Wesco International Inc (WCC) 2009 Q3 法說會逐字稿

Good morning, and welcome to the third-quarter 2009 WESCO International earnings conference. For your information, all participants will be in a listening-only mode. There will be an opportunity for you to ask questions at the end of today's presentation. (Operator Instructions). This conference is being recorded. I would like to turn the conference over to Dan Brailer. Please go ahead.

Thank you. Good morning, ladies and gentlemen. Thank you for joining us for WESCO International's conference call to review the third-quarter 2009 financial results. During the quarter, WESCO completed the previously announced executive management transition related to the Company's management succession plan. Effective September 1, Roy Haley is Executive Chairman of the Board; John Engel became President and Chief Executive Officer; and Steve Van Oss assumed the role of Senior Vice President and Chief Operating Officer.

Participating in the earnings conference call this morning are the following officers -- Mr. John Engel, President and CEO; Mr. Steve Van Oss, Senior Vice President and Chief Operating Officer; and Mr. Richard Heyse, Vice President and Chief Financial Officer.

The 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. Following the conclusion of this conference call, we will post on our website a supplemental financial data presentation that provides a summary of certain financial and end-market information provided in today's commentary by management.

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 SEC filings, including the risk factors described therein. 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 John Engel.

Thank you, Dan, and good morning, everyone. The final chapter of this economic downturn is not yet written, but it appears that a bottom is forming. Our current outlook is for the overall economy to recover slowly with continued contraction in non-residential construction in 2010.

With that said, we see excellent potential for value creation. Our customers and our suppliers are increasingly concerned about the integrity of their supply chains and are looking to do business with a smaller number of larger partners, which bodes well for us. The challenging market conditions and the expected duration of this downturn provide opportunities for share gain and additional acquisitions by stronger, well-capitalized companies like WESCO. Our Company is larger, more diverse, more profitable and financially stronger than during the last downturn in 2001 to 2003 and as a result, well positioned to gain ground during this period.

In the third quarter, we delivered stable sales and margin in the face of continued weakness and highly competitive conditions in our end markets. As you will recall, we experienced the initial effects of the economic downturn and a decline in our daily sales rates in mid-November 2008. We responded quickly and took actions to protect profitability over the last four quarters while continuing to invest in our growth initiatives.

Specifically, we have maintained our 100% contract renewal rate with our national account customers and have secured over 60 new wins since the beginning of 2008 while increasing our opportunity pipeline to an all-time record level.

We have strengthened our international operations by establishing several new foreign subsidiaries over the last 12 months. This geographic expansion strategy supports an evolution of our national accounts program to a global accounts management approach directly in response to our customers' increasing requests to address their needs outside of North America.

We have opened nine new communications supply operations within WESCO branches over the last year to geographically expand our data communications and security products footprint. These branches are taking share in their local markets.

We have established dedicated government and stimulus teams supported by a centralized lead generation and qualification group to target both government customers and stimulus-funded projects through proactive selling efforts earlier in the construction project cycle.

We have conducted six green/sustainability summits with large customer audiences in major cities across the US this year to provide education on the opportunities and benefits of energy-efficient buildings and data centers. This is helping to position our Company as a trusted business advisor and solutions provider for our customers as they work to cost-effectively meet their energy efficiency requirements and sustainability goals.

And finally, we are investing in local/regional markets, which offer attractive share gain potential such as in Edmonton, Canada where we opened a new distribution center serving the Prairie region and in Houston, Texas where we opened a new facility, which houses our industrial, construction, data communications, integrated supply and international personnel. This is in support of a one WESCO saturation strategy that targets the Gulf Coast region.

Now shifting to our productivity initiatives, we are on track to deliver over $140 million of cost reductions for 2009 and are maintaining our industry-leading cost structure and sales-per-employee performance. We are continuing to execute a series of comprehensive lean programs focused on improving the efficiency and effectiveness of pricing, purchasing, transportation, operations and customer sales and service. We are now in year six of our lean journey and see more opportunities to improve our business than the day we started.

As a result of our margin, cost and productivity initiatives, we are protecting profitability. Our operating margins are holding up well with 4% EBIT delivered in the third quarter versus 3.9% in the first half of this year.

In late August, we completed the exchange of outstanding convertible debentures with a new issue having a 2029 maturity. This very effective financing provides significant long-term funding flexibility with attractive after-tax interest rates. Richard will provide more detail on this transaction in his commentary.

Strong working capital management contributed to record free cash flow, enabling us to further reduce our debt and increase our liquidity position to a record level. Now that the A/R securitization and convertible debenture exchange have been successfully completed, we enter the fourth quarter with a strengthened capital structure, which provides the financial flexibility required to support our growth strategy of organic growth above market plus accretive acquisitions.

Now Richard Heyse, our CFO, will provide details on the third quarter and provide an outlook for the balance of the year. He will be followed by Steve Van Oss, our Chief Operating Officer, and Steve will then give you an update on our major end markets and various growth initiatives before we go to the Q&A section. With that, Richard.

Thanks, John. Good morning. During the third quarter, we continued to invest our resources on a series of growth initiatives targeting end markets with immediate and long-term growth potential, continue to execute on our cost-reduction and working capital management efforts and successfully completed a refinancing of the majority of our convertible debentures.

As John mentioned, our third-quarter daily sales rates were stable, which is a positive indicator that we have entered a bottoming process. Our industrial end markets had slight sequential sales growth while sales to our construction customers were down slightly. Adjusting for the negative impact of foreign exchange, consolidated sales at $1.15 billion decreased 28.5% versus the third quarter of 2008.

Reductions in product prices reduced current quarter revenue by approximately $35 million in comparison to third quarter of 2008. Backlog, which consists of firm construction orders for future delivery, ended the quarter down 8% from year-end and 1% from the second quarter.

Product margin showed slight improvement on both a comparable and sequential basis despite very competitive market conditions throughout the quarter. Gross margins at 19.2% were down 20 basis points versus last year due to costs associated with our inventory reduction efforts and lower supplier rebate rates. Sequentially, gross margins declined 10 basis points primarily due to expenses related to our inventory management efforts offsetting other positive factors. Our overall mix of business was consistent with the third quarter of 2008 and had minimal impact on gross margins.

In the last year, we have reduced nearly 1100 positions or approximately 15% of our employee base as part of our cost-reduction efforts. As a result of this and other initiatives, third-quarter 2009 SG&A costs were reduced $43 million, or 20% versus last year. We are on track to deliver over $140 million of operating expense reduction in 2009.

Approximately $70 million of the $140 million reduction is related to lower headcount, branch closures and other permanent actions. Approximately $45 million are related to incentives and freight costs that vary with business activity. The balance, or roughly $25 million, is related to the temporary suspension of benefits and mandatory unpaid leaves of absence. We do not anticipate continuing mandatory unpaid leaves of absence and benefit suspensions in 2010. Our actions to protect profitability are reflected in the third quarter's operating margin of 4.0% of sales.

In the third quarter, our all-in cash borrowing rate on total par debt value remained low at approximately 3.8%. This rate is higher than the 3.3% experienced in the second quarter in part due to the higher coupon rate on our new debentures. Exiting the quarter, our all-in cash borrowing rate was 4.8%.

The effective income tax rate for the quarter was 15.8% versus last year's second-quarter (Sic-see press release) rate of 25.2%. Without the convertible debenture exchange, our effective tax rate would have been 20.3%. This lower-than-expected rate was driven by the effectiveness of our tax planning initiatives.

Net income for the quarter was $33.6 million and resulted in an EPS of $0.79 per share versus net income of $63.7 million and an EPS of $1.48 per share last year. A pretax earnings gain of $6 million net of expenses and the associated tax rate impact of the convertible debenture exchange had a favorable impact of $0.16 per share.

During the third quarter, we successfully exchanged $357 million of our outstanding $450 million of convertible debentures. These new debentures are a long-term foundational piece of our capital structure. The new debentures have a 20-year term and are callable by WESCO after seven years and have no put rights for the debenture holders. Essentially all of our 2026 debentures, which total $300 million and $58 million of our 2025 debentures, were exchanged for $345 million of the new 2029 debentures. $92 million of our 2025 debentures remain and we expect those to be put to the Company in October 2010.

The combination of stable gross margins, operating cost reductions and working capital management drove strong free cash flow for the quarter. Year-to-date, we have generated $280 million of free cash flow, a record for the Company. This free cash flow has been used to reduce debt levels and improve our liquidity position. Our successful debenture exchange, the second-quarter renewal of our accounts receivable securitization and record year-to-date cash flow generation has significantly improved WESCO's financial flexibility. At the end of the third quarter, liquidity at $439 million is at an all-time record level for the Company. We are therefore confident that WESCO has ample capacity to handle anticipated future funding requirements.

Now I would like to turn to our outlook for the fourth quarter. In the fourth quarter, we anticipate a positive impact from our sales initiatives, strengthening in our industrial end markets and contraction in our nonresidential construction end markets. When these factors are combined with traditional fourth-quarter market seasonality, we anticipate a 4% to 6% sequential decline in quarterly sales.

Month-to-date, October daily sales rates are stable and consistent with third-quarter rates. Despite competitive pressures, we expect to maintain fourth-quarter gross margins at the levels experienced in the second and third quarter. While we will not reduce our focus on cost controls in the fourth quarter, we will experience some negative operating expense leverage due to lower sales.

Finally, our fourth-quarter interest expense will reflect the full-quarter impact of our new debentures. We expect our effective tax rate will trend up to 30% over the next several quarters with the fourth-quarter tax rate expected to be approximately 24%.

Our financial priorities remain unchanged -- to generate sales performances better than the market, to manage improved operating margins, to deliver upper quartile return on invested capital, to generate strong free cash flow and to maintain a strong capital structure. At this point, I would like to turn the call over next to Steve Van Oss. Steve will provide additional commentary on our end markets and growth initiatives. Steve?

Thank you, Richard. Good morning, everyone. I will be providing some insight on the activity levels for each of our major end markets and our actions relative to those markets. Sales to our construction, industrial and OEM and utility customers were down 29% in the third quarter versus last year and were down slightly sequentially. The sales declines were broad-based across our end markets and have continued at a similar rate into mid October.

Looking at construction, sales to construction customers were down versus last year in all geographic regions. Sequentially, sales were down slightly at 2%. Backlog, which includes construction-oriented firm orders, declined slightly in the third quarter at a rate comparable to sales. While the Architect Buildings Index has continued to reflect rapid declining levels of activity, recent forecasts from Dodge indicates that starts for the primary nonresidential construction market segments of commercial, institutional and manufacturing buildings are forecasted to be down $3 billion, or less than 2% in 2010. Construction expenditures, however, are forecasted to be down in the mid-teens.

Our construction sales and service initiatives continue to be focused on large, regional and national contractors, particularly those involved with healthcare, educational facilities, data centers, energy and government infrastructure-related projects where we expect to see the most activity over the next four to six quarters.

We have a series of major initiatives and opportunity with our utility, industrial and contractor customers in the $2.5 billion outdoor and area lighting market as innovations such as LED technology and stimulus funding provides catalysts for increased spending.

Data communications project activity and our opportunity pipeline in enterprise cabling and security remains healthy as our sales and marketing initiatives are continuing to yield positive results. Key wins during the quarter were posted in the government, education and healthcare sectors with seven project awards in excess of $1 million each.

Our data communications geographic expansion program utilizing existing WESCO facilities has resulted in the opening of nine communication and supply locations since this program started in 2008. We are planning on significant further expansion of this program in 2010. This branch within a branch expansion strategy increases cross-selling and service opportunities into our blue chip customer base. Our long-term outlook is for increasing bandwidth demand as customers will continue to use information technology to drive productivity improvements, invest in data centers, improve the security of their facilities and IT networks and seek green solutions that are cost-effective and reduce power consumption.

We have increased our American Recovery and Reinvestment Act of 2009 or the stimulus efforts. As discussed last quarter, due to project timing considerations, it is unlikely that the industry will see significant benefits from the stimulus plan investments in 2009. And in fact, in the near term, the stimulus plan may be delaying projects as customers wait for qualifications of projects for stimulus funding.

Our efforts around stimulus-funded projects are supported by a full-time leader and a team of over 30 personnel across our operations. Late last quarter, we launched an online WESCO stimulus clearinghouse, which provides our branch personnel with a centralized repository of qualified project opportunities in their local geographic markets. This target list of stimulus-related projects increased significantly in the third quarter as have early sales cycle activity levels, resulting in an active pipeline and new orders.

We have an increased level of confidence that stimulus-related opportunities will rise at an increasing rate into 2010 and 2011. In addition, we are encouraged with the overall results we are seeing in our targeted government market efforts, which resulted in government sales increasing in the third quarter 15% versus last year.

Also, we are seeing contractors put more emphasis on the financial health and stability of their potential distributors in their supplier selection and project award criteria. With our strong balance sheet, this is a positive trend for WESCO.

Moving to industrial, sales to our national accounts customers declined in the quarter driven by reduced MRO demand associated with low capacity utilization and tight purchasing controls. Our integrated supply and OEM customers, most of whom are diversified manufacturers, reflected the overall weakness in the industrial market and declined more than 30% as destocking pressures continued through the quarter.

National account bid activity levels were high in the quarter and our national account opportunity pipeline expanded to another successive all-time record level. The Purchasing Managers Index indicates a moderate improvement in sentiment by purchase executives as they commented in this month's report that, 'it appears the fundamentals for continuing recovery are still at work as inventories and sales are gaining balance.'

Purchasing executives at our customers continue to be concerned about supply chain integrity and are looking for large, financially strong companies to mitigate their risk. We believe our increased activity levels reflect their heightened concerns and overall favorable assessment of WESCO. Our customer facing initiatives continue to be focused on providing value-added services and selling the complete WESCO portfolio of products to serve our global customers' needs in MRO, capital projects and direct materials and value added assemblies.

We are encouraged with our national account customer wins in the third quarter where we added a total of six new customers across four different industries. We maintained our 100% renewal rate for the 13th quarter in a row, renewing eight customers and currently have a majority of the Fortune 500 companies as our customers.

Looking at utility, as a result of the economic downturn, industrial demand for power is reported to be an eight-year low and residential demand has declined at an unprecedented rate, resulting in our utility customers addressing primarily the required maintenance activities. Transmission-related and alternative energy projects remain a priority for our customers over the mid to long term.

Our response is twofold -- expanding the scope of our existing alliance business models to include high-voltage product categories and combining our integrated supply and project management service models to increase our scope of supply on large-scale transmission, generation and alternative energy construction projects, which are now receiving a disproportionate share of utility capital spending.

Additionally, we continue to see an increasing number of investor-owned utilities and public power customers apply for federal grant money under provisions of the American Recovery and Reinvestment Act, specifically targeting energy-efficient lighting, system upgrades and Smart Grid programs, which will require products sourced through the distribution channel.

The market remains active with bid requests and interest in our lean customer value creation programs and integrated supply capabilities remains high. We are actively involved in new customer presentations and remain well-positioned as utilities look to rationalize their supply chains, improve their inventory management process.

Our Canadian markets have fared better during the economic downturn and based on published data for the first half of the year, we have outperformed the market significantly. While sales on the Canadian dollar basis were down modestly, our backlog in Canada has grown throughout the year and at over 10% growth versus last year is at record levels. We believe we will see top-line growth in Canada in 2010. At this point, I will open the call for the question-and-answer session.

(Operator Instructions). Deane Dray, FBR Capital Markets.

Thank you, good morning, everyone. I am not sure who wants to take this question, but just the phenomenon of the past couple of quarters has been all about destocking and it didn't sound as though that was called out as a factor. Is that over and you are seeing that tide shift the other way yet?

Deane, good morning. We definitely would say that we have not seen the destocking come to an end. As we mentioned, we saw a sequential uptick in our industrial end markets. But I think you can take a look at that and think of that as destocking still occurring with us gaining some momentum. We had been adding new accounts and we had been increasingly trying to sell all our products and services to each and every customer.

Thanks. And then just with regard to pricing, can you just give us a sense of the impact of pricing in the quarter and then specifically address the issue whether you are seeing any big project rebidding or coming back, customers repricing?

I will hand it to Richard to talk through pricing and then I will follow on with kind of the dynamic we are seeing in the market.

Sure. Just on a year-over-year basis, pricing had about a $35 million impact on the quarter. Roughly $20 million of that was related to the impact on commodities, commodity prices and I think that is fairly consistent with what we have been seeing in the last -- in the second quarter and first quarter of this year. So really no big change there.

And I would say if I were to characterize the pricing environment, Deane, which is the heart of your question, it is very competitive. We are seeing a similar dynamic in the third quarter as we saw in the second. That is there are many more, I will call it, contractors bidding for new projects and those projects that are underway, there is increased pressure to look at price reduction and/or additional rebids.

So if you step back and take a look, a lot of capacity came out of the industrial market, the destocking has been occurring, it is not quite finished. On the construction side, we still have -- a large number of competitors are still in the market competing for a smaller number of opportunities. And the pricing dynamic, I would say, in the third quarter is very much similar to the second, which is highly competitive.

Just last question from me related to pricing is how do you reconcile the dynamics with copper price that is now expected to escalate in the face of broad customer pushback on getting prices through?

Deane, on the copper front, we have seen some real nice movement in this year, still below where it was last year. And I would say WESCO specifically and the industry in general is pretty efficient on the commodity side as it relates to copper content or steel conduit of getting that pushed through the marketplace. There is a little bit of lead lag on that.

As you know, we have talked many times that we address that by maintaining a tight inventory supply. Where we do have annual or multiyear agreements, we have specific breakouts in those contracts for commodity movement. So I agree that there is a sentiment out there, but I think the industry is relatively efficient at dealing with that phenomena because it has been really volatile since starting mid 2004.

Great, thank you for the color.

Hamzah Mazari, Credit Suisse.

Thank you. Could you speak a little bit about your own inventory levels and where they need to be right now given what you are seeing in your end market? You spoke last quarter of them having to come down some more. How should we think about that?

Good morning. We feel very good about our current inventory levels as we exit the third quarter and enter the fourth. As we have mentioned in the past, we are very much focused on our customer service metrics. We look at fill rate. We look at inventory availability for our high-velocity items. So we want to make sure we have in stock those items that our customers are going to need. We monitor that. And keep in mind, we have a distribution center network that feeds the branches and provides daily replenishments to our branches.

So if you look at our entire system, we have got a high degree of sophistication in terms of how we set our inventory stocking levels. Not to mention we are, for most of our suppliers, their largest customer, which gives us opportunity to command -- let's say if we are short in a particular product area, we can work that supplier to get that product.

So I would say we are in good shape. And just to bring a point to that, we have reduced inventory significantly over the last year and we have included some additional reduction in the third quarter, as we mentioned we would have in our last release. Presently, we feel good about the levels.

Okay. And then is it fair to say that your business is more mid to late cycle because of your exposure to CapEx spend and projects and so your top line is going to lag some of the lead economic indicators getting better by say six months? And assuming that non-resi doesn't take another huge leg down from here and sort of deteriorates a little bit, that implies that we should start seeing a stronger sequential growth in your top line sometime in the first half 2010. Is that a fair way to think about your business? I am not asking for guidance, but just some color around there.

We are relatively balanced across the cycle. I would say we are more balanced if you were to look at us over a 15-year time horizon since we spun out of Westinghouse. If you look at the acquisitions we have done, it created more balance, but I would say we are more biased towards a mid to late cycle.

Here is how -- here is how we are thinking about it and just to be very direct, we are presently going through our 2010 operating planning process, so we have not established how we are dialing up next year as of yet. But the way we think about it is we are seeing positive indicators on the industrial end markets. So in terms of our industrial and our OEM value-added assemblies, we are seeing sequential -- potential for sequential positive momentum, i.e., a tailwind.

On the institution and government segments, the I and G of C&G, we absolutely, given what our initiatives and the market and stimulus funding as a positive contributor, see that as the potential for sequential positive momentum, i.e., a tailwind.

Utility I would say is a mixed bag. As Steve mentioned, power demand is down for the first time in essentially a decade. So distribution, the D of T&D should have some headwind in 2010. Transmission through the substation will have some relative tailwind. We wouldn't say a lot. How does that integrate? We are sorting through that as we speak. And then finally as you suggested, the non-resi clearly is going to be a headwind.

If you look at the starts this year, down over 30% and McGraw-Hill now says starts next year will be down low single digit, but it is the time lag factor of a relatively long cycle industry. And so the put-in-place effect, we are going to feel the starts being down in 2010. That clearly represents a headwind. So that is how we are thinking about it from an end-market dynamic perspective.

And then obviously we are going through our process now of working all our growth initiative. We gave some deeper insight in this call about what we are doing and how do we integrate that into -- against the end market. And so as we have done in prior years, we will give very detailed color on that in our next earnings call.

Okay, thank you. That is very helpful. I appreciate it.

Sam Darkatsh, Raymond James.

Good morning, John, Steve, Richard. How are you?

Good morning.

Three questions if I might. The first one, looking at the sequential gross margin guidance, Richard, you were mentioning you thought it might be flat sequentially. I am guessing, do the inventory reduction efforts then continue into Q4 and then therefore, you are going to have negative pressure there? Or I mean I would think that that would begin to moderate, as well as you might be getting some sequential benefit from copper. And so I am curious as to why the sequential flatness in gross margins.

I think to answer your first question, yes, we are going to keep focused on inventory management. Effective use of capital is clearly a priority for us. I would expect -- we are targeting about a similar reduction in inventories in the fourth quarter as we had in the third quarter and so the costs associated with that should be about the same. Beyond that, as John said, it is a very competitive landscape from a pricing point of view. But we have been doing a good job on that front, so overall, our expectation is that the gross margin should be similar to second and third-quarter levels.

We ended up doing a lot of work on the product side of that and even in the second quarter with the gross margin being relatively flat, we have got our product margins up a bit and the offset was in the inventory -- related around the inventory areas. Also, as you know, tied to that is the rebates from suppliers and with the growth program bias in those, you have to have growth in the programs to maintain parity on a percent of cost of sales. So obviously, with sales being down, we lost some. That has been a major headwind on that, but the exciting part or the promising part, even in this competitive environment, is we have been able to have some success in our product margins across the board.

Second question. Your incremental cost savings in 2010 versus 2009, how would you quantify that generally speaking? I know you are going to have some of the discretionary spending cuts in 2009 return in 2010 or at least the spending come back in 2010. So how should we look at incremental cost saves next year?

Yes, the one-time discretionary benefits that we got this year as a result of eliminating those programs, we are going to reinstate those for 2010. That is our current planning construct. As we have mentioned before, we had $160 million of total cost savings targeted that we are executing against. We are going to deliver over $140 million of that in 2009. It is a residual that rolls into next year.

But the bottom-line answer on it is it is a function of ultimately how we size our 2010 plan because that is the process we are going through now. So it is a question of our growth initiatives, the level of investment in those growth initiatives and that -- once we have the 2010 plan solidified, that will speak to how much cost moves year-over-year. Richard, you may want to add some additional commentary.

I think you pretty much covered it all. We would expect to get the full-year benefit in 2010 of our permanent reductions that we made in 2009.

So you've got $20 million of overflow and then $25 million of discretionary spend coming back. So they net against each other, so how should we look at productivity then next year if cost saves net against each other?

Correct. The full-year impact of the permanent reductions is approximately $90 million. As we noted, we will see about $70 million this year and given the planning construct John mentioned, we expect to restore the temporary benefits suspension next year. But again, we have to go through our planning cycle and we will give more color to that in our next conference call.

Got you. Last quick question and then I will defer to others. John, in your answer to a prior question, you mentioned that you don't think the destocking from your customers have come to an end. Some other peers, distributor peers have mentioned that destocking, at least with their customers, they think has come to an end. Is that an issue of electrical versus other and market categories or a mix of your customer base or a share situation? How would you -- I know you -- I am asking you to put words in other people's mouths perhaps, but how would you reconcile that?

This is a not a WESCO-specific issue. I think we serve so many different end markets; it depends. Example, our steel customers, our steel customers began to bring factories back online in the third quarter and add back -- recall people that they had taken out and production levels are up. So if you were to say what has happened in terms of at least our view into the steel industry and those that we serve, destocking is over and you begin to see some uptick in sequential demand.

So I think that is where -- our statement we are very clear on. Overall, you look across all the various subsegments of the industrial end markets that we serve, we are stating very clearly that destocking has not stopped across the board; it is end-market dependent. Overall, we still saw that in the quarter, but I think the indicators are positive, but we still saw that occur.

Thanks much.

Matt Duncan, Stephens Inc.

Good morning, guys. Getting back to the gross margin for just a second, did you guys have any (technical difficulty) this quarter?

We missed that. You cut out at the end of that question. Could you repeat it?

Yes, did you have any LIFO layer liquidations this quarter that impacted gross margin?

No, we don't use LIFO. So we are on a non-LIFO basis for accounting.

And then when you look at supplier rebate levels, I would assume that they are down versus 2008. Are you trying, in essence, to accrue for that evenly throughout the year or is there some chance that there may be an impact there in the fourth quarter?

No, we attempt to accrue it at an even rate and the year-over-year rates of accrual are somewhat down.

Okay, fair enough. And then when you look at sort of the expectation for a slow recovery in industrial, I am wondering if you can kind of give us some color around that. And typically, I would assume that you would be hearing positive chatter from your customers, your order patterns might be changing a bit and industrial was up under 1% sequentially. Is that kind of activity starting? Are you beginning to see those early signs or are you referring more to sort of what you're seeing in the economic data than when you were talking about a slow recovery there?

Yes, I think you are seeing it in both. You are obviously seeing it in the economic data, the utilization rates are starting to trend back up. The Purchase Managed Index is in positive territory. The backlog of orders is in the right direction. The one that hasn't really turned positive yet and probably won't for some period of time is in the manufacturing employment area. That tends to lag as people are going to bring on full shifts or work some overtime before they commit to full-time employment.

But we have a fair amount of business and where we have worked with our OEMs on a direct material basis where we are getting future forecasts and they are starting to show some signs of strengthening. Certainly not back to the '07, '08 levels, but better than what we have seen through most of 2009. So I would say it is both. We are seeing it in specific customers and their activity level on the maintenance and repair and in their forecasts for their direct material where we work with that.

That's very helpful, Steve. And the last thing here, and I will jump back in queue, on the convert exchange and then also on your tax rate, Richard, can you give us a rough guesstimate as to what annual interest expense ought to look like on a go-forward basis? And then on the commentary that you will start at 24% in the fourth quarter, slowly ramp to a 30% tax rate, how long do we need to think about that process taking?

On your first question as I mentioned in the script we exited the quarter at about a 4.8% cash interest rate, and that is on total par debt value. And that fully reflects the impact of the convert. So I think roughly it is about a $13 million to $14 million year-over-year change in cash interest rate due to the convert.

What about for reporting purposes, I guess is what I'm getting at? What you going to have to report through the P&L?

It is slightly up. It gets, again, fairly complicated as far as the debt discount. But yes -- so I think overall, it is a modest difference. But the main effect is on the cash interest rate.

Sure. Yes, I understand that. I just want to make sure we kind of model it right so it doesn't goof up the -- doesn't goof up EPS estimates. But that is helpful. And then on the tax rate?

On the tax rate the -- again, the 24% rate was our effective year-to-date rate without -- when we remove the impact of the convert exchange. And that is a good number for the fourth quarter. And during the -- and 2010, we expect that there is going to be some tax law changes and some changes in some of our international structure that will move our effective rate up to approximately 30% next year.

For the full year then?

Yes, for the full year. And that should be pretty much in place, we would estimate, by the second quarter.

Okay, thank you very much.

(Operator Instructions). Shannon O'Callaghan, Barclays Capital.

Good morning, guys. Do you have a sense -- I mean can you quantify the impact this year on gross margins of your inventory management efforts, the volume rebates, anything else that was flowing through there that you think is going to go away?

I would say approximately about 30 basis points, if you look at the inventory management and recall this quarter is about 20 basis points. There is another miscellaneous 10 basis points of other factors related to rebates, etc. And I think that is a pretty good number overall.

And that was basically for the quarter and for the whole year?

Yes, I think for both on the year. We mentioned on the rebates we attempt to true that up and keep that at a full-year estimate rate. So that is for a full-year basis, those are the two main impacts that affected both the quarter and year-to-date.

Okay. And then in terms of commodity impact on the pricing, I mean you mentioned keeping lean inventories there. So when would we expect that to turn positive? I mean is it going to track pretty closely with a copper price chart we might see, or when do you expect that to go from a negative to a positive?

We generally see on the copper -- we have two components there. If you look at it year over year, it definitely had an impact on the top line, as Richard mentioned. We have already worked through it for the most part, so the margin percents were pretty good year over year and sequentially.

But it usually takes a period of time, maybe a quarter or so, for it to go through. And it depends on how fast it goes up and how much it goes up. Because there is a lot -- what happens with the numbers you will see on Comex, that is more on the speculative side. And in the near run, we can see, from our suppliers on the price sheet, sometimes they can go counter to where Comex is going. But generally, it tracks it over time. They want to make sure that it is going to hold as they try to push prices through. And we have a bias to help the suppliers push that price through the channel as quickly as we can because it helps everybody. So a couple of months lag typically on that for us.

And if you were to look at the supplier pro sheets, they are constantly updating those. They strategically -- each one of those suppliers, to us, has their own strategy on how they try to work price in. In general, they have been trying to push prices through and get the price sheets up. But the environment is very difficult. What we have been seeing is the price sheets have not been sticking.

Okay. And just last quick one, did you guys mention what severance charges were this quarter or next quarter?

No, we haven't and we did have severance charges, but they weren't material enough for us to call them out.

Okay, thanks a lot.

David Manthey, Robert W. Baird.

Hi, guys, good morning. You mentioned that industrial was up about 1% and construction down about 2% sequentially. Can you tell us what normal seasonality from 2Q to 3Q would be in those two segments? And then just one minor question beyond that is datacom, could you hang a number on what it was year-over-year in the quarter?

Normally, our typical seasonality, the second and third quarter on kind of aggregate sales, would be flat. What we have been experiencing for the last almost a year and a half or so have been a bit stronger in the commercial construction side. So it has been showing growth and if you look at it for all of 2009, it is relatively flat for the year when it typically would have been down in the first quarter and then grown a lot in the second and the third quarter.

So it has shifted and I think it talks do what we talked about, the economic environment with the industrial looking like it wants to -- maybe it has found its bottom and is looking to improve. We will see what happens going forward. It is a huge market. We have got I think absolutely the best program in place to take advantage of what is happening with the stimulus funds. And a lot of that is construction project-related and a lot of that is going to be related in the energy efficient [lighting], as well as datacom.

Datacom is, versus last year, is down, but it is down roughly half the rate what we are seeing in our overall business and it is doing pretty good. It actually grew sequentially third quarter versus second quarter. We talked about opening up facilities within a facility. We talked about doing nine of those so far. To put that into perspective, when we bought CSC, they only had 32 locations. So that is a significant number and we would look to really expand that. So we are pretty bullish on that. It is a lot of taking share and a lot of taking the opportunity of the stimulus spending.

Okay, Steve, just so I am clear on what you said here, at normal seasonality, it sounds like industrial would normally tick up a little bit second quarter to third quarter, which is what it did. Non-res probably would tick up a little bit as well, but it didn't. Is that how I am reading you?

No, I said that we would typically see second- and third-quarter activity levels in both of those being similar with generally a bigger pickup in construction second quarter versus third quarter, a lot related to weather. What we had been seeing was our construction business had been stronger on a relative basis, didn't fall off as much originally or as quickly. We talked earlier a little bit about the lag mid to late cycle kind of fielded the business.

Perfect. Thank you.

John Baliotti, FTN Equity Capital Markets.

Good morning. John, I had a question. If you think about -- you guys have been pretty realistic about visibility when markets are going to come back and I was just thinking do you have a feeler, as you think about 2010 or as you think about just the upcoming months, if you think about inventory levels before customers started shutting facilities and becoming more efficient and rationalizing locations, do you have a sense of where you think, if you index that at one, where with respect to that do you expect inventory levels to get? Do you think -- I mean if customers have fewer facilities, I wouldn't expect them to put as much stuff in because they have -- cause now they have fewer locations to put them. Do you have any feel for that?

I will just give you kind of a general sense we have based upon talking to both our customers, our suppliers. Keep in mind our suppliers have the same challenge, right, where they have decapacitized. If you kind of step back and put it in context, set the clock back a year ago, look at how much capacity has been taken out of the system over the last four quarters. Significant headcount reductions, factories being shut down, furloughing parts of workforces, etc., etc. You could pick any end market, submarket as part of industrial and you see that to a large degree. So we have been facing that.

I think that quite frankly, and I think we think that a number of our leading industrial companies, and even our supply community, as the end-market demand begins to come back, you are not going to see a rapid rebuild in terms of adding people back in, adding inventory back in, releasing the controls on purchasing, releasing the controls on capital because the leaders of these companies in essence have the opportunity to drive significant productivity. As that market demand comes back and pulls through the value chain, they will kind of add back not at the rate that the demand is pulling. I think that speaks to fundamentally -- this is going to be a long, slow recovery and that is our planning construct.

Right. But that can also be a good thing for you?

We think it is a very good thing for us from an industry perspective. The longer the downturn is, if you take a long-term view, it is a large market, highly fragmented, many small players. The longer this downturn occurs at these kind of levels with some sequential uptick, the more opportunity for it to begin to squeeze out the weaker players over time. The fact that this cycle is longer is different than prior cycles.

So it is fair to characterize that you are being realistic about the pace of inventory coming back, but if it does come back quicker, you are positioned for that as well?

Yes. That is our planning construct. We know we can react very quickly. We did it on the downturn, which no one forecasted this level of decline. We are absolutely extremely well-positioned to do it on the upturn. And if you recall, from the 2004 through 2007 timeframe, we had double-digit organic growth through 11 quarters. We had tight controls on our headcount and we got great operating leverage. So we know how to deal with a spike in the top line and we know how to manage that thoughtfully.

Okay, great. Thank you.

Steve Gambuzza, Longbow Capital.

Good morning. I just wanted to make sure I understood the comment on the impact of inventory reductions on margins in the third quarter. Was that 20 basis points of a sequential headwind from the inventory reductions?

Correct.

Okay, great. And it seems like cash flow was stronger in the third quarter than perhaps you expected at the end of the second quarter. Is that generally from greater-than-expected inventory reductions?

I think cash flow was a little bit stronger than what we expected, but I think we were pretty clear on our inventory targets and we met them in the quarter. So overall, that is a high priority for us being a strong generator of free cash flow and we are pretty satisfied with the results in the quarter.

And you expect an additional or a similar dollar amount of inventory reduction in the fourth quarter with a similar P&L impact, is that correct?

We are going, as John mentioned, we focus on managing our inventories very in a focused fashion. We are targeting to reduce inventories. As far as specific, we will be selective in what we reduce because we want to make sure we maintain service level.

If you were to take kind of a four-quarter view, our inventories peaked in the third quarter of last year. We brought them down successively each quarter Q4, Q1, Q2. The amount of drop from Q1 to Q2 and then Q2 to Q3, each successive quarter, it was less. And so Q4 may have come down slightly. We are going to focus on customer service levels. We feel very good right now, as I stated earlier, about our current inventory position to satisfy customers. And then we are very much poised as we see any sequential pickup to begin to add to our inventories appropriately. So we don't want to signal that there is a significant -- any significant further movement in inventories in the current quarter.

Thanks very much.

Dan Whang, B. Riley & Co.

Good morning. First question was -- well, I guess about -- your free cash flow -- you had good free cash flow performance probably better than what we all expected. What are the opportunities you see going forward on really managing the working capital? And I guess kind of related to that, I think I heard an additional mention of acquisitions and probably more so than the last couple quarters conference call and sounds like you are more actively looking there and what type of potential deals are you pursuing? And is that something we could hear more about in the next couple quarters or a little bit beyond that?

Richard, why don't you address the cash flow and then hand it back to me for the acquisitions.

We have touched on -- clearly, we are going to stay focused on being an efficient user of working capital. That won't change. And as far as use of free cash flow, recently our focus has been on improving our liquidity position. And clearly, you can see with our record liquidity as far as this quarter, that has been successful. I think on the M&A side, I am going to let John touch on that.

And just again if you take a four-quarter look at free cash flow, we are north of $300 million. It has been very strong and if you step back and think -- how should you think about that? It is us managing our working capital effectively and responding to this precipitous decline in end-market activity. We did the same thing with our cost structure.

But as we look forward, we will be thoughtful in terms of the appropriate investment in working capital to support sequential uptick in demand as we see it across our end-market segments. We tried to share a little more in detail this time in terms of where our investments are.

So let's come to the second part of your question, which is acquisitions. Look, they have been an integral part of our growth and value creation strategy having done over 30 since 1994 when we spun out of Westinghouse. We see ourselves as a good acquirer. We have a pretty stringent process in terms of how we identify acquisitions. We have a very healthy pipeline.

Look at the capital structure transaction we did this year, it positioned us to continue to be positioned to take advantage of outstanding acquisition opportunities. And as we have mentioned, we think the challenging market conditions and this expected duration of the downturn is going to give us opportunities to continue to do acquisitions that are very powerful additions to our portfolio and are accretive.

So the takeaway should be we are well-positioned to do it and it is a matter of right deal, right time, right place. We have a rigorous process.

I just would add to that, Dan. There is two ways to do the acquisition. One is kind of a formal process by the Company and the other way, which we don't talk about that much with this economic backdrop is giving us a tremendous amount of ability, is to pick up the pieces of a weak competitor. There is a lot of capacity in the market. We would like to see some of that taken out. We are also, while we are looking at good solid companies for product expansion or geographic market saturation, we are also looking at the weaker competitors and how we can kind of acquire a business by being aggressive on the customer front, as well as the employee acquisition front.

Right. I think just coming out of the last downturn, you probably steered away from acquisitions or weren't as active coming out of it, maybe waited a little bit more as the markets recovered.

That was really twofold. One was the balance sheet, the financial strength, the size of the Company is significantly better today than it was before and we are in position now to do it more real-time as the opportunities provide themselves to us.

Okay. So probably continue to target good opportunities perhaps on the OEM and the attractive parts of the business that you have historically focused on?

In terms of that, if you look at the acquisitions we have done, we have been clear, they have been very much, I will call it, product category and portfolio strengthening moves. We haven't just bought geographic position. If you look at a CSC, you look at a Carlton-Bates, you look at a Fastec, we could go on and on. So those that were done in the recent four to five years. So we see increasing opportunity to continue down that path. As we get additional products and services and we add them to our portfolio, we expand, we can plow through our national accounts business model, integrated supply model.

We have time for one more quick question.

Matt Vittorioso, Barclays Capital.

Yes, I will just pile in on the back of that question. Is there any sort of target leverage or max leverage that you will kind of manage to as you think about getting back into the M&A game? And then if you could just maybe prioritize, as things stabilize and you have such strong liquidity, is M&A at the top of that cash deployment strategy or are there other things or would you look to pay down debt as well?

In the near term, we will be cautious with the leverage. The Company is in great shape, but we are looking at the end markets and when they are going to recover in that regard. But if you think about it for a distribution company and the way we have structured our ability to grow the Company, the acquired assets become part of our borrowing base, the earnings come into that and it helps us kind of keep the leverage in check as we go up. But our bias in the near term would be to maintain lots of flexibility in the capital structure, but take advantage of a -- if it is a strategic acquisition, we would certainly look at the right way to fund that.

Yes, I mean our bias has been, over the recent quarters, to pay down debt. We have been doing that. And the capital structure transaction we did this year provides the flexibility to continue -- and that is in the business organically as well as through acquisitions. We do feel good. We don't think about a leverage ratio as an explicit target. It is kind of the outcome of our strategy. If you look at the other acquisitions we did, leverage will go up when they did the transaction, but we always had a target one year out and it had to be accretive and get leverage back in a reasonable target range.

The only other point I would make is, in the last downturn, our leverage ratio started with a seven. Now we are sitting here with a three. We feel very good about the strength of the Company going forward.

Very helpful. Do you guys have the debt balances real quickly or maybe I can get that off-line, but just curious what your revolver balance and A/R securitization balances were at the end of the quarter.

Matt, that is on the supplemental. I can talk to you off-line about that.

Great. Thank you very much.

Okay, I would like to wrap now. Thank you all for attending today's call, and we appreciate your interest and support of WESCO. We are successfully managing our way through these challenging times. We see these challenges, however, as an opportunity, an opportunity to strengthen the Company and build on and extend our market leadership positions. In the spirit of our lean culture, we are continuously focused on providing superior customer satisfaction, maintaining our cost leadership position, strengthening our team and delivering improved shareholder returns. We have strengthened our organization and talent base and have the strongest team we have ever had. Our extra effort people are our differentiator. With that, we are committed and remain confident in our ability to exit this downturn a stronger company. Thank you and have a good day.

Thank you, gentlemen. That does conclude today's conference. You may now disconnect your line.