Wesco International Inc (WCC) 2004 Q2 法說會逐字稿

Please stand by. We are about to begin. Good day and welcome to the WESCO International Inc. second-quarter 2004 earnings conference call. This call is being recorded. 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 second-quarter financial results. My name is Dan Brailer, and I am the Treasurer and Director of Investor Relations of WESCO International. This morning Mr. Stephen Van Oss, WESCO's Senior Vice President and Chief Financial and Administrative 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 midnight Eastern time, July 28th.

Following the commentary of Mr. Van Oss, Mr. Roy Haley, Chairman and Chief Executive Officer, and Mr. Van Oss 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 10-K for the fiscal year ended December 31, 2003, 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 WESTCO's Web site at www.wescodist.com.

I would now like to turn the conference call over to Stephen Van Oss.

Thank you, Dan. Good morning and thank you for participating in our call. I would like to start the discussion with an overview of actions taken which we believe have positioned the company for ongoing solid operational and financial performance.

First, we had an outstanding quarter. During the last three years, WESCO's management has taken a series of steps to strengthen its earnings power, improve the balance sheet and position the company to maximize the operational and financial leverage inherent in our business model. Significant progress has been made in all areas including margin enhancement, cost containment and productivity, marketing and sales promotions, working capital performance, cash generation, debt reduction and overall capital structure and liquidity. The positive impacts of these actions began to be reflected in the business last year and are evident in this quarter's results.

Let's review some key metrics. In 2003 and continuing through the first quarter of 2004, we demonstrated a significant level of operational efficiency. Our key measure of overall operational efficiency is the ability to convert a high percentage of incremental gross margin dollars to operating profit and net income. We refer to this as pull-through to the bottom-line. For the full year of 2003, despite a sales decline of $39 million, the Company produced 19 million of additional gross margin with a pull-through of $9 million or 49 percent of the 19 million going to incremental operating profit and 7 million or 36 percent to incremental net income. For the first quarter of this year, we had similar performance with pull-through of 50 percent to incremental operating profit and 32 percent to net income.

While these accomplishments were solid, we know that we must also grow our top line to significantly and consistently improve our business. The fourth quarter of last year with the sales gain of 4.2 percent marked a return to growth that continued into the first and second quarters of this year with sales gains this year of 7.2 percent and 13.5 percent respectively.

Now for the second quarter. Growth in sales coupled with the margin and cost initiatives produced outstanding operating results. Our sales increased 111 million, and the Company produced an additional $33 million of gross margin with a pull-through of 24 million or 73 percent to incremental operating profit. Net income more than doubled as 12 million or 36 percent of the incremental gross profit was pulled through to the bottom-line. Earnings per share increased by 28 cents to 44 cents, a 175 percent improvement over last year's earnings of 16 cents per share. Working capital performance improved by 14 days from last year's second quarter, and liquidity remained high at $181 million. Our strong liquidity position was utilized to retire $36 million of high-cost senior subordinated debt, and our leverage and interest coverage ratios were also improved during the quarter.

LEAN enterprise initiatives continued to be expanded throughout the company with more branches getting involved in basic programs, while we launched additional programs targeting high-costs or service improvement opportunities. These new initiative supplement and expand programs touching virtually all aspects of our operations from sales, margins, inventory and transportation, to accounts receivable and order processing. The results are encouraging. Our productivity reached record levels in the quarter, and sales per employee increased 16 percent over last year's second quarter, and by 8 percent over our historical best.

Now for some more specific second-quarter results. Sales were 931 million the second quarter and were up 110.8 million or 13.5 percent in the second quarter of last year. Sales were up 83.2 million over the first quarter of 2004 and were approximately 13 percent over the 2003 full year average.

Activity levels in the majority of the major industrial groups that are heavy users of electrical equipment and MRO products strengthened further during the second quarter, although not yet at the historical high levels of 2000 and 2001. Strength in the recreational vehicle and modular construction markets of our manufactured housing operations and increased market penetration resulted in sales to this market being up more than 30 percent over last year. Improvements in day-to-day MRO activity, certain OEM segments, and increased sales activity in small and medium-sized construction projects resulted in our sales to customers in these large market segments being up in the aggregate approximately 15 percent.

Our utility operations were also up almost 15 percent, improving upon the positive trend that started in the third quarter of 2003. International operations were up over 6 percent, helped somewhat by the strength of the Canadian dollar. On the strength of new programs and improving MRO activity, sales to customers through international accounts and integrated supply programs were up approximately 13 percent and 9 percent respectively, improving the positive trend from last quarter and last year.

The daily sales rate improved throughout the quarter with a strong finish in June. The daily sales rate of $15.2 million of sales per day achieved in June was the highest daily sales rate experienced since December of 2000. While the industry does not publish discrete market share data, successes in our integrated supply, national accounts and alliance programs and routine feedback from our supplier base gives us confidence that we are growing market share.

A portion of the increase in the cost of certain products was able to be pushed through to customers. On an overall basis, pricing had an estimated favorable $24 million or 2.6 percent impact on sales. The second-quarter gross margin at 19.7 percent compares to 18.4 percent for the second quarter of 2003 and is a historical best for WESCO. Sales mix and inventory profits from increased commodity prices in copper and steel played a partial role in the gross margin improvement.

Billing margins increased by approximately 40 basis points over the second quarter of 2003, 50 basis points over the full year of 2003, and 30 basis points over the first quarter of 2004. SG&A as a percent of sales improved by 90 basis points, reflecting efficiency gains resulting from our LEAN initiatives and the positive leverage of the increase in sales. Our management and personnel have done an outstanding job in improving the efficiency and effectiveness of our organization. Despite a 13.5 percent increase in sales with more labor-intensive stock sales increasing over 18 percent, headcount rose less than 1 percent during the quarter and was essentially flat year-to-date.

SG&A expense for the quarter at 136.2 million is up 9.4 million or 7.4 percent over the second quarter of 2003 on a sales increase of 13.5 percent due to the variable nature of certain components of our compensation programs. Total payroll expense was up approximately 9.2 million over last year's second quarter, primarily due to increased performance incentive accruals and higher commissions associated with higher margin performance. Healthcare costs and expensing of stock options associated with the adoption of FAS 123 in the third quarter of 2003 also contributed to a portion of the increase.

Second-quarter operating income was 42.9 million or 4.6 percent of sales versus 19 million or 2.3 percent of sales last year, representing a company best performance. Gross margin dollars were significantly ahead of last year and more than offset the increased SG&A spending. Operating income increased 126 percent over the second quarter of 2003 on a 13.5 percent increase in sales.

Interest expense and other costs totaled $13.1 million for the second quarter of 2004 compared to 11.8 million in the second quarter of 2003 and 11.1 million in the first quarter of 2004. The increase in interest expense resulted from a $1.6 million nonoperating charge associated with the early retirement of $36 million at par value of the company's 9 1/8 percent senior subordinated notes.

Income before taxes of 29.8 million for the second quarter of 2004 compares to 7.2 million in last year's second quarter and 15.2 million for the first quarter of 2004. For the second quarter, our effective tax rate was 36 percent compared to a -2.6 percent for the second quarter of 2003, which benefited from a onetime net operating loss carryforward associated with an acquisition made in 2001 and compares to 36.1 percent for the first quarter of 2004. We expect to see the effective tax rate for the entire year to be approximately 34.5 percent as we implement additional foreign tax planning initiatives in the third quarter of 2004.

Second-quarter net income of $19.1 million increased by 11.7 million over the second quarter of 2003 due primarily to the gross margin improvements. Compared to the first quarter of 2004, net income increased by 9.4 million or 96 percent. Earnings per share for the quarter was 44 cents compared to 16 cents for the second quarter of 2003 and 23 cents for the first quarter of 2004.

Let's move now to the balance sheet and some working capital items. For discussions on debt, working capital and cash flow, our Accounts Receivable securitization program will be described as if it were on book. Our total debt net of cash increased $84 million from last year's second quarter and 100 million over the first quarter of 2004. Significant improvements in cash generation from increased earnings and working capital days performance was used to fund acquisition earnout payments, working capital associated with the increased sales, and higher commodity prices for copper and steel, as well as equity transactions.

Free cash flow for the second quarter was negative at $23 million and positive $41 million for the trailing 12 month period. Working capital days improved 14 days over the second quarter of 2003 and one day over the first quarter of 2004. Our financial leverage which stands at 5.3 times improved by 1.8 turns from the second quarter of 2003 and .2 turns over last quarter. The components of net debt, including the Accounts Receivable securitization program at June 30, were senior subnotes and other of $335 million, finance receivables at 300 million, real estate financing at 50 million, acquisition notes payable at 50 million, and cash of $9 million.

Our liquidity, defined as readily available borrowing capacity and invested cash, was $181 million and compares to 180 million in the second quarter of 2003 and 197 million at year-end. Capital expenditures for the second quarter of 2004 were approximately $2.6 million versus 1.7 million for the comparable period in 2003.

In summary we had an excellent quarter. Higher sales coupled with improved gross profit margins resulted in improved operating profit both quarter-over-quarter and sequentially and was a best operating profit both in terms of dollars and percent of sales that the Company has achieved. Net income more than doubled.

Further progress was made in working capital initiatives. Leverage and interest coverage ratios improved and liquidity remains strong. With our LEAN enterprise initiatives providing additional emphasis in all areas of the Company, we are well positioned to make further earnings gains and improve our balance sheet in an improving economic environment.

Let's turn now to the outlook for the remainder of the year. The Company will not be providing specific sales and earnings guidance for the full year; however, we do offer the following comment. Based on end market activity experienced last quarter and a continuation of positive macroeconomic trends, our expectations for top line growth for the third quarter are in the realm of 10 percent over the third quarter of 2003. Based on current momentum and continuing operational improvement projects, we expect to achieve further expansion on billing margins as companywide initiatives are continued in this important area.

Gross margins are expected to compress slightly from last quarter as 40 to 50 basis points of inventory profit were realized from increased commodity prices in copper and steel. Working capital productivity is anticipated to be maintained on a days supply basis, and free cash flow over the next several quarters will be directed at debt reduction. Capital expenditures for 2004 are anticipated to be in the $14 to $16 million range.

Despite recent economic news suggesting some softening, we saw favorable trends in the second quarter, including initial signs of improvement in small and medium-sized project activity, although not yet at the levels experienced in 1999, 2000, and 2001. Even with further improvement, we anticipate that there will be a timelag before we see a significant log-based increase in capital spending for commercial, industrial and infrastructure construction which have been areas of traditional strength for WESCO. Our companywide initiatives to drive operating profit improvement and emphasize sales programs and sales management activities to increase market share to local level and leverage momentum developed in our national accounts and integrated supply programs are working. We will continue to focus on programs and initiatives to design to deliver organic growth in excess of the market growth on an ongoing basis.

At this point, Roy and I will open the call for our question and answer session.

(OPERATOR INSTRUCTIONS). Dan Whang, Lehman Brothers.

Good morning. My first question was regarding the strong sales trends that you saw. How much of that was from the better than expected results from the project versus the more stock-related sales?

Actually, Dan, we are still waiting on some further improvement in project-related business. In terms of taking a look at our total activity for the quarter and looking at the business that we see as being supportive of day-to-day maintenance and repair work, OEM product resupply and replenishment, and what we think of as contractor fill-in business generally served out of our branch warehouses, that business was up in the range of 16 to 18 percent for the quarter. Whereas the larger orders, engineered materials, and other direct shipment kind of product that is typically associated with contractor and larger project related business increased in the range of 6 to 7 percent for the quarter, and on the year-to-date basis, that business is still lagging and up on the order of magnitude 3 to 4 percent for the year-to-date.

So that business that we have seen even in the direct ship and project area has been beneficial, and it has been a good sign by comparison we are up significantly more in the activity shipments out of our warehouse operations and basic MRO and OEM supply.

Okay. So the upside really came from both of those as being stronger than what you had initially expected?

Much stronger than we had initially anticipated.

In terms of the typical quarterly seasonality that has been seen on historical basis, I think the third quarter typically has seen the strongest sales?

We typically would see the first quarter from a seasonality we would typically be our softest quarter. With the second and third quarters, generally pretty much evenly matched. They could have second be slightly stronger than the third or the third slightly stronger than second on a historical basis. And then the fourth quarter would tend to drop-off as holidays and firms get towards the end of some of their maintenance budgets. So we typically see a softer first quarter, pretty much even second and third quarter, and a little bit of a drop-off in the fourth as typical year.

Right. In terms of the operating margin during the quarter, the 4.6 percent, I mean very strong. Where do you expect that to go in the second half of the year? And also in this up cycle, where could peak operating profit margins go in your estimate at this point?

That is an interesting question because we are now in unchartered quarters. We're at peak performance levels, and our expectation is that we're going to maintain and/or improve on that level of performance. So what we have got going for us is a lot of momentum on improvement initiatives that we had been working on for quite some time. And to the extent that we continue to operate in a favorable economic environment, we would expect to maintain or improve on that level of performance.

On an ongoing basis, the Company is committed to continue to progress in our margin activities you know on a 2, 3, 4, 5 quarter basis going out. We will see some challenges, though, for the next quarter from where we ended up the second quarter because we did have a lot of hard work by our organization of getting in front of price increases, particularly in the steel as it relates to conduit that we sell a lot of. And we did a very good job of getting ahead of that, getting our prices right out to the marketplace on that, and we did benefit from some inventory profits that gave us a nice boost on the gross margin.

So we're going to be challenged in the second quarter to hit that level. But on an ongoing basis next year out, we are committed to continue with our programs and deliver that. But it will be a challenge next quarter.

Finally, you mentioned the pricing trends out there. I think that there had been some talk that particularly steel pricing had peaked and come down and maybe more recently that things might be heading up a little. What are you seeing out there? Can you make some comments around that?

We saw steel prices increase rapidly through the second quarter. They have stabilized at this point in time, and the visibility that we have gotten from our supply base would say that surcharges will become worked into the base price and that probably towards the end of the year there may be some retrenchment on that. But they are not looking for a dramatic decrease, but not expecting steel to go up in our products significantly for the rest of the year.

Copper had settled down during the quarter. In the recent couple weeks, we saw some price increases coming back into that. So that has been a little volatile over the last two to three weeks. But our expectations are that we have seen the big run-up in both copper and steel at this point in time.

Great. Thank you very much.

(OPERATOR INSTRUCTIONS). Robert Damron, 21st Century Research.

Outstanding quarter, guys. I just wanted to ask you a question about the operating leverage in the quarter. It was very impressive, 70 percent of the incremental gross profit following to operating income. How long do you think this can last at that kind of level, at 70 percent, or do you think that that number starts to come down closer to 50 percent over time? Will you need to start adding to some fixed costs as the business continues to grow?

And then along with that maybe Roy could mention a little bit about any additional LEAN initiatives that have recently been rolled out or plan to be rolled out to generate some additional operating efficiencies going forward?

Well, thank you. With regard to what we characterize as pull-through, and you mentioned the 70 plus percent pull-through of incremental gross margin to the operating income line, that was very strong. Our expectations are looking forward, say, certainly for the next year or more, we would expect that to be routinely in the line of 50 percent pull-through. Some quarters maybe a bit more, some maybe a bit less. But that would be our expectation based on various modeling that we have done. So the 70 percent was really a superior performance for this particular quarter looking at leverage.

You also use that term operating leverage, and as you know, that is a powerful characteristic of our business model, that if we get some sustained strength in the economy you will continue to see significant leverage extended through our business model. You saw it dramatically affecting the operating expense or SG&A expense ratio in this time period, and you would see that kind of improvement continuing on a go forward basis.

With respect to your question about LEAN initiatives, this is a very significant activity for our organization, and we believe it is a game changer for our company. We continue to extend our basic programs into branch operations. As you will recall, we started last year with the goal of getting these basic programs implemented in 100 locations. And in terms of being at various stages of introduction or implementation, we have more than 200 of our operations that are now introduced to and working on some aspect of our LEAN programs.

As far as new initiatives go, perhaps the most significant, and the one with some really big opportunities for us, both in terms of cost performance and in terms of service enhancement, involves the area of delivery of products to customers. It is our second-largest expense, that is delivery expense, second-largest with payroll and related costs being our largest single cost item. And so there is tremendous opportunity in this arena. We have already been in the stage of implementing pilot programs in multiple locations, and we are looking for -- as typical of our LEAN initiatives, we are looking for something in the order of 10 to 25 percent improvement in productivity, service and quality levels. So that's a very exciting opportunity for us, and we will continue to develop new initiatives.

We have a master plan that goes out several years, so there is plenty more to come beyond that. But let me simply say that this will have a powerful long-term impact on the performance of the organization.

Okay. Excellent and just one other unrelated question on the topline growth. One of the things that you have mentioned in the past was growth opportunity with OEM customers. A lot of your business in the industrial segment currently is MRO. I guess what kind of progress have you made to date in terms of penetrating that market, and is the company positioned well for expanding into the OEM market?

This is an exciting opportunity for us, and we have made some good headway. I think it is probably still a little premature to declare victory by any means, but we have some excellent customer work that is going on. We are perfecting our business process. We have got some large proposal activities that we are walking on right now, and stay tuned would be my message on that particular area. This has the potential of being at least several hundred million dollars of incremental new business and potentially a lot more than that.

So it is significant, but I think it is just a little premature to say more than that we are organized for it, we are working with customers, we are piloting various techniques, and we are leveraging the work that we are doing in the LEAN initiatives into that service model.

At this time, we have no further questions. I will go ahead and turn the conference back over to Mr. Haley for any additional remarks or closing remarks.

Well, thank you. I guess I would like to make a few comments and observations, if I may, just in wrapping up. I thought maybe I would have the opportunity to comment on a few of these things with regard to explicit questions.

We are in a situation today where we have a lot of different activities that have been started over the last several years, and they are coming together really quite nicely. In this business, a success is dependent on doing a lot of little things right every single day, and a big part of the success that we have experienced on a year-to-date basis and supporting our expectations for the future are that those little things are being done better and better. Supporting the topline growth, for example, is, in fact, a recovery and a very large and solid base of established business. We have a very diversified business, many different industries, many different products and service categories, and recovery generally in the base will have an important positive impact, especially with the efficiency and productivity initiatives that we have taken over the last several years.

Secondly and reflected also in our results for the quarter is the fact that we have been systematically obtaining new customers in a variety of the market segments and categories. We have commented about this in prior earnings conference calls. But the effect was muted in part because the general decline across that larger base that I was just referring to. And what we see picking up right now is clear indication of share gains that reflect the recovery in the base business, plus the fact that we have this increasing number of large blue-chip customers that are going to be a very powerful sales opportunity for us in the months and years to come.

Thirdly, we have been developing a wide range of marketing and sales development programs, and we have got quite an effective marketing organization that has been very effective at targeting specific opportunities, and those targeted sales development activities are clearly showing results. As we have gone after product segments, our industry segments where we have seen that we were underpenetrated and by using targeted marketing programs, we have demonstrated that we can zero in on, identify the opportunities, put resources against it and see some systematic incremental sales development.

We have been talking also today and in previous discussions about the construction market, particularly the infrastructure-related. That is commercial, industrial and institutional infrastructure, larger types of facilities-related project activity. This has been a mainstay of WESTCO's business for a long time. No matter what data source you might look at, you will find that that form of construction has generally had a lower-level of recovery. It had a deeper trough in terms of the recession. It is coming out of it more slowly, and that is a natural aspect of our business cycle.

As the recession comes on, those projects that are in process do not end immediately, but when the recovery begins, it takes a longer period of time for them to get new projects to get studied, speced out, bid and built. So we still expect to see some significant recovery there.

Nevertheless, we started some time ago with a whole series of developmental programs for the construction market, and normally I would tell that we would be thrilled with the 6 to 7 percent growth that we experienced in the second quarter. But with all of the activity that we have had and knowing that the market is generally not recovered at this stage, we have still got a long way to go in improvement in that area. And the groundwork that we have been laying now for several years with targeting key market areas and key parts of our organization to support the construction market are going to contribute in a significant way over the next 6, 12, and 18 months in my opinion.

So a lot of things on the marketing front coming together that reflect a very strong commitment to developing our capabilities to sustain organic growth at above-average rates on a long-term basis. So those are a couple of key things.

Another theme for our meeting today, and you heard it in Steve's opening comments, had to do with record best, and we are still trying to figure out how many record bests that we have had. But let me comment on a couple of others because I do think that they are powerful and significant and they set the stage for organizational standards that will live with us for a long time to come.

Let me first comment on the performance of our sales and service organization. We have a very productive and a very effective sales organization. We produce at a level that is significantly greater than the industry average for our type of business. In this quarter, we had a sales per employee. That is total employees and total sales, and when I say total employees, I usually refer to that as people like Steve Van Oss and myself who typically sell nothing included in that total. But $700,000 per employee. Our industry runs in the neighborhood of 350 to $400,000 per employee. This is an enormous productivity difference, and it is an enormous competitive advantage for our organization. This level of almost 700,000 per employee sets a new high watermark for us, and Steve passed over it in his opening comments saying it was 8 percent higher than our previous best. I am anticipating that if we get some improvement in the construction markets we expect, you will see that number show even greater performance.

Another area that is oftentimes of interest is the productivity of capital, and the performance and return relative to the investments in the business. I will mention to you that as an internal measure we use for all of our various operations a measure of EBIT or operating profit divided by networking capital. Networking capital is our most visible, most variable and most controllable investment, and it is a significant part of our capital structure.

Having said that, our targets over the long-term have been to be first as an entire organization in excess of 25 percent return on working capital. Again, that is EBIT return on working capital. Then the threshold was raised to 30 percent, and frankly that was such a stretched target that many of our own management team were questioning it because we have tied incentives to getting to that level and beyond. I am pleased to say that for the quarter we set a new record level of EBIT to working capital, some 13 percent higher than our previous best and reached a level of 34 percent. So that is again a very important combined metric that shows the efficiency of working capital management, as well as the internal operational efficiencies.

So I will just end by maybe saying that there are a lot of good things happening in the organization. We have a variety of strategic and competitive strengths. We have this broad base of business in many different industries and geographies. It is a terrific sales and service organization. We have a low operating cost model and culture. We do a very good job at efficiently using capital, and I think that we have demonstrated that our business model works. It worked clearly in the weak economy, and it is working extraordinarily well in an expanding economy. It demonstrates the power and the value of the operating and financial leverage that is inherent in our business.

I am sorry for the lengthy monologue there at the end, but we did have a terrific quarter, and our organization has worked hard for these results, and we are very pleased with the outcome. Thanks for being with us, and thanks for your continued interest in WESCO.

Thank you. That does conclude today's conference. You may disconnect at this time.