Good morning, and welcome to the WESCO's Third Quarter 2019 Earnings Conference Call. All participants will be in listen only mode. Please note this event is being recorded. I would like to now turn the conference over to Will Ruth Raff, 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 Schultz, 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 7 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, and Dave will take you through our Q3 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 3rd quarter and sales in all of our end markets and geographies 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 margins within our expected range and 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 Q3. 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 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 Q3 results and our updated outlook for 2019 as well as our initial look at sales for 2020. Dave?
Thank you, John, and good morning, everyone. I'll start with an overview beginning on Page 4. Reported sales in the quarter were up 3.9% within our outlook range of 3% to 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 and A expenses were 2% higher than the prior year driven by the SLS acquisition. Operating profit was $93,700,000 or 4.4 percent 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 2 60 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, non deductible 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 5.
As John mentioned, gross margin was 18.6 percent in the quarter, down 60 basis points versus the prior year and 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 2 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 mixed 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 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 6, 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 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 7, industrial sales were up 5% overall and up 3% 7% in the U. S.
And Canada respectively, reflecting a stronger result in the first half. Industrial sales were up 1% sequentially from the 2nd 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 3rd 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 8, 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 2nd 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 in constant currency was down versus prior year and flat on a sequential basis reflecting normal seasonality. We ended the quarter with the 2nd 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 the new hospital in Canada. Moving to Page 9, 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 7 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 multiyear 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 Q1 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 2 year stack basis, CIG sales were up 9% in the quarter. This performance was again driven by our strong capabilities and value added services in 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 multimillion 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 $117,000,000 in the quarter or 181 percent of net income. Year to date, Wesco has generated $86,000,000 or 51 percent 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 3 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 2 to 3.5 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 $723,000,000 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 3 of the presentation, during the quarter we extended the maturity dates for our 2 credit facilities and increased overall borrowing capacity by $50,000,000 Capital expenditures were $9,000,000 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 $150,000,000 and received an incremental 700,000 shares in the quarter. We have now completed $275,000,000 of the $400,000,000 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 and 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. 2nd, we seek to maintain a targeted financial leverage ratio of between 2x and 3.5x EBITDA. 3rd, we returned cash to shareholders through share repurchase under our 3 year $400,000,000 share buyback authorization.
Now 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 1st 9 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 lowtomidsingledigits for the year. On a consolidated basis, our outlook is for sales growth of 1% to 3%, operating margin of approximately 4.2%, an effective tax rate of approximately 21% and diluted EPS of $5 to $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 4th quarter. This full year guidance implies sales growth of approximately 3.5% at the midpoint, operating margin of approximately 4.2 percent and effective tax rate of approximately 21% for the 4th 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 twenty nineteen 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 plus 4% for next year and we'll provide the balance of our 2020 outlook during the Q4 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 4 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
The first question comes from David Manthey with Baird. Please go ahead.
Thank you. Good morning, guys.
Good morning, Dave.
Since the Analyst Day, you've been talking about transformational M and A. And 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?
And for something big and meaningful, would you consider using WESCO stock or not?
Yes. So as you recall at our Investor Day, we did outline our priorities relative to our overall acquisition strategy as part of our overall strategy. And they were, 1st, to consolidate large core electrical distributors 2nd, to expand into adjacent product and service categories and third, you'll recall that we said we want to invest in digital technologies that advance the enterprise strategy. So those are our core elements of our acquisition strategy. And transformational acquisition means it basically fits within those three priorities.
It could be a large acquisition, 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 technology 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.
So we're comfortable running with financial leverage, very strong free cash generation, very strong balance sheet. And if we're 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. And then maybe one for Dave. Gross margin has been flat to higher year over year the past 5 quarters and 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?
And then what changes between here and the Q4 to get you back on track?
Certainly. So as we highlighted, there are 2 primary factors and we've talked about this in some of the previous quarters as well, but the first was mix. And as we highlighted during the Investor Day, we saw mix as a headwind across all three of the vectors of our gross margin composition. So our end market mix was primarily driven by the growth in utility business and also with construction. Additionally, within our industrial end market, the mix of the growth by end market created a mix headwind.
And so 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. And then 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 in 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. So finally, we also had that higher percentage of sales that were direct shipped.
So these are direct shipped 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. And then 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. And 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. So 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. And 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. And wanted to add my congrats to Nelson. He's a great addition to the C suite. Love that.
And then also that gross margin slide mix, that's really helpful and that was very informative. So I appreciate that color.
Thanks a lot, Dean. Appreciate the real time feedback on that.
All right. So if what surprised me most first is that we're all seeing across the industrial sector signs of short cycle industrial weakness. And if I look at your results in the industrial side and on the construction side, it doesn't come through this quarter. I mean, you just you seem to be breezing through it, up 5% organic and industrial and up 3% in construction. So when you talk about slowing in the Q4, it sounds like you're pointing to the economic data suggesting there's slowing.
But are you actually seeing it in your day to day business, maybe in some of your MRO business? So maybe we start there.
So your question is, you're right. When we say we're seeing increased headwinds and challenges, that is the end markets. So that is more around commentary from customers. There's continued uncertainty with the economic outlook. And so again, all those comments around more challenging economic and end market environment, it is the end market.
So 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 the backdrop that's much tougher. And you cited 2 of the end market end markets industrial and construction. Remember, we grew in all of them and we grew in all geographies. But 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. And the overall growth was mid single digits. And that's with oil and gas sales being flattish in the Q3 as they were in Q2. So overall, overall oil and gas across the company.
So 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 at Investor Day. In terms of construction too, I think what's really notable and this is particularly important to put this in the historical context because we've had periods of I've been here 15 years. We've been having periods over that time where residential construction was materially stronger than non resi. End markets, 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 non residential construction is holding up. And 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 Q3. The majority of our regions, geographic regions grew in the U.
S. And 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. So I actually I'm actually very pleased with how we've picked up our sales execution, positive sales momentum. And 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. And 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.
And the backlog held up consistent with normal seasonality. And as Dave mentioned, the margin rate in the backlog is higher. So that does give us a and that's unique to us, right? So I think that gives us some confidence as we start moving through Q4.
Got it. That's very helpful. And then if we look at your 2020 comments, and 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. And when I looked at flat to 4% total, it just struck me as a bit optimistic, but then I look at the underlying assumptions about your outgrowth that seems in line. So maybe the industrial and construction
low end of the
range is of low single digit. How did you arrive at economic data and some of the around the end markets. But on the economic data and some of the around the end markets. But what's the sensitivity there from a bottom up on the low end of those ranges? And could they actually be lower?
Yes. So the answer to your question is yes. In terms of the end market ranges, that's and our view of the end market is 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. But let me come back to our momentum because I think that's the really important point. And let me start with, I said backlog is very healthy as we move Q3 to Q4.
That's number 1. Number 2, 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 plan. But our pipeline that we're managing again of opportunities is the largest it's ever been by a meaningful measure. And then 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%.
So a little bit stronger than when we locked down the chart, we wanted to be comfortable with the low single digit, which for us is 0% to 3%. But 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.
Good morning.
I echo Dean's comments, great information. Just want to pick up on that, the gross margin differentials. I think we were sort of aware of the differences. Can you just remind us how does the operating margin compare? So the SG and A structures amongst the different verticals and geographies, is there a big difference in operating margin as well?
Nigel, it's Dave Schulz. So 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. And remember that the shipment type, the margin differential is because of our cost to serve. And so 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. So if you take a look at the average for WESCO, Canada is higher. So 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. And then moving on to 2020, you called out utility as a sort of tailwind to growth next year. And I'm just curious, we've obviously seen very nice trends right now in T and D. What kind of visibility do you have into next year at this point?
Then I know that generation isn't a big driver for Wesco, but maybe just touch on what you've seen in generation as well, that would be helpful.
Yes. So our utility business, we've got Nigel, an interesting portal into the utility industry in terms of we serve the investor owned utilities and that grew in the Q3. We serve public power, municipals and co ops and that grew in the Q3. And then 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 utility and that grew in the Q3.
So this was we see really good about foundationally the strength of the growth in the 3rd 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, but it's much smaller than the rate of sales we had in Q1, Q3.
And then when we move through Q4 into 2020, we expect again strong results in utility across our Canadian business. So I just wanted to set the stage with that a bit. And it's through those relationships that we have insight into their capital spending plans. And what's driving our growth isn't just, I wouldn't call it fundamentally duplicate. We've been consistently outperforming the market.
And now when we finish this year, we'll have 8 years of sales growth in a row in utility organically. That's despite exiting these large contracts that we walked away from. So 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 wins, sales growth, etcetera. But as you think about the drivers going forward, it's grid automation, renewables, storm hardening initiatives, as well as continued growth in resi, to contribute growth in resi as meters to the ground, which is a direct first derivative growth driver for utility and then non resi typically follows.
So and finally, I would say that the contractor business remains strong because structurally utilities continue to outsource their capital project work. So when you integrate all these, I'll call those dynamics, we just see with our value proposition, the end market, but 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.
The next question comes from Steve Tuss with JPMorgan. Please go ahead.
Hey, guys. Good morning.
Good morning. Good morning.
Can you just talk about what you're seeing in the machine builder vertical? There's 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?
Yes, it's a really good question. We're seeing challenges. So we've got part of, we'll call them, OEM type customers that Dave alluded to in his earlier comments that would include that. And then we have some specialized businesses around industrial automation and builders. Okay.
How much what is the is it down like mid singles or what would you say?
For us, For us, it's in the single digit range, yes. It's not down double digits. Yes. Yes, in mid to high single digit range, not double digit.
Okay. And then I know I try and ask question almost like every quarter just to kind of reinforce the dynamics. But there's kind of a view out there that there's like an inventory correction that's going on here. I mean, you guys in particular are very good about managing your inventories and you never really get too bloated or too lean. Is that correct?
So if like somebody selling into you, you're managing that pretty tightly, they have a lot of visibility into that, right? So there wouldn't be like a correction at your point in the channel?
Correct. And then for us specifically, we did end up having our we increased our inventories in the first half and we spoke about that in the Q2 conference call. And 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. So 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. And we did specifically talk about 2 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.
And we reduced inventories over approximately $40,000,000 $40,000,000 $40,000,000 sequentially in the quarter.
Yes. That's a good performance. And then just lastly on price 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, it's probably too strong, but anybody kind of backing off their aggressive pricing and pulling back on price increases to book deals?
Have you seen that in any of your
major suppliers? I'll answer it with 2 different I'll break it into a 2 part answer. The short answer is no. And for, I'll call it, the pricing that they said 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 move through the customers. And in some cases, we've got multiyear contracts with a global account customer and that's the time lag, right?
So but 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, it works in a real time way. So 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 execute the backlogs. Number 2 is they try to take on new business to increase their record backlog.
They have to have confidence in the skilled trades and the uncertainty around pricing is just another dynamic there. So 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 is 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?
Yes. Okay. That's helpful. I appreciate it. Thanks.
Yes.
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 that something or is it something more that you would integrate it under the WESCO brand?
So 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. So 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. We were able to after working that deal for over 5 years, we were able to make that happen. That was acquiring me coal and that was done 7 years ago. And so we went to market with a dual brand if post acquisition closed in Canada and that was expressly the strategy. 1, the WESCO brand is lined up with a very large global leading electrical supplier for core electrical and E.
Cole is lined up with a different large leading global leader electrical supplier leader. So we've already had that model working within WESCO at a very on a large scale basis. And 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. So I think that that would be we would do the right thing from a branding perspective.
And we would also 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. And since we're on the topic of deals and branding, there's been some meaningful shifts in your supply chain, lighting Cooper with 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?
Yes. So it's
I'm sorry, supplier win standpoint.
No, no, no. I understand. That's how I interpreted your question. It's early days on the latest lighting combination, that being the announcement of SignifAI 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. We have very strong and long standing relationships with SignifAI, that is the prior fill ups. In both cases, those relationships go back well into the Westinghouse days when we were a captive distribution arm. So 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. There's a lot of changes occurring fast and I think the manufacturer's supplier partners are 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. And we can work with our supplier partners, bring the best brands together. What it turns out to be the differentiator is the controlled solution and our ability to wrap services around that. And we've got a turnkey retrofit renovation and upgrade set of capabilities that we acquired a number of years ago with Aelux LumiJet that we've been investing in. And our SLS acquisition earlier this year is supportive of strengthening that.
All right. Thank you very much. I'll pass it along. Yes.
The next question comes from Robert Barry with Buckingham Research. Please go ahead.
Hey guys, good morning.
Good morning, Robert.
I want to ask you about SG and A, but since it keeps coming up, the M and A question, just curious your thoughts about doing a transformational acquisition that this what something is late stage in the cycle?
So 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. We took we tried 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, so which we are clearly in that class. And we were very clear about our overall enterprise strategy and our acquisition strategy as part of that, which again, we to consolidate large core electrical distributors, expand into adjacent product and service categories and invest in digital to help lead the digital transformation. So that is that's our ambition. 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. And 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. So the thing with acquisitions is you can't always they're just you can't time them, right? I mean, 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 chance to get a century old company that was a very strong operator and we did it, right? So I think, again, we look at the opportunities. Obviously, the numbers have to work. But this is our strategic view is there is an excellent opportunity to lead the consolidation and digital transformation of B2B Distribution for our served end markets and the value chains that we operate.
Got it. Okay. I did want to just touch on the SG and A. Performance there continues to be very good, very low SG and A growth. I'm assuming there's maybe about 5,000,000 dollars from SLS in that number.
But give or take, how long do you think you could sustain growing the SG and A at what looks like less than 1% kind of adjusted for the M and A?
Rob, it's Dave Schulz. So again, what we see right now in our Q3 SG and 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 and A in the current quarter, the Q3 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. So that's also having an impact on the SG and A in the Q3.
Going forward, obviously, that's something that we want to make sure that we're able to restore. So again, we'll provide more details about our 2020 on our January earnings call.
Got it. And 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?
Yes. So again, the driver of the share count reduction Q3 was really just the carryover of what we saw from the $150,000,000 share repurchase that was initiated in the Q2. In terms of the share count for the full year, I think if you took a weighted average of the 4 quarters, you get somewhere in the range of 43.3 to 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. I wanted to follow-up on the transformational deal comments. So it takes 2 to tango. Just wondering if there's any signs you're kind of parallel players in the large electrical distributor space or thinking similarly about the industry structure as you are?
You'd have to ask them, Chris. I would be speculating.
Okay. And then another housekeeping. Does interest expense revert to kind of the first half run rates after the adjustment in the Q3?
That's correct, Chris. So again, we did have the benefit, a non cash benefit in the Q3. That was reversing an accrual that was made years ago related to this Canadian transfer pricing issue. You should expect that that's going to revert back to the trend in the 1st two quarters of the year.
Okay. And then if I can get one on gross margin. It 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?
So the price cost issue from the supplier increases is the larger of the 2 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 Q3 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 Begg and Will are going to are available as always to take your questions. And we look forward to seeing many of you at one of our investor marketing events we will be participating in during the Q4, including the Baird 2019 Global Industrial Conference next week. Thanks again, and have a great day.
The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.