WCC

WESCO International, Inc. - Q1 2006 10-Q Summary

Business Context and Reporting Period

This report covers the quarterly period ended March 31, 2006. WESCO International, Inc. is a full-line distributor of electrical supplies and equipment and a provider of integrated supply procurement services. The company operates approximately 370 branch locations and eight distribution centers across the United States, Canada, Mexico, and other international markets. Approximately 87% of net sales are generated from U.S. operations.

Key Financial Metrics

Material Changes vs. Prior Period

• Revenue Growth: Net sales increased 27.7% ($274.6 million) year-over-year. This was driven by $106.6 million in sales from two 2005 acquisitions (Carlton-Bates and Fastec), market share growth, higher commodity prices, hurricane rebuilding activity, and favorable exchange rates.
• Profitability: Operating income nearly doubled (99% increase) to $76.9 million, aided by gross margin expansion to 20.0% and cost containment initiatives. Net income increased 293% to $44.5 million.
• Expense Management: Selling, general, and administrative (SG&A) expenses increased in absolute dollars but decreased as a percentage of sales (13.4% vs. 14.4%) due to sales volume leverage. Interest expense decreased 30% due to the redemption of higher-interest 2008 Notes in the prior year.
• Cash Flow: Operating cash flow decreased significantly to $32.5 million from $102.6 million in Q1 2005. This decline was primarily due to a $90.5 million cash inflow from the receivables facility in 2005 that was not repeated in 2006, alongside increased working capital requirements (receivables and inventory) to support sales growth.

Outlook, Risks, and Unusual Items

• Outlook: Management believes the company is well-positioned for 2006 following 2005 acquisitions and capital structure improvements. Macro data indicates improving activity in manufacturing and construction markets, though levels remain below 1999-2000 peaks. Focus remains on market share growth, pricing, and margin expansion.
• Accounting Changes: The company adopted SFAS 123R (Share-Based Payment) in Q1 2006. This resulted in $2.6 million of stock-based compensation expense and reclassified $8.1 million of excess tax benefits from operating to financing cash flows.
• Legal Proceedings: WESCO is a defendant in a Florida state court lawsuit alleging failure to fulfill commercial purchase obligations, with damages sought in excess of $17 million. A trial is scheduled for October 2006.
• Customer Bankruptcy: Dana Corporation filed for Chapter 11 bankruptcy on March 3, 2006. Dana represented $48.5 million of WESCO sales in 2005. WESCO has established a $4.0 million reserve against $9.7 million in receivables due from Dana's U.S. entities.
• Debt Structure: The company has $150 million in 7.50% Senior Subordinated Notes due 2017 and $150 million in 2.625% Convertible Senior Debentures due 2025. The revolving credit facility had no outstanding balance as of March 31, 2006, with $275 million available.

Investor Verification Checklist

• Verify the collectibility of the $9.7 million receivable from Dana Corporation and the adequacy of the $4.0 million reserve.
• Monitor the outcome of the Florida litigation seeking over $17 million in damages.
• Assess the sustainability of the 20.0% gross margin given commodity price fluctuations and competitive pressures.
• Review the integration progress and performance of the 2005 acquisitions (Carlton-Bates and Fastec) which contributed significantly to Q1 growth.
• Confirm the status of the $5.0 million contingent acquisition payment due between 2006 and 2008.