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WESCO International, Inc (WCC) Q3 2021 Earnings Call Transcript

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WCC earnings call for the period ending September 30, 2021.

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WESCO International, Inc (WCC 0.97%)
Q3 2021 Earnings Call
Nov 4, 2021, 10:00 a.m. ET

Contents:

  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:

Operator

Hello, and welcome to WESCO's Third Quarter 2021 Earnings Call. [Operator Instructions] Please not that this event is being recorded. I will now hand the call over to Leslie Hunziker, SVP, Investor Relations and Corporate Communications, to begin.

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Leslie Hunziker -- Senior Vice President of Investor Relations & Corporate Communications

Thank you, and good morning, everyone. Before we get started, I want to remind you that certain statements made on this call contain forward-looking information. Forward-looking statements are not guarantees of performance and by their nature, are subject to inherent uncertainties. Actual results may differ materially. Please see our webcast slides as well as the company's SEC filings for additional risk factors and disclosures. Any forward-looking information relayed on this call speaks only as of this date, and the company undertakes no obligation to update the information to reflect the changed circumstances. Today, we'll use certain non-GAAP financial measures. Required information about these non-GAAP measures is available on our webcast slides and in our press release, both of which are posted on our website at wesco.com. On the call this morning, we have John Engel, our CEO; and Dave Schulz, WESCO's Chief Financial Officer.

Now I'll turn the call over to John.

John J. Engel -- Chairman, President and Chief Executive Officer

Thank you, Leslie, and good morning, everyone. Well, we had another exceptional quarter and again delivered outstanding results across the board. We're early into the second year of our transformational combination of WESCO and Anixter, and a substantial value creation of the new WESCO is underway and is building. The impressive progress we're making in the integration is a direct result of the dedication, commitment and relentless execution of the entire WESCO team. I want to thank all our associates for their strong teamwork, their supplier engagement and their exceptional customer focus and providing the product services and resilient supply chain solutions that our customers need. Now moving to Page 4. Our sales growth accelerated versus 2019 pre-pandemic levels in the third quarter, and our margin performance and backlog achieved new records for the company. Based on our strong third quarter results, we are raising our sales, margin and profit outlook for the year. We're outperforming the market across our three business units.

Our comprehensive product and value-added service offerings, our broad and deep supplier relationships and our technical expertise are proving to be critical differentiators for our company. Importantly, we're ensuring continuity of supply for our customers, which is especially critical as the economic recovery continues. At the same time, we've built a foundation for sustainable margin improvement through our increased global scale, our value-based pricing program and realization of cost synergies at both the pace and scale that continues to exceed our expectations. Our new earnings power is reflected in our third quarter profit performance, which was at record levels and has been a key catalyst to rapidly delevering our balance sheet since acquiring Anixter in June of last year. In just five quarters since closing the transaction, we've improved our leverage ratio by 1.6 times, which is well ahead of schedule and highlights very clearly the power of our business model.

Now moving to Page 5. We have an expanding pipeline of sales opportunities, and our cross-sell momentum is building. We are on track to deliver $500 million of cumulative cross-sell synergies by 2023. We're capitalizing on the strength of the complementary portfolio of products and services as well as the minimal overlap that exists between legacy WESCO and legacy Anixter customers. Our customers are benefiting from our ability to be the one-stop shop for their product, service and supply chain solution needs. Opportunities exist across all three of our global business units. We have already generated over $220 million of sales synergies since the merger closed in June of last year, with $105 million being realized in the third quarter. Leasing cross-sell wins in the third quarter include our EES business, expanding our local relationship with a solar contractor into a national multi-brand service model that now provides wire, cable and balance of system electrical products. In another example, our CSS business as a supplier of choice for one of the largest data center providers in Latin America won a multiyear data center project by utilizing the combined technical expertise of both our CSS and EES teams.

And finally, our UBS business is also growing through cross-selling, where we recently expanded the scope of a three-year project for an electric utility customer by supplying wire and cable in addition to our inventory management project planning and storm response services. Our cross-sell growth opportunity is further amplified by the six secular growth trends that we've outlined previously. Last quarter, I talked about how we're capitalizing on growth opportunities in grid modernization and the rural broadband build-out. Today, I wanted to spotlight how we're capitalizing on the ongoing growth opportunities in data centers. Currently, there are approximately 27 billion connected devices around the world, and this number is expected to surpass $40 billion by 2023.

These devices generate substantial amounts of data that is being captured, routed, stored, retrieved, analyzed and ultimately, operationalized. With the rise of IoT and Industry 4.0, customers and suppliers are increasingly relying on big data and data analytics to enhance the efficiency, productivity, security and cost effectiveness of their businesses. As a result, more data centers are being constructed, and we're participating in these data center upgrades and build-outs. And we're doing that by providing solutions for our customers' electrical infrastructure, network infrastructure, physical security and thermal management needs. Our dramatically increased scale and expanded portfolio positions us very well to capitalize on these secular growth trends that will sustain the current economic recovery and are foundational for the global economy in the years ahead.

So in summary, this is really a growth story. We're transforming into a growth company as a result of our digital investments, cross-selling our expanded portfolio of products and services and providing resilient and sustainable supply chain solutions for our customers around the world. Continued execution of our aggressive integration plan and capitalizing on the secular growth trends will only accelerate this shift. Finally, I'm happy to say the value creation potential of the new WESCO is building, and we are only in the early days.

With that, I'll turn it over to Dave to walk you through the details on the third quarter and our updated guidance. Dave?

David S. Schulz -- Executive Vice President and Chief Financial Officer

Thanks, John, and good morning. Starting on slide seven. This summary table compares our third quarter results to the prior year. Sales were up 14% on both the reported and organic basis. Currency added 140 basis points to growth, which was partially offset by the divestitures we completed in February. We estimate pricing added approximately 5% to sales in the quarter. Notably, sales were up 8% versus 2019 pre-pandemic pro forma levels. As John mentioned, our backlog reached another record level this quarter, up 60% from the prior year and up 15% from the prior record in June. Each business unit posted backlog increases of more than 50% over last year. Heading into the fourth quarter, demand continues to be strong. Preliminary October results are encouraging, with sales up mid-teens year-over-year on a workday-adjusted basis. Gross margin was also a record at 21.3% in the quarter, up 170 basis points versus the prior year. The strong gross margin performance included a 50 basis point contribution from supplier volume rebates. We recorded a 10 basis point impact related to the write-down of safety inventory.

As you know, we've been managing the change in carrying value and inventory levels of certain personal protective equipment products like KN95 mask and hand sanitizer, all year. From here, we don't expect any further material inventory write-downs related to these safety products. The balance of the gross margin improvement, approximately 130 basis points, was driven by the benefits of our margin improvement program and inflationary pricing. Mix did not have a material impact on gross margin versus the prior year. Sequentially versus the second quarter, gross margin increased by 30 basis points. Approximately 10 basis points of the improvement was due to a lower inventory write-down related to safety equipment. The balance of the sequential increase was driven by the benefits of our margin improvement program and positive price cost.

Adjusted EBITDA, which excludes the merger-related costs, stock-based compensation and other net adjustments, was 31% higher than the prior year and represented 7% of sales, which was 90 basis points above the prior year and 150 basis points above the 2019 third quarter on a pro forma basis. Adjusted diluted EPS for the quarter was $2.74, up 65% from the prior year. Turning to Page 8. You can see that the higher sales, expanded gross margin and integration cost synergies drove the $78 million increase in adjusted EBITDA. As you'd expect from the strong demand and inflationary environment, we also experienced higher volume-related operating costs, including shipping and sales commissions as well as higher expenses for employee benefits. As a result of our performance year-to-date and expectations for the year, we also increased our accrual for incentive compensation, which we alerted you to last quarter. Finally, the temporary cost reduction actions taken in response to the COVID pandemic weren't reversed until October last year.

Overall, strong operating leverage is evident as we generated a 31% increase in adjusted EBITDA on a 14% organic sales growth.

Now let me walk you through the results by business unit, beginning on slide nine. Sales in our EES segment were up 19% year-over-year with double-digit growth in all operating groups. This growth reflects construction sales that continue to increase with the recovery of the nonresidential market. We also continue to see increasing momentum in our industrial and OEM businesses, in line with the broader industrial recovery. We continue to experience robust bidding activity levels that are driving a further increase in our EES backlog from its record level in the prior quarter. We also made further progress on our cross-sell initiatives and are capturing demand driven by the secular growth trends.

Adjusted EBITDA for EES was $174 million, up 60% from the prior year. Adjusted EBITDA margin was 8.8%, 220 basis points higher year-over-year. This increase reflects the gross margin initiatives I discussed earlier, effective price cost pass-through, strong cost synergy realization and operating cost leverage. Turning to slide 10. Sales in our CSS segment were up 6% versus the prior year on an organic basis. We saw high single-digit growth in network infrastructure driven by the data center and hyperscale projects that John mentioned as well as continued investments in cloud-based applications and professional audio/visual installations. The security operating group sales increased by low single digits. Backlog was up more than 90% from December to another record level due to continued strong demand, along with the impact of supply chain challenges on project deliveries.

Profitability was also strong in CSS with adjusted EBITDA at 9% of sales, 30 basis points higher than the prior year, driven by operating leverage, integration cost synergies and the execution of our margin improvement initiatives. I'd point out that most of the PPE inventory write-down that I mentioned was recorded in CSS, which negatively impacted its adjusted EBITDA by approximately 20 basis points. In addition to our cross-sell programs, CSS is positioned to benefit from numerous secular trends: the need for increased bandwidth, 24/7 connectivity, IP-based security solutions and the capacity demands related to remote work in school applications.

Turning to slide 11. Organic sales in our UBS segment were up 15% versus the prior year. Utility demand has remained strong as both our investor-owned utility and public power customers continue to invest in grid hardening and modernization. In the quarter, we benefited from storm recovery sales in both the Gulf Coast and in the Northeast. However, year-over-year, storm recovery sales were slightly below the prior year activity levels. Our broadband business was up double digits versus the prior year, driven by continued strong demand for data and high-speed connectivity as well as expansion and connectivity requirements for home-based applications.

Additionally, we are benefiting from sales activity related to Phase one of the federal government's Rural Digital Opportunity Fund project. For UBS, adjusted EBITDA in the quarter was up 34% with margin 130 basis points higher at 9.1% of revenue versus the prior year. This growth was driven by the scale benefit of sales and gross margin expansion. Turning to slide 12. On the left side of the slide, you can see in the blue boxes that we have realized cumulative run rate cost synergies of $128 million year-to-date through September. Because of the accelerated pace of execution and synergy realization, we have increased our 2021 targeted cost synergies from $170 million to $182 million and our 2022 target from $210 million to $230 million. Recall that these savings are relative to the 2019 pro forma base.

On the right side of the slide, we've outlined the total $300 million cost savings target by synergy type. And in the chart, you can get a sense for the synergies that have been realized to date in each category. For example, the majority of the targeted $45 million in corporate overhead savings have been realized. The largest remaining synergies are those that take longer to execute, including the supply chain and field operation buckets. Moving to slide 13. Reducing our leverage is a top priority. In the third quarter, we reduced leverage by 0.4 times trailing 12-month adjusted EBITDA for the third quarter in a row. Total debt was reduced by $91 million in the third quarter with net debt down by $55 million. Free cash flow was $85 million in the quarter or 54% of adjusted net income. Net working capital was a use of cash of $233 million in the quarter, including $150 million for accounts receivable and $160 million for inventory, partially offset by a higher accounts payable balance.

We are gaining efficiencies in working capital. Using a 4-quarter average calculation, net working capital improved six days versus 12/31/2020, and just over one day sequentially versus Q2. We have been investing in our inventory to support the strong demand we have been experiencing and to support projects in our backlog. As John mentioned, since closing the Anixter acquisition 15 months ago, our leverage is 1.6 turns lower. We're committed and remain on track to return to our target leverage range of two to 3.5 times in the second half of 2022. Moving to the outlook on slide 14. Based on continued strong demand, the effectiveness of our value-based pricing program, inflationary benefits and the progress we're making on the integration front, we are updating our outlook for 2021.

As we close out the year, we're raising the lower end of our sales range and now expect 2021 sales of 11% to 13%. For our strategic business units, we now expect the Electrical & Electronic Solutions SBU for the year to be above the company's range of 11% to 13%, given the macro recovery in performance to date. We expect our Communications & Security Solutions SBU to be below the range, noting the strong backlog and continued management of supply chain disruptions. For the Utility & Broadband Solutions SBU, we expect full year sales will be within the range. Utility market demand continues to be strong, and we expect continued growth in broadband. As we think about the supply chain, we're in daily contact with our supplier partners to stay up to date on capacity levels and shipping time lines. We expect to continue to be able to mitigate the supply constraints in the fourth quarter through managing our inventories effectively, supplier engagement and alternate sourcing, if necessary.

The fourth quarter is off to a strong start, with October sales up mid-teens. For adjusted EBITDA margin, we've raised our outlook to the range of 6.4% to 6.5%. We continue to expect our effective tax rate to be approximately 23% for the year, assuming proposed tax changes do not take effect in the fourth quarter. We've also increased our adjusted diluted EPS outlook to a range of $9.20 to $9.40. When it comes to free cash flow conversion, we're modifying our outlook to approximately 80% of adjusted net income to reflect continued investment in working capital to support customer demand and maintain our service levels. To date, we spent $25 million of cash recorded as capital expenditures, with about $30 million of cash flow recorded in other for investments in IT and digital. We are narrowing our forecast to approximately $100 million for the full year for capital expenditures and other IT/digital investments.

Turning to Page 15. Before opening call to questions, let me provide a quick recap. We've had an exceptionally strong performance year-to-date. In the third quarter, organic sales were up double digits, and our backlogs are at record levels in each of our businesses. We are capitalizing on our leadership position and the benefits of scale and are executing well on the cross-selling opportunity resulting from the Anixter merger. We are also effectively managing global supply chain challenges to ensure we continue providing high levels of customer service. When it comes to margins, we're leveraging our value proposition to improve pricing and increase operating leverage through cost synergies that are tracking well ahead of our original schedule. Our rapid pace of deleveraging continues. We reduced leverage by 0.4 turns for the third consecutive quarter and have delivered a total average reduction of 1.6 turns since closing the transaction just 15 months ago. These strong results have enabled us to increase our full year outlook for sales growth, adjusted EBITDA and adjusted EPS for the third time this year.

With that, I'd like to open the call to your questions.

Questions and Answers:

Operator

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

Sam Darkatsh -- Raymond James -- Analyst

Good morning, John. Good morning, Dave. How are you. Terrific margin, gross margin performance in the quarter. Two questions. First, I wanted to reexplore the topic of M&A. I mean you've rightfully been in deleverage mode post Anixter. But a few weeks ago, Rexel announced it was acquiring Mayor in a $0.5 billion deal at what looked like a very attractive multiple, at least to sales. I imagine that Mayors fit isn't great with WESCO, but they are a major member of a buying group, which I would imagine probably shakes out a whole bunch of other folks that are looking for large-sized dance partners. I guess my question is, at what point do you believe WESCO is ready to take on M&A of some size? Under what circumstances would that occur? And how would you look to finance those deals?

John J. Engel -- Chairman, President and Chief Executive Officer

So thanks for the question, Sam. I've said for years that the market was very fragmented, and it would take some external catalysts to accelerate the consolidation. It's true today that the distribution portion of the value chain is much more fragmented than our supplier base. We clearly saw this. And as you know, and we've talked at length, M&A is a critical value creation lever for us. We signaled strongly back in 2019 in our Investor Day that the bigs had to start to come together. And quite frankly, what's WESCO and Anixter coming together is the first move in the bigs consolidating. I think we have a situation where the bigs are going to get bigger faster now.

And so that's just an intro to my answer, Sam. We don't look at M&A as an event. It's a process. We have a pipeline of opportunities we're managing right now. As we speak, we have several NDAs that have been signed with potential targets. We are thrilled with our deleveraging performance. It's not a surprise to us. I know it's a surprise for many investors, particularly those that don't understand our business and our leading distribution model. But it's not a surprise to us. We're delevering very quickly.

And we always said we can't perfectly time the M&A transaction. We've got to be positioned when the deals are put into place to be the final bidder. We'd like to be the only call. In many cases, we inspire them to be put into play. So we're working that -- those set of opportunities as we speak to them. And we think that as a result of the two companies coming together, we got -- and how quick we're delevering showing the strength of our model, the profit growth, and we paid down debt further in the quarter. We're in an exceptionally strong position to continue to drive M&A. We're committed to delever back to within our target range. And as Dave mentioned, but we're working a whole multitude of opportunities in parallel.

Sam Darkatsh -- Raymond James -- Analyst

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

John J. Engel -- Chairman, President and Chief Executive Officer

I find this question very interesting. It's something we're -- we've been all over in the process of how we're engaging with customers. And we have a very clear view of -- we'll get multiple. We'll be -- we'll see it in the bid activity, but not multiple orders there. Well, I don't have one example of where something was double ordered. And because we're not seeing cancellations out of our backlog.

And so it's just I find it a very surprising question, quite frankly. I know a lot of folks are asking about this. We are not seeing that from the customer end of our value chain. Period. On the supplier end of the value chain, I can tell you. Across the board, we've not placed a single double order. So I just -- this is really interesting. I know that this has some narrative in the investor and analyst community. You need to think about as a distributor, we have many, many supplier partners, and we are a supply chain management solutions company.

So we're in the position to help customers solve their supply chain challenges. What we've been seeing, and there are clearly supply chain challenges, but I think we're doing an exceptional job of managing through it. As I said, it's our job. We're seeing new customers come to us, and we're seeing current customers want to make -- want our assurance that we can ensure integrity of supply and resilience as they ramp up their operations. That's why we very purposely increased our inventories significantly over the last two quarters.

Sam Darkatsh -- Raymond James -- Analyst

We're seeing new customers come to us, and we're seeing current customers want to make -- want our assurance that we can ensure integrity of supply and resilience as they ramp up their operations. That's why we very purposely increased our inventories significantly over the last two quarters.

Operator

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

Deane Dray -- RBC Capital Markets -- Analyst

Thank you. Good morning, everyone.

John J. Engel -- Chairman, President and Chief Executive Officer

How are you doing, Deane?

Deane Dray -- RBC Capital Markets -- Analyst

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

David S. Schulz -- Executive Vice President and Chief Financial Officer

Yes, Deane. So we noted the 5% benefit that we received in our revenue line from price. As we think about the balance of the year, we've assumed that that 5% stays steady as we go through the fourth quarter. And what we have not included is any incremental new pricing that we could potentially see in the fourth quarter. Again, that's very hard for us to predict. So when you think about the impact of pricing on our outlook for the year and raising the bottom end of the range, price contributed. One of the things that we're also taking into account is just the strength of our business, the backlog that we see.

And then obviously, we're still effectively managing through these supply chain constraints. We're also taking into account that December is always a wildcard month. And particularly with how the calendar falls where the holidays on a Friday. So 12/31/2021 is a Friday. So obviously, we'll be open for business, but we're not sure where our customers will be. We think we've got the appropriate guide given that risk.

Deane Dray -- RBC Capital Markets -- Analyst

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

David S. Schulz -- Executive Vice President and Chief Financial Officer

Yes, it really boils down to the December wildcard, Dean. As you mentioned, if you take a look at the midpoint of our outlook for the full year, you imply the fourth quarter, it's a low double digit at the midpoint in terms of the year-over-year increase. Remember that our December comp from prior year -- our Q4 comp from prior year, we were essentially flat in sales. So again, a slightly tougher comp, it really boils down to the December wildcard and what shipments our customers will be receiving given the holiday period.

Deane Dray -- RBC Capital Markets -- Analyst

Great. And it's not a question, just to shout out the nice work on gross margins. Thank you.

John J. Engel -- Chairman, President and Chief Executive Officer

Thanks, Dean.

Operator

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

David Manthey -- Baird -- Analyst

Thank you. Good morning, everyone.

John J. Engel -- Chairman, President and Chief Executive Officer

Good morning, Dave.

David Manthey -- Baird -- Analyst

John, in your model, you noted ensuring customers continuity of supply. And Dave, you talked about some of the sourcing efforts that you've made. And there's clearly issues everywhere. But having listened to a lot of conference calls this earnings season and talking to a number of other companies, is electrical just bearing better as it relates to the supply chain issues? Or is that my imagination? It seems like you mentioned it as a --. It doesn't sound as dire as some other industries are portraying it today.

John J. Engel -- Chairman, President and Chief Executive Officer

There's a lot of -- Dave, it's a great question. There's a lot of variation by category. So I don't want to paint electrical with one paint brush. There's portions of electrical that are a bit more challenged than others. There's portions of wire and cable in electrical that capacity is -- utilization rates of our suppliers are at an all-time high. But in general, I would say if the end system we're delivering has a lot of semiconductor content, i.e., does that supplier have a lot of semiconductors built into that product? Depending on the type of semiconductors and how they've been positioned with their build plans and their inventory build to support their manufacturing schedule, that's where I think the most acute issues are occurring.

There are clear challenges out there. So I don't -- we didn't really see any material impact, Dave, in Q2. In Q3, I mean we're thrilled with how we've executed. And I think we're, again, seeing the benefits of our newfound scale and global supplier partnerships as a result of doubling up the company. But sales would have been a little higher, had we had 0 supply chain constraints or past dues from our suppliers. And they would have been higher than the -- 1% to 2% of sales in the quarter. And so I think that's just an important mark. And those sales don't go away.

Remember, these sales now occur into Q4 just and moves forward. So I mean, we're thrilled with what we posted in the quarter. But we're not completely immune from supply chain challenges. With that said, I think a lot of folks have reported now, and I think you can put in the context how we perform versus others. We're very confident that we're executing at a high level and feel very good about our value prop.

David Manthey -- Baird -- Analyst

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

David S. Schulz -- Executive Vice President and Chief Financial Officer

Dave, good morning. So very clearly as we've done the merger and we've recognized some synergies in our corporate overhead, there are a couple of factors that are also adding to our overall corporate expense. A portion of it is really the incentive compensation. We also have -- from an overall net income perspective, we've seen the increase in our interest expense and some of our other expenses to run the company.

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

David Manthey -- Baird -- Analyst

Okay. Thank you.

Operator

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

Christopher Glynn -- Oppenheimer -- Analyst

Thanks. Good morning, everyone.

John J. Engel -- Chairman, President and Chief Executive Officer

Good morning, Chris.

Christopher Glynn -- Oppenheimer -- Analyst

Just curious -- hey, John. so the SG&A, that's been a nice build in the spend rate. I know variable comp is improving with the great results. But in the past, I recall, you've kind of leaned into SG&A pretty regularly, and it appears now you can leverage top line and gross margin execution a little more. So curious how to think, is there some capitalized spend what we might call going into SG&A? Or is it really the variable to commit?

David S. Schulz -- Executive Vice President and Chief Financial Officer

So Chris, it's Dave Schulz. So if you're taking a look at our Q3 numbers versus the prior year, the majority of that increase is really twofold. The incentive compensation accruals, we're expecting to pay out much higher than our target compensation. And if you compare that to the prior year, we were below our target compensation. So that's the majority of the increase. The second factor is we had COVID in the base. So you're seeing that increase year-over-year.

Now we will continue to manage effectively all of our focus on SG&A and being cost-effective, as I mentioned just on the previous response, we're also investing in some of our IT and digital capabilities, particularly as we think about the year-over-year capabilities that we want to build. And again, keep in mind that we're also paying out not just incentive compensation from a short-term incentive, we're also paying out much higher compensation to our sales force given the results that we had year-over-year.

John J. Engel -- Chairman, President and Chief Executive Officer

And Chris, on that point, that's really important, remember, when we took all the investors through the recipe of our enterprisewide margin improvement program last quarter, and a key pillar, a key component of that reset program is sales force compensation. So look at the gross margin results we're getting and the commission rate on gross margins is also showing up, as Dave outlined, which again is obviously very accretive. We're seeing excellent pull-through on that investment to the bottom line.

Christopher Glynn -- Oppenheimer -- Analyst

Yes, yes. I acknowledge that as well. Curious, too, are you seeing any suppliers make material strides against past -- in recent weeks, ability to get stuff through? And then comment maybe net basis versus, does it shift around to other suppliers?

John J. Engel -- Chairman, President and Chief Executive Officer

Yes. So that's a great question. I can tell you, we're in real-time dialogue with our supplier partners. I personally spending a larger percentage of my time engaging with the senior leadership of our top supplier partners. I'm very confident that they are aggressively attacking -- where there any bottlenecks in the process as well as -- a number of them are selectively expanding their capacity. They've got some real tough challenges on the supply chain. And I think you've heard many of them in their reports this quarter talk about that. But I do think that we'll just -- we're closely coupled with them, great partnership.

And we're ensuring we get our proper fair -- or kind of our fair share given the size of the relationship and the allocation coming off the manufacturing lines. In many cases, we're the largest customer. If we're not the largest in the top three, clearly. That's the first point I would make. Second point I would make is, and this is really important, and depending on the end customer application, in some cases, the supplier's product, size, brand, spec-d in. So in that case, there's not the ability to offer alternative suppliers or sources of supply.

But in other cases, that's not the case. And so we obviously lean in heavily and are working in partnership with our top preferred suppliers to help them grow their business. But if they're short and they're not spec-d in at the end customer. Again, this is the power of distribution. We have a much broader supply base and array of products and services than any of our individual suppliers have. That's part of our value prop to our customers. We -- it's our job to provide complete and resilient supply chain solutions for our customers and help them manage their challenges. And that is what we're doing, Chris, in those categories where we can. -- if we're limited, if and only if we're limited based on the output of our preferred supplier partners. Does that help?

Christopher Glynn -- Oppenheimer -- Analyst

Yes, that's great. Thanks for the color. Good to see the numbers.

John J. Engel -- Chairman, President and Chief Executive Officer

Thanks.

Operator

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

Nigel Coe -- Wolfe Research -- Analyst

Thanks. Good morning, everyone. So inventory are building quite nicely. Stanson in contrast to your suppliers, the claiming that the channel is low and probably need to restock. So my question is, number one, are you satisfied with your inventory levels? Secondly, would you expect to see the typical liquidation going into 4Q? Or do you think that's going to be more moderate in order to buffer of those inventories? But my real question is, do you think your suppliers are prioritizing you versus competitors because you are now the big order in the market?

John J. Engel -- Chairman, President and Chief Executive Officer

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

So we purposely increased our inventory to support the book of business. The higher demand we're seeing and what we've got booked as well as maintaining high customer service levels, and that's represented by the fill rates. And we're holding up our fill rates at very high levels. We've not seen a real fundamental or material degradation in our fill rates, which we're thrilled with. So that's paramount for us. I do believe doubling the company in this one move and the transformation we're going through, put took in a much stronger partnership position with our top supplier partners. We feel that given our value prop with our end customers, that we're driving differentiated demand to our suppliers.

And at the end of the day, as we do that, they will invest in our relationship. If we can drive differentiated demand to our supplier partners, they invest in us, and that is what we're seeing, which, by the way, was -- you would -- it should happen. It needs to happen when you scale up that way. And I think I'm so proud of the team in terms of how they're managing that scale up. And to your point, we still got headwinds. The economic recovery cycle is underway, it's building momentum, and it is still supply chain constraint. With that said, I think we're doing an exceptional job given that.

Nigel Coe -- Wolfe Research -- Analyst

Yes. No question, no question about it. And then...

John J. Engel -- Chairman, President and Chief Executive Officer

I will say this, Nigel before it does -- but one other point, there are select categories, and I think you all understand what those are because various companies are talking about, where there is a greater shortage in the value chain. But again, when you think about the whole value chain and the role that a B2B distributor place, it's our job to manage that problem. And because we have a wide array of global suppliers, that's how we're going about it.

Nigel Coe -- Wolfe Research -- Analyst

Great, great. And then my follow-on is really about long-term EBITDA margins. And if we just run rate the remaining cost synergies, we get probably -- and close to eight [Indecipherable] handle on, the EBITDA margin. Do you underwrite that? I mean do you think that we transitioned to like an 8% to 9% EBITDA margin over the next two or three years?

John J. Engel -- Chairman, President and Chief Executive Officer

So Nigel, we've not put the longer-term target out there yet, but I can -- I'll make this strong statement, and which I've already made. But now we have five quarters under our belt. This is not a one or two quarter phenomenon. We now have five quarters under our belt post Anixter merger in a market that's recovering with still a lot of headwinds. And against that challenging set of market conditions, we are demonstrating outstanding margin expansion and inherently, we have a stronger margin profile for the combined company going forward.

So absolutely, we see our -- we're well on the path of significantly expanding our EBITDA margins. Look at where we stand today, not versus last year, because many companies from 2019 to '20 and then '20 to '21 had their businesses impacted in different ways. Our measurements against 2019, which is pre-pandemic levels, and we got pro forma results out there that we're measuring ourselves against, that's how we're measuring our synergies. Look at what our margins have done versus 2019, just up substantially.

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

Nigel Coe -- Wolfe Research -- Analyst

Okay. John. All the best. Thanks so much.

Operator

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

Steve Barger -- KeyBanc Capital Markets -- Analyst

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

John J. Engel -- Chairman, President and Chief Executive Officer

Yes. I can't and -- I'm not going to answer that yet, Steve. I mean clearly, we will have our sights on expanding margins and generating strong profit growth in 2022 versus 2021. We've not outlined our guidance yet and outlook, and we'll do that as part of our Q4 earnings call. I think it will be -- it's a very important time when we deliver Q4 earnings to do that because where will we be? We will be six quarters in post Anixter merger. So we'll be halfway through the three-year integration period. And at that point, we'll be setting our targets for 2022.

But based on -- I mean I'll just answer it this way though. We've got very strong and positive momentum that we've built throughout 2021. That's going to carry through the end of the year is represented by our increased guidance. We increased our guidance three times this year. So as part of that -- the biggest part of that, quite frankly, was our -- was the accelerating execution on the integration and putting these two strong companies together. We think 2022 is an excellent setup. The economic recovery cycle continues. We do envision strong demand across our end markets, all our end markets, we are in a recovery cycle.

And as we move into 2022, you'll see the supply chain issues get mitigated because the supply chains are going to get rebuilt. It's not if, it's just when and at what rate of speed. Coupled with our record backlog, our strong execution, and particularly cross-sell. That's one of the most notable accomplishments this quarter. Remember, this is the first quarter where we've disclosed actual numbers and quantified the delivery of cross-sell. That's proves to be the most elusive synergy in any acquisition, and I couldn't be more pleased with those results. And so we clearly expect that with the expanding cross-sell pipeline that, that execution contributes to a greater fashion and drive that market outperformance next year. And then finally, as Dave talked about, the digital transformation that we started is well underway. I recognize we've not talked a lot of details about that. That's something we will be doing in 2022. And it's very, very exciting. And the digital transformation is going to build momentum as we move through 2022.

Steve Barger -- KeyBanc Capital Markets -- Analyst

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

John J. Engel -- Chairman, President and Chief Executive Officer

This is clearly building momentum. It's why we've spiked it out at one of our six secular growth trends. And my time with the company being -- having joined WESCO back in 2004, we've talked at length about this over the years, about the state of the grid. I mean it's several decades older to design, and it is a massive need of investment and upgrade. And that was with before digital, kind of in 5G and all these other technologies started -- and the convergence that we're seeing starting to impact the entire grid.

So these discussions we're having with our utility customers now are unlike anything we've had in my tenure with the company. And I think there's a real sense of urgency on behalf of our customers, and they're having those discussions. If it's an investor-owned utility, you're seeing them increase their capital spending, you can literally look at their disclosure. You're seeing step-up capital spending. If it's public power and municipal co-ops, etc., they're going and trying to make their case for increased investment with the regulators.

And so this is why exactly why we spiked it out as one of the six secular growth trends. This is going to be a meaningful growth driver for our business for the next several decades. I will also make the final point on this, which should not be underestimated. I'll coupled in with green energy. So you just see a tremendous grounds around ESG, but particularly around sustainability. And so that, to me, is a key underlying driver to this secular growth trend now. And we are exceptionally well positioned. We're not a manufacturer, right? Remember that. We're not a manufacturer. So the best way we can impact the overall value chain, and the greatest impact that we can have is on our customers' operations and supply chains.

And we do that by delivering sustainable solutions, our LED lighting turnkey retrofit renovation upgrade capabilities, our new automation solutions, safety, our safety or other renewables. And so just a terrific and outstanding growth opportunity. And again, that's one of the six. That's why I'm so bullish on the future of this company. And that's why I test us now of our growth story. The past is not prolonged. We are not yesterday WESCO. This is a new company.

Steve Barger -- KeyBanc Capital Markets -- Analyst

No question about. Thanks very much.

Operator

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

Patrick Baumann -- JPMorgan -- Analyst

Hi, good morning, John. Good morning, Dave. Congrats on the results. A lot of great questions already asked, so I just have some minor ones here. Can you update us on the merger-related costs to achieve the synergies, just kind of where we are to date versus plan? It's just hard to reconcile with some of the details you provided. I'm just trying to get a sense of when you might be through with that. And then relatedly, what were the biggest items within the $36 million during the quarter?

David S. Schulz -- Executive Vice President and Chief Financial Officer

Yes, Patrick, it's Dave Schulz. So I appreciate the question. So we've talked about the cumulative cost to achieve through 2021 of $125 million. We've obviously had some changes between what we're classifying as capital versus operating expense, that $125 million was all operating expense. So we're still trending below that number in terms of our total spend year-to-date through September.

What you're seeing in the numbers that we reported for Q3, it's primarily related to some of the pure execution. We did have some FTE reductions, so we've recognized separation expense. We also have a series of consulting arrangements who are assisting us with some of the implementation and execution of our synergy capture. So those expenses have been accrued for and recognized in the quarter. And as we think about our 2022 outlook, where we talked to you about that in our next earnings call, we'll provide a full update on our synergy, our synergy timeline and also the cost to achieve.

Patrick Baumann -- JPMorgan -- Analyst

Got it. Okay. So $125 million through '21, and that was relative to that -- was it the $225 million number you had last mentioned? I'm asking for an update on it. I just want to sure it's apples to apples.

David S. Schulz -- Executive Vice President and Chief Financial Officer

That's correct. So we've not updated those numbers yet. We're still working through some of the annual operating plan requirements for 2022. As we provide you our full year 2022 outlook, we'll update those numbers.

Patrick Baumann -- JPMorgan -- Analyst

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

David S. Schulz -- Executive Vice President and Chief Financial Officer

Yes. Let me talk about how we capture it and track it, and then I'll turn it over to John, who will walk you through some of the examples. So one of the things that we put in place was a very rigid set of guidelines of what we're calling a cross-sell. And it has to be a capability that was only enabled through the merger of the companies and some of the enormous capability that we are able to bring together through the merger. So we have a digital app that we're actually using with our sales reps to make sure that we track and validate each of the cross-sell.

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

John J. Engel -- Chairman, President and Chief Executive Officer

Yes. It's a rigorous process. And again, we still -- I'll remind you, we still have that dedicated integration management office, dedicated resources in place. They are in place and will be across the three-year integration period. And so there's a tremendous amount of mature process and insurance metal rigor around validating all synergies. We thought it was really important because we were getting the question increasingly, are you starting to really see the sales synergies? We had not quantified it So that's why we came out with the disclosure this quarter.

I did mention in the prepared remarks three examples, which are really good examples. I'll give you another one or two. This is a case where Anixter had a pre-existing relationship with a real estate services company, so existing legacy Anixter customer. And we went in and expanded the offering dramatically with our turnkey lighting solution and a separate EV charging station solution. Both of those capabilities were not in Anixter portfolio. So here's an existing legacy Anixter customer, and this was another win in the quarter where we sold capabilities that existed on the WESCO side.

Another example, and that was in our CSS business because they had the existing relationship with the real estate services company, and the relationship with Datacom. So we had a Datacom relationship. Another example in the UBS business, where we were selected by a telecom and broadband provider to provide all the fiber optic materials for our high-speed Internet expansion program for over 50,000 residences. So there's a fiber to the X, where the X is a home. Again, neither company was well positioned previously before coming together. It's the combined capabilities that put us in a position to win this strongly and win it in the fashion that we did. So there's a couple of other examples.

Patrick Baumann -- JPMorgan -- Analyst

Very helpful. Best of luck.

John J. Engel -- Chairman, President and Chief Executive Officer

Thanks.

Operator

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

Chris Dankert -- Loop Capital -- Analyst

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

John J. Engel -- Chairman, President and Chief Executive Officer

Yes. It's an outstanding question. When you look at what's in the backlog, it's orders that will ship within the current month within the current quarter, and it extends out for the next 12 months or so. It's really important to understand what we lay in the backlog. These are firm orders, price and delivery, bonafide orders we get from the customer that goes into our backlog that we're going to execute and fulfill against or ship against. Where we have a multiyear agreement with a national account or global accounts customer, and you can look at that as an annuity-like business. We don't load that in the backlog.

We don't say, "Oh, effectively, it's in backlog because we have this multiyear agreement." No, we only load what in backlog when we have firm POs. And so, again, I don't know I don't -- there's no single example of a customer double order, the earlier question. That's something we continue to check and ask. We haven't had canceled orders out of our backlog. We've had some delayed. They're delayed because we may have a particular supply chain issue that pushes out the delivery date, but we haven't had any cancellations.

And we haven't had any material dis-synergies as a result of Anixter and WESCO coming together. It's something we update every quarter. So that still is the case as we exit Q3. So that gives you a sense. I put a lot of weight in that backlog personally. Not the absolute value, but it's the trend of the backlog. And the reality is it's so counter to anything I've seen in my tenure and it's counter to seasonality. Now we do have a different set of conditions. We've doubled the size of the company overnight. We brought two strong leaders together. So that is a clear driver of our backlog growth. The way I look at it is you got to look at backlog growth plus sales growth. That's really what you're doing in the market. And you put those two together, we're talking exceptional numbers because our backlogs are up strongly. You're talking 50% up plus in UBS and EES, and CSS is up 90%.

Chris Dankert -- Loop Capital -- Analyst

No, very, very encouraging. Thanks for the color. Very much appreciated. And just kind of a point of clarification of the excellent work on gross margin and kind of execution on those supply chain synergies. I guess, a point of clarification, the steel operation savings, is that entirely in 2023? Or could some of sort of trickle in a little bit in late '22?

David S. Schulz -- Executive Vice President and Chief Financial Officer

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

Chris Dankert -- Loop Capital -- Analyst

Thanks so much, guys.

John J. Engel -- Chairman, President and Chief Executive Officer

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

The next event will be the Baird Global Industrial Conference that we're participating in, that will be next Wednesday. And then we'll be participating in the Stephens Investment Conference on December 2. So thank you very much again for your support. Have a great day.

Operator

[Operator Closing Remarks]

Duration: 62 minutes

Call participants:

Leslie Hunziker -- Senior Vice President of Investor Relations & Corporate Communications

John J. Engel -- Chairman, President and Chief Executive Officer

David S. Schulz -- Executive Vice President and Chief Financial Officer

Sam Darkatsh -- Raymond James -- Analyst

Deane Dray -- RBC Capital Markets -- Analyst

David Manthey -- Baird -- Analyst

Christopher Glynn -- Oppenheimer -- Analyst

Nigel Coe -- Wolfe Research -- Analyst

Steve Barger -- KeyBanc Capital Markets -- Analyst

Patrick Baumann -- JPMorgan -- Analyst

Chris Dankert -- Loop Capital -- Analyst

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