Wesco International Inc (WCC) 2006 Q2 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the Wesco International Second Quarter 2006 Earnings Conference Call. My name is Onika and I will be your operator for today. (Operator Instructions.) As a reminder, ladies and gentlemen, this conference is being recorded for replay purposes. At this time, I would like to turn the call over to Mr. Daniel Brailer, Vice President, Director of Investor Relations and Legal Affairs. Please proceed, sir.

Thank you, Onika. Good morning. Thank you for joining us for Wesco International's conference call to review the second quarter 2006 financial results. This morning, participating in the earnings conference call are Mr. Roy Haley, Wesco's Chairman and Chief Executive Officer, Mr. John Engel, Senior Vice President and Chief Operating Officer, and Mr. Steve Van Oss, Wesco's Senior Vice President and Chief Financial and Administrative Officer.

Means to access this conference call by 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. 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, 2005, including the risk factors described therein, as well as other reports filed with the SEC.

The following presentation may also include a discussion of certain non-GAAP financial measures. Information required by Regulation G with respect to such non-GAAP financial measures can be obtained via Wesco's website at www.wesco.com.

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

Thank you, Dan. As you've seen by our earnings release, we had outstanding results. We continue to see success in our fundamental programs of driving double-digit organic sales growth, demonstrated by nine straight quarters of double-digit internally-driven growth.

Consolidated sales increased by 26% over the second quarter of 2005, driven by 16% growth in our base business. Second quarter sales for two businesses acquired in the latter part of the third quarter of 2005 were $107 million. Gross margins improved to 20.3% from 18.3% last year, due to improvements on comparable branch sales and higher margins from sales by acquired companies.

Productivity gains and reduced exposure to a specific bankruptcy situation resulted in operating expenses as a percent of sales at 12.7%, declining by 70 basis points from the second quarter of 2005. Operating margins at 7.1% expanded by 250 basis points over last year's second quarter, driven primarily by improvement in comparable branch operations.

In March 2006, we took a pre-tax charge of $4 million related to the write-down of accounts receivables from a major customer which filed for bankruptcy during the first quarter. Based on detailed discussions with the customer, the Creditors Committee, and receivable recovery firms, $2 million of the first quarter charge was reversed and recorded as a favorable adjustment in this quarter. The remaining $2 million reserve should be adequate to cover our estimated exposure at this time. Consolidated earnings per share were $1.05 versus $0.56 in the second quarter of 2005 and were the best ever reported by the Company.

Our focus on productivity improvements in all aspects of our business continues to produce outstanding results. The key measure of our personnel and cost productivity is operating profit pull-through. We define operating profit pull-through as the ability to convert incremental gross margin dollars into operating profit and net income. For the previous 11 quarters, we have had pull-through of incremental gross margin dollars to incremental operating income of 63%. Comparable operating profit pull-through for the second quarter of 2006 was 75%.

Our lean initiatives are producing favorable results in most areas of our business and contributed to improved working capital productivity during the quarter. This resulted in strong free cash flow of $32 million even after funding additional inventory and accounts receivable required to support the 26% sales growth.

Our balance sheet is strong and improving. Our debt/leverage ratio for the trailing 12 months was at a record low of 2.3 turns, and dropped by one full turn for the second quarter of 2005 and 1.2 turns from year-end. We have ample liquidity to fund organic growth as well as accretive acquisitions. The integration of the systems and operations of both Fastec and Carlton-Bates is progressing well, and we are on track to deliver synergies and operating performance in line with our expectations of 2006 earnings per share accretion of $0.45.

Let's now look forward. From our perspective, the overall economy remains stable with solid activity across our end markets. We are seeing good activity levels in our commercial construction markets and strong activity in our industrial markets for day-to-day maintenance, repair, and operating supplies. We continue to believe that an increased level of capital expenditures will be forthcoming in both the industrial and commercial markets, driven by factory utilization, occupancy rates, oil and gas, and utility industry initiatives.

In the first half of this year, we saw what we believe is the beginning of increase quote and bid activity for larger projects in many of our end-markets. As we have a relatively small portion of Wesco sales in the residential construction market, the long awaited and forecasted decline in the resi market will have little impact on our business.

In the past, we have explained that modest levels of predictable and manageable product cost increases, i.e., inflation, are generally good for our business. Volatility, and in particular, unanticipated rapid and steep declines, can be a risk factor. Over time, we have refined our processes and controls for dealing with rising and falling commodity prices, and we address our exposure to commodity-based products by tightly managing our inventory of those items.

Commodity pricing, primarily for copper, was quite volatile in the first and second quarter of this year. Copper commodity future prices ranged from $2.57 in the beginning of the second quarter, were as high as $4.07, averaged $3.37, and ended the quarter at $3.46. Our close attention to pricing, purchasing, and inventory management, and our sustained lean programs, have been particularly beneficial to us as copper and metallic wire and wire-based products now account for approximately 13 to 15% of sales. For the second quarter, we believe that a very good job was done in managing cost increases, including copper-based commodity products.

Previous work on pricing systems and discipline has contributed to continuously improving cost recovery. We estimate that as much as 7 to 8%, or approximately $80 million of our sales growth, was the result of pricing related actions selectively and carefully taken by our sales personnel across all categories of products. Going forward, we expect to see commodity and product cost pressures continue at a moderate pace. And we would expect to maintain or increase the sales levels in these commodity product categories.

We finished 2005 with a strong backlog of project activity, which has continued to grow. For the remainder of 2006, we expect to see the Company continue to gain market share and outpace the industry in overall sales growth.

Let's restate our operating philosophy, objectives, and expectations. We will continue to work on operational improvement projects to increase sales performance, personnel productivity, and operating margins. We believe that our double-digit organic sales growth performance can be extended. Gross margin dollars should increase at least as fast as sales with margin improvement initiatives offsetting any mix shifts towards increasing project business. Operating leverage and productivity initiatives are expected to sustain pull-through at 50% or more of incremental gross profit to operating profit on comparable operations.

Working capital productivity should be maintained on a days supply basis, and free cash flow over the next several quarters will be directed at debt reduction.

More specifically, for the third quarter of 2006 - historically, WESCO’s sales seasonality is such that second and third quarter are the strongest quarters and tend to mirror each other. The first quarter is generally the weakest, followed by the fourth quarter. Given our current view of the end-market and continuation of current trends and macroeconomic activity, combined with market share gains, we expect to see similar operating results for the third quarter to what we reported in the second quarter.

The tax rate for 2006 is expected to be in the 33 to 34% range.

Share count for the third quarter of 2006 is expected to be 53.5 million shares and average 53 million for the full year. The increase in share count is a result of the higher share price and the convertible debt put in place in September of 2005.

You may recall, last quarter, we communicated a new overall three-year target for operating margins in the range of 8%. We are off to a good start and remain committed to deliver on that target.

Again, we had a terrific start for 2006 and are looking for another record-setting year. Our view for the remainder of 2006 remains positive, and we believe that we are extremely well-positioned to capitalize on increasing non-residential commercial, industrial, and infrastructure construction projects. Despite difficulties in some industries, we also remain bullish on sustained good performance in industrial markets.

Our momentum is strong, and we look forward to another year of delivering excellent service to our customers, improving our operations, providing a rewarding and growth environment for our employees, and creating superior shareholder value.

At this point, I will open up the call for a question and answer session.

(Operator Instructions.) Your first question comes from the line of Curt Woodworth with JP Morgan. Please proceed.

Yes. Hi. Good morning.

Good morning.

Steve, you addressed the revenue impact from the price actions that you took this quarter. Can you comment on the P&L impact? Do you have any margin benefit to getting ahead of the commodity curve this quarter?

Yes, Curt, we do. I'd like to make a couple of comments. We talked about the impact on the top line, and that would be for all categories, including the copper impact, which has been the most volatile. I would also like to mention that we believe that this is a sustainable top line impact and that we don't see any significant changes occurring in the commodity prices in the near term.

As it relates to what would be the P&L impact of the commodity pricing relating to the inventory, it's not a precise science. But we estimate that somewhere in the $0.06 to $0.07 a share range would be the impact for the second quarter. We believe we would see a similar impact - given copper where it's at today - in the third quarter.

And so that's a cumulative benefit of potentially $0.14. Looking to '07, I know this is hard to do. But if you would see commodity deflation, is that--would you have to give that back or do you feel like there's other lean initiatives? Do you think you can continue to get margin improvement there? Just specifically on the gross margins up 190 basis points this quarter. It was a pretty strong performance - better than what we were looking for. So I'm just trying to get a sustainability of that trend and maybe talk to some of those drivers.

Well, you had really two questions there, Curt. One was the sustainability. And as you know, we're into lean for several years now. We look at it as a journey, a continuous process. We have a wide array of initiatives that are driving both sales top line progress as well as margin expansion, and we don't intend to let up on that.

Yes.

There would be--your second--so the answer is that we would expect to continue to drive gross margin initiatives to expand the gross margin and operating margins. We also commented that as we tend to get into the--solidly into the fifth part of the cycle and start to see some of the larger commercial and industrial projects come on-stream, we will need some of that expansion to maintain the gross margin percentage. We think the dollars will continue to expand and will offset any anticipated mix shift at this point in time.

If there were to be a significant movement in a particular commodity, it would have a one-time potential impact on the gross margin percentage. To put it into perspective, let's talk about copper, since that seems to be getting all of the headline attention today. What we estimate based on our business and cost structure and margins, if you saw a $0.50 movement or a 15% movement in copper prices, that would probably be in the neighborhood of $0.03 or $0.04 a share impact. So it's kind of .07 to .08 of a point for every $0.10 movement in copper that goes into place, that's pushed through the channel and sticks.

One thing that's important to realize is that the prices of copper that you see in the paper everyday moving $.10 and $0.15 is not indicative of what happens with the industries as most manufacturers have a portion - a significant portion - of their production--forward production covered by hedges. So the total actual impact is very difficult to calculate. We've worked very hard over the years to make sure that our systems are in place to allow us to do a very good job of identifying and pushing it through all industries. And we feel that our team has done an excellent job in getting that done.

Great. And one final question, if I may. On the large project business, can you give us a sense for how meaningful are those sales to you today? I think in the last peak of the cycle it was roughly maybe 20% of the revenue of the Company. So I assume it's a--you're starting from a relatively low base right now. Could you give us a sense for where you are today and maybe how--is that 20% number correct from the peak?

No, it's not--I mean, when we look at our--kind of our project business in total and it's a larger number than 20%. It's--.

--Okay--.

--Closer to the 40% range.

On large projects?

No, for our total projects.

Yes.

And large projects--it's a tough definition. We look at it depending on what kind of end market it is and also what time period it's over. We don't really track it specifically as a large, medium, or small project. It's a little bit anecdotal on that side of it. But there's some meaningful projects in our backlog and we have a pretty good mix of projects in the current results. We think it will be beneficial and we think it will be a business that will give good impact on our operating margins. And we would say we're not full into that swing at all. We're really just starting to enter it.

Great. Thank you very much, and congratulations on a great quarter.

Thank you, Curt.

Your next question comes from the line of Adam Uhlman with FTN Midwest Securities Corp. Please proceed.

Hi. Good morning. Great quarter. I was wondering if we could stick with this pricing environment topic, and if you could talk about the impact of the higher product costs for your customers--if you're seeing any indications that the volatility here in product costs are delaying any sort of project activity.

We are seeing some delays in project activity. And I think the good news from our perspective is - as Steve outlined - if you look at our performance and the strong double-digit organic growth--we've had both strong double-digit organic growth, both on the stock side of our business and the project side. So even with some of these deferrals and push-outs, we're able to deliver this very strong double-digit growth.

It's not like that can be put off indefinitely. We're still very--still have a very positive outlook through the balance of the year and into next year. So as those projects do come online, that will support our future growth, as we've discussed.

But to put it into a little bit more of a dialogue with customers, which you were asking about, it wouldn't be unusual for a customer to say, hey, the prices look like they are continuing to go up or they have spiked up. Let's wait and see what is going to happen. And then, when they go down, there is a tendency to say, hey, look, the pricing has gone down somewhat. Let's wait and see if it goes a little bit lower.

So what we have actually seen is some moderation I think in the customer--in some customers' behavior to recognize that they have to lock in a cost and a price at some point in time. And in a way that's beneficial for our business, both in terms of the ability to have appropriate conversations about pricing, as well as the ability to move forward.

But I will tell you, in any commodity business there is an enormous amount of price shopping going on. I think there is a tendency, broadly speaking, in financial markets to believe that price increases are automatic. And we went through a very long period of time in the late 90s and the early part of the 2000s that we were seeing no price increases. And it is extraordinarily different to get a price increase moved through into our customers.

The nature of our model is that we work with a relatively small number of suppliers and we have a huge number of customers. And so, suppliers can push price increases to us a lot easier than we can get them confirmed, validated, approved, and into computer systems for our thousands and thousands and thousands of customers. So this is enormously difficult work. I am particularly pleased that we started our lean initiatives on these kinds of activities three years ago because of that whole activity of process improvement.

Okay. Well, thanks, Roy. That's very helpful. And my follow-up question here is, John, if you could give us a little bit more color on the Carlton-Bates integration process. What's left there for the remainder of the year? And then, also, Steve, how much accretion have we already captured year-to-date of the $0.45 that's been targeted?

Okay. A quick update on Carlton-Bates. We remain extremely pleased with the progress that our Carlton-Bates team is making and the success of our integration efforts. We're seeing strong demand in the end markets for OEM and value-added services, specifically in semicon, oil and gas, and the people-moving industries. We see strengthening supplier support. As we've talked about before, we've got a number of broader, stronger supplier relationships as a result of acquiring Carlton-Bates, and we're seeing those benefits across the new combined Wesco.

And Carlton-Bates as a unit has come--comes out of the second quarter with a record-setting performance - all-time record - in terms of backlog, sales, productivity, and overall performance. So here we sit nine months after the acquisition closed and we're very pleased with the performance. We are ahead of our expectations in terms of the overall integration.

We still have the integration efforts running. They're intense. We have consolidated a number of facilities. We've consolidated a distribution center. We're realizing a number of sales synergies by aggressively working joint teams across Wesco and Carlton-Bates, focused on a number of different market verticals, as we've outlined in the past. And overall, I would say, again, our integration is on track.

Your question also asked--kind of implied when's the integration complete. We're in the midst of a system conversion. As we speak, in this quarter, we're converting Carlton-Bates to our new--to our [Wesnet] system. And, as we've talked about in the past, we also have a revision of that system. It improves the front-end user interface for sales and order entry--sales management and order entry. They're going directly to that new implementation. We've got--the initial results are very encouraging. And that's scheduled to be completed in the third quarter. We're on track. We're on schedule.

And I can tell you that that will be the one year point. So effectively, at the end of the third quarter, the integration efforts - the heavy lifting - will be complete. And we will have the foundation in place. We will continue to work on synergies and opportunities across Wesco. But for all intents and purposes, we'll be through the system conversion and the integration will be complete.

Adam, the second part of your question was where we're at with the accretion target of $0.45 for the year after the halfway mark. We're slightly ahead of halfway on the accretion. So we're well on the way to deliver that.

And let me just also add on--you didn't ask it, but I'm sure the question will come up. How are we doing with Fastec? We also are very pleased with the results with our Fastec acquisition. Our insights [in the work that] could provide to us, I think we're spot-on. We're seeing very strong double-digit growth.

Again, here we are at the--at essentially the 10-month point--10.5-month point, and we're seeing very strong double-digit top line growth, good performance across the operation. It has been very effectively integrated with our manufactured structures group. As we've talked about in the past, upwards of 70% of their end-market applications are in the manufactured housing markets. And we've got very, very nice momentum coupled with--coupled in those markets.

In terms of the Asian sourcing efforts, which the Fastec acquisition represented really a catalyst and gave us a set of capabilities for being more thoughtful about leveraging Asian sourcing. We've talked about that in the past. Let me give you a little history and put it in context. We're making very good progress there. The acquisition closed in August of last year. We had our first Asian sourcing trip in October. We placed our first PO's in November. We received our first shipments in February of this year, and I--as we've mentioned in the past, we expected customer deliveries would start in the early second quarter. We did meet that milestone. Customer deliveries did start in the early second quarter in the manufactured structures end markets.

The feedback from customers on quality and form, fit, and function has been very positive. In summary, we've met or exceeded our--kind of versus topical products domestically. And we've got our initial sales that result from Asian sourcing here in the second quarter. We expect ramping up in the third and the fourth quarter.

Overall, I would say our relationship with the Asian supply base is developing--developing rapidly. And we feel very good about the progress. The summary of Fastec as well is we feel very good about the team and the performance, and we're exceeding expectations.

Great. Thank you very much.

Your next question comes from the line of Steve Fisher with UBS. Please proceed.

Good morning. Just first to clarify the $2 million reversal. Did that flow through SG&A?

yes.

Okay. Great. And then, I think you were looking for 1 to 2% sequential growth, but it came in 5.5%. Where were things better than you expected, or was that largely commodity price?

Some of that was the pricing, but if we look, Steve, historically, we generally come in in that 5 to 6% range on a sequential basis. Some of it might have been a little bit of conservatism as we had an extremely strong first quarter. We thought some of that was related to a milder winter, as well as some of the FEMA activity in the Gulf Coast area. So if you take those premises away, it would have been from a seasonality and a historic standpoint pretty much right on with expectations.

Okay. And then, on the non-residental construction side with the bidding and quote activity that you were talking about. Is that largely new bids coming in or are you seeing kind of re-bids from previous work because of changing prices? I know you talked before about things being pushed out. But are you seeing kind of--is some of that activity actually just re-bidding?

We don't track it specifically as re-bid or new activity, but it would tend to anecdotally be more towards the new. If you look at the McGraw-Hill or the Dodge forecast, they're still calling for a very strong outlook through '07 of high single, low double-digit growth in those end-markets. And so, as we--our activity levels are good and we look forward to the next five or six quarters of strong activity in those areas.

John Engel, Wesco International SVP & COO: It--but for all intents and purposes, it's pretty much new bid activity. As Steve mentioned, the Dodge forecasts are still--are 8 to 10% sales growth forecasts for non-resi construction through the balance of the year into next year. And we're seeing broad participation across really in all segments across non-resi construction. We've got our backlog increasing, our bid activity is up, and so, we're--we see a positive outlook for that segment for the balance of the year into next.

Okay, great. And then, lastly, could you just remind me what's the visibility you have on the MRO business? I assume there's not much lead time there. But maybe you can just comment on--you were talking about sales in the MRO being strong. What's the trend that you've seen there?

It's been positive. And you're right - there's not a lot of visibility. And probably a better way to think and look at that is through the macro numbers or looking at manufacturing, employment, capacity utilization, and the like, which have seen some slight acceleration, but still quite strong given the last couple to three years.

It used to be, Steve, that writers would describe it as annuity business. We never ever considered it as annuity business. But if you think about sort of the bid activity that you were referring to in construction-oriented activity, the MRO business tends to be stickier longer-terms - the major commitments. You're generally getting a lot closer to the production requirements or facility requirements of the customer. And there's a--tends to be stronger reliance on organizations like ourselves.

Additionally, some significant changes have occurred over the last several years with organizations--industrial organizations scaling back. They're scaling back in their sourcing, procurement, inventory management, receiving activities, and the like. And they are as reliant, or more reliant than ever, on the skills and capabilities of the distributors. So our position in the supply chain has never been stronger, which is a--which in a way it doesn't provide exact visibility. But it is a--it's a comfort to know that the likelihood is that those relationships will continue next week, next month, and next quarter.

And so, the trend--as the quarter progressed, did that decelerate?

No, it did not. It maintained just to build momentum. And another leading--.

--We built momentum through the quarter.

We built momentum through the quarter. And our stock sales have very, very strong growth and that's an indicator. In addition, the industrial project activity, which you can think about as a precursor, is ultimately--will translates to MRO activity down the line, has also picked up throughout the quarter with existing customers. So the trends are we're positive through the quarter.

We've been a little bit contrarian, as you will recall, with respect to our outlook on the industrial market. It's a huge market. We recognize that there are outsourcing activities and moves to low-cost country kinds of changes that are taking place. But the industry as a whole is huge. And part of this outsourcing is to companies just exactly like ours to take on the roles that previously a company had their own staff being responsible for.

So from our vantage point, we're still very bullish on the industrial markets by-and-large. There are some soft spots and some areas of sensitivity - the automotive industry generally being one because of the dynamics going on right now. But by-and-large, we're bullish on the industrial markets.

Okay, great. Thank you very much.

Your next question comes from the line of Rob Damron with 21st Century Research. Please proceed.

Good morning and great quarter, guys. I wanted to ask you about the acquisition landscape currently. Your last two acquisitions last year have certainly been very positive for the business. But what does the landscape look like today, and could you talk a little bit about the competitive environment for new deals?

Hey, Rob. The landscape is littered with acquisition opportunities to a degree. There's a lot of activity out there. You're kind of in the second year or so in the distribution space with a lot of companies reporting some good numbers. Those coming out of the downturn '01 to '03 that maybe wanted to sell couldn't sell during that period of time. So there's a lot of opportunity out there. We're actively participating in looking at various opportunities. There's nothing eminent to announce at this point in time.

But we've been acquisitive in the past. We did a few last year. We're in this game. We know how to do it. We're going to pay a fair amount. We know how to integrate them. As John talked about, we've had a real nice success with our last two. And we'll continue to do it when and as appropriate. But there's quite a bit of activity out there from a--both from strategic players, as well as a significant amount of activity. Whether they are the final purchaser or not, they are involved in virtually all of the significant size deals that would be the private equity groups or the sponsors.

It's had a little bit of upward pressure on the pricing. I wouldn't say it's out of hand, but it's certainly not on the low end of what we've seen on historical multiples.

Okay. That helps. And then, just one other unrelated question. Could you just talk a little bit about the--your national accounts business, as well as your integrated supply - the growth of those segments during the quarter? And do you still see nice opportunities in those segments?

Yes.

Yes. Both of those have performed nicely. Integrated supply got off to a slow start in the first quarter in that it wasn't in the 20% range like it was in the past. It's--it had a real nice second quarter - double-digit. National account continues to be strong for us. It continues to be a big driver in strengthening us both in the market position, and probably as or more importantly, with our suppliers. When you take a national account you're now bringing a lot more focus and control of the type of products that go in. So we get very, very good support and lineup with our supply base. No longer do we--will we have to go at them one buy each and try to put together particular pricing. Across the country, as you know, in our industry, there's a lot of regional type pricing.

So we've got very good relationships there and continue basic--continue the number one leadership position in national accounts. And there's basically not a number two, per se.

A little more color on national accounts. As Steve mentioned, again, for both integrated supply and international accounts, strong double-digit growth. When you look underneath the national accounts umbrella, we saw very strong growth and balanced growth across all of the various--let's call them industry verticals, with really the exception of automotive. We saw some sluggishness in automotive. Roy alluded to that earlier. A little bit of softening in the foods industry, but still growth.

But the takeaway is we are seeing very strong balanced growth, but really across all of the various segments that we play in. And I think, as we've talked about in the past, we're focused on Fortune 500 companies and we've got north of 350 of the Fortune 500 companies that are our national accounts customers.

Okay. That's helpful. Thank you.

Your next question comes from the line of Deane Dray with Goldman Sachs. Please proceed.

Thank you. Good morning, gentlemen.

Good morning.

The question is utility spending. And I'd like to hear what you're expecting in terms of seasonally this year out of the utilities. We're entering hurricane season. There's big heat waves going on. How might the spending by utilities impact you the next couple of quarters?

Yes, Deane. Here's the opportunity. Maybe put utility market in context. When you think about the market and the drivers for that market, obviously, housing starts are a driver, capital projects are a major driver, ongoing maintenance is a major driver, as well as natural disasters. Overall, the industry remains firmly in the cycle of improving the infrastructure. When you look at what residential construction has done over the last two years, we're coming off a tremendous housing boom. And even with the residential construction slowing down, it's still at very high levels, which is a major driver, again, for the utility demand.

So if you look at investor-owned utilities, we're still seeing very strong efforts in terms of upgrading the aging infrastructure. When you look at the public power customer base, that's a more stable spending pattern. In that case, public power is owned by their customers and it provides a much--they have a longer term view for investing and that's a nice stable platform.

So when you look at it overall, Deane, we're seeing that we're in the midst of really just strong investment over the next four to five year period in the utility industry. We're bullish on the utility industry. We've been growing it double-digits. In terms of our initial--our performance coming through the quarter, we had increasing backlog and we've come out of the second quarter with record backlog in our utility business.

And specifically to your point, demand's high. And to your point, we're at the mid-point of the construction season now. And with this heat wave that's going across the country, that just adds additional fuel to the fire for a--brown-outs, et cetera. What are we going to do in terms of utility investment? So we feel very good about it. We're bullish on it. Our backlog, again, is at a record level and our overall sales performance is strong, both for stock and project activity.

And then, just--I believe if we have our numbers right, utility spend represents just under 20% of total revenues. Is that number right? And do you--I don't think you disclose your backlog on the utility side. But maybe directionally or a percent either sequentially or year-over-year, could you give a sense when you say the backlog is up?

Well, 20% is the right number in terms of overall sales mix. And in terms of--we don't disclose the utility backlog, but the backlog growth of utility is up very strong double-digit. And, again, it speaks to our comments around the bullishness outlook for utility.

Terrific. And then, the comment in the prepared remarks regarding expectations that Wesco will build market share during the course of this year. Now is that based upon--just give us a sense of your metrics and how you're looking at that. Is it in terms of organic growth versus the rest of the market? Is it in particular geographies? How are you measuring yourself that way?

We measure--we are--that statement's with respect to organic growth. And we've got a sense on what the overall electrical industry, distribution industry is growing. And we have been outpacing the overall market growth. And we're looking at it across Wesco.

In addition, when you look at the--when we look at our acquisitions, specifically, Carlton-Bates, we try to focus on those end-markets and make sure that we're kind of running at the same rate or running faster than our competition. And so, through the first quarter and through the second quarter, we're confident and we believe we've taken market share. And that's true for core Wesco and it's also true for our acquisitions.

Great. Thank you.

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

Yes. Good morning. Just a question regarding your comments on the third quarter guidance. Again, you stated that you expect the results to be somewhat similar to second quarter. And I think--could you just clarify--I think there's less selling days there and probably slightly more difficult costs from the hurricane impact last year. Could you just clarify maybe some of the organic growth rate assumptions that's embedded in that third quarter outlook?

Yes, Dan. The comps are a bit tougher, as you mentioned and saw that. I think what you're--I think what we're telling you--that we expect to get similar operating results, similar profitability. And that's a result of what we do and what our hallmark is, which is continuous improvement and--from a sales arena, from a margin arena, from continued leverage on cost control, continued implementation of our lean initiatives. But we expect to see similar--that will require improvement in our operations because you'll be looking at, as you said, some little tougher comparables in the--during the quarter.

And the only thing I would add is if you look at the last eight quarters--actually, six quarters, we've had tougher comparables because we're setting records in performance quarter-after-quarter. So it's something we're familiar with. And again, as Steve said, it's this daily focus and execution and continuous improvement with our breadth and depth of lean initiatives that we're using to drive our overall performance.

You did mention the fact that we don't know whether there will be any natural disasters. We hope and pray that there will not be any in terms of the social impact. And that could be a factor. But I will tell you, a lot of organizations are holding off, making sure that they are adequately prepared for a disaster - a hurricane - if one were to occur. And if one--or a series of serious storms do not adversely affect us, we're going to see a surge of activity in the latter part of the year.

So even without the incremental gain that we might expect to see from storm-related activity, I believe we'll see a lot of activity break loose even if there are no storms.

When you just commented that some of the customers are being a little conservative with some of their spending. You're saying that is more related to anticipation of some of these disasters, or is it more--?

--Well, it's highly--it's actually highly publicized that oil patch projects are--.

--Right--.

--In some cases contingent on the outlook for the hurricane season. So it's just a matter of the tendency to say let's make sure that we've got everything buttoned down in terms of our current activity, as opposed to looking at some of the launching of new projects. So we think that there's a latent, if you will, unlaunched project phase that we'll see in the event that we pass through the September/October timeframe without a serious storm.

Okay. The second question was I know you have initiated some projects a few years back to further expand and penetrate the commercial institutional markets with respect to MRO spend and so forth. And maybe just an update on that--those initiatives would be great.

The big news there, Dan, is revenues. That is, state and federal government revenues. And so, that will have a positive--that is having and will have a positive impact on schools, universities, hospitals, city halls, all manner of infrastructure. So, again, the outlook there is favorable. I think you can also see that in industry data, such as the Dodge reports produced by McGraw-Hill and others. So there should be positive impact in the commercial and institutional markets.

Okay. And lastly, I just wanted to get your thoughts on the recent announcement of one of your larger national competitors - their combination with another more regional player. I guess, to be [supply].

I [can] tell that.

And just your comment on anything--does that provide a near-term opportunity for you and just your general thoughts on that would be great.

Well, I presume that you're referring to the announcement regarding Rexel and General Electric Supply. If that's what you're referring to, that is expected to close in a couple of months. So in the short-term, there's not dramatic change taking place. We do believe that there will be opportunities, but we are not a Pollyanna. We know that there will be some potential for risks whenever a business changes, and certainly if it changes in the context of private equity ownership. There are going to be increasing challenges and standards and demands for performance.

Generally speaking, we look at that in a positive way. We believe that our whole industry can benefit from higher standards of the operational and financial performance, just generally speaking, and profitability pressures and the like that investors can put on a change in management we think can be beneficial just generally for the industry and from a competitive standpoint. But time will tell. We have a--we're watching it to the extent that we can. We're doing our best to try to listen to the noise on the street, so to speak. But there is no real short-term impact and no big impact that would significantly affect any of our forecasts or our outcomes.

Great. Thank you very much.

Your next question comes from the line of Barry Haimes with Sage Asset Management. Please proceed.

Good morning. I had a quick question about end-markets in relation to the 16% sales increase. You've already actually answered half of it mentioning that auto and food were kind of the weaker markets. But were there a couple of markets that were meaningfully above the 16% average? Thanks.

Generally speaking, we had broad balanced growth across the end-markets. And similar to the first quarter, the oil and gas sector was a little higher than the median. But for the most part, we had things in the low to upper double-digits growth. A nice balanced growth across virtually all of the end-markets, with the exceptions that we just talked about.

Great. Thanks so much.

Your next question comes from the line of Dave Manthey with Robert W. Baird. Please proceed.

Hi. Thank you. I know the question has been addressed, but in case you can clarify, could--can you quantify the amount of hurricane-related or FEMA-related sales in the third and fourth quarter of last year?

We talked about last year--a little bit from memory here, Dave. It was kind of in the $30 to $40 million range in the third quarter and slightly less than that in the fourth quarter. Some of that tailed into the first quarter, which would have been a less amount than the third and the fourth.

Okay. And then, I might be getting too granular here. But in terms of your guidance where you talked about 10% same-store sales growth--this is the guidance for the current quarter--and acquisition contribution. I believe you said 105 to 110 million and you ended up at 107, I believe.

Yes. Right.

Should we read anything into that in terms of the relative acceleration at Carlton-Bates, or am I just--am I over thinking this?

I just would--I would reiterate some of John's thoughts and they are both acquisitions are performing well, performing at the high-end of expectations and above their past performance. They are relatively non-seasonal during the second and third quarter. We will have some tougher comps on some other areas and through the third quarter of last quarter. But that's why we feel that these quarters are going to pretty much mirror each other on the top line basis. There'll be some challenges on the profitability. If you want to think about the accounts receivable reversal, we won't have that going into the third quarter. So some items like that, we'll have to have improvements in our operating results.

Additionally--we didn't talk about it, but we adopted back in 2003 the expensing of stock options. There were awards that were made in July that will add about $1 million non-cash comp expense in the third quarter. So we're still seeing--we're going to--we'll need to absorb that through improvements in other areas. So it's going to be--we felt that the second quarter results were terrific. And we're expecting to repeat that in the third quarter with additional challenges.

Okay. And just to fill that out then. Sequentially, from first quarter to second quarter, I believe the acquisitions contributed 107 million in each quarter. Is that a normal seasonal pattern first quarter to second quarter? I think you said second to third should be about--should mirror each other, right, in the top line?

Well, we don't--again, we don't even have both the acquisitions for a year, so I can't--a full year. I can't tell you what their normal seasonality is. We can look at some of the historical seasonality they had, but it's really a new ballgame. We're applying a lot of help with these both of these on the front-end marketing, the utilization of our lean techniques in the back-end. We don't expect to see them change dramatically. And if it did, they're not that large that it's really going to move the needle at this point.

Okay. And then, the final question. In the utility business, we've talked to some people in trying to understand the outsourcing play. Is there a difference between public-owned utilities and others in terms of their desire to outsource the T&B distribution? Because what I heard from one player was that the asset base that the utility would hold in T&B products would be a part of their rate base. And therefore, they could get a profit on that.

I'm just wondering, is that different from other types of utilities? Or any light you can shed on the outsourcing play there.

Just in an absolute term, the investor-owned utilities are more directionally inclined to outsource more. They are the larger players. They have more pressure on their--you said on the rate base. They used to be able to include the kitchen sink and everything else in the rate base. With deregulation, that's becoming more and more difficult. They are becoming more profit-oriented. And we believe--and the trends and what's in the industry literature is talking about getting refocused into reinvesting and having incentives to reinvest into the T&B infrastructure, which even if they held inventory in there, David, we would be the ones resupplying that inventory as it turned through the system.

So we view that as a positive development. That is somewhat different than what you'd see with the rural electric coops or municipally-owned power companies. But we don't--we've been good strong players in those markets. That was our heritage. That's a good business for us. They tend to outsource that historically. So as the spend goes, that should be beneficial for Wesco. As the spend increases in absolute term, regardless of whether it's through the public power or rural electric coop or investor-owned utility, that should be beneficial to Wesco.

Okay. Thanks for the clarification.

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

Yes. I wanted to follow-up on I think some of the earlier comments about pricing. I think you mentioned 7 to 10% - and I assume that's year-over-year - and then, an $80 million number. I was hoping you could give me--because I guess I thought last year between the first and second quarter the pricing environment was fairly flat. And I was hoping you maybe could comment on this year from Q1 to Q2.

First of all, it was 7 to 8%, not 7 to 10%.

Okay.

--What the price impact was. And in 2005, the second quarter versus the first quarter had a pretty good jump in it. That was the first time, you may recall, that copper really began to move and we had a pretty good boost from the second quarter to the first quarter. And this quarter--this year in 2006, there was more price impact we believe by a little bit than the first quarter.

So you're saying the pricing probably sequentially here is up to the order of just maybe 1 or 2%, something like that, sequentially?

Versus the first quarter of 2006? Yes.

Okay. Does that mean then--I guess, looking at that and looking at the timing of when copper really, really started to take off. Does that again imply that kind of the copper products that you're utilizing are lagging the actual raw material increases?

I think you've got to look at it as not just Wesco. You've got to look at the whole supply chain and the fact that I think everybody is focused on the spot market. And that's just what it is. It's the spot market for people that are buying things that don't have them under long-term contracts, really. And I think you need to talk with the manufacturers as well. This will roll through multiple quarters.

And what we view on this is what I call sustainable top line growth. If you look at where copper was--the spot prices in the first quarter of this year, it was like $2.25 on average. In the second quarter, it was around $3.30-something on average. Today, copper is 3.60, 3.70. If it maintains a three handle on it, we view that as a sustainable impact on our top line, which won't change.

Okay. And that maybe begs the other question. You had mentioned earlier about a $0.06 to $0.07 impact related to the price increases. And I just wanted to clarify that. Is that related to kind of just the revenue uplift providing an overall boost, or does that imply that that's the difference in terms of your product prices--or your product prices to your customers rising faster than your costs are flowing through?

The latter, not the former. What I would refer to it - as others maybe do - is a--.

--An inventory profit--?

--Inventory profit. So there's really two components, if you think about it. The top line revenue increase in absolute dollars, maintaining margins on that business in absolute dollars creates more dollars, which should be sustainable going forward. So that's kind of a--under the monitor is inflation. Inflationary pressure is good for a distribution company over time, as long as they can be managed and pushed through the channel, which, as Roy said, is not something that's automatic. But we have worked extremely hard with our lean initiatives, our systems upgrade, and with our people, to make sure that we're able to do that. Then on a more of a one-time basis relates to this inventory profit, which we said was in that $0.06, $0.07 range.

And then, remind me. You said, again, it sounds like for the third quarter that inventory profit is going to be a similar amount in Q3.

That's correct.

Okay. Okay, great. Thank you very much.

Thank you, Brent.

Onika?

Yes, sir.

We'd like to just take one more call. We're coming up on an hour for the conference call. So if you could just do one more call, that would be great.

Question.

One more question and then we'll wrap it up.

Your next question comes from the line of Sam Darkatsh with Raymond James. Please proceed, sir.

Good morning, folks.

Good morning.

Most of my questions, mercifully, have been answered. But one question that I would have. I think you mentioned, Steve, in your opening remarks, that you had 75% operating pull-through excluding the acquisitions. Was that correct?

Yes, sir.

I'm trying to get a sense of when you begin to anniversary those acquisitions, the tail-end of the third quarter and into the fourth quarter, what the overall pull-through might be. I mean, the--my gut reaction would be it would come up closer to the 75. However, the 75 would have been helped out by the $2 million reversal on the reserve. And then, also--.

--Right--.

--I'm guessing would be helped out by the pricing benefits as well. So how should we look at the core leverage of the business, excluding some of those kind of non-recurring or semi-recurring items?

You are correct in your analysis of the bad debt helping the core somewhat. I guess I would kind of reset it a little bit and just tell you our basic operating philosophy over time is to drive 50%-plus operating profit pull-through. To put that into perspective of why, first, other firms are not doing it, and, two, why it is such a high target.

If you looked at an industry normalized growth over a period of time of 5 to 6%, and then, Wesco's stated objectives are growing faster than market. So let's just take some easy numbers. Two points above that is an 8% top line growth. At 50% pull-through, given a distributor's cost structure is such that two-thirds or so generally relate to people and payroll-related costs. If you put normal wage inflation of 3 to 3.5% on top of that, and you put maybe 6, 8, maybe 10% on benefits, it would come to about 4%, which would say in a normalized environment growing at 8% continuously, you could add no headcount unless you got more productive in generating better gross margins on that and maintain a 50% pull-through target.

So that is a very, very tough target. We've been able to do a couple of things - maintain our headcount relatively flat for several years with our lean initiatives, and drive higher gross margins. And that's where we're getting the pull-through in excess of 50%.

So our long-term target is to continue to grow at that 50% target level. And that either means we can have no headcount additions or add-in an item where we've got to continue to do a balance of getting productivity up and increasing our gross margin percent. So a long answer to saying that over time it's not easy to maintain the 50%. That is our target. We've been ahead of that and that's been through a series of margin expansion initiatives and some help from an inflationary environment.

So I guess what my question is, Steve, then, if you backed out the bad debt adjustment and if you backed out the benefit of additional profits from the pricing, would you still have been over the 50% pull-through on the core business in the quarter? I'm guessing the answer is yes.

The answer is yes.

Okay. And then, the follow-up question to that would be once you begin to anniversary the acquisitions in the fourth quarter, would you expect the overall leverage or the overall operating pull-through to remain at this 60% range? Or would you expect it to rise a little bit because the core business has been having better leverage than the overall business for a few quarters now?

If you adjust for what you've talked about, what you might consider is some one-time items. The math would be such that when you include the acquisitions on the one-year anniversary, the pull-through should improve.

Okay. So it's not dependent upon pricing per se?

It's depending on doing the same things in the acquired business that we're doing in the core, which means maintaining cost controls, trying to get more efficient, and incrementally improving their gross margin performance percentage.

Understood. Very nice quarter, gentlemen.

Thank you, Sam.

Thank you. And thank all of--we thank all of you for your participation. We've had really outstanding results. I'm very proud of the organization. And I'm particularly pleased with the fact that we've been able to continue this organic growth run that we've had the last nine quarters - well over--well, the last eight quarters, more than 15%. In nine quarters I think we had the second quarter of 2004 was over 13. So we've had really terrific results and I'm very pleased with the performance of our sales team and our management structure. We've also had outstanding results from the two acquired companies. They've been a terrific group of people. They've fit in extraordinarily well. And our long seasoned and experienced Wesco personnel have really jumped in to provide a lot of assistance. And they're motivated by some of the things that they're learning as well.

So this has been a--clearly a win-win for the organization. Productivity is something that we think about every day and it's driving our record-breaking performance this quarter and for quite a number of quarters prior to that. And we anticipate that we'll continue to see productivity gains and as a result we'll continue our record-breaking financial performance.

Again, we thank you and we look forward to seeing you sometime soon. Have a good day.

Thank you for your participation in today's conference. This concludes the presentation. You may now disconnect. Thank you and have a good day.