Sam Darkatsh: Two questions. First, John, you mentioned in your prepared remarks that you see WESCO shares is trading far below in as that due to a concern around the sustainability of gross margins. I mean, they are up a couple of hundred basis points over the past two years, three years. If we could just unpack gross margins a little bit
John Engel: Sam, I think, you lost
Sam Darkatsh: over the past couple of years? Hello?
John Engel: Would you
Sam Darkatsh: Can you hear me okay.
John Engel: Yeah. Would you mind repeating after unpacked gross margins, I think, we lost you?
Sam Darkatsh: Sure. I am sorry. Can you hear me now, John?
John Engel: Yeah, Sam.
Sam Darkatsh: Okay. Sorry about that. Just trying to get a sense, how much of the gross margin expansion is specifically price cost benefit on stock and flow inventory?
John Engel: So let me answer the question this way. The enterprise-wide gross margin improvement program that we put in across the enterprise that we now are multiyear — several years into execute has great momentum. It’s not focused on stock and flow versus ship and debit versus, it’s looking at all categories of our all fulfillment method types. It’s really focused on at the core level of pricing and the value of our supply chain solutions and services. So we have seen improvement in margins both for stock and flow and our DS business, our direct ship business. So and we are focused on continuing to drive gross margin expansion across all our business models. I think there’s tremendous legs left in our gross margin expansion program.
And look, we have set a mark of 10-plus percent EBITDA margins for the enterprise. We have got north of 8%, a huge mark for us, all-time record results in 2022 to eclipse the 8% adjusted EBITDA margin level. And we are looking at, going forward here, having a strong contribution of both gross margin expansion plus operating cost leverage, those two both being additive to contributing to overall operating margin expansion. So I understand your question. I can tell you that the bottomline is, we have seen contributions, since we put the two companies together, including in 2022, improvement in gross margins for both stock and flow and DS, and again, it’s because of the nature of our gross margin improvement program and the way we are going about pricing value.
I know this is the question. I think the bigger question is, how does the new WESCO perform against an economic backdrop that has some recessionary pressures? Well, look at the guide we just put out there for 2023 and we are highly confident in the guide that we have outlined and so that should speak volumes about our confidence in the new WESCO and our ability to generate profitable sales growth across all phases of the economic cycle.
Sam Darkatsh: My second question, assuming my phone is still working. So the — what expectations do you have, Dave, for year-on-year backlogs by the end of the fiscal year 2023 that informs your free cash flow guide for the year?
Dave Schulz: Yeah. So, Sam, I would say that our free cash flow guide is less tied to the backlog. It’s more tied to the supply chain’s healing. And one of the ways that I would ask you to think about this is through the first half of the year, we are expecting some product categories, we will still be facing severe supply chain constraints. Some product categories, we are starting to see some improvement, but right now, our expectation is that it will be the back half before we get more to a normal lead time in order to support our customers. The way that I would encourage you to think about this and how we think about it internally is that, we expect that in order to support our sales growth, our net working capital will grow half the rate of sales.
And that includes that we have elevated our days of inventory outstanding. So our financial days outstanding, you can take a look at that, it’s up substantially because of the supply chain lead times and our need to service the customers. We expect to make some progress against our DIO metric in 2023. That’s what’s informing our free cash flow and we are assuming that we will have a typical seasonal pattern to sales, meaning fourth quarter sales will be down sequentially from the third quarter to release working capital.
Sam Darkatsh: Thank you, both.
Operator: The next question comes from Nigel Coe with Wolfe Research. Please go ahead.
Nigel Coe: Thanks. Good morning. So I wanted a little bit
John Engel: Good morning, Nigel.
Nigel Coe: Hi. Just want to switch gears to Rahi, really exceptional performance as you pointed out. So where did the upside come from, the 110, I think, it was in the quarter versus 60 to 80 guide. If I have got this wrong, please correct me. But where did that strength come from and how much visibility do you have in that 20% growth in 2023?
John Engel: What was the second part of that, Nigel? How much — what did you say…
Nigel Coe: Yeah. The visibility — yeah. The visibility
John Engel: Oh! Visibility
Nigel Coe: on the 20% growth.
John Engel: Visibility.
Nigel Coe: Yeah.
John Engel: Okay. Thank you. Yeah.
Nigel Coe: Yeah.
