Wesco International Inc (WCC) 2012 Q3 法說會逐字稿

Good morning and welcome to the WESCO third quarter 2012 earnings conference call. All participants will be in listen-only mode.

(Operator Instructions)

After today's presentation, there will be an opportunity to ask questions.

(Operator Instructions)

Please note this event is being recorded. I now would like to turn the conference over to Dan Brailer. Mr. Brailer, please go ahead.

Thank you. Good morning, ladies and gentlemen. Thank you for joining us for WESCO International's conference call to review our third quarter financial results. Participating in the earnings conference call this morning are the following Officers. Mr. John Engel, Chairman, President and Chief Executive Officer; and Mr. Ken Parks, Vice President and Chief Financial Officer. 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.

As you know, yesterday afternoon, we announced the acquisition of EECOL Electric. An 8-K was filed with our press release and presentation, and posted to our website. This announcement, along with our third quarter earnings, will be discussed in today's call. Additionally, relating to the -- to this morning's release of our third quarter earnings announcement, a supplemental financial presentation has been produced, which provides a summary of certain financial and end market information to be reviewed in today's commentary by Management.

We have filed a supplemental presentation with the Securities and Exchange Commission, and have posted it on our corporate website. This conference call includes 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 Reg G, with respect to such non-GAAP financial measures can be obtained via WESCOs 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. Our third quarter results reflect the continued effective execution of our One WESCO growth strategy. We delivered another strong quarter of earnings growth and cash generation against a backdrop of moderating demand levels in our end markets. Driven by both gross margin expansion and operating cost leverage, operating margins improved 40 basis points to 6.2%, the highest level since the economic downturn in 2008. Free cash flow exceeded our net income in the quarter and is up over 300% September year-to-date versus prior year. Our investments continue to pay off and our lean operational excellence initiatives are producing the expected productivity gains. We have now posted eight consecutive quarters of double-digit EPS growth on a year-over-year basis.

In the third quarter, organic sales per workday were up in all four of our end markets, industrial, construction, utility, and CIG, but sales momentum slowed considerably. The declines in organic sales momentum were principally driven by data communications and government, which were down approximately 6% and 10% respectively. Organic sales per workday varied across the quarter, and were up 4% in July, 2% in August and 4% in September. Overall, organic sales in the US were roughly flat versus prior year, while organic sales in Canada and the rest of the world were above 10%. While incoming order rates are positive, our fourth quarter is off to a slow start with sales currently trending below our third quarter levels. In July, we completed the acquisitions of Trydor Industries and Conney Safety products. These two acquisitions strengthened our product and service portfolio and support our One WESCO growth strategy of providing our customers with comprehensive supply chain solutions. The integration of these two acquisitions is on-track. We have now completed seven acquisitions since mid-2010 with annual sales of approximately $580 million as of their respective closing dates.

Last night, we announced that we signed an agreement for WESCO to acquire EECOL Electric for a purchase price of approximately CAD1.14 billion. This is a significant event for both companies, and we are very pleased to be making this announcement. It is a milestone transaction. EECOL was founded in 1919 as one of Canada's premier full line distributors of electrical equipment, products and services with approximately 57 branch locations in Canada and 20 locations in South America, in the countries of Chile, Peru, Argentina and Ecuador. EECOL has an effective warehouse-based business model focused on serving a broad set of over 20,000 customers in the commercial and residential construction, industrial, oil and gas, mining and utility industries. EECOLs annual sales are $0.9 billion with low double-digit EBITDA margins. The Company has established a long and successful track record of delivering above-market sales growth and profitability.

We have a high regard for the EECOL sales culture. Their team of more than 1,400 associates and their outstanding customer service capabilities and supplier partnerships, all of which compliment WESCO very well. The addition of EECOL expands WESCOs presence in Western Canada, and enhances our ability to grow and capitalize on the ongoing investments we have made across the Canadian market. In addition, EECOL will broaden our international footprint and our One WESCO capabilities in South America. This transaction meets our key acquisition investment criteria and is expected to be accretive to earnings by approximately $1 per diluted share in the first full year of operation. The transaction is subject to certain closing conditions, including approval under the Canadian Competition Act and is expected to close in the fourth quarter of 2012.

In summary, our investments are paying off, effective execution of our growth strategy continues, and we are pleased with our business results in the first three quarters of 2012. As we move through the fourth quarter, we are operating with a much stronger and more diverse business. Stronger and more diverse in terms of customers and end markets, products and suppliers, and geographies. Our long-term outlook for a multi-year economic recovery remains unchanged. We expect the economy to continue to recover slowly over the next several years. We are continuing to invest in our eight growth engines and our six operational excellence initiatives, and we remain focused on executing our One WESCO growth strategy while delivering strong results in this slower growth economic environment.

Now, Ken Parks will provide the details on our third quarter results and our updated outlook for the fourth quarter. In addition, Ken will address the EECOL financing and our post-closing estimated leverage and liquidity. Ken?

Thanks, John, and good morning. I'm going review the results in the context of the outlook that we provided in July during our second quarter earnings call. At that time, we expected third quarter consolidated sales, including acquisitions, price and foreign exchange, to grow between 9% and 11% year-over-year. Consolidated sales in the quarter actually increased 4.8% year-over-year and that included 4 percentage point contribution from acquisitions, an estimated 0.6% negative foreign exchange impact, and a 1.6% negative impact from one less day in the quarter compared to last year's 3Q. As John mentioned earlier, organic sales growth in the third quarter slowed from the first half. Adjusting for the impact of one less workday, organic sales grew 3% including a positive pricing impact of 0.5%. This was down from the 8% normalized organic growth we saw in the first half.

We reported at our August 7th Investor Day that organic sales per workday were up approximately 4% in July. In August, organic sales per workday growth slowed to approximately 2%, and then in September, came in at approximately 4%. September sales per workday did reach a record high. Backlog remains at a healthy level while core backlog declined 3% from the end of the second quarter, it does remain up 2% versus year-end 2011 with solid growth in Canada, as well as our international business. Four companies accounted for our acquisition growth in the quarter. Bruce Supply with annual sales of approximately $50 million was acquired in October 2011. RS Electronics with annual sales of approximately $60 million was acquired in January of 2012, and then in the third quarter, we rolled in the acquisitions of Trydor, with annual sales of approximately $35 million and Conney Safety products with annual sales of approximately $85 million, both of which closed in the month of July.

In July, we estimated that third quarter gross margin would be at or above 20%. It actually came in at 20.5%, or obviously, a 50 basis point increase over the prior year. Approximately half of that expansion was driven by acquisitions, while half came from improvements in the core. We continue to focus on our gross margin target of 22%, and we feel good about the progress against that during the quarter. SG&A for the quarter was $225.8 million, that's 13.6% of sales, and compares to $216.2 million or 13.7% of sales in the prior year quarter. Approximately $8.5 million of the year-over-year SG&A increase was a result of the four acquisitions noted earlier. Therefore, core SG&A was essentially flat on organic sales growth of 3%.

Core employment levels did grow 1% year-over-year, as we do continue to invest in our growth engines, but remained unchanged from the end of the second quarter. Sequentially, SG&A declined $5.4 million, that's 2.3%, even after absorbing $4 million of incremental SG&A from the Trydor and Conney businesses. That SG&A reduction was the cost -- the result of cost containment and productivity actions, which were taken in the quarter in response to the slowing sales growth momentum that we saw. In our July call, we estimated third quarter operating margin would be at or above 6%. Operating profit for the third quarter was $103.1 million or 6.2% of sales, and that's up 12% or 40 basis points over last year's comparable quarter. Gross margin expansion was the primary driver of the increase.

At our Investor Day, we outlined our objective to expand operating margin by 40 basis points to 60 basis points annually through the combination of both gross margin expansion, as well as operating cost leverage. We continue to progress toward that objective, and we're pleased to see the contribution from gross margin in the third quarter. Year-to-date, operating margin has expanded 40 basis points over the prior year. Operating profit pull-through measured as year-over-year incremental operating profit dollars divided by year-over-year incremental gross profit dollars, is a metric we use to drive operating margin expansion while continuing to invest in the business for growth. Over time, our objective is to consistently generate an operating profit pull-through rate of approximately 50%. Our reported operating profit pull-through rate was 49% for the third quarter, and is at 48% for the first nine months of the year. On the core, operating profit pull-through rate for the third quarter was 72% and 55% for the first nine months of the year.

Interest expense in the third quarter was $12.7 million versus $15.1 million in the prior year. And in the prior year, the interest expense number included a $1.8 million non-cash, one-time cost related to the write-off of deferred financing fees, which was a result of entering into a new revolving credit agreement. While our weighted average borrowing rate at 4.4% is flat compared to last year, cash interest expense decreased slightly due to lower borrowing levels. The third quarter effective income tax rate came in at 29.9% and is 29.7% on a year-to-date basis, that's consistent with our expectations. Net income for the third quarter increased 18% year-over-year to $63.4 million, and resulted in EPS of $1.25. This compares favorably to net income of $53.9 million and EPS of $1.11 in the third quarter of 2011. Of note, net income has increased at least 15% year-over-year for the last eight consecutive quarters.

For the first 9 months of 2012, net income was $175.3 million, that's up 24% over the comparable 2011 period of $141.4 million. EPS during the same time frame was $3.43, or up 21% versus $2.84 in 2011. Our trailing 12-month ROIC grew to 12.6%, that's growth of 70 basis points from the full year 2011 metric. We continue to progress toward our long-term 15% ROIC target that we communicated at the August Investor Day. CapEx was $7.2 million in the third quarter and $19.5 million for the first nine months of the year. We continue to invest in our people, our technology, as well as our facilities through both capital expenditures, as well as operating expenses.

Now, free cash flow for the third quarter was $67.2 million. That's 106% of net income and compares to free cash flow of $41.2 million or 76% of net income in last year's third quarter. For the first nine months of 2012, we've generated free cash flow of $170.1 million, or 97% of net income, well above our ongoing free cash flow to net income target of at least 80%. WESCO has historically been a generator of strong cash flow throughout the entire business cycle. As a first priority, we always redeploy cash through organic growth and acquisition initiatives to strengthen and profitably grow our business. Second, we work to maintain a financial leverage ratio between 2 to 3.5.

As we exited the third quarter, our financial leverage ratio was 2.2, which was down from last year's ratio at the end of the third quarter of 2.7. Liquidity defined as invested cash plus committed borrowing capacity was $489 million at the end of the third quarter. We expect to finance the EECOL acquisition on an all-debt basis with a new institutional term loan and through our current facilities, by increasing the size of our existing revolvers. We estimate that upon closing the announced transaction, our leverage ratio will be less than 4 when we include EECOLs trailing 12 months of EBITDA with liquidity of at least $300 million.

I will now take a look at the fourth quarter outlook. We continue to believe the pace of economic recovery will be slow, and that we're well positioned to take share and outpace economic activity, even in this slower growth macro environment. As previously indicated, we expect the EECOL transaction to be completed sometime during the fourth quarter, and that would be subject to the regulatory approval process. Therefore, our fourth quarter outlook does not include any results from EECOL. We expect fourth quarter consolidated sales growth of approximately 2% to 4% above last year's fourth quarter, and that would include acquisitions related growth of approximately 2% to 3%.

Year-over-year organic sales growth is expected to be flat to up 1%. Sequentially, organic sales are expected to be flat to down 2% from the third quarter. While different from the last two years, this is directionally consistent with the typical seasonal trend from 3Q to 4Q, which we usually see when sales have historically declined 2% to 4% from the third quarter to the fourth. In the fourth quarter, we expect gross margin to be at or above 20.2%. That's consistent with our gross margin rate for the first 9 months of the year, and we expect operating margins to be at least 5.6%. The fourth quarter effective tax rate is expected to be in the range of 30% to 32%. With this outlook, we now expect sales growth of between 7% and 8% for the full year with two to three points coming from acquisitions and approximately 5% of organic growth. This is within our expected organic growth range of 5% to 8%, but is moved to the low end as we see sales growth momentum slowing.

While we're not surprised by the moderating growth that we're seeing in the second half, it's clearly more pronounced than was expected at the time of our Investor Day in early August when we provided our first look at 2013. As always, we will closely monitor business trends through the balance of 2012 in order to better refine our outlook for next year both at the top line and on earnings. In addition, a fourth quarter closing of the EECOL acquisition would have a significant impact on 2013. Consistent with our past practice, we will provide an updated outlook for 2013 during our fourth quarter earnings call in January.

Now with that, I would like to open up the conference call for your questions.

Thank you. We will now begin the question-and-answer session.

(Operator Instructions)

At this time, we will pause momentarily to assemble our roster. And please also remind you -- please remember, too, limit yourself to one question. If you wish to ask a follow-up question, you may re-enter the question queue. The first question comes from David Manthey from Robert W. Baird.

First question, in terms of, as you're looking at the price you're paying for EECOL and the accretion, are we looking at two different time periods there? Is the 10 times EBITDA a trailing figure versus the dollar, is obviously 2013? I assume that's a synergized value? Could you just talk about the synergies you're expecting both in terms of magnitude and what areas?

Sure, the 10 times EBITDA is a trailing multiple, to answer that question. What we're looking at for synergies, as you know, we have a pretty good tax structure in Canada. We believe that rolling this business as we model it in, into our Canadian structure does provide us with tax related synergies. And as far as the remainder of the synergies, it's really rolling the business in as it is. It's complimentary to our existing footprint, and that's basically the makeup of the deal.

Okay, and in terms of the rest of the business, just so we have an idea, is D&A roughly similar to WESCO core D&A? In terms of the borrowing rate, you're assuming for your accretion calculations, if could you touch on that, and then the tax rate that EECOL will be coming in at.

Yes, as far as the borrowing rate, as we have talked about in the 8-K and in some of the other materials, we'll be entering into a new term loan facility. We've obviously already had some preliminary discussions with our bankers about what that looks like. And well, first of all, I can say based upon what's going on in the market right now, we're seeing a lot of -- we're anticipating seeing a lot of interest in this new term loan and the rates are running very comparable to what our existing variable rate portion of our debt portfolio looks like. So you can look at what the variable rate of our portfolio looks like and kind of estimate where you think the rates would be. The part of your question about tax rates, we have not disclosed publicly what our existing effective tax rate is in Canada, but it is lower than our overall effective tax rate.

Right.

And then on depreciation and amortization, we would expect it to the run at essentially the same kind of rates as we've seen for other transactions.

Got it. All right, Ken, thank you very much.

Thank you.

Thank you. The next question comes from Deane Dray from Citi Research.

Thank you. Good morning, everyone. For first question is, in for the quarter, any time I see WESCO coming in a little bit light on the top line, but then good progress on gross margins, good progress on Op margins and pull-through, it's usually -- mix is a little better, but also you're passing on what could have been unprofitable business. So can you provide some color both on mix and maybe on what businesses -- what types of business you might have passed on?

Good morning, Deane. Thanks for that question. I would say that has been our -- historically characteristic of how we run the business. That hasn't changed. We still spend a lot of time and energy, and focus our Management attention around, what I will use the term both customer selection and project selection. And so that's not changed. We clearly saw a down-shift though, in terms of demand across our end markets in the third quarter.

I think what was most notable to address your question first on the cost structure side, we began really working hard on kind of tuning up and taking actions on the discretionary -- several discretionary cost categories, and I think that ended up bearing fruit in the quarter. We did that as we started to see the slowing in the end market momentum as we went through the second half of the quarter and moved through the balance of the quarter. The gross margins, we're very pleased with. To be at 20.5% in a market that is down-shifting, we're particularly pleased with that.

In the Investor Day this year, Steve gave a little more insight in terms of the breadth of initiatives that we're working on and driving margins. And so we're going to continue to plug away at that, but I think we're hopeful that this represents a good data point and a good indication of that we're beginning to make progress on fundamental core billing and gross margin expansion.

And is there anything on the mix that you were going to call out?

Not really. I mean, if you look at -- from an end market perspective, it did contribute a bit, but not helpful. It actually created a little bit of a challenge because look at industrial being down in the very low single-digits. Construction, CIG flat, this is on a non-workday adjusted basis, and utility at 4% to 5%. The utility margins are a little different profile, as we've spoken over the years, than fundamentally industrial, and construction kind of falls in the middle.

So I would say that mix-wise, if anything, it didn't have a major effect. It may have presented just a little bit of a challenge. And we feel good -- given that challenge, we feel good about the gross margin. We feel particularly good, though, about the ability to deliver the operating profit pull-through, as Ken mentioned, on a reported basis is 15%, but when you adjust for acquisition, we were 70% plus, and we haven't been at that level for some time. So I think our cost actions, our productivity initiatives and just that focus of being very diligent around cost controls is still a hallmark of how we try to operate.

Great. Just the last one from me on the acquisition. What can you comment on regarding the EECOLs best practices? They're coming in with higher margins. Comment on the growth. They're obviously doing something well in terms of their approach to distribution, maybe the supplier relationships, the warehouse model. But what and how does WESCO expect to benefit from being able to take best practices from EECOL and then apply it to the rest of the Company?

If you look at EECOL versus WESCO side-by-side and say -- and first of all, let me say, Deane, it's a great question, there's a lot of similarities. The similarities are in culture, the customer service orientation, the way that they partner with suppliers, so there's a lot of similarities. They're very growth oriented. Their company has been around almost a century, they're private, and they've done exceptionally well in terms of outperforming in the market, so I think there's a lot of similarities. The one difference, which we're very excited about, is fundamentally, they're much more warehouse stock and inventory based.

So if you look at WESCOs profile, we have a terrific stock and warehouse business, but we also have this direct ship business and the ability to manage large, complex projects. And our mix is different than more of the classic independent electrical distributor. EECOL is large in size and scale, that capability, I think, is terrific. We'll get some good best practices out of that. In addition, you have to look at where they're positioned geographically, and they're predominantly positioned in the western half of Canada, which has fundamentally very attractive end markets in terms of growth characteristics. This is something we spotlighted in particular at our Investor Day. You will recall, Deane, you were there in Toronto earlier this year; it was Canadian-oriented.

And then finally, I think the South American business we're at -- represents significant upside for us. It's not just in South America. The majority of that business is in Chile and Peru, which are particularly attractive to us. If you look at the growth characteristics versus market, and the fundamental operating margin characteristics, it's not at an absolute level, but just in general, in a relative sense, it performs very similar to how our Western Canadian business does, which is also strong and well run.

Great, thank you.

Thanks, Deane.

Thank you. The next question comes from John Baliotti with Janney Montgomery Scott.

Can you guys -- obviously, a very good job on the gross margin that came in above what we were -- should have been expecting. The SG&A looked like you guys did a nice job of absorbing that extra bit from Trydor and Conney. I'm wondering, it seems that then you really haven't been able to get, or you haven't benefited yet from the accretion you're expecting, so that still sounds like that's to follow. Is that fair?

The accretion that we're expecting from --

The 10 to 15 -- the $0.10 and $0.05 from those two deals.

It's effectively in there, because if you think about the gross margin expansion, we said about 50% of that expansion comes from the acquisitions. In the quarter, that was primarily Conney and Trydor, so we've started to see some of the accretion in the margin line.

I mean, if you look at the gross margin, if you were to decompose it, as Ken mentioned, about 50% is from acquisitions, 50% is improvements in our core operations business, both billing and gross margins. Again, it's all those initiatives as Steve talked about at the Investor Day. The acquisitions that contributed, John, is not just Trydor and Conney. On a year-over-year basis, it's Bruce Supply, which was done in the latter part of last year, RS Electronics done in January, Trydor Industries and Conney Safety products done in July. So it's all four that contributed to the acquisition component of the gross margin expansion.

But they all did contribute.

And they all did contribute, including Trydor and Conney. They were done early in the quarter, so they did contribute.

Right. I wasn't -- I don't think we should have expected them to be getting the full benefit of that because it was still so early since they closed.

Fair, exactly. But they are beginning -- the integration, as John pointed out, are on track, and they are beginning to contribute.

Sure. I was thinking more to the fact that you haven't, despite the improvements in margin, you still haven't gotten the full benefit of those two yet.

Correct.

On EECOL, it's interesting that given the margins and given the business, it seems like Western Canada, for some companies, could be harder just because of the way things are spread out there. I'm wondering, how can you -- what benefit can you get from their business, let's say, in the US? Is it enough opportunity to bring that down here, in terms of some of their model as you were kind of talking about earlier?

No, I would say that best practice sharing across both companies will start, and it's what we do with every acquisition. So we could see some potential best practice sharing in terms of how we run large branches with -- that have a large footprint with inventory management and, or some of our DC concepts in the US, but that is -- I would say that is kind of tertiary.

Primary and secondary opportunities are taking advantage of the fundamentally strong inherent growth characteristics of the Canadian market and it's natural resource based, both in the tar sands, oil sands region. Of which both EECOL and our Western Canadian business are very well positioned geographically with capabilities, and in mining. So these long cycle industries in Canada, we view very bullishly over the mid- to long-term. When you look at the global macroeconomic environment, you look at the -- and you take a long-term view of the globe, we think the Canadian economy and the various industries are very well positioned over the mid- to long-term.

The reason we spiked out also our growth, in Canada, Rest of World, Outside of US, was north of 10% in the quarter organically, so that's without Trydor and Bruce. And so we've got very good fundamental organic sales momentum in Canada, and I think EECOL acquisition just positions us to continue to take advantage of that. The final point I made, which is inherent in your question is you know, spread out, tough landscape to do business. You're right. The reality is EECOL has been around since 1919; WESCO Canada has been in operation since 1922. So you have two companies that together, have been around the better part of a century, and I think history, reputation, location, experience, multiple cycles matters.

Right, I think it certainly makes it a defensible market share.

We're also excited, not to forget about the South American piece of this that adds onto our footprint in South America. They bring almost $90 million of sales that we add a to our existing footprint. And as we continue to expand in that area, that's a significant contributor, as well.

Could you just quickly comment on the return of invested capital. How does that compliment the progress that you've been able to make so far with the base business?

We will clearly take -- it will not progress on the rate that we talked about in the Investor Day call. We set a target for 15%. We still have that target. We need to absorb this acquisition, and we'll re-calibrate the timeline for the 15%, if it does change. But the 15% target is not out of the reach of reality with this.

Great, thank you.

Thank you. The next question comes from Steven Fisher from UBS.

Hi, good morning. Just trying to reconcile a couple of things. You said that EECOL is more a stock business, but it's also based in Western Canada, where I thought the growth was generally expected to come from a more project based opportunity set. So does that mean that they're going to serve those projects from a stock type of structure? And then I guess the real question is, what has to happen in the underlying EECOL business to achieve that $1 a share of accretion? Are you kind of relying on some of these bigger projects to go forward on a particular schedule?

When we say it's a stock-based business model, that's the way -- that's the fulfillment method, fulfillment method. And so -- and you get a sense of what the product category mix is laid out on the deck that we issued along with the press release. So we didn't talk about this as of yet, but when you look at the mix, and this is our current estimate, we'll ultimately do a -- as with all acquisitions, do a detailed product code mapping after closing.

But with that said, you look at their mix in the general supplies area, and particularly lighting, very, very attractive in terms of that product category, which lines up nice well our growth engine. So, Steven, think of it as the fulfillment method to serve that region is more stock-based, warehouse base fulfillment.

The reality is yes, capital investment -- these large -- tar sands is a capital investment driven market, but whenever these capital investments are being made, there's significant infrastructure that's built up around that. It's not temporary. So there's a tremendous amount of demand that flows subsequent to that.

In terms of the final question, what has to happen in EECOL, Ken addressed this. When you look at the dollar of accretion, the synergies that we have captured in our operating model are related to tax and our tax position and tax structure in Canada. In terms of the base business, we have a very good view of Canada. From a WESCO perspective, having been there, again, since 1922. We expect the EECOL business to continue to run at their current trajectory. That's our view of what they will do, and that's the factor in the model, and that's our view of what our WESCO Canadian business will do. So to the extent we get additional synergies, that would be up side to the dollar, if we get true operational synergies.

Okay, terrific. I will leave it there.

But again, we're not counting on that. We haven't baked that into the model.

Right. Okay, thank you.

Thank you.

Thank you. And the next question comes from Ajay Kejriwal of FBR.

Hello, thank you. Good morning. Congratulations on the deal. And maybe a couple on EECOL.

So Western Canada, natural resource based, I would imagine seeing nice growth last couple years. If you can maybe just share with us what the growth rate in that business, last couple of years, and then what you kind of expecting? I know you said sustaining the growth rate, but any thoughts beyond that? And on the synergies, that's the up side, so you, I guess, are bringing -- there are some common suppliers, but you obviously have a lot more suppliers. So is it possible to kind of leverage your supplier base and use their customer relationships to drive the up side?

As far as the growth rates, we don't disclose the specific growth rates, but as we've talked about, the growth rates in Canada have been higher than the overall average. So it has been a solid growth rate business. The synergies, clearly again, come from the tax structure that we have in Canada, and operational synergies would be on top of it.

And as part of that, Ajay, the operational synergies, we don't have factored in any supplier leverage or supplier synergy. To the extent that happened down the road, that would be up side. Again, I don't -- I think the real opportunity is, here's this terrifically well-run business, with an outstanding set of talent. I mean, the people that we've met in EECOL, we're thoroughly impressed with. The culture that they have matches us very well in terms of discipline, the way it's run, the customer service orientation, the ethics and integrity, and their reputation is impeccable with customers, and the way they partner with suppliers, they operate similar to us. So we just think this is a terrific combination, and what we're essentially doing is acquiring this terrifically well-run company that has excellent end market exposure.

These are higher growth markets. We expect the growth will continue in terms of what we've seen in Canada, the Canadian market is growing, the nonresidential construction market in Canada is growing. Our construction piece of the Canadian market, on the WESCO side, grew double-digits in the third quarter organically, and overall, it grew double-digits. So we're bullish on Canada. This is why earlier this year, we went and had that Investor Day and really shined a spotlight on our business up there. The composition, what our long-term view is, and in addition, what this acquisition does is bring us some terrific capability and position in South America, which is very attractive to us. And the substance of that, the strength is really in the mining vertical, which matches very well with WESCOs long running capability, it goes way back into the Westinghouse days.

So just directionally, is it fair to say that EECOL grew faster than your Canadian business last couple of years?

No.

No.

Okay.

Very consistent.

Very consistent with our Canadian business. Our Canadian business, and we have shared this before, has grown at a higher rate over the last three years than WESCO overall, which is what we went through in this some detail at our Investor Day in Toronto earlier this year.

Maybe one more on the fourth quarter. So as revenues kind of decelerate, how should we be thinking about the rebates?

Well, keep in mind that we're still growing year-over-year, right. So the rebates will continue to be -- we anticipate rebate volume to be essentially in-line with what we had expected, because, as you know, there are triggers and thresholds as you reach certain volumes.

Ajay, as you will recall, we're always -- we are looking at rebates on a full-year basis, and we do that as we go through every month closing, in our hard close every quarter. And so we have a view of what the full year is. What happens is, when you get into the fourth quarter, to the extent, we over perform or under perform our expectations, that is a factor. And it could be a measurable factor if we significantly outperform or significantly miss the top line. What's the more significant factor is the mix, because the programs vary by supplier -- and for a given supplier. There may be certain product categories that have unique and special incentives on it, if that's a particular product that's important [to us to] supply our new product launch or whatever.

And a lot of times, these SVR, supplier volume rebate curves, are nonlinear, so you hit a certain point and you kind of get an increased rebate rate back to dollar one, and there's all different structures that are in place. So I think, mix is the biggest determining factor. Last year, you will recall it was probably the nature of your question, that we ended up outperforming our view of what our sales would be in Q4. And also, the mix was favorable, which resulted in a significant benefit to supplier volume rebates in the quarter. So the volume helped, but also the mix was significant. So the mix is the factor.

Yes, exactly.

Very helpful. Thank you.

Thank you. The next question comes from Anthony Kure with KeyBanc.

Hi, good morning. Thanks for taking my questions.

Good morning, Tony.

Good morning. Just talked a lot about the Canadian construction market, obviously, for good reason, but just wanted to touch on the US construction market here. Obviously, incremental data -- well, first question is, maybe if could you gauge for us, how far would you guess below a normalized cycle do you think we still are, not relative to prior peak, but relative to what's a normalized construction market in the US. And then, with incremental data points coming out over the last several months to the positive, do you see any up side for expectations as we move into next year, or has your opinion of the construction market domestically changed at all?

We -- I won't give you a precise number. We're down -- I would say we're double-digits below where the normal recovery cycle could have and should have been, but it's not; first point. Second point is, here's what is encouraging. I'll give you a little color. One is the residential construction market is absolutely starting to recover. I think we have enough data points now that we see that recovery has started. Typically, residential construction leads the nonresidential construction recovery. This recovery cycle has been different in that it was industrial led, but it is encouraging to see the non -- the housing starts increase. And I think that's a positive factor going forward, for ultimately, nonresidential construction, which flows from that later in the cycle, plus our utility business. You know, as that drives, new meters starts.

In addition, I would say that -- and we are in -- obviously on a daily basis, deeply engaged with consulting engineers and design architects, and those activities are continuing. There's a number of projects that are in final design phases that have not yet been approved; that's kind of a six- to nine-month lag. So it's a great question, Tony. We had a view that not many others had a few years ago that non-resi recovery was a few years out, and we were wrong. Everyone else thought it was a bit earlier; we were kind of an outlier saying it was going to take longer. We were wrong. It's taking even longer than we thought. So -- but I think it's still out there in front of us, and again, the housing and resi construction recovery is an encouraging leading indicator.

Great. Appreciate that. Just a quick follow-up, more on the structure of WESCO now going forward with the EECOL in there. We've talked about in the past the achievement of the 6% EBIT margin being a benchmark or a watermark to be progressing toward. Now with this mix benefit, so to speak, coming in, does that bar get set higher, or does the time frame become a little bit more near term to maybe progress past that 6% EBIT margin on an annualized basis?

Great question. First, we're very pleased that we got north of 6% this quarter. To be at 6.2% operating margins, to get north of 6% with the challenging end market conditions and the top line we delivered, we're very pleased with that. And I think obviously, the acquisitions that we've done, this would -- obviously, it's not closed yet, and we've got to get through that process. We do expect that to close in the fourth quarter, but this would be our eighth acquisition since the middle of 2010, June of 2010, when we started playing offense again, and we launched our new WESCO growth strategy. Our One WESCO growth strategy with all the growth engines; it's the largest acquisition we've ever done as a Company by a significant margin.

As Ken reviewed at our Investor Day in August, the prior seven acquisitions, you know, all of them met our four key investment criteria, higher gross margins, higher out margins. That is part of our value creation strategy; it's got two legs. Fundamental priority one is organic growth above the market, and to do that profitably, and to have a 50% pull-through of the operating target. And number two is to do accretive acquisitions and operate within our leverage ratio ban, and then use the good cash flow characteristics to pay down the debt quickly so we can reload and do more acquisitions. So, we are working hard to close this acquisition, then we'll be back, as Ken said, to say what does 2013 and beyond look like. But I think this puts us, you kind of -- we take another step up the ladder in terms of size, scale, and fundamental profitability, we're very excited about that.

Okay, great, thanks. Appreciate the color.

Thank you.

The next question comes from Matt Duncan from Stephens Inc.

Good morning, guys, and again, congrats on the deal.

Thanks, Matt.

I want to look at organic growth trends for a minute. You said you were up 4% July, 2% August, 4% September, but the guide for the 4Q is kind of flat, up 1%. Should we extrapolate that to mean that, that's sort of what you're seeing so far in October, or is that, that you are maybe forecasting further deceleration?

In my opening comments, and you may have missed that, Matt, it -- so far in October, we are growing versus prior year, but it's at a lower rate than we delivered in the third quarter. It's early, but that's where we are today.

Okay. And then John, maybe as you look at the end market, can you talk a little bit about what you think is causing the deceleration that you're seeing right now, and should we expect to see that pick back up in 2013?

Yes, I think that's the question that all of us are kind of wrestling with. We're hopeful that it will pick up, but the way we run this Company is we're saying, look, the environment we're seeing now, if that's the environment that we're going to continue to have to deal with in the next couple of quarters, we need to execute in the context of that market. So that's how we operate. We're very consistent with that. I will just give you a few color points maybe that help.

We are seeing some of our customers are reducing their inventory on the industrial side. We talked a little bit about, if some of the activity levels in construction. Utility, we think we had a really nice quarter. We'll see where the other competitive data points come out relative to our growth, but that was a really nice quarter, we think, given the backdrop. We're still bullish on utility. The housing starts is a good leading indicator for future growth. But utilities are being very -- have a kind of a tighter vice grip on spending as we're going through the third quarter into the fourth.

We did win another new major IOU alliance agreement in the third quarter, and it's integrated supply for both power gen and delivery, so we're very excited about that, and that will start to really kick in, in the fourth quarter. Those take four to six quarters to reach full implementation rate.

Data com, very challenging. We didn't have any questions on that yet. But we are absolutely seeing kind of weak -- these weak construction markets and government activity levels, and IT spending constraints impacting our communications business. It's broad based, and feedback from suppliers and other sources have confirmed that demand is much weaker than expected for communications in the third quarter. So clearly, I think the markets have down-shifted, and it's relatively broad-based. Our focus is, and our -- is on our initiatives and how do we perform given this backdrop of still growing overall, but a lower growth rate.

Okay, and John, that color is helpful. Two quick questions on the EECOL deal. First of all, Ken, is there any help you can give us, as you look at that dollar of EPS accretion, what annual level of amortization of intangibles are you accounting for in that accretion estimate?

We're still working. Clearly, that's driven by all kinds of analysis around the valuation of the businesses and the components. It's early for us to tell that you piece.

Okay, and then looking at the post-deal leverage, it looks like you are going to be up sort of close to four times, I think. I know the high end of the comfort zone for you guys is kind of 3.5. So, does that suggest that maybe now you need to shut down the M&A in the very short run unless it's a small bolt-on, and sort of absorb some of the bigger deals that you've been doing. And how quickly are you hoping to get leverage, maybe back closer to the middle of your leverage target range?

I think the important part of that answer is that, you're right, we'll be a bit -- as I said, a bit below four as we anticipate at closing. That will come down nicely over a few quarters, and we'll be back within our range.

We've shown that historically. This is the largest deal we've ever done. It's very strategic and very compelling, in terms of what it does for us, and it's absolutely lined up with our strategy, so we feel terrific about it. In terms of your question on the pipeline and the process, M&A process, here's our view. We still have a very active pipeline. We're going to keep managing the pipeline and running the evaluation process in parallel. Here's the reason why. We're not going to shut it off and try to restart it again.

It's part of our offensive growth strategy. EECOL has been on our list and in our pipeline for many, many years. And EECOL is another example of our ability to execute and capture acquisitions of private companies in a non-public market auction process. The only way you can do that consistently over time is to consistently work the pipeline. So we're going to continue to do that, and it's our plan and our intent, and given how we've operated historically in the cash flow generation characteristics of this business, and our operating margin expansion goals and targets that we've laid out. That we're going to bring down that leverage ratio over the next series of quarters, and we continue to work the M&A pipeline in parallel, and we're going to continue to keep that as one of the key legs of our value creation.

Okay, great. Thanks for the color, guys.

Thank you.

Thank you. The next question comes from Adam Uhlman from Cleveland Research.

Hi guys, good morning.

Hey, Adam.

Can we dig into the SG&A expense for the quarter? John, you had mentioned that there were some temporary actions taken as demand slowed. I guess I'm wondering how you're thinking about that going into the fourth quarter. Have those turned into permanent actions, or maybe just a little more color on why the cost came in below what you thought they would.

Yes, they -- you know, I wouldn't really categorize them as temporary actions in the sense of what that indicates to me. What it is, is really, we have a bucket of things that are really non-payroll related discretionary expenses, and things that are much more variable that we -- as we saw the volume growth start to slow early in the quarter. We started to control those things, which allowed us to continue to not have to take kind of temporary actions that could turn into permanent. We were really managing the things that we could move right, the things that we didn't need to spend out of the variable cost bucket. So as you think about it for the fourth quarter, I think what I would tell you is that we will continue to manage those variable costs very tightly just like we have. And that's what I would think about as we move through the balance of the year.

Okay, got it. Then a couple of cleanup questions on EECOL. What's the -- there has been a lot of talk about the mining and other exposure that it has. I was wondering if you could just put some numbers around what the end market breakout looks like. We've got the product and the geographic in the slide deck, and then if you could also just talk to -- or if there's any supplier agreements you need to sign off on before the deal closes, anything that could hold it up.

No, as far as the further breakdowns, we're going to clearly have to continue to refine that as we continue to go through the process. We don't have -- as we get closer to closing.

Okay, I think with that --

Let's play -- we still have a few in the queue. I know with the acquisition combined with earnings, it's a lot of news. So let's, Dan, if it's okay, do you want to go another five minutes?

Yes, let's extend another five minutes.

Five minutes, then if we don't get to you, I think Dan and I are available starting immediately after the call until the wee hours of the morning, so.

Okay, and the next question comes from Steve Tusa from JPMorgan.

Congratulations on the deal. Just on the industrial side, are you seeing -- can you maybe just talk about the project spending on that front? Maybe just a magnitude of what you have seen a lot of companies on the industrial side of the house talking about, you know, pushing projection forward. Have you seen any of that? What is the magnitude? Have you at all changed your inventory buying patterns because of what you're seeing? You talked about some inventory reductions with some of your customers.

On the second question, no. I think you can see, our inventory is at a very healthy level consistent with prior year. We have a very disciplined process for that. We've made no change fundamentally to how we're managing inventory and working capital. And we're not seeing a wholesale shift of projects moving out, to answer your question. The market is challenging, it has been bumpy. But I wouldn't -- absolutely not seeing this shift of things fundamentally moving out. We do, though, have good insight in a -- again, on a design architect staff and consulting engineers, where projects are in various phases, and there are still projects that are kind of not at the approval phase that are kind of [loss the end] a little bit, but, no, we're not seeing a wholesale shift, Steve.

Okay, and then one last question just on the deal. Do we read into that it at all about your confidence in the macro? Clearly, we're not growing very much here. There's a lot of consternation out there. Does this mean that you're -- you think kind of recession is off the table, and so you're willing to kind of make this big bet? How should we read that from a confidence perspective?

I think you should look at in this way. Look at the profile of the company that we're looking to complete the acquisition of. The Canadian business and profile that they have in the South American business and profile that they have. So you look at those fundamental markets, what the inherent market growth rates are, how EECOL is positioned against the appropriate verticals in those two respective geographic markets.

And we've got good data around how we've been performing in Canada, right, which has been performing at a higher rate. So I think, you know, this is -- it's a terrific transaction and deal we hope to consummate here in the fourth quarter; we worked on it for many, many years. I think it just -- it's lined up, and given our view right now, very attractive organic market kind of growth characteristics in Canada and South America, as we look out in the next X years. So that's our view of it.

Right. Thanks a lot for the time.

Thank you.

The next question comes from Josh Pokrzywinski with MKM Partners.

Hi, good morning, guys. Just a couple questions. Can you talk about maybe some of the product lines in the quarter? How -- you know, lighting or medium voltage or some of the tech and telecom verticals did? Just trying to get a sense of what was better, what was worse.

Yes, I'll just spike out two. We had some lighting growth, so that was encouraging. Up a little bit, in the very low single-digits versus prior year, but sequentially, moved up very nicely. And so we continue -- even though the challenging construction markets aren't helping, in terms of new builds with lighting. The retrofit renovation and upgrade markets we're focused on and solid state lighting solutions, including control, we have a terrific set of suppliers, and we're working those aggressively.

So we're encouraged with kind of the building momentum of lighting. It is one of our growth engines; that's on the plus side. On the minus side is data com, as I mentioned. Data com was down 6% in the quarter and relatively broad based. And then the rest kind of fell -- you know, I think -- I've always wanted to spike out lighting as sequential growth, and kind of spike out data com in terms of the challenge and the decline, that kind of book ends it a bit.

Got you, so the rest of it, including automation, would kind of be somewhere in the middle?

Yes.

Okay, that's fair.

I mean, some may have been a little bit above, but they're the two that I want to kind of spike out for you.

Okay, and then maybe I missed it earlier on the call, but can you help me with the walk in SG&A from 3Q to 4Q? How much of that is the deal, then thinking the about kind of ex deal costs, what we would have expected for gross profit pull-through in fourth quarter?

Right, well, as we have said, we haven't included anything related to the acquisition of EECOL in our outlook. There will be some deal costs in the fourth quarter, but we have a pipeline of activity that's been going on for a period of time, and those costs will continue. So I would say they're not significantly different quarter-to-quarter. So I think the walk from 3Q to 4Q will be primarily driven by our continuing management of headcount, likely at the levels that we're at right now, as well as managing the variable cost part of the equation as we see the volumes growth continue to moderate. There's really no significant one-time big items, plus or minus, that in walk.

Got you, but just thinking about absolute revenue, it's more or less flat 3Q to 4Q.

Right.

But it seems like you get a little bit of erosion on the OpEx line, and I don't get the sense that you guys are curtailing a lot of that -- those cost controls in the third quarter.

We're going to be continuing to manage those costs through the fourth quarter.

Right, but then Op margins are going down.

Right, and what we've said is that we're expecting our gross margin part of the equation to be at about 20.2% in the fourth quarter, and that's really what drives the Op margin change.

Okay, that's fair. And I can follow up off-line with anything there. Then just body language from customers in terms of a pause in activity, and maybe some uncertainty around the election, fiscal cliff, et cetera, versus really wanting to sit back and feeling like they're out of organic opportunities. Are you getting feedback that this is a timing issue and we want to keep some irons in the fire?

I would tell you -- I wouldn't, and there has been a lot of talk about tying it to the election uncertainty. We're still getting -- our bidding activity levels are still very high. Even in construction, but particularly in industrial, and with utilities. And so I think there's still a lot of evaluation, and they're looking at what they can be outsourcing, what they should be outsourcing. They still have these very high, and they're higher than they've ever been, expectations for process improvements and savings in the supply chain. So, I think it's just a matter of -- they're still evaluating, seeing what's available, how can they improve their operations fundamentally, but there has been a pause in terms of actually pulling the trigger and doing the spending. Hopefully, that's something that springs back here shortly.

Got you. All right, appreciate the time, guys, and congrats on the deal.

Thanks, Josh. We're going to take one more call, and then we're going close off just to respect everyone's time.

Very good. That last question comes from Sam Darkatsh from Raymond James.

Good morning, John, Ken. How are you? Thank you for taking the call, I know it's a long, long morning. I apologize if these questions have been asked because my line got dropped midway through the call. Talk about pricing expectations for Q4, and I think four quarters in a row now, we have seen moderating trends. Are you seeing those moderating trends even perhaps decelerate further with the moderation in the end markets? Then lastly, Ken, at what point do you begin to de-leverage OpEx naturally over the next year or two with respect to growth rate, at what growth rate do you begin to de-leverage OpEx?

Sam, I'll handle the first one, and good question, because we have not had this one yet, and I know we didn't address it in our first comments, Ken, yours or mine in the beginning. As we sit here today, and I say this is notable. There's a significant reduction in the number of planned supplier price increases that will be announced in the fourth quarter, so your question is spot-on. We did see that kind of declining, as we went through the third quarter in terms of number of price increases and also the level at which the price increases were trying to be pushed through by suppliers with us, the customers, on the input side of the equation. And we've seen it, again, a significant reduction in those numbers as we sit here today for Q4. It's notable. So that's our current view.

It could change as we move into the first part of January, as we get into it, past the election and we're into the new year, don't know, but that's what we see right now. One thing I will mention, and we did outline in our press release and our supplemental deck, that was what our estimated pricing impact was, which was below 1%, and we had it at a 0.5%. That's something that's very notable in Q3. One thing I will mention, and we've found this to be interesting, as with our Conney acquisition, we didn't get a question about that, but we're very pleased with how that's starting. We've got some nice new wins since closing in July.

One particular global account asked for a centralized web based safety solution, which Conney could deliver and we captured that. It's not something we ever could have had before or ever could have participated in before. Also, we had an integrated supply customer where we were able to deliver substantial cost savings by switching to one of Conney's private label products. So we're very encouraged with what we've seen out of the gate with Conney. That's a backdrop.

In terms of pricing, Conney's pricing was roughly around 4% in the quarter, and so -- actually, probably a little better than that. So I think we really feel good about that addition of the portfolio, and we're learning kind of what that model can do and what the pricing power is, but I thought I would share that. We didn't get a question about that, I know, probably because the EECOL acquisition took up most of the questions, but Conney has been part of us now, just really for a few months, and it's off to a great start and we really like what we see. Ken, you want to handle the second part?

Yes, absolutely. As far as deleveraging OpEx, you saw us deleverage a little bit this quarter with 3% organic growth. We've looked at 2013, and we gave you initial guidance that said 7% to 11% top line with 5% to 8% of organic. Really, when we get to those mid single-digit level organic growth numbers is when we start to see solid deleveraging of the OpEx line. So I think the point, to answer the question, is as we see and start to define what the quarter calendarization looks like in 2013, that's when we can tell you, kind of as that starts to come back and we de-lever.

So what did you have in Q4 for an assumption for pricing, John? I'm sorry, I didn't know if you answered that.

Yes, that's in our -- we don't have that. We don't do that prospectively, as you know, Sam. All I wanted to share, it was approximately 0.5% Q3, that's in our supplemental. Right now as we sit here, it looks like there's a reduction, significant reduction, in the number of announced supplier price increases planned for Q4. I'm just speaking to kind of the general trend in the market, which I think was your question.

Very helpful. Thank you both.

Okay, let me now start with some closing comments. Thank you very much for your time today. I know we went a bit long, and your continued support. As with you can see, we're continuing to execute our One WESCO strategy of investing in our business and in our people to deliver above-market organic growth, plus accretive acquisitions. We've strengthened our global enterprise since we started playing offense a few years ago, and remain focused on producing strong shareholder returns. Thanks again, and have a great day.

Thank you. The conference has now concluded. Thanks for attending today's presentation. You may now disconnect your line.