Business context and reporting period
WESCO International, Inc. distributes electrical, industrial and communications products and provides supply-chain and logistics services to industrial, construction, utility and commercial, institutional and government customers. This unaudited Form 10-Q covers the quarter and nine months ended September 30, 2015; comparisons are with the same 2014 periods.
Financial performance and position
| Metric | Q3 2015 | Q3 2014 | Nine months 2015 | Nine months 2014 |
|---|---|---|---|---|
| Net sales | $1,923.9 million | $2,078.2 million | $5,656.9 million | $5,894.1 million |
| Operating income | $106.3 million | $133.2 million | $283.8 million | $342.0 million |
| Operating margin | 5.6% | 6.4% | 5.0% | 5.8% |
| Net income attributable to WESCO | $63.5 million | $80.8 million | $162.3 million | $201.5 million |
| Diluted EPS | $1.28 | $1.52 | $3.16 | $3.78 |
| Operating cash flow | $43.3 million | $89.0 million | $176.0 million | $139.8 million |
| Free cash flow | $39.7 million | $84.7 million | $159.8 million | $123.8 million |
Gross margin was 19.8% in Q3 and 20.0% for the nine-month period, versus 20.3% and 20.5% in the respective 2014 periods. SG&A was 13.4% of sales in Q3 and 14.1% for nine months, compared with 13.1% and 13.8%.
At September 30, 2015, cash and cash equivalents were $132.9 million, total assets $4.64 billion, total liabilities $2.88 billion and stockholders’ equity $1.76 billion. Debt was $1.50 billion on the balance sheet, including short-term debt, current maturities and long-term debt net of discount; management’s total-debt measure including unamortized discounts was $1.67 billion. Financial leverage was 3.5x, up from 3.0x at year-end 2014. Management reported $446.5 million of revolver availability and $20.0 million of receivables-facility availability, and defined total liquidity as $520.2 million, including $53.7 million of cash in that measure. Separately, reported consolidated cash included $99.4 million held by foreign subsidiaries, some of which could incur additional U.S. tax if repatriated.
Material changes versus prior period
- Q3 sales fell 7.4%; normalized organic sales declined 5.3%, foreign exchange reduced sales by 4.1%, and acquisitions added 2.0%.
- Nine-month sales declined 4.0%; normalized organic sales declined 1.9%, with foreign exchange and workdays reducing sales by 3.2% and 0.5%, respectively, partly offset by a 1.6% acquisition contribution.
- Lower sales, lower supplier volume rebates, business mix and competitive pricing pressure reduced operating income and margins. Cost reductions in headcount, variable compensation and discretionary spending partly offset those pressures.
- Foreign currency translation losses were $95.4 million in Q3 and $183.6 million for nine months, contributing to comprehensive losses attributable to WESCO of $31.9 million and $21.4 million, respectively.
- Operating cash flow improved for nine months, but the company spent $150.0 million on share repurchases under its authorization and $68.5 million on acquisitions. Equity fell $168.3 million from year-end, reflecting currency translation and repurchases, partly offset by earnings.
Outlook, risks and unusual items
- Management cited continued weakness in commodity-driven end markets and unfavorable currency effects. It expects to focus near term on working-capital management, liquidity and credit availability; excess cash is expected to be directed primarily to debt reduction, acquisitions and share repurchases. No quantified earnings or revenue guidance is provided.
- Management believes operating cash flow and financing availability will meet foreseeable needs, but cautions there is no assurance this will continue. The company reported compliance with debt covenants at quarter-end.
- On September 24, WESCO refinanced its revolving facility with a $600 million facility maturing in September 2020 and amended its receivables facility, increasing its limit to $550 million and extending maturity to September 2018.
- Hill Country Electric Supply, with approximately $140 million in annual sales, was acquired May 1, 2015. On October 30, after quarter-end, WESCO acquired a commercial-construction and lighting distributor with approximately $115 million in annual sales.
- The ArcelorMittal Indiana Harbor litigation settled in April 2015; insurers paid $35.8 million, and reversal of the previously recorded liability and receivable, including accrued interest, had no net effect on financial condition or results.
- Risks include a Delaware unclaimed-property compliance audit with an uncertain outcome and a New York investigation into contracting practices. WESCO could not estimate exposure for the New York matter. Management also noted that weak market conditions could affect the upcoming annual goodwill and indefinite-lived intangible asset impairment tests.
Important facts for investors to verify
- Whether sales weakness, margin pressure and foreign-exchange impacts persist, and whether cost reductions can offset them.
- Drivers of the increase in leverage and the company’s intended pace of debt reduction, acquisitions and repurchases.
- Cash conversion and working-capital trends, including the effect of receivables, inventory and supplier rebates on operating cash flow.
- Integration and performance of Hill Country and the post-quarter acquisition, including final purchase accounting.
- Developments in the Delaware audit, New York investigation and annual impairment testing.