Wesco International Inc (WCC) 2005 Q2 法說會逐字稿

Good day, ladies and gentlemen. And welcome to the second quarter 2005 WESCO International, Incorporated earnings conference call. My name is Mia, and I'll be your coordinator for today. At this time all participants are in a listen-only mode. We will be facilitating a question-and-answer session towards the end of the conference. [OPERATOR INSTRUCTIONS].

I will now turn the presentation over to your host for today's call, Mr. Daniel Brailer; Treasurer and Director of Investor Relations. Please proceed.

Thank you, Mia. Good morning, ladies and gentlemen. Thank you for joining us for WESCO International's conference call to review the second quarter 2005 financial results. My name is Dan Brailer, and I am the Treasurer and Director for Investor Relations at WESCO International.

This morning, Mr. Steve Van Oss, WESCO's Senior Vice President and Chief Financial and Administrative Officer, will provide a overview of the earnings press release issued earlier this morning, followed by comments from Mr. Roy Haley, WESCO's Chairman and Chief Executive Officer. Following the Company's commentary, we will open the session to your questions. 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 seven days.

The 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 31st, 2004, as well as other reports filed with the SEC.

The following presentation may also include a discussion of certain non-GAAP measures. Information required by regulation G, with respect to such non-GAAP financial measures can be obtained at WESCO's website at www. WESCO .com. I would now like to turn the conference call over to Steve Van Oss. Thanks, Dan.

Let's start with the results of the second quarter and how we see the third quarter and the rest of the year shaping up. I'll start the discussion with an overview of the few items in order to put the quarter's results into perspective.

2004 was an outstanding year for WESCO. We delivered record results in virtually all significant financial and operational aspects of our business. We ended the year with good momentum, and the momentum continues. Our results of the first two quarters have been excellent, improving off the progress made last year.

Our sales productivity, combined with margin and cost initiatives delivered our highest ever quarterly operating results and are expected to yield further improvements in 2005 and beyond, as our investment in productivity, sales and marketing initiatives continue to pay off. Sales increased 14% in the second quarter. Our late initiatives continue across the major functions in our Business, and are creating capacity for future growth in both facility and personnel related such as sales, marketing and administrative functions. This capacity creation was reflected in our productivity as measured by sales per employee per work day, which improved 13% and set a new benchmark for our Company, beating previous records which were set in each of the last two quarters. We expect the capacity expansion characteristic of our Lean programs to continue and facilitate increases in our organizational productivity and profitability.

Operating profit pull-through, which we define as the ability to convert incremental gross margin dollars to operating profit and net income, is an important metric for the Company, and is the key internal measure of our operating efficiency. For the full year 2003, and each quarter of 2004, we had pull-through of incremental gross margin dollars to incremental operating profit ranging from 50% to 70%+. The trend has continued into this quarter, as operating profit pull-through for the second quarter was strong at 56%.

Last quarter we discussed the economic recovery, which for our Business occurs in three stages. We continue to believe that we're in the second phase of a three phase recovery in the WESCO markets.

In the first phase, which began to possibly affect us in the fourth quarter of 2003, we saw an accelerating pick-up in our day-to-day MRO activity and what is often called, "fill in business." Stock sales of standard components and commodity products began strengthening in the fourth quarter of 2003, improved throughout 2004, and continued in double-digit growth in the first half of this year.

Our mid-cycle business, or second phase, is reflected in our small and medium-sized project business, which began to show signs of strength in the second quarter of 2004 and continues to gain momentum.

Our late cycle business, or third phase, is reflected in larger, more complex, longer leadtime projects and is beginning to pick up, but is yet to emerge in a meaningful way.

While each phase of the cycle produces different dynamics as it relates to both gross margin and operating costs characteristics, we view the three phases as cumulative and additive to improving our operating margins. Specifically, in this corridor, our project,or mid-cycle business, grew by over 20%. While this business comes with a lower gross margin, it provides strong operating margins as demonstrated in our second quarter results.

Our operating margins this quarter were 4.6%, and equaled the operating margin percent achieved in the second quarter of 2004; which, as we discussed last year, included 80 basis points of inventory profit generated by our persistent efforts to pass through higher commodity prices in copper and steel-based products. Our profit model is working exactly as projected.

While increases in project-related business have lower gross margins, we expect to improve operating margins due to cost efficiencies. Having said that, we're also committed to increase our gross margin percent along with further expansion of our operating margin, and have directed even more resources towards margin improvement via our Lean programs. Let's now look at a summary of the second quarter 2005 results.

Gross in sales, coupled with our productivity, margin and cost initiatives produced outstanding operating results. Our sales increased $131 million, and the Company produced an additional $11 million in gross profit with a pull-through of slightly more than $6 million, or 56% of incremental operating profit. Net income improved by $8 million or 44%.

Earnings per share by $0.12, to $0.56, a 27% improvement over last year's earnings of $0.44 on an increased number of shares. While the working capital dollar investment increased to support higher sales levels, working capital productivity improved over both the first quarter and year-end.

Before we review the detailed results for the quarter, I would like to take a few moments to discuss our planned acquisition of Fastec Industrial Corp. As was stated in our press release today, the Company announced it is in the final negotiations to acquire the assets and business of Fastec Industrial Corp. Fastec is a nationwide importer and distributer of industrial fasteners, cabinet hardware and locking and latching products.

The Company was established in 1979. It is the leading supplier in recreational vehicle and manufacturing housing industry. Fast-track is headquartered in Elkhart, Indiana; with distribution facilities in California, Georgia, Oregon,Texas and Tennessee. The Company's annual sales about $55 million, and it has 145 employees. WESCO acquisition's of Fastec will strengthen and expand our leadership position in the manufactured housing markets and augment WESCO's overall financial performance.

Fastec has a track record of growing sales and profitability. Additionally, Fastec has significant sourcing capabilities in China and Taiwan, which can be leveraged by WESCO both near-term in our manufactured structures operations, and where appropriate in support of other market segments served by WESCO. We expect this transaction to be immediately accretive, adding $0.02 to earnings in 2005, and $0.04 to $0.06 in 2006.

The acquisition of Fastec will be WESCO's first acquisition since March of 2001. As previously indicated, we're evaluating other opportunities as a means to further accelerate strategic initiatives. Let's talk a little bit, now, about specifics of the second quarter results.

Sales were $1.62 billion for the second quarter, and we're up $130 million, or 14.1% from the second quarter of last year, and represented our first quarter ever over $1 billion, and a higher level of sales per work day per employee than any quarter in the Company's history. Sales were up 7.2% over first quarter of 2005, and above the 3%-5% that we would have normally experienced due to seasonality.

Activity levels in the major industrial groups that are heavy users of electrical equipment and MRO products, strengthened further during the second quarter. And current sales sales activity has exceeded the highest levels previously experienced by the Company. Sales gains were achieved with markets outside the U.S. being up 20%, helped somewhat by the strength of the Canadian dollar. Sales to utility customers remain strong and were up over 18%.

Improvements in day-to-day MRO and OEM activity, and increased sales activity in small and medium-sized construction projects resolved within our sales to customers in these large markets segments being up in the aggregate, approximately 9%. The recreational vehicle and modular construction markets showed sales improvements of 5% over last year, which was very strong, being 30% over the prior year period.

On the strength of new programs and improving MRO activity, sales to customers through our national accounts, and integrate supply programs were up 14%. And while the industry does not publish market share data, successes in developing customers for our integrated supply, national accounts and alliance programs, as well as reporting by other companies and routine feedback from our supplier base, gives us confidence that we are systematically increasing our market share.

On an overall basis, pricing had a minimal impact on the quarter. With an estimated favorable $4 million, or approximately 0.5% impact on sales. Categories with the most significant price increases were building wire and cable and non-metallic conduit.

The second quarter gross margin of 18.3% or 40 basis points below the first quarter 2005, and compares to 19.7% for the second quarter of 2004. The decline relative to 2004's record quarter has been anticipated due, in part, to the favorable impacts of commodity inventory mark-ups experienced in 2004, and more recently, to a shift in mix towards our project business.

The magnitude of general price increases experienced across much of our product and supplier base in the first half, has diminished somewhat, but we continue to see a significant number of cost increases. While keeping up with the supplier price increases has been challenging, we are committed to adjust and implement new pricing throughout our customer base, and expect to see margins improve, going forward.

Selling, general and administrative expenses as a percent of sales was 13.4%, a 120-point basis improvement over last year's second quarter, expense ratio of 14.6%; reflecting efficiency gains resulting from our Lean initiatives and a positive leverage of the increase in sales.

Our management and employees have done an outstanding job in improving the efficiency and effectiveness of our organization. Our sales increased 14%, while our total employee base rose approximately 1% compared to last June. Continued cost control focus and success in our Lean initiatives, resulted in productivity improvements over year-end and the first quarter of 2005. This is a meaningful departure from the past, when sales increases and personnel additions were closely correlated.

Since the first quarter of 2001, productivity is measured by sales per employee per work day has increased by 32%. Again, our SG&A expense rate for the quarter declined by 120 basis points as a result of productivity improvements and a favorable impact of sales leverage across our cost base.

SG&A expense for the quarter at $142 million, is up just $6 million, or 4% over the second quarter of 2004 on sales increase of 14%, due to the variable nature, certain components of our compensation programs.

Total payroll expenses up approximately $2 million over last year's second quarter; primarily due to increased salaries and additional costs of $1.2 million for stock option expense associated with the early adoption last year -- in 2003, of FAS123 on our previously granted stock options. All other SG&A expenses were up slightly due to double-digit increase in sales, with the bulk of the increase related to transportation costs. SG&A costs declined slightly as compared to the first quarter 2005, despite the increase in sales.

Second quarter operating income was $48.9 million, or 4.6% of sales; versus $42.9 million or 4.6% of sales last year. Operating income increased 14% over the second quarter 2004, which was a record best performance aided somewhat by the recognition of inventory-related profits.

Interest expense and other costs totaled $9.9 million for the second quarter 2005, compared to $13.1 million in the second quarter of 2004, and $11.2 million in the first quarter 2005. As expected, the retirement of a portion of our higher cost bonds offset increases in interest rates over last year.

For the second quarter, our effective tax rate was 30%, reflecting the Company's ability to implement tax planning initiatives. We expect the effective tax rate for 2005 to be approximately 32% to 33% due to benefits from our forward tax-planning initiatives implemented in the third quarter 2004. Second quarter net income was $27.4 million, increased by $9.6 million, or 44% over the second quarter 2004. Reported earnings per share for the quarter were $0.56, or an improvement of 27% over last year.

Switching to the balance sheet now. We talk about debt working capital and cash flow, our accounts receivable securitization program will be described as if it were on book.

Total debt net of cash decreased $7 million from year-end, and is down $142 million from the second quarter of 2004. Free cash flow for the second quarter was slightly negative at $4 million, reflecting the growth in working capital to support increased sales. Working capital dollars have increased $37 million from year-end, due to higher levels of sales and result in accounts receivables, somewhat offset by increased accounts payable.

Inventory dollars were essentially flat. Leverage on total debt net of cash was 3.2 times at the end of the quarter, and improved by two full turns from the second quarter 2004. Liquidity, defined as readily available borrowing capacity and invested cash, was $245 million, and compares to to $181 million in the second quarter of 2004. The Company is in a strong position to further organic growth, as well as acquisitions.

The components of net debt, including the accounts receivable securitization program at the end of June, were finance receivable at $330 million, senior stub notes and other of $200 million, acquisition note payables $20 million, real estate financing $49 million, and cash of $15 million. Capital expenditures for the second quarter 2005 were approximately $5.2 million, and compares to $2.6 million in 2004.

In summary, we had an excellent quarter, continuing the strong momentum from 2004 and from the first quarter of this year. Higher sales drove additional gross profit dollars and significantly improved SG&A expense rates, resulted in a 14% increase in operating profits, and a 44% increase in net income. Leverage and interest coverage ratios improved to our best levels since our recapitalization in 1998, 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 together with our improved balance sheet to fund future organic growth, as well as capitalize on other improvement opportunities.

Switch now to our outlook. The Company will not be providing specific point estimate guidance for sales and earnings. However, we will reiterate the fundamental tenets of direction and commitment objectives we provide for our leadership team in driving our Business over the next few years. Our industry has historically grown at the rate of one to two full points above GDP growth rates. WESCO should grow at a rate of at least one to two points above the industry growth rate, based on our extensive local sales, marketing programs, coupled with our unique positions in our current markets, penetration of our national accounts and integrated supply programs.

With current economic projections of 3%-4% increase in GDP for 2005, we expect to see industry growth in the 5%-6% range. Normally, we would expect to grow at around two points above the industry, given the leverage of our national program overlaying our local sales and marketing initiatives. Based on our strong second quarter results and current momentum, our growth should be in the 10% range for the balance of the year, notwithstanding the excellent sales growth achieved in 2004 and the increasingly difficult year-over-year comparisons we will face in the second half of this year.

Our Lean initiatives affecting all aspects of our Business, are expected to drive operating margins to 6% over the next 36 months. We intend for organic sales growth to produce annual growth in net income of 20% to 25% on an ongoing basis. Recognize that any given quarter may exceed of fall short of these metrics, given the discrete events in the economy or Company dynamics. Regardless, we expect our management to drive initiatives to deliver superior results on an ongoing basis.

Capital spending is projected to be in the $13 to $15 million range. As for the third quarter of 2005, given a continuation of positive macroeconomics trends and end-market activity, similar to what was experienced last quarter, along with market share gains, we expect to be, again, to be able to generate growth of 10% or more over the third quarter of 2004, which grew 18% over the third quarter of 2003.

Historic seasonality in our served end markets generally results in similar sales level as our second quarter sales results. And month-to date July activity levels are often a good start. Based on current momentum and continuing operation improvement projects, gross margins are expected to improve over last quarter.

Working capital productivity is anticipated to be maintained on a day supply basis, and free cash flow over the next several will be directed to cover our announced acquisition and net debt reduction.

Share count used for calculating earnings per share is estimated to be 49.3 million, reflecting December equity offering and current stock price.

Again, we had a strong quarter. With good momentum entering into the third quarter of 2005. We will continue to focus on programs and initiatives designed to deliver organic growth in excess of market growth, and to improve operating margins and strengthen the Company on an ongoing basis.

We're excited about the addition of Fastec Industrial Corp, business to WESCO, and look forward to growing this business and leveraging off the significant sourcing capabilities in China for other products across WESCO's base of operations. I will now turn the call over to Roy for some comments on end- market activity levels and observations on the overall economy and implications for our Company. Roy?

Well, Steve's done a thorough job of going through the numbers and trying to put them into context. What I'd like to do now, is shift the discussion to talk just a little bit about market conditions.

As was indicated, we almost always start from the perspective that our industry tends to grow a rate of 4%-6%, or a couple points faster than the GDP. Recent investor relations reports for manufacturers who concentrate in our industry have presented a fairly ride range of sales growth indications, something with a range of 2%-12%, but 6%-8% seems to be somewhat typical. Our conclusion is that both the overall economy in our specific industry growth characteristics position us for good growth over the next 12 to 18 months.

Looking at a couple key segments, though, the manufacturing industry and it's challenges get a lot of attention in the press. Despite some ups and downs from month-to-month, and occasional articles about the demise of manufacturing in the U.S., industrial production and the utilization rates for industrial capacity continue to increase modestly. Additionally, recent articles and announcements indicate that capital spending commitments in the industrial segment are increasing. This bodes well for both MRO and OEM demand, and for increasing industrial construction over the next couple of years.

Also important to us are the commercial and industrial construction markets. Regarding overall nonresidential construction, you will recall that we have been consistently optimistic about the long-term prospects of this important market. Despite a variety of data sources that indicate growth of 0% to 5% versus last year, our construction-related business is doing well. With sales activity in the range of 10% to15% year-over-year growth. Areas of particular strength have been the central and western U.S., Canada and specialty contractors serving the utility industry.

Regarding anticipated future growth in project-related business, we're still trailing the peak sales levels achieved in 2001, but we expect to have fully recovered by year-end. Our backlog of booked, but unshipped business has been growing, and is currently 15% to 20% above last year's level.

So, on an overall basis, at least for us, the construction and project-related business is looking pretty good, both currently, and looking out over the next year or so.

Our total sales activity in growth over the past 18 to 24 months has brought us now to the point where we are generating more than $1 billion of revenue per quarter. And this is resulted in WESCO surpassing Gray Bar as the acknowledged sales leader and largest company in the North American electrical wholesale market. This performance naturally strengthens the relationships we have with key suppliers, and enhances our ability to attract top-quality personnel to our organization.

Our excellent sales growth has been driven by a number of factors, including a dedicated long-term focus in selected market segments, a multifaceted and ever-improving marketing capability, and a high performance sales and service organization that keeps getting better.

Steve mentioned the growth and profitability model that we've been operating under. And the idea behind that model is to achieve targeted improvement in operating profits across multiple customer markets and multiple logistics or service modes. Now, certain types of business, particularly in the mid to late- cycle construction and project-related business, but also in a couple of other segments, have lower gross margin rates, but they also have a lower cost to serve. As demonstrated this quarter, our model is working as planned, and record levels of profitability have been achieved, even though the blended mix has a lower gross margin rate.

As Steve pointed out, we've indicated in prior presentations a multi-year goal for increasing our operating margin by two points. We've achieved 40 basis points of operating margin improvement during the first half of the year, and I'm confident that the combination of a new round of Lean initiatives targeting margin improvement, along with our demonstrated ability to achieve overall SG&A expense leverage will continue to produce favorable results. Mia, let's now open the phone lines for the question-and-answer session.

[OPERATOR INSTRUCTIONS] Your first question comes from Deane Dray of Goldman Sachs. Pleased proceed.

Thank you very much. Good morning.

Good morning.

I'd like to hear a little bit more about Roy's last point, there, regarding the three stages of the recovery. And, specifically, when you talk about each phase having a different gross margin and then lower costs to serve; could give us a better sense of what the magnitude might be for each cycle? And then, maybe some color around what's the difference in the cost to serve? I would guess in the large projects, it's more competitively bid, which would lower the returns, but also are there direct ships involved that then lower the cost? A little bit more color along those lines, please.

Well, Deane, maybe the way to look at this -- if you look at our overall SG&A expense as a Company, and look at where we are in this quarter, you'll see that the expense ratio is 13.4%.

Now, if you think about a blend of business, the early stage business tends to have a higher margin, but it also has a higher operating expense. And you can understand that because there are lots of small transactions, a lot of warehouse activity, a lot of delivery mechanisms in support of that type of business. As we move into more project-related business, the margins come down, but the operating efficiencies go up. And you would see, if you're just trying to take a blend, you would say -- well, the operating ratio will be at least several points below that for that type of business. Now, I don't have specifics to give you on that, in part because, it seems like every transaction is different, every project is different, every location is a little bit different; but you can understand the mechanics of how we look at that as we sort of progress through.

Is not that we lose anything, it's just that as you stack on top of one another, this first stage of business has one set of dynamics, and as you stack some more business on top of that, you get a blended change that's a little bit different. And, again, if you stack more on top of that, you give a different blended rate. So we're anticipating, as we go forward, that we will maintain or improve upon our gross margin and we would expect to see our operating expense leverage continue to improve.

Another way to help you through -- think through this is -- as we manage our businesses and the operation folks drive it, we really work them towards the operating margin component more than the gross margin, or SG&A rate, because of the different dynamics of different pieces of our business. And so they really look at working the operating margin component of that. In addition to that, we have complementary initiatives to work the various elements of each piece of those business to get the profitability of each piece within those businesses up.

So, given the nature our Business, having a lot of stock business, as well as a significant component of our Business related to projects, and you mentioned the term 'direct-shipment'; we try to work it a couple of different ways. So group -- operating groups that have moved more product,, larger projects, and have less going through the warehouse may not have as high as a gross margin, but we would demand and run their Business to deliver the same type, or higher, operating margins.

So think about as running the businesses to deliver an operating margin, and think about a lot of the Lean initiatives being driven towards improving each element -- whether it's a stock sale or a direct ship sale. We're trying to get each individual component better. And then this mix will play out in our consolidated results, as you saw this quarter, where we have a mix shift, yet we still deliver very good operating margins. That might be another way to think through the Business.

That's very helpful. And just on that point regarding the focus on the operating margin -- if we look at this quarter as being flat, versus a year ago, and your goal is very much intact to get 6% in the next 36 months. How shall we think about this quarter coming in flat? When should we start seeing the traction on those Lean initiatives?

I would say that you saw it this quarter, and I'd say it was an outstanding quarter. We're talking about coming in flat to a very strong quarter in the second quarter of 2004, which had the dynamics of a very rapid and dramatic run-up in both copper and steel-based commodity prices. Which the Organization did a great job of pushing that through immediately to the market the best we could, and we were able to get inventory profits on the stock that we had in our inventories.

I would estimate almost a full point, or 80 basis points of impact in the second quarter of 2004. So if you look at what was a very strong quarter -- if you look at our results for all of 2004, the second quarter stood out almost as a mountaintop in there, but it had a nice slope for the entire year -- we hit that with an unfavorable business mix, we hit the 4.6% operating margin. So I think that you are seeing in a big way, the Lean initiatives already kicking in. But as we said, we are a couple years into Lean, others have been doing it for more then a decade. And every day we're at it, we see more opportunities.

Great, if I could just get one more question before I pass it on? I'm not sure you're going to be able to comment extensively on this, but in anyway that you can be helpful in discussing the potential scenarios for disposition of the financial sponsor's shares? And what might the expectations be?

Well, as you know, the Cyprus Group has been our lead private equity investor for the last seven years or so. And they have all of their shares registered and they,at their discretion, have the opportunity to sell those shares by a variety of different means. So that is not something that I am privy to, that I tell you what the exact plan would be. I can only tell you that they have been a very thoughtful, a very patient and a very good shareholder for the Company over this time period. And I would expect that there would be nothing that they would do that would impair or effect it in an adverse way what the Company is doing.

And I would add to that, I mean if you think about it, to a degree, Deane, there's been a significant reduction in the risk as it relates to an overhang. At one point, their position was 43%, it's half of what it used to be. And I think, at this point, very manageable for them to exit over the next series of quarters, months, years, without having a big down draft on the stock. So I think that the risk component of that is very much less then it was a year ago.

Plus, you've had the secondary sense -- issuing primary shares since then.

Right.

And so you just give us a pretty wide range of potential timing. It literally, could be several quarters, or as long as a year to play out?

Right. As Roy said, that's their decision. They have the flexibility to do that. As we understand it, they don't have any restrictions in the fund that would require them to have it done by date certain. So expect them to be very thoughtful in how they handle this.

Thank you very much.

Your next question comes from Dan Whang of Lehman Brothers. Please proceed.

Yes. Good morning, everyone. This first question is the regarding the Lean. I think you mentioned that you expect a new round of Lean initiatives at various levels of your Organization. Maybe some details around that? And also, I think you specifically mentioned some initiatives to target the gross margins, and any details around that would be helpful.

I'll take a stab at that. The first thing you have to recall is that Lean is something that goes on forever; and every initiative that we have is going to be revisited on a regular basis to see if we can't extend whatever we're doing again, another round.

Just as an example, back -- several -- when we first got started, I established the point of view that before any location was relocated, or a change in the building's structure, or the lease or anything like that -- before any renegotiation, the whole operation had to go through a Lean facilities review. And I just pulled one off of the near-to-be-signed list because the last Lean review was months ago, rather than current. So we just keep going through these things and we will keep after them over the long term. So that's point number one.

Point number two is that we've got a great capability as being widely understood and adopted and used, and we've got lots of projects that we're working on. With regard to margin, margin was actually one of the very first things that we attempted to tackle with a Lean program. But as so many Lean projects go,it was to try to deal with issues related to data accuracy, backlog, pending changes, maybe some obvious variances or discrepancies, improved reporting and mechanisms and the like. So that was kind of the first stage. And that would have been a year and a half ago or so.

As we go through these things, we learn more and more, and we now have a focused team that is working a kind-of rotational basis with each of our major operating groups, going through a kind of a next wave. And we're seeing some excellent, initial results that we expect to be able to apply, not to just any one part of the Business, but across different service types, across different kinds of customers and the like. That only got started in one region a month or so ago. So in a way, it is premature to talk about it. But we have high expectations for further improvement.

Okay, and you talked about the ability to expand capacity in terms of facilities and the labor activities through Lean. I just wanted to get your thoughts on your current IT systems and it's capacity to handle this strong growth out there. Any commentary around that would be great.

Yes, Deane, from an information technology perspective we've got a very large amount of capacity. And we just finished -- and we've seen it in our CapEx expenditures for the second quarter -- we just finalized a rollout across the entire Organization of a new-generation of servers for our businesses.

In our Business we run a common application, but it's decentralized and distributed at the branch level. So each branch has the computing power, rather than at it's facility. And we had a -- as technology goes, the previous servers were in the 6 or 7 years of age. So we quadrupled or 10 timed the power in there.

So essentially, if you want to think it, an infinite capacity at the branch level to handle any levels of business is a matter of adding a server, or upgrading. On our central systems, if you want to look at how we consolidate -- while we don't operate with an enterprise resource package like SAP or something like that, we have a very strong, active data warehouse that accumulates and rolls up the information, then gives us system-wide visibility. And we have a lot of capacity expansion on that.

It's very easy, if we needed to, to add additional horsepower on the hardware side. There is no issues on the software side. We've got a lot of capacity, in that regards. And you're seeing that in the productivity, both in the people standpoint, from our head count additions. We were, as I mentioned before, we were up 1% over last June. If you look at the results of our most recent initiatives, headcount from year-end 2004, we're actually down about 0.5%, so wer'e down 30 to 40 people from where we were at year-end.

We're very confident of our ability to continue to be a low-cost operator and continue to drive productivity improvements across virtually all elements of our Business. We saw it in sales, we've seen it in head counts, we've got good capacity in IT, our working capital performances as measured by day supply of inventory, or days of receivable were near best record and better than year-end and better than in the first quarter. We're very confident that we'll continue to make good progress.

Okay. I think in the past, you had mentioned -- I think one of the initiatives was to switch-out the line operator user interfaces to make it a little bit more standardized across the Organization as part of the whole I T upgrade process. How's that processing?

I think what you're talking about is our point-of-sales system, what we call our 'branch system.' And we're not switching now, per se, we're laying some new technology onto that, and making it ,what I call, the [indiscernible], the information technology group, make it walk up intuitive. So we're taking -- in reality, what were doing is we're adapting and adopting the Lean processes that Roy was talking about, we have something we called, when we talked about it

in the past, we've called it ZDI, or Zero Defects Initiative. And what we're doing is taking the Lean techniques and the personnel from our Lean group, miring them up with some administrative and branch operations. So it's, essentially, go into an operation such as accounts payable. Whereas the case right now, we have a big focus group and quarter entry, and they deconstruct the process, simplify it, error-proof it, reconstruct it, and then work with the information technology group to memorialize those type of changes into the system. So what we do is, essentially, migrate instead of having a big single event where we have to go back and run a system's risk, or retrain the entire Organization. We're incrementally approving this as part of our Lean initiatives.

Okay. And finally, regarding the acquisition of Fastec, you talked about the overseas sourcing opportunity there, and, actually, to try to source some of WESCO's existing business products from overseas. Can you press help by trying to quantify that? Is it on a quarter of the products that you currently sell that could be sourced overseas, as well?

We're in the process of trying to quantify it in more precise terms. I can give you a sense of direction here, Dan. About three-quarters of the products that Fastec sells into the markets today are sourced from China and Taiwan. They play two-third of their businesses in in the manufactured housing and recreational vehicle markets, which is a sweet spot for WESCO. We have a very big position in those market, and we're already matched up our procurement people -- had a video conference with the folks overseas already, trying to look at a lot of the SKU numbers that we provide into our supply base, and see what we can migrate over that.

We're optimistic that we can get some pretty meaningful gains in there. I don't have anything to quantify for you at this point in time. We'll give you some good color on that next quarter.

Okay, thank you very much.

Your next question comes from Steven Fisher of UBS. Please proceed.

Good morning. Just pushing you a little more on the gross margins. Last quarter you expected gross margins to be flat to up slightly from the 18.7% you had in the first quarter, but you came in at that 18.3%.

I guess it seemed like pricing wasn't much of an impact in the quarter, it was really just the mix shift, which we kind-of expected. Was there something unique about the specific projects that were booked into revenue this quarter that caused the gross margin to be a little bit lower?

Well, there was nothing unique. There was just a very, very strong quarter in our businesses that have different margin characteristics..

As I mentioned, our project business was up over 20% for the quarter. If you looked at kind-of a same picture last year, project business -- our stock business would have been up in the mid-teens, and our project business would have been up over the previous year in the high, or mid to high single digits in which we're seeing a pretty --. Our stock business was still good, it was up in the high single digits over a very strong period the quarter before in 2003.

It's just that, a mix shift -- I wouldn't read anything into that, Steve. It's just a general trend towards that, and in fact, as we stated to be our operating -- our profit model is behaving exactly as we anticipated and as we projected it.

Okay. Then, going forward, I know you've talked today about still improving the gross margins. So it's improvement from 18.3% from here for the rest of the year, and beyond?

It's like a mathematical equation, you have to at least keep something constant. So if we keep the mix constant, that's the Company's position. With a constant mix as related to the second quarter, we'd expect to see our gross margin percent improved.

Okay. On to the tax rate. It came in lower. Can you give a little more detail there? You said it was some initiatives -- and a little more color there. And would we expect that to be sustainable beyond '05 into '06?

We'll be looking at two things for the tax rate for this quarter. First, is the continuation and further refinements of some initiatives that we put in place, primarily with some Canadian tax planning initiatives that we did in 2004.

Additionally, as you may be aware, is the changes in some of the tax law and the removal of domestic foreign sales corporation. Those rules have been changed, moving more towards a manufacturing process credit. And our work of determining where, with our value add services, we could come about and take advantage of those new tax law changes. We became aware of some discreet benefits that we booked in this quarter related to about five years worth of previous work and activities in software. Where we could take a research and development credit.

So this came up as a result of our work on this new FFC credit, and it gave us kind-of one time benefit in the second quarter. But continuation of tax planning initiatives and our past ability to do that, we think that the rates for the full year will be in the 32%, 33% range. And we'd be looking for a similar level, or perhaps lower, for to continue to be successful in some current initiatives that were on for 2006.

Okay, great. And then on free cash flow, you had forecast, last quarter, $70 million for the year. And I guess you're at about $5 million first half.

Right.

Can you just talk about what branched you up to get -- if that $70 million is still the target -- what branched up to get you there?

The target hasn't changed, dramatically. There be a couple things that'll drive it towards that; the continued strength in earnings. And we typically -- and this would be great for earnings and not so great for cash flow -- we would, typically, in the fourth quarter, due to seasonalities, see a falloff in sales in the 3%-5% range for the quarter. And the generation of cash flow on that, is strictly relates to a reduction in receivables and inventories required to support that.

We would have -- and our cash generation model for our Business is proving this out during the challenging times, '01 to '03, when the sales were flat or down, we threw up a tremendous amount of cash. If sales are stronger then that, our cash flow won't quite be at that level, but then profitability should be up. All the cash flow that gets consumed as our activity level continues, goes into very fundable, marketable [inaudible]. It's accounts receivable and it's inventory, which is very liquid assets for us. So, it'a matter of timing on that. So that's what we would expect to see.

Can you just give us a sense of what the revised target would be?

Still in that same range.

Okay.

We saw the ramp-up, really -- what will drive it will be the delta between the third quarter in the fourth quarter, as we hit year-end. So December sales has a big -- November to December sales has the most significant impact, what we see for the total year.

Okay. And just lastly, on Fastec. When do you expect that to close?

In the next ten days.

Okay. And how you plan to pay for that?

That will be -- we have, as I mentioned in the call, $245 million in available credit on our existing lines. So we have ample capacity, that won't even be a bump in the road for us.

Okay, thanks very much.

Your next question comes from Rob Damron of 21st Century. Please proceed.

Good morning. I wanted to ask a couple more questions about Fastec acquisition. Maybe you could give us a little bit more color on the margin structure relative to WESCO's gross and operating margins; some of the synergies that you expect to get once you integrate the acquisition. And also, wanted to find out your view on -- now the one looks like it's been revalued and it may continue to be revalued, going forward. Does this change your -- change the potential pricing advantage that Fastec has, going forward?

I'll try to address that and I'm going to ask you to rephrase that last question. I didn't quite catch it. I'm not going to give you any discrete data, per se, on the margin. Number one, we haven't finished the acquisition, and two, we're under an MBA with them. So, I'm not going to do that. Other then, I will tell you that, from a profitability level, it will be additive to our Company, it won't dilute our profitability level, it will help it.

The synergies were talking about, will be severalfold. The end markets and customers, there are a lot of similarities in the sweet spot of their business, as well as the strength of our manufactured structures. They also bring some other markets to play, particularly in the locking and latching areas that would be supportive to our integrated supply business, so we see some good opportunities there.

The real synergies, at least in the near term, that we see, is going to be in the sourcing area. And they've got two decades worth of experience of sourcing in Taiwan and China, very long relationships with folks over there. The same people, like I said, for almost 20 years, as well as having an employee on-site in mainland China. So we believe that, certainly, initially, we will get some good benefits as it relates to our structured housing business. And, certainly, as we look at taking advantage of sourcing in other areas as well. And I didn't quite catch your last --

With regard to the revaluation, as you know, it's just a minor adjustment at this point. And it looks like there's a certain amount of testing of the waters, and likely to be a bit more. But, at least the preliminary information I've seen is, it's not going to be a dramatic change for us, because we do so little sourcing of that type today. We just don't see it having a significant impact. And to the extent that your question deals with what is the competitive implication of that -- to the extent that the cost goes up. Costs will go up for others, there is a tremendous amount of sourcing of these kind of products today, in low-cost countries. So from that standpoint, I don't think it would significantly change the competitive landscape and it would still be beneficial, in terms of our Business.

There is actually another component to that, Rob, to add to what Roy said. The Fastec organization has done an outstanding job as they innovate into new products that are bidding patents, or trademark protection on what they've done. So they've got a track record of getting, not only sourcing as a low-cost, but protecting that for a couple, three-year period.

Okay, that's helpful. Thank you.

Your next question comes from David Manthey of Robert W. Baird. Please proceed.

All right, thank you. I was wondering about the gross profit margin. Again, it seemed like if you excluded the commodities impact from a year ago period, that the first quarter would of been sort-of flat year-to-year, and then the second quarter was down 100 basis points on the same basis. And if I'm hearing you right, at least in the monologue, it seemed like you didn't really change your cyclical view that much, in terms of where we are in phase one, two and three. Correct if I'm wrong on that, but if that's the case, I'm just trying to justify that with -- well, you said there's been a shift in the mix of business. And then, finally, if you could discuss if there's any commodities impact on the GP this quarter, you could discuss pricing up or down, and then rebate levels.

More than one question there, David, but we'll try to get an answer for you. As far as the phase, if you look at it in a big component, it was a first, second and third; and we still think we're in the second phase. We're, obviously, moving further into that phase. We did see continued growth in our project business, which supports moving in to that -- more deeper into that second phase level.

As far as the quarter-over-quarter, the 140 basis points difference in the gross margin, we tried to communicate it, the bulk of that related to the inventory products -- profits. So, 80 plus basis points. So that leaves mix taking care of another big component of that, I would say, of what was left, two-thirds of that -- there's another component we didn't talk about, that essentially, in my mind, puts it, I think at being [indiscernible]. We had a flat comparison. We'll put the gross margin on parity to what we had in the second quarter, and that relates to our level of supplier volume rebates. They are at a good level, they're moving along.

But in 2004, in the second quarter is when we were getting a better visibility on how strong the year was. And we had some catch-up in the second quarter, which puts the supplier rebates for that quarter a little bit higher than what we would have seen if we had perfect vision and then been able to go back and put exactly one quarter's worth in each quarter of the year. So if look at the inventory profits, you look at the mix shift, you look at a little bit of additional -- as a percent of sales, supplier volume rebates in the second quarter of 2004; match that up to the second quarter of 2005, you can get to where the gross margin is essentially flat.

I don't think we've lost any ground, in that regards. We have seen, if you think about what has happened over the past two to three quarters, was a lot and a fairly high degree of supplier price increases that we have been aggressively pushing through the channel. We've seen that slowdown, somewhat, and we're optimistic that we'll continue to -- because there's always a lead lag impact on being able to push those price increases through -- that we'll get that totally caught up, and we'll be able to continue to address and grow our margins through the Lean and other initiatives we have in place.

Okay, that's very helpful. I appreciate that.

There's a different way of thinking about that, too. With the activity that manufacturers have on attempting to raise their prices, they come directly at us. And then we have to take that into the marketplace to thousands of customers. So it is an enormous amount of work to go through that process.

A different way of looking at this is that, you just have to be candid. We don't get all of those price increases through. Nor do we get them all through on a timely basis, or through 100% There's some, if you will, yield loss that occurs. So the difference to say flat, is actually margin improvement in other areas that, in effect, offset any failure or shortcoming to push price increases through to the end customers, either completely or on the same time cycle.

I wouldn't say that there hasn't been ant margin improvement, there's been a fair amount of it. It's just difficult for us to track the exact pluses and the exact offsets. That's another dynamic that's working through this process. It's also the reason, I believe, we're going to see some improvement as we continue to work on pushing through and renegotiating, and essentially, capturing additional pricing which will have a favorable effect on the margins.

With regards to your question about pricing and the impact in the quarter. As I'm sure you tack these things also, there has been moderation in steel pricing. The big issue for us, on pricing impact, is that we're seeing a return, now, to a pattern of making more modest and more regular price increases. And it's just taking that up and passing that through on a continuous basis, has been a challenge that are working on. So I look at this as, frankly, a good job in terms of the ability to absorb and pas through the gross margins.

And lastly, I'd just say, and I remind everyone of this everytime we talk, there is an obsession of looking at gross profit margins. And again, we try to manage this Business to the operating margin line, recognizing that there can be good and valid reasons why there -- either by business unit or particular customers within a business unit, you can justify a lower price, a lower margin, because you have a lower cost of serve. Again, we focus on the operating margin line, it's the blend, obviously, of gross margins and of operating expense; and would put equal pressure on both of those categories.

Got it. So as we move through the year, here, assuming that we beyond the mountain of commodities impact. Let's just say on operating margin, the year-to-year delta there, should increase over time, naturally. Because what you're saying is the 4.6 in Q2 '04 was artificially high by 80 basis points or something, based on the spike in commodities prices.

A different way of saying that is that every quarter, perhaps, has things that maybe are a little bit exceptional. And we try to interpret that, as do other companies, in terms of thinking about quality of earnings. I know they tell you 4.6 today is a much higher quality of earnings than 4.6 was in the second quarter last year, primarily because of the speed with which, and the magnitude of price increases that were occurring. We don't see that speed or the magnitude on the horizon.

So we don't anticipate any kind of big, if you will, benefit from inventory profits. Because if they are more modest and they're stretched out over time, we tend to manage our inventories, not on a speculative basis of buying in big quantities in order to take advantage of price increases, we try to keep close to the line on inventories and we're able, therefore, to pass through price increases as they occur as opposed to seeing them as inventory profits. In the second quarter last year it was such a dramatic run-up, that it did have a different kind of impact which was, in fact, a favorable impact because we were able to get those prices through and sellout inventory that had been acquired at a lower price.

Great, all right, guys. Thanks a lot.

Your next question comes from [Joe Garner] of Emerald Management. Please proceed.

Good morning.

Good morning.

Question for you, regarding -- Hughes Supply came out this morning and lowered their forecasts on a number of issues, most of which seem unrelated. But, two of the factors they mentioned were some softness of the MRO area, and increasing competition and the impact that it's had on pricing. I'm wondering if you could comment on both those factors and what you're seeing out there.

It would probably be inappropriate for me to comment on their specific situations because there probably no two exactly alike. But what I do know of their business, what they call MRO, I think, was probably their apartment and commercial MRO business. So it's really something, pretty much different from what we are doing. And I don't know that I could comment about those particular end markets.

With regard to their comments about competition and pricing, all I would say is, yes, we see exactly the same thing. Competition has been very aggressive and pricing issues have been very challenging because, as we are trying to achieve this pass through, if you will, there are distributors who may have lower costs inventories in their level of inventory, and they may or may not be willing to sell those products out at a lower price because they have a lower cost on them. They're trying to get an aggregate increase on the competitive situation can be very situational, and it's very widespread because of the fragmentation in our industry, generally. But I don't know any of the particulars. I'd just say that's not a surprise to me that they would be facing that kind of challenge.

Right, so on your MRO side, you're not seeing anything that concerns you there?

Well, I think the market dynamics are different from the market to market, but yes, we face those same issues every day in the MRO business. But we've been effective at managing the activity and the cost performance and the pricing issues. So I don't see anything that you say is a trend or a form of a flu that we will catch. I don't see that happening.

Okay, and then, finally, beyond Fastec, what are your thoughts on the acquisition pipeline? Are you seeing more and more opportunities out there? Would you expect more activity to follow in the future? How are you looking at that right now?

Well, I think we've talked the last couple times that we've had these conference calls that the activity levels have definitely picked up. There are more opportunities that could be worthwhile looking at. We do spend time evaluating and assessing different opportunities. My guess is that will continue, we'll continue to see opportunities present themselves. But we have a pretty disciplined process making sure that the types of businesses that we look at fit the strategic initiatives that we have, and the type of business that we have. And so we look at a lot of businesses, and there or a lot of good businesses, but they don't necessarily fit our particular profile. It is active, we are looking at others. But I don't have anything more than I can tell you, at this point.

And Joe, another way to think about it is, what we've done with the Company over the last couple years has really positioned it into a very strong position. Our balance sheet has been dramatically improved, we continue to work on these Lean initiatives and believe we have developed and demonstrated over the last few years that we've taken this Company and put it into a position that can deliver superior earnings results better than what you're seeing out there from other investment opportunities to generate 20%, 25% plus EPS growth, net income growth on organic sales.

And this has really positioned us very strongly to continue to work and leverage off the big base that we have. And then take advantage of opportunities like companies like Fastec and others. And we have a history of being an acquisitive company in the past, we do look at opportunities as they unveil themselves, or search out opportunities. But we position the Company as such that we can yield the type results we believe are appropriate for the shareholders without the acquisition straining. Having said that, in the improvements that we've done in the balance sheet, including the equity offering that we did back in December, has really positioned the Company in a good spot.

Okay. Thank you.

Your next question comes from Brent Rakers of Morgan Keegan. Please proceed.

Good morning, guys. Actually, this is [Michael Shepherd] calling for Brent. I was wondering about the SG&A line. I was just wondering if there's any one time or unusual events holding these numbers out sequentially, or if you believe you can maintain this level, going forward.

There's no one-time credits in there. Pretty much indicative of the Business. If there's a positive in 2005, through a series of design changes and other changes of carriers, we've been able to avoid bad surprises in the health care and the benefit cost areas. So it's behaving much as budgeted. Last year the costs were on the rise. But there's nothing, there's no credits in there, there's one timers in there, just good solid results.

Okay. And you believe this might sustainable -- you might be able to hold this level, going forward?

Depending on the mix of business and everything. But our goal is to continue to work to improve on these numbers.

Okay. All right. Moving on to the revenue side, I'm just curious if there was any impact from the [inaudible] in the quarter, either -- yes, benefiting the quarter?

Our number of workdays were the same both quarters. Shouldn't have been anything dramatic, there.

Okay. Then I guess, moving on to the early version of the quarter, were there any impact in the quarter, maybe to July results from that?

No. Nothing of significance. We didn't see it last year during that season, dramatically. We get a little bit of pick-up in our utility business when they're able to get out there and repair the damage to the lines. At the same vein, on the industrial side, to the extent a building gets shut down for a couple, three days because of flood damage, we lose a little bit. We don't view that as a big plus or a negative.

Okay. Can you guys make any commentary on any sales growth by month, maybe June or July timeframe.

What we did see during the quarter on a sales per work day improved throughout the quarter, with June being the strongest.

Okay, great. And then lastly, if you would touch just a little bit more on what you're seeing within the non-res construction markets. Some companies have decided to pick up there, and others seem almost a deterioration from Q1 levels. Any thoughts there? And what's your timing exposure to those markets, is it more front-end loaded, or back-end loaded as that end segment picks up. Any thoughts there?

Well, I can understand your question ,because like you, I've seen a wide range of responses. But as we indicated, we have a big position in the construction markets, and we are particularly well known for being expert at larger, more complex, more demanding kinds of project activity. We are anticipating to see that pickup over time. And we're anticipating that that will be a positive impact on overall profitability, whether you are looking at it in dollars or percents. So we expect that to be beneficial to us over time.

I will tell you that as most, I think, organizations would tell you, you don't get a lot of visibility in terms of what you will actually end up having as your base. We track what we call our backlog of booked projected business. And we also track leads and opportunities, and our backlog is very healthy at the moment. In fact, it is approaching record levels, as I indicated, our construction business is also approaching peak levels from 2001. So from where we stand today, there's been a nice improvement, and a nice pick up in that business.

Now, part of the reason that maybe there such wide variances is that because of the geographic spread that we have. Because of the multiple industries that we operate in and have access to, we have a very broad based construction and/or project-related business in commercial and institutional, as well as in industrial kinds of activities.

So I think the blend that we get, the opportunities to go after multiple markets, and the success that we have with the techniques and methods that we use, have positioned us a little better than some others. For us, the market is performing well, we're very optimistic that there's a lot more yet to come and assuming it does, it will be a positive impact on our results.

Okay, great. Thanks, guys.

[OPERATOR INSTRUCTIONS]

Okay. If there no other questions, then we will end this session. I want to thank all of the for your interest in WESCO. And we appreciate the opportunity to share the quarter's results with you and respond to your questions.

We've had a very good first half. A lot of things are going very well for the Company. I would tell you that the tone of the Business is quite good, and we look forward to giving you a report on Fastec and other matters as of the end of the third quarter. Thanks again, and have a good day.

This concludes today's conference. [OPERATOR INSTRUCTIONS] Have a great day.