Wesco International Inc

NYSE:WCC

Earnings Call Transcript 2021-Q3

[Operator]

Hello, and welcome to the WESCO’s Third Quarter 2021 Earnings Conference Call. I would like to remind you that all lines are in listen-only mode throughout the presentation. [Operator Instructions].

I would now like to turn the conference over to Leslie Hunziker, the SVP Investor Relations and Corporate Communication to begin.

[Leslie Hunziker, Senior Vice President of Investor Relations]

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 performance and, by their nature, are subject to inherent uncertainties. Actual results may differ materially. Please see our webcast slides as well as the Company’s SEC filings for additional risk factors and disclosures. Any forward-looking information relayed on this call speaks only as of this date, and the Company undertakes no obligation to update the information to reflect the changed circumstances.

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 the call this morning, we have John Engel, our CEO; and Dave Schulz, WESCO’s Chief Financial Officer.

Now, I will turn the call over to John.

[John Engel, President and Chief Executive Officer]

Thank you, Leslie, and good morning, everyone. Well, we had another exceptional quarter and again delivered outstanding results across the Board. We are early into the second year of our transformational combination of WESCO-Anixter and a substantial value creation of the new WESCO is underway and is building.

The impressive progress we are making any integration is a direct result of the dedication, commitment and relentless execution of the entire WESCO team. I want to thank all our associates for their strong teamwork, their supplier engagement and their exceptional customer focus in providing the product services and resilient supply chain solutions that our customers need.

Now moving to Page 4. Our sales growth accelerated versus 2019 pre-pandemic levels, in the third quarter, and our margin performance in backlog achieved new records for the company. Based on our strong third quarter results, we are raising our sales, margin and profit outlook for the year.

We are outperforming the market across our three business units. Our comprehensive product and value-added service offerings our broad and deep supplier relationships and our technical expertise are proven to be critical differentiators for our company. Importantly, we are ensuring continuity of supply for our customers, which is especially critical as the economic recovery continues.

At the same time, we build a foundation for sustainable margin improvement through our increased global scale, our value based pricing program, and realization of cost synergies at those a pace and scale that continues to exceed our expectations.

Our new earnings power is reflected in our third quarter gross profit performance which was at record levels. And has been a key catalyst rapidly delivering our balance sheet since acquiring Anixter in June of last year.

In just five quarters and closing the transaction, we have improved our leverage ratio by 1.6 times, which is well ahead of schedule and highlights very clearly the power of our business models.

Now moving to Page 5, we have an expanding pipeline of sales opportunities and our cross sell momentum is building. We are on track to deliver 500 million of cumulative cross sell synergies by 2023.

We are capitalizing on the strength of the complementary portfolio of products and services, as well as the minimal overlap that exists between legacy WESCO and legacy Anixter customers. Our customers are benefiting from our ability to be a one-stop-shop for their product service and supply chain solution needs.

Opportunities exist across all three of our global business units. We have already generated over 220 million of sales synergies since the merger close in June of last year, with 105 million being realized in the third quarter.

Leasing cross sell wins in the third quarter include our EES business, expanding a local relationship with a solar contractor into a national multi grant service model and now provides wire, cable and balances system electrical products.

In another example, our CSS business as a supplier of choice for one of the largest data center providers in Latin America won a multiyear data center project by utilizing the combined technical expertise of both our CSS and EES team.

And finally, our UBS business is also growing through cross selling, where we recently expanded the scope of a three year project for an electric utility customer by supplying wiring cable. In addition to our inventory management, project planning and storm response services. Our cross sell growth opportunity is further amplified by the six secular growth trends that we have outlined previously.

Last quarter, I talked about how we are capitalizing on growth opportunities in grid monetization and the world breadth and build out. Today I want to spotlight how we are capitalizing on the ongoing growth opportunities in data centers.

Currently, there are approximately 27 billion connected devices around the world. And this number is expected to surpass 40 billion by 2023. These devices generate substantial amounts of data that has been captured, routed, stored, retrieved, analyzed, and ultimately operationalized.

With the rise of IoT and industry 4.0 customers and suppliers are increasingly relying on big data and data analytics to enhance the efficiency, productivity, security and cost effectiveness of their businesses.

As a result, more data centers are being constructed and we are participating in these data center upgrades and build up and we are doing that by providing solutions for our customers electrical infrastructure, network infrastructure, physical security, and thermal needs.

Our dramatically increased scale and expanded portfolio positions us very well to capitalize on these secular growth trends that will sustain the current economic recovery and are foundational for the global economy in the years ahead.

So in summary, this is really a growth story. We are transforming into a growth company as a result of our digital investments, cross selling our expanded portfolio of products and services and providing resilient and sustainable supply chain solutions for our customers around the world.

Continued execution of our aggressive integration plan and capitalizing on the secular growth trends will only accelerate this shift. Finally, I’m happy to say the value creation potential the new rescue is building and we are only in the early days.

With that, I will turn it over to Dave to walk you through the details in the third quarter and our updated guidance. Dave.

[David Schulz]

Thanks, John. Good morning. Starting on Slide 7. The summary table compares our third quarter results to the prior year. Sales were up 14% on both the reported and organic basis, currency added 140 basis points to growth which was partially offset by the divestitures we completed in February.

We estimate pricing added approximately 5% of sales in the quarter. Notably, sales were up 8% versus 2019 pre-pandemic pro forma levels. As John mentioned, our backlog reached another record level this quarter of 60% from the prior year and up 15% from the prior record in June. Each business unit posted backlog increases of more than 50% over last year.

Heading into the fourth quarter, demand continues to be strong. Preliminary October results are encouraging with sales up mid-teens year-over-year on a workday adjusted basis. Gross margin was also a record at 21.3% in the quarter, up 170 basis points versus the prior year. The strong gross margin performance included a 50 basis point contribution from supplier volume rebates.

We recorded a 10 basis point impact related to the write down of safety inventory. As you know, we have been managing the change in carrying value and inventory levels of certain personal protective equipment products like KN95 masks and hand sanitizer all year. From here, we don’t expect any further material inventory write downs related to the safety products.

The balance of the gross margin improvement approximately 130 basis points was driven by the benefits of our margin improvement program and inflationary pricing. Mix did not have a material impact on gross margin versus the prior year.

Sequentially versus the second quarter gross margin increased by 30 basis points, approximately 10 basis points of the improvement was due to a lower inventory write down related to safety equipment. The balance of the potential increase was driven by the benefits of our margin improvement program and positive price costs.

Adjusted EBITDA which excludes the merger related costs, stock based compensation and other net adjustments was 31% higher than the prior year and represented 7.0% of sales, which was 90 basis points above the prior year and 150 basis points above the 2019 third quarter on a pro forma basis. Adjusted diluted EPS for the quarter was $2.74 up 65% from the prior year.

Turning to Page 8, you can see that the higher sales expanded gross margin and integration cost synergies drove the $78 million increase in adjusted EBITDA. As you would expect in the strong demand and inflationary environment.

We also experienced higher volume related operating costs, including shipping and sales commissions, as well as higher expenses for employee benefits. As a result of our performance year-to-date and expectations for the year, we also increased our accrual for incentive compensation, which we alerted you to last quarter.

Finally, the temporary cost reduction actions taken in response to the COVID pandemic weren’t reversed until October last year. Overall, strong operating leverage is evident as we regenerated a 31% increase in adjusted EBITDA on a 14% organic sales growth.

Now let me walk you through the results by business unit, beginning on Slide 9. Sales in our EES segment were up 19% year-over-year with double-digit growth in all operating groups. This growth reflects construction sales that continued to increase with a recovery of the non-residential market.

We also continue to see increasing momentum in our industrial and OEM businesses, in-line with the broader industrial recovery. We continue to experience robust bidding activity levels that are driving a further increase in our EES backlog from its record level in the prior quarter. We also made further progress on our cross-sell initiatives and our capturing demand driven by the second growth trends.

Adjusted EBITDA for EES was $174 million, up 60% from the prior year. Adjusted EBITDA margin was 8.8%, 220 basis points higher year-over-year. This increase reflects the gross margin initiatives I discussed earlier, affected price cost pass-through, strong cross synergy realization and operating costs leverage.

Turning to Slide 10. Sales in our CSS segment were up 6% versus the prior year on an organic basis. We saw high single-digit growth in network infrastructure, driven by the data center and hyper-scale projects as John mentioned, as well as continued investments in cloud-based applications and professional audio visual installations.

The security operating group sales increased by low single-digits. Backlog was up more than 90% from December to another record level due to continued strong demand, along with the impact of supply chain challenges on project deliveries.

Profitability was also strong in CSS, with adjusted EBITDA at 9.0% of sales, 30 basis points higher than the prior year, driven by operating leverage integration cost synergies, and the execution of our margin improvement initiatives. I would point out that most of the PPE inventory write-down that I mentioned was recorded in CSS, which negatively impacted its adjusted EBITDA by approximately 20 basis points.

In addition to our cross-sell programs, CSS is positioned to benefit from numerous secular trends with the increased bandwidth, 24/7 conductivity, IP-based security solutions and the capacity demands related to remote work and school applications.

Turning to Slide 11. Organic sales in our UBS segment were up 15% versus the prior year. Utility demand has remained strong, as both our investor owned utility and public power customers continue to invest in grid hardening and monitorization.

In the quarter, we have benefited from storm recovery sales in both the Gulf Coast and in the Northeast. However year-over-year storm recovery sales were slightly below the prior year activity levels.

Our broadband business was up double-digits versus the prior year, driven by continued strong demand for data and high-speed conductivity, as well as expansion and conductivity requirements for home-based applications. Additionally, we are benefiting from sales activity related to Phase 1 of Federal Government’s Rural Digital Opportunity Fund project.

For UBS adjusted EBITDA in the quarter was up 34% with margin 130 basis points higher at 9.1% of revenue versus the prior year. This growth was driven by the scale benefit of sales and gross margin expansion.

Turning to Slide 12. On the left side of the slide, you can see in blue boxes that we have realized cumulative runway cost synergies of $148 million year-to-date from September. Because of the accelerated pace of execution and synergy realization, we have increased our 2021 targeted cost synergies from $170 million to $182 million, and our 2022 targets from $210 million to $230 million. Recall that these savings are relative to the 2019 pro forma base.

On the right side of the slide, we outline the total $300 million cost savings target 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 majority of the targeted $45 million in corporate overhead savings have been realized. The largest remaining synergies are those that take longer to execute, including the supply chain and field operations budgets.

Moving to Slide 13, reducing our leverage is a top priority. In the third quarter, we reduced leverage by 0.4 times trailing 12-months adjusted EBITDA for the third quarter in a row. Total debt was reduced by $91 million in the third quarter with net debt down by $55 million.

Free cash flow was $85 million in the quarter or 54% of adjusted net income. Net working capital was a use of cash of $233 million in the quarter, including $150 million for accounts receivable and $160 million for inventory, partially offset by a higher accounts payable balance.

We are gaining efficiencies and working capital using a four quarter average calculation. Networking capital improved six days versus 12/31/2020 and just over one day sequentially versus Q2. We have been investing in our inventory to support the strong demand we have been experiencing and to support projects in our backlog.

As John mentioned since closing the Anixter acquisition 15-months ago, our leverage is 1.6 times lower. We are committed and remain on track to return to our target leverage range of 2 to 3.5 times in the second half of 2022.

Moving to the outlook on Slide 14, based on continued strong demand, the effectiveness of our value based pricing program, inflationary benefits and the progress we are making on the integration front we are updating our outlook for 2021.

As we close out the year, we are raising the lower end of our sales growth range and now expect 2021 sales of 11% or 13%. For our strategic business units we now expect the electrical and electronic solutions SBU for the year to be above the Company’s range of 11% to 13% given the macro recovery and performance to-date.

We expect our communications and security solutions SBU to be below the range noting the strong backlog and continued management of supply chain disruptions. For the utility and broadband solutions SBU we expect full-year sales will be within the range. Utility market demand continues to be strong, and we expect continued growth in broadband.

As we think about the supply chain, we are in daily contact with our supplier partners to stay up to-date to capacity levels and shifting timelines. We expect to continue to be able to mitigate the supply constraints in the fourth quarter to managing our inventories effectively supplier engagement and alternate sourcing as necessary. The fourth quarter is off to a strong start with October sales up mid-teens.

For adjusted EBITDA margin we have raised our outlook to the range of 6.4% to 6.5%. We continue to expect our effective tax rate to be approximately 23% for the year. Assuming proposed tax changes do not take effect in the fourth quarter. We have also increased our adjusted diluted EPS outlook to a range of $9.20 to $9.40.

When it comes to free cash flow conversion, we are modifying our outlook to approximately 80% of adjusted net income to reflect continued investment in working capital support customer demands and maintain our service levels.

To-date we spent $25 million of cash recorded as capital expenditures to be about $30 million of cash flow recorded in other for investments in IT and digital. We are narrowing our forecast to approximately $100 million for the full-year for capital expenditures and other IT/digital investments.

Turning to Page 15. Before opening the call to questions, let me provide a quick recap. We had an exceptionally strong performance year-to-date. In the third quarter, organic sales were up double-digits and our backlogs are at record levels in each of our businesses.

We are capitalizing on our leadership position and the benefits of scale, and are executing well on the cross selling opportunity resulting from the Anixter merger. We are also effectively managing global supply chain challenges to ensure we continue providing high levels of customer service. When it comes to margins, we are leveraging our value proposition to improve pricing and increase operating leverage and cost synergies that attracting well ahead of our original schedule.

Our rapid pace of deleveraging continues. We reduced leverage by 0.4 times for the third consecutive quarter, Jeff delivered a total leverage reduction of 1.6 times since closing the transaction just 15-months ago. These strong results have enabled us to increase our full-year outlook for sales growth, adjusted EBITDA and adjusted EPS for the third time this year.

With that I would open the call to your questions.

[Operator]

We will now being the question-and-answer session. [Operator Instructions] Our first question today comes from Sam Darkatsh at Raymond James. Sam your line is open.

[Sam Darkatsh, Raymond James]

And terrific margin, gross margin performance in the quarter. Two questions. First, I wanted to re-explore the topic of M&A. I mean, you rightfully been in deleveraged mode post Anixter but A few weeks ago Rexdale announced it was acquiring Mayer and a $0.5 billion deal at what looked like a very attractive multiple, at least to sales. I imagine that mayor’s fit is great with WESCO, but they are a major member of a buying group, which I would imagine probably shakes out a whole bunch of other folks that are looking for large size dance partners.

I guess my question is, at what point do you believe WESCO is ready to take on M&A of some size, under what circumstances would that occur? And how would you look to finance those deals?

[John Engel, President and Chief Executive Officer]

So thanks for the question, Sam. I have said for years, the market was very fragmented, and it would take some external catalysts to accelerate the consolidation. It is true today that the distribution portion of the value chain is much more fragmented than our supplier base. We clearly saw this and as you know, we have talked at length, M&A is a critical value creation lever for us.

We should go strongly back in 2019 in our Investor Day that the big shot to start to come together and quite frankly, WESCO and Anixter coming together is the first move and the biggest consolidating. I think we have a situation where the big they are going to get bigger faster now.

And so, that is just an intro to my answer, Sam. We don’t look at M&A as an event. It is a process. We have a pipeline of opportunities, we are managing right now. As we speak, we have several MBAs that have been signed with potential targets. We are thrilled with our de-leveraging performance.

It is not a surprise to us. I know, it is a surprise for many investors, particularly those that don’t understand our business and our leading distribution model, but it is not a surprise to us. We are de-levering very quickly. And we always said, we can perfectly time the M&A transaction. So, you have got to be positioned and need to put in the place to be the final bidder.

We would like to be the only call. In many cases, we inspire them to be put into place. So we are working on those set of opportunities as we speak to them. We think that as a result of the two companies coming together, we got to quickly deleverage elaborating strength of our model, the profit growth and we came down that further in the quarter.

We are an exceptionally strong position to continue to drive M&A. We are committed to deliver back within our target range and as Dave mentioned, when we are working a whole multitude of opportunities entirely.

[Sam Darkatsh, Raymond James]

Thank you. Second question, John, in your experience, where would customer double ordering most likely occur in your business and what is your assessment, whether that is in fact occurring, or what sorts of guideposts are you are looking at to manage that dynamic?

[John Engel, President and Chief Executive Officer]

I find this question very interesting. It is something we have been in all over and in the process of how we are engaging with customers, and we have a very clear view of, we will get multiple, we will be issued in the bid activity, but not multiple orders now.

So, I don’t have one example of where something was double ordered and because we are not seeing cancellations out of our backlog. And so, it is just, I find it a very surprising question, quite frankly. I know a lot of folks are asking about this. We are not seeing that from the customer end of our value chain.

On the supplier end of the value chain, I can tell you, across the board, we have not placed a single double order. So it is a really interesting, I know that ties from narrative in investor and analyst community. You need to think about as a distributor, we have many, many supplier partners, and we are a supply chain management and solutions company.

So, we are in the position to help customers to solve their supply chain challenges. What we have been saying, and there are clearly supply chain challenges. But I think, we are doing an exceptional job of managing through it.

As I said, it is our job. We are seeing new customers come to us and we are seeing current customers want to make our assurance that we can ensure integrity of supply, and resilience as they ramp up their operations. That is why we very purposely increased our inventories, significantly over the last two quarters.

[Sam Darkatsh, Raymond James]

Terrific to hear it. Thank you gentlemen.

[Operator]

The next question comes from Deane Dray at RBC Capital Markets. Deane please go ahead.

[Deane Dray, RBC Capital Markets]

So, first question, can we start with what is the assumptions in the boosting the low end of sales guidance by the percentage point. I would have thought pricing alone would have accounted for all of that. But just on that topic, you said five percentage points of price in the quarter, where does that put price costs? I know, that is not a lot of specifics you typically provide here, but in this environment any further color would be really helpful.

[David Schulz]

Yes Deane. So we noted the 5% benefit that we received in our revenue line from price. As we think about the balance of the year, we have assumed that that 5% stays steady as we go through the fourth quarter. And what we have not included, is any incremental new pricing that we could potentially see in the fourth quarter. Again, that is very hard for us to predict.

So when you think about the impact of pricing on our outlook for the year and raising the bottom end of the range, price contributed. One of the things that we are also taking into account is just the strength of our business, the backlog that we see and then obviously, we are still effectively managing through the supply chain constraints.

We also taking into account that December is always a wildcard month, and particularly with how the calendar falls where the holidays on a Friday. So 12/31/2021 is a Friday. So obviously, we will be open for business, but we are not sure where our customers will be. We think we have got the appropriate guide given that risk.

[Deane Dray, RBC Capital Markets]

That is really helpful. And maybe we will just stay there for our follow-up question. If we kind of think about the comps for October, November, December, and recall that you stopped giving monthly sales updates a year-ago. But by our numbers in order to hit the 2021 sales guidance on an adjusted days basis, we would actually have to slow down so low-double-digits in the quarter and you have told us in October already is up mid-teens. So are you assuming just tougher comps, the timing, holidays, maybe some conservativeness on supply chain issues, but any color there would be great.

[David Schulz]

Yes really boils down to the December wildcard game. As you mentioned, if you take a look at the midpoint of our outlook for the full-year, and you apply the fourth quarter, it is a low-double-digit at the midpoint in terms of the year-over-year increase.

Remember that our December comp from prior year and our Q4 comp prior year, we were essentially flat on sales. So again, slightly tougher comp really boils down to the December wildcard and what shipments our customers will be receiving given the holiday period.

[Deane Dray, RBC Capital Markets]

Great and it is not a question, just to shout out, nice work on gross margins. Thank you.

[John Engel, President and Chief Executive Officer]

Thanks Deane.

[Operator]

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

[David Manthey, Robert W. Baird]

John, in your model, have you noticed ensuring customers continuity of supply and Dave, you talked about the some of the sourcing efforts that you have made and there is certainly issues everywhere. But anyway, listen to a lot of conference calls this earnings season and talking to a number of other companies. Is electrical just very better as it relates to these supply chain issues or is that my imagination. It seems like you mentioned it as in your absence, it doesn’t sound as dire as some other industries are portraying it today?

[John Engel, President and Chief Executive Officer]

Dave it is a great question. There is a lot of variation by category. So I don’t want to paint electrical with one paintbrush. There is portions of electrical that are a bit more challenging than others. There is a portion of wiring cable and electrical that capacity is utilization rates of our suppliers are at an all time high.

But in general I would say, at the end system we are delivering as a lot of semiconductor content into that supplier have a lot of semiconductors built into that product, depending on the type of semiconductors and how they have been positioned with their build plans and their inventory dome to support their manufacturing schedule, that is where I think the most acute issues are occurring.

There are clear challenges out there. So I don’t, we didn’t really see any material impact Dave in Q2. In Q3, I mean we are thrilled with how we have executed. And I think we are, again, seeing the benefits of our newfound scale and global supplier partnerships as a result of doubling up the company.

But sales would have been a little higher had we had zero supply chain constraints, where we are past due from our suppliers. And they would have been higher to the tune of 1% to 2% of sales in the quarter. And so I think that is just an important mark. And those sales don’t go away. Remember, those sales now occur into Q4 just move forward.

So I mean, we are thrilled with what we posted in the quarter but we are not completely immune from supply chain, geologists. With that said, I think a lot of folks have reported now and I think you can put into context that we perform versus others. We are very confident that we are executing at a high level and feel very good about our value prop.

[David Manthey, Robert W. Baird]

Yes, I would agree with that. And looking at unallocated corporate expenses. I think if we look at pro forma numbers, that you reverses the third quarter of 2019, those are up like 30%. And they are a pretty sizably from last year as well. Can you just talk about the key components of corporate expenses have driven that uptick?

[David Schulz]

Yes, Dave, good morning. So very clearly, as we have done the merger, and we recognize some synergies in our corporate overhead. There are a couple of factors that are also adding to our overall corporate expense. A portion of it is really the incentive compensation.

We also have from an overall net income perspective, we have seen the increase in our interest expense and some of our other expenses to run the company. We have also been investing in some of our digital transformation.

And we have talked about that as we bought both WESCO and Anixter capabilities together, you think about the future, how we create competitive advantage that we have been investing in some of those digital applications that we believe are going to help create competitive advantage versus our peer group. Those are primarily sitting in that corporate overhead bucket.

[David Manthey, Robert W. Baird]

Okay. Thank you.

[Operator]

The next question today comes from Christopher Glynn from Oppenheimer. Christopher, please go ahead.

[Christopher Glynn, Oppenheimer]

Thanks. Good morning, everyone. I’m curious, John, so SG&A, that is been a nice build in the spin rate. I know variable comp is improving with the great results, but you know, in the past, I recall you kind of leaned into SG&A pretty regularly. And it appears now you can leverage top-line and gross margin execution a little more. So, curious how to think, is there some capitalized spend what we might call going into SG&A or is it really the variable to comment?

[David Schulz]

So, it is Steve. So if you are taking a look at our Q3 numbers versus the prior year, the majority of that increase is really twofold. It is the incentive compensation accruals where we are expecting to pay out, much higher than our target compensation. And if you compare that to the prior year, we were below our target compensation. So, that is the majority of the increase.

The second factor is we had COVID in place. So you have seeing that increase year-over-year. Now, we will continue to manage effectively all of our focus on SG&A and being cost effective. As I mentioned, just on the previous response, we are also investing in some of our IT and digital capabilities, particularly as we think about the year-over-year capabilities that we want to build now.

And again, keep in mind that we are also paying out, not just incentive compensation from a short-term incentive. We are also paying out much higher compensation to our salesforce, given the results that we have year-over-year.

[John Engel, President and Chief Executive Officer]

And Chris, on that point, that is really important. Remember when we took all the investors through the recipe of our enterprise-wide margin improvement program last quarter, and a key pillar, a key component of that recipe or program is salesforce compensation.

So look at the gross margin results we are getting and the commission rate on gross margins is also showing up, as Dave outlined, which again is obviously very accretive. We are seeing the excellent pull through on that investment to the bottom line.

[Christopher Glynn, Oppenheimer]

Yes. I knowledge that. I was curious too, are you seeing any suppliers make material strides against pass throughs in recent weeks ability to get stuff through and then comment maybe net basis versus does it shift around to other suppliers?

[John Engel, President and Chief Executive Officer]

Yes. So, that is a great question. I can tell you we are in real-time dialogue with our supplier partners, I personally spending a larger percentage of my time, engaging with the senior leadership of our top supplier partners.

I’m very confident that, they are aggressively attacking, where there any bottlenecks from the process, as well as a number of them are selectively expanding their capacity. They have got the real tough challenges on the supply chain. And I think, you have heard many of them in terms in their report to talk about that.

But I do think that, we are closely coupled with them, great partnership and we are ensuring we get our proper, or kind of our fair share, given the size of the relationship and the allocation coming off their manufacturing lines, in many cases with our largest customers. We are not their largest. We are in the top three clearly, that is the first point I would make.

Second point I would make is, this is really important. Depending on the end customer applications, in some cases, the suppliers product/brand is stepped in. So in that case, there is not the ability to offer alternative suppliers or sources of supply. But in other cases, that is not the case.

And so we obviously lean in heavily and are working in partnership with our top preferred suppliers to help them grow their business. But if they are short and they are not stepped in at the end customer. Again, this is the power of distributions, we have a much broader supply base, an array of products and services than any other individual suppliers.

That is part of our value prop to our customers. It is our job to provide complete and resilient supply chain solution for our customers to help them manage their challenges. And that is what we are doing this, in those categories where we can. If we are limited if and only if we are limited, based on the output of our preferred supplier partners. Does that help?

[Christopher Glynn, Oppenheimer]

Yes. That is great. thanks for the color and good to see the numbers.

[John Engel, President and Chief Executive Officer]

Thanks.

[Operator]

The next question today comes from Nigel Coe at Wolfe Research. Nigel please go ahead.

[Nigel Coe, Wolfe Research]

So inventory, building quite nicely. Stands in contrast to your suppliers, claiming that the channel is low and probably needs to restock. So my question is, number one, are you satisfied with your entry levels? Secondly, would you expect to see the typical liquidation going into 4Q or do you think that is going to be more moderate in order to buffer the inventories. My real question is do you think your suppliers prioritizing you since your competitors, because you are now the big goal in the market?

[John Engel, President and Chief Executive Officer]

Great question Nigel. We are very clear that we increased our inventories and that was by design. We purposely did it and we want to ensure - first of all, we have an all time record backlog. And I will just stay on this for a moment. That backlog has increased every month this year. That in my tenure, I became CEO in 2009, I have not seen this in my tenure. So we are setting new records each and every successive month as we move through this year.

So we purposefully increase our inventory to support the book of business to those higher demand we are seeing and what we got booked, as well as maintaining high customer service levels. And that is represented by the fill rates. And we are holding up our fill rates at very high levels. We have not seem a real fundamental or material, big degradation in our fill rates, which we are thrilled with. So that is paramount for us.

I do believe doubling the company in this one move. And the transformation we are going through puts us in a much stronger partnership position with our top supplier partners. We feel that given our value prop with our end customers, they were driving differentiated demands for suppliers.

And at the end of the day, if as we do that, they will invest in our relationship. If we can drive differentiated demand to our supplier partners, they invest in us, and that is what we are seeing, which by the way, it should happen it needs to happen when you feel up that way. And I think I’m so proud of the team in terms of how we are managing that scale up.

And to your point we still got headwinds. The economic recovery cycles underway, it is building momentum, and it is still supply chain constraints. With that said, I think we are doing an exceptional job given that.

I will say that Nigel it is important. My one other point, there are select categories and I think you all understand what those are because various companies have talked about where there is a greater shortage in the value chain.

And so, but again, when you think about the whole value chain and the role that a B2B distributor plays, it is our job to manage that problem and because we have a wide array of global suppliers, that is how we are going about it.

[Nigel Coe, Wolfe Research]

Great. And then my follow on it is really about long-term EBITDA margins. And if we just run rate the remaining cost synergies, we get probably less than eight handle, if not above the handle on the EBITDA margin. Do you on the right path, I mean do you think that we transition to like an 8% to 9% EBITDA margin over the next two or three years?

[John Engel, President and Chief Executive Officer]

So the Nigel, we have not put the longer term target out there yet, but I think I will make this strong statement and which I have already made, but now we have five quarters under our belt. This is not a one or two quarter phenomenon. We now have five quarters under our belt, post an extra merger.

In a market that is recovering, there is still a lot of headwinds. And against that challenging set of market conditions, we are demonstrating outstanding margin expansion and inherently we have a stronger margin profile for the combined company going forward. So absolutely, we see our, we are well on the path of significantly expanding our EBITDA margins.

Look at where we stand today, not versus last year, because many companies from 2019 to 2020, and in 2020 to 2021 had their business is impacted in different ways. Our measurement against 2019, which is pre-pandemic levels, and we got pro forma results out there that we are measuring ourselves against again, that is how we are measuring our synergies. Look at what our margins have done for 2019. Just up substantially and so and getting tremendous operating leverage.

So yes, I’m thrilled with the trajectory we are on and I think as a result of this strategic combination and a transformation we are going to, we are going to be delivering margins that are well above anything that we had done historically, either legacy Anixter or legacy WESCO. The combined company inherently has a much stronger margin profile.

[Nigel Coe, Wolfe Research]

Okay gentlemen, I will leave it there. Thank you very much.

[Operator]

Our next question comes from Steve Barger at Keybanc Capital Markets. Steve please go ahead.

[Steve Barger, Keybanc Capital Markets]

Thank you. John, your last comments really kind of segue into the question that I was going to ask. After all the positive changes this year, presumably 2022 look more normal in terms of year-over-year comps and cost structure. If we get a mid to high single digit growth here was deflationary tailwind. What do you think the right incremental operating margin is this business now?

[John Engel, President and Chief Executive Officer]

Yes. you know, I can’t I’m not going to answer that yet Steve. I mean, clearly we will have our sights on expanding margins and generating strong profit growth in 2022 versus 2021. We have not outlined our guidance yet, and outlook. And we will do that as part of our Q4 earnings calls.

I think it will be, it is a very important time, when we deliver a Q4 earnings to do that, because where will we be? We will be six quarters in post Anixter merger. So, we will be halfway through the three-year integration period. And at that point, we will be setting our targets for 2022.

But based on - I mean, I will just answer it this way though. We have done very strong and positive momentum that we built throughout 2021, that is going to carry through the end of the year, as represented by, our increased guidance.

We increased our guidance the times this year. So, as part of that, the biggest part of that quite frankly was our accelerating execution on the integration and putting in these two strong companies together.

We think at 2022 is an excellent set up. The economic recovery cycle continues. We do envision strong demand across our end markets, all our end markets. We are in a recovery cycle. And as we move into 2022, you will see the supply chain issues mitigated, because the supply chains are going to get rebuilt.

It is not if, it is just when, and at what rate of speed. Coupled with our record backlog, our strong execution, and particularly cross-sell, that is one of our most notable accomplishments this quarter.

Remember this is the first quarter where we have disclosed actual numbers and quantified the delivery of cross-sell that proves to be the most elusive synergy in any acquisition. And I couldn’t be more pleased with those results. Instead, we clearly expect with the expanding cross-sell pipeline, that execution contributes to a greater fashion and drive that market outperformance next year.

And then finally, as Dave talked about, the digital transformation that we have started is well underway, I recognize we have not talked a lot of details about that. That is something we will be doing in 2022, and it is very, very exciting. And the digital transformation is going to build momentum, as we move through 2022.

[Steve Barger, Keybanc Capital Markets]

I appreciate that context. It is good. And just looking at some of the growth drivers for the business, it doesn’t seem like there is a national strategy for grid infrastructure upgrades. But it is obviously a really important topic. What are you seeing more locally or maybe what percentage of the country is showing a sense of urgency around that?

[John Engel, President and Chief Executive Officer]

This is clearly building momentum. It is why we have spiked it out as one of our six secular growth trends. And my time with the company, having joined west through back in 2004, we have talked at rights about this over the years, about the state of the grid.

I mean, it is several decades older design, and then there is a massive need of investment and upgrade. And that was before digital, kind of in 5G and all these other technologies started to end the convergence that we are seeing, starting to impact the entire grid.

So these discussions we are having with our utility customers now are unlike anything we have had in my tenure with the company. And I think there is a real sense of urgency on behalf of our customers, and they are having those discussions.

If it is an investor-owned utility, you are seeing them increase their capital spending. You can literally look at their disclosures. We are seeing step up capital spending. If it is public power municipal co-ops et cetera, they are going and trying to make their case for increased investments, with the regulators.

And so this is why exactly why we spiked it out as one of the six secular growth trends. This is going to be a meaningful growth driver for our business for the next several decades. I will also make the final point on this, which should not be underestimated, you are coupled in with green energy.

So you just see a tremendous grounds around ESG, so particularly around sustainability. And so that to me is a key underlying drivers to this secular growth right now. And we are exceptionally well positioned, we are not a manufacturer. Remember that we are not a manufacturer. So the best way we can impact the overall value chain. And the greatest impact that we can have is on our customers operations and supply chain.

And we do that by delivering sustainable solutions, our LED lighting, turnkey retrofit renovation, upgrade capability, all new automation solutions, safety, or safety or other renewables and so, just a terrific and outstanding growth opportunity.

And again, that is one of the six. That is why I’m so bullish on the future of this company. That is why I catch this now, as a growth story. The past is not prologue. We are not yesterday in WESCO with a new company.

[Steve Barger, Keybanc Capital Markets]

No question about that. Thanks very much.

[Operator]

The next question comes from Patrick Baumann at JPMorgan. Patrick please go ahead.

[Patrick Baumann, JPMorgan]

Lot of great questions already answered, just some minor ones here. Can you update us on the merger related costs to achieve the synergies just kind of where we are to-date versus plan. It is just hard to reconcile with some of the details you provide. I’m just trying to get a sense of when you might be true with that and then relatedly, what were the biggest items within the 36 million during the quarter?

[David Schulz]

Yes Patrick it is David Schulz, I appreciate the questions. So we talked about the cumulative costs we achieved through 2021 $125 million. We have obviously had some changes between what we are classifying as capital versus operating expense, that 125 was our operating expense.

So we are still trending below that number. In terms of our total spend year-to-date through September. What you are seeing in the numbers that we recorded for Q3, it is primarily related to some of the pure execution, we did have some FTE reduction. So we recognize separation expense.

We also have a series of consulting arrangements who are assisting us with some of the implementation and execution of our synergy capture. So those expenses have been accrued for and recognized in the quarter.

And as we think about our 2022 outlook, where we talk to you about that in our next earnings call, we will provide a full update on our synergy, our synergy timeline, and also the cost to achieve.

[Patrick Baumann, JPMorgan]

Okay. So 125 million through ‘21 and that was relative to that, was it a 225 number you last mentioned if any update I just want to make sure it is an apples-to-apples?

[David Schulz]

That is correct. So we have not updated those numbers yet. We are still working through some of the annual operating plan requirements for 2022. As we provide you our full-year 2022, we will update those numbers.

[Patrick Baumann, JPMorgan]

And my follow-up is on the sales synergies which sounds pretty positive. Can you talk about some examples of where you are seeing the most traction on the cross sell. And then how you go about measuring when these are in reality synergies.

[David Schulz]

Yes. Let me talk about how we capture and track in and then I will turn it over to John, who will walk you through some of the examples. So one of the things that we put in place was a very rigid set of guidelines of what we are calling a cross sell.

And it has to be a capability that was only enabled through the merger of the companies and some of the enormous capabilities that we are able to bring together through the merger. So we have a digital app that we are actually using with our sales reps to make sure that we track and validate each of the process.

And as we have mentioned earlier, we are providing incentives to our sales force, when they are able to record a cross sell. And so we have a process we go through every month to make sure that we can tie out the numbers, not only from for the purposes of reporting it to you, but also to make sure that we are compensating our employees appropriately.

[John Engel, President and Chief Executive Officer]

Yes. It is a rigorous process and again, we still, I will remind you, we still have that dedicated integration management office, dedicated resources in place. They are in place and will be across the fear integration periods. And so there is a tremendous amount of - short process assessment of rigor around validating all synergies.

We thought it was really important, because we were getting the questions increasingly, I starting to really see the sales synergies we have not qualified. So that is why we came out with a disclosure this quarter.

I did mention in the prepared remarks three examples, which are really good examples. I will give you another one or two. This is a case where Anixter had a pre-existing relationships with a real estate services company. So existing legacy Anixter customer and we went in and expanded the offering dramatically, with our turnkey lighting solution, and a separate EV charging station solution.

Both of those capabilities were not in Anixter’s portfolio. So here is our existing legacy as to customers and this was another win in the quarter, where we sold capabilities that existed on the WESCO side.

Another example, and that was in our CSS business, because they had the existing relationship with the real estate services company, and their relationship with data com. So we had a data com relationship.

Another example in the UBS business, where we were selected by a telecom and broadband provider provide all the fiber optic material for a high speed internet expansion program for over 50,000 residences. So here is a fiber to the Ex where Ex is a home.

Again, neither company was well positioned previously before coming together. It is the combined capabilities that put us in a position to win this strongly and win it in the fashion that we did. So there is a couple other examples.

[Patrick Baumann, JPMorgan]

Very helpful and thanks for the color and best of luck.

[John Engel, President and Chief Executive Officer]

Thanks.

[Operator]

Our next question comes from Chris Dankert at Loop Capital. Chris your line is open.

[Christopher Dankert, Loop Capital]

I guess thinking about that backlog, particularly within EES, can you give me color around how the duration there and how things are moving. I mean, just how early are customers kind of getting in line here and how much weight we can be putting on that record backlog in the near-term?

[John Engel, President and Chief Executive Officer]

Yes, it is an outstanding question. When you look at what is in the backlog, it is ordered that will ship within the current month, within the current quarter and it extends out to the next 12-months or so.

It is really important to understand what we lay in the backlog. these are firm orders, pricing delivery, bona fide orders we get from the customer to go in our backlog that we are going to executive and fulfill against or ship against.

Where we have a multi-year agreement with a national account or global account customer, and you can look at that as an annuity like business. We don’t load that in the backlog. We don’t say effectively it is in backlog because we have this multi-year agreement.

No, we only load within backlog when we have firm POS. And so, again, I don’t know if, there is no single example of a customer double order, the earlier question, that’s something we continue to check and ask. We haven’t had canceled orders out of our backlog.

We have had some delays. They are delayed because we may have a particular supply chain issue, that pushes out the delivery date. So, we haven’t had any cancellations. And we haven’t had any material dis-synergies as a result of Anixter-WESCO coming together. It is something we update every quarter. So that still is the case, as we execute three.

So, that gives you a sense for that. I put a lot of weight in that backlog personally. Not the absolute value, but it is the trend of the backlogs. And the reality is, it is so counter to anything I have seen in my tenure, and it is counted as seasonality. It is just, now we do have a different set of conditions. We have doubled the size of the company overnight. We brought two strong leaders together. So, that is a clear driver of our backlog growth.

The way I look at it is you have got to look at backlog growth, plus sales growth, that is really what you are doing in the market. And you were putting those two together we are talking exceptional numbers because our backlogs grew up strongly. You are talking 50% off plus in UBS and ESS. It is up 90%.

[Christopher Dankert, Loop Capital]

Very, very encouraging. Thanks for the color there, much appreciated. And just kind of a point of clarification, obviously, excellent work on gross margin to kind of execution on those supply chains, synergies. I guess, point of clarification, the field operation savings, is that entirely in 2023, or could someone sort of trickle in a little bit in late 2022?

[David Schulz]

No, some of that will be in 2022, Chris. So we are continuing to execute the field operations. We have executed and initiated some of those activities here in latter part of 2021, but we are not going to start realize significant savings until we get into the middle part of 2022.

[Christopher Dankert, Loop Capital]

Perfect. Thank you so much guys.

[John Engel, President and Chief Executive Officer]

Well thank you all again. I think we are at the top of the hour, so I’m going to bring the call to a wrap. And, uh, thanks again for all your support. Very much appreciated. You got a number of follow-up calls scheduled today and tomorrow, so we look forward to diving in deeper to take you through the business. And we look forward to speaking with as many of you, throughout the quarter, as well as including our upcoming investors event.

The next event will be the Baird Global Industrial Conference that we are participating in that will be next Wednesday, and then we will be participating in the Stevens Investment Conference on December 2nd. So thank you very much again for your support. Have a great day.

[Operator]

This concludes today’s conference call. Thank you for joining. You may now disconnect your lines.