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WESCO International, Inc. (NYSE:WCC)

Q2 2013 Earnings Call

July 25, 2013 11:00 am ET

Executives

Daniel A. Brailer - Vice President of Investor Relations & Corporate Affairs

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

Kenneth S. Parks - Chief Financial Officer and Vice President

Analysts

David J. Manthey - Robert W. Baird & Co. Incorporated, Research Division

Christopher Glynn - Oppenheimer & Co. Inc., Research Division

Deane M. Dray - Citigroup Inc, Research Division

John Anthony Baliotti - Janney Montgomery Scott LLC, Research Division

Matt Duncan - Stephens Inc., Research Division

Shawn M. Harrison - Longbow Research LLC

Drew Pierson - JP Morgan Chase & Co, Research Division

Sam Darkatsh - Raymond James & Associates, Inc., Research Division

Noelle C. Dilts - Stifel, Nicolaus & Co., Inc., Research Division

Operator

Good morning, and welcome to the WESCO Second Quarter 2013 Earnings Conference Call. [Operator Instructions] Please note, this event is being recorded.

I would now like to turn the conference over to Dan Brailer. Please go ahead, sir.

Daniel A. Brailer

Good morning, ladies and gentlemen. Thank you for joining us for WESCO International's conference call to review our second quarter 2013 financial results. Participating in the earnings conference call this morning are the following officers: Mr. John Engel, Chairman, President and Chief Executive Officer; and Mr. Ken Parks, Vice President and Chief Financial Officer.

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 7 days. Additionally, relating to this morning's release of our earnings announcement, an earnings webcast presentation has been produced, which provides a summary of certain financial and end market information to be reviewed in today's commentary by management. We have filed the presentation with the Securities and Exchange Commission and posted it on our corporate website.

During today's call, we will be webcasting selected slides from the presentation to facilitate our review of the results. As John and Ken go through their prepared remarks, they will reference specific pages that relate to their comments.

In order to accommodate as many investors and analysts as possible, we respectfully ask that you try to limit your questions to 1 per person.

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.

To make the year-over-year comparisons more meaningful, we have adjusted the nonrecurring favorable items from 2012 and the first quarter of 2013. The reconciliation of the adjustments is shown in the appendix of the presentation. For the remainder of today's call, John and Ken will reference the adjusted amounts.

As such, the following presentation includes a discussion of certain non-GAAP financial measures. Information required by Regulation G with respect to such non-GAAP financial measures can be obtained via WESCO's website at www.wesco.com.

I would now like to turn the call over to John.

John J. Engel

Thank you, Dan, and good morning, everyone. Our second quarter results reflect solid execution in a soft economic environment. The end market condition is consistent with our prior expectations. Our bidding activity levels have picked up, and business momentum improved through the quarter. With June core sales per workday being up 2%, driven by growth in Lighting and continued strength in Utility.

On a sequential basis, we experienced sales growth in all 6 of our major product categories, with Data Communications being up double digits. We remain focused on what we can control, that is, the execution of our One WESCO sales, productivity and LEAN initiatives.

We posted record sales in the second quarter, and record operating profit as well, excluding the ArcelorMittal litigation impact. We continue to invest in our 8 growth engines and 6 operational excellence initiatives, while maintaining operating cost discipline.

In the first half of 2013, we added over 100 personnel in our Global Accounts, Integrated Supply, Utility and Safety businesses, as well as our pricing and supply chain management functions. Meanwhile, we continue to execute our LEAN productivity initiatives. As a result, overall core headcount was down during the first half, and core SG&A declined $3 million year-over-year in Q2, after being flat versus prior year in Q1.

In the second half of the year, we're opening a large new One WESCO location in Los Angeles. We will be completing a regional hybrid distribution center network for our Datacom business in the U.S. We also plan on opening several new branches in the U.S. and Canada, along with a new hybrid DC in Montréal. These continuing investments approve our ability to provide One WESCO solutions to our customers, and support delivering our profitable growth objectives.

We continue to be pleased with the performance and effective integration of our recent acquisitions. Conney grew 5% in the second quarter, and has been effectively integrated into our WESCO operations. The EECOL integration is also progressing well and we remain on track to deliver our EPS accretion expectation of $1 this year.

Sales momentum in Canada, however -- has moderated, however, driven by a late and rainy spring. In the second quarter, WESCO's Canada sales were up 1% versus prior year, x EECOL. EECOL's Canada sales were down approximately 2% versus prior year. Construction projects came to a halt and contractors redirected their activities to storm recovery efforts as Alberta experienced its worst flooding in history.

As a result, EECOL's Direct Ship project business declined in the quarter, but their warehouse sales continued to grow versus prior year. At this point, we have only seen project deferrals and not any project cancellations.

For the first half, net income grew double digits, while operating margins expanded 20 basis points to 5.7%, driven by improving gross margins and continued effective cost controls.

We remain committed to our long-term gross margin target of 22%. We're making very good progress, improving from 20% in the first half and 20.5% in the second half of last year, to 20.9% in the first half of this year. Overall, we delivered a solid result in the first half, given the economic backdrop and challenging end market conditions.

Free cash flow generation remains strong at greater than 80% of adjusted net income in the first half and continues to be directed for debt reduction. As a result, leverage has been reduced to 3.5x on a pro forma basis, and is now at the top end of our targeted range.

Our acquisition pipeline remains strong and continues to be actively managed, and we see excellent opportunities to further expand and strengthen our portfolio in the second half of 2013 into 2014.

Our third quarter start, so far, in July is consistent with our first half results, with overall sales being up approximately 13% versus prior year. Backlog is at a healthy level entering the second half, and our book-to-bill ratio is tracking above 1.0 at this point in July.

Now, Ken Parks will provide details on our second quarter results, including highlights of our end markets and our outlook for the balance of 2013. Ken?

Kenneth S. Parks

Thanks, John, and good morning. Similar to the first quarter, sales to our Industrial customers declined in the quarter versus prior year, and that's driven by non-repeating industrial capital projects and delays in customer spending. On a sequential basis, demand was relatively stable and Industrial sales were flat. Channel inventories appear to be in balance with current demand and second quarter bid activity levels remains strong.

Customer trends have increased outsourcing and supplier consolidation are continuing, and we're very well-positioned to provide a one-stop shop for our customer's supply chain management needs.

Our opportunity pipeline remains large at over $2.4 billion and continues to be actively managed. As a result, in the second quarter, we were awarded a large integrated supply contract with a US-based manufacturer. Initially, we're serving 5 different production facilities and we have the opportunity to expand the service footprint over time.

Now moving to our construction performance on Page 5. Nonresidential construction markets do remain challenged in the U.S. but continue to grow in Canada and in our targeted markets around the world. The continuing strength of the residential construction recovery this year is a positive leading indicator for future improvement in nonresidential construction later this year and the next.

Sales to construction customers in the second quarter were down versus prior year, but grew 13% sequentially versus Q1. Notably, we experienced nice growth in Lighting in the quarter with sales being up 6% versus the prior year, driven by LED and retrofit applications.

We also saw Datacom strengthening as we progress through the quarter and continued to secure some nice, new construction wins, including a large electrical project we were awarded for a precious metal mining operation in Canada.

As we entered the second half, backlog remains strong and is up approximately 5% versus year end 2012. Bidding activity levels have increased as well, and the nonresidential construction market, despite its challenges, remains large with opportunities for new construction and retrofits, renovations and upgrades.

Now moving to our Utility performance on Page 6. We're pleased with the strength of our utility business and continue to deliver above market sales growth. Organic sales to our Utility customers grew 23% versus last year, following 18% growth in the first quarter. The second quarter marks the ninth consecutive quarter of year-over-year organic sales growth, driven by new wins and an expanding scope of supply with our existing Utility customers.

Customers are embracing the efficiencies offered by our Integrated Supply capabilities, as I look to improve their own supply chains. We continue to implement the new customer wins from last year and we're pleased to report that we were awarded an integrated supply program in the second quarter to provide a large IOU with supply chain management and logistics services for their entire power generation and distribution network.

Now moving to our CIG performance on Page 7. Sales in the second quarter remains weak due to ongoing government spending constraints and project award deferrals. With that said, we were pleased to see sequential sales growth in the quarter and expect some improvement in government bidding activities prior to the end of the fiscal year in September.

Similar to construction and despite the challenges in the CIG market, we continue to secure some nice new wins, including the second quarter award to install security systems in approximately 2,700 buses and trains for a large U.S. metro transit authority.

Now, I'll move on to the financial results. On Slide 8, I'm going to review the Q2 results from the context of the outlook we provided during our first quarter earnings call. As Dan indicated at the beginning of the call, I'll speak to the year-to-date 2013 results adjusted to exclude the favorable impact of nonrecurring items.

During our Q1 call, we estimated second quarter consolidated sales would grow between 13% and 16% year-over-year, or minus 3% to flat organically. Sales were in line with that April outlook.

Consolidated sales in the quarter were $1.89 billion, an increase of 13.2% year-over-year. Acquisitions accounted for 15 percentage points of the growth, and that's comprised of approximately 13 points from EECOL and 2 points from Trydor and Conney combined.

EECOL's Canadian sales for the quarter were $212 million, which were down 2 points primarily due to the spring thaw and the Calgary flooding that John spoke about earlier.

Organic sales declined approximately 1.2% in the second quarter, that's slightly better than the 1.8% organic decline that we saw in the first quarter.

We did see an improved daily organic sales trend as we moved through the quarter, with June sales up 2 percentage points, after April and May were down 2.5 and 2 points, respectively.

Sequentially, second quarter organic sales increased 4.8%, normalizing for the impact of 1 additional workday versus the first quarter of 2013. Organic sales increased approximately 3.2%, which is in line with our typical seasonal trend.

Backlog remains at a healthy level, as core backlog declined only 3.5% from last year's second quarter and grew approximately 5% sequentially from year end 2012.

Due in part to the stronger sales in June, core backlog declined approximately 2% sequentially from the end of the first quarter. Overall pricing was essentially flat in the second quarter.

In our April earnings call, we estimated that second quarter gross margins would be at or above 20.9%. We fell a bit shorter at that, but reached 20.7%, which is a 60 basis point improvement over last year's second quarter. The strong growth in our Utility business, which runs at lower gross margins than the company average put approximately 20 basis points of pressure on gross margins year-over-year.

We've seen gross margins step up from 20% in the first half of 2012 to 20.5% in the second half of last year, and then again up to 20.9% in the first half of 2013. We continue to focus on delivering against our 22% gross margin target and we feel good about our progress to date.

SG&A for the quarter was $266 million, compared to $231 million in the second quarter of 2012. The acquisitions of EECOL, Conney and Trydor accounted for all of the year-over-year growth. At $228 million, core SG&A remains unchanged over the last 3 quarters, and down approximately $3 million from the second quarter of last year.

Core employment was down approximately 1% from last year's second quarter and down slightly from year-end 2012. We continue to closely manage our overall cost. And as John mentioned, we selectively are investing our business to support our growth engines and our operational excellence initiatives.

In April, we expect the second quarter operating margins to expand to at least 6%, operating profit for the second quarter grew 14% to $110 million, improving operating margin to 5.8% of sales, which is an expansion of 10 basis points over Q2 of last year. Sequentially, operating margins expanded 20 basis points.

Interest expense in the second quarter increased to $21.8 million versus $11.5 million in the prior year, as a result of the acquisition-related financing. As a part of this financing, we were able to obtain very attractive rates and as a result, our overall weighted average borrowing rate for the quarter declined to 3.9% from 4.9% last year.

Finally, the second quarter effective tax rate was 25.8%, and net income grew 11% to $65 million compared to $59 million last year.

Taking a look at Slide 9, second quarter EPS grew from 9% to $1.25 from $1.15 in the second quarter last year. As we've shown in the chart, the core business was a $0.12 drag on EPS, driven by the 1.2% organic sales decline, 30 basis points gross margin headwind and growth in WESCO shares, partially mitigated by SG&A reductions. On the other hand, acquisitions contributed approximately $0.22 of EPS accretion in the quarter. EECOL's contribution for the quarter was approximately $0.19 of EPS and stepped down slightly from Q1, due to the lower volumes previously discussed.

Year-to-date, EECOL has contributed $0.41 of EPS and we maintain our outlook that EECOL will be accretive to WESCO earnings per share by approximately $1 in 2013. A note, we completed the acquisitions of Trydor and Conney Safety in July of 2012. As we move forward, they will therefore become a part of the core results beginning end of third quarter.

Onto cash. We have a history of generating strong free cash flow through all portions of the business cycle. Over the last 8 quarters, we've generated $0.5 billion of free cash flow or approximately 110% of net income over that period. Free cash flow for the first half of 2013 was $108 million, and that's up $5 million from the same period last year, and equal to 87% of net income.

As we've indicated, the acquisition of EECOL increased our leverage ratio above our targeted range of 2x to 3.5x EBITDA. As we stated at the time of the acquisition, we're committed to prioritizing near-term cash redeployment towards debt reduction until we're comfortably within our target range. We reduced our leverage ratio in Q1, and then again in Q2. At the end of June, our reported leverage ratio was 3.9x EBITDA, which is down from 4.7x at year-end. More importantly, our pro forma leverage ratio improved to approximately 3.5x or just at the top end of our targeted range. We expect to continue to delever the company as we move through the year.

Our overall cash redeployment strategy remains unchanged. Over the long term, our first priority for cash redeployment is to invest in the business through organic growth initiatives, and acquisitions. Liquidity, defined as invested cash plus committed borrowing capacity, was healthy at approximately $429 million at the end of the second quarter and has increased nicely from the $300 million level it was at, at the end of 2012. ROIC at the end of June was 10.2%, although the EECOL acquisition is expected to reduce our overall ROIC in the short term. We remain focused on our long-term target of 15%.

Now to the Q3 and full year outlook. In January, we indicated that the economic recovery was expected to be weighted to the second half of the year, with a flattish organic top line in the first half and mid-single-digit organic growth in the second half. Including EECOL, we expect the full year sales to grow between 16% and 18% for the full year. The first half results for 2013 have been consistent with that outlook, organic daily sales are down a little more than 1 point to date. However, we no longer expect mid-single-digit organic growth in the balance of the year. Instead, we now expect flattish organic sales for the full year with only modest organic sales growth in the second half, offsetting the small organic decline in the first half.

Overall, full year sales are now expected to grow between 14% and 16%, including acquisitions.

In the third quarter, we expect organic sales to grow between 2% and 4%, and total sales to grow 17% to 19%, including EECOL. We expect gross margins to expand to approximately 20.8% in Q3, and approximately 20.9% for the full year, driving operating margins to approximately 6.2% in the third quarter and 6.6% for the year.

We're also narrowing our effective tax rate outlook range to between 26% and 27% for both the third quarter and the full year. Putting all this together, we now expect full year diluted earnings per share in the range of $5.15 to $5.35, and that's excluding the favorable impact of the litigation matter recorded in the first quarter of this year.

The reduction from our previous EPS outlook of at least $5.75 is driven fully by the reduction in our second-half sales expectations, as the protracted economic recovery continues to move to the right.

We do continue to be pleased with our execution on One WESCO initiatives, gross margin expansion and cost control.

With that, I would now like to open the call up to your questions.

Question-and-Answer Session

Operator

[Operator Instructions] Our first question is from David Manthey from Robert W. Baird.

David J. Manthey - Robert W. Baird & Co. Incorporated, Research Division

First off, I guess everyone is interested in what's going on at EECOL in Canada. Could you talk about the trends through the quarter and into July? You said that there was some early seasonal impact there, could you just talk about how that's trending? And then second, if you could discuss the outlook for EECOL in Canada in general over the next 12 months, particularly given the energy and industrial exposure, if you could talk about those in particular?

John J. Engel

Yes. Well, I think we mentioned overall that our sales momentum improved through the quarter overall for WESCO, that was really driven by our U.S. and International operations outside of Canada. The sequential improving momentum which moved through the quarter was driven by those parts of the business. Canada looked the opposite, it actually degraded as we moved through the quarter. Part of it was the later spring impacted the overall quarter, but the flooding had a particular and acute impact in June. So that's what was happening underneath the overall reported results. And that's continued so far into July. I mentioned that our July sales versus prior year was consistent with the first half, but the mix of July is consistent with how the quarter ended at the end of the second quarter. We do think that the weather impact, particularly the flooding impact, should result in some upside opportunities over time but clearly, contractors were impacted, efforts were redirected to supporting the recovery efforts. We've not seen any project cancellations, I repeat. It's just in deferrals at this point. In terms of our overall outlook, and let me also -- I'm sure the question will come up, have we quantified the weather impact, which is inclusive of the flooding for Canada? It's approximately $15 million in the quarter, and that's not just for EECOL, that's for WESCO Canada plus EECOL. So that's -- we can give a little additional color. In terms of the overall Canadian economy, we see the economic indicators improving slightly at the midyear point, as we enter the second half of the year. I think this is very consistent with Bank of Canada's expectation for a gradual pickup in activity. And we're still bullish on the mid to long-term growth prospects. So I mentioned that we're still investing, we're opening some locations, we're gonna open up a DC in Montréal. And we see, really, the demand for Canada's heavy crude to still be strong by U.S. Gulf Coast refiners, as well as, as pipelines are built, not just the keystone pipeline, at some point, we believe that will go through, but also pipelines to the Canadian shores, I think that will result in a boost in demand as well. Ken, i don't know if you had anything else to add?

Kenneth S. Parks

No, I think that covers it.

John J. Engel

David, did that help?

David J. Manthey - Robert W. Baird & Co. Incorporated, Research Division

It does, yes. If I could just ask one more quick one here. In terms of the Utility business, obviously, doing very well. Could you talk about what the growth would be if you excluded sort of shifting any major alliance contracts? Just -- I mean, is it growing excluding project wins? And when I say project, it means these major ...

John J. Engel

I think it's really important to understand there's 2 drivers to our growth and it's hard to separate or attribute what the contribution is. But I will, at least, take a shot at it. One is winning new customers. And we've had a series of nice wins over the last 18 to 24 months. This win in the quarter is substantial, it is a very substantial win, so we're very excited about that. The second driver of our growth, and it's really important to understand it's expanding our scope of supply with our current utility customers. And think of it as kind of a One WESCO implementation for Utility, which includes additional safety products, MRO supplies and so that's -- and both are contributing to our growth. Maybe one way to look at it is, by end market segment in Utility -- or Customers segment, our investor-owned utilities are driving very strong double-digit growth. Our public power is growing and it's in the mid to upper single-digit range, positive growth versus prior year in the quarter. So it's not just coming from the IOUs. And so, I think, that again speaks to the scope expansion. And the scope expansion isn't just products, but it's also supply chain management services of the ilk, like what we've done for Duke. That is being stepped in repeated into other relationships. Does that help?

Operator

The next question is from Christopher Glynn from Oppenheimer.

Christopher Glynn - Oppenheimer & Co. Inc., Research Division

Just noticing at the midpoint of guidance seems to have operating margin ticking up sequentially in the fourth quarter, which is maybe a little bit atypical. So just curious of the thought process behind that?

Kenneth S. Parks

Yes. What's kind of changing this year versus prior year is we talked a little bit about it in the first quarter, is that EECOL actually has a trend where they have an increasing level of sales and therefore, profitability each quarter through the years, for each of the 4 quarters. So their fourth quarter is typically their strongest. That weighs a little bit more positively on our year-over-year trend in the fourth quarter than what we typically see. In addition to that, as you know, the second half of last year weakened, so we have the benefit of better comps, specifically in the fourth quarter. And those are really the 2 big drivers.

Christopher Glynn - Oppenheimer & Co. Inc., Research Division

Okay. And then, your gross margin core, down 30% year-over-year, held up the utility mix, I think that would've been a similar headwind in the first quarter though and presumably, partially in guidance. So just wondering if there are any other moving pieces with the gross margin in the near term?

Kenneth S. Parks

Well, one of the other things, and we talked a bit about it on the call already, is the move in Canada. And as you know, we've talked about pretty openly, Canada and EECOL are our highest profitability businesses. So as that kind of took a step down from Q1 to Q2, that had a sequential weighting on the gross margins.

Christopher Glynn - Oppenheimer & Co. Inc., Research Division

And then just lastly, the midpoint of guidance, what would be a plug for the interest expense?

John J. Engel

Interest expense, I think it's fair to say, if you look at the run rate where we are for the first half, it will step down slightly through the balance of the next 2 quarters. But you could probably just kind of get there that way.

Operator

Our next question is from Deane Dray from Citi Research.

Deane M. Dray - Citigroup Inc, Research Division

John, you stepped through a number of positive data points between Industrial bidding activity, sequentially better in Construction, as well as the sequentially better in core revenue growth through the quarter. Of those, maybe you can expand on the construction activity, especially being up sequentially? And I know you all have a project tracker and maybe give some color there, specifically on what kinds of projects you're seeing being added?

John J. Engel

Yes. Well, we were -- it was an encouraging data point in what was otherwise a quarter that quite frankly, didn't meet our expectations. So I do need to say that the quarter did not meet our expectations, and we're aggressively driving execution. With that said, when you look at Construction, it picked up very, very nicely sequentially. We are absolutely seeing increased bidding activities and I'll tell you Deane, they're pretty pervasive. Now that means they translate into orders that needs to translate into sales ultimately. Our backlog's holding up well, it's healthy. And I would say, I only parse Construction a bit, was absolutely seeing an improving momentum in Datacom. Datacom was down 1 point x percent in the quarter, Q2 versus prior year but heavily driven by the government portion of Datacom, either Datacom is going to the government contractors and government projects, which was down 12%, government was down 12% in the second quarter. If we pull out Datacom -- government for Datacom, it grew. And I think what's important to note is the Datacom momentum improved as we moved through the quarter, which was encouraging to us. Feedback from our sources, both suppliers and customers would suggest that second half is setting up more positively for Datacom. And there is an overall expectation, I think, in the industry that there'll be growth in the core Datacom markets in the second half. For our IP physical security part of the business, which is not large, it's nowhere near as large as our major competitor, but it's still growing very nicely. It grew very strong double digits again in the second quarter, and after being up double digits in the first quarter. And David Bemoras highlighted that in last year's Investor Day. So I mean, it's a nice growth engine. In terms of the other parts of Construction, another bright spot was Lighting. And so, Lighting was up 6% versus prior year in the quarter, which we felt good about. And it was driven by, again, not new construction yet. So I think we're setting up nicely for when new construction kicks in. But it was driven by retrofit renovation upgrades and LED. And we're getting some feedback from -- at least a couple of our suppliers have told us that our LED mix is at the high end of the range and kind of leading our competition, so another decent data point. ABI still is in a positive territory. I think the big question is -- and we've talked about it, is the traditional linkage and interdependency between residential construction recovery and nonresidential construction recovery. And clearly, resi is in recovery, non-resi will follow but our view is very similar to what it's been for a few years. It's a protracted recovery, it's going to come, not sure of the amplitude, but it seems to be shifting out to the right. With that said, we're encouraged by a number of these leading indicators.

Kenneth S. Parks

And as John pointed out, we talked about the Datacom backlog in the opening part of the comments. I'd also add to that, just to kind of give us a feel about the backlog in U.S. overall. While we saw Canada backlogs stay at a healthy level from year end 2012, we quoted that overall backlog was up 5%. If you look at the U.S. in totality, including Datacom and looking at across the business, it was actually up more than that. So we actually saw some strengthening in the backlog, higher than the 5% level in the U.S. business.

Christopher Glynn - Oppenheimer & Co. Inc., Research Division

That's really helpful. And just last one for me. John, I would love to hear the sales pitch for the Analyst Meeting in August. What's going to be new, what's the format and are there any particular themes you'll be highlighting?

John J. Engel

We can't scoop ourselves. Well, look, we very much look forward to seeing you in 2 weeks. I think similar to what we've done in prior years, we'll have a number of our business leaders present. I think what we're excited about this year, honestly -- and because our Investor Day typically takes a longer-term view and talks about the major initiatives, we've been working on this gross margin thing for some time and we think we're absolutely getting some nice traction there, so Steve will explode that in some detail. And I think we'll give an updated view of just kind of industry structure, where we're positioned in the industry. We think our strategy of initiatives we're investing in and driving growth organically, plus the acquisition is working. We're encouraged that we're are the top end of our leverage range now and we're going to continue to focus our cash flow and debt reduction. But I think it sets up for continuing to run this playbook. And our portfolio is larger and more diverse now. So we'll give some deeper insight. Obviously, now that we've had Conney and Trydor on for a full year and EECOL on for the better part of 7, 8 months, we'll be able to give some much deeper insight into how they're going to contribute to our profitable growth. And then finally, we will give an outlook, as we have done historically in terms of what our framework and financial expectations are for 2014.

Operator

Our next question is from John Baliotti from Janney Capital Markets.

John Anthony Baliotti - Janney Montgomery Scott LLC, Research Division

John, if you looked at -- you made some positive comments about how the quarter ended and how third quarter is starting and coincidentally, U.S. durable goods data came out today and it looks like across the board, new orders were pretty positive, as well as the backlog growth was a nice trend upward and it's been the first in a couple of months. So if you look at, I'm guessing the 2 areas that you might see, that would be Industrial and Utility and that's combined about 60% of the company. Are you seeing any of that yet or is it still too early relative to what the data said today?

John J. Engel

Well John, again, the way July is setting up so far, when you look at the composition, the composition -- I said in my prepared comments that it's okay, it's up approximately 13% so far in July. Book-to-bill is above 1.0, it's actually well above 1.0 and so that's encouraging. But the composition is a bit different because it very much reflects so far, what we're seeing in July, how we ended the second quarter. So let me emphasize again, we saw positive and sequential and improving momentum in U.S.-based operations and outside of Canada, International outside of Canada and Canada experienced a sequential slowdown as we move through the quarter because of June. That flooding impact, we're still feeling the residual of that and the project shifting in July. I didn't mention earlier, I don't believe, so let me mention now and make this point, that if you look at the composition of EECOL's Canada sales, it's really the project part of our business, the Direct Ship that took the big hit through the quarter in general. But particularly in June, we're still feeling that in July. Our warehouse sales grew and our warehouse sales were up approximately 2% in the second quarter, and that's continuing here in July. So that's my comments overall about kind of by geography. Industrial, we have a particularly tough comp we had with some large non-repeating projects last year. Sequentially, our momentum is kind of flattish but if you were to adjust for Canada, we're actually up a bit as we move through the quarter. So I think there's a little positive momentum vector there. And Utility, were doing really well, we're significantly outperforming the market. And again, it's as I mentioned, it's new wins plus scope expansion. So hopefully, that helps, that additional color.

John Anthony Baliotti - Janney Montgomery Scott LLC, Research Division

Okay, great. And because it's saying -- it does kind of point out that you do have some easing comps when the second half did start to decline to the balance of the year. And it seems like from what the data we saw today, that could complement the easing comps in the back half.

John J. Engel

Right.

Operator

The next question is from Hamzah Mazari, Crédit Suisse.

Unknown Analyst

This is Flavio, I'm standing in for Hamzah today. I was just wondering if you guys could give us some color on pricing, how pricing is trending, especially given where the commodity prices are? And if you're expecting any pricing pressure to continue?

John J. Engel

It's flattish, and so we're getting no benefit of anything. I think Ken shared at that comment earlier, it's overall flattish and I would not signal that the pressure is any worse than what we normally face. I think what's driving the competitive dynamics is not any pricing affect, it's the overall demand across the value chain. And just maybe make this comment. The Industrial customers that we're serving, and we're trying to expand our scope of supply with, they're in good shape financially, they have a lot of cash on their balance sheet. There is still, we think, a lot of pent up potential for capital projects spending and even increased maintenance efforts and the like. But it takes confidence on behalf of them and what their end market demand is going to look like. So I think in this protracted recovery period where there is fits and starts and there's not much growth if anything, economically, the bigger, stronger players have an opportunity to kind of take additional share. And that's the real affect, though. It's really the demand view versus the pricing dynamics that's causing any issues that we're seeing now in the market. Inflation is under control, it's not -- it's really the demand.

Kenneth S. Parks

And that said, you'll see in the webcast presentation backup, we always give you kind of an outlook on what pricing is to date. As John said, wouldn't expect a lot of additional downward pressure, but as you're looking out to the second half of the year, there's really probably no anticipated uplift in pricing from our perspective. I think we're kind of dealing with this kind of neutral pricing environment in the near term for the balance of the year.

Unknown Analyst

That makes sense. That's very good detail. So on that note of the demand side, like on this sluggish demand environment, how are you thinking about your investment spend? And if demand keeps on being weak or weakens, which buckets of investment do you focus on and reprioritize, and which ones do you...

John J. Engel

Flavio, it's our growth engines and I cited that even though -- we believe we've done a good job with maintaining our cost discipline and controls over the last 3 to 4 quarters. It really started midyear last year when we started seeing the top line slowdown. We haven't gone in taking major structural cost takeout actions, but we're very aggressively and diligently managing our discretionary cost controls and challenging any headcount replacements and also applying our LEAN initiatives to certain back office operations and processes. And we have actually reduced headcount in 2013 as we move through the year, and it started actually, in the middle of last year. So we reduced overall headcount, yet we have increased our investments, and I cited that in my comments, Global Accounts, Integrated Supply, Utility, our International operations and Conney, our Safety business, as well as our pricing and sourcing functions. So we're putting net our resource, our headcount is down. But overall, underneath of it, the mix has been shifted to top line generating personnel and margin improvement personnel in the pricing and sourcing functions. So we'll give much more insight on this in our Investor Day. Obviously, resource allocation and prioritization of where we put the investments is critical, that's one of our top jobs and we think we're doing a decent job.

Operator

We have a question from Matt Duncan from Stephens Incorporated.

Matt Duncan - Stephens Inc., Research Division

Ken, can you maybe help us a little bit with understanding on EECOL with the EPS accretion of $1? It was $0.41, first half, so it's got to be closer to $0.60 in the back half. What drives that increase? Is it a little bit of improving sales? You mentioned earlier, that you get a little bit of a sequential sales build there to the year, or is it something else?

Kenneth S. Parks

It's really the improving sales, but driven by 2 things: one is the natural kind of sequential improvement that they see in the quarters as they moved through the year. And then on top of that, John talked about the impact of the weather, both the late spring and the rains and the flooding in Calgary in June. As we talked to the business, we see solid warehouse sales, we see the projects still out there, the people have just been kind of refocused on other areas. So the anticipation is that's going to start to come back in the second half and that will help us. Hard to call whether that's 3Q or 4Q, but the demand we believe, is deferred, not diminished.

Matt Duncan - Stephens Inc., Research Division

Okay, well you may have just answered my next question because you said typically, the revenues are up there through the year, but you were down about $13 million sequentially, 1Q to 2Q. Obviously, some of that is the weather impact. Is it the deferred projects that would primarily account for the balance of that then?

Kenneth S. Parks

It would be -- it's basically the decline from 1Q to 2Q are the reasons that we noted tied to the weather. And that would primarily be in the project side of the business.

Matt Duncan - Stephens Inc., Research Division

Okay. And then last thing for me, just on the M&A pipeline. You guys have obviously done a couple of things that has been outside electrical recently, Conney's a good example of that. Maybe can you characterize that M&A pipeline? How much of the stuff that you're most focused on is outside sort of electrical or Datacom where you guys have a big presence currently versus more bolt-on type deals in your core product categories?

Kenneth S. Parks

Great question. I don't know that we've ever sized the pipeline, in terms of company revenues and the number of targets. But suffice to say, it's very large. It's as large as it's ever been. We're actively managing it. And I would tell you, it has a good mix of some core electrical distribution companies, as well as nonelectrical, call them broader based industrial or especially, distribution companies like Conney. So there's a very good mix. We continue to run our management process of the priority targets in the pipeline, it is a phase-gated process. And I mentioned that we're not going to -- a knife edge switch turn on and off the M&A process. It's a core part of our strategy, it's one of our 2 key value creation levers. We're continuously managing that pipeline as we did, even after we closed EECOL in the first half of this year. We're encouraged kind of where the leverage ratio has come in. And so, I think as we've expanded outside of core Electrical over the years, Matt, and as we are able to deliver real synergies, it gives us even greater confidence to look at these targets that are kind of more broad-based Industrial distribution or specialty distribution inside Industrial distribution. And because we have belief for -- and we've espoused this for some time, that our business model extends horizontally to many product verticals. We're very encouraged with Conney. I mean, Conney grew 5% in the quarter, it grew 4-plus percent in Q1, it's picking up. We put substantial investments into Conney and they're paying off, and we're getting -- we're now getting some Global Accounts leverage and Integrated Supply leverage with that business. So there's a good example, I think, of taking a specialty distributor. In this case, Safety, have some private label, and what are we doing? We're leveraging key assets that WESCO has, our blue chip customers base in the form of Global Accounts and Integrated Supply customers. So I would -- it's a long answer and we'll develop this more at the Investor Day but I would say recent past is prologue. Recent past for M&A is prologue.

Operator

The next question is from Shawn Harrison from Longbow Research.

Shawn M. Harrison - Longbow Research LLC

Just 2 brief questions. Just first off on the second half outlook, does that include any sequential improvement in your commercial construction related businesses? And then second, just with EECOL's second-half weighting, how does that kind of affect the free cash generation in the back half of the year? Are you going to be building maybe a little bit more incremental inventory into the back half than typical?

Kenneth S. Parks

I don't think I would say -- I'll answer the second one first, which is I don't think we'll see any incremental weight on the cash flow from EECOL. As we talked about a lot of the incremental growth in the second half in EECOL will come from projects, which that doesn't sit in inventory very long. So I wouldn't rethink our second half cash flow outlook. The first half of the question, we certainly saw some incremental improvement in volume from Q1 to Q2, in the Construction business and we've talked several times throughout the call about the improvement in our backlog. That indicates for sure that we're expecting some improvement as we move forward. It's just very hard to calibrate how that rolls out.

John J. Engel

I mean, typically, Q2 and Q3 are the strong quarters for Construction. Q1 and Q2 obviously, due to winter effects, are down from that. And so, we'll have to see how we progress through Q3 and into Q4 and what that seasonality looks like.

Operator

The next question is from Steve Tusa from JP Morgan.

Drew Pierson - JP Morgan Chase & Co, Research Division

It's Drew Pierson on for Steve. We've covered some ground, just a couple of quick cleanup questions. First, Datacom, you talked about the improving trends there. What was the absolute rate for Datacom in 2Q roughly?

John J. Engel

Say that again?

Drew Pierson - JP Morgan Chase & Co, Research Division

Datacom growth in 2Q for you guys?

John J. Engel

It was a little under -- Datacom growth rate in Q2, Datacom was down versus prior year, a little under 2%, 1.X%. If you take Datacom sales to government out, it was up low single digits. But all in, Datacom for the whole company as a category, it was down a little under 2%.

Kenneth S. Parks

1% to 2%, yes.

Drew Pierson - JP Morgan Chase & Co, Research Division

And then your comment was June was up, however, on the Datacom set?

John J. Engel

I was just saying, momentum improved through -- as we moved through the second quarter, particularly -- in the U.S.-based operation, particularly for Datacom. I didn't give a number, I'm not going to give that number by month. But just suffice to say, it was -- it had very nice improving momentum as we moved through the quarter.

Drew Pierson - JP Morgan Chase & Co, Research Division

That's helpful. And then just some cleanups on margin items in the second half. I guess I wanted to ask specifically about incentive comp. If there's anything that moves around on that front? And then anything related to supplier rebates in 4Q, given the lower volumes?

Kenneth S. Parks

Yes. We bulk and look at incentive comp as we move throughout the year so I wouldn't expect any kind of large movements in any of that driving margin rates in any quarter or specifically, in the second half. As you look at SBR, really, there's a slightly more favorable impact onto margin in the first couple of quarters of the year, and slightly less in the second, and that's not because we reestimate so much SBR. It's just that we kind of book it based upon an outlook for the year on a run-rate basis. So just very mathematically, as you kind of think of the same amount running through the months and quarters of the year and sales increasing, then that kind of has lesser of a favorable margin impact. But it's not large and that's kind of the only thing I would tell you to consider.

Operator

Next question is from Sam Darkatsh from Raymond James.

Sam Darkatsh - Raymond James & Associates, Inc., Research Division

Most of my questions have been asked and answered. Just a couple of housekeeping. I'm still a little confused as to why the core gross margin was down 40 basis points sequentially. You had utility mix sequentially was basically flat and pricing was flat. So I'm still confused as to why sequentially that was down?

Kenneth S. Parks

I actually -- core gross margins weren't down 40 basis points, they were essentially the same sequentially. They were down year-over-year but only slightly.

Sam Darkatsh - Raymond James & Associates, Inc., Research Division

Okay. I'll have to recheck my math. That's fine.

Kenneth S. Parks

We can help you clean that up, and we'll do that with you.

Sam Darkatsh - Raymond James & Associates, Inc., Research Division

That's fine. The second question, you said July, up 13%, your third quarter guidance, up 17% to 19%. Now I know you have some momentum that's favorable, I know you have some weather that's impacting you here in the July month, but do the comparisons get easier in August and September also or is it -- is the higher guidance than what you're seeing so far in July purely a function of the momentum through June and July?

John J. Engel

I think there's kind of 2 points to that, and that's the July-to-date, I think we had, on a month-to-date basis, the way the July 4th holiday fell, we estimated kind of cost us a half a day or so in our growth rate, which is a couple of points if you think about how that would affect the month than on a day adjusted basis. Well, John quoted 13% month-to-date. You can kind of adjust that up a little bit, and that gets you closer to the range. Also, I would tell you that the quarter has an extra day in it for the year. So you need to compare this year to last year on a day adjusted basis. And then finally, the comps in August and September do get slightly easier.

Operator

Next question is now from Noelle Dilts from Stifel.

Daniel A. Brailer

Noelle, this is Dan. We have time for one quick question before we wrap up.

Noelle C. Dilts - Stifel, Nicolaus & Co., Inc., Research Division

Okay, sure. I was just hoping to get a little bit more detail on -- you talked about strength in the international markets outside of Canada. Can you just give us a little more detail in which countries you're seeing strength -- where you're seeing and just parse that out a bit?

John J. Engel

Yes. International, outside U.S. and Canada, so this will be inclusive of our standard distribution model, global account customer sales that are in country, as well as Integrated Supply. So just to kind of make sure I set the kind of the backdrop, it was -- and it grew in the quarter and it grew low-single-digits, and that's inclusive of everything that's international. I would say that, Noelle, it was pretty balanced. If you look at our international footprint outside of U.S. and Canada, it includes Mexico, it includes some sales into Middle East, and it includes sales into a number of countries in Asia as well as Australia, and now with EECOL in South America. So I think the prospects are very -- our prospects internationally are very, very strong. We actually have been throttling our growth, I believe, but consciously so, by being very thoughtful about what investments we make into what country and making sure the growth is profitable. And it is, it has been to date. So I think as we gain confidence -- and we gain confidence as we move to the right, we've been increasing our investments and we'll be able to even drive even better growth. So again, low single digits, very positive backlog. Backlog in International, outside U.S. and Canada is up over 20% since year-end 2012. I think the prospects look good. Ken, I don't know if you want to add anything?

Kenneth S. Parks

No. Well, I guess I would just add one thing, which is very consistent with what John has said and each of the last few quarters, which is we grow with our customers as they expand. And as we talk about some of these wins that we've talked about in the last couple of quarters, as well as what we're doing going forward, you would see that the growth that's occurring around our solid and stable and expanding customer base. So you think about where our customers grow, that's where our growth is. It's not a greenfield, it's a follow.

John J. Engel

So with that, let me close the call today. Thank you for your time and your continued support. And we look forward to seeing you hopefully, in 2 weeks, at our Annual Investor Day in New York. Have a great day.

Operator

The conference has now concluded. Thank you for attending today's presentation. You may now disconnect your lines.

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