Good day, and welcome to the Wesco Third Quarter 2020 Earnings Call. All participants will be in listen only mode. Please note this event is being recorded. I would now like to turn the conference over to Will Ruthwaffe, Director of Investor Relations and Corporate Communications. Please go ahead.
Thank you, Andrew. Good morning, ladies and gentlemen. Thank you for joining us. Joining me on today's call are John Engel, Chairman, President and CEO and Dave Schultz, Executive Vice President and Chief Financial Officer. This conference call includes forward looking statements, and therefore, actual results may differ materially from expectations.
Please see the webcast slides for additional risk factors and disclosures. For additional information on Wesco International, please refer to the company's SEC filings, including the risk factors described therein. The following presentation includes a discussion of certain non GAAP financial measures. Information required by Regulation G of the Exchange Act with respect to such non GAAP financial measures can be obtained via WESCO's website at wESCO.com. Means to access this conference call via webcast was disclosed in the press release and was posted on our public website.
Replays of this conference call will be archived and available for the next 7 days. With that, I'll turn the call over to John Engel. Thank you, Will. Good morning, everyone, and thank you for joining us for today's call. I'd like to start out by saying on behalf of WESCO, I hope that all of you have been staying safe and healthy.
Start with the Q3 highlights, then I'll provide an introduction to our 2 to our 3 new strategic business units, and I'll be emphasizing their strong positioning to deliver above market sales, margin and profit growth. Dave will then take you through our Q3 results, the excellent progress we're making on our second half commitments and synergy capture efforts and our increased synergy targets for the transformational combination of WESCO and Anixter. So let's first start with an update on our business and third quarter results. WESCO's new era is off to an absolutely exceptional start as our results exceeded our expectations across the board for sales, cost, margins, profit, EPS, free cash flow generation and reduced financial leverage. This was our 1st full quarter of results after completing the acquisition of Anixter in June and clearly highlights the substantial value creation potential of this transformational combination.
Our management actions and strong execution were effective in this COVID driven environment. We expanded margins, reduced costs and grew profits, both sequentially and versus prior year. Business momentum improved through the quarter as we took market share and built an all time record 3rd quarter backlog. Our positive momentum has continued into the 4th quarter with October Workday adjusted sales down just 3% versus prior year and a book to bill ratio remaining above 1.0. Free cash flow generation was at over 300 percent of net income and demonstrates our resilient business model and strength through the cycle.
Notably, net debt was reduced by $280,000,000 consistent with our capital allocation priorities. More importantly, financial leverage was reduced to 4.8x at the end of the third quarter, marking a reduction of about 1 half turns over the 4 month period since closing the Anixter acquisition. Again, this quarter, I'd like to recognize and thank all of our associates for their inspirational dedication, commitment and hard work in effectively managing those COVID driven by. Now turning to Anixter. We accelerate our integration planning execution and synergy realization efforts and made outstanding progress in the 3rd quarter.
The strong cultural alignment between Westco and Anixter is proving to be a key driver in our initial success. As Dave will explain in more detail momentarily, just 4 months since closing the acquisition on June 22, we have already initiated actions that will deliver 100% of our year 1 cost synergy target of $68,000,000 I could not be more pleased with the team's execution of our integration plan. As a result, we are raising our year 1, year 2 year 3 cost synergy targets to $100,000,000 $180,000,000 and $250,000,000 respectively. Our initial integration progress gives us confidence that we will revisit our synergy targets as we build success upon success. We're also realizing initial sales synergies through leveraging our expanded global footprint and cross selling our broader product and service portfolio.
We believe our sales synergies efforts will support incremental important incremental sales growth in the years As we build on these early successes, we are increasingly confident in our ability to achieve significant upside potential and exceed our 3 year cost savings, sales growth, margin expansion and cash synergy targets. So let's turn to Page 4. We're reporting our results for the first time under our new organizational structure that we announced in June, And these are our 3 strategic business units or SBUs as we call them, outlined on this page. So first is Electrical and Electronic Systems or EES, which is a little more than 40% of our company's total business. 2nd, Communications and Security Solutions or CSS, which is roughly 1 third of our company's total business.
And then 3rd, Utility and Broadband Solutions, or UBS, which represents the remaining onefour of our overall combined company business across the enterprise. The respective industries and types of customers that these SBUs serve are outlined on this page. We provide a high level summary for each of these businesses, including their respective growth drivers in the additional information section of this webcast presentation. Yesterday, we also filed an 8 ks with pro form a operating performance for each SBU on a quarterly and annual basis for 2019 and for the 1st 2 quarters of 2020. As I mentioned last quarter, one of the most meaningful and positive discoveries post close is how complementary the WESCO and Anixter portfolios are.
The pie charts on this page depict the legacy WESCO and legacy Anixter composition for each of the three businesses. EES is comprised of WESCO's leadership and deep roots in electrical, coupled with Anixter's depth and breadth and leadership position in wiring cable solutions. And EES brings the complete electrical package and best in class solution also to customers. CSS includes Anixter's leading global position, capabilities and scale in communications and security, and that's coupled with WESCO's Datacom, AV and Safety portfolio. Combined, CSS is exceptionally well positioned in high growth markets with very attractive secular growth trends.
And finally, UBS, which combines WESCO's and Anixter's leading utility and broadband businesses, is also very well positioned to outperform the market with a strong execution track record and unmatched supply chain capabilities. Organizing our company around these 3 global businesses enables us to leverage their industry leading scale and highly complementary portfolios in super serving our customers. Each of these SBUs does between 4,000,000,000 dollars $7,000,000,000 of business annually, and they offer 100 of thousands of products and industry leading services, which makes them highly valued partners to both our suppliers and our customers. In what remains a highly fragmented distribution value chain, the combined company benefits from a step change in scale and capability. And we're leveraging that to sell more products and more services to more customers in more locations all around the world.
Finally, the leadership teams of these three businesses are comprised of the best of the best from each company and all possess decades of experience in our industry. Nelson Squires, who was previously Wesker's Chief Operating Officer and Head of the Canadian and International Businesses is leading our ESS business. Bill Geary leads our Global CSS business and he previously was Head of Anixter's Network and Security business. And Jim Cameron leads our UBS business after running WESCO's Utility business since 2014 and WESCO's Broadband business since 2016. I'm very pleased that each of these leaders is off to a great start in delivering strong results in our 1st full quarter of LESCO plus Anixter.
Now let's move to Page 5. Our SBUs, each and every one of them are extremely well positioned to benefit from the numerous secular trends that will drive future growth for WESCO. We shared these 12 evolving secular growth trends with you previously, but today we want to specifically highlight that they will drive growth across all of our businesses. As we see an increase in automation, machine to machine connections, electrification of our infrastructure and demand for faster bandwidth and data center capacity, along with or coupled with the positive impact of the emerging trends, such as relocation of supply chain fact in North America and increased remote connectivity. All three of our strategic business units have the scale and the capabilities to capture the resultant secular growth.
We've created the industry leader in electrical, communications and utility distribution and supply chain services just as these trends are poised to drive secular growth in the markets we serve. Finally, moving to Page 6. We first communicated our 3 year cost savings, sales growth, margin improvement and cash generation synergy targets back in March. Since that time, we've been executing a detailed, rigorous and process oriented plan to integrate LESCO and Anixter. Against the backdrop of a challenging COVID driven economic cycle, this strategic combination is even more compelling as we have doubled the size of our company and are transforming our new global enterprise.
With the benefit of what we have learned since the closing in June and our strong initial execution of our integration plan, we are increasingly confident in our ability to achieve these financial goals, including our updated synergy targets. And most importantly, we're increasingly confident that we'll ultimately deliver the substantial value creation associated with this transformational combination. As I mentioned in my opening remarks, WESCO's new era is off to an exceptional start. As the industry leader, we are now larger and more diverse with differentiated scale and capabilities in what remains a highly fragmented industry. We're evolving into a growth company and are exceptionally well positioned to lead the digital transformation of our business and our industry.
With that, I'd now like to turn the call over to Dave for his remarks.
Dave? Thanks, John. Turning to Slide 7. During our Q2 earnings call, we outlined 6 second half priorities, and we want to provide you with an update on the substantial progress on each of these goals. Starting with sales, demand continued to improve, and we believe we've taken share.
Sales in the quarter were down versus prior year due to COVID and up 8% on a pro form a basis from Q2. We maintained our focus on cost management and exceeded expectations. Prior to completing the merger with AnixServ, we laid out our expectation to deliver $50,000,000 of COVID related cost actions. Between Q2 and Q3, we exceeded this target. On a pro form a basis, operating expenses were down $44,000,000 in the 3rd quarter versus the prior year.
On gross margin, we discussed the success Anixter had expanding gross margin through a targeted improvement program, and we are deploying it to the legacy WESCO business. Gross margin was up 20 basis points on a pro form a basis with broad based improvement across the combined company. We are extremely pleased with the progress made on the integration. As John mentioned, we have already initiated actions to achieve the full year 1 synergy cost target of $68,000,000 in the 1st 4 months of the integration and are increasing our cost synergy target. One of the areas we are most pleased with is cash generation.
Capri cash flow was extremely strong at $307,000,000 in the quarter, and we reduced net debt by $280,000,000 Our leverage, including year 1 synergies, improved to 4.8 turns on an adjusted EBITDA basis. Lastly, we have fully transitioned our reporting structure to our new strategic business units that John walked you through a moment ago. We issued an 8 ks yesterday providing you with the historical WESCO only results we've passed to the new segment reporting structure as well as a pro form a combining the historical WESCO and Anixter results, including the reconciliation of adjusted EBITDA. Again, we're very pleased with the results in the quarter against a difficult operating environment due to COVID. Moving to Slide 8.
We are increasing our 3 year cumulative cost synergy target to $250,000,000 2 drivers to the increase. First, we set internal goals that are higher than we announced publicly and our teams are delivering. 2nd, there were specific areas where detailed information and analytics could not be completed until after we closed the transaction. We are finding upside to our initial estimates in all four buckets of synergies and are particularly excited about the incremental synergy opportunities in the areas of supply chain and SG and A, giving us confidence to take up our target. In Q3, we realized $15,000,000 of cost synergies and expect to achieve $100,000,000 in the 1st year of the merger.
We still believe there is additional upside, and we plan to build upon our successes to drive additional value capture in the areas of cost, cross selling and networking capital synergies. I'll also mention that we continue to make progress with the divestiture of the legacy WESCO Canadian Utility and Datacom Businesses, which represent less than $150,000,000 in revenue. We engaged in an investment bank and are working with potential buyers and are on track to complete the divestitures on a timely basis. Turning to our Q3 results on Page 9. This summary table compares our Q3 results to the WESCO Plus Anixter pro form a results for the prior year period and sequentially against the Q2 of this year.
Sales were down 5% versus the prior year and up 8% sequentially. These sales improvements represent substantial growth above peers and indicate we are taking share. October workday adjusted sales were down just 3% versus prior year. As John mentioned, our book to bill ratio remains above 1.0. Sequentially, October workday adjusted sales versus September were better than typical seasonality.
Adjusted gross margin, which excludes the effect of merger related fair value adjustments of $28,000,000 was 19.6%, up 20 basis points versus prior year and sequentially. We are clearly seeing traction from our margin improvement initiatives and are just beginning to deploy Anixter's proven gross margin improvement programs across the business. Adjusted earnings before interest and taxes was $200,000,000 in the quarter. Reported EBIT was to remove the effect of merger related costs of $14,000,000 the merger related fair value adjustments on inventory of $28,000,000 and a gain on the sale of an operating branch in the U. S.
That was unrelated to the integration of $20,000,000 Regarding the branch sale, we divested a single location that primarily sold Rockwell Allen Bradley Automation equipment in a specific geography. Compared to the prior year, adjusted EBIT margin was up 30 basis points, reflecting the benefits of synergies and cost management actions in response to COVID related demand declines. On a sequential basis, adjusted EBIT was up 60 basis points. I mentioned on the prior slide, the legacy Westco business expected to generate $50,000,000 in total COVID related cost savings in the last three quarters of the current year. This quarter, we delivered approximately $28,000,000 of these savings.
Adjusted EBITDA, which excludes the effects of the adjustments I just mentioned as well as stock based compensation in both the current and prior year periods and other net adjustments, was $252,000,000 5% higher than the prior year and 19% higher sequentially. As a percentage of sales, adjusted EBITDA margin was 6.1%, 60 basis points higher than the prior year and sequentially. These exceptional results reflecting both year over year and sequential improvements of both adjusted EBIT and an adjusted EBITDA reflect our continued strong execution, disciplined cost management, market share gains, industry leading value propositions across all of our business units and the acceleration of our synergy capture. Our leading position and participation in the many secular trends discussed earlier as well as our track record of operational excellence sets us up exceptionally well to drive substantial value creation. Adjusted diluted EPS for the quarter was 1 point $6.6 A full reconciliation of adjusted EPS is included in our press release.
Turning to Slide 10. Our EES segment delivered sales that were down 10% versus prior year and up 13% sequentially. This sequential growth reflects construction demand that continues to improve in North America and which was up double digits in the U. S. And Canada.
Our backlog, which primarily reflects construction activity, was a 3rd quarter record, consistent with the trend we have observed of project delays due to COVID-nineteen but not cancellations. We continue to see increasing momentum in our OEM business as well as in many industrial verticals that we serve. It is important to note that oil and gas, which previously represented approximately 7% of Westcoast's business prior to the combination with Anixter, is now a low single digit percentage of the combined company's revenue. Adjusted EBITDA of $108,000,000 was 6.5 percent of sales, approximately in line with the pro form a prior year results and 70 basis points higher sequentially, which is an excellent result given the lower sales versus the prior year. During the quarter, we were pleased to be awarded multiple contracts to provide switchgear and electrical materials, including lighting, for the upgrade of a water treatment facility in Ontario, Canada.
Turning to Slide 11, our CSS segment delivered an exceptional quarter. Sales were down 2% versus prior year against a broader market that was down substantially more and up 10% sequentially. We are clearly taking share in these markets. As with EES, we saw continued positive momentum throughout the quarter. Security sales were up low single digits versus a market that was down mid single digits and our global accounts activity was up low single digits, reflecting strong performance with hyperscale data centers, global security and system integrators.
Profitability was also strong. Adjusted EBITDA of $121,000,000 was up more than 8% versus prior year and adjusted EBITDA margin improved 80 basis points above the prior year. In the Q2, we were pleased to be awarded a multimillion dollar contract to provide a comprehensive solution of products and material management services for the construction of 2 data centers in Mexico. Turning to Slide 12. Sales in our UBS segment were flat sequentially and down 2% versus the prior year.
This result reflects strong growth from broadband sales, offset by weakness in the industrial focused areas of our integrated supply business. Broadband sales were up mid single digits versus the prior year and high single digits sequentially, driven by continued 5 gs build outs and fiber to the X deployments. Utility sales were flat on a pro form a basis compared to the prior year. Storm response activity contributed to this growth as there were a number of hurricanes and tropical storms that made landfall in the U. S, especially in September.
Adjusted EBITDA of $86,000,000 was up more than 11% versus prior year on pro form a basis and represented 7.8 percent of sales, 100 basis points above prior year and 30 basis points above Q2. As an example of our recent success, we were awarded a multiyear contract to provide electrical transmission and distribution materials and inventory management services for a public utility. Moving to free cash flow and liquidity on Slide 13. This quarter, Wesco generated $307,000,000 of free cash flow or 3 15 percent of adjusted net income. This exceptional result highlights our countercyclical cash flow generation, which is one of the many reasons we are highly confident in our ability to reduce leverage through all phases of the economic cycle.
Year to date, the company has generated $462,000,000 of free cash flow or 2 92 percent of adjusted net income. Our capital allocation priority remains unchanged. We will allocate capital to support the integration and invest in our business. Our priority is to rapidly delever the balance sheet and be within our long term target leverage range of 2 to 3.5 turns net debt to EBITDA by the end of year 3 in June 2023. We made substantial progress on this goal in the quarter as we reduced net debt by $280,000,000 Our leverage ratio, including the revised target of year 1 synergies, was 4.8 turns, about 0.5 turn below the comparable metric in Q2 of 5.3 turns.
Our liquidity, which is comprised of invested cash and borrowing availability in our bank credit facilities, is exceptionally strong and totaled approximately $1,100,000,000 at the end of the Q3. A reminder that we will remit the first cash interest payment on the 20252028 senior notes and expect to pay the quarterly dividend on the preferred stock in December. Exceptional free cash flow throughout the economic cycle remains a hallmark for WESCO. That along with strong liquidity supports our future growth. Moving to Slide 14.
Before opening the call to your questions, I'd like to just walk you through a quick summary. We've also provided additional information about the business units and a slide that answers some FAQs regarding the upcoming quarter. This quarter was clearly an exceptional result on all fronts for WESCO against a COVID driven economic backdrop. We increased margin across the board despite the challenge of COVID driven nineteen sales weakness. This was driven in part by decisive actions to reduce costs given the uncertainty of demand.
We see core demand continuing to improve across our businesses, noting that we typically see a seasonal effect to Q4 sales and have 3 fewer workdays sequentially in the current quarter. We restored salaries and benefits effective October 1, and we are incredibly proud of how our team has responded to the crisis and has continued to service our customers. In just 4 months since closing the transaction, we have initiated actions to meet the initial full year 1 cost synergies. We have increased our year 1 target from $68,000,000 to $100,000,000 and are increasing our total cost synergy target from $200,000,000 to $250,000,000 In addition to the substantial cost synergies, we are already generating revenue synergies from our cross sell pilot program. As a result of this excellent position and continued integration of Anixter, we expect to exceed our value creation targets of sales growth, margin expansion and cash generation.
Our free cash flow was also exceptional, demonstrating our resilient business model and cash generation ability throughout the cycle. These of the new strategic business units that we reported on today are extremely well positioned to capitalize on several continued and emerging secular growth trends. And with that, we look forward to taking your questions.
The first question comes from Deane Dray of RBC Capital Markets. Please go ahead. Thank you. Good morning, everyone.
Good morning, Dean. Good morning, Dean.
Hey, I really like the new segmentation and all of these disclosures in the slide deck. I mean, it's very helpful to see the continuity like on Page 4 where you show legacy Wesco combined with Anixter legacy. So it's a big help to us. And if we start, I think the surprise for me is how much we're seeing share gains in the quarter right out of the blocks. So you referenced it in the Communications and Security as well as Utility segment.
So if we could just start there and frame for us how any specifics around the share gains, but is it coming in the combined go to market? Are there new products? And if we can start there, please.
Yes. Well, thanks for that. Yes, I would say that it's we're seeing the results of really two things. And I referred to 1, both of these at the last quarterly call. Remember, we closed on June 22.
So we really couldn't get a look at all the details of the portfolio. And so one major and meaningful positive surprise that we obviously became aware of post close was the complementary nature of the portfolio, Steve. So I'll come back to that in a minute. Yes, we thought we conceded in the market, and we did, predominantly in utility. But even in utility, these are highly complementary portfolios when you look at the array of services that each company has.
Secondly, it's the cultural match, which I find to be also just a major kind of new learning or surprise and just this relentless focus on the customer and delivering value. But to specifically get at your point, I think the team has come together exceptionally well. There's a spring in our step. We're very focused externally on the customer and taking this new broader and stronger portfolio of products and services to market. And we did once we stood up the new organization, we launched a series of cross sell pilots.
And we'll report on these as we move forward. It's always it typically proves to be the most elusive synergy to get when companies come together. But we're really excited and encouraged by the initial results. And so we launched a series of cross sell pilots in each of the 3 businesses. So specifically in EES, we've we're taking our lighting capability, this turnkey retrofit renovation and upgrades and applying that those capabilities, bringing that to the Anixter's customer base.
And we're taking the tremendous depth, breadth and strength that Anastor has in water and cable, which is where their deep roots are, and bringing that to the Westco customer base. And as I mentioned in my prepared remarks, we have the complete electrical package now we can bring to customer. So thrilled about that. In CSS, we're leveraging that global footprint and bringing additional categories to those customers, that in terms of AV, in terms of safety. And fundamentally, what we're realizing, this is even without them, the new secular trends that have been accelerating due to COVID.
5 gs, Royal Broadband Buildout, data center growth, in building wireless, we're just seeing really strong growth in the end markets and customer applications. And now we have the most comprehensive and leading portfolio of products and services to bring to bear on that those applications. And finally, for utility and broadband, we've got 2 very strong leading companies coming together. And so I think in conjunction with our supplier partners, we're able to offer even more value now, even more value. The real key was the array or range of services that we have, services that we have a part of the overall solution offering is broader than we fully appreciated pre close.
So hopefully that gives you some color,
Deane. It really does. And just to clarify on that last point, because it was really interesting, you didn't highlight the services that are part of the sales offering and the combined entity and I know that was important to WESCO before. Do you have a data point on how much services are attached to the revenues? I remember you were saying before it was like 70% or in that neighborhood before.
What does it look like as a combined company?
Yes. What I'd like to do, Deane, is not answer that yet because I think as we build out these businesses, we are planning on some additional teach ins at Investor Day in 2021. And what I think the best way to get to that is as opposed to one aggregated number, we'll give you kind of insight business by business and what exactly those services are. And I will say that Anixter also had, very similar to WESCO, just a tremendous service value proposition and some specific service offerings that were at the heart of their end user relationship. So at that level, Dean, to give you some answer to the question, very similar.
But I think the entire portfolio is much more extensive as a result of the 2 coming together. And this will increasingly become one of our key value drivers, I think, going forward.
Great. And then separate question for Dave. It is an often we see over 300 percent free cash flow conversion, especially in a quarter where 100 percent was considered to be good. Can you take us through the dynamics in that high cash conversion? Are there any one timers?
Is there anything tax payment related? So just trying to get a sense of what the run rate should be. Thanks.
Yes, Dean. Good morning. Probably the one thing to keep in mind is in our free cash flow statement, we do have accruals in our income statement for the expected interest payments that we'll be making here in the Q4. So that's the one thing to keep in mind as we do have those interest payments that will be coming out. That's in that other line on the free cash flow statement that's in our press release.
Terrific. And do you have room to increase the free cash flow target? I know we increased the cost synergy target, but what's your sense on free cash flow target 3 years?
Yes, we've already gone out and we talked about there being $75,000,000 of net working capital improvement through
the integration
of the companies. And as I mentioned during our prepared remarks, we are working on upside to that. And that's one of the things that we're most pleased with is, as we brought the companies together, there's a, as John mentioned, a very, very strong cultural alignment when it comes to bringing the companies together from a customer perspective, but also how we think about working capital. And we do believe that there is going to be substantial upside across all three elements of our synergies, including net working capital going forward.
Great. Thank you and congrats to everyone.
Thanks, Dean.
The next question comes from Sam Darkatsh of Raymond James. Please go ahead.
Good morning, John. Good morning, Dave. How are you?
Good morning, Sam. I had
two observations following the disclosures of your new segment reporting yesterday, if you could explore them a little bit. The first one had to do with corporate overhead. Anixter roughly the same size as WESCO, but had and I'm looking specifically in 2019 had nearly twice the overhead.
Why it's a kind of a big number,
the $80,000,000 to $100,000,000 or something higher. Why is that? And I'm wondering if your overhead synergies should be considerably higher than the $35,000,000 to $40,000,000 that you've highlighted based on just simply rightsizing the overhead between the companies?
Well, thank you for that question, Sam. I love your question. Look, 2 comments. 1 is, yes, there's opportunity. 2, if you get underneath the covers and look at the composition of that, there were some functions that were more centralized, Sam, than distributed into the businesses.
So the answer is you should take both of those into account. There were certain, I'll call it, corporate level or administrative processes that they had centralized and within that corporate cost bucket. But your insights are right. We saw that as an opportunity for synergies as we work the financial commitments and model well in advance of closing, and we're beginning to realize those synergies already. I mean, I think we're absolutely thrilled.
Thrilled is the word with the progress we made with the integration teams on synergy, it's why we've raised the $200,000,000 to $250,000,000 But we also took the year 1 from $68,000,000 to $100,000,000 So and as Dave mentioned, that's in the G and A area as well as supply chain is where we've got some really strong momentum. With that said, we have increased confidence that we'll be able to deliver upside against these new higher targets. And we are still running to, which I mentioned before, to substantially higher targets internally. So the teams right now, the numerous integration teams that are executing have targets that are well above our new revised external targets.
Second question, the other observation I had, I mean, obviously, John, you've mentioned repeatedly that higher scale means higher margins. And I think that's really intuitive for a distribution business. What else was interesting to me though is Anixter's EES business clearly subscale versus you folks, it's like half the size, you folks, WESCO, half the size and yet it consistently had a point or 2 higher margin than legacy WESCO. I'm wondering why that is. I'm guessing some of that's wire cable product mix, but I'm wondering if there's also some branch or labor productivity in there.
I'm just curious as to how Anixter could consistently get higher margins with a much smaller business and if there's any learnings or takeaways as to how to capture that more holistically?
The way you frame the question, you actually have the answer. So they're absolutely undisputed leader in wire and cable. If you go back and look at Anixter's deep roots, wire cable connectivity solution, this is pre fiber and they pivoted into fiber organically and built out that business globally organically and now have the preeminent leadership position in communications and security. But in that category, wire and cable and all that that means, they are the industry leader with scale, size, scope and scale. That garners higher margins.
And that gives us the complete electrical package. The balance of their electrical business, Sam, is what they picked up through the HD Supply Power Solutions acquisition. And so the other categories that I'll call more complete electrical package, broad based electrical, would really, for all intents and purposes, kind of relegated to the southeastern portion of the U. S. And that's the legacy HD Supply Power Solutions Broad Based Electrical Business is the old huge supply, if you go back quite some time ago.
They did not have the broad based electrical capabilities in other geographic regions. So your insights are right. The way you asked the question is right, that it really wraps around that category and the way they actually the value added capabilities they have around wire cable connectivity solutions and the services, it just that delivers tremendous value to customers, and they're seeing that in the result margins. So I think on a combined basis, the real important point is on a combined basis though, this was probably this was not probably this was competitively the weakest part of Westco's broad based electrical offering. We had strength in wire enable in some local geographies, but we didn't have it besides scope or scale across the U.
S, across Canada, we were not able to take it internationally. And that's what Anixter gives us. And so that really is the leverage point, Sam, for the EES business. I mean, it's something I've always wanted and now we've got it. On a combined basis, we've got the complete package.
And if I can sneak one more in real quick, Dave, not to forget about you. Can you help us on a pro form a basis in the 4th quarter as to how we should think about incremental decremental margins?
Yes, Sam, that's something that we're not going to get into too much detail over. I mean, we're not providing any guidance for the Q4. One of the things that I would point you back towards is prior to the acquisition with Anixter, during our Q1 call, we had targeted on a WESCO only basis that our Q3 through sorry, Q2 through Q4 decremental margins would be in the range of 10%. And I would just highlight that we indicated back during our Q2 call that we were well within that range. We were within that range here in the Q3, but we're not providing any specifics for the Q4.
We're really focused on driving value for the shareholder on the combined company basis now.
Very helpful. Terrific quarter folks. Thanks, Sam.
The next question comes from David Manthey of Baird. Please go
So I'm hoping to understand the key factors behind the very strong gross margin and if the mid-nineteen is sustainable from here, was the majority of the $15,000,000 you achieved in synergies related to supply chain is the first question?
No. The majority of what we're seeing in that $15,000,000 is really related more to the SG and A. Just given some of the changes that we've made to the organization plus duplicative corporate overhead costs. So we've not really seen the full benefit of our supply chain initiated actions here in the Q3.
I would say the supply chain benefits, we are in the very early days in terms of realization, Dave. But based on the work we've done, that was a factor 68 to 100 and the 200 to 250.
Okay. Makes sense. And just But back
to your gross margin question. Look, Anixter now and going forward with these segments, we're not going to continue to talk legacy Anixter and Westco. But I think it's really important with respect to this point and probably a few other in this call. With respect to margin, this would have been this was the 8th consecutive quarter of gross margin expansion for Legacy Hanister. And they as I alluded to in the last quarterly the last quarterly call earnings call, They had they put in place a very comprehensive gross margin improvement 3 years ago, and we're still seeing the benefit of that.
We are taking that enterprise wide, and we are in the very early days of that. That did not has not contributed yet to the parts of legacy WESCO that are now part of EES, CSS and UBS. Legacy WESCO expanded gross margins on a like for like basis. And that's the result of a series of hard work and initiatives we had going on last year into the 1st part of this year. So and with that although that does not have the Anixter program with how we're going to drive it enterprise life influencing or impacting those results yet.
So to answer your question, we're going to be very focused on operating profit growth and operating margin expansion, but highly confident that gross margin expansion will be part of that recipe going forward.
Okay. Thanks, John. Yes, pretty remarkable in this environment to keep that moving higher. 2nd, construction. I know it's a smaller percentage of your business today, but it's just surprising to me that you're seeing growth when no one else in the world seems to be seeing growth.
And maybe you could just give us some examples, maybe it's mix that's driving that. Could you give us some examples of particular construction verticals you're seeing growth in?
Yes. Well, I think that first, let me start to go to the aggregate level. The backlog is a record backlog exiting the Q3. And we came through October, the momentum is improving overall for the business and our book to bill stayed above a 1.0 as we exited October and entered November. So and when you look at our sequential improvement of Q2 to Q3, that was what was most notable.
So construction was up double digits sequentially, the sales were in both U. S. And Canada, Q2 to Q3. That's above normal seasonality. That's not typical.
Typically, as we move through Q3, Q3 is typically a strong quarter like Q2 for the construction season. But typically, we start tailing off as we go into Q4 and the winter season. We saw pretty good momentum across all our construction branches and focused businesses, Dave. From a product category standpoint, we had growth in distribution equipment, we had growth in wire and cable, as I was referencing earlier. The other ancillary electrical, we had growth in motor and controls, We had growth in some nice sequential growth in lighting, some nice sequential growth in solar.
So I don't I mean, I share a view that at the aggregate level, non resi construction still is challenged. With that said, it's a very, very, very large market. And some verticals are more challenged than others. They spoke to oil and gas as having it's very low it's low single digit percent of the combined business now. So I think a big part of this is, I'd like all of you to understand is, we've mix shifted up to higher growth markets.
And construction is still an important end market and value chain for us. We have exceptional capabilities, but it's disproportionately a much smaller part of the company. And with that said, when you get underneath construction, it's our current momentum factor is encouraging. And so, look, all that we can do is focus on a weak control. We haven't seen any meaningful cancellations of projects, Only some projects had slipped out earlier in the year that we mentioned.
And but net net, sequential sales growth, backlog holding up nicely, it's a good position to be, particularly given the backdrop of the end markets and the environment.
The next question comes from Christopher Glynn of Oppenheimer. Please go ahead.
Yes, thanks. Good morning. Congrats on the fast start, especially the cash statement on getting deleverage underway.
Thanks, Chris.
Yes. Pat, a question on the ranges of investment you're contemplating for the digital B2B value chain initiative, is that included in the $140,000,000 cost to execute? And also, how are you thinking about guardrails around complexity, potential disruption of IT transitions?
Yes. So there's a couple of questions in that. As we go back to the integration update page in the deck, which is Page 8, webcast deck that is, you see what we do with cost synergies. And right under that, we've also increased our onetime operating costs, onetime operating costs to deliver the higher synergies. So just I didn't want to call that out on that page.
That's an important comment. But let me talk about digital and IT. First, I'll say that, and I know I mentioned this last time, we have a dedicated IT digital team, both comprised of LESCO and Exter as part of our integration office, as our best minds and talent across both companies. In addition, we have a separate dedicated consulting partner beyond the overall partner, not it's not the overall integration partner we have who is in place and doing a terrific job. This is a separate world class consulting firm that's helping us specifically on this effort.
And I mentioned last time, we're looking at all the current state systems, identifying how to best leverage digital applications and our combined big data to create competitive advantage. Chris, we're completing that assessment of systems and digital investments. Recall that we had been very clear in our original financial models of that we're going to have about 120 $1,000,000 per year in capital expenditures for the 1st 3 years post close. And our typically, our base capital is running at a $90,000,000 as you look at the 2 companies combined. So we laid in an additional $85,000,000 to $90,000,000 of incremental capital on top of the run rate capital.
That was in the original financial targets and models that we outlined to you, and now we're taking synergies up and one time costs up just slightly to implement. We said that anything everything that we expect to do, we think we can fit within our current financial parameters. That's really important to understand. I will tell you as a kind of initial proof point, we have 2 very interesting digital use cases underway. I'm not going to describe what they are in this earnings call.
This is something we'll want to do as we get into 2021 and with our Investor Day and other investor presentations begin to much develop much better exactly what we're doing visavisigital. But in both cases, we've got agile development underway. We're standing up these digital use cases in our current environment and leveraging our big data. We have taken Anixter's data and WESCO's data and we now have combined it and we're using a version of essentially a data lake to leverage that data to support these 2 digital use cases, I am thrilled with our initial progress. And I expect that we'll have some interesting results as we move through Q4 and into early Q1.
This is rapid agile development on these 2 use cases, and I expect to have some really interesting and compelling results coming out of that. So I probably gave you a bit more than you were asking. I think it's just really important to understand that and I'll put this in context. In the near to mid term, this is an integration execution story. Going above market, leveraging cross selling opportunities with broader product and services portfolio expanding with broader product and services portfolio expanding margins, reducing costs, delivering those synergies, exceeding the synergy targets, generating exceptional cash flow, paying down debt delever.
In the mid to long term, this is a digital transformation story. And we've already begun with the specific initiatives and activities to start standing up these digital use cases. I'm absolutely thrilled that we've got that underway only a few months post close. So hopefully that gives you a little insight.
Yes. No, thanks. That's great. I was asking all
of that.
And follow-up, as you're driving cost synergies and managing sales synergy strategies, I wonder if you've seen any pockets or issues around key retention or workforce on We with the integration environment or any kind of fallout around those types of issues?
No, we've had no issues. I'm absolutely kind of thrilled with the cultural combination, as I said, and kind of the extra effort being applied to customer focus, we've come together terrifically. So no issues there. I will say that you'll recall in our initial targets that we outlined, we had assumed some revenue dis synergies that was in the basic construct. We have not seen any revenue dis synergies to date.
So it's our goal not to have any. But I thought I'd just answer that because I think your question was probably work Force Plus also any disruption we're seeing. So far, exceeding expectations in both regards.
The next question comes Chris Dankert of Longbow Research. Please go ahead.
Hey, good morning everyone and again congrats on a really great quarter here. Can't help but notice with the increased synergy targets, only $10,000,000 more coming from field operations. Is that more a function of, hey, we have so much opportunity elsewhere, let's focus on those areas? Or are you just being conservative on the field operations? Just any commentary on kind of that mix would be great.
Yes, Chris, good morning. Appreciate the question. One of the things that I'd highlight here, and we said this earlier in the year as well that as we started to come together, particularly in year 1, we anticipated that the majority of the synergies in the 1st year would be coming from the SG and A and corporate overhead side and that we would be working on the supply chain and the field operations initiatives as we get more information, more data and we think about how we transform the company going forward. So we're actively working the synergies in those areas. We have gotten some additional synergies in the supply chain area just based on what we've been seeing and what we've been able to work against, particularly in the indirect procurement area.
But again, most of what we're seeing here in the 1st year is related more to that G and A and the corporate overhead side.
Got it. Got it. And then we touched on it earlier, but I
guess just trying to pull
the thread a bit more. On the gross margin improvement front, that cross pollination of best practices, I guess, if there is a way to kind of size how much of that knowledge has been disseminated, how long it's going to really take to try and get those best practices out into the field. So just any commentary on timetable there would be great.
Yes. So as we are in the process of implementing that now and the first part of that effort. It's organic through a couple of quarters, just a few quarters. So I started seeing results, as I said, on a legacy basis is their 8th consecutive quarter of gross margin expansion. And look, we all know what the environment has been.
I have to I'll give credit where credit is doing. There are exceptional results given the market environment over the last 2 years, no doubt about it. It did that did not drive the improvement in gross margins in legacy WESCO in Q3. I think, again, we're seeing the benefit of some of the actions and initiatives we had going on. So I would expect that, that will be a contributor going forward.
It could start as early as Q4 incrementally, but clearly, it will be a 2021 driver, no doubt.
Got it. Thanks so much for the color. And genuinely, congrats again.
Yes. Thank you.
The last question today will come from Nigel Coe of Wolfe Research. Please go ahead.
Hi, John. Good morning. This is Christian Ramos filling in for Nigel. A lot of ground being covered, but I really wanted to touch on cost synergies here and given your excitement for continued cost synergies. Two more questions, but first, could you maybe size and talk about what the pipeline, potential pipeline cost synergies is?
I mean, I know you raised it $250,000,000 total and $200,000,000 but really interested in hearing what the pipeline sounds like. And then 2, I think you've spoken about sales synergies in the realm of 100 basis points. And again, it sounds like you're pretty confident about how you could accelerate that. Can you just also touch on that as well?
So we're not going to size the pipeline, because what that question is, is how much what we it's not so much a pipeline. We actually have targets that are substantially higher than that that have been worked to a great detail in terms of what the potential opportunities are to hit those targets. They've been detailed out. They've been scheduled. And that's what we're that's what the teams are executing to internally.
And again, yes, we went from 2 to 250, but the targets we had previously set are the same targets that are in place and they're substantially above the PSA. So that's point 1. Point 2, one of the biggest pleasant surprises, I think, because we had very high confidence we'd deliver the cost. We also had pretty good confidence that we'd get some margin improvement, core margin improvement. Again, Addicts for 8 quarters in a row now, they had 7 in a row.
We didn't think that would and we actually have good confidence we'd step up margins on the West Coast side. So what was the biggest positive surprise? It's top line. I mean, you look at the top line, if you really analyze the top line and what we deliver versus market versus other, I'll call it, competitive competitors, It was really strong top line results. And we've got some initial success stories on the cross selling.
So as I said and as Dave said, I'll just put an exclamation point on it. Our top line sales growth synergies, our margin expansion synergies, our cost reduction or cost synergies and our free cash flow stepped up free cash flow generation. All four buckets, very, very high confidence and that confidence increased as we went through the quarter that we'll over deliver the 3 year targets.
Got you. That's very helpful, John. And if I could just follow-up and perhaps ask about the cadence of demand throughout the quarter because it sounds like or it seems like my math here suggests that back half of September was really strong. And so any incremental color there you could offer would be really helpful. Thanks.
Yes. We had given a data point partially through the quarter, I think. And so we did have a strong close and that momentum has continued in October, as I said. Dave, you may want to add to that. But we have a positive momentum vector right now, period, in terms of opportunity pipeline, bookings, book
to bill above 1 and sales. Dave? Right. And we also had indicated when we were through the we and we did get the benefit of an extra work day. But as John mentioned, we also finished strong.
And I think a lot of that goes back to when we combined with Anixter, both companies had been working on how to grow share. And we saw that beginning to take place here as we brought the companies together in the Q3. We had a strong close in September.
Great. Thanks. Thanks, guys. I'll leave it there.
This concludes our question and answer session. I would like to turn conference back over to John Engel for any closing remarks.
Well, thank you all for your time this morning. Brian and Will are available to take your questions. I know we had a number of follow-up sessions scheduled already. And we look forward to being able to spend some additional time with you at our upcoming investor events. That includes our week and the Stevens Investor Conference later this month.
Thanks again. In the meantime, please stay safe and healthy. Have a great day.