Good morning, and welcome to the WESCO's third quarter 2019 earnings conference call. All participants will be in listen-only mode. Should you need assistance, please signal a conference specialist by pressing the star key, followed by zero. After today's presentation, there will be an opportunity to ask questions. To ask a question, you may press star, then one on your telephone keypad. To withdraw your question, please press star, then two. Please note, this event is being recorded. I would like to now turn the
conference over to Will Ruthrauff, Director of IR. Please go ahead.
Thank you, Jacob. Good morning, ladies and gentlemen. Thank you for joining us. Joining me on today's call are John Engel, Chairman, President, and CEO, and Dave Schulz, Senior Vice President and Chief Financial Officer. This conference call includes forward-looking statements, and therefore, actual results may differ materially from expectations. For additional information on WESCO International, please refer to the company's SEC filings, including the risk factors described therein. The following presentation includes a discussion of certain non-GAAP financial measures. Information required by Regulation G of the Exchange Act with respect to such non-GAAP financial measures can be obtained via WESCO's website at wesco.com. Means to access this conference call via webcast was disclosed in the press release and was posted on our corporate website. Replays of this conference call will be archived and available for the next seven days. With that, I'll turn the call over to John Engel.
Thank you, Will. Good morning, everyone, and thanks for joining us for today's call. I'll lead off with a few high-level remarks, then Dave will take you through our third quarter results and provide an update to our 2019 outlook. He will also provide our initial view on our 2020 top-line sales. We achieved record sales in the third quarter, and sales in all of our end markets and geography grew on a year-over-year basis as expected. Importantly, we achieved these results in a more challenging economic and end market environment. We were encouraged with our improving results in the U.S. and strength in industrial, utility, and datacom. Gross margin was under pressure and declined in the quarter, driven by mix and the time lag to pass through the record levels of supplier price increases to customers this year.
Dave will take you through the margin drivers in more detail in a few moments. We continue to focus on what we can control and effectively manage operating costs to deliver operating margin within our expected range, an EPS growth of 8% versus prior year. Free cash flow was also very strong as we expected, driven by inventory reduction and strong collections in the third quarter. As you saw in our release earlier this morning, based on our September year-to-date results and our view of the end markets, we have narrowed the range for our full-year outlook for sales growth, operating margin, and EPS while maintaining our outlook for free cash flow generation of at least 90% of net income. Finally, as you know, we recently announced that Nelson Squires was appointed Senior Vice President and Chief Operating Officer.
This organizational change is part of a broader streamlining of our operating structure that I will discuss a little bit later in this call. We were also very pleased to welcome a new member to our WESCO Board of Directors earlier this month. Laura Thompson joined our board, and she brings deep financial expertise and global operations experience to our board. With that, I will now turn the call over to Dave to provide further details on our third quarter results and our updated outlook for 2019, as well as our initial look at sales for 2020. Dave?
Thank you, John. Good morning, everyone. I'll start with an overview beginning on page four. Reported sales in the quarter were up 3.9%, within our outlook range of 3%-5%. U.S. sales were up 4% with growth in all end markets. Construction increased 4%, industrial up 3%, utility sales grew at a strong 6%, and CIG sales increased 2% over the prior year. Sales in Canada were up 1% with our industrial and CIG end markets up 7% and 6% respectively. Construction sales in Canada were up 1% on top of 12% growth in the prior year period. Utility sales were down due to the contract non-renewal mentioned in previous quarters. International sales were up more than 5% on an organic basis. SG&A expenses were 2% higher than the prior year, driven by the SLS acquisition.
Operating profit was $93.7 million, or 4.4% of sales within our outlook range for the quarter. The effective tax rate for the quarter was 19.8%, lower than our expected rate of 22% and 260 basis points higher than the prior year. Our effective tax rate is typically impacted by the tax effect of intercompany financing, foreign tax rate differences, nondeductible expenses, and state income taxes. The effective tax rate was lower than our outlook for the quarter, primarily due to the full application of the international provisions of U.S. tax reform, partially offset by the discrete effect of accruing taxes attributable to undistributed earnings from operations in China that are expected to be remitted in the foreseeable future. Interest costs were lower than the prior year due to the non-cash benefit of settling a Canadian transfer pricing issue.
Moving to slide five. As John mentioned, gross margin was 18.6% in the quarter, down 60 basis points versus the prior year, 40 basis points lower than the June quarter. I'd like to provide some more detail on what drove this result. Relative to prior year, gross margin this quarter was impacted by two primary factors, mix and price cost headwinds. On the right side of this slide, you may recall from our Investor Day that we provided an overview of historical differences in gross margin rate by sales type. The growth we experienced in construction and utility, which are below the line average for WESCO, created a mix drag to gross margin. The same was true on a geographic basis, as sales in our high-gross margin Canadian business grew less than in the U.S. and our international markets.
Lastly, our direct ship sales grew at a higher rate than our stock sales, and direct ship sales have lower gross margins and operating costs than stock shipments. Regarding supplier price increases, we are aggressively working to pass through increases to our customers. Year to date, the number of supplier price increases continue to exceed those seen in 2018, with tariffs cited as a significant driver for approximately half of all increases. The magnitude of supplier price increases also continues to exceed that seen in 2018 and averaged high single digits in the quarter and year to date. We are experiencing the typical time lag of working the increases through the value chain to customers. We expect to see positive effects of our efforts in the coming quarters. Moving to the diluted EPS walk on page six.
We reported diluted earnings per share of $1.52, up 8% from the prior year. This reflected a combined $0.21 benefit from foreign exchange rates, a lower tax impact net of interest, and a lower share count following our repurchase activity in 2018 and 2019, partially offset by a combined $0.10 decline due to core operations and the SLS acquisition. We've also provided you the reconciliation of organic and reported sales growth. Foreign exchange was a drag to reported sales, but more than offset by the benefit of the SLS acquisition. Moving to our end market results, beginning on page seven. Industrial sales were up 5% overall and up 3% and 7% in the U.S. and Canada respectively, reflecting a stronger result than the first half. Industrial sales were up 1% sequentially from the second quarter.
Among our global account market verticals, petrochemical, metals and mining, and food processing were all up double digits from the prior year period, while OEM was down versus the prior year. Year to date, industrial sales were up 2%, and we continue to expect growth in this market. Although moderating, the macroeconomic indicators still support solid production levels and capacity utilization rates in the U.S. and Canada. RFP quotations and bidding levels remain very strong, with third quarter and year-to-date activity up mid-single digits versus prior periods. During the quarter, we were awarded a new 3-year contract to provide electrical MRO and OEM products to support the U.S. and Canadian operations of a high-voltage equipment manufacturer. Turning to page eight. Sales in the construction end market were up 3% in the quarter, reflecting sales that were up 4% in the U.S. and up 1% in Canada in local currency.
Sales were up 2% sequentially from the second quarter, in line with typical seasonality. Project activity levels remain active. However, we have seen some project delays with industrial contractors due to skilled labor constraints and overall uncertainty, partially caused by tariff-driven price increases. The skilled labor shortages that our customers are facing represent opportunities for WESCO project management and construction services that help our customers meet these challenges by reducing supply chain complexity and increasing job site productivity. Backlog and constant currency was down versus prior year and flat on a sequential basis, reflecting normal seasonality. We ended the quarter with the second highest Q3 backlog in our history. We're pleased to note that margin in our backlog was higher on both a sequential and year-over-year basis.
As an example of our recent success, this quarter, we were awarded a multimillion-dollar contract to provide switchgear for the construction of a new hospital in Canada. Moving to page nine. Our utility sales continued to be strong. Sales were up 3% for the quarter after delivering 11% growth in the prior year. This result was despite a 28% decrease in our Canadian business due to the non-renewal of a contract that was at an unacceptable margin that we have discussed in prior quarters. This is the last quarter for which there will be a negative comparison in our Canadian utility sales from the absence of this contract. U.S. sales increased 6% and improved 4% sequentially. WESCO is benefiting from secular trends in the utility sector, including construction market growth, increased industrial output, grid hardening and reliability projects, and higher demand for renewable energy.
In addition to these trends, we continue to expand our scope of services with investor-owned utility, public power, and utility contractor customers. Our utility business has posted seven years of growth, and we expect this to continue going forward. Bidding activity levels are high, and we have a robust opportunity pipeline. This quarter, we were awarded a multi-year contract to provide broadband cable and fiber equipment to support a Fiber to the x project for a municipal utility in the U.S. We also began servicing a new utility alliance customer in October, which we had highlighted on the first quarter call. Finally, turning to commercial, institutional, and government, or CIG, on page 10. Sales were up 1%, with the U.S. up 2% and Canada up 6% in local currency. International was down double digits, reflecting strong project activity in the prior year. Sequentially, sales were down 3%.
Sales to datacom and security customers were up double digits. On a two-year stack basis, CIG sales were up 9% in the quarter. This performance was again driven by our strong capabilities in value-added services and LED lighting renovation and retrofit applications, as well as Fiber to the X deployments, broadband build-outs in Canada, and network and security solutions. As an example of the continued strength we are seeing in CIG, this quarter, we were awarded a multi-million dollar contract to provide data communications products for the construction of a U.S. federal government facility. Turning to page 11, the company generated free cash flow of $117 million in the quarter, or 181% of net income. Year to date, WESCO has generated $86 million, or 51% of net income. We continue to expect to generate free cash flow of approximately 90% of net income for the full year.
Debt leverage net of cash was three times trailing 12 months EBITDA, down from the prior quarter, driven by lower debt and a higher cash balance. Leverage is within our target range of two to three and a half times trailing 12-month EBITDA. The new lease accounting standard did not have a material impact on the income statement or the statement of cash flows. We maintained strong liquidity, defined as available cash plus committed borrowing capacity of $723 million at the end of the quarter. Our weighted average borrowing rate was 4.4% for the quarter. Our fixed-rate debt is approximately 62% of total debt, consistent with historical averages. As referenced on slide three of the presentation, during the quarter, we extended the maturity dates for our two credit facilities and increased overall borrowing capacity by $50 million.
Capital expenditures were $9 million in the quarter, reflecting investments to digitize our business, including information technology tools and digital applications. We completed the previously mentioned accelerated share repurchase transaction that we entered into in May for $150 million and received an incremental 700,000 shares in the quarter. We have now completed $275 million of the $400 million share buyback authorization that will expire at the end of 2020. WESCO has a history of generating strong free cash flow throughout the entire business cycle. We expect this to continue. Our capital allocation priorities remain consistent. The first priority is to invest in organic growth initiatives and accretive acquisitions, including large core electrical distributors that consolidate the market or transactions that provide a new strategic capability. Second, we seek to maintain a targeted financial leverage ratio of between two and three and a half times EBITDA.
We return cash to shareholders through share repurchase under our three-year, $400 million share buyback authorization. Let's turn to our outlook for the remainder of 2019 on slide 12. For the full year, we are lowering the midpoint of our outlook to reflect our results in the first nine months of the year, as well as economic data that now points to slower growth. We expect our industrial, construction, and CIG end markets to be up low single digits for the full year and our utility end markets to be up low to mid single digits. We expect the U.S. to be up low single digits and sales in Canada to be up low to mid single digits for the year.
On a consolidated basis, our outlook is for sales growth of 1%-3%, operating margin of approximately 4.2%, an effective tax rate of approximately 21%, and diluted EPS of $5-$5.40. At the midpoint, this outlook would represent the highest earning per share in WESCO history. We still expect to generate free cash flow of approximately 90% of net income as the increase in accounts receivable that impacted the first half will continue to be converted to cash in the fourth quarter. This full year guidance implies sales growth of approximately 3.5% at the midpoint, operating margin of approximately 4.2%, and effective tax rate of approximately 21% for the fourth quarter. Moving to slide 13, we are providing our first end market outlook for 2020 today.
We expect our end markets to provide profitable growth opportunities for WESCO in 2020, while macroeconomic uncertainties could affect the industrial and construction end markets. Overall, we expect that the current soft demand environment will continue next year, similar to the second half of 2019, with the utility and CIG end markets offering relatively stronger growth potential, driven by long-term electrification and digitization secular trends. Our 2020 plan includes outperforming the end markets by leveraging our full range of WESCO services and solutions, investing in our people and digital capabilities, and maintaining our cost and cash management discipline. As a result, we expect sales growth in the range of flat to +4% for next year, and we'll provide the balance of our 2020 outlook during the fourth-quarter earnings call in January.
As the economy slows and end markets become more challenging, the strong free cash flow generation capability of our business supports execution of our strategy and capital allocation priorities. Customers are seeking continuous improvement and supply chain stability in an increasingly complex and rapidly changing world. Our talented team of associates and our robust portfolio of products and value-added services continue to differentiate WESCO in providing our customers with complete solutions for the MRO, OEM, and capital project needs. With that, let me turn the call back to John.
Thanks, Dave. Before we open the call to questions, I wanted to comment on the press release that we issued earlier this month promoting Nelson Squires to our Senior VP and COO. As you know, Nelson has had responsibility for our Canadian operations since 2015 and was given additional responsibility for our integrated supply and international operations in early 2018. Nelson has proven to be a highly capable and effective business leader who has delivered results since joining WESCO four years ago. All of our business leaders now report directly to Nelson, and the overall U.S. business leader position has been eliminated. These organization changes further streamline our operations and will help WESCO grow as a leaner, more agile company. With that, we'll now open it up for questions.
We will now begin the question-and-answer session. To ask a question, you may press star then 1 on your touch-tone phone. If you are using a speakerphone, please pick up your handset before pressing the keys. To withdraw your question, please press star then 2. At this time, we will pause momentarily to assemble our roster. The first question comes from David Manthey with Baird. Please go ahead.
Thank you. Good morning, guys.
Morning, Dave.
Morning.
Since the Analyst Day, you've been talking about transformational M&A. I'm just wondering if you could help us in your thinking of how you define transformational. Are you thinking about just a large deal, or is it something outside your core business? What do you consider transformational? For something big and meaningful, would you consider using WESCO stock or not?
Yeah. If you recall at our Investor Day, we did outline our priorities relative to our overall acquisition strategy as part of our overall strategy. They were, first, to consolidate large core electrical distributors. Second, to expand into adjacent product and service categories. Third, you'll recall that we said we want to invest in digital technologies that advance the enterprise strategy. They're our core elements of our acquisition strategy. Transformational acquisition means it basically sits within those three priorities. A large acquisition will provide that potential because of the synergies that we would be able to extract and then thoughtfully reinvest a portion of, and also investing in digital technologies that advance our enterprise strategy and helping lead the digital transformation for our type of company in the B2B distribution value chain. Relative to financing, Dave, I think that, we've always run with leverage.
We have excellent free cash flow generation. In fact, if you go back and look at what our cash generation has been since we went public 20 years ago, it's been very strong cash generation through all phases of the economic cycle. Our free cash flow yield is very high. We're comfortable running with financial leverage, very strong free cash generation, very strong balance sheet, and if we were talking a very large transformational acquisition, we would use the most optimal mix of financing that would get the deal done, combination of tapping the debt markets as well as considering equity when appropriate.
Makes sense. Okay. Maybe one for Dave. Gross margin has been flat to higher year-over-year for the past five quarters. We took a little step back here. Could you give us a bit of a walk from the 19.2% last year to the 18.6% this quarter? What changes between here and the fourth quarter to get you back on track?
Certainly. As we highlighted, there are two primary factors, and we've talked about this in some of the previous quarters as well, but the first was mix. As we highlighted during the Investor Day, we saw mix as a headwind across all three of the vectors of our gross margin composition. Our end market mix was primarily driven by the growth in the utility business and also with construction. Additionally, within our industrial end market, the mix of the growth by end market created a mix headwind. That's something that we haven't talked about quite a bit publicly, but for example, we highlighted that our OEM business was down versus the prior year. That has a higher gross margin than the balance of the industrial end market, so that created a headwind even within our industrial end market.
Clearly, the geographic mix was also a key driver. It's relatively straightforward. We highlighted that our Canadian business has a significantly higher gross margin than the balance of the company, and organic sales were only up 1% in the quarter versus the U.S. and international being up in the low single-digit range. Finally, we also had that higher percentage of sales that were direct ships. These are direct ship sales. They don't touch our inventory, and we have a lower gross margin on these sales compared to stock sales, which resulted in the margin headwind. On price cost, again, we've seen this cumulative effect of significant number of price increases, and we're averaging low or mid-single-digit price increases with our suppliers.
We just are continuing to see that lag between being able to pass through those price increases and get the margin rate recovery with our customers. That's clearly been providing a drag versus the prior year. Going forward, as we highlighted, we are continuing to work through driving through and getting gross margin rate with our customers. As we look at it going forward, we've got a series of initiatives in place that we anticipate will drive that expansion of our gross margin rate.
Very good. Thank you.
The next question comes from Deane Dray with RBC Capital Markets. Please go ahead.
Thanks. Good morning, everyone. Wanted to add my congrats to Nelson. He's a great addition to the C-suite. Love that. Also that gross margin slide mix, that's really helpful, and that was very informative. I appreciate that color.
Thanks a lot, Deane. Appreciate the real-time feedback on that.
All right. What surprised me most first is that we're all seeing across the industrial sector signs of short cycle industrial weakness. If I look at your results in the industrial side and on the construction side, it doesn't come through this quarter. You seem to be breezing through it, up 5% organic in industrial and up 3% in construction. When you talk about slowing in the fourth quarter, it sounds like you're pointing to the economic data suggesting they're slowing, but are you actually seeing it in your day-to-day business, maybe in some of your MRO business? Maybe we start there.
Your question of. You're right. When we say we're seeing increased headwinds and challenges, that is the end markets. That is more around commentary from customers. There's a continued uncertainty with the economic outlook. Again, all those comments around more challenging economic and end market environment, it is the end markets. I have to say, I'm actually very pleased with what we've done in terms of driving the top-line results in Q3. I know the comparables are easier year-over-year, but it's against a backdrop that's much tougher. You cited two of the end markets, industrial and construction. Remember, we grew in all of them, and we grew in all geographies. I think of particular note is industrial, because when you look at our industrial end market, as you alluded to, we had growth in Canada, U.S., and international.
The overall growth was mid-single digits, and that's with oil and gas sales being flattish in the third quarter as they were in Q2. Overall oil and gas across the company. I think that's a testament to a number of the sales-related initiatives that we have underway, and we talked about those as part of our Commercial Excellence Strategic Client and Investor Day. I think what's really notable, and this is particularly important to put this into historical context. I've been here 15 years. We've had periods over that time where residential construction was materially stronger than non-resi end markets. That's what we're seeing now. I would say that most of the end market indicators and what we're hearing from contractor customers, again, around the uncertainty, there's increased headwinds across non-residential construction. Residential construction's holding up.
Again, I would say that I'm pleased with our results, particularly in the U.S., stepping up to a 4% growth in construction in the third quarter. The majority of our geographic regions grew in the U.S. In Canada as well, the regions that we experienced some increased pressure was the western provinces, which I think we've all seen what the commentary is in the paper, particularly out in Alberta and the other portions of the western provinces. Coming back to industrial, one other comment as well. At a regional level in both U.S. and Canada, we had a majority of those regions also grow organically in sales. Deane, I'm actually very pleased with how we've picked up our sales execution, positive sales momentum.
I'd say there's a few others that have reported results thus far, and both, I would call them investor peers, some competitors, as well as suppliers.
I think when you put it in that context, the fact that we grew all end markets, all geographies, and the numbers that we posted, it's something we feel pretty good about. We want to obviously build on that momentum. The backlog held up, consistent with normal seasonality. As Dave mentioned, the margin rate in the backlog is higher. That does give us, and that's unique to us, right? I think that gives us some confidence as we start moving through Q4.
Got it. That's very helpful. Then if we look at your 2020 comments, we're actually pleasantly surprised that you wanted to take a stab at this because a bunch of the companies are holding off on giving their sneak peeks, and here you are giving a pretty detailed bottom up. When I looked at flat to 4% total, it just struck me as a bit optimistic. I look at the underlying assumptions about your outgrowth, that seems in line. Maybe, the industrial and construction low end of the range is of low single digit. How did you arrive at those? Is this, again, you're extrapolating what you're seeing on the economic data and some of around the end markets. What's the sensitivity there from a bottom up on the low end of those ranges, and could they actually be lower?
Yeah. The answer to your question is yes. In terms of the end market ranges, and our view of the end market, and it's a combination of all the different indicators that we look at, some of which are in the public domain, a number of which are not. Let me come back to our momentum, because I think that's the really important point. Let me start with, I said backlog is very healthy as we move Q3 to Q4. That's number one. Number two, the pipeline, and we manage a phase-gated pipeline of opportunities. Our pipeline has actually increased substantially. This is our opportunity pipeline. It's increased substantially over the last several quarters as we've moved through 2019.
To be fair, part of that is a direct outcome of some of the additional digital tools and analytics that we've built for the front-end sales and marketing teams as part of our Commercial Excellence strategic plank. Our pipeline that we're managing again of opportunities is the largest it's ever been by a meaningful measure. What's our momentum thus far in Q4? We said on the slide that we reported, we said sales were up low single digits. With one day to go, our sales growth is between 3% to 4%. A little bit stronger. When we locked down the chart, we wanted to be comfortable with the low single digit, which for us is zero to three. I did want to give that point, that with one day to go, and that's today, we're running roughly a 3% to 4% sales growth.
That's helpful. Thank you.
The next question comes from Nigel Coe with Wolfe Research. Please go ahead.
Thanks. Good morning, guys.
Morning.
I echo Deane's comments. Great information. Just want to pick up on that gross margin differentials. I think we were sort of aware of the differences. Can you just remind us, how does the operating margin compare? The SG&A structure amongst the different verticals and geographies. Is there a big difference in operating margin as well?
Nigel, it's Dave Schulz. Overall at the company level, it's relatively agnostic at the operating margin line. The one thing that we did highlight is that's particularly true when you take a look at our end markets and when you take a look at our shipment type. Remember that the shipment type, the margin differential is because of our cost to serve. For example, something that goes direct ship doesn't touch our inventory, the gross margins are lower, but the operating costs are lower as well. Therefore, it's relatively agnostic at the shipment type level. Where we have the significant difference from an operating margin perspective is by geography. If you take a look at the average for WESCO, Canada is higher. Again, we've invested heavily in Canada primarily because we're attracted by the margin composition.
The operating margin composition, it does tend to be significantly higher than the balance of the business. Conversely, based on the mix of our international markets, international tends to be slightly lower than the overall line average from a geographic perspective.
Thanks, Dave. That was great. Moving on to 2020, you called out utility as a sort of a tailwind to growth next year. I'm just curious. We're obviously seeing very nice trends right now in T&D. What kind of visibility do you have into next year at this point? I know that generation isn't a big driver for WESCO. Maybe just touch on what you're seeing in generation as well. That'd be helpful.
Our utility business, we've got, Nigel, an interesting portal into the utility industry in terms of we serve the investor-owned utilities, that grew in the third quarter. We serve public power, municipals, and co-ops, that grew in the third quarter. We also serve specialty utility contractors. I would say it's those contractors that are uniquely geared from a business mix and capability standpoint to serve utilities. That grew in the third quarter. We feel really good about foundationally. The strength of the growth in the third quarter and the U.S. growing at 6% was a really good number, we think. Canada, again, is that contract that we walked away from. We'll have a little bit of sales that we still have in Q4 of 2018 last year, it's much smaller than the rate of sales we had in Q1, Q3.
When we move through Q4 into 2020, we expect, again, strong results in utility across our Canadian business. I just wanted to set the stage with that a bit. It's through those relationships that we have insight into their capital spending plans. What's driving our growth isn't just, I wouldn't call it fundamentally different. We've been consistently outperforming the market. Now, when we finish this year, we'll have eight years of sales growth in a row in utility organically. That's despite exiting these large contracts that we walked away from. We're getting the sales growth from increasing our scope of supply with current customers, expanding our product categories. There's additional spend on grid hardening, project win, sales growth, et cetera. As you think about the drivers going forward, it's grid automation, renewables, storm hardening initiatives, as well as continued growth in resi.
Because continued growth in resi adds meters to the ground, which is a first derivative growth driver for utility, and then non-resi typically follows. Finally, I would say that the contractor business remains strong because structurally, utilities continue to outsource their capital project work. When you integrate all these, I'll call those dynamics, we just see with our value proposition, the end market, with the ability to outperform the end market with our capabilities, we've got great confidence in that, and we've got a long and strong track record.
Okay, John, thanks a lot for that.
The next question comes from Steve Tusa with JP Morgan. Please go ahead.
Hey, guys. Good morning.
Morning.
Morning.
Can you just talk about what you're seeing in the machine builder vertical? It's kind of a small vertical in the grand scheme of things, but there's just been a little more chatter around weakness there given cross-border concerns.
Yeah. It's a really good question. We're seeing challenges. We've got part of, we'll call them OEM-type customers that Dave alluded to in his earlier comments, that would include that. Then we have some specialized businesses around industrial automation and control, and we're seeing some headwinds with customers that we would categorize as the machine builders.
Is it down mid-singles or what would you say?
For us, it's in the single-digit range. Yeah. It's not double digits.
Down.
It's not down double digits.
Yeah. Okay.
It's down mid to high single-digit range. Not double digits.
Okay. I know I try and ask a question almost every quarter just to kind of reinforce the dynamics. There's kind of a view out there that there's an inventory correction that's going on here. You guys in particular are very good about managing your inventories, and you never really get too bloated or too lean. Correct? If somebody's selling into you're managing that pretty tightly. They have a lot of visibility into that, right? There wouldn't be a correction at your point in the channel.
Correct. Then for us specifically, we increased our inventories in the first half, and we spoke about that in the Q2 conference call. That was one of the drivers of our first-half cash flow, as well as a significant growth in the AR balance given the shape of the sales in the first half and the increasing sales growth in May into June. When we gave our Q2 earnings call, we were very clear to make some comments around Q3 and said we do expect very strong free cash flow generation in Q3. We did specifically talk about two contributors, which were strong collections, which we have executed now and have seen and have benefited us in the quarter, as well as inventory reduction. We reduced inventories over approximately, I call it $40 million.
$40 million in the quarter.
$40 million sequentially in the quarter.
Yeah. That's a good performance. Just lastly on the kind of pricing side, are you seeing any of your major suppliers get, I wouldn't say aggressive, but in targeted areas, try and bring in some business either kind of late in the quarter or as we go forward here in kind of a weaker environment? Is anybody, I wouldn't use the term breaking ranks, that's probably too strong, but anybody kind of backing off their aggressive pricing and pulling back on price increases to book deals? You seeing that in any of your major suppliers?
I'll break it into a two-part answer. The short answer is no. For, I'll call it, the pricing that Dave set that kind of works its way through the channel and impacts our stock and flow business, that's the area where they try to move the price increases through, and we've got to try to obviously get that moved through to customers. In some cases, we've got multi-year contracts with a global account customer, and that's the time lag, right? The short answer to your question is no. On that, I have not seen any change in behavior, and Dave's earlier commentary speaks to the record level in terms of number of price increases and magnitude of those increases.
On the direct ship business, which in many cases will get special pricing and supplier costing to support that business, that always works in a very, I'll call it works in a real-time way. As projects are being bid, we're simultaneously with customers and contract customers, we're working with supplier partners on what the appropriate level of cost and what cost they're willing to go forward with that project on, and we work that as a team. That dynamic hasn't changed. That's always a very, I'll call it, aggressive real-time process. I would say that because contractors have record backlogs and there's a labor shortage for the skilled trades, as they continue to work. The number one priority for them is to execute the backlogs. Number two is they try to take on new business to increase their record backlogs.
They have to have confidence in the skilled trades, and the uncertainty around pricing is just another dynamic there. That kind of sorts itself out real time. The way we look at that and a good measure is what's our backlog done, and we said it was flat sequentially, but the margin rate in our backlog's up a little bit, which really speaks to the WESCO value proposition with contractors, and we're very focused on supply chain services, including prefab and material management capabilities with our contractor customers. We're focused on job site productivity and improving that for our contractor customers. Does that help?
Yeah. Okay. That's helpful. I appreciate it. Thanks.
Yep.
The next question comes from Michael McGinn with Wells Fargo. Please go ahead.
Thank you. If I could just follow up on the acquisition line of questioning discussed earlier. Is this something transformational on the digital side where you would entertain a dual brand strategy, kind of like a high touch, low touch model, or is it something more that you would integrate it under the WESCO brand?
That's an excellent question. As I recall, I probably haven't gotten that question before, so terrific. I will say that in terms of branding strategy, we already run a dual brand in Canada with customers. I'll just take you back and summarize history a little bit. We had a very strong Canadian business. We had the opportunity, we thought, which was a unique opportunity in our career as a 100-year-old private company. After working that deal for over five years, we were able to make that happen. That was acquiring EECOL. That was done seven years ago. We went to market with a dual brand post-acquisition close in Canada. That was expressly the strategy.
The WESCO brand is lined up with a very large global leading electrical supplier for core electrical, and Nicoll is lined up with a different large leading global electrical supplier leader. We've already had that model working within WESCO on a large scale basis. Also, other acquisitions that we've done over the years, we've done over 45 since WESCO spun out of Westinghouse 25 years ago, and there's still a handful of brands that we use where they add value in the value chain and with customers. I think that we would do the right thing from a branding perspective. It would be a function of what we're acquiring, what the business model is, and what we think would make most sense in serving customers.
Okay. Since we're on the topic of deals and branding, there's been some meaningful shifts in your supply chain, lighting, Cooper and then as well as on the data center side. Can you just comment on those big changes and what you're seeing structurally from a just customer win standpoint going forward?
Yeah.
I'm sorry, supplier win standpoint.
No, yeah, I understand. That's how I interpreted your question. It's early days on the latest lighting combination, that being the announcement of Signify acquiring Eaton's Cooper Lighting business. We've got very strong relationships, obviously, with all the Cooper divisions that are part of Eaton and Eaton overall. Eaton is our largest supplier partnership, and we have very strong and longstanding relationships with Signify, that is the prior Philips. In both cases, those relationships go back well into the Westinghouse days when we were a captive distribution arm. From my perspective, and I've been very clear about this with respect to lighting, and I know we had a number of questions and comments around that at our recent Investor Day earlier this year.
And then on the-
There's a lot of changes occurring fast, I think the manufacturer supplier partners have particular challenges given additional entrants and new entrants in terms of manufacturers of lighting products globally. As a supply chain solutions provider, we're able to provide good, better, and best solutions for lighting applications, we can work with our supplier partners, bring the best brands together. What it turns out to be the differentiator is the control solution and our ability to wrap services around that. We've got a turnkey retrofit renovation and upgrade set of capabilities that we acquired a number of years ago with [Elex Lumagent] that we've been investing in. Our SLS acquisition earlier this year is supportive of strengthening that.
All right. Thank you very much. I'll pass it along.
Yep.
The next question comes from Robert Berry with Buckingham Research. Please go ahead.
Hey, guys. Good morning.
Good morning, Robert.
I want to ask you about SG&A, but since it keeps coming up, the M&A question, just curious your thoughts about doing a transformational acquisition at this, what some think is a late stage in the cycle.
again, I think we were very clear about what our plans and strategies were at Investor Day, and I'll reinforce them. Remember what we did at Investor Day. I tried to provide a very forward-looking view of the state of evolution, the state of disruption, i.e., transformation being required in the B2B value chain. I think the opportunities are significant, particularly for the largest and those companies that are well-capitalized, which we are clearly in that class. we were very clear about our overall enterprise strategy and our acquisition strategy as part of that, which again, was to consolidate large core electrical distributors, expand into adjacent product and service categories, and invest in digital to help lead the digital transformation. that's our ambitions. I think that we will be very thoughtful.
You can't always control the timing of deals, and so we'll be very thoughtful and take advantage of opportunities when they arise appropriately. We've got a very strong balance sheet, as I commented on earlier, and have shown strong and consistent free cash flows across all phases of the economic cycle. The thing with acquisitions is you can't time them, right? It'd be great to say we could strategically time them, but you can't. You got to be prepared to, when it makes sense, to take action. That's a great example, again, EECOL, because we worked that for many years and we had a chance to get a century-old company that was a very strong operator, and we did it. I think, again, we look at the opportunities. Obviously, the numbers have to work.
Our strategic view is there is an excellent opportunity to lead the consolidation and digital transformation of B2B distribution for our served end markets in the value chains that we operate.
Got it. Okay. Thank you. I did want to just touch on the SG&A performance there continues to be very good, very low SG&A growth. I'm assuming there's maybe about $5 million from SLS in that number. Give or take, how long do you think you could sustain growing the SG&A at what looks like less than 1%, kind of adjusted for the M&A?
Rob, it's Dave Schulz. Again, what we see right now in our third quarter SG&A is the increase year over year is primarily driven by the SLS acquisition. As a company, we have a long track record of carefully managing our costs. One of the other things that has impacted our SG&A in the current quarter, the third quarter, is obviously we're not performing to our internal expectations across the entire business, and therefore, some of our incentive compensation accruals are lower than they were in the prior year. That's also having an impact on the SG&A in the third quarter. Going forward, obviously, that's something that we want to make sure that we're able to restore. Again, we'll provide more details about our 2020 on our January earnings call.
Got it. Just maybe a quick housekeeping item. Looks like the share count keeps coming down. I know you've been doing a fair amount of repos. What now is the share count assumed in this guidance update?
Yeah. Again, the driver of the share count reduction in the third quarter was really just a carryover of what we saw from the $150 million share repurchase that was initiated in the second quarter. In terms of the share count for the full year, I think if you took a weighted average of the four quarters, you'd get somewhere in the range of 43.3-43.5. I think that would be the right expectation to think about as you're looking at your model.
All right. Thank you.
The next question comes from Christopher Glynn with Oppenheimer. Please go ahead.
Thanks. Good morning. On the transformational deal comments. It takes two to tango. Just wondering if there's any signs your kind of parallel players in the large electrical distributor space are thinking similarly about the industry structure as you are?
You'd have to ask them, Chris. I would be speculating.
Okay. Another housekeeping. Does interest expense revert to kind of the first half run rates after the adjustment in the third quarter?
That's correct, Chris. Again, we did have the benefit, a non-cash benefit in the third quarter. That was reversing an accrual that was made years ago related to this Canadian transfer pricing issue. You should expect that's going to revert back to the trend in the first two quarters of the year.
Okay, if I could get one on gross margin. Noted mix differences, but the rates weren't worlds apart, so maybe the supplier price increases are the bigger piece there. I'm curious if you're seeing good visibility to reclaiming that or if kind of mid-'18s is a good place to reside for now.
The price cost issue from the supplier increases is the larger of the two drivers that we called out, so that's fair. Again, we're continuing to monitor what comes through from the supplier price increases, and we're focused on catching up and driving through not only the dollar for dollar price increases, but also the gross margin rate benefit that we would get typically in an inflationary environment. Quite frankly, the rate and pace of the supplier price increases has considerably hampered our ability to get that done. We normally have a lag, but obviously in the third quarter, we saw more of an impact than we have historically seen.
Great. Thanks for that.
This concludes our question and answer session. I would like to turn the conference back over to John Engel for any closing remarks.
Thank you all for your time this morning. Brian Bagg and Will are available as always to take your questions. We look forward to seeing many of you at one of our investor marketing events we will be participating in during the fourth quarter, including the Baird 2019 Global Industrial Conference next week. Thanks again, and have a great day.
The conference is now concluded. Thank you for attending today's presentation. You may now disconnect.