Wesco International Inc (WCC) 2016 Q4 法說會逐字稿

Good morning and welcome to the WESCO International Incorporated fourth-quarter and full-year 2016 earnings conference call.

(Operator Instructions)

Please note this event is being recorded. I would now like to turn the conference over to Mary Ann Bell, Vice President of Investor Relations. Please go ahead.

Thank you, Gary, and good morning, ladies and gentlemen. Thank you for joining us for WESCO International's conference call to review our fourth-quarter and full-year financial results. Joining me on today's call are John Engel, Chairman, President and CEO, and Dave Schulz, Senior Vice President and Chief Financial Officer.

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 includes a discussion of certain non-GAAP financial measures. Information required by regulation G of the Exchange Act with respect to such non-GAAP financial measures can be obtained via WESCO's website at WESCO.com 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 the next seven days. With that, I would now like to turn the call over to John Engel.

Thank you, Mary Ann. Good morning, everyone, and thank you for joining us today to review our fourth-quarter and full-year 2016 results which I am happy to say are in line with our original and updated outlooks. Looking first at the fourth quarter on slide 3, workday adjusted organic sales were down 3.6% but grew sequentially reflecting improving momentum in our business. This marks the first time in five years we had sequential growth in workday adjusted organic sales in the fourth quarter.

Operating margin was in line with our expectation as we took additional actions to reduce our cost and improve productivity. Free cash flow generation remains strong, enabling us to reduce debt and get back within our target financial leverage range. And for the full year, sales operating margin and EPS were down versus prior year but were in line with our expectations.

We delivered free cash flow of over 150% of adjusted net income, our strongest performance since 2009. And also successfully completed the acquisition of AED last March. In addition, we also completed the early redemption of $345 million of convertible debt last year which simplified our capital structure, reduced our interest expense and eliminated future EPS dilution associated with these debt instruments. The new year is starting off as expected with January month-to-date sales down low single digits on a consolidated basis. And that is with a few days left in the month.

Now let's turn to the market environment, starting first on page 4 with our industrial performance. We experienced a 7% workday adjustment organic sales decline in the fourth quarter with the US down 5% and Canada down 14% in local currency. With that said, we are beginning to see improving momentum with our industrial customers. Workday adjusted organic sales were up 2% sequentially in the quarter and notably over half of our end market customer verticals or groups within global accounts are contributing to that sequential growth. US industrial production and capacity utilization essentially remained flat throughout last year enabling customers to defer capital spending.

Forward-looking indicators are positive and customers are becoming more optimistic regarding our future growth prospects. We had been focused on helping our customers achieve their supply chain objectives through process improvements, cost reductions and supplier consolidation. And our global accounts and integrated supply opportunity pipeline and bidding activity levels are healthy. We are well positioned to support our customers and their future growth.

Now turning to page 5. Construction sales declined 2% in the fourth quarter with the US down 3% and Canada flat to prior year in local currency. Sales growth with commercial contractors in the US, again, partially offset declines with industrial oriented contractors. These customers have been deferring or cutting capital investments in response to lackluster demand and ample capacity last year.

Our outlook for the nonresidential construction market is modestly positive this year with the overall market still below its prior peak. Recently we've been hearing of increased front-end engineering activities at some of our customers which is certainly a positive sign for future nonresidential construction activity. In addition, the trend towards lump sum projects is still in place which is a positive for WESCO because of our expertise in project management, cost control and risk mitigation for customers. Notably during the quarter we were awarded multiple contracts associated with the construction and maintenance of oil and gas facilities outside of North America.

Now moving to page 6. Utility sales were up 3% with the US up 2% and Canada up 5% in local currency. We experienced growth with each of our customer groups, that being investor-owned utilities, public power companies and utility contractors.

We have achieved five years of sales growth from scope expansion and value creation with our utility customers and this quarter WESCO was awarded a multi-year contract to provide power delivery and generation materials for a large publicly owned utility. As we have discussed the past, trends in the utility industry play well to our strengths, including continued consolidation of the industry, growth in renewable energy and customers seeking operational and supply chain savings. We are well positioned to benefit from these trends with our ability to provide complete supply chain solutions for our customers.

Finally turning to CIG on page 7. Sales declined 6% with the US down 10% and Canada up 17% in local currency. This quarter continued election related slowdown in federal government spending was partially offset by solid growth in bulk broadband communications. We expect continued market growth in data and broadband communications driven by data center construction and retrofits, cloud technology projects and cyber and physical security for critical infrastructure protection.

With that, I would now like to turn the call over to Dave Schulz to provide further detail on our fourth-quarter results as well as our outlook for Q1 2017. Dave?

Thank you, John, and good morning, everyone. Moving to page 8, we provided a fourth-quarter sales outlook of down 1% to down 4%. Actual sales were near the bottom of this range down 3.7%. As John noted, organic sales were down 3.6% reflecting a competitive environment across multiple end markets. Pricing was flat.

Our acquisitions of Needham Electric and AED added 2 percentage points to sales which was offset by the impact of one fewer work day and a small headwind from foreign currency translation. Our core backlog decreased 3% from Q3 to Q4, in line with typical seasonal impact and was down 3% from year end 2015.

Gross margin was 19.4% in the quarter, down 10 basis versus the prior year and down 30 basis points sequentially. During the quarter, we recorded several one-time charges that collectively made up more than the full reduction in gross margin versus the prior year. The largest of these was to resolve a prior-year contract dispute. No further liability is expected for this matter.

SG&A expenses for the third quarter were $250 million including acquisitions which added approximately $5 million of incremental SG&A. Excluding acquisitions, core SG&A decreased by $12 million compared to last year. This reflects our cost reduction actions over the last seven quarters to eliminate more than 950 positions and exit or consolidate more than 40 branches along with ongoing discretionary spending controls.

Operating margin was 4.6%, within our outlook range of 4.5% to 4.8%. Operating margin was down 20 basis points from the prior year driven by lower sales in the nonrecurring charges I just mentioned. The effective tax rate was 26%, down 200 basis points from the prior year adjusted rate and below our expectations of approximately 30% due to the impact of several one-time items. Going forward, we expect the tax rate will be about 30%.

Moving to page 9, our full-year results were in line with our original outlook range for sales and EPS provided in December 2015. Reported sales were down 2.4%, within the range of our original outlook of flat to down 5% and our updated outlook of down 2% to down 3%. Organic sales decreased approximately 5%.

Acquisitions added 3% to the top line while foreign exchange reduced sales by 1%. Gross margin was 19.7% for the year, down 20 basis points from the prior year, primarily driven by business mix. SG&A expenses for the year were $1 billion including 2015 and 2016 acquisitions, which added approximately $32 million of incremental SG&A. Excluding acquisitions, core SG&A decreased by $38 million or 4% compared to last year.

Operating profit of $332 million was $42 million lower than the prior year, or approximately 11%, as the benefits of cost management only partially offset the impact of lower sales in gross margins. Resulting full-year operating margin was 4.5% consistent with our outlook but down 50 basis points from the prior year. Excluding the impact of the Q3 convertible debt redemption, the effective tax rate was 28%, down 50 basis points from the adjusted rate last year and slightly lower than our outlook of approximately 29%.

Moving to slide 10, looking at the fourth quarter, we reported net income of $0.96 per diluted share versus prior year. Core operations unfavorably impacted EPS by $0.12 as the impact of lower organic sales was only partially offset by our actions to reduce operating costs. Tax and acquisitions increased EPS by $0.08 and $0.01, respectively, while a higher fully diluted share count decreased EPS by $0.04.

For the year we reported net income of $2.10 per share, including a third-quarter net loss from redeeming the convertible debt of $1.70 per diluted share. Setting aside this charge, we delivered full-year EPS of $3.80 per diluted share compared to $4.18 last year. Core operations unfavorably impacted EPS by $0.68, again driven by lower organic sales, partially offset by our actions to reduce operating costs. Acquisitions, taxes and share count increased EPS by $0.15, $0.07 and $0.15, respectively, while foreign exchange reduced EPS by $0.07.

Moving to page 11, fourth-quarter free cash flow was again strong at $78 million, or 164% of adjusted net income. For the full year, we generated $282 million of free cash flow, or 154% of adjusted net income. As John pointed out, our best cash generation performance since 2009. WESCO has historically generated strong free cash flow throughout the entire business cycle. Our capital allocation priorities remain the same.

The first priority is to invest cash in organic growth initiatives and accretive acquisitions to strengthen and profitably grow our business. Second, we target a financial leverage ratio of between 2 to 3.5 times EBITDA. Third, we return cash to shareholders through our share repurchase program. And we currently have $150 million remaining on our existing share buyback authorization.

At the end of 2016 our leverage ratio was reduced to 3.5 times EBITDA, back within our self-imposed target leverage range, as John noted earlier. Leverage net of cash was 3.2 times EBITDA, also slightly below last quarter. Liquidity, defined as available cash plus committed borrowing capacity, is $705 million at the end of the quarter.

Interest expense in the fourth quarter was $18 million. Setting aside the effective tax settlement last year, which reduced interest expense and increased tax expense by $9 million, this year's expense was about $1 million lower. Our weighted average borrowing rate for the quarter was 4.2%, consistent with historical averages. As we enter 2017, our debt is appropriately balanced between fixed rate and variable rate instruments. Capital expenditures were $5 million in the quarter and $18 million for the year. We continue to invest in our people, technology and facilities through both capital expenditures and operating expenses.

Now let's turn to our outlook for 2017 on page 12. For the full year we reaffirm the guidance that we provided in our 2017 outlook call on December 15. We expect sales to be flat to up 4% and operating margin in the range of 4.4% to 4.6%. We anticipate delivering EPS in the range of $3.60 to $4 on an effective tax rate of approximately 30% and 49 million shares outstanding.

Note that we will have one fewer work day in 2017 which occurs in the Q3 time period. We also expect free cash flow of at least 90% of net income. For the first quarter, we expect a decrease in sales of down 3% to flat, reflecting gradual improvement in our end markets.

As you know, the first quarter is seasonally WESCO's lightest quarter with sales generally 5% to 7% lower than the other quarters. As a result the first quarter is typically the lowest for operating margin. And accordingly, we expect operating margin of 3.8% to 4.1%. With that, we'll open up the call to your questions.

(Operator Instructions)

Deane Dray, RBC.

Thank you. Good morning, everyone.

Morning, Deane.

Maybe we can start, John, with your observation that you are beginning to see signs of a recovery. And you gave a couple specifics. You talk about sequential improvement, some optimism in the industrial customers, but maybe expand also on the comment that half of the industrial end markets are contributing. So maybe that's a good place to start.

Thanks, Deane. I think what was encouraging for us is particularly the improvement in industrial. It was clearly down year-over-year but it grew sequentially. That's our big end market segment. And it is really industrial sequential growth, Q3 to Q4, that helped drive the whole Company to slightly positive on a workday adjusted basis sequential growth, which is notable because that is not our typical seasonality.

When you get underneath of it, I think there are two things I would like to site. First, there are terms of bidding activity levels. They are strong. More specifically, for global counts and integrated supply -- those types of opportunities -- the bidding activity levels are up year-over-year and sequentially in the fourth quarter. So that is an encouraging data point and a good leading indicator.

Then when I mentioned about over half of the customer groups in global accounts were up sequentially, again, that is our global account customer segments that we reviewed with you in the past. And what I think is notable about that, Deane, is that two of the segments that are part of the segments that are up sequentially are two of our largest segments -- it is oil and gas and metals and mining. So they grew sequentially for global account relationships, Q3 to Q4.

So I think my sense is that -- and we gave some indications on where we thought the market was and our framework for 2017 in the outlook call last month. But I think now, in retrospect, as we look at the whole quarter industrial picked up. The momentum vector is positive. It is still very early days and it has a long way to go. And we are not growing again yet -- so as we said back in our outlook call. But I think we are encouraged by that start. And thus far in January, our sales are down low single digits and so, again, I think consistent with the momentum vector exiting the fourth quarter.

That low single digit -- that is Company overall. Correct?

That is consolidated Company overall.

Good. And then maybe on construction you had some reaffirm the outlook for nonres being up modestly. Any change in customer behavior, either through the election or any hesitancy to commit to projects given the expectation there will be some government funding on infrastructure? How do you see that playing out real-time?

Maybe I will first start with the composition of our results. US was down 3% in the quarter for construction. So better than Q3 -- not as good as Q2. Notably though Canada was flat. So if you were to look underneath the US, we had some regions grow, some regions shrink. So there was not a wholesale -- it's not like a wholesale decline across all portions of the US. It was kind balanced in terms of where it occurred or where it did not occur.

When you look at Canada, it is interesting when you look at it in aggregate. The prairies were down double digits. And that is the area that includes Alberta. And it has been most directly impacted by oil and gas. But the rest of Canada -- this is for construction only in Canada -- the rest of Canada grew to offset the prairies double-digit decline. So backlog is healthy, consistent with normal seasonality.

So that is how we are set up exiting the year and entering 2017. And I would say our conversations thus far are -- I think there is still some wait and see. There is increased optimism. Our book-to-bill is starting out very strong in January. But typically we would expect a pretty strong book-to-bill to start the year.

I think what is going to be important for us is as we move through the first quarter and enter the second and build for the construction season, do we start seeing the increased optimism translating into increased true bookings. So hopefully that gives you a little color on construction.

It does. And just last question for me if I could. On the utility win, I know recently you walked away from a new contract or renewal contract with the utility because pricing got silly. How did this play out? Was pricing a factor? And how does this compare versus the business that you've walked away from?

So we feel as strong as we have ever felt about the strength of our utility value proposition and the relationships and the value we can bring the utility customers. I think it was a really solid quarter, particularly given the fact that we had growth in both the US and Canada in utility in the quarter. We had one new customer win as we outlined on that page in the webcast deck. We also had -- I did not mentioned this in the script -- we also had two renewal that were notable.

So one new win, two renewals, and we did not have a repeat of having to walk away with our discipline from any large customer renewal or new win opportunity like we had earlier and we had described previously. With that said, I think it is a competitive pricing environment. Utilities are facing some real challenges because of the lackluster economic growth. If you look at electrical -- electricity demand -- that's their demand curve and it's created a challenging set of business conditions for them.

So I think we are hopeful if we get an uptick in GDP and demand kicks up. Hopefully that is a better outlook for utilities. But in the meantime they have really been taking a real hard look at their supply chain, trying to squeeze more productivity, looking for more value. And some are choosing -- and certain competitors may choose some different business model to go out after that. We're going to maintain our margin discipline. So bottom line is one new win, two renewals, maintained our margin disciplines and feel very good about our utility business.

Got it. Thank you.

Yes.

Joshua Pokrzywinski of Buckingham Research Group.

Good morning, guys.

Good morning, Josh.

Just to continue that threat on January, John. If I look back over the past couple years, I think -- not to dig too deep into the archives but January 2015 was a viciously tough comp for you guys. If I kind of roll out some of these daily numbers into February, if we build a little momentum here could you go positive in the first quarter on a stand alone monthly basis?

So I think we are not going to call that. I think you have our guidance and our framework for the first quarter. And I think -- let's be very clear, when Dave and I went to our outlook call and all the discussions a month ago, we do have as our core plan and our external outlook returning to growth in 2017. But our framework entering the year was -- it will be much more back half driven than front half driven.

I think -- because the reality is there is increased optimism with customers and there's some increasing bullishness based upon what may occur and what the new administration may drive to spark economic growth. But none of that has occurred yet. And so we will see, Josh. As we move through the quarter I think we did have accelerating momentum in industrial and backlog is healthy. And we have given you our framework for Q1, which says that we will be flat to down 3. Obviously, we would love to do better than that but that is our current outlook.

And then one thing I noticed that was not president in the slide deck, or maybe I missed it -- you guys used to report pricing in the quarter way out where it had been. Is that starting to flatten out here? I know you don't have price in your guidance explicitly. But can you give us an update on how that is trending, especially with some price increases starting to come in from [expires]?

Dave's commentary he mentioned it, Josh. So pricing was flat in the quarter. So you can think of that as an incremental positive versus what we have had the last two quarters. With that said, I do not want to characterize or mischaracterize the pricing environment. The competitive environment, I think, is as competitive as ever, because we have not seen a material uptick in demand yet.

In terms of supplier price increases in the fourth quarter -- and I foreshadowed this in our Q3 earnings call -- they are about as we expected they would be. They generally range from 1% to 5%. And we get a forward look in what suppliers are planning and work with them on that. And that look is anywhere from 60 to 90 to 120 days out depending on the supplier and the category.

For the first quarter, as is typical for the first quarter, the number of supplier price increases are much greater in number, because there are certain suppliers that view that first quarter of the calendar year to set their pricing strategies in place. But the range is typical on what we have been seeing historically kind of in the 1% to 5% range, depending on what category, by what supplier.

There is a few selected categories, but it is only a few that are about 5% on certain select categories that maybe have more steel content, or there is a particular pricing strategy for that supplier to take it up a bit. But I would characterize it as somewhat typical thus far.

Got you. And then just one final one. I guess congrats to you guys on getting back in your target leverage range. Is there a plan to maybe push that bar a bit lower and bias towards the midpoint? Or just being back in the range again, do you feel like that gives you a license to go out and be on the offensive with M&A again?

That is a self-imposed range. And I've said very consistently over the years, we are confident even operating above it if the right deal comes along. When we acquired AED in March of last year, we were above the leverage range. We were above [3.5] when we did it. It is good that we got back within it.

We would like to be within that range for the majority of the time. Would like to operate within that range. It just gives us more flexibility obviously. It is good that we are back within. We did foreshadow in forecast we'd be back within the 3.5 range by year-end.

With that said, again, we managed this pipeline process. We can't control deal timing. And we are very comfortable operating anywhere within that range or even above the high end of the range as we have done in the past for the right deal.

Okay. Thanks, guys.

Andrew Buscaglia, Credit Suisse.

Hi, guys. Thanks for taking my questions. Can you just talk little bit about SG&A? You brought that down about 4% on a core basis this quarter and did a good job throughout the year. What do we expect in 2017 as sales -- as they start to ramp? Do you think you can still keep that growth rate of SG&A below sales in 2017?

Good morning, Andrew. It's Dave Schulz. One of things that we are focused on is as we anticipate with our outlook, we expect sales will recover in 2017. Obviously the Company has been very focused on cost management. We will remain cost focused as we think about SG&A going forward, while we're also making the investments that we believe we need in order to be competitive and take advantage of the end market recovery.

So we will stay focused on cost. Obviously we are expecting top line recovery. We will stay focused. We will make the investments that we believe are appropriate going forward.

Okay. And then similar question I think as we -- just given your strong cash flow here -- what you looking at? What is the environment right now like now for M&A? I know you were looking at some bolt-ons in your core electrical space. But what are you guys seeing in the near-term?

I would tell you that for the well-run companies, their price expectations are relatively high in terms of multiple. And that really did not change even through the challenging economic period over the last couple years -- the quote/unquote industrial recession. The best run companies can command those multiples.

So now publicly traded companies -- obviously, there has been increases in equity prices in the markets. But the overwhelming majority of the opportunities in our pipeline in number are private companies. Right? Because 99 point X X percent of our competitors are private companies. So I would just -- the short answer to your question is the well run companies command higher multiples. It is relatively consistent. And it really becomes more of an issue of do they want to be part of WESCO? Do we want them part of us? It is the value proposition.

If they are looking at just maximizing price through the transaction and they are not looking at strategically what -- where the company goes post acquisition, integration with WESCO, what happens to the employees -- we will let some of those opportunities go. For us it is really about the value creation. Is it consistent with our strategy? And so we paid multiples over the years. We have done over 40 acquisitions since we spun out of Westinghouse. We paid multiples that ranged from 5 times up to just 10 times effectively. And we will continue to maintain that discipline.

Do you think having moved past the election could free up some of this? Or is it mainly just strictly multiples are too high and sellers don't want to sell?

Again, I am commenting more about what our opportunities set in the pipeline is. Because the overwhelming number of opportunities are private companies. And what drives that honestly is not the election, the cycle or any uncertainty in the market. It is more about governance in governing transition.

Who is the owner operator -- individual or that family? Are they at the point where through estate planning they want to transition, do something else? Do they have a son or daughter or cousin that they can hand the business off to? Yes? No? It is those kind of triggers that are determining the timing more so. I am talking the private company targets that are in our pipeline. That is what determines it more than anything related to the election.

Okay. Thank you.

Yes.

Matt Duncan, Stephens Inc.

Good morning, guys.

Good morning.

John, I was just curious specifically on the industrial piece of the business. So you've had some of your more industrial or manufacturing driven peers that saw pretty strong finish to 2016. And I think it is creating a lot of optimism out there. In that piece of your business specifically, what monthly sales trend are you seeing? Is it similar to what some of the more pure industrial public guys have been talking about?

Remember, our mix is a little bit different. Right? So it's the first thing I would sight, Matt, and I think you are aware of this. For those that are much more higher percentage MRO, they are seeing -- and we've talk about this in the past -- when things start to recover, what is going to kick in first? What's going to kick in first is MRO before CapEx and even some selective OEM.

So I guess the comment I would make is that if you get underneath of that a bit, as I mentioned in response to Deane's question, we are encouraged with the sequential pickup in kind of the quarter over all as we move through the quarter. And we are seeing it in the form of MRO. And we are also seeing it in the form of OEM. So we have some real nice capabilities that support OEM and those activity levels -- I would lead it as picked up sequentially in the quarter. And the discussions about future opportunities in Q1 are picking up a bit too.

What we have not seen yet is really the unlocking or the movement of CapEx. So that is not what drove our sequential uptick in the fourth quarter. And that's is an important point. And I think that is in important potential driver as we move through 2017 of increased growth going forward.

Absolutely. That helps. And the second thing I've got -- historically you guys when we're talking about the guidance next quarter of giving us a few pointers on how SG&A expense may trend sequentially and talked with about gross margin -- I do not know if you are prepared to do that now. But it might be helpful to put some parameters around that for us if you can. And then on the sales guide for the year at the midpoint of 2%, are you prepared to talk about how that shakes out first half, first back half?

Matt, we are not going to provide you with the details between the quarterly splits on our full-year outlook. Obviously we provided you with Q1. As John mentioned earlier, we would anticipate that we would see a stronger back half that the front half. But we have not provided you any more specifics than that.

And I think the only other comment is follow-up with Mary Ann, Matt. She can take you through how we think about that. But you recall that -- and this is typical seasonality. Our costs are highest in the first quarter as a percentage of sales versus the other three. And the outlook that we have provided is consistent with normal history -- historical seasonality. And I think Josh's question earlier -- when do we start inflecting positive?

Again, I think we absolutely have a return to growth plan planned this year and that is what we are driving to. It is good to have to start out the year with some positive momentum. But our first quarter outlook does not have return to growth built in yet. I would love to be able to beat that. But right now I think indications are -- the message is that momentum improved as we moved through the fourth quarter. So far in January it is consistent with that. And now it is just a matter of what that slope rate is versus when we start turning positive on a reported comp basis.

Got it. Very helpful. Thank you.

Christopher Glynn, Oppenheimer.

Thanks. Good morning. I have a question on Canada. It seems to be showing a little more tendency for circle pivot now than the US. It's coming from a deeper trough. It was worse than the US for quite a period of time -- now was less pressured in the quarter. Out of that trough, are you seeing the signs to give real conviction for cyclical momentum emerging up north?

I still think the overall conditions -- and I will call them the economic and end market condition, Chris, are challenging. Against that backdrop, we obviously feel really good about the strength of our Canadian business, the capabilities and how we are performing. As you look across Canada geographically, in the fourth quarter, the distribution of performance, I'll call it, is very consistent with the third quarter, which is challenges, continue in the prairies including Alberta down double digits. But we had nice growth in BC and Ontario. And so that story is what manifests itself as we move through 2016 and still occurred in the fourth quarter. And I think it's going to occur for some time.

The question is when does the prairie bottom and turned the other way? And now you get into what is the Canadian government going to do to? The new liberal majority government was elected obviously late 2015 in the fourth quarter. What is Trudeau going to do relative to supporting oil sands related investments, L&G, et cetera? It will be interesting to see what happens if the Keystone pipeline does get approved. Because obviously it offers opportunities for both sales in US and Canada, and we will have to see how the Canadian government responds, because now it has got new leadership. Right?

So with all that said, I feel really good about our Canadian business, the quality of the team, the value we are delivering, the customers. And if you look at the Canadian retaining results, to your point, they are solid given the market backdrop. The key thing is going to be -- I think it is going to take some time still until the customers, particularly in oil and gas, metals and mining -- are they confident and begin to start turning on -- starting the capital investments again? That going to be the key. We have not seen that yet. And that is something we are monitoring very closely.

Thanks for that. And on the gross margin, that is really merged towards a neutral year-over-year dynamic or pretty darn close. So I am just wondering if it is time to move to a bias -- to some upward bias versus the flat minus trend for the gross margin?

I think when you calibrate our gross margin performance versus the hand we were dealt -- economic backtrack, inflationary environment, competitive pressures -- we feel pretty good about how we performed all in -- in 2016. When you calibrate for, again, external conditions out of our control. And so now I think the key question is going to be do we turn -- does growth pickup and consequently does inflation pickup? And to the degree that it does, that's going to provide a more supportive environment for managing pricing increases through.

The other headwind we had in 2016, was business mix. So our higher gross margin segments down much more precipitously -- i.e. principally industrial in Canada. And so when you look at that to the extent we get the industrial recovery, that's going to help from a mix drive perspective as well.

Great. Thank you.

Yes.

David Manthey, Robert W. Baird and Company.

Hi, guys. Good morning.

Good morning, Dave.

So if we look at the sequential trends, we're talking quite a bit here about what you are seeing and how those trends are going. And if we think about the second quarter relative to the first, it is typically up mid single digits. And so what I am wondering is if you are seeing growing strength this year, should that be the standard? Should it be 4% or 5% or greater to give us an indication that things are picking up? Or is there some reason why seasonality would be different this year versus the past several?

I think the question is going to be -- here is our current framework. The construction season and the start of that has a big impact on Q2 versus Q1. So if that trend is consistent with more typical normal seasonality, maybe there's a pick up in non-resi. That could help a bit. I think the big wild card is going to be, Dave, industrial. So what is the shape?

Hopefully we truly have bottomed and we are in an industrial recovery. And what is the shape of that? And what I mean by that is does MRO and OEM -- are those demand curves keep picking up sequentially, building momentum? And then when does CapEx start to pick kick in? I think that's the wild card. Once CapEx kicks in, that will drive better sequential improvement. But it is a question of when that starts to kick in.

Okay. And you sort of indicated that you will see a back half acceleration. And you needed over 3% growth in the second through the fourth quarters to get to the midpoint of your guidance. But if you are able to regain growth this year, should we expect 50% to 60% read through margins immediately, or is it possibly higher or lower right out of the gate, and then it normalizes and 2018? Or how should we think about those read through margins from GP to EBIT?

Excellent question. So we have given you our framework for 2017. And so I think the question on -- let's be very clear. We still are very focused on 50% operating margin pull through over the mid to long-term. Now to the extent we are getting nice improvement in our top line, we return to growth and there is positive momentum, what we're going to make a decision on as we move through the year -- we kind of gave you our thoughts on this and Dave and I in the outlook call -- how do we feather in incremental investments? Because I want to make absolutely sure we are taking advantage of when that starts to occur -- if and when that starts to occur, the improving economic backdrop to really build on the accelerating momentum and get the leverage in our future operators results.

So we have investments we want to make but we are being very thoughtful about when we start those we want to make sure that we stabilize and we are getting this return to growth. So that is the only thing I would say, Dave, that we -- depending on how we feather in the incremental investments, that could essentially eat into a bit of the operating profit pull through, but not in a material sense. That is not our operating framework over the mid to long-term.

You've seen how we have operated over the mid to long-term. And typically when we get that top line growth kicking in, we can still incrementally invest and get excellent pull through. That is our model and that is what we want to get back to.

Okay. That's great. Thanks a lot, John.

Thanks, Dave.

Hamzah Mazari with Macquarie.

Good morning. Thank you. John, just had a question on your service portfolio. Maybe give us a sense of how that has evolved over time. It was running 25%. Can it be higher? And what advantage does it specifically give you? Is it just a sticky relationship with the customer? Or is there anything more to that as you think long-term about the business?

Good morning, Hamzah. Good to hear from you. Great question. I think this is -- we feel really good about -- let's call it the core service offerings, the value they provide and it does create a stickier relationship for us. We are very confident of that. And that is clear in our customer renewal rates, renewal retention rates and just in discussions we have with customers and the feedback that they give us.

We have not updated that 25%. That is typically something we do at an investor day. And it is something we are planning to take a fresh look at and give you a sense of that in our investor day later this year. I would like to. I have had this aspiration and we are not anywhere near there yet.

This is more a long-term aspiration to the extent these services are really productized better. And can we begin to start charging for them in some incremental way? This is a longer-term discussion. Right now we are seeing the benefits in retention.

So in essence, we are providing this value add and it is in the context of the whole relationship and the pricing structures that exist in these multi-year agreements. But is there an ability to get some incremental price for these services? Because we are quote/unquote offering product versions of them -- productized versions of them. That is more of a long-term vision. And I think that speaks to being a much more value added supply chain solutions partner.

So that is where we are heading. I feel we have made really nice progress. And we really haven't exploded this out for the investors in some time in terms of the breadth and depth of our service offering. So we will take a note on that. I think it is something we will make sure we highlight when we have our investor day later in the year.

Great. And just to follow up and I'll turn it over, is there any difference when your cash tax rate and your book taxes? And the reason I ask is just trying to gauge cash flow savings impact if corporate taxes go down. Is there anything going on the cash tax rate side that we should be aware of in terms of judging that benefit? Thank you.

Currently our cash tax rate is very similar to our effective tax rate. So we do not have a large divergent cash tax rate versus our effective taxes. Obviously we are still evaluating some of the tax proposals that are out there, both with the new administration, with the new house. It is difficult for us to really comment on it at this time until those proposals are finalized. But one of the things that we are focused on is whether or not there will be a change in the overall US corporate tax rate. Obviously that would also reduce our cash taxes. But there are some other elements of those proposals, which may have an impact on cash tax rates which we are still evaluating.

Okay. Got it. Thank you.

Robert Barry, Susquehanna.

Hi, guys. Good morning. Thanks for taking the question. Just a follow-up on the price discussion earlier. Are you assuming any pricing in the outlook for 1Q?

We don't ever do that, Rob. So we don't build price assumptions into our outlook.

Okay. I'm just wondering -- it sounds like the last couple quarters you have started to see some of the suppliers putting through some pricing. And it sounds like there is some expected in 1Q as well. But is that a margin headwind for you guys if you are not at least in the reported couple periods seeing down or flat price?

No. I think, again, the way I think about that is there are suppliers that are trying to push price increases all throughout the quarter of 2015 and 2016. And the ability to do that is a function of the -- at a very detailed level, the competitive dynamic for that type of customer and that product category and what the capacity is in it, let's call it the value chain, and how that whole price volume relationship works. It has been a very challenging environment because the demand curves haven't been strong and robust. There has been plenty of capacity and it has been in low-inflation environment.

We experienced some rising pressures. There is competitive pricing pressures, but net/net our pricing effect in Q2, Q3 of last year was a negative half-point. And this is now flattish, so we feel good about -- again that's kind of our ability to push them through. So we are feeling pretty good about that all in. And we, again, we don't forecast pricing in our outlook.

Earlier I did comment relative to what we are seeing so far from suppliers, and their desire to push pricing increases through. And this has a forward look of 90 plus days out that they are looking at 1% to 5% on average depending on the category and some selectively higher. But they are much greater in number but that is typical for a first quarter. So we will have to see how that really manifests itself as we move through.

What's going to determine the ability to push it through is the whole supply/demand equation and are we getting uptick in demand and can you start moving? Customers have been very reticent to any price increases.

I guess that is where I was going. Is there a risk maybe it is only temporary the next couple quarters, but if the end markets are still weak -- but we have seen the inflation building. That may create some near-term margin pressure because the inflation is happening.

I guess I -- it would be hard for me to see how we have margin pressure greater than we have right now over the last -- honestly the last six to eight quarters. And the only thing I would say is too -- the only thing I say is that we are working a whole set of billing, margin expansion initiatives, supply chain related initiatives that we have outlined. So we're working real hard.

I think that helped us deliver the margins we had last year against the competitive backdrop we are facing. And we're going to continue to drive those, execute those at hopefully build better execution momentum on those. That is not -- that's continuous.

John, just a follow-up also on the question or the comment earlier about feathering in this investment spending. Is it fair to assume that in 1Q there is no assumed incremental year-over-year headwind from investment spending? And maybe there won't be until we start to see a return to growth?

Yes. I think that is how we are starting the year. But we may -- obviously we have great opportunities to do some incremental investment and that is day-to-day running the business. The business leaders and product category leaders are making their cases every day. But Dave and I both want to make absolutely sure that we have got a solid base and we are in a recovery. And we will make those decisions as we move along.

So I think I have provided you the way we think about it in the framework, Rob. So we want to make sure we have confidence that the momentum is clearly improving and we are confident it is going to continue before we start really layering those in.

And just a quick housekeeping item on industrial. What is the mix now OEM versus CapEx versus MRO in your industrial business?

We have not disclosed that. And so that is not in any of our material. So we're not going to hit that in this call.

Okay. Thank you.

Chris Belfiore, UBS.

Good morning, guys. Thanks for taking my question. I just kind of want to go back to the dynamics between I guess December in January. The low single-digit trend that you are seeing in January seems like -- someone else pointed our earlier -- it is pretty normal. So I guess my question is really around the dynamics of December. And some other distributors have noted some potential year-end budget flush or pull forward into December.

Did you guys see anything like that? Or I guess what is the dynamics in September and January. And then I guess in line with that, how does the New Year's holiday affect the two months?

We did not see those dynamics -- not material, no year-end budget flush, no significant movements, even holiday budget. Again, we're not -- you got to look at our mix. We have MRO, electrical, industrial, we got OEM and we got capital projects. And this just gets to our core mix. Our business mix, our product category and services mix is broader than some of the other companies you are referencing. So bottom line is, no, we did not have those effects.

Thanks and then second -- just kind of follow up a second question in terms of gross margins. And I know in the past you guys have talked about supplier volume rebates. This is going to be the first year in the last couple of years that you are looking for growth next year in terms of top line. How should we maybe think about that for 2017 in terms of the impact on the gross margin line going forward for that year?

So supplier volume rebates kind of a reset every year. And the biggest factor in those -- overall growth is in important variable to look at. There is no doubt about it, but mix is really what matters. So I think that is going to ultimately be the determining factor.

What product categories with which suppliers are growing versus not growing? We could be growing over all, but the mix may be such that certain products that have better SVR curves are not growing at that same rate or vice versa. With all that said, when we return to growth we would expect that obviously we would get some leverage with SVR -- no doubt.

Thanks a lot.

Stephen Tusa, JPMorgan.

Hi, guys. Good morning -- I guess still for a few minutes here.

Good morning, Steve.

The inventories picked up a little bit year-over-year as a percentage of sales. I think quarterly as well you had a bit more of a drawdown from 3Q to 4Q last year. Anything going on there? Is that just you've stabilized the reduction, because you are a little more optimistic about growth? Any meaningful tweaks there that you want to highlight by segment?

Excellent question and well said. (laughter) What you said is exactly what we did. I think we are very focused on inventory availability and fill rates. And so when you look at the inventory position we had as we exited the year, it is not an area we really clamp down on excessively. We want to make sure we are well positioned given the starts of this accelerating momentum we are seeing. So you are spot on.

And that would be given that most of the commentary around the optimism is around industrial? Is that kind of the primary where you are building a bit?

So, again, that is an insightful question, because when you think about our different end market segments, we are going to have a higher percentage of direct shift sales for construction versus industrial. So to the extent industrial is recovering, we need to make sure that we have the appropriate stock positions. The answer is yes.

Okay. That makes a ton of sense. As far as oil and gas is concerned, what adjusted high-level are you seeing there and the conversation with the customers there specifically in oil and gas?

You just triggered a thought, because I don't think we gave you the explicit oil and gas number for the quarter. So let me do that -- get it out there so, Mary Ann, you can follow-up if asked this. Because it just hit me that we didn't say that. We said for the year we were down approximately 25%, but for the quarter we were down approximately 18%. So still down double digits but not down as much as the earlier quarters. And I mentioned in response, Steve, to Dean's question as he was asking about the sequential momentum build. One of the verticals, which was one of our larger verticals in global accounts, we saw that sequential sales increase in the fourth quarter versus the third was oil and gas. So that is encouraging.

With that said, I think there is still -- the discussions we're having with customers by and large are they want to make sure that oil prices are really stabilizing at this level. And one or two or three or four months does not necessarily mean that they are stable at these levels. (laughter) I think that is what is impacting fundamentally decisions on CapEx being released which -- now with that said, some of our oil and gas customers are planning on spending meaningful CapEx in their plans for 2017. But they also -- if you were to go back -- set the clock back a year ago, they had the same plans for 2016, and they kicked the can on a lot of those investments.

So I think that is where we are. I think our own momentum is incrementally positive and that is good. And we were down not as bad year-over-year. And the discussions with customers are little bit more encouraging, but I think we are not seeing it yet in terms of the CapEx.

While those questions were good, I think this is going to be the really good one. On sourcing -- Rockwell has given us a number -- they have a big plant in Mexico that they kind of sell about 5% to 10% of their US production comes from Mexico. Obviously you guys are a big buyer there. I don't believe the number that you have given out at least on cross-border sourcing is that material.

I guess dating back in over the last several weeks or even months since the election, is there any update that you have found in your supply chain, any areas that would be I guess more exposed to sourcing cross-border? Is there any kind of extra color you can give -- you've talked to the chain. I'm sure everybody is going back and trying to check this out. So just curious if there is any extra color on your cross-border sourcing.

So I would ask you to think about in two ways. One is where do we source directly -- i.e. WESCO source directly outside the US? And where do we sell outside the US? We look at both ends -- import, export. And that is a very small percentage of our purchases and sales, very small percentage. And -- so I see us as having really kind of a de minimus impact on any of the other things that are being discussed, versus other companies that are in the publicly traded space that have a large percentage of their products that are private label. In essence, if they are a private label, they've got their own supply chain and they are not buying from another supplier that is a US manufacturer in a lot of cases.

So there is one distinction. The other point I would make is that for our supply base we buy -- for the most part we buy and sell in each country. Now we are -- Rockwell is a terrific supplier partner. And to the extent Rockwell is impacted for a piece of their portfolio, given their manufacturing footprint and they are bringing that back into the US, that is going to impact Rockwell and their entire channel partner base. And we will work with Rockwell to manage that appropriately in terms of managing that through the customers.

That is a way I think about it. I bifurcate our supply base, because fundamentally we're a branded supplier. WESCO is a service value wrapper branded supplier wrapped around world-class manufacturing supplier partner brands.

So that is how we think about it. And we have always said that do -- particularly for current carrying products -- we don't do private label. Private-label is always an opportunity for us and Asian sourcing was an incremental opportunity for us as we went into the future for certain categories, but we absolutely shied away from electrical current carrying products because of the liability. And so that is the way I would ask you all to think about it. Again, the amount that we direct source import and direct sale export is very small percentage. It is a very low single-digit percent.

Okay. Great. Great color. Thanks a lot. I appreciate it.

Ryan Cieslak, KeyBanc Capital Markets.

Hi, guys. Thanks for fitting me in here.

Sure. Good morning -- or afternoon now I think.

Yes, I guess it is the afternoon. The first question I had -- I just wanted to -- Dave, it I heard you right in the prepared remarks you mentioned there was some nonrecurring charges that hit the gross margin line. Is that right and did you quantify that?

That is correct. We did not quantify it specifically. What we said that -- we had at 10 basis point reduction. More than all of that was made up by some of these one-time items, none of which was material on its own.

Okay. Thanks. And then the other question I had was when I look at the CIG sale -- or in terms of the CIG end markets during the quarter that had decline there had gotten a little bit greater and it was below what you were looking for. I think you had mentioned, John, some weakness with regard to the federal government year-end spending. Just some additional granularity around that -- what happened there? How should we be thinking about that run rate going into the first quarter and maybe what you are assuming for your CIG end markets in the first quarter here?

We have got some real breadth of customers in CIG. Just to be clear, just to baseline everyone, it is government agencies, federal, state and local level, it's schools, hospitals, property management firms, financial institutions and the like. And so there is some breadth there.

What we saw was really a slowdown in government activity levels basically. We saw that in the third quarter. We saw it in the fourth quarter. We feel very good about our value proposition and the services and products we provide to government customers, but we clearly saw a slow down.

We grew -- our government -- business with our government customers grew in this first half of last year after going in 2015. But they declined in the second half. And so we saw that decline in the third quarter and it continued in the fourth quarter. And that was partially offset by some growth in broadband and IT security.

How do we think about it going into 2017? Have a very strong and broad pipeline. The bidding activity levels are solid. And we would expect, particularly with our respect to government, we're seeing some pickup in activity levels now more around quoting. And we have laid out a framework for 2017 to have low single digit to mid single digit growth for CIG, which includes government growing at those levels. So that is our framework for 2017.

Okay. So if I hear you right, John, there is nothing coming out of the December quarter here that makes you feel any different about that up, low single digit to mid single digits for 2017? You feel like there is enough there that business can eventually recover?

Yes. The only other thing I would say, and I will say this, because it will also be helpful for Mary Ann and her follow-up, we did have one large global account customer -- very large global account customer and we had some non-repeating projects that occurred in 2015, but did not occur in Q4 2016. Now that global account customer is still a strong customer. We in fact renewed an agreement with them -- a three year agreement in the fourth quarter.

So that is the only other contributor. If you look at CIG, it is down a little bit more than it had been in some time. When you add it all up, it was government -- this one big customer. But all in, I think our framework for 2017 is intact. We see low to mid single digit growth all in with government at that level as a supporter as well.

Okay. Thanks, guys. Best of luck.

Great. Go ahead.

I was going to say this concludes our answer session. I would like to turn the conference back over to John Engel for any closing remarks.

Thank you all again. We did go a little bit longer. We wanted to finish with all the calls in the queue. So thank you for your time this morning and your continued support. And Mary Ann and Dave are around today to take any further questions. Have a great day.

The conference is now concluded. Thank you for attending today's presentation. You may now disconnect.