Earnings Call Transcript - WCC Q2 2022

Operator, Operator

Hello, and welcome to WESCO's Second Quarter Earnings Call. Please note that this event is being recorded. I will now turn the call over to Scott Gaffner, Senior Vice President of Investor Relations, to begin.

Scott Gaffner, Senior Vice President of Investor Relations

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

John Engel, Chairman, President and CEO

Thank you, Scott. Good morning, everyone. It's great to be here today. As mentioned in our earnings release earlier this morning, we continue to create value with WESCO's successful new business model, especially as we mark the second anniversary of our transformational merger with Anixter. Our second quarter results were outstanding, setting new records for sales, backlog, margin, and profitability. Importantly, our leverage is now back within our target range, achieving this a full year earlier than we had anticipated following the Anixter merger in June 2020. Our momentum is growing as we outperform the market and provide exceptional value to our customers. Each quarter, the strength of our scale, expanded portfolio, and leading industry positions becomes increasingly evident. Demand in our end markets remains strong, and our three strategic business units once again posted double-digit sales and profit growth, driven by our enterprise-wide cross-selling and gross margin improvement initiatives. In total, we achieved impressive organic sales growth of 21%, with record profitability marked by an adjusted EBITDA margin exceeding 8%, which is a significant milestone for WESCO, along with adjusted EPS growth of 59% year-over-year. You may recall that we significantly increased our outlook for the year after a strong first quarter. Thanks to our excellent second quarter results and effective operations across the business, we are raising our 2022 outlook. I want to emphasize that our higher profitability is enabling us to invest in advanced digital capabilities, which should enhance our performance, operational efficiency, and customer loyalty. Dave will elaborate on our financial results and our increased full-year outlook shortly. Before I hand it off to Dave, I will discuss our transformational results compared to pre-pandemic levels, as well as our strong position to benefit from favorable growth trends in our end markets. Now, moving to Page 5. The robust nature of our business model and the success of our integration efforts over the past two years have established a proven record of exceptional results for the new WESCO. The value we've created since the merger in June 2020 is evident. This page compares our record first half 2022 results to our pro forma first half pre-pandemic results from 2019. Clearly, we have outperformed the market, recorded impressive sales growth and margin improvement, and reached record profitability while effectively reducing our debt. While we are proud of this progress, we are even more excited about the substantial value still to be unlocked from our merger with Anixter, and we are confident in the future of sustained growth and market leadership. Now, moving to Page 6. Our goal is to provide global customers with end-to-end solutions that enhance their efficiency and effectiveness through pricing and supply chain services. We are executing at a high level and are well-positioned to take advantage of strong growth trends and increased public sector infrastructure investments, which I previously outlined. These long-term trends support growth across our three global business units and our entire global enterprise. We have again raised our cumulative sales synergy target to $1.2 billion, which is seven times our original target set before the merger. Our cross-selling momentum is driving our market outperformance and growth. As I have stated before, the new WESCO is evolving into a growth-oriented company. We have a record backlog, an expanding cross-sell program, a growing opportunity pipeline, and strong overall momentum. However, it's important to note that we are still in the early stages of realizing our full growth potential. With that, I will now turn the call over to Dave.

David Schulz, Executive Vice President and CFO

Thanks, John, and good morning, everyone. Thank you for joining our call. I'll start on Slide 8 with a summary of our second quarter results compared to the prior year. As John mentioned, second quarter sales set a record, and cross-selling during the quarter exceeded our expectations. Our ability to cross-sell WESCO and Anixter products and services contributed over $200 million in sales for the quarter, and we continue to benefit from pricing. Overall, sales increased by 19% compared to the previous year. On an organic basis, sales were up 21%, although foreign exchange rate differences posed a 160 basis point challenge in the quarter. We estimate that pricing contributed approximately 8 points to sales growth, consistent with the first quarter, particularly benefiting our EES and UBS businesses. The CSS business experienced a low single-digit benefit from pricing but showed sequential improvement. Supply chain challenges have continued to affect some areas of our business. We believe the lack of certain products from our suppliers reduced sales by a similar amount as in the first quarter of this year. We are strategically investing in inventory to tackle these challenges and support our strong backlog of future sales opportunities. Backlog reached a new record this quarter, increasing by more than 10% from March and over 80% from the prior year. Each business unit reported backlog increases of more than 60% compared to last year. As we enter the third quarter, demand remains strong. Preliminary results for July are promising, with sales up around 17% year-over-year. Our gross margin was the highest ever at 21.7% for the quarter, up 70 basis points from last year and 40 basis points sequentially. This achievement was mainly driven by our gross margin improvement program, effective handling of supplier price increases, and the lack of a COVID-related PPE inventory write-down from the previous year, which had a 20 basis point impact. Adjusted EBITDA, excluding merger-related and integration costs, stock-based compensation, and other net adjustments, was 44% higher than last year, representing 8.1% of sales, marking a record high for the company and 140 basis points above the previous year. This reflects increased gross margin, benefits of higher sales scale, and realized cost synergies from our merger with Anixter. I’ll detail the key factors behind this improvement shortly. Adjusted diluted earnings per share for the quarter were $4.19, a record and up nearly 60% from last year. This increase was primarily driven by core operations but faced headwinds from foreign exchange rates, interest expenses, the effective tax rate, and a higher share count, which collectively reduced adjusted diluted EPS by 39 cents in the quarter. The adjusted effective tax rate was higher than our fiscal year forecast due to lower benefits from intercompany financing and specific tax items. Moving to Page 9, you can see that increased sales and expanded gross margins contributed to a $135 million rise in adjusted EBITDA. We also recognized an additional $66 million in cost synergies during the quarter, which is $22 million more than the same period last year. As anticipated in a period of strong demand and inflation, we faced higher operating costs related to volume, including shipping and sales commissions, along with increased expenses for employee benefits and incentive compensation. Given our strong results, we have approved short-term incentive compensation above target levels. Additionally, we incurred an extra $8 million in expenses related to our long-term incentive programs, which we also expect will pay out above target. Lastly, as planned, we faced higher costs associated with our investments in systems and digital tools that offset some of the growth in adjusted EBITDA. Overall, we achieved strong operational leverage with a 44% increase in adjusted EBITDA, more than double our organic sales growth of 21%. Moving to Slide 10, sales in our EES segment grew by 23% year-over-year in the second quarter on an organic basis. This growth reflects strong construction sales, which rose by double digits with the ongoing recovery of the nonresidential market. We also observed increasing momentum in our industrial and OEM sectors, supported by broad market demand. Heightened bidding activity led to a further rise in our EES backlog from the previous quarter's record level. We made progress on our cross-selling initiatives, capturing demand driven by the growth trends John discussed earlier.

Operator, Operator

Ladies and gentlemen, please hold. The call will resume momentarily. You may resume.

David Schulz, Executive Vice President and CFO

Good morning, everyone. It's Dave Schulz. We apologize for the technical difficulties with our service providers. So I'm going to point you back towards Slide 11 of our webcast deck. So turning to Slide 11. Sales in our CSS segment were up 12% versus the prior year on an organic basis. We saw strong growth in both Network Infrastructure and Security Solutions operating groups driven by growth with security integrators, cloud applications and wireless, as well as data center and hyperscale projects. While we are pleased with these results, CSS sales growth was not as robust as EES and UBS primarily due to ongoing supply chain constraints in certain pockets of the industry that we discussed last quarter. We are helping our customers effectively navigate these challenges. Additionally, pricing in CSS saw a low single-digit benefit versus the prior year but did improve sequentially. Backlog in CSS increased 7% sequentially from March to another record level, reflecting continued strong demand driven by the secular growth trends in our end markets. Profitability was also strong with adjusted EBITDA of 9.4% of sales in the quarter, 40 basis points higher than the prior year, driven by operating leverage, integration cost synergies, and the execution of our margin improvement program. Turning to Slide 12. Organic sales in our UBS segment were exceptionally strong, up 29% versus the prior year on an organic basis. Utility demand has remained consistently strong as both our investor-owned utility and public power customers continue to invest in grid hardening and modernization. Sales growth in our broadband business was also strong again this quarter, driven by continued demand for data and high-speed connectivity, including requirements for home-based applications. We continue to benefit from sales activity related to the federal government's Rural Digital Opportunity Fund. Backlog in UBS was up 25% sequentially and 140% versus the prior year, reflecting future benefit from strong end market demand. Adjusted EBITDA in the quarter was up 68% for UBS, and adjusted EBITDA margin expanded 260 basis points to nearly 11% of sales. This growth was driven by the scale benefit of sales and gross margin expansion. Now moving to Slide 13. The size of the cross-sell opportunity of combining WESCO and Anixter continues to exceed our expectations. In Q2, we recognized more than $200 million of cross-sell revenue, our largest quarter to date, and up nearly 30% sequentially from Q1. Our pipeline of sales opportunities continues to expand, and our cross-sell momentum continues to build. We are capitalizing on the complementary portfolio of products and services as well as the minimal overlap between legacy WESCO and legacy Anixter customers. The size of this opportunity has turned out to be one of the most significant value drivers of the combination of WESCO plus Anixter. Recall that two quarters ago, we increased our cumulative cross-sell target to $600 million. Last quarter, we increased it again to $850 million. Due to the continued strength of this program, we are increasing our target again by 40% to $1.2 billion cumulatively by the end of 2023. To date, we have generated $729 million of that target. Turning to Slide 14. On this slide, we've highlighted three recent cross-sell awards. These wins represent approximately $50 million of year one sales. However, all three are multiyear projects that extend as far as 2026. Collectively, these wins represent more than $165 million in total potential sales value over the next five years. In the first example, EES won a $12 million award to provide electrical cable, switchgear and miscellaneous electrical equipment to support the construction of a 900,000 square foot data center from a legacy Anixter customer and end-user relationship. Our complete EES product offering and ability to provide an end-to-end solution drove this win. In the second example, CSS leveraged the legacy Anixter product set and WESCO's TVC expertise to support a middle mile broadband build-out initiative. The third example, UBS generated $10 million of initial sales to support a fiber network expansion project with a legacy Anixter customer by leveraging the unified sales team and legacy WESCO's comprehensive supply chain solutions. Our cross-sell momentum is building, and it clearly highlights the power of the combined portfolio. Turning to Slide 15. On the left side of the slide, you can see in the gray boxes that we realized cumulative run-rate cost synergies of $188 million in 2021, $63 million in Q1, and $66 million in Q2. Due to this progress, we are increasing our 2022 target by $15 million and now expect to realize $265 million of cost synergies in 2022. We remain on track to meet our expected target of $315 million by the end of 2023. Recall that these savings are relative to the 2019 pro forma base. On the right side of the slide, we've outlined the $315 million of cost savings by synergy type. And in the chart, you can get a sense for the synergies that have been realized to date in each category. For example, the estimated $45 million in corporate overhead savings have now been fully realized. The largest remaining synergies are those that take longer to execute, including those related to supply chain and field operations. Turning to Slide 16. On this page, you will see a year-to-date bridge for the free cash flow, which reflected a cash draw of $293 million. Starting with adjusted net income and moving right, the $40 million source of cash primarily reflects a combination of depreciation and amortization, interest, and income taxes. In total, working capital has been a $714 million use of cash in the first half, driven almost exclusively by increases in receivables due to our exceptionally strong sales growth, which has far exceeded normal seasonality. Inventory and payables offset each other in the first half as we continue to invest in inventory to support our backlog and manage through supply chain challenges. Lastly, the CapEx and IT spend reflects the investments related to our ongoing digital transformation consistent with our plan. Moving to Slide 17. Reducing our leverage has been a top priority since we announced the acquisition of Anixter. In the second quarter, we reduced leverage by 0.2x trailing 12-month adjusted EBITDA and brought our leverage ratio down to 3.4x. This represents a decrease of 2.3x leverage turns since closing the acquisition in June 2020. We are now within our target range of 2x to 3.5x and returned leverage to that range a full 12 months faster than the target date provided to investors prior to the closing of the Anixter merger. This accelerated pace of deleveraging reflects the strength of our B2B distribution operating model. Moving to Slide 18. We are again updating our full-year outlook based on this quarter's results. Due to the strong demand trends we are seeing, the continued expansion of our backlog, and significant growth of our cross-sell synergies, we are increasing our full-year outlook for sales growth from the previous range of 12% to 15% to a range of 16% to 18%. Our assumption for market growth is 12% to 14%, including the benefit of price, which is an increase of 3% from our prior outlook. We expect the demand environment for our products, services, and solutions to continue to be strong. However, we recognize that supply chain constraints and the pace of inflation present some uncertainties for the second half of the year. Due to the strength of our cross-sell program, we are increasing our estimate for share gains and cross-sell from a range of 3% to 4% to approximately 5%. We are also updating our outlook regarding foreign exchange rates to reflect a headwind of approximately 1%. Lastly, keep in mind that 2022 has one more workday than 2021 and that occurred in the first quarter, which we estimate will add 1.5 points of growth in 2022. With regard to our business units, we continue to expect that EES and UBS businesses will be at or above the upper end of our sales range. CSS should be below the lower end of the range due to experiencing less of a benefit from price relative to EES and UBS as well as a larger impact to sales from supply chain disruptions. Also recall that included in our outlook is a contract with a utility customer that will shift from a full revenue model to a service fee model, which will negatively impact sales by approximately 0.5 points with no impact to EBITDA. For adjusted EBITDA margin, we are increasing our outlook to a range of 7.8% to 8.0% of sales, fully above our prior range primarily reflecting increased operating leverage on higher sales, as well as continued benefit from our gross margin improvement program. At the midpoint of this sales and EBITDA margin range, our full-year outlook for adjusted EBITDA is $1.68 billion and represents a substantial increase versus the midpoint of our prior outlook range of $1.54 billion and our original outlook midpoint of $1.33 billion. We are also slightly increasing our effective tax rate outlook to a range of 24% to 25% for 2022 based on the effective rate in the first half of the year. Our outlook does not assume any additional benefit from discrete items that we experienced in the first quarter. We are also increasing our adjusted EPS outlook to a range of $15.60 to $16.40, which represents growth versus the prior year of approximately 55% to 65%. Lastly, we are adjusting our expectation for free cash flow to approximately 50% of adjusted net income, which reflects the need for higher investment in working capital to support our increased sales outlook. As noted earlier, the primary driver of our net working capital increase is accounts receivable, driven by our strong sales growth. We are adjusting our free cash flow forecast to reflect continued strength on sales through the fourth quarter. The quality of our net working capital has not degraded. We are confident we will collect this cash, and there is no change to the long-term free cash flow conversion capability of the company. This outlook reflects a handful of assumptions that I would like to remind you of. Based on our first half results and outlook for the year, our short-term compensation structure is reflected in our margin outlook at an above-target payout. We've also included the impact of an increase in transportation and logistics costs that we mentioned last quarter. On cash flow, we expect to spend approximately $120 million in combined capital expenditures and IT digital investments. On the statement of cash flows, approximately $45 million will flow through capital expenditures and approximately $75 million will flow through changes in other assets. We expect to realize the full $18 million of annual interest savings related to the redemption of our 2024 notes that we completed in June of last year. Recall that in 2021, we realized approximately $2 million of the full $18 million annual benefit. Our outlook does not incorporate the potential effects of any further refinancing activity this year that has taken into account higher short-term interest rates. Our outlook assumes an average diluted share count of approximately 53 million shares for the year. Lastly, this outlook does not reflect any potential changes to applicable tax laws. As it relates to the third quarter, as I mentioned earlier, preliminary July sales were up 17% versus the prior year and margins are steady. Moving to Slide 19, and before opening the call for questions, let me provide a brief summary of what we've covered this morning. This was an exceptional start to the year, and we have strong momentum across our business. We delivered very strong financial results across the board, including record-level sales, operating profit, adjusted EBITDA, and adjusted EPS, and the strongest quarter since the Anixter transaction closed in June 2020. This segment of our business grew versus the prior year and sequentially in the quarter, as well as compared to 2019 levels. We delivered adjusted EBITDA margin expansion of 140 basis points over the prior year, driven by our value-based pricing execution, accelerated cross-sell, and continued cost synergy generation. Our pace of deleveraging has exceeded our expectations, and we are now back within our target leverage range, just eight quarters after closing the acquisition of Anixter. Lastly, we're making excellent progress on our IT and digital road map, and are exceptionally well-positioned to benefit from the secular growth trends and increasing public sector investments that John discussed earlier. And with that, let's open the call to your questions.

Operator, Operator

Our first question today comes from Deane Dray of RBC Capital Markets.

Deane Dray, Analyst

First of all, I think your service provider might need to be eligible for that broadband upgrade with the Rural Digital Opportunity Fund.

John Engel, Chairman, President and CEO

I love your sales lead, Deane.

Deane Dray, Analyst

Then secondly, a big welcome to Scott. Scott and I have a lot of history together. I've seen him in action. I'm confident you'll be successful. So congrats, Scott.

Scott Gaffner, Senior Vice President of Investor Relations

Thanks, Deane.

Deane Dray, Analyst

John, to begin with, there is a lot of concern right now about a potential slowdown occurring because all the financial markets are indicating it's happening. However, if you examine any of the metrics you're presenting, there are no signs of a slowdown, as the information on Page 6 demonstrates the long-term drivers that work in your favor. This isn't just a temporary surge post-COVID; we perceive a sustained growth trajectory. Could you provide some insights into what's currently happening regarding product availability, project delays, or any observations related to daily stock and flow business? Any real-time updates would be appreciated.

John Engel, Chairman, President and CEO

That's a great question, Deane. We are not seeing any indication of a slowdown regarding the new WESCO based on our leading indicators and KPIs. With the WESCO Anixter combination, our backlog looks strong, and our opportunity pipeline largely consists of cross-sell synergies. Our daily sales and margin momentum are solid, reflecting normal seasonal patterns. I would describe Q1, and now Q2, as accelerating. We're witnessing strong momentum, and it's the power of the combination at work. With respect to your supply chain question about stock and flow, we are managing through various supply chain challenges. I'm proud of how the team is handling those. In some areas, conditions have improved slightly, but we have seen some ongoing supply chain constraints that have impacted our top line. The supply chain is healing, though we initially anticipated a longer timeline for this recovery, and demand continues to exceed supply on our end. I hope this answers your question, Deane.

Deane Dray, Analyst

Absolutely. That's great. Really good to hear. And then just as a follow-up for Dave on free cash flow. And look, we are seeing this everywhere across the industrials in order to fill this big demand, you got 80% backlog up. You've got to take on more inventory. We get that and then higher sales, higher payables. So two questions. One is anything in the payables that is unusual, like past due or anything like this? Some assurances there. And then secondly, on the inventory. There's some misperception as of once you put this to rest that somehow WESCO is a bit like Target, that you put inventory on the shelves and you hope customers come. You're project-based. And the inventory that has been committed to by the customers for these projects, the customers are on the hook for that. You're not adding speculative inventory. Maybe just address that in terms of the certainty of that inventory that you're carrying?

David Schulz, Executive Vice President and CFO

Yes. Thanks, Deane. Let me address your second question there on inventory. You're absolutely right. So we have been taking in inventory given the strong backlog, which are committed orders, and we do have terms and conditions. So that inventory will be shipped to a customer. We have not seen any cancellations in the backlog. So we're very confident in the quality of the inventory. Going back to your first question about the quality of our net working capital, including payables, we actually improved about half a day versus the prior year quarter. We've not seen any degradation in the quality of the payables. We run our consistent process. So again, nothing out of the ordinary in terms of our net working capital or the quality of our net working capital. Again, our free cash flow guide coming down specifically for the accounts receivable impact that we expect going forward and the strong sales that we expect in the second half of the year.

Deane Dray, Analyst

Great. We call that a high-quality problem.

Operator, Operator

The next question comes from David Manthey of Baird.

David Manthey, Analyst

You mentioned 8% inflation and that there are variations in how different companies calculate the impact of pricing on revenues. Could you first explain your methodology, Dave? Then, could you discuss which product lines are experiencing the highest inflation? You noted that CSS is seeing the least, but is it accurate to say that most of the inflation is in heavy gauge wire and steel conduit, with less impact on finished goods, switchgear, and general supplies?

David Schulz, Executive Vice President and CFO

Yes, Dave, let me start with the calculation. I mean, we essentially looked at changes to the pricing and what we've been able to pass through to our customers to calculate that 8%. So it really does start with what are the suppliers passing on to us. We then, again, take a look at that and how do we pass that through to ensure that we're appropriately getting paid for not only the product, but the services attached to the product that we're delivering to our customers. In terms of the overall inflation, we have seen spikes over the last, call it, 12 months that are pure commodity-related. But I would tell you that a lot of the price increases that we're seeing are relatively consistent across all product categories, primarily given the inflation that our suppliers are seeing outside of just the commodities. So very clearly, on some of the more commodity-based, that's going to move with the market. All our suppliers are also passing through the increases that they're seeing on labor, increases they're seeing on logistics, transportation, and their ability to service the orders to us. So I would tell you that it's across all the product categories. The one area that we called out was we're not seeing the same level of inflation in some of the suppliers to our CSS business. We did start to see that pick up late in Q1, and we did get a sequential benefit. We do anticipate that, that will continue to be volatile. But for the most part, we're seeing broad-based inflation across the board being passed through to us from the suppliers.

David Manthey, Analyst

Okay. And just to be clear, Dave, are you saying that you look at specific SKUs this year versus last year? Is it just the same SKU, same SKU, same product? I mean, there's different methodologies people use. I'm just trying to understand how to read that 8% number.

David Schulz, Executive Vice President and CFO

Yes. We're looking at it by product category because we don't always sell the same SKU consistently from quarter to quarter year over year. So we're looking at the group of product categories within the SKU family in order to calculate that 8% number this quarter.

Operator, Operator

The next question comes from Sam Darkatsh from Raymond James.

Sam Darkatsh, Analyst

Two broad topics, if I could. The first would be about the new $1 billion repo authorization. I don't recall it being in your prepared remarks, or at least certainly wasn't accentuated. First, can we infer from this that you find that your own equity is considerably more attractive than any prospective M&A opportunities? And then secondly, rightly or wrongly, the market generally perceives 3 turns of debt leverage, I guess, the point at which the stock becomes high beta. And knowing this, and knowing the broad concerns of an industrial slowdown, are you really looking to do more substantial repo when you get under 3 turns? Or will your repo plans be more based on simply the absolute value of the equity?

David Schulz, Executive Vice President and CFO

Sam, it's Dave. So I appreciate the question. As you mentioned, we take a look at multiple factors when we make decisions. We did not purchase any shares in the second quarter. We do have the authorization that was approved by the Board back during our May Board meeting. In terms of how we're thinking about this right now, we just got under the target leverage range. So we're at 3.4 turns. We actually increased our borrowings against our facilities to support that net working capital and the strong sales growth. So right now, we're still focused on being able to drive down that leverage in the near term. Over the long term, we'd expect our leverage to be closer to the middle of that 2 to 3.5 turn range. We want to continue to focus on that. In the immediate term, we always look at the equity value against other uses of our capital. Right now, we have been focused on making sure that we get that leverage down within the target range. From there, we'll continue to evaluate those opportunities and what we believe will drive most value for our shareholders.

Sam Darkatsh, Analyst

My second question follows up on what Deane mentioned regarding inventory. Like almost all of your competitors, you will likely be working to reduce your inventories. While you may not experience direct inventory risk, this reduction will impact your vendors' volumes, pricing, and ultimately your rebates. At what point do you think your gross margin expansion will stop? Additionally, how do you plan to handle price costs if you no longer receive price increases from your suppliers in the future?

John Engel, Chairman, President and CEO

Sam, we have navigated various cycles and our management team is very experienced. The leaders of our three businesses, along with myself and Dave, have dealt with many cycles, and we're equipped to manage the company through all phases. We have strong confidence in our cash generation ability at all cycle stages. To address an earlier point, the increase in working capital during the first half is largely in accounts receivable that we are confident will be collected. Regarding margin, we have implemented a company-wide gross margin improvement initiative. In the years leading to the merger, Anixter consistently expanded its gross margin even in tough conditions while others faced margin compression. We made this initiative a top priority immediately after the merger and have been refining and executing it across WESCO. We have been building momentum on gross margins throughout 2021 and so far in 2022. Although we don’t provide specific guidance on this now, we see strong potential for both gross margin expansion and operating cost leverage, which we are focused on to enhance our operating margin. The strategy is effective, as evidenced by this quarter’s gross margin reaching a new record level, despite some significant commodity price declines. The foundation of our gross margin improvement program is centered on the value we provide to our customers’ operations and supply chains. I am very pleased with how well our sales and account management teams are communicating this value. While we did invest in working capital, we are a comprehensive solution provider for our customers. In increasingly volatile markets, customers rely more on their most capable and high-performing suppliers. Supply chain management has become a strategic priority at the highest levels. We offer substantial supply chain integrity and resilience, which adds value for our customers. I understand there are concerns about potential slowdowns, but we remain highly confident in our continued potential for margin expansion.

Sam Darkatsh, Analyst

So to paraphrase. Gross margins in the back half continue on its favorable trajectory despite the inventory drawdowns?

John Engel, Chairman, President and CEO

We're not experiencing any issues with our margins. As Dave mentioned, I'll reiterate that our margins in July have remained strong, consistent with our performance throughout the second quarter. As I noted earlier, Sam, we implemented some key changes for gross margin improvement related to our sales force's profit statements. This added incentive for performance is significant. They are focused on selling value and are benefiting from continued margin expansion.

Sam Darkatsh, Analyst

Terrific to hear and a terrific performance in the quarter. Onward and upward.

Operator, Operator

The next question comes from Nigel Coe of Wolfe Research.

Nigel Coe, Analyst

I just had a question about the company accruals. I want to ensure I understand how this works. You've topped up the full-year payout, which means there is a catch-up for Q1 and Q2, and the third and fourth quarters will be a run rate, with Q2 serving as a catch-up for Q1. Is that correct, Dave?

David Schulz, Executive Vice President and CFO

Yes. Nigel, in 2022, we trued up incentive comp above target payouts in Q1 as well as in Q2. So there's only a slight increase sequentially on that short-term incentive plan accrual.

Nigel Coe, Analyst

Okay. Can you help us where is that in dollar terms now running for the full year compared to where we were back in January?

David Schulz, Executive Vice President and CFO

Yes. Back in January, when we provided our initial guide, we called out that if we pay at target for 2022 against 2021, where we did pay out above target, that it was roughly a 30 basis point tailwind. Well, that tailwind has essentially going away. I mean, we are performing much better. Therefore, we are accruing appropriately for that short-term incentive compensation. The dollars year-over-year are not materially different than what we experienced in 2021.

Nigel Coe, Analyst

Okay. But as we look into 2023, assuming that the volumes are positive in '23, that's obviously a big if, but based on the backlog it doesn't seem unreasonable. Is there a scenario where margins could be down in '23? And I'm thinking here about maybe some price cost headwinds. I don't know what else, but is that a scenario that's even on the table?

David Schulz, Executive Vice President and CFO

Well, I would tell you, Nigel, we’ve been through these cycles in the past. We know how to operate. There's always things that are going to be impacting the overall margin. As we've said in previous years, we will be looking at market inflation rates on our people cost. So we've got to have enough top-line growth to offset that and hold the margin. Clearly, in a volatile economic environment, if one was to take place, we would have to pull the appropriate levers to protect our margins going forward. We've done it before. We're focused on making sure that we continue to drive value long-term for the shareholder. Again, we think we've got a good setup for 2023 as you mentioned. The incentive compensation would be adjusted back to target as we think about our plan for next year.

John Engel, Chairman, President and CEO

I would add to Dave's point. I would say the setup for 2023 is excellent as we sit here in the early part of the second half. We just substantially raised our full-year guidance for the second time for 2022. We have very strong momentum. We raised the sales synergy target substantially again to $1.2 billion. Our sales synergies in the second quarter of $200 million exceed our original targets that pre-merger close. This is the breakout growth opportunity. I think that is really showing itself as we establish this track record of success over the last eight quarters. Our backlog continued without any normal seasonality and is at a new all-time record level sequentially, which is a great setup, not just for 2022 but in particular for 2023. Our opportunity pipeline is evidenced by raising the cross-sell target, the largest we've ever seen, continues to grow. We think we're outperforming the market significantly. We're the market leader, an undisputed market leader in our core markets, and to the extent that the cycle gets a bit more challenging, customers will want to double down even more with their strongest supplier partners. Supply chain integrity and resilience, demand is still outstripping supply. It's a really important point. And I think, again, clearly, our full year guide for 2022 now is above current analyst consensus for 2023 on the top line. Second point, we expect to grow in 2023. That's the answer.

Operator, Operator

The next question comes from Tommy Moll of Stephens Inc.

Tommy Moll, Analyst

John, I wanted to start on the big data theme. You've given some transparency into the digital and IT investment recently. So I'm curious what inning we're in for that investment cycle. And then on the flip side, when you start to monetize and unlock some of the revenue and margin benefits from these investments. Have you even started to see some of those benefits yet? Or when do you anticipate that those would show up in a meaningful way where we'll see it in the P&L?

John Engel, Chairman, President and CEO

Thank you for that question. It's an excellent one. Using a baseball analogy, we are in the very early stages of experiencing the benefits. I'll begin by discussing these benefits. We've identified a few areas where we've implemented digital solutions for our business through digital products. Over the past couple of quarters, we've invested in various applications. We intend to provide more details about our overall digital transformation at our upcoming Investor Day in early September, which we are very excited about. This will be our first Investor Day since the merger of Anixter and WESCO and since the pandemic began. Regarding digital, we initiated a three-year integration program in June 2020, merging these two strong companies to create the new WESCO. We also indicated we are in the process of digital transformation. This integration provided us with the opportunity to invest in digital transformation at a scale that neither company could achieve alone. It's a long-term effort, approximately five years in total. We are two years into both the three-year integration and the five-year digital transformation periods. Our planned investments are outlined, and Dave reiterated in his comments what we are spending on different aspects of our profit and loss statement. Our synergies and top-line results enable us to fund these investments. I am highly optimistic about our mid to long-term growth prospects and the transformative impact of our digital initiatives, which will enhance our ability to serve customers more efficiently and unlock new growth opportunities and monetization avenues that will shape our new business model as we leverage big data. We're excited about this. The good news is that it's not yet reflected in our results. While the investments are included, we have not yet seen significant sales growth or margin expansion in our results. A significant increase in working capital is also not yet visible in our results. So, stay tuned. Please join us at Investor Day, where you'll gain a clearer understanding of our five-year digital transformation journey. While the narrative has been strong so far, and I believe exceptional since our merger, we are currently in the third year of our integration with impressive results and a series of increases along the way. The digital transformation aspect represents a whole new level of opportunity that is truly exciting.

Tommy Moll, Analyst

I appreciate that. As a follow-up, I just wanted to ask about CSS. Organic sales were quite strong in the quarter, although they were well below the other two segments. You mentioned supply chain as one challenge in that area. Could you comment on that? Was that the main reason for the difference in that segment's growth rate compared to the others?

John Engel, Chairman, President and CEO

Yes, that's a great question. Let's examine the overall performance over the last four to six quarters compared to the other two businesses. There are strong growth trends, a leading value proposition, a global presence, and an exceptional business model. It is a strong franchise. There have been supply chain challenges. Nevertheless, my comments and Dave's remarks have been very positive and optimistic regarding the medium and long-term outlook for that business, and that remains unchanged. I'm more optimistic than ever. Regarding the applications within our total solution offering, I'm very satisfied with the progress in CSS. If you analyze everything in the context of the business, you'll notice that momentum is building in CSS. The backlog growth is outstanding and at a faster pace than EES, though not quite at the UBS backlog growth rate, but still exceptional. Sales and margins are beginning to improve as the supply chain recovers. This is the key narrative here. We are seeing an accelerating trend with CSS, and I’m thrilled with the growth, which is now at 12% for the quarter.

Operator, Operator

And the final question of today's Q&A session will come from the line of Ken Newman of KeyBanc.

Ken Newman, Analyst

John, I think you touched on it briefly in a prior question, but regarding the increase in the cross-sell and share gain synergy capture for 2022, do you have a sense of just how much of those benefits have already been realized within the current guidance? I'm just trying to get a sense of how conservative that portion of the sales guide increase is? Just where do you see the momentum for those synergies coming up even further?

John Engel, Chairman, President and CEO

I'll let Dave handle that.

David Schulz, Executive Vice President and CFO

Yes. So when we think about the bridge in our sales outlook from our previous quarter call, the success that we're seeing in share gain and cross-sell, we called it out as 3% to 4% of the growth previously. It's now approximately 5%. As we look at Q2, we’re confident that we increased share. We believe that we are taking share, but really the benefit of the cross-sell. We are now expecting that to be combined approximately 5 points of the growth within our outlook for 2022. We're also very diligent about looking at not just the pipeline, but the backlog of the cross-sell, which is one of the reasons we had confidence in taking the number up for the target this quarter.

Ken Newman, Analyst

Understood. And then just for my follow-up here. You talked about the balance between share repurchases and working capital needs and keeping the balance sheet and that target leverage, but I'm curious if you have any comments on just how you look at the priorities between repurchasing the preferred shares and the common shares, understanding that there are some caveats and how much you can repurchase from that preferred bucket.

David Schulz, Executive Vice President and CFO

Yes, very clearly, there are some constraints on repurchasing the preferred. It will come back down to best value. If we take a look at where the preferred is trading and the premium that would be required to buy back those shares, there are some make-whole provisions on that. We take a look at that just from the pure economic perspective, whether it would make more sense to buy back common stock or preferred, and we are able to buy back both classes within the authorization. It purely will come down to the economics at the time.

John Engel, Chairman, President and CEO

I think it's important to also understand. I know we foreshadowed this earlier in the year, and I want to foreshadow it again. We think we have a new company we've created, clearly, that's fundamentally different characteristics. It's mix-shifted to higher growth markets, the execution, it's showing up in the execution and the results thus far, and we think we've fundamentally shifted this company to a different value creation trajectory than either prior company ever was on in their history. In terms of cash utilization, cash generation capability over the mid- to long-term and cash utilization priorities. That's something that we've not outlined as a longer-term view since we put these two great companies together, and that is something we are going to absolutely address at our upcoming Investor Day. We foreshadowed that earlier, and we will do that. Getting the authorization in place for the share repurchase was vital because we did not have an approved authorization in place. We put that in place ahead of being back within our target range. We did that purposely. We will always need to make sure we have an ongoing share repurchase authorization in place. That's the bottom line. The cash generation of this new WESCO is exceptional. I'm not going to address it in this earnings call, but take a look at when we outline this at the Investor Day, the optionality in terms of the value creation levers we have going forward is unlike anything either company had in the past, and I represent a kind of a breakout opportunity for us, which we'll share with you next month.

Ken Newman, Analyst

I understand. Looking forward to it.

John Engel, Chairman, President and CEO

Okay. With that, I think we did go a little bit longer. I'm going to wrap it because we had, again, a technical difficulty where we lost connection for a few minutes. That's why we went a few minutes over. I'll bring the call to a close. Thank you for all your support. It's very much appreciated. As I just mentioned, we look forward to speaking with many of you in the coming days as well as at our upcoming Investor Day. That date has been set. It's September 7 in New York City. As I mentioned earlier, this will be our first Investor Day since closing the Anixter merger, and it will be an excellent opportunity to learn more about our combined business and get to know our entire senior management team better. I hope all of you will be able to join us, hopefully in person or at least virtually. Additionally, we're going to be participating in the Raymond James Diversified Industrials Conference in August, and both the RBC Global Industrials and Morgan Stanley conferences in September. With that, we've got many calls scheduled this afternoon and tomorrow, bringing you to a wrap. Have a great day. Thank you again.

Operator, Operator

That concludes the conference call. Thank you for your participation. You may now disconnect your lines.