Business context and reporting period
WESCO International, Inc. distributes electrical, industrial and communications products and provides supply-chain and logistics services. This unaudited Form 10-Q covers the three months ended March 31, 2011; comparisons are with Q1 2010 unless noted. The company served more than 100,000 customers through approximately 400 branches and reported 81% of Q1 sales from the United States and 15% from Canada.
Financial results and liquidity
| Metric | Q1 2011 | Q1 2010 |
|---|---|---|
| Net sales | $1,431.3 million | $1,148.6 million |
| Income from operations | $64.7 million | $38.3 million |
| Net income | $37.3 million | $19.2 million |
| Diluted EPS | $0.74 | $0.44 |
| Operating cash flow | $31.8 million | $68.7 million |
| Capital expenditures | $5.6 million | $2.2 million |
- Gross margin was 20.0% versus 19.8%; operating margin was 4.5% versus 3.4%; net margin was 2.6% versus 1.7%.
- Net interest expense was $12.6 million, down from $13.5 million. The effective tax rate was 28.4%, compared with 29.5%.
- At March 31, cash was $52.4 million, current assets were $1,633.7 million and current liabilities were $806.8 million. Total debt on the balance sheet, including current maturities, was approximately $708.2 million, versus $729.9 million at December 31, 2010.
- Available borrowing capacity was $276.1 million under the revolving credit facility and $66.1 million under the receivables facility. Management also reported liquidity of $354.3 million including invested cash; it separately described total available borrowing capacity as $342.2 million.
- Operating cash flow was lower year over year as growth absorbed working capital: receivables used $69.7 million and inventory used $38.7 million, partly offset by a $107.4 million increase in accounts payable. Cash declined $1.1 million during the quarter to $52.4 million.
Material changes versus the prior period
Sales rose 24.6%; management attributed growth to improving conditions in many served markets, growth initiatives, acquisitions, higher product prices and favorable foreign exchange. Acquisitions accounted for 7.0% of sales growth, according to management. The company also acquired the business of Richard Equipment Company, Inc. (RECO), with $7.8 million of acquisition payments in the quarter.
Operating income increased 69.2%, which management primarily attributed to organic growth. Cost of goods sold fell to 80.0% of sales from 80.2%, partly due to higher supplier volume rebates. SG&A rose in dollars but declined to 15.0% of sales from 15.9%, reflecting sales growth and fixed-cost leverage. Prior-year results included a $3.4 million impairment charge related to the sale of WESCO’s 40% interest in the LADD joint venture.
Outlook, risks and unusual items
- Management gave no specific numerical earnings or revenue guidance. It expected to maintain working-capital productivity and direct excess cash primarily to debt reduction and acquisitions, while focusing near term on cost management, liquidity and credit availability.
- Management believed operating cash flow and available financing would meet current needs and reported compliance with all covenants at March 31, 2011. It cautioned that financing sufficiency cannot be assured indefinitely.
- Management said recent commodity price increases had exceeded general inflation, expected to pass most increases through to customers, and estimated inflation-related pricing represented $40.0 million of Q1 sales revenue.
- A customer lawsuit alleges defective products sold by WESCO and others and seeks approximately $47 million. WESCO denies liability, intends to defend the case, and recorded no liability. Management said the ultimate outcome of pending litigation cannot be predicted.
- Q1 included $1.4 million of discrete tax benefits related to state taxes and uncertain tax positions, partly offset by a $0.4 million state tax-rate adjustment. Unrecognized tax benefits were $2.4 million; the company said these could change by $2.7 million over the next twelve months as examinations are resolved.
- Forward-looking statements are subject to risks described in the company’s 2010 Form 10-K and other SEC filings. Management reported no material change in market-risk exposures and no Q1 event requiring an interim goodwill impairment evaluation.
Most important facts for investors to verify
- Whether sales growth and margin improvement are sustainable, including the contributions from organic growth, acquisitions, pricing, foreign exchange and supplier rebates.
- Whether receivables and inventory growth can be converted into cash, given the year-over-year decline in operating cash flow.
- Debt balances, facility availability, covenant compliance and the difference between reported borrowing capacity and total liquidity.
- Potential outcomes and financial exposure from the approximately $47 million Indiana lawsuit and pending tax examinations.
- The impact of convertible debentures and stock-based awards on diluted EPS; Q1 diluted EPS was $0.74 versus basic EPS of $0.87.