WESCO International's (WCC) CEO John Engel on Q2 2016 Results - Earnings Call Transcript

| About: WESCO International, (WCC)

WESCO International, Inc. (NYSE:WCC)

Q2 2016 Earnings Conference Call

July 28, 2016, 11:00 AM ET

Executives

Mary Ann Bell - VP, IR

John Engel - Chairman, President and CEO

Tim Hibbard - Interim CRO

Analysts

Deane Dray - RBC Capital Markets

David Manthey - Robert W. Baird

Andrew Buscaglia - Credit Suisse

Christopher Glynn - Oppenheimer & Co.

Shannon O'Callaghan - UBS

Ryan Merkel - William Blair & Company

Matt Duncan - Stephens Inc.

Robert Barry - Susquehanna Financial Group

Operator

Good morning, and welcome to the WESCO International Second Quarter 2016 Earnings Conference Call.

[Operator Instructions] After today presentation, there will be an opportunity to ask questions. [Operator Instructions] Please note, this event is being recorded.

I would now like to turn the conference over to Mary Ann Bell, Vice President of Investor Relations. Please go ahead.

Mary Ann Bell

Thank you, Robert, and good morning, everyone. Thank you for joining us for WESCO International’s conference call to review our second quarter financial results. Participating in today’s conference call are John Engel, Chairman, President and CEO; and Tim Hibbard, Vice President and Corporate Controller and Interim Chief Financial Officer.

The conference call today includes forward-looking statements, and therefore, actual results may differ materially from expectations. For additional information on WESCO International, please refer to the company’s SEC filings, including the risk factors described therein.

The following presentation includes a discussion of certain non-GAAP financial measures. Information required by Regulation G of the Exchange Act with respect to such non-GAAP financial measures can be obtained via WESCO’s website at wesco.com. Means to access this conference call via webcast was disclosed in the press release and was posted on our corporate website. Replays of this conference call will be archived and available for the next seven days.

With that, I would now like turn the call over to John Engel.

John Engel

Thank you, Mary Ann. Good morning, everyone, and thanks for joining us today. This morning, we’re pleased to report our second quarter results that are in line with the outlook we provided back in April.

Reported sales were flat to prior year, reflecting an organic sales decline of 3% in both the U.S. and Canada. Notably, only the industrial end market declined organically this quarter as the construction, utility and CIG end markets all posted positive organic growth, the first time all three have done so in the last five quarters.

Gross margin was flat to prior year, a good performance within a very challenging market environment. Our operating margin and EPS were within our expected range and free cash flow generation also remained strong at more than 100% in net income.

Let’s turn to the market environment. In total, our end markets are performing as we expected when we set our 2016 outlook last December, although industrial took another step down in the quarter and was below expectations. As a result of our efforts to diversify our portfolio and customer base, we were able to partially offset this industrial weakness with continued growth in utility and CIG, and notably, a return to growth in construction in the quarter.

So let’s start on Page 4 with our industrial performance. We experienced a 10% organic sales decline in the second quarter, once again driven by oil and gas, metals and mining and OEM customers. U.S. sales decreased 9%, and Canada sales were down 21% in local currency.

Direct oil and gas sales declined 25% this quarter on top of a 25% decline in Q1 and a 30% decline in Q2 of last year. As a result of this downturn and our efforts to expand our customer base, direct oil and gas sales are now approximately only 5% to 6% of our total business.

A reduced demand outlook, weak global commodity prices, a strong dollar and global uncertainty continued to weigh on the manufacturing sector. Business equipment investment is under pressure, and companies remain cautious about investing. More than ever, customers in this end market environment must respond to these challenges with supply chain process improvements, cost reductions and supplier consolidation.

We’re well positioned to deliver these solutions, and our Global Accounts and integrated supply opportunity pipeline and bidding activity levels remain strong. Of note, we were recently awarded a multiyear contract to supply MRO supplies for a major U.S. automotive manufacturer in the quarter.

Now moving to Page 5 and the construction market. After four quarters of declines, we’re very pleased to deliver return to growth in construction in the second quarter. Overall, construction sales grew 2% organically, with the U.S. up 2%, and notably, Canada up 4% in local currency. Sales growth to commercial contractors more than offset continued weakness with industrial-oriented contractors in both the U.S. and Canada.

Outside the industrial sector, our outlook for the non-residential construction market, commercial education and health care, in particular, is modestly positive, and the overall market is still well below its prior peak. Our latest acquisitions, Hill Country and Needham Electric last year and AED earlier this year, each grew in the second quarter, further expanding our share in the construction end market.

Now moving to Page 6. We had another quarter of sales growth in utility, with the U.S. flat and Canada up 4% in local currency. We have now achieved 5.5 years of sales growth from scope expansion and value creation with investor-owned utilities, public power and utility contract for customers. This quarter, we were awarded a contract to help a large energy developer construct a wind farm in the U.S.

We expect the utility industry to continue to consolidate, while benefiting from secular growth in the housing market and a continued demand for renewable energy. We are well positioned to benefit from these trends and deliver the increasingly complex supply chain needs in this market, included -- Including integrated supply solutions for our utility customers.

Finally, turning to CIG on Page 7. Sales grew again in the second quarter, with the U.S. up 10% and Canada notably up 10% in local currency -- U.S. up 2% and Canada up 10% in local currency. Our communications category sales were up mid-single digits, following solid growth throughout 2015 and into the first half of this year.

We expect continued growth in data and broadband communications, driven by data center construction and retrofits and cloud technology projects. Overall, I’m pleased with our performance in the first half of this year and the results that we’ve delivered thus far in a market that has been much more challenging than we expected.

With that, I will now turn the call over to Tim Hibbard to provide further details on our second quarter results. Tim?

Tim Hibbard

Thank you, John, and good morning, everyone. Moving to Page 8. We expected second quarter sales to be down between 1% and 3% when we provided our outlook in April. Actual reported sales were slightly better than this range, down only 0.3% to prior year. Organic sales declined by 3%, while pricing was down 0.5.

Our acquisitions of Hill Country, Needham Electric and AED added 4 percentage points to sales, while foreign currency translation reduced sales by 1%. Our core backlog increased 4% from year-end 2015 and was down 3% from the second quarter of 2015.

Gross margin was 19.9% in the quarter, flat to the prior year and down 10 basis points sequentially. Effective execution of our supply chain management initiatives offset pricing and business mix. SG&A expenses for the second quarter were $275 million, including acquisitions, which added approximately $9 million of incremental SG&A. Excluding acquisitions, core SG&A decreased by $10 million compared to last year. This reflects our cost-reduction actions over the last six quarters to eliminate approximately 600 positions and eliminate or consolidate more than 30 branches, along with ongoing discretionary spending controls.

Operating margin was 4.6%, within our outlook range of 4.5% to 4.9%, and down 10 basis points from the prior year, but up 70 basis points sequentially from the first quarter. The effective tax rate was 27.3%, down 200 basis points from the prior year, driven by a shift in the relative proportion of income between the U.S. and Canada.

Turning to Page 9. Second quarter EPS was $1.02 compared to last year’s EPS of $1. Core operations unfavorably impacted EPS by $0.13, while acquisitions increased EPS by $0.05.

The foreign exchange impact was favorable by $0.01 as the current year's unfavorable translation impact was more than offset by a favorable change in transaction gains and losses. Tax-related items increased EPS by $0.03, and a lower fully diluted share count increased EPS by $0.06.

On Page 10. Free cash flow in the second quarter was again strong at $57 million or 113% of net income. Year-to-date, we've generated $132 million of free cash flow or 156% of net income. WESCO has historically generated strong free cash flow throughout the entire business cycle. Our capital allocation priorities remain the same. As a first priority, we invest cash through organic growth initiatives and accretive acquisitions to strengthen and profitably grow our business. Second, we work to maintain a financial leverage ratio of between 2 to 3.5 times EBITDA. Third, we have $150 million remaining in our existing share buyback authorization to repurchase shares.

Following the completion of the Hill Country and Needham Electric acquisitions last year and the AED acquisition in March, our leverage ratio was 3.8 times EBITDA at the end of the first quarter and remains 3.8 times at the end of the second quarter, slightly above our target range but flat to year-end 2015.

We anticipate the continued solid free cash flow generation will enable us to bring this ratio back within our target range in the near term.

Leverage on a net debt basis was 3.4 times EBITDA, slightly below the first quarter. Liquidity, defined as available cash plus committed borrowing capacity is $997 million at the end of the quarter. This is above our normal liquidity level, largely due to the issuance of the new 5 3/8% senior notes in June, with the intention of using the proceeds to redeem the convertible debenture in September. During the quarter, we used the proceeds from the new notes to temporarily pay down short-term debt.

Interest expense in the second quarter was $19.5 million versus $18.6 million in the prior year, including the incremental cost of the new senior notes. Our weighted average borrowing rate for the quarter remains stable at 4%.

After the planned redemption of the 6% convertible debentures, we expect that our debt will once again be equally balanced between fixed-rate and variable-rate instruments. Capital expenditures were $3 million in the quarter. We continue to invest in our people, technology and facilities through both capital expenditures and operating expenses.

Now I'd like to turn the call back to John Engel to discuss our third quarter and full year 2016 outlook on Page 11.

John Engel

Thank you, Tim. We expect weakness in commodity-driven end markets and foreign exchange headwinds that continue into the second half. As I said earlier, the market environment has been more challenging than we expected this year, especially in industrial. However, we are maintaining our current outlook for 2016 within the original guidance we provided last December.

Turning first to our outlook for the third quarter. We expect sales to be down 3% to flat, with the same number of workdays as last year. This includes the impact of prior acquisitions in an average Canadian exchange rate assumption of $0.77 to the U.S. dollar. We expect operating margin of between 4.9% and 5.3% and an effective tax rate of approximately 29%. We also expect higher interest expense from carrying the new 5.375% senior notes. We are assuming a fully diluted share count of between 48 million and 49 million shares for the quarter.

Month-to-date, July sales are down mid-single digits, organically, roughly in line with June. The book-to-bill ratio is positive, above 1.0. We are closely monitoring the current environment and our customer activity levels, and we'll continue to maintain stringent discretionary cost controls while taking additional cost-reduction actions in the second half.

Now moving to our full year outlook. We are narrowing our full year 2016 outlook range as follows: sales of down 2% to flat versus prior year; operating margin of 4.6% to 4.8%; fully diluted EPS of $3.85 to $4.10; an effective tax rate of approximately 29%, the reduction of which is offset by our higher interest expense; and finally, we are increasing our free cash flow outlook to at least 100% of net income for 2016.

Our third quarter and full year outlook excludes any impact from a potential redemption of the convertible bonds, which I will discuss next.

So let's turn to Page 12. As I mentioned earlier, last month, we issued new 5.375% senior notes and announced that we intend to use those proceeds to redeem our 6% convertible debt on or after the first call date of September 15. Redeeming our convertible bonds simplifies our capital structure and eliminates future EPS dilution associated with those debt instruments. We also expect an ongoing benefit from reduced interest expense as a result of replacing the 2029 debentures with lower-cost debt.

Upon redemption of the convertible debt, we expect to record a nonrecurring, noncash charge. The decision to redeem the amount of the charge and the final share count will be based upon prevailing debt market conditions later in the third quarter.

Assuming conditions similar to those as of June 30, 2016, the estimated charge would be approximately $120 million on a pretax basis or about $1.70 reduction to EPS. We expect that this transaction will have no impact on our fully diluted share count or our debt ratios.

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

Question-and-Answer Session

Operator

We will now begin the question-and-answer session. [Operator Instructions] The first question comes from Deane Dray of RBC. Go ahead sir.

Deane Dray

Thank you, good morning everyone.

John Engel

Good morning, Deane.

Deane Dray

I'd like to start on the good news in gross margins, and maybe you could provide some color in terms of some of the dynamics across mix and pricing. You said supply chain was an offset, and it really hasn't come through in your pull-through numbers yet, and maybe your expectations there.

John Engel

Yes. Thanks, Deane. Good question. I'm very pleased with our margin performance in the second quarter. It's a very challenging pricing environment. I would say it's even -- it's been a challenging price environment since we've been in this lackluster economic recovery period.

With that said, I'd say it's a bit tougher pricing environment this quarter. As Tim outlined in his comments, we had approximately 0.5 percentage point of price impact negative in the quarter. And so I think what we've begun to see is the initial positive impact of our wide array of supply chain initiatives, pricing, sourcing, et cetera, that Hemant took all of you through at our Investor Day, and we continue to work the front end of our business very hard as well.

So I'm particularly pleased, I think, with what we're able to do with margins in the quarter relative to the overall market environment. I think as I've seen other companies presenting their results, there's no doubt that there's a tremendous amount of margin headwinds in the environment today in the competitive environment.

In terms of the pull-through versus Q3 last year, I think we've done an excellent job of resizing our cost structure. We've been -- we have had stringent cost controls in place, really throughout last year and the first half of this year, and we've consistently been continuing to squeeze out productivity improvements and making structural cost reductions and organizational streamlining moves in the company.

As Tim outlined, we've taken our headcount down by over 600 positions over the last six quarters, five to six quarters, really starting in earnest Q2 of last year. We've closed or consolidated 30 branches this in the first half this year. Of that 600, 150 personnel reductions were executed in 10 of those 30 branches. So I think we're taking the right actions.

The pull-through -- we're well positioned with our cost structure, Deane. And when the sales growth kicks back in to positive organic growth, we'll have very strong operating cost leverage and good pull-through -- positive pull-through to EBIT, and we've shown that historically across prior cycles.

Deane Dray

That's good color. And I just, second question was on the free cash flow guidance. And I really do like seeing that plus 100%, and you and I have talked about this before. I think you all have had this penchant to under promise and over deliver. There used to be a plus 80% or better then there was a plus 90% or better.

You've always had good cash flow conversion capability. But now we're at that 100% level, what's driving this confidence? Any specific changes in working capital? Is there anything that Tim's doing here in the background that just -- what's the significance of now back to that 100%?

John Engel

I appreciate the question. I think we have, if I were to take an objective look at our company, and it's really a function of, I think, inherently our business model and how we run our distribution business model and the strong execution of the team.

We've been a very, very strong free cash flow performer across all phases of the economic cycle. To your point, Deane, to be fair, we had an 80% market out there and that was a low bar, and we were consistently beating that. We took it to 90% entering this year. I think that was appropriate.

As we move through the first half, I would say we continue to have great controls in place. The team is focused. We all know what we're doing in terms of driving the performance there. And the fact that our -- we're not in positive organic sales growth territory does result in a little better free cash flow generation.

We're not doing anything unnatural to our inventories. We're very focused with our inventory levels on two metrics: availability for our key SKUs and then the ability to provide and service our fill rate, our commitments to our customers. So I would, the one word I would always use, I think, and this has been very consistent, I think, in my 10 years with the company, the team does a great job is execution. That's the word I'd apply to free cash flow.

Now Tim's been here the better part of the decade. I don't think that you and the investor community have had a chance to meet him. He was very strong are very strong number two in finance, a very seasoned operator. I call him operating-oriented finance business partner to myself and the business leaders.

Quite frankly, having Tim here is one of the reasons we did such a great job in ramping Ken up. When we hired Ken four years ago, Ken had never been in the full CFO seat, let's say, right? And he -- Ken did a terrific job for us. But having Tim -- I think, it's just the testament that's kind of the strength of the organization and the team that Tim has built.

Deane Dray

Good to hear. Thank you

Operator

The next question comes from David Manthey of Robert W. Baird. Go head sir.

David Manthey

Hi, good morning guys.

John Engel

David good morning

David Manthey

Yeah, looking at the third quarter guidance here, John, where second quarter sales were flat year-to-year, and then when you look across the comparisons in every segment, they get easier.

And I'm just trying to understand the flat to down 3% rather than sort of a midpoint around flat or even better than that, based on the trend and sort of what things look like here. And then second and related, I guess, is do you think there was any kind of pull-forward in your outdoor sports, construction or utility business that would distort that sequential pattern into the third quarter?

John Engel

Yes, I don't, let me address the second one first. I don't think, Dave, that there was any pull-forward from Q3 to Q4 in the segments you're outlining. I will say -- because we didn't address this in the prepared commentary.

I will say that with certain of our industrial customers, we did experience some reduced hours. Some adjustments to their schedule, let's say, in the latter part of Q2, entering Q3. It wasn't significant and it wasn't broad-based. But I would say that's the only dynamic that we've seen, thus far, kind of that was a little different. It was not consistent across the quarter, more wrapped around the 4 of July holiday.

It seems like there were some customers where they are taking kind of extended holidays, durations around the 4. We saw a little bit of that. I think look, I think, Dave, we've tried to set, we took a very hard look at our outlook for the second half and full year based upon what we saw in the first half. I want to kind of make sure I frame it for all of you properly.

As I reflect upon 2016 versus the outlook, that we provided in December of last year, I think industrial has turned out to be tougher than we thought, and we've got prolonged weakness, let's say lingering weakness. We had expected industrial would improve as we kind of move through the year, particularly in the second half.

We're clearly not seeing that because, Q2, our industrial end market, our largest end market, was down 10%. So our outlook in last December for industrial was for it to be down at mid to high single digits, you'll recall, for the year. And now we're looking at much more high single digits to low double digits. So that's part of what informs our second half look, Dave.

And secondly, construction, if you recall, when we set our outlook for 2016, we said that would be down low single digits to up low single digits based upon, really, some improving momentum. And I think, to a large part and large degree, our execution in the second quarter in construction, we've revised our full year outlook to be flat to up low single digits for construction.

Utility and CIG are operating as we anticipated, as we expected last December. We said flat to low single digits on each, and we're maintaining this. So I think it's just -- just taking a look at kind of Q3, Q4, the industrial headwinds continuing, still foreign exchange headwinds there. Hopefully, the -- I'm pleased with the return to growth at construction. We're only partway through the construction season, and that's how we reflected it in our updated outlook for the full year. It's spread at Q3 to Q4.

David Manthey

Okay. And just one follow-on here, John. As it relates to the outlook for the full year, my biggest concern has always been the second half SG&A required to get there. When you look at the guidance, even as you assume sort of a 20% gross margin, SG&A run rate would have to decline by about $10 million versus the second quarter level by the end of the year to get you there.

And when I look at the restructuring, the headcount reductions, by my calculations, you did maybe 50 of the 600 in the second quarter. I'm just, I'm trying to understand how you drive absolute SG&A dollars down, especially in the third quarter when revenues are going to be sequentially rough, flat.

John Engel

Yes, Dave, I know. I think you had some discussions with Ken and Mary Ann after the first quarter as well. So let me frame it for you. I think if you look at what we did last year, and we did -- we do break out as we go quarter-to-quarter, what the core is i.e. ex acquisitions versus the acquisitions contribution to SG&A. We had a significant step-down in our costs second half to first last year.

Now we took a series of actions. They were large in magnitude. So if you look at -- If you were to do kind of a first half to second half walk this year, I'm going to give you a number of factors. I'm not going to size each piece, but at least give you a sense, directionally, of how I suggest you look at it.

We will have higher sales in the second half. That does give us some operating cost leverage on our cost base. That doesn't reduce SG&A dollars, but at least it gives us some higher leverage through the up margin. Employee benefits costs are always substantially higher in the first part of the year versus the second.

We have continued discretionary cost controls, and there are some specific items we've identified that will be non-repeating costs in the second half that we had in the first half under, I'll call it, the category of discretionary cost controls. Variable, I'll hit variable compensation last.

And then we did take actions across the first half, Q1 and Q2, so you got that in your, we have that in our full run rate in terms of structural cost take-out as we go through the second half. We don't ever take restructuring charges. We never do that, right? We've never done that since I've been here.

So we just any cost required to execute the cost take-out rolls right through our P&L. We expense it in the current period. And so when you look at how the first half rolled out, what we did in the run rate in the second half, we get some sequential benefit from that.

We have a policy in place now where there's no automatic replacements, so we're highly scrutinizing any replacement headcount, and we run and our turnover rates, our attrition rates are relatively consistent, and so that gives us some additional leverage. And then we have some additional cost take-out that is being executed for the second half. And then I would say, finally, variable compensation, which was a very large factor last year.

I know that we've taken you through that. Ken's taken you through that previously. It'll be it's another factor as we go through the second half. We, as a matter of practice, build our internal plans above the external outlook that we committed to. That's -- that was true last December when we provided our 2016 outlook.

It was true as we -- as we provided our revised outlook. But what I -- the point I did want to make was our compensation, our variable compensation is tied to our internal plans, which are higher than our external outlook, and that the delta of which forms our contingency. And so and depending on the mix of that performance by business, by function and such, that can have a pretty dramatic effect. That's what we saw last year, right, when we missed our internal plans and had to revise our external outlook, both.

So when you factor all those together, we're driving to some internal targets that are above our outlook in the second half. We're still running with some contingency and you address all -- you factor in all the other items I said, that's what speaks to the second half outlook, Dave. Hopefully, that helps.

David Manthey

Thank you.

Operator

The next question comes from Andrew Buscaglia of Crédit Suisse. Go ahead.

Andrew Buscaglia

Hi guys, thanks for taking my questions.

John Engel

Sure. Good morning.

Andrew Buscaglia

Can you just talk -- I'm just looking at the guidance as well. You guys laid out a little bit of a contingency in the past or just in the last couple quarters that is about 1% to 2%. Can you talk about how have we worked through some of that year-to-date? Or how much is left in that?

John Engel

Yes. I'm not going to quantify what's left, Andrew, but we did use up some in the first half and we do have some in the second half. But as the methodology is what I just outlined in my comments to Dave's question.

Andrew Buscaglia

Okay.

John Engel

So we're continuing to drive the organization to targets that are a bit above that. We're not pulling back the reins on sales one iota. Maybe to give a little more insight in that, we talked about seeing some of the positive effects of the supply chain initiatives in this quarter's gross margin results. You'll recall at Investor Day, David Bemoras went through all our front-end sales and marketing initiatives, and we're building momentum there. I think that did help us speak to and was a driver of what we're doing on the -- with our sales force of outperforming our sales outlook range for Q2.

So we're driving that very, very hard. And so hopefully, if we -- the key thing is we see headwinds persisting in the environment. We're focused -- continuing to focus on improving our execution. We think we have been improving our execution. If our assumptions proved to be overly optimistic, we'll be working to capture the upside.

Andrew Buscaglia

Okay. That's helpful. And then can you just talk broadly, Canada just seem to tick up multiple segments this quarter. Was there anything specific that you guys noticed that you could talk to? And how you think of that of Canada just going forward? Is this sustainable here?

John Engel

Yes. I am very, very pleased and proud of our Canadian team. The on-the-ground conditions are very challenging. It didn't get easier. It didn't get better in the second quarter versus the first, versus what we're facing the second half of last year. So it is and we're not calling the bottom yet, but I'm very pleased with the team's performance and execution that have overall Canadian sales down 3% organic and that have growth in construction and utility and CIG.

All three of our four market segments in Canada organically in the quarter with CIG at 10%, I think is very notable. When you look at by geographic region, the prairies are down double-digits, as expected, and the on-the-ground conditions are it's, it didn't get better. Some are -- there are parts of those geographies where it was worse in Q2 than Q1. The worst we've seen. British Columbia, we grew double-digits. Very notable. And when you match our performance against the market, I think we're performing well.

I think we continue to strengthen our position in the market. We're gaining ground. And then as you move West to East, the economies remains a bifurcated economy, as we've talked in the past, with the oil-producing provinces facing the challenges and the oil-consuming provinces starting to see pickup.

So as you get in the Manitoba, Ontario, et cetera, you can start moving in the East, the overall GTA area, Québec, those market conditions are a little more accommodative. And we're getting, we're seeing positive results. So I think when you integrate all that, I actually couldn't be more pleased. They were the positive surprise in the quarter. It was the factor, along with utility, I'll come back to that because utility in Canada too, that helped drive us to outperform our sales outlook range.

The only other thing I would note is -- and that was with facing fires in Fort McMurray, that, as we said before, less than 5% of our sales, we have two branches there, one WESCO, one EECOL, we were down double -- very high, very high double-digit sales were down, right? Double-digit declines in -- as a result of the fire.

The operations are back up and running. Our customers' operations, but they're not back to "rate" production and the rebuild has not started yet in earnest. So I think we said that might be second half. If anything, it may be late and maybe Q4/2017. So I think we've also worked hard as part of that cleanup of the fire, the remediation, that Hazmasters acquisition we did in Canada that we have some -- we're actually driving some very nice safety growth to support kind of the cleanup after the fire. So look, we're working it hard. When you really calibrate the performance versus the market, I couldn't be more pleased. Thank you for that question.

Andrew Buscaglia

All right yes. Great color. Thank you.

Operator

The next question comes from Christopher Glynn of Oppenheimer. Go ahead.

Christopher Glynn

Thanks, good morning.

John Engel

Hey, Chris, good morning.

Christopher Glynn

Hey John. So I just want to go in a little more detail what changed in the margin guide. You kind of wiped out the lower half of the revenue guidance range, narrowed it into the top half, and then maybe a little detail on what trimmed the margins.

John Engel

I mean, it's really this easy. Look at our first half op margin versus last year. So we -- it's and so what we've been facing as a business, mix, pressure and challenges in the competitive environment. I think that's it just reflects that. I think our op margin was solid in Q2. Our op margin wasn't as strong versus prior year in Q1. You take a look at the first half. It's just, it's kind of flowing that through the second half.

Christopher Glynn

Okay. And then taking another crack at the conservative look in 3Q revenue guide. I think FX should flatten out. And what did July do qualitatively or quantitatively, if you adjust for the July 4th week?

John Engel

I didn't do that math. And so remember, when I give you July, when I say July is mid-single digits, roughly in line with June, that's 4th of July is in both periods. So the only thing, I would say that we experienced and I've seen some commentary from other companies in our supply chain, let's say, that have spoken to maybe more significant manufacturing and factory shutdowns, slowdowns and such, I didn't -- we didn't see anywhere near to that degree.

We -- there are some select customers that had kind of extended holidays over the 4th. And it's not like, it didn't seem like that was preplanned as they entered the second quarter. It wasn't pervasive. And I only call that out as kind of a fine point that's not -- it wasn't really material. So the July number represents kind of July to July, both the 4th of Julys year-over-year.

Christopher Glynn

Yes, just like the holiday timing was a little bit of a headwind this year. And then the implied lack of seasonality into 3Q, were you maybe suggesting that Canada had a little bit of an off-trend breather from the headwinds in the second quarter?

John Engel

Yes. No, I understand. Good question. Look, we're still net-net, looking at sales higher in the second half than the first, so that seasonality is preserved. I'm Canada really performed, I think, strongly, given the end market’s conditions in the second quarter, and so it's our intent to continue to drive that performance.

But we tried to factor in all the conditions that we're facing, an outlook of what we're hearing from customers, how our backlog, quality of our backlogs, the nature of our backlog. And so -- and that's what we built into the outlook. So I -- there's not much more I can really say on that.

Net-net, though, we do have a second half that's higher than the first, all-in on a sales level basis. When you look at it, how we've shaped it, it's a little bit more balanced, Q3 versus Q4. And the only thing I'll cite and I know you'll recall this, was we were facing a lot of end market downturns as we -- progressively, as we went through the second half of last year, in particular.

But Q4, you may recall, which typically is up, EECOL has a strong contribution to our fourth quarter results. It was a particularly mild winter, and the winter didn't -- in the winter effects in Q4 of last year were not equivalent to what they had been the prior couple of years. So do we expect this to be more normal? We'll see. But I think that would result in maybe a different balancing between Q3 versus Q4.

Christopher Glynn

Okay, got it. Thanks

Operator

The next question comes from Shannon O'Callaghan of UBS. Go ahead.

Shannon O'Callaghan

Good morning.

John Engel

Good morning Shannon.

Shannon O'Callaghan

Hi, John, so on industrial, still down even though the comps are getting easy. What do you think it's going to take for that to sort of join the growth club of the other segments here? And I mean, can you break it out at all between how much of the continuing pressure there do you think is commodity-related versus other things?

John Engel

Yes. I mean, let me give you some; let me give you this color. We're still seeing pervasive challenges across industrial, I think. Business investment is being controlled tightly. You're not seeing a big uptick in really capital spending. As we look across our Global Accounts and integrated supply customer base, we're growing with some customers, we're declining with others. Where we're growing, we're increasing scope of supply, by and large. It's not because they're increasing their spend.

But if you look at Global Accounts, in particular, we're seeing the tremendous challenges continuing in oil, gas, metals and mining and selective OEMs, with selective OEM customers as well. We are getting growth, however, in technology -- with technology customers, our Global Accounts technology customers, aerospace and automotive.

So it's just, it is broad-based. And I think when it does kind of flatten out in turn; we have such a terrific set of value, our value propositions stronger. Our solutions are strong. We'll get really good leverage on the upside. But when we originally set our outlook for 2016, we did not expect the degree of industrial challenges we faced in the first half.

And in fact, we did absolutely expect that it would improve in the second half versus the first, and we're not seeing that. So I think it -- ultimately, it requires confidence on the part of the CFOs and the executive teams and our customers to go back into investment mode, quite frankly.

Now in terms of MRO spending, if they're really, if that customer's facing real challenges in the end market, they're also tightly controlling the MRO spending. And you can only do that so long and so far. Ultimately, it kicks in. But so it's -- Industrial's tough. Let's make no mistake about it. And I don't -- there are certain customers, certain verticals we're doing exceptionally well in, but the challenges is pretty pervasive.

Shannon O'Callaghan

Great. That's helpful. Thanks. And then just on this variable comp issue, I mean, it's a benefit this year. I mean, just as you kind reset, assuming you have better dynamics with some of your businesses improving here, better dynamics than next year, how do we think about that kind of resetting and representing an increase in a better environment?

John Engel

Yes. So that was a significant contributor last year. I know Ken had previously taken you through that. And then when we start - when we lay out our outlook for the current year, that resets. And so that was a reset as we entered 2016. But we're not on our internal plan, so make no mistake about it. Because we have essentially use some of the contingency. I'll just share that with you. And so -- but we won't know, really, the full impact/contribution/reset impact until we get through the fourth quarter.

So I think as we move through -- because it's going to be a function of how we finish up Q3, Q4 and the mix of that. So as we do that, we'll talk through that relative to what's in our SG&A and how to think about that, Shannon.

Shannon O'Callaghan

Okay, great. Thanks.

John Engel

Thank you.

Operator

The next question comes from Ryan Merkel of William Blair. Please go ahead.

Ryan Merkel

Good morning everyone.

John Engel

Good morning.

Tim Hibbard

Good morning, Ryan.

Ryan Merkel

So I noticed that construction core backlog was down 3% year-over-year. Is there anything that you could call out that's driving that? And then does that not temper your expectations for the second half even a little bit?

John Engel

Well, I think our performance in construction was the best we've seen in five quarters because we've gotten some growth. And again, backlog is one of the data points that we use, along with a variety of other data points and how we look at the second half and revise our second half, our full year outlook and our Q3 outlook. So it's factored in.

Ryan Merkel

Okay. And then back in construction, which was better this quarter, is there anything else you would call out? You mentioned execution. But was there one or two big jobs that hit? Or was commercial better than you thought? Is there anything else that you can sort of unpack there?

John Engel

Yes. Let me unpack it. I think I gave you a sense of how Canada performed. Let me start with Canada then move to the U.S. okay? I gave you a sense of how Canada performed, and that was all-in across all end markets by region. But that was also true in construction.

So the strong double-digit growth in British Columbia -- across British Columbia was heavily construction-driven. And the growth, as we got East of the -- got into the Eastern provinces, GTA and plus, we're seeing growth in construction and CIG.

So I think that's important to understand. It's not just all-in those regions. It was construction was a key factor and utility was a key driver and CIG so was a factor. As you go into the U.S., I think I gave a little more color on that last time, and I'll give you a similar color. As you look across all our regions in the U.S., where approximately half of our regions grew in construction in Q2 and two of them were up double-digits, none were down double-digits, okay, versus Q2 of last year.

That complexion, that mix is a nice improvement versus Q1. If you recall, I gave a little insight on that in Q1, and we did not have that level of performance, right? It was spottier. And all-in, we didn't grow. So that was encouraging because it was a -- I'm not going to say it was broad-based. It's not like 90% of the regions grew. But more regions grew than not, and having a couple up double-digits was encouraging. The other thing, I will mention is our last three acquisitions, Hill Country, Needham Electric and AED, all three grew in the quarter organically; two were up double-digits; one was up single digits.

And they are varied construction -- the majority of their sales are construction-oriented. And so and recall where they are positioned, right? Texas, Metro Atlanta and New England, three very different markets in terms of dynamics, yet we're growing in all three. So again, as I said earlier, I'm pleased with the -- with our construction results in the second quarter. The industrial-oriented contractors are still down. Those that are impacted by oil, gas, metals, mining. But health care, education, commercial is where we're seeing some of the projects.

Ryan Merkel

Okay. That's helpful. And I guess, just lastly, just looking at oil and gas, I know it's a smaller percent of sales now. But what are you hearing out there? And then as part of the guide, are you expecting oil and gas to stable in the second half versus where you are in 2Q? Or are you expecting it a little worse?

John Engel

Yes, I'll tell you. We haven't called the bottom yet. We didn't forecast necessarily quarter-by-quarter what we thought it would be. But at this point, I thought, I was hopeful that it would stabilize. The fact that we lagged down another 25% in the quarter on top of what we did last year in the first, it's just -- we're still kind of bouncing along there, it's tough.

The only thing I would say is and I don't know if I would, I'm not using it, I won't use the term the green shoot, but this is a positive. This is a positive. With three of our Global Account customers that are in more of the longer-cycle infrastructure-oriented industries, with three different ones. They reached positive FID decisions in Q2 on large capital projects.

So that's final investment decision. FID is final investment decision. So I don't know if that's the start of a trend here. Is that indicative of some incremental confidence? But what's happened throughout 2015 and the first half of 2016 make no mistake about it. Projects that were underway were continuing. Some were kind of trimmed back. New projects weren't being started, so you go through the whole construction cycle. FID decisions were kind of frozen weren't being made.

The fact that we -- I'm not speaking to the whole market, but I'm speaking to at least three of our Global Account customers. The fact that three were reached in Q2 that is an incremental positive indicator. Now these are longer-cycle projects, and they're not sales in the second half. They're sales next year, but it's a data point. So it's something we look at. Again, this is just all part of -- we look at our business in great detail, and that's what we try to factor into our outlook, right?

Ryan Merkel

Very good, thank you.

John Engel

Okay.

Operator

The next question comes from Matt Duncan of Stephens. Go ahead sir.

Matt Duncan

Hey good morning guys and nice job this quarter.

John Engel

Thank you Matt, good morning.

Matt Duncan

So John, I want to go back to the conversation on July for a second. I don't know if you've got the data or even just a feel for sort of how different July has been since those days on either side of the 4, July. But if the month is tracking, call it, similar to June, does that imply that it's a little better than that once you kind of got past the July, 4 hangover?

John Engel

Yes, I'm not, I'll just say it's roughly in line. I'm not going to say its better, worse. It's within our rounding error right now. And so and we're not linear in the month, as you know and we're down to the last couple days. In our last couple days, we're not -- our last couples of days are -- last several days are always bigger sales versus what our average sales are across the month. We'll see where we finish.

Again, I would just tell you that here's what I'd leave you with, if you and I hadn't made this comment yet. If you were look across the second quarter, if you adjust April for Easter, we were down five, we were down three in May, we're down four in June. It was basically down, it was flattish, right?

We didn't see a lot of puts and takes. We did get a little bit of these kind of with some select customers in industrial with some kind of extended holidays in the latter part of Q2, early part of - it was the latter part of June, early part of July, and July's roughly running in line with June. So it just that gives you a sense of kind of how it started. We'll see. We're in the construction season, industrial headwinds continue to exist.

I think utility; I didn't comment on, I'm continued to be very confident and pleased with our utility business. And given a recent public data point from another company, I'm particularly pleased with our utility performance. So I think it helps really put that into context. And also some data points from our supplier community on the challenges in utility. So that's where the mix in July is no different than what we really had been experiencing. So that's just the only other color I'll share, same old notes.

Matt Duncan

And I want to go back to Canada as well because you guys are clearly doing better in Canada than other distributors are right now I just want to point that out. Do you think you're taking share in Canada? Sort of what's your view on the Canadian market in general?

John Engel

I will tell you absolutely. I think we're outperforming the market. And I really believe strongly that when -- and I've said this before, it's part of our fundamental thesis that where we have a stronger market positions in the form of the breadth of our solutions and a higher market share, where we have a stronger role in the value chain, we're more important to customer. We're better partners with the suppliers.

So when a market growth through a cycle and there's contraction, we're even better positioned to super serve those customers. And so I believe strongly, always have. It's part of our thesis. It's what part of what we drive. We're driving the businesses. It's why we're doing acquisitions in conjunction with our organic initiatives. It's to increase our scale and scope in all our served markets.

As we do that, I believe benefits accrued to the strongest players in all markets clearly for distribution that's true. And when the market goes through a cycle, it's even more so. And I think we're seeing it. With all that said, I expected some outperformance, but it was a very positive surprise for us in Q2. Because the market conditions are better, all-in, particularly in the prairies. But as I said, you get in the oil-consuming provinces, and there are some positives, right, that we are taking advantage of. So hopefully, that helps.

Matt Duncan

And then last thing, let's bring Tim in on this conversation. Gross margin and sort of what were thinking on gross margin going forward? And then just help us to make sure we get interest expense right here. 3Q, what should all-in interest expense be? And then how much does it go by down once you redeem the 6% notes?

Tim Hibbard

Well, I'll take the interest expense first. Our guidance is it doesn't contemplate calling the convert. And so we intend or we think the interest expense will continue as though we were carrying that note for the full quarter. So I think you have to look more for it to be like that. In terms of the gross margin, our gross margins, we feel, have stabilized over the last few quarters, as we said. We'll continue to work hard on our supply chain initiatives and continue to execute on those, be opportunistic as we can, and we intend for them to be stable going forward.

John Engel

Yes. I think the margin environment if you look at all the other public data, it's challenging. So I think I would just, I believe if there's anything, the headwinds are a bit stiffer in the general, it's relative to gross margins. So it requires continued strong execution.

Matt Duncan

Okay, all right. Thanks guys. Appreciate the color.

Operator

Our final question today will come from Robert Barry of Susquehanna. Please go ahead.

Robert Barry

Hi guys, still good morning I think, thanks for sitting me in.

John Engel

Good morning.

Robert Barry

Actually, I just did want to follow-up on that and you kind of touched on it a little, John. I mean, with the pricing looking a little weaker and weaker industrial, stronger construction. I think all those things are kind of headwinds for gross margins. So and you took you’re out margin guidance down. So just maybe to put a finer point on the commentary around what the back half outlook includes for gross margin.

John Engel

Yes. And we don't -- we're not, I'm not going to give you that, Robert, because we don't -- what we really want to focus on, which is we moved to that is sales, operating margin, tax through EPS and so. I mean, I thinking, clearly, you've seen and you're seeing from others and not everyone's reported yet. There's some others to report.

But as evidenced by across the companies in our supply chain, right, in our competitive space, right, whether it's other distributors or manufacturers, there's a lot of pressure on margins in this environment, and it's around the pricing and competitive dynamic. And it's because we have this lackluster economic recovery, Industrial's challenged. Construction is, at least, getting some growth, but there's also some pits and starts from an end market perspective there.

Utility, overall, we're not seeing a lot of end market growth so the only way you grow there is by taking share. And so it's just the tough environment. So the competitive intensity is stoked up. There's no doubt about it. And so I think it's -- I'm particularly pleased again with what we did with gross margins relative to us. When you look, the fact that we're flat year-over-year and the fact that we're down only 10 basis points sequentially, I think, is notable results, given the market environment we're in and some of the mixed challenges we have been facing and is still our, effectively, is in our results, right? We're seeing this mix shift.

So it's our intent, Robert, as we outlined at Investor Day, continue to grind away and execute. I'll leave you with this. Again, we said this. This is not hitting a couple of home runs in the margin initiative front. This is a lot of singles, and we want to have a good batting average. And so I think that's what you're seeing. It's not one or two things we did in the second quarter. It's a whole number of things that we're just grinding away on, trying to kind of maintain margin. And hopefully, at some point, get some improvement.

The only other thing I will say is that supplier price increases, at least what they're -- we have a view, at all times, of what's been of what suppliers have published and what they're intending to publish. And so if you look at supplier price increases that are that suppliers would like to do in the third quarter, some of them are desiring to have a little higher price pushed through the value chain.

So that'll be interesting to see how that ultimately, does that flow through or not? Will the market absorb that? So it's not by a large degree. I'd normally comment on this. Last couple of quarters has been relatively consistent. When you look at what the level of price increases were, kind of the range by category and their suppliers try to push through, that's a consistent process in our industry.

Here, there's a few categories with a few suppliers that are trying to edge that up a bit. And I think part of that's probably a reflection of the rising steel prices, in particular. But steel's really the only commodity that spiked up significantly as we've moved through the first half. And you look at copper, copper hasn't really moved much. There's a little bit of downward pressure. Aluminum really hasn't moved much. Zinc's moved up a bit, but it's steel. So hopefully, that's some additional color.

Robert Barry

Yes, appreciate it. Just quickly in the outlook for the revenue, since you gave the total growth expectation. What's the assumption now for M&A and currency in there?

John Engel

So there's no incremental M&A assumed. And for currency, we assumed a $0.77 on the U.S. dollar for the second half, both Q3 and Q4.

Robert Barry

Yes. I mean, I think since you updated the outlook, the M&A was expected to add two points, so maybe now it's three.

John Engel

Yes, it's a little bit higher than two, yes, because of AED. Right.

Robert Barry

And the currency, I think, had been a headwind of two to three, but I think now it would be I don't know much lower than that.

John Engel

Yes. It will be a little bit lower. But again, we've given you an assumption of $0.77 on the U.S. dollar, so that's our assumption right now for Q3 and 4.

Robert Barry

Right, right. Okay, thank you.

John Engel

Yup.

Operator

This concludes our question-and-answer session. I would like to turn the conference back over to Mr. John Engel for any closing remarks.

John Engel

Thank you all again, for your time this morning and your continued support. I know Mary Ann has a lot of scheduled calls already, and she's around and we're around to take any further questions. Have a great day.

Operator

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

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