Wesco International Inc (WCC) 2003 Q3 法說會逐字稿

Good day, everyone. Welcome to today's WESCO International Incorporated Third Quarter 2003 Conference Call. This call is being recorded. And with us today from the company is the Treasurer and Director of Investor Relations, Mr. Dan Brailer. Please go ahead, sir.

Thank you. Good morning, ladies and gentlemen. Thank you for joining us for WESCO International's conference call to review the third quarter 2003 financial results. My name is Dan Brailer and I'm the Treasurer and Director of Investor Relations at WESCO International.

This morning, Mr. Roy Haley, WESCO's Chairman and CEO, Mr. Steve Van Oss, WESCO's Chief Financial Officer will provide an overview of the earnings press release issued this morning. Means to access this conference call via Web cast was disclosed in the press release and was posted on our corporate Web site. Replays of this conference call will be archived and available for seven days through October 29th, midnight Eastern Time.

Following the commentary of Mr. Van Oss, we will open the session to your questions. This conference call may include forward-looking statements and therefore actual results may differ materially from expectations. For additional information on WESCO International, please refer to the company's annual report on Form 10K for the fiscal year ended December 31, 2002 as well as other reports filed with the SEC.

The following presentation may also include 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 Web site at www.wescodist.com. I would now like to turn the conference call over to Mr. Steve Van Oss, Vice President and Chief Financial Officer.

Thank you, Dan. Good morning and thank you for participating in our call. I would like to start the discussion by putting this quarter's performance into context before getting into specific results. WESCO's profit performance is showing good improvement. Our business model was effective in the markets we operate and appear to be stabilizing and are showing emerging signs of an increase in activity. We're making progress on improving our product margins.

We continue to be selected as preferred supplier partner by demanding high profile customers and because of this, we believe we are holding or gaining market share. We are generating positive cash flow and paying down our debt. Our capital structure has been significantly improved and we have a strong liquidity position. We have launched a variety of improvement initiatives and we've built up momentum that should deliver favorable results throughout the balance of the year.

Overall, our company is in a strong position in what we believe to be the trough of his economic cycle. Having said this, we know that we must regain positive momentum on our top line sales performance to deliver even stronger operating results. Our results for the third quarter reflect the positive impact of our margin improvement and cost containment initiatives.

Gross margin dollars at $154 million and 18.6% were the highest since the third quarter of 2001 on lower sales. Cost containment programs have resulted in good SG&A performance despite higher ploy medical and retirement related costs. Interest expense continues to decline and is at its lowest point since the re-capitalization of the company in 1998. Free cash flow generation in the first nine months of the year was used to reduce debt, net of cash by $81 million from year end 2002.

The series of capital market transactions over the past two years have significantly strengthened our balance sheet. These transactions coupled with continued free cash flow generation has positioned the company with considerable operating flexibility $186 million of liquidity and no significant debt maturities until 2007.

Lean enterprise initiatives are in place in a significant number of our operations and the initial results are encouraging. These initiatives supplement and expand programs touching virtually all aspects of our operations from sales, margins and inventory to accounts receivable and order processing.

Lets now turn to our third quarter results. Sales were $825.6 million for the third quarter and were down $27.3 million or 3.2% from the third quarter of last year's. Sales increased by $5.4 million or 0.7% over the second quarter of 2003. The improvement over the second quarter is in line with what we would expect to see due to normal seasonality.

Although daily sales rates decline quarter over quarter, monthly sales rates improve sequentially throughout the quarter with the sales rate for the month of September approximately 3% over the year-to-date average. We are seeing initial signs of improved activity in a variety of major industrial groups that are heavy users of electrical equipment and MRO products although not at the historical high levels of 1999 and 2000. A continuation of this trend would be reflected in favorable comparisons in upcoming quarters.

The third quarter results reflect the continued softness in capital spending and its impact on construction and other industrial project activity. Correspondingly our sales to customers in these large market segments are down 5 to 6%. Additionally, utility operations were down 4 to 5% for the quarter but had a very strong finish in September. Activity levels for our customers in our manufacturing housing markets continued to be depressed, but we are seeing signs of improvement in the recreational vehicle segment and in our overall market penetration resulting in essentially flat sales into this market for the quarter and improvement from earlier trends.

Now somewhat upsetting these declines were improved sales in Canadian operations were up 8 to 9% primarily on the strength of the Canadian dollar and our sales to other international customers were up over 10% as a number of large project orders were completed.

On strength of new programs, sales to customers through our integrated supply programs were up almost 8% over the third quarter of last year and are up almost 9% year-to-date. Gains in new programs international accounts programs have more than offset the weaknesses experienced in current programs where industrial and utility customers are experiencing weak end user demand.

For the quarter, sales to our national accounts customers were up approximately 3% and are up approximately 2% for the year. Pricing did not have a significant impact on sales for the quarter and overall the total electrical price index for September was up 0.7% from last year. Turning to gross margins, the third quarter gross margin was 18.6% and compares to 17.2% for the third quarter of 2002. Now the third quarter of 2002 gross margins were negatively impact by $5.2 million accrual for specialty inventory related to customers in the telecommunication and certain international markets.

Adjusting for this accrual the 18.6% gross margin reported for 2003 compares to an adjusted 17.8% in 2002. Our sales and business mix did not play a significant role in the margin change. Billing margins increased by approximately 30 basis points over the third quarter of 2002 and 40 basis points over the full year of 2002. Continued gains and billing margins have more than offset lower than historical levels of supplier rebates and cash discounts.

Our cost containment and reduction programs continue to receive focus and attention, although SG&A expense for the quarter at $124.7 million is up $1.5 million or 1.2% over the third quarter of 2002. It includes approximately $3.8 million of additional accruals for retirement and health related benefits and an additional $800,000 for bad debt reserves and write-offs.

We have seen an increase in low profile, small dollar amount bankruptcies and troubled accounts as companies try to cope with pro-longed economic downturn. We are monitoring credit worthiness of our customer base closely and believe our credit limbs and reserves were appropriate at this time.

Company-wide cost containment actions continue with the primary impact coming from staffing related compensation and general expense program reductions. Since March, 2001, when our staff rebalancing program was initiated, full time head count has been reduced by over 930 personnel or 15% with staff reductions continuing in the third quarter of 2003. Our severance related costs have been absorbed in related periods and we will continue to take actions to reduce and/or balance head count as the economy and our performance dictates.

Moving to earnings, third quarter operating income was $23.9million or 2.9% of sales versus $18.3 million or 2.1% last year. Gross margin dollars were significantly ahead of last year despite the sales short fall and more than offset the increased SG&A spending. Operating income increased 26% over the second quarter of 2003 on less than a 1% increase in sales.

Interest expense and other costs totaled $11.3 million for the quarter of 2003 compared to $12.5 million in the third quarter of 2002 and $11.8 million in the second quarter of 2003. The decrease in expense from last year resulted from lower debt outstanding during the quarter. During the quarter, we finalized the renewal of our accounts receivable securitization facility.

The new $300 million facility incorporates a unique feature whereby $165 million is provided under a one-year term agreement with the remaining $135 million provide under a three-year term agreement. This arrangement significantly improves our term and minimizes annual renewal risk while providing very competitive pricing.

Also, during the quarter, the company entered into a $50 million fixed to floating rate floating interest rate swap, reducing the effective interest rate on this debt by approximately 3% points. Income before tax of $11.8 million for the third quarter of 2003 compares to $5.8 million in last year's third quarter and $7.2 million for the second quarter of 2002. The improvement in income before taxes reflects improvement in gross margins, lower inventory adjustments and lower interest expense resulting from focus programs in those areas.

We continue to work on planning initiatives to lower our effective tax rate and over the past two years we have had several positive adjustments. For example, in the third quarter of this year, we were able to record approximately $600,000 in favorable adjustments relating to foreign tax credits which were previously unavailable.

This resulted in an effective tax rate of 28.9% for the quarter. In last year's third quarter, we completed some major work that resulted in a favorable $5.3 million or 11 cents per share tax benefit from the reversal of income tax contingency accruals. For planning purposes, our normalized ongoing effective tax rate on a go-forward basis is estimated to be in the range of 34 to 36% . We believe that our current tax reserves are adequate at this time.

The third quarter's net income of $8.4 million decreased by $600,000 over the report third quarter of 2002 due primarily to the favorable $5.3 million of income tax contingency also included in last year's results. Net income for the quarter was $1 million or 14% higher than the second quarter of this year. Earns per share for the quarter was 18 cents on net income of $8.4 million and compares to 19 cents for the third quarter of last year and 16 cents for the second quarter of this year.

We move now to our balance sheet for discussions on debt, working capital and cash flow, our accounts receivable securitization program will be described as if it were on book. Operating earnings and reductions in working capital have been used to reduce debt and improve the liquidity position of the company and continued progress was made in the third quarter of this year.

Total debt net of cash plus the total of accounts payable commitments decreased $46 million from year end. Free cash flow for the third quarter was $35 million. In debt net of cash was reduced by $35 million during the quarter and $81 million since year end 2002. For the trailing four quarters, free cash flow was $109 million and total debt net of cash has been reduced by $109 million or 15%.

Our working capital which improved 8 days over the third quarter of 2002 and nine days over the second quarter of 2003 contributed to the favorable cash flow during the quarter. The components of net debt including the accounts receivable securitization program at September 30, 2003, were senior sub notes and other of $372 million, financed receivables of $205 million, real estate financing at $51 million, cash at $30 million, and revolver at $10 million.

Our liquidity which is defined as readily available barring capacity and invested cash was $186 million and compares to $106 million in the third quarter of 2002 and $161 million at year end. Our capital expenditures for the third quarter were approximately $2.1 million which is identical to the comparable period in 2002. There were no shares repurchased during the quarter.

In summary, we had a good quarter. Our softness and end markets was offset by improved gross profit margins resulting in improved operating profits both quarter over quarter and sequentially and was the best operating profit both in terms of dollars and percent of sales since the third quarter of 2001.

Progress in working capital initiatives coupled with operating earnings, tax and debt initiatives provided strong cash flow allowing the company to pay down debt net of cash by $35 million in the quarter and $109 million over the past 12 months. This progress, coupled with improvements in our capital structure, has positioned WESCO with liquidity in excess of $186 million, no significant near term debt maturities and no restrictive debt covenants.

With our lean enterprise initiatives providing additional emphasis in all areas of the company, we are well positioned to take advantage of a what appears to be an emerging uptick in economic activity and to remain profitable in a weak economy.

As for our out look and guidance the company will not be providing specific sales and earnings guidance at this time, however, we do offer the following general comments. Our planning assumptions reflect an economic environment similar to what we've seen this year with signs of strengthening which may audit some of the normal fourth quarter seasonality.

Based on current momentum and continued improvement projects we expect to achieve expansion on billing margins as company wide initiatives are continued in this important area. Working capital productivity is anticipated to improve slightly with the result in cash flow directed at debt reduction. Capital expenditures for 2003 are expect -- anticipated to be in the 10 to $12 million range. We remain concerned about the current state of the economy. We do not foresee as significant near-term broad-based increase in capital spending.

Accordingly, we will continue to identify and implement further cost reduction and profit improvement actions while being cognizant not to impact the company's ability to generate new sales or respond to an uptick in activity levels in our end markets.

During the first quarter, we launched comprehensive company-wide initiatives to drive operating profit improvement with the assumption of flat or it is planning sales environment while concurrently emphasizing sales programs and sales management activities to increase market share at the local level and benefit from momentum developed last year in our national accounts and integrated supply programs.

These programs are beginning to favorably impact our operating results and will continue to receive top priority as we strive to continually improve our performance. At this point, Roy and I will open the call for question and answer session.

Thank you. If you would like to ask a question at this time, you may ask it by pressing the "*" key followed by the digit "1" on your touch-tone telephone. If you're on a speakerphone today, please turn off the mute function to allow the signal to reach our equipment. Again that will be "*' then "1" if you would like to ask a question. Today's first question comes from Dan Whang at Lehman Brothers.

Yes, good morning, every one. Now, I just had a question about your overall sentiment on the outlook of the business going forward. Would it be correct to say -that you're a little bit more positive than the previous second quarter outlook?

Dan, we are slightly more positive, but as you know, the news varies day to day and it's hard to get a good read on projected activity. We're a little bit more bullish in part because of the activity we see that is not yet reflected in our sales, but is reflected by discussions with our customers about their expectations for next year with regard to maintenance projects and certain other capital spending expectations. Now those are things that can be deferred and in the past have been deferred. So we wouldn't say that we are very confident in that, but it certainly is a positive relative to what we were hearing three to six months ago.

OK, great. And also, in terms of gross margins, I mean you've continued to make progress on that end sequentially. And you know, although the fourth quarter is, could see some seasonal effects, I mean, you expect sort of sequential improvements in gross margins?

Yes, we do. We're going to be continuing the programs that we've had in place now, systemically attacking low margin and our low profit accounts and working to enhance or upgrade those particular relationships. So we've got a lot of recently developed analytical capabilities and we've been mobilizing even more personnel in the organization in these, the margin improvement efforts.

OK, great. Finally, a question on the lean implementation program. I think previously you had stated as a goal to roll out this initiative to about a third of the branches by year end and just trying to see how that is tracking. And perhaps some little more details on some of the progress being made.

We're making excellent progress. We had in excess of 100 training sessions. We got between 500 as many perhaps as a thousand individual employees engaged in this activity and effort across our entire system. And by year-end, we expect to have completed in excess of 500 separate lean process improvement events.

So, it is a very active program and we're making outstanding progress. The nature of what we're doing involves sort of some classic applications of lean thinking and modified, however, for a service business. And they're not a lot of good models for comparing service industry applications using lean tools. Most of the lean implementations are done in a factory environment and that's where you see most of the examples. In our case, the closest thing we have to a factory is our warehousing operation.

And as an example, we will be on or ahead of our target of 100 branch locations for the lean improvements in our warehousing operations and each of these projects, we are identifying ways to improve scheduling, reduce overtime or temporary help, adjust staffing levels and improve quality and performance. We're doing the same kinds of things in a number of different areas, including inventory management, purchasing, payables and receivables, process management and quality enhancement.

Your question about margin improvement, part of the effort on lean is to get even better at tracking and location by location improvement in margin. And our most recent activity and one that we really expect to see create a lot of benefit is our lean initiative on sales processes. And improvement activities at the point of customer contact and engagement. And while that is still very early in its development, we've got a lot of activity going and a lot of momentum and we should see that yield results for us next year.

OK, great. Thank you very much.

We will go next to Rob Damon at 21st Century Research.

Good morning guys. Just a couple of questions about your national accounts and integrated supply business. Clearly, you saw growth status quarter while the rest of the business was down. Can you may be give us an update on how that business is progressing? Is the growth that you are seeing that a new business with new customers or is growth with existing accounts?

It's actually a little bit of both. Rob, you see, for example, with some existing accounts, there clearly is growth being recorded. However, that's being offset by declines in other industrial and utility type accounts. So, if we thought about it as something like comparable customer growth, probably in the aggregate would be down, but we are seeing increases in different industry segments and with different customers. However that's offset elsewhere.

On the other hand, we continue to see significant gains with new accounts and with expansion to new locations with existing customer accounts. Both in the integrated supply business and in our electrical component and project oriented business.

And I know you had an initiative to expand in the construction area national accounts as well, are you seeing increased activity from that perspective?

We definitely have increased activity, but that segment is still down. You'll recall that in WESCO's case, our focus has been on industrial and commercial and institutional construction activity with a lot less on the residential market activity.

And if you look at the -- if you factor out residential construction and look at commercial industrial and institutional, those markets are down in the double digit range on a year-to-date basis by virtually any measure. Our totals, in terms of sales to the contractor industry are off on the range of 4 to 5%. So a lot of initiatives have been launched and we continue to see some opportunities begin to flush out. Perhaps the most significant thing that we are doing in this regard would be in two areas.

One, as you mentioned, there are national contractor groups and we've escalated the activities in support of those customers. We have assigned dedicated personnel to those key customers. And we active programs in making sure that we are spending the appropriate amount of time with them in many different locations. So that's a part of the contractor development.

A second and equally important, maybe more important activity, is some significant work that we're doing in improving our ability to development market and customer segmentation so that we are able to provide more specialized sales support in targeted niche markets and I expect that that will have some very positive results for us.

OK and then just one last question, unrelated question, you know, clearly there's a manufacturing outsourcing trend to Asia, and you know, we see WESCO's primarily servicing the North American market. Is there any need for WESCO to expand more aggressively into Asia to capitalize on this trend?

We're studying that currently. We have sales activity in Asia already on a number of different fronts and we have sold into China for probably ten years, but it's been at a relatively low level. Probably not exceeding 4 or $5 million in any given year.

But what we are doing at the present time is looking at a number of different angles. We've conducted at this stage, two focus group research meetings, principally with manufacturers of electrical equipment and we are scheduling similar kind of activities with our large national account customers who are operating in China, in particular. And we have begun to open up discussions with business leader leaders in -- with strong Chinese roots. And we have hired and have our staff an individual that has worked on Chinese trade programs for 10 or 15 years.

So, we've got a number of initiatives going in that direction. At present, what we see for the most part, are companies taking advantage of sourcing opportunities for parts of sourcing. And not as much focus on supporting the industrial production in China. When I say that's what we see, we see that with the electrical manufactures we've been spending time with. So our thrust would be how do we sell more product in China as opposed to the sourcing initiatives. Although as a byproduct of this, we will identify a variety of sourcing opportunities.

OK. That helps. Thank you.

We'll go to Lauren Holland at Lehman brothers.

Actually, it's Sarah Thompson. Good morning. I have two kind of nit picky questions for you. You may have already explained this so I apologize, but Ian, when you're talking about gross profit margin having improved about 80 basis points year over year and 30 of that being the billing margin improvement, is the rest mix? Or I guess the cost cutting you're doing, I was under the impression was flowing through SG&A. Am I not thinking about that correctly?

Sarah, this is Steve, the cost cutting initiative would generally be reflected in the SG&A. Two things have happened and the gross margin. The spread between billing margin and gross margin is composed of several large items. Inventory adjustments, supplier volume rebates. Cash discounts that we received from suppliers, cash discounts that we give to our customers and transportation costs relating to bringing inventory into our system.

And we've been as a continuation of our improvement programs and a direct focus with our lean enterprise initiative attacked each one of those areas. For example, in the customer cash discount area, we've had over a million dollars in improvement of what we would give out to cash discounts. We've also been working on similar improvements and receiving better discounts than what we bring to from our suppliers.

Supplier volume rebates areas, another one, while we've not recover on a dollar basis, we're seeing incremental improvements on that. So, it's been a combination of product margin, improvement in all the other lines in between product and gross margin. So, transportation in as a percent of sales we've made improvement in there as well as we negotiate with our suppliers across the wide variety of fronts. But head count reductions, general cost reduction areas and expenses would be reflected in SG&A as you stated.

OK. Now that's really helpful. I appreciate that. Just one other nit picky question. I'm trying to just get to your cash flow numbers and said you had repaid about $35 million in debt for the quarter. Is there, if I just used kind of basic, you know, income statement and balance sheet information that you've given us I'm about $10 million short, is there something going in taxes?

In the tax area, we had to have paid essentially no cash taxes based on refunds and we're actually slightly favorable. That would probably be the bulk of what you've seen. Then on the cash interest, you're going through the year on the odd quarter, the second --or I'm association the mid quarter, first and third quarter of the year, the expense on the P&L will be higher than our cash interest because we make our bond payments in the second and fourth quarter.

Right. No that's perfect.

So a big piece is income tax and there is some on the interest, cash interest.

Perfect. That's all I had. Thank you very much.

This is to remind. "*" then "1" if you have a question today. We'll go to Cathy Nolan at Solomon Asset management.

Yes. Good morning. I would just like to confirm that free cash flow is the same thing as cash flow from operations.

It would be cash flow from operations less capital expenditures.

OK. And could you also repeat what the senior subordinated debt balance was at the end of the quarter and comment on whether or not the company bought back any bonds during the quarter.

The senior sub note and other was $372 million. That includes the sub notes as well as the miscellaneous acquisition seller notes. The company did buy back in the neighborhood of 18 to $20 million in bonds during the quarter.

Thank you.

Just to check again. "*" "1" if you would like to ask a question today. We have a question from Josh Lipton at Prudential.

Hi, I just wanted to find out about earn out payments that you expect to make, potentially can make in this year or next.

OK, Josh. As far as 2003, we have made some minor earn out payments that were reflected in our first and second quarter results. We don't anticipate any further earn out payments to be made during 2003. When you see our balance sheet information, you will see that we have made provision for an anticipated earn out payment of around $30 million for our Rucker acquisition in 1998. That would be a 2004 payment. So there would be an adjustment to our good will as well as a short-term liability.

OK. Great. Thank you.

Standing by with no further questions at this time, I'll turn the call over to Mr. Roy Haley for any additional or closing remarks.

Well, first of all, I would like to thank all of you for participating in the call this morning. And we appreciate your continuing interest and support. The company has made some very good progress on improved business fundamentals and we've adjusted to the market. We continue to make adjustments and we continue to identify and work at a variety of improvement initiatives. As you can tell from this quarter's results, we've made some excellent progress so far the past six months or so. With that, I wish all of you a good day. And we thank you again for participating.

Thank you for your participation in today's conference. You may disconnect at this time.