Wesco International Inc Q4 FY2020 Earnings Call

Good morning, and welcome to the WESCO Fourth Quarter and Full Year 2020 Earnings Conference Call. All participants will be in listen-only mode. The operator provided instructions. After today's presentation, there will be an opportunity to ask questions. The operator provided instructions. Please note that this event is being recorded. I would now like to turn the conference over to Leslie Hunziker. Please go ahead.

Thank you, and good morning, everyone. 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 future 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 changed circumstances. Today we will use certain non-GAAP financial measures. Required information about these non-GAAP measures is available on our webcast slides and in our press release, both of which are posted on our website at wesco.com. On this call this morning we have John Engel, our Chief Executive Officer; and Dave Schulz, WESCO's Chief Financial Officer. Now, I'll turn the call over to John.

Well, thank you, Leslie. And a warm welcome to WESCO, it's great to have you on the team. Good morning, everyone. And I hope that all of you have been staying safe and healthy. I'll start out with a summary of 2020 and some of our most notable accomplishments. Dave will take you through at that point an update on our rapid progress that we're making on integrating Anixter. And I'll take you through our fourth quarter and full year results, and then give you an overview of our outlook for 2021. After that, I'll offer a quick recap before we open the line for questions. So starting up, 2020 was an extraordinary year for WESCO. We completed a transformational acquisition of Anixter, doubling the size of the company and changing our trajectory for years to come. We're off to an excellent start, and I'm more bullish than ever on delivering against our substantial value creation potential. In addition, I'm inspired by and we'd like to thank all of our associates for their dedication, commitment, resilience and extraordinary effort in serving customers during the global pandemic. As most of you know, we announced our agreement to acquire Anixter International last January. And we were very pleased to close the transaction a little more than five months later. The first six months of the integration have gone exceptionally well. Our synergy capture exceeded our expectations, both in terms of size of the opportunities, as well as the rapid pace of our execution. You'll recall, last quarter we increased our three-year post-merger cost synergy target from $200 million to $250 million. In addition, the highly complementary nature of WESCO and Anixter, and our substantially larger scale has enabled us to build a cross-sell pipeline that's starting to show up in our top-line results, and this is very encouraging. At the same time that we're working towards closing the transaction and beginning integration, we're managing through an incredibly challenging macro environment driven by the COVID-19 global pandemic. In response to this, we took quick and decisive actions that are really on three priorities, and we've talked about this in the past. First, protecting our employees. Second, ensuring that our customer experience, service and support was seamless and exceptional. And number three, taking the necessary actions to reduce our cost and efficiently manage our operations. The diversity of our end markets, our differentiated service offerings, our global footprint and the attractive secular trends we support help temper the effects of COVID-19 on our business last year. On the right-hand side of this page, you can see the attractive secular growth trends that are driving demand for electrical, communication, security and utility solutions, all of which will continue to drive demand in the years ahead. All three of our strategic business units have the scale and capabilities to deliver growth associated with the increasing use of automation, machine-to-machine connections, the electrification of our infrastructure, and the demand for faster bandwidth and data center capacity. Emerging growth trends such as the relocation of supply chains back to North America, and increased remote connectivity also drive additional growth opportunities. In combining WESCO and Anixter, we have created the industry leader in electrical, communications and utility distribution and supply chain services, just as these secular trends are poised to drive strong growth in all the markets we serve. Now moving to Page 5, during our second quarter earnings call in August, we highlighted our priorities for the second half of 2020. They were to take share, deliver synergies, and focus our free cash flow generation on debt reduction. In the fourth quarter, we saw improving sales momentum coming out of the COVID-19 trough, and are successfully utilizing our increased scaling capabilities to take share. Sales were up 4% sequentially in Q4, on a workday adjusted basis, when typically our sales declined sequentially in the fourth quarter. We closed the year with a record year-end backlog, which sets us up well to continue building on this positive momentum in 2021. Even more importantly, January sales reflected a return to year-over-year sales growth, with sales up low single digits on a comparable workday basis. We've made great progress across the board on our synergy capture efforts. Our team is laser-focused on driving synergies. As we have combined into one organization, we've made great progress in reorganizing and recognizing the savings from duplicative corporate overhead and functional integration. Adjusted gross margin was up versus a pro forma prior year for the second consecutive quarter. Our management team is now in place, and we've been able to streamline roles across functions for greater efficiency. We're on track to meet the higher synergy targets that we announced last quarter, and have very high confidence in delivering upside to these targets. Free cash flow was another major highlight for us in 2020; we generated $586 million of free cash flow last year, close to the $600 million target that we set for three years out, and more than 250% of our adjusted net income. This enabled us to reduce net debt by almost $400 million and leverage by 0.4 times in just the first six months since Anixter closed. And last month, we completed a debt refinancing of our 2021 notes that reduces our interest expense by $20 million per year, which will further enhance cash flow and support achieving our 2023 debt reduction and debt repayment target. Overall, we are very pleased with the results we're delivering on all fronts. We're entering 2021 from a position of strength, with an unwavering commitment to our strategies and growth plan, and an extraordinary team of associates and outside partners. Coupled with our strong execution and accelerating progress on the integration, we have very high confidence in our ability to deliver sustainable, long-term value creation. 2021 will be another positive and important stepping stone in our transformational journey. With that, I'll turn the call over to Dave, who will take you through our financial results. Dave?

Thank you.

Thank you, John. Before getting into the results for the fourth quarter, I'd like to address where we are with cost synergies from the integration with Anixter. When we announced the merger with Anixter back in January of 2020, we anticipated a mid-2020 close and provided investors with our view on synergies for the first three years post-close. On Slide 7, you'll see that we've converted our synergy timeline to align with our fiscal year-end. This chart on the left side of the slide shows the cumulative realized cost synergies that we expect to generate by fiscal year. Realized synergies are those that are reflected in our income statement. In the first six months post-close, we have realized $39 million of cost synergies, $15 million in Q3, and $24 million in Q4. In 2021, we expect to realize an additional $90 million of synergies, bringing our total to $130 million by the end of the year. Consistent with the expectation we provided on our last earnings call, we still anticipate realizing $100 million of cost synergies in the first 12 months of the merger, through June of 2021, with a cumulative cost synergies of $130 million by December. In addition to the cumulative cost synergies, we have shown the cumulative one-time operating expenses to achieve the synergies below the bar chart. As you can see, we have spent $37 million in one-time operating costs in the first six months, and expect to spend an incremental $78 million on one-time operating expenses to generate the incremental $90 million of synergies in 2021. By June of 2023, we expect to generate $250 million of realized cost synergies on a trailing 12-month basis. In total, this $250 million target is comprised of initiatives that are approximately 20% related to cost of goods sold, and approximately 80% related to reducing operating expenses. This is consistent with the sources of synergies we previously discussed, and we expect the synergies related to corporate overhead, G&A and field operations will drive the SG&A synergies, with the majority of the supply chain synergies impacting cost of goods sold. Turning to Slide 8, in Q4, we delivered another quarter of strong free cash flow that represented more than 160% of net income. For the full year, free cash flow was $586 million or more than 250% of adjusted net income. This level of free cash flow generation highlights WESCO's ability to generate strong cash flow throughout the economic cycle, and especially during down cycles like the one related to COVID-19. This resilient model, coupled with our execution on the integration with Anixter gives us very high confidence that we will successfully reduce leverage below 3.5 times adjusted EBITDA over the next two and a half years, consistent with our commitment when we announced the merger. Our capital allocation priority remains unchanged. We will allocate capital to support the integration, invest in our business and rapidly delever the balance sheet. We made substantial progress on this goal in 2020, as we reduced net debt by $389 million and leverage by 0.4 times trailing 12-month adjusted EBITDA since closing the Anixter acquisition in June. Net debt was reduced by $109 million in the fourth quarter, following our first semi-annual payment of $103 million of interest and our new 2025 and 2028 notes. Liquidity, which is comprised of invested cash and borrowing availability on our bank credit facilities, is exceptionally strong and totaled $1.1 billion at the end of the fourth quarter. In early January, we increased the size of two bank credit facilities by a combined $275 million. We utilized this higher capacity and existing availability to retire our $500 million 2021 notes. Turning to Page 9, this summary table compares our fourth quarter adjusted income statement results to the pro forma for the prior year period, and our adjusted results in the third quarter. Because Anixter and WESCO had different fiscal reporting periods, there was an extra week of Anixter sales in the fourth quarter of 2019, making comparisons to that period less meaningful. For that reason, most of my comments today will be on the sequential comparison against the third quarter. On a reported basis, sales were flat versus the third quarter. It is important to note that the fourth quarter had three fewer work days compared to the third quarter. When adjusting the results to a comparable workday basis, sales were up more than 4%. The momentum has continued into January with workday adjusted sales up low-single digits versus the prior year. Adjusted gross margin, which excludes the effect of merger-related fair value adjustments to inventory, and an out-of-period adjustment related to inventory absorption accounting was 19.6%, in line with the prior quarter and up 10 basis points versus the prior year. We are seeing continued traction from our margin improvement initiatives, including early results from deploying Anixter's proven gross margin improvement programs across the combined business. Note that the out-of-period adjustment relates to the cumulative effect of the adjustment to inventory since WESCO was spun out of Westinghouse, and no period was the adjustment material to our reported results. Adjusted income from operations was $172 million in the quarter, after adjusting to remove the effect of merger-related costs of $40 million, merger-related fair value adjustments on inventory of $16 million, and the out-of-period adjustment of $23 million related to inventory absorption accounting. Adjusted income from operations was $28 million lower than the third quarter, which primarily reflects an increase in SG&A related to the discontinuance of temporary cost reduction measures we had taken in response to COVID-19. As we had highlighted in our Q3 earnings call and reiterated in the 8-K that we filed on December 15, we reinstated the full salaries of legacy WESCO employees, instituted 2020 merit adjustments and resumed the retirement savings plan employer matching contributions, effective October 1, 2020. These measures along with certain other actions had generated more than $50 million of savings during the second and third quarters of 2020, relative to WESCO’s Q1 SG&A run rate before the merger. In total, adjusted income from operations was $13 million lower than prior year pro forma, on sales that were $223 million lower, representing a decremental margin of approximately 6%. Adjusted EBITDA, which excludes the effect of the adjustments I just mentioned, as well as stock-based compensation and other net adjustments was $216 million or 5.2% of sales, lower than the third quarter due to the higher SG&A I just discussed, and approximately in line with the prior year. Adjusted diluted EPS for the quarter was $1.22. A full reconciliation of adjusted EPS is included in our press release. Before getting to the SBU results, I'd like to remind you of our new three-segment structure on Slide 10, which we introduced in the third quarter. First, Electrical and Electronic Systems, or EES, which is approximately 40% of our company's total business. Second, Communications and Security Solutions, or CSS, which is roughly one-third of the company's revenue. And then third, Utility and Broadband Solutions, or UBS, which represents the remaining 27% of the overall sales across the enterprise. As we have said previously, one of the most meaningful and positive discoveries post-close is how complementary the WESCO and Anixter portfolios are. The pie charts on this page depict the legacy WESCO and legacy Anixter composition for each of the three businesses. It is this very highly complementary suite of products and solutions that enables us to offer even more end-to-end solutions for our customers, and supports the cross-sell programs John mentioned. Additionally, we found that customer overlap between the legacy companies was more favorable than expected. Turning to Slide 11, reported sales in our EES segment were up 1% versus the third quarter on a reported basis, and up 6% on a comparable workday basis. This growth reflects improving construction demand in North America in the second half of the year, as well as the first sales from our cross-sell initiatives and our ability to offer a complete electrical package to our customers. We have continued to see some project delays, primarily driven by COVID-19, but still no cancellations. EES backlog was a fourth quarter record, consistent with the trend we have observed since last March, as some projects are delayed, and we continue to be awarded new projects. We also continue to see increasing momentum in our industrial and OEM business. In the fourth quarter, MRO and project activity levels improved in all of the verticals we serve. Adjusted EBITDA of $94 million represented 5.6% of sales, about $14 million lower than the third quarter. The decrease primarily reflects higher SG&A due to the reinstatement of the temporary COVID-19 cost reductions discussed earlier. Turning to Slide 12, our CSS segment closed at a strong year in part, driven by an increased focus on bandwidth needs stemming from COVID-19, as well as our global scale, which offers greater value to our customers. On a reported basis, sales were 1% lower than the prior quarter, but were up 3% on a comparable workday basis. We are taking share in all geographic regions and especially in areas outside the United States. As with EES, we saw continued positive momentum throughout the quarter. Specifically, we experienced growth in our network infrastructure markets that was driven by increasing global accounts and continued strong demand in data centers, in-building wireless and professional audiovisual applications. Sequentially, security sales were up low single digits on a comparable workday basis, driven by expanding demand for secure network and IP security applications. CSS is uniquely well-positioned to benefit from several of the secular growth trends that we have highlighted as the pace of technological innovation, demand for data and reliance on security are all driving an accelerated pace of both new installations and upgrades to existing systems. Profitability was strong; adjusted EBITDA was $112 million, or 8.2% of sales. This was 50 basis points higher than the prior year, but down sequentially from the third quarter, primarily reflecting the reinstatement of temporary cost reductions. Turning to Slide 13, sales in our UBS segment were down slightly versus the third quarter on a reported basis, but up 4% on a comparable workday basis. Strong utility demand continued this quarter, as our utility customers continue to invest in grid hardening and modernization projects, as well as LED lighting and automation projects. The broadband business was also resilient to COVID-19, driven by 5G deployments, last-mile fiber installations and increasing broadband projects. The global demand for data and high-speed connectivity has never been greater due to the step change in requirements driven by remote work and school environments. Adjusted EBITDA of $79 million was in line with the prior year and up 10 basis points as a percentage of sales. Adjusted EBITDA margin was down sequentially on slightly lower sales, and the restoration of COVID-related cost actions. Turning to Slide 14, I'll walk you through our outlook for 2021. On a pro forma basis, sales were $16 billion in 2020. In 2021, we estimate market growth of roughly 3% to 5%. We recognize that COVID and the timing of broad scale vaccinations may create volatility and influence the overall demand pattern of our business. We are encouraged by the economic indicators and expect the demand environment to continue to improve, as we progress through 2021. On top of that, we expect that the combination of continued outperformance in our cross-sell programs will grow sales 1% to 2% above the market. Lastly, keep in mind that 2021 has one fewer workday than 2020, and we will have the impact of the U.S. brand sale completed in Q3 of 2020, as well as the expected completion of the Canadian divestitures in the first quarter. Aggregate sales relating to divested businesses are approximately $125 million. The impact of these will be a headwind of approximately 1%. So in total, we expect sales to grow 3% to 6%. We expect differences in foreign exchange rates to be neutral to slightly favorable for the full year. On the right-hand side of the page, we have provided the bridge for our 2020 pro forma adjusted EBITDA margin of 5.3% to our outlook for adjusted EBITDA margin of 5.4% to 5.7%. We expect to benefit from improving mix, market outperformance and operating leverage, which we expect to collectively drive about 50 to 80 basis points of margin expansion. In addition, as you saw on the prior page, we expect to generate an incremental $90 million of realized cost synergies in 2021, which will contribute approximately 55 basis points of additional EBITDA margin. Partially offsetting these two margin drivers will be the restoration of the employee compensation benefit costs discussed previously, and the restoration of a full accrual for incentive compensation, the aggregate amount of which is approximately 90 basis points. Continuing down the income statement, we expect our effective tax rate to be approximately 23% and adjusted diluted EPS in the range of $5.50 to $6. We assume a diluted share count of approximately 51.5 million shares. We expect to spend between $100 million to $120 million on capital expenditures in 2021, much of which will be invested in the early stages of aligning our systems and investing in digital tools. We expect to continue generating substantial free cash flow, which we're forecasting to be at least 100% of adjusted net income. As we look at the drivers of the first quarter of 2021, we expect to benefit from $28 million of realized cost synergies in the quarter. Please keep in mind that the first quarter has two fewer workdays than the first quarter of 2020, as shown in the table. With that I'll return the call back to John for his summary.

Thanks, Dave. We covered a lot of material this morning. Before opening the call to questions I'd like to walk you through a quick summary. Again, 2020 was a transformational year for WESCO and highlighted many of the company's strengths. First, we responded with quick and decisive actions as I mentioned earlier, due to the global COVID-19 pandemic and delivered excellent performance through the downturn. Number two, our integration with Anixter is off to an excellent start and it is accelerating. We made substantial progress on the integration in just the first six months, and we're very pleased to be able to increase our synergy targets. Our new leadership team is the strongest management team in our history, and is driving our high performance culture. We have launched our cross-sell programs in all three of our business units, and are already seeing positive results. And three and most importantly, the business is uniquely well-positioned to capitalize on the highlighted secular growth trends that will drive demand for our full spectrum of end-to-end solutions for years to come. 2020 marked a watershed year and the beginning of a new era for WESCO. As the industry leader, we are now larger and more diversified with differentiated scale and capabilities, in what remains a highly fragmented industry. We're exceptionally well-positioned and intent to lead not only a digital transformation of our business, but also of our industry. So with that, I'd like to open the call for questions.

We will now begin the question-and-answer session. The operator provided instructions. The first question comes from Sam Darkatsh with Raymond James. Please go ahead.

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

Good morning, Sam.

Two questions if I may. First, you're calling out, I guess if my math holds, about $150 million of resumed costs in fiscal '21 from COVID restoration, incentive compensation, and so on. We knew about the $50 million specific to COVID. The $100 million of incentive compensation and benefits, at least to me, was a surprise in its scale. To the extent that it doesn't look like you're going to be levering the $500 million to $1 billion dollars in incremental sales on an organic basis. First off, I think my math holds, but why not lever that type of incremental sales, especially knowing that price and price cost and presumably building margins are going to be favorable for you this year?

Yes. Sam, good morning. Thank you for the question. We were very clear that we had $50 million on the legacy WESCO business that was COVID-related actions that we took in 2020. Obviously, that's being restored as we entered 2021. We also mentioned on several of our earnings calls that our results were well below our expectations coming into 2020. And as such, we have not paid out or accrued for full incentive compensation and sales commissions here in 2020. You see that in our results. So, similar to what we've done in previous years, our intent is to include 100% target payouts, not only on the incentive compensation, but also our sales commissions. We also do have a couple of other volume-related increases to SG&A, including some higher benefits costs that we've included in that outlook of a 90 basis point drag for 2021.

Okay. My second question, if I may. You had $24 million in synergies that you realized in the fourth quarter, and it looks like you're guiding the $28 million in the first quarter. I would have thought that the synergy recognition would have been a step function higher, meaning a meaningful step function higher in the first quarter over the fourth quarter because of the timing of vendor supply agreements and then rolling over and therefore your benefits to purchasing. Is there an offset to that? Or what am I missing in terms of thinking about sequential synergies Q1 over Q4?

Yes. Sam, a lot of the benefit that we're expecting to see in the first quarter particularly will really be more on the SG&A side. You are correct that we are continuing to focus on some of our supplier agreements and getting the alignment between the two legacy programs. Obviously we've included some of that in our expectations for the adjusted EBITDA margin. But right now, at this point, we don't expect there to be considerable cost-of-goods synergies, at least in the front half of the year for 2021.

And Sam, let me just make a comment, because I think both your questions get at this, which is, what I want to be very clear, that we have high confidence on our upside. And the upside is sales, sales growth, cost synergies, margin expansion and free cash flow generation. Our confidence is the highest it's ever been. As we've gone through the first six months plus post close, our confidence has increased, quite frankly. But we did not and appropriately, we believe, did not build that into our 2021 guide.

Very helpful. Thank you, gentlemen.

The next question comes from Deane Dray with RBC Capital Markets. Please go ahead.

Thank you. Good morning, everyone.

Good morning, Deane.

Hey, I'd like to pick up where Sam left off there. In terms of the rollback of the temporary cost, it looks like it hit the Electrical segment disproportionately, just in terms of the margin hit. And I know you've given for 2021 you size it at 90 basis points. What was it for Electrical? Maybe for the three segments in the fourth quarter, because it just feels like there wasn't a feathering back of these costs, but it was more just a full reversion there. So just take us through the size that maybe that'll help us calibrate the impact?

Yes, certainly. So, going back to what we talked about in the third quarter, on our COVID-related cost actions, again, this was really on just a legacy WESCO business. And obviously we've done quite a bit of work to begin the integration. But, as we highlighted that COVID-related costs reduction of $50 million as part of our Q1 earnings call, as you see, we had $28 million of benefit from that program in the third quarter that basically came back in the fourth quarter as we restored those activities. If you take a look at the composition of our strategic business units, there are more sales from the legacy WESCO business within the EES SBU and therefore they took a higher portion of that recovery of COVID-related actions within the fourth quarter relative to the other two SBUs. So that's really what's driving that margin degradation in EES relative to the sequential numbers from Q3.

That is actually very helpful. We're just looking at the context of having higher legacy WESCO sales in the Electrical segment. That's a good input there. And then…

And Deane, on that again, it was temporary salary reduction, which then the benefits came with that 401(k) match. It was a very, as you know, and we’ve articulated a very aggressive set of actions and so that mix effect is what you're seeing as Dave highlighted.

All right. So that color is helpful. And then second question on Page 7, the whole cost synergies timeline. Just as a reminder, these are net synergies. And are you seeing any sort of lost sales and branch consolidations, sales force reductions or any of the revenues walking out the door?

So I'll answer the second part, and Dave may want to tag on the first. The very encouraging answer to this is, we have not, Deane. We feel very good about our momentum in the marketplace. And we're not seeing—first of all, we have structurally addressed the combination of two companies with structural cost takeout. And we highlighted that we had over 650 full-time equivalents that have left the business. So we've been working that, we've not seen unplanned or unwanted attrition, point one. Point two, we are not seeing any share leakage. So we're very encouraged by the results thus far.

That's helpful. Thank you.

And Deane, let me address your question on Slide 7 of our deck. What we're showing here are essentially the gross cost synergies that we expect to achieve, which would be a structural takeout versus our 2019 pro forma. And we were showing you separately the cost to achieve which would be one-time in nature.

The next question comes from David Manthey with Baird. Please go ahead.

Thank you. Good morning, everyone. First question, you don't mention price in the sales outlook, but with copper and other industrial commodities being up as much as they are, how are you thinking about price increases in 2021? And related to that, we talked about the 50 to 80 basis points of EBITDA improvement for mix, share and leverage. How much of that is mix alone? Are you assuming gross margins higher in 2021?

So Dave, for our outlook, we have not specifically called out the inflationary benefits that we would expect to see as commodity prices increase. It's always extremely difficult for us to project what that would look like for the full year. So clearly, we have seen what's going on within the current market, we know what's volatile. And our expectation is that as we see those cost increases, we will continue to pass them through to our customers. But inherently we have not built that into our outlook for 2021.

And Dave, I will comment on gross margin. We're not guiding gross margins, but I'll give you some indication of how we're thinking about it. Because clearly, we're now seeing—if you look at the first quarter of this year, supplier price increases that we are aware of have been communicated, and we also have knowledge of what suppliers are intending to do to some degree before everything is fully rolled through. We work with them in conjunction. The number and overall average of those price increases has increased. So clearly above a year ago, we're seeing that momentum build. Net-net, that'll be a good thing and it will be a positive support for our margin expansion. We absolutely intend and are very focused on getting core gross margin expansion this year. We're just not guiding to that level. And what we've done and we've talked about in the last two quarterly earnings calls, Anixter did an outstanding job with their multiyear margin improvement program. We've taken that program and made some refinements. We incorporated those improvements and that is being deployed enterprise-wide. So the refined version from Anixter has been deployed; enterprise deployment is underway. Across WESCO, we do fully intend and expect to see core gross margin expansion. Anixter delivered more than 2.5 years of gross margin expansion looking back every quarter. That environment is going to get a bit better here with inflation increasing. And then finally, we've got unmatched supply chain capabilities. If you look at the two together, strategically, we've doubled the size of the company and we've got unmatched supply chain capabilities. We are in the process now of going through our category review, category by category, and looking at the complete supplier line-up. It's part of that integration work to drive business through to our preferred supplier partners. That inherently will result in a larger, more strategic relationship with them. Net-net, together we will be able to provide even better value, and I think that will be margin accretive as well. Does that help?

It does. Thank you very much, John.

The next question comes from Christopher Glynn with Oppenheimer. Please go ahead.

Thanks. Good morning, John, Dave. You guided adjusted EBITDA margins for the segments, for the DNA, in order to kind of bridge to the adjusted earnings on the P&L. Is the fourth quarter a good annualized run rate for the segments in total? What are you expecting for DNA?

It's a good proxy for what we're expecting for DNA in 2021. I mean, with the fourth quarter, you can see how our DNA came down slightly versus Q3; that's a good starting point as you're thinking about 2021.

Okay. And back to Slide 7, in cumulative one-time cost, can we tell the incremental amount; I believe that gets adjusted out within the merger cost buckets each quarter, just want to verify that?

That is correct.

Okay. And then in terms of the restoration of costs, that $150 million for Sam's accurate math there, how much of that run rate would you say was realized or restored in the fourth quarter, maybe on a percentage basis?

The only thing that really hit us in the fourth quarter, Chris, was that restoration of the COVID actions. And so, relative to Q3, we restored a little over $28 million of COVID-related cost actions here in the fourth quarter. The balance is really what we're expecting in terms of primarily target payouts, and the impact of inflation on some of our benefits programs for 2021 that have not impacted 2020 in our numbers.

Okay. Thank you.

The next question comes from Nigel Coe with Wolfe Research. Please go ahead.

Thanks. Good morning.

Good morning, Nigel.

I hope as well. Just wanted to dig a little bit deeper into Slide 14. Now in your adjusted EBITDA margin targets that exclude stock-based comp but stock-based comp hits. So I just wanted to size that. I think it's $35 million in 2020. Just wondering what that is? And then interest costs below the line, what should we dive into that?

Certainly. So the stock-based compensation, you should assume approximately $35 million for a 2021 impact. And again, as you mentioned, we do exclude that when we talk about our adjusted EBITDA, but that impact is included in the adjusted EPS numbers.

And then interest?

For interest expense, you're probably looking at somewhere in the range of $67 million to $70 million per quarter in 2021, that's taking into account what you saw here in Q4. But then we also do have the benefit of the 2021 notes being called. And we'll also be obviously managing our facilities down aggressively.

Okay. So $67 million to $71 million per quarter. My broader question is that when I put all these inputs into my model, I was struck against your EPS guidance range. So I'm wondering, if there's some conservatism or hedge baked into that range over and above all the inputs you've given us? Thank you very much.

Again, we've given you a fairly clear view of our expectations throughout the income statement. We've also provided you with our view of what you should expect in terms of the free cash flow generation. Again, we know that there's some volatility in the end markets. We're laser-focused on not only meeting the expectations we set on delivering the synergies, but exceeding them. And so, I'll let you draw your own conclusion in terms of how we put together the guide. Again, we believe that we are just starting to see the true benefit of the strategic combination of WESCO and Anixter coming together in 2021, in terms of top-line and our ability to drive cost synergies.

And Nigel as I mentioned earlier, again, very high confidence we have substantial upside, completely down the P&L and with cash generation. Again, look at our cash generation in 2020, a little under $600 million, which is the three-year target that we have set. And again, we did not build that into the guide and we think appropriately so. Let's keep in mind that there are a lot of positive indicators around overall market recovery. We feel very good about our trajectory, because we think we're accelerating and doing better than market. But we're not fully recovered yet. And there's still many, many customers who have not returned to work. And so that's what also informs what we think is an appropriate guide.

Great. Thanks, guys. I appreciate that.

The next question comes from Tommy Moll with Stephens. Please go ahead.

Good morning, and thanks for taking my questions.

Good morning.

Good morning.

I wanted to start on your outlook for revenue this year. If I'm interpreting correctly, I think we're looking at up 3% to 6% year-on-year across all three segments. But could you give us any insight, maybe a rank ordering of segments which might skew toward the higher end of that range or the lower? Or relatedly any kind of specific end market color you could give would be helpful? Thanks.

Sure. The three businesses—I'll start with the one that is the most global and the second largest is CSS, Communications and Security Solutions. So, when you take a look at our materials, and you look at the secular growth trends we called out, almost all of those directly impact that business. It's the most global business, it's been enjoying a multiyear run of very strong growth; that's the legacy Anixter NSS business and the legacy WESCO Datacom business. But mix-wise, it's substantially driven by the legacy Anixter NSS business. And so the secular growth trends really weigh in heavily there. Of the three businesses, that's the one that has the highest growth opportunity. So, you put that at the higher end of the range on a relative basis. UBS is next, Utility and Broadband Solutions. The utility market is very stable. We've got a tremendous franchise in that business; pulling together the legacy HD supply and Anixter assets with the legacy WESCO utility business is really strong and service-oriented. We feel very good about utility. There's pent-up demand for investment, we've talked about this at length in prior calls that we clearly see that in the future. And broadband is also part of that business unit and faces an exceptional set of growth opportunities driven by 5G build-out. So feel very, very good about that. I put that one kind of mid to higher end of the range. EES is our largest business, and that's predominantly the legacy WESCO electrical business plus Anixter wiring and cable. We're now positioned to sell the complete electrical package. That's the strategic power of that combination. From an end market perspective, it is a global business. It has big industrial exposure and big construction exposure. The industrial exposure we're seeing improved demand, positive momentum in industrial spending. There are turnaround projects that have been delayed and other spend levels that we are getting good indications should increase as we move through 2021 and the economy recovers. For construction, we're predominantly non-residential and have very little direct residential construction exposure. The good news is residential ended 2020 on a very strong note and that portends well for non-residential. Non-residential this year will be a mixed bag; some verticals will grow very nicely, like healthcare and education infrastructure, while others will remain pressured, like oil and gas. Net-net, that hopefully gives you a sense. We expect all three businesses to grow. The highest growth opportunity in relative terms is CSS, then UBS, and then EES. I will say this about construction: despite a mixed bag outlook on non-residential, we ended last year with an all-time year-end record backlog, and that speaks to our project business. We haven't seen any material cancellations; it's been spotty delays. It sets up very well for us in 2021. Our bid activity levels and quoting activity levels are very robust to start the year. Our opportunity pipeline is also at a record level.

That's all very helpful and appreciated. I'll shift to a follow-up question to drill down a bit more on the first quarter. We don't have official quarterly guidance here, but any color you could give us on margin expectations. It sounds like there are some crosscurrents with incremental synergy capture and then offsets of some of the incremental costs. Specifically, you called out the $150 million for the full year and $50 million that's already in Q4, but $100 million annualized that has yet to hit. So anything you could frame for us in terms of incremental possibilities or maybe even a margin bridge first quarter year-on-year, or first quarter sequential, anything to calibrate expectations would be helpful. Thanks.

Tommy, I appreciate the question. The one thing I would call out is, if you look historically at the WESCO business, Q1 is primarily our lowest adjusted EBITDA margin quarter of the year. Also in Q1 of 2020, we did not have the COVID-related cost actions, so that will create a different comparison versus Q3 and Q4 going forward.

Thank you. I'll turn it back.

The next question comes from Steve Barger with KeyBanc Capital Markets. Please go ahead.

Hey, good morning, guys. John, you said this is the strongest management team in WESCO’s history. And you also said you have high confidence in upside to sales, margin and free cash flow. But you decided not to build that into the 2021 guide. I just want to make sure I understand the message. If your confidence is that high, why not push the organization to accomplish that via stated goals?

Internally, we've got targets that are well above our external target. I've already said that. Let's think back on how the last 13 months have unfolded. It was literally just a year ago, January, that we struck the deal to acquire Anixter. A few months later we closed and then put out three-year targets on cost synergies, margin expansion, EPS growth, and free cash flow generation. We closed the acquisition on June 22. We reported our second quarter results that included a short stub period. We're well into the integration because we had started aggressively integrating pre-close. We had a flawless day-one close. Look at our third quarter results—they were very strong versus our expectations. We beat our own expectations. We raised our guidance around synergies substantially, from a year one target to $100 million and from $200 million to $250 million in year three. In Q4 we delivered and came in a bit stronger than we had signaled. We had record backlog, strong sales, solid margins, and exceptional free cash flow. We're close to $600 million of free cash flow in our first full year which didn't even include the full Anixter fourth quarter. It gives us confidence entering 2021. What we don't control is the macro environment. There's still enough uncertainty around that. We reinstated a guide and we think this is an appropriate guide. We have continued to drive internal targets above our external commitments with substantial margin. That's what gives me confidence.

So the key takeaway being that if the macro comes in the way you may expect internally, then you would expect to significantly outperform the guidance that you've put out today to start the year, is that fair?

You're trying to get me to guide to a guide. I'm not going to do that. We set an appropriate guide given all considerations, most importantly macro. Internally, we are driving targets well above our external commitments, and the organization is lined up for that. We're excited about this combination and intend to deliver upside, but we set a prudent external guide.

Okay. And it's the street's job to best guess macro conditions and company info. We'll never get it exactly right, of course. But this time, there was a sizable disconnect between expectations and how WESCO is looking at earnings power. Any thoughts on how we can improve the messaging so we don't have this kind of one-day volatility going forward?

Look, you asked me directly. We didn't have a guide out there in 2020. We were very clear on the temporary cost actions coming back in and the other aggressive cost structure actions. I think Q4 exceeded expectations. In the absence of a Q4 guide, results got extrapolated into 2021, I understand that. We are working aggressively to be as transparent as possible. We have multiyear targets around the transformation and will continue to report progress clearly. We are improving in our communication. We welcome your feedback. Leslie is leading IR now and is an outstanding addition; we will continue to improve in that area.

Thanks for the time.

The next question comes from Chris Dankert with Longbow Research. Please go ahead.

Hey, morning, guys. Thanks for taking my question. I guess coming at this another way, thinking about the first quarter SG&A, I mean looking at that step up from the fourth quarter. If we were to baseline the first quarter SG&A in the $630 million range, is that in the right ballpark? Just trying to see how that $100 million rolls and obviously it's got to be first-half weighted, correct?

Chris, the way to think about it is, we called out very specifically the $50 million that's primarily a Q2 and Q3 comparable. Given the integration results, the restoration of bonuses, sales commissions and some benefits and other inflation will be consistently affecting SG&A throughout 2021. As you're thinking about how to frame that within the quarter, you'll see outside of that $50 million in Q2 and Q3, the balance is relatively consistently spread across the quarters.

Okay. Well, I guess the $100 million beyond the COVID-related $50 million, does that actually make whole for incentive comp last year? Am I understanding that correctly?

That is correct. When you take a look at our prior results, we did not meet our board-approved plan in 2020 and because of that we did not accrue nor are we planning to pay out at target compensation levels for 2020. That's been rolled into our numbers and we've spoken to that in our earnings calls. This is consistent with what we've done historically in downturns where we didn't hit targets and did not pay incentive compensation. We built back in target 100% payout for 2021.

Okay. Thank you for the clarification. On a more optimistic note, in the slides you highlighted reshoring as a positive driver. Is there anything tangible to offer on that dynamic? Are we seeing actual projects coming through at this point? Are you seeing customers reshoring?

We're having a lot of discussions with customers who are evaluating their operations and supply chains. The global pandemic put a microscope on extended supply chains and their fragility. Customers are looking to streamline, get efficiencies, remove supply chain cost and reduce supply chain risk. That is driving conversations about reshoring. We are seeing examples and having direct discussions and plans shared with us by customers. I can't call out specific customer examples on this call, but I do think there's potential for a broader trend that could be a meaningful driver of incremental growth opportunities in North America. Shortening supply chains changes risk profiles and is a big driver.

Understood. Thanks for the time, guys.

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

Well, thank you all for your time today and your support. We have numerous follow-up calls that have already been scheduled. Dave, Leslie and Will are available for your follow-up discussions. Have a good day and please stay safe and healthy. Thank you.

The conference is now concluded. Thank you for attending today's presentation. You may now disconnect.