WESCO International, Inc. — Q3 2016 Form 10-Q
Business and period: WESCO distributes electrical, industrial and communications products and provides supply-chain and logistics services. This unaudited filing covers the quarter and nine months ended September 30, 2016; balance-sheet comparisons are with December 31, 2015.
Financial performance and liquidity
| Metric | Q3 2016 | Q3 2015 | Nine months 2016 | Nine months 2015 |
|---|---|---|---|---|
| Net sales | $1.855 billion | $1.924 billion | $5.543 billion | $5.657 billion |
| Operating income | $92.6 million | $106.3 million | $250.1 million | $283.8 million |
| Operating margin | 5.0% | 5.6% | 4.5% | 5.0% |
| Net income (loss) attributable to WESCO | $(31.6) million | $63.5 million | $54.2 million | $162.3 million |
| Diluted EPS | $(0.73) | $1.28 | $1.13 | $3.16 |
| Operating cash flow | — | $217.2 million | $176.0 million | |
| Free cash flow (non-GAAP) | — | $204.0 million | $159.8 million |
- Q3 cost of goods sold was 80.3% of sales versus 80.2%; SG&A was 13.8% versus 13.4%. For the nine-month period, these were 80.2% versus 80.0% and 14.4% versus 14.1%, respectively.
- At September 30, cash and cash equivalents were $112.8 million; total debt, including debt discount and financing fees for the leverage calculation, was $1.474 billion. Financial leverage was 3.6x, down from 3.8x at year-end 2015. The company reported compliance with debt covenants.
- Available borrowing capacity was $512.8 million under the revolving credit facility and $109.6 million under the receivables facility. Management’s stated liquidity measure was $693.2 million, including $70.8 million of available cash. Of reported cash, $82.6 million was held by foreign subsidiaries, and some could incur additional U.S. tax if repatriated.
- Current assets were $2.244 billion and current liabilities $960.0 million. Stockholders’ equity was $1.993 billion, compared with $1.774 billion at December 31, 2015.
Material changes and unusual items
- Sales fell 3.6% year over year in Q3 and 2.0% for the nine months. Excluding acquisitions, foreign exchange and workday effects, normalized organic sales declined 6.2% in Q3 and 5.4% year to date.
- Management cited challenging end-market conditions. For the nine months, lower sales reduced operating profit; cost actions partly offset the decline. Pricing and unfavorable mix pressured gross margin, partly offset by supply-chain initiatives. Cost controls included headcount reductions, branch closures and consolidations, and discretionary-spending limits.
- WESCO issued $350 million of 5.375% senior notes due 2024 and used the net proceeds to redeem its 6.0% convertible debentures due 2029. The redemption involved $344.8 million of cash paid to holders and issuance of 6.27 million shares to holders who converted. It generated a $123.9 million non-cash loss, including write-off of unamortized debt costs, which drove the reported Q3 loss. Management reported adjusted Q3 net income attributable to WESCO of $51.1 million and adjusted diluted EPS of $1.05; nine-month adjusted figures were $136.9 million and $2.85. These are company-defined non-GAAP measures.
- Atlanta Electrical Distributors was acquired in March 2016; acquisition-related cash payments, net of cash acquired, were $50.7 million for the nine months. The acquisition had approximately $85 million in annual sales.
- Operating cash flow increased from the prior-year period; free cash flow also rose. Investing used $67.8 million, including acquisition spending and $13.2 million in capital expenditures. Financing used $198.1 million, including debt refinancing and redemption activity. Cash declined $47.4 million from year-end.
Outlook, risks and contingencies
- No numerical revenue or earnings guidance was provided. Management said it expects cash from operations and financing availability to meet foreseeable working-capital, capital-expenditure and other needs, while cautioning that this cannot be assured. It planned to manage working capital and direct excess cash primarily toward acquisitions, debt reduction and share repurchases.
- Management planned its annual goodwill and indefinite-lived intangible asset impairment testing for Q4; it reported no triggering events requiring an interim review. Fair-value estimates are judgmental and could be affected by economic and market conditions.
- WESCO is undergoing a Delaware audit concerning unclaimed-property reporting and escheatment; the outcome is uncertain. The company has recorded a liability based on currently known facts. A New York County District Attorney investigation into minority and disadvantaged business contracting practices also includes the company; potential exposure could not be reasonably estimated.
- Management said there were no material changes to previously disclosed risk factors or market-risk exposures, and no material changes to contractual obligations. Forward-looking statements remain subject to risks and actual results may differ.
Important facts for investors to verify
- Whether weak normalized organic sales and margin pressure persist, and how much cost reductions can offset them.
- The effect of the 2029 debenture redemption on ongoing interest expense, share dilution and leverage; distinguish reported results from company-defined adjusted measures.
- Cash availability and restrictions, including foreign-held cash, borrowing capacity, covenant headroom and debt maturities.
- Final acquisition purchase-price allocations and performance-linked contingent consideration for Atlanta Electrical Distributors.
- Developments and possible financial exposure from the Delaware unclaimed-property audit and New York investigation.
- Results of Q4 goodwill and intangible-asset impairment testing.