WESCO International, Inc. — Q3 2017 Form 10-Q
Business context and period: Unaudited results for the quarter and nine months ended September 30, 2017. WESCO distributes electrical, industrial and communications products and provides supply-chain services, primarily in North American markets.
Financial performance
| Metric | Q3 2017 | Q3 2016 | Nine months 2017 | Nine months 2016 |
|---|---|---|---|---|
| Net sales | $2.00 billion | $1.86 billion | $5.68 billion | $5.54 billion |
| Operating income | $89.3 million | $92.6 million | $239.4 million | $250.1 million |
| Operating margin | 4.5% | 5.0% | 4.2% | 4.5% |
| Net income attributable to WESCO | $53.7 million | $(31.6) million | $140.9 million | $54.2 million |
| Diluted EPS | $1.12 | $(0.73) | $2.90 | $1.13 |
| Operating cash flow | Not provided separately | Not provided separately | $81.1 million | $217.2 million |
| Free cash flow | Not provided separately | Not provided separately | $65.1 million | $204.0 million |
- Q3 sales rose 7.8% year over year; organic sales growth was 8.6%. Nine-month sales increased 2.5%, with organic growth of 2.7%.
- Gross margin, calculated from reported sales and cost of goods sold, was approximately 19.3% in Q3 and 19.4% for the first nine months, down from approximately 19.7% and 19.8%, respectively, in 2016. Management cited business mix and challenging pricing.
- Operating income declined despite sales growth, mainly because of higher SG&A payroll costs. Q3 SG&A was $280.0 million versus $255.5 million; nine-month SG&A was $814.3 million versus $799.4 million.
- Net income comparisons are affected by the prior-year $123.9 million non-cash loss on redemption of 6.0% convertible debentures. On an adjusted basis excluding that item, nine-month 2016 net income attributable to WESCO was $136.9 million and diluted EPS was $2.85, versus reported 2017 results of $140.9 million and $2.90.
- Net interest expense declined to $17.3 million in Q3 and $50.8 million for nine months, from $20.8 million and $59.1 million, respectively, primarily reflecting reduced higher-cost debt.
Liquidity, debt and capital allocation
- At September 30, 2017, cash and equivalents were $94.1 million; current assets were $2.41 billion and current liabilities were $1.04 billion.
- Total debt, including short-term borrowings and debt discount/financing-cost adjustments used in management’s leverage calculation, was $1.42 billion. The financial leverage ratio was 3.7x, up from 3.5x at December 31, 2016. WESCO reported compliance with its debt covenants.
- Available borrowing capacity was $542.9 million under the revolving credit facility and $150.0 million under the receivables facility. Management reported total liquidity of $742.4 million using available cash of $49.5 million plus those facilities. Approximately 60% of debt was fixed-rate.
- Nine-month operating cash flow fell to $81.1 million from $217.2 million, primarily reflecting working-capital investment: receivables increased $174.7 million and inventory increased $86.7 million, partly offset by a $138.3 million increase in accounts payable.
- Capital expenditures were $16.0 million. The company repurchased $106.7 million of shares during the period, including $100.0 million under its repurchase program. Management said excess cash over coming quarters would be directed primarily toward acquisitions, debt reduction and repurchases.
Outlook, risks and unusual items
- No specific financial guidance was provided. Management described improving sales momentum in end markets and geographies, but noted challenging pricing and planned to closely manage working capital. It stated that operating cash flow and available financing were expected to meet foreseeable needs, while cautioning that this could not be assured.
- WESCO plans its annual goodwill and indefinite-lived intangible impairment testing in Q4 2017; management reported no interim triggering events through September 30.
- The company disclosed an ongoing Delaware unclaimed-property compliance audit and a New York criminal investigation concerning minority and disadvantaged-business contracting practices. It has recorded liabilities based on currently known facts; outcomes and potential adverse consequences remain uncertain.
- Management revised the December 31, 2016 balance sheet for prior-period tax-account misstatements: reported assets and equity were reduced by $59.1 million and $46.4 million, respectively, with a $10.2 million adjustment to goodwill and deferred taxes. Management deemed the prior-period errors not material to previously issued statements; the comparative balance sheet in this filing is revised.
- The new revenue-recognition standard was scheduled for adoption in Q1 2018 using the modified retrospective approach; management was still assessing its impact.
Key facts for investors to verify
- Whether sales momentum can persist and margins recover amid pricing pressure and rising payroll costs.
- Whether working-capital growth reverses and operating cash flow improves from the weaker nine-month result.
- Debt leverage, refinancing and liquidity capacity, including the distinction between reported cash and management’s available-cash figure.
- Potential financial or reputational effects of the Delaware audit and New York investigation, and the adequacy of recorded liabilities.
- The effects of the revised comparative balance sheet and the forthcoming revenue-recognition standard.