And Dave will take you through our notable progress in much more detail shortly. Number five, the financial benefits of this combination that will be generated will be exceptional. We expect our EPS growth rate to double and adjusted EBITDA margins to expand by more than 100 basis points through the cost synergies I just discussed. Number six, both companies benefit from a highly resilient business model to generate substantial free cash flow through all phases of the economic cycle. The combined company is expected to generate free cash flow of more than $600 million annually by year three, which we expect will enable rapid deleveraging, so within our target range within 36 months, as well as provide future capital deployment options to drive value creation. And finally, number seven, the collective WESCO and Anixter management teams are results oriented and laser-focused on driving an efficient integration and on generating these synergies to drive the substantial value creation. In summary, with Anixter, the new WESCO will capitalize on the accelerating secular trends of electrification, increased bandwidth demand driven by higher voice, data, video and mobile usage, and the digitization of our B2B value chain. We are more bullish than ever on the substantial value creation that this transformational combination will create for our customers, our supplier partners, our employees, our investors and the communities in which we operate. With that, I will now hand it back to Dave to provide additional details on the excellent progress we're making on the Anixter integration. Dave?

Moving to slide 10. The enhanced scale that this merger creates is clear. It brings together two highly complementary companies, combining them benefits our customers and creates value through significant cross-selling opportunities, premier supply chain services, acceleration of our digital initiatives and improved operational and supply chain efficiencies. On a trailing 12-month basis through June 30, the business generated revenue of approximately $17 billion and adjusted EBITDA of over $1 billion on a pro forma basis, including the $200 million of cost synergies we are confident that we will deliver. Turning to slide 11, the North American electrical distribution industry is very large and highly fragmented with an estimated total size of $114 billion per year. With the merger, the company has a share of approximately 13%. Even with this merger, the market remains highly fragmented and offers substantial opportunities for accelerated organic growth. Both WESCO and Anixter have invested in supply chain services to differentiate our overall customer value proposition. The combination of these two companies not only increases our overall scale, but also improves our ability to better serve our customers through an expanded product and services portfolio. Moving to page 12, as we consider the future of the combined enterprise, there are numerous ongoing and attractive secular trends and growth opportunities. The demand for increased bandwidth, driven by higher voice, data, video and mobile usage; greater connectivity needs for remote work, home and school applications; and the increasing electrification of our infrastructure are just a few of the growing secular trends that are directly aligned with the core capabilities of our combined business. The right-hand side of this page outlines the financial benefits of this transformational combination. We are highly confident in exceeding our three-year cost savings, sales growth and cash generation synergy targets communicated earlier this year. With a challenging economic cycle we're facing near-term, this strategic combination remains compelling as we're doubling the size of our company and will transform the new enterprise through execution of the integration plan and delivery of these synergies. Moving to slide 13, we are focused on meeting and exceeding the commitments we made to our investors when we announced the merger in mid-January. We raised approximately $5 billion in bank and bond debt with favorable terms, and the bond offerings were substantially oversubscribed. We closed the transaction near the end of Q2, in line with our initial commitment to close in Q2 or Q3. We increased our liquidity to more than $800 million as of the end of Q2. We are rapidly executing our integration plan and have already completed actions to deliver over one-half of our year one cost savings target of $68 million. We're already generating sales synergies from the merger that are in addition to the minimum $200 million of cost synergies that we expect to generate. Turning to page 14, our top focus is executing a detailed, rigorous and process-oriented integration that delivers our committed synergies as well as the clear upside potential while combining the best elements of each company. The three objectives that our planning has encompassed are; first, executing a flawless day one and first 100 days post-closing that ensures business continuity and an effective on-boarding process; second, delivering the value of the combination through both the cost and sales growth synergies; and third, implementing an operating model for the new enterprise, which deploys cutting-edge digital tools and applications and is led by an organization that is staffed with the best leaders of each company. Value delivery teams, comprised of approximately 150 employees from both legacy organizations, have identified more than 500 initiatives and 2,500 milestones to combine the best of our two companies. The six value delivery work streams that we are working on in our integration planning and execution include commercial, digital and IT, supply chain, operations, marketing and the corporate functions. We are also mindful of the critical importance that culture plays in the value creation opportunity of this combination. We conducted a wide-scale and thorough survey of all employees to understand the key attributes of the cultures and are developing a plan to combine the best of both. The high degree of collaboration among and across these teams has been inspiring and underscores the strong cultural alignment between the two companies. We are taking advantage of the opportunity to leverage the best talent and ideas of two successful organizations as we create a new world-class enterprise. Turning to slide 15, this slide highlights our progress against the three core integration objectives outlined on the prior page. We achieved our first priority, which was to execute a flawless day one. Our various value delivery teams have spent months preparing for day one, which I'm pleased to report was very successful. We executed a detailed plan of communicating to our customers and suppliers, providing updates to our 18,900 colleagues and held multiple town hall events for our employees to get to know our new management team. Our second critical objective is to complete all of our master planning and value capture initiatives. Having generated more than half of our year one target of $68 million of run rate synergies, we're on track to exceed this target. We have deployed commercial targets for sales growth, margin improvement and cash flow, and are already experiencing success with our first cross-sell pilot program. Our final critical objective is to build a new world-class company. We have announced our three strategic business units and the first two levels of our senior management team. Moving to page 16, you can see the detail of the composition and expected timing of our synergies. Of the 45% that is corporate and administrative, approximately two-thirds will come from the elimination of duplicative general and administrative costs and one-third will come from corporate overhead. Of the 55% that will be generated from supply chain and field operations, the majority will come from supply chain efficiencies. The field operations estimate includes the footprint rationalization of both companies' branch networks. Approximately two-thirds of WESCO and Anixter facilities in the US are within 20 miles of each other. Additionally, with the combined $14 billion in total cost of goods, we have identified over $70 million of supply chain-related synergies. Both the supply chain and field operation synergies are expected to begin in year one, but the bulk of these opportunities will be realized in years two and three. We are confident in achieving these synergies and believe that they can be realized efficiently with minimal disruption to our day-to-day business. To date, we've already executed more than 30 unique initiatives across the four synergy types, resulting in more than $35 million of run rate synergies. We have eliminated duplicative public company-related expenses of approximately $7 million as well as C-suite and other duplicative roles that provided an additional $20 million in savings. Moving to page 17, both WESCO and Anixter have strong track records of generating free cash flow throughout the economic cycle. Over the past five years, the business has generated an average of $370 million in free cash flow on a combined basis. With the combination of earnings growth and the realization of cost synergies, we expect the annual cash generation of the combined company will expand to over $600 million per year by year three. This includes $75 million in free cash flow through the release of working capital. As we mentioned earlier, the strong free cash flow and earnings growth will enable us to rapidly deleverage the balance sheet. Our ratio of debt to adjusted EBITDA was 5.7 times as of June 30, 2020. Including year one synergies of $68 million, our leverage ratio was 5.3 times. We are expecting to return to leverage within our target range of 2 to 3.5 times net debt-to-EBITDA within 36 months. Moving to slide 18, both WESCO and Anixter benefit from several dynamics that make our company highly resilient to economic cycles. First, our cash flow is countercyclical as we release working capital during a downturn. Second, a cost structure that allows for quick adjustments in response to changing demand levels. And third, low required capital expenditures, given the nature of the business model. Over the past 10 years, WESCO and Anixter capital expenditures have averaged less than 0.5 point of sales. In the current environment, this resilience is enhanced by WESCO and Anixter's high degree of diversification by customer, supplier, end market and geography. Both WESCO and Anixter have proven abilities to delever through the economic cycle, as they both did from 2007 to 2011, when their net leverage was reduced to below 2 turns as a combined $1.9 billion of free cash flow was generated. Additionally, both companies have demonstrated the ability to use their cash flow to rapidly pay down debt following a sizable acquisition. In the case of WESCO, we reduced leverage from 4.5 turns to 2.7 turns, following the acquisition of EECOL in 2012. In Anixter's case, it reduced leverage from 4.1 turns to 2.8 turns in the two years following its acquisition of HD Power Solutions in 2015. This quarter was an excellent example of our strong countercyclical free cash flow, as the combined company generated $142 million in free cash flow or approximately 248% of adjusted net income. Moving to slide 19, you may have seen the press release we issued on August 6, announcing the consent agreement we reached with the Competition Bureau of Canada. We had closed the merger on June 22, 2020, as the waiting period for the Competition Bureau expired on June 18, 2020. Under the terms of the agreement, WESCO agreed to divest the legacy WESCO Utility and Datacom businesses in Canada. This includes the Utility businesses of Brews, Trydor and LaPrairie acquired some years ago. Combined, the WESCO Canadian Utility and Datacom businesses represent approximately $150 million in sales or less than 1% of the revenue of the combined organization. The divestitures will have no impact to the overall outstanding value creation opportunity of this merger. I'd now like to hand it back to John for a quick summary before we open it up to Q&A.

Thank you, Dave. Well, we've covered a lot of material this morning. So before opening the call to your questions, I'd like to just walk you through a quick summary. We responded with quick and decisive actions in response to the global COVID-19 pandemic. We will continue to aggressively manage our business, as we have done in prior economic cycles and respond to this crisis as needed. Just five months after announcing the definitive Anixter agreement in January, we completed a very successful and oversubscribed capital raise in May, and then we successfully closed the Anixter merger on June 22. Most notably, all of this was done against the COVID-19 backdrop. As I mentioned earlier, integration is off to an excellent start and execution is accelerating. We expect to exceed our cost savings, sales growth, margin expansion, and cash generation synergy targets, and deliver the substantial upside potential and value creation associated with this transformational combination. And finally, it's the start of a new era for WESCO. As an industry leader, we are now larger and more diversified with differentiated scale and capabilities in what remains a highly fragmented industry. As a result, we are exceptionally well-positioned to lead not only a digital transformation of our business but also of our industry. Overall, we are doing what we said we would do, and we will continue to transparently provide our progress versus our plan and our commitment. With that, I'd like to open the call for your questions.

We will now begin the question-and-answer session. The first question comes from Deane Dray of RBC Capital Markets. Please go ahead.

Thank you. Good morning, everyone, and congratulations.

Thank you, Deane. Good morning.

Hey. Really great to see how well you've hit the ground running on the cost synergy side and already realizing half of the first year target. And lots of good color on the merger rationale and the specifics and just really appreciate the color you provided today. Question I wanted to ask is, because we've hit you with this a couple of different times in the last five months, and with regard to some more specifics on Anixter's business practices, P&L and where and how are they able to generate such attractive margins. And the idea here was you were never able – you had not gotten full access to their books. Well, you have now. So, what have you learned that you didn't know before, maybe you have a higher degree of confidence that especially gives you this line of sight on margin expansion and maybe specifically gross margin? Start there, please.

That's a great question. To your point, when we had a clean room process in place, we couldn't get to the specifics on pricing and costing by customer and supplier, the construct of the margin, and the margin improvement programs. Since June 22 when we closed and crossed the wall, we've engaged our commercial teams and gotten much deeper insight. The bottom line is I'm more bullish than ever. As I've gained a much deeper understanding of where the strength is and how the business is run, it reinforces and reaffirms my expectations around the following. We have the global leader in communications and security, unmatched capabilities, and the operating and business models are outstanding. They generate very good margins from gross margins through to operating margins and return on total invested capital. Second, the wire and cable business is an undisputed leader. As we've gained deeper insight into that business, the power and structure of the margins from gross margins through operating margins and return on total capital is very strong. I had a view that they were both leading businesses, but now I have a much better sense and understanding of their true profit and cash generation characteristics. Furthermore, WESCO historically had some deficiency in wire and cable strength. We did not have the wire and cable capabilities of Anixter. So, for the first time in my WESCO tenure, we are in a unique position to sell the entire electrical package with very strong capabilities in core wire and cable. That's a high-level summary. One other observation: both companies are leaders in Utility, which speaks for itself. Probably the biggest surprise has been the excellent cultural match. Post close, we engaged the field teams and business leaders, announced the new business leadership structure, and found the cultural alignment to be exceptional. That cultural fit is enabling our rapid execution and early results.

That's all helpful. And just given how much of the integration roadmap you provided this morning and the progress you've made so far, my follow-up might surprise you a bit. Having covered WESCO for so long with multiple storm events, we have seen how WESCO provides critical support during power restoration. My house in Connecticut was without power for seven days, so I felt this real-time. We did have a generator, but still. Just give us a sense as to how you coordinated as the merged company in response to utilities. Did you have any supply chain issues? And where does that stand? And am I correct in assuming that's about a $10 million benefit, if I compare that to what you did with Sandy? So that's my follow-up. Thanks.

We have a robust internal process. Every week we communicate our integration successes from a dedicated integration office. Coordinating and operationalizing support for customers during storms was one of our top priorities. This was a wind-driven storm affecting the Northeast. Both WESCO and Anixter had Utility customers in the affected area. We looked across supply chain, supplier relationships and inventory positions, and mobilized resources as if we were one company. I'm very pleased with the rapid reaction and response executed by the combined team. In terms of meaningful sales impact, this event was not material so far. We will see over time whether there is permanent damage and rebuild demand, which would be captured in broader non-residential construction activity. For Q3 to date, the incremental sales associated with storm-related work are under $10 million, so it's not material to the quarter. That said, the coordination demonstrated the value of the combined capabilities and supports our claims of improved momentum.

That's exactly what I wanted to hear. Best of luck. Thank you.

Thank you.

The next question is from Sam Darkatsh of Raymond James. Please go ahead.

Good morning, John. Good morning Dave. I hope you both are well.

Good morning, Sam. I hope you and your family are safe and healthy.

Thank you. A couple of questions, if I could. First, the backlog growth is encouraging, up 17% year-on-year. This is a little more challenging for us to see, especially with the new segment reporting. Can you remind us right now, within your non-residential construction backlog, what your end market vertical mix is? Specifically, where we might see long-standing hotspots like office, retail and hospitality? And then remind us, what the total non-residential construction is pro forma as a percent of your mix? I've got a follow-up.

I'll start with WESCO backlog characteristics. The WESCO backlog reflects legitimate booked orders. I want to distinguish that from releases under multiyear global accounts contracts, utility alliance contracts, or large global capital construction projects that result in numerous releases over time and are not yet booked. Global accounts and utility alliances and large complex capital projects may not be reflected in backlog. The backlog we report is booked orders, and it is a good directional indicator of our project business versus MRO or OEM. The majority of that backlog is construction-related projects, but it includes direct end-user customer orders that are already booked, whether MRO, materials or projects, which would also show up in our backlog. The opportunity pipeline is exceptionally strong. Anixter also had strong backlog coming into the transaction and is up double-digits year-over-year in areas that will be part of our new Communications and Security Solutions business. We will provide a much more detailed presentation of our new segment reporting as part of Q3 earnings. We have announced our three strategic business units: Electrical and Electronic Solutions (EES), Communications and Security Solutions (CSS), and Utility and Broadband Solutions (UBS). We are operating under that structure internally and will report under it beginning with Q3 results. That presentation will provide details on what is in each of the three businesses, the end markets they serve and the operating characteristics.

And total non-residential construction pro forma as a percent of your mix?

That's an important point. We have dramatically reduced our exposure to the more cyclical portion of non-residential construction. It is now roughly 24% to 25% of total company mix on a pro forma basis. To put that in perspective versus earlier days, the standalone WESCO business used to be heavily concentrated in construction; today, we sit at approximately a $17 billion revenue base with roughly 24% to 25% non-residential construction exposure.

So after the Canadian divestiture and following the close of the Anixter deal, there may be other businesses you consider non-core or potential sources of cash. What are your thoughts in terms of other planned contemplated divestitures at this point?

We are conducting an unconstrained, clean sheet evaluation of all businesses across the enterprise and particularly how they align with our three global strategic business units. This work ramped up in earnest after close because we could fully engage business leaders. Right now, I feel terrific about the portfolio and the mix shift toward higher-growth end markets that align with leading value propositions. That said, there may be areas that are not strategic or core that could be suitable for disposition. We're reviewing the portfolio and have nothing specific to report yet, but we are evaluating all options.

So the 2 to 3.5 times target leverage in year three does not contemplate any material divestitures or equity raises? It would be entirely an organic free cash flow and EBITDA growth story?

Correct. We are highly confident that returning to our target leverage range will be achieved through organic free cash flow generation and EBITDA growth. The Q2 cash generation demonstrates our free cash flow capability and supports our three-year targets. Any disposition of non-core assets would only accelerate deleveraging.

Very helpful. Stay well.

Thanks.

The next question is from David Manthey of Baird. Please go ahead.

Good morning, everyone.

Good morning, Dave.

Good morning.

First off, thanks for the insight into how you're going to segment report this going forward. As you roll into these new segments, will EES be Anixter EES plus WESCO construction and industrial, and CSS be Anixter NSS plus WESCO CIG, or will you reshuffle and give us restated historicals?

We will provide a detailed presentation in Q3, but generally think about it this way: EES includes WESCO's deep electrical roots combined with Anixter's legacy wire and cable business and the electrical portion of HD Supply Power Solutions. EES will be the largest global business. CSS will include Anixter's NSS legacy business and WESCO's Datacom business and AV capabilities. Bill Geary will lead that segment. UBS, Utility and Broadband Solutions, includes both companies' Utility businesses and broadband/outside plant capabilities, combining complementary assets including HD Supply's prior Utility business. Each segment will be global, and we'll present historicals and a detailed breakdown as part of Q3 reporting.

I did want to talk about the core SG&A reduction, which is clearly a highlight of this quarter. How much of the $33 million in legacy WESCO OpEx reduction was COVID related that we should expect will come back in the third quarter versus cost that'll only feather back in with volume? Second, did any of the synergy benefits hit the second quarter at all? And third, should we assume roughly half of the $68 million goes into the third quarter for synergy capture?

I'll address the COVID-related savings posted in Q2. We talked in April about delivering $50 million of run-rate savings versus Q1 on the legacy WESCO business, realized in Q2 through Q4. We delivered greater than $20 million of that $50 million in Q2. These were primarily temporary measures to address lower demand, so most will come back as sales recover. Our salary reduction plan was only in effect until the end of Q3, so those costs will be restored beginning in Q4. We did not record any synergy savings in the legacy WESCO or legacy Anixter numbers during Q2. We anticipate seeing some of those savings beginning in Q3 and will call them out in our results.

Okay. Thanks a lot for the time, guys.

Thanks, Dave.

The next question is from Nigel Coe of Wolfe Research. Please go ahead.

Thanks. Good morning, everyone.

Good morning, Nigel.

How did the legacy Anixter pro forma numbers look for 2Q? The 10-day contribution was exceptionally strong, especially at the margin line. How did the pro forma numbers look during 2Q?

The legacy Anixter businesses performed relatively in line with the legacy WESCO numbers. By their previously reported segments, their NSS sales were down roughly 13%, EES was down 22%, and their Utility business was down just under 4%, on a like-for-like basis.

The 10% contribution margin within that bridge: was that just the seasonality we normally see, or was there something else that explains that 10% margin contribution?

That's correct. The nine days of ownership post-closing saw a relatively higher level of sales from the legacy Anixter business on a roughly level-loaded SG&A, which drove the higher margin in that stub period for Anixter.

And then a quick follow-up: you're very confident on the free cash flow bridge and deleveraging story. Is equity off the table here? Or is there a level of stock price where you would contemplate coming back in with a treasury issuance?

When we originally financed the transaction, we decided to use debt rather than equity after considering market conditions and the value proposition. Today, looking at our three-year financial targets and the upside potential from cost and sales synergies, our intrinsic value should be multiples higher than current trading levels. At present stock prices, equity issuance would be highly dilutive relative to the value we expect to create. Our plan is focused on deleveraging through free cash flow and synergy realization, but we will evaluate all options in the context of maximizing shareholder value.

Very clear. Thanks John. Thanks, David.

The next question is from Michael McGinn of Wells Fargo. Please go ahead.

Morning, everybody.

Morning.

Good morning.

Feels good to be back covering WESCO again. As we switch gears from decrementals to hopefully incrementals by year-end, you mentioned the $75 million release in relation to the long-term free cash flow target. Can you frame what a near-term recovery looks like, specifically in terms of working capital? Does the combined business have a different working capital load-in versus a standalone entity, given supply overlap with Anixter?

Typically, we can rapidly reduce net working capital during a downturn and see it return as sales recover, primarily driven by accounts receivable. We haven't provided specific guidance for 2020 on net working capital, but we are laser-focused on it. We believe there are significant working capital synergies from the combination and have included $75 million of net working capital release in our three-year forecast. We haven't provided specific timing on when that release will occur.

Okay. And July was a tough comp last year. Can you frame how much of that played into the quarter-to-date decline of 8%? What are you seeing in terms of recovery broadening by end market?

We focused on sequential performance because we're still down year-over-year. Q2 results came in better than expectations in several areas. Construction and industrial were better than we thought, and construction for WESCO is largely non-residential, with very low residential exposure. We expect to see resi-driven demand eventually flow into non-resi projects, but that is a different timing pattern. We concentrate on sequential improvement: grow sequentially until we reach flat year-over-year and then rebuild growth. As we moved into Q3, the improving momentum continued through July and into August. We reported record backlog and a book-to-bill above 1.0. We are focusing on what we can control: operations and sales execution. Historically, during downturns we have doubled down on end-user customers and sold broader solutions, which paid dividends as cycles turned. Both WESCO and Anixter have a strong set of end-user relationships, which is a distinctive advantage and part of our strategy to win market share as the cycle recovers.

Makes sense. Thanks for the time.

Thanks.

And the last question today comes from Chris Dankert of Longbow Research. Please go ahead.

Hey, morning guys. Lot of detail—thanks so much for all the color thus far. Thinking about the reformatted segments, how are legacy WESCO businesses and new Anixter pieces talking to each other within the new segments? I know Anixter had plans to convert systems like SAP. Where do we stand on technology and internal communication?

We're operating under the new structure and have defined top levels of management. We are building out the organization and expect to complete the remaining layers in Q3. Collaboration and teamwork are excellent. In terms of systems, both IT teams have done strong work connecting the two systems. We have built internal applications that allow us to analyze across disparate systems to leverage combined inventory, view customers on a combined basis and identify cross-sell opportunities. Those custom apps are being used to measure and drive cross-sell synergies. We'll decide on longer-term system consolidation plans as part of the integration roadmap.

Thanks. Any further detail on the Canada business beyond the divestiture? Is it still a higher-margin business overall for WESCO?

Yes, Canada remains a strong, higher-margin business relative to some markets. It has inherently higher market share and a terrific team. With the combination, our overall market position across North America is much stronger. Customers are consolidating suppliers, which plays to our advantage. The combination springboards us to be more aggressive and create more value for customers across the region.

Is cross-selling opportunity bigger internationally or cross-segment?

There are cross-segment and some global cross-border opportunities, but the largest immediate opportunity is cross-segment. Anixter lacked safety and lighting, which WESCO provides, and WESCO lacked Anixter's wire and cable and communications and security scale. We can bring safety and lighting to Anixter customers right away and introduce wire and cable and communications to WESCO customers. That is a top priority and where we see early sales synergies.

Thanks for the color, John, and best of luck going forward.

Thank you.

This concludes the question-and-answer session. I would like to turn the conference back over to John Engel for closing remarks.

It was a very busy quarter. I think you all got a sense of that. We feel really good about how we closed it out, and we're looking forward to executing strongly here as we go through the next two quarters and close out this year, which has been challenging. With all that said, thank you for your time this morning. Brian and Will are available to take your questions. We look forward to meeting with you in person as our investor events eventually resume. In the meantime, please stay safe and healthy. Have a great day.