WESCO International, Inc. — Q3 2018 Form 10-Q
Business and period: WESCO distributes electrical, industrial and communications products and provides supply-chain services, primarily in industrial, construction, utility, and commercial, institutional and government markets. This unaudited report covers the quarter and nine months ended September 30, 2018; comparisons are with the corresponding 2017 periods unless stated otherwise.
Financial performance
| Metric | Q3 2018 | Q3 2017 | Nine months 2018 | Nine months 2017 |
|---|---|---|---|---|
| Net sales | $2,067.2 million | $2,000.2 million | $6,165.2 million | $5,682.4 million |
| Operating income | $97.5 million | $88.8 million | $261.9 million | $238.1 million |
| Net income attributable to WESCO | $66.8 million | $53.7 million | $169.2 million | $140.9 million |
| Diluted EPS | $1.41 | $1.12 | $3.56 | $2.90 |
| Operating margin | 4.7% | 4.5% | 4.2% | 4.2% |
- Q3 sales increased 3.4%; organic sales grew 4.2%, with foreign exchange reducing reported growth by 0.8 percentage points. Nine-month sales rose 8.5%; organic growth was 7.9%, including a 0.6-point foreign-exchange benefit. Management reported no acquisition or workday contribution to growth in either period.
- Q3 gross margin, calculated from reported sales and cost of goods sold, was approximately 19.2%, versus 19.3% a year earlier. Nine-month gross margin was approximately 19.1%, versus 19.4%. SG&A was 13.7% of sales in Q3 versus 14.0%, and 14.1% for nine months versus 14.4%.
- Q3 effective tax rate fell to 17.2% from 25.5%; the nine-month rate was 19.3% versus 25.3%. The company attributed the decrease mainly to the 2017 Tax Cuts and Jobs Act; Q3 also benefited from audit settlements.
- Nine-month operating cash flow was $174.5 million, versus $81.1 million; capital expenditures were $23.7 million versus $16.0 million. Reported free cash flow, a non-GAAP measure, was $150.8 million versus $65.1 million.
Balance sheet and liquidity
- At September 30, 2018, cash and cash equivalents were $142.8 million; total debt, including debt discounts and issuance costs, was $1,272.2 million. Net debt was $1,129.4 million, compared with $1,244.8 million at December 31, 2017.
- Financial leverage was 3.1x, down from 3.6x at year-end 2017; net-of-cash leverage was 2.8x versus 3.2x. WESCO reported compliance with debt covenants.
- Available capacity was $562.8 million under the revolving credit facility and $185.0 million under the receivables facility. Management’s stated liquidity total was $827.6 million, using $79.8 million of available cash in that calculation. The facilities mature in September 2020.
- About 67% of debt was fixed-rate. Of reported cash, $94.5 million was held by foreign subsidiaries and could incur additional taxes if repatriated.
Material changes, outlook and risks
- Management cited sales growth, operating leverage, cost discipline and cash generation. Nine-month operating income increased mainly from higher sales volume and cost-control initiatives. Sales growth was broad-based across end markets; utility showed the largest reported nine-month increase among the listed markets.
- Cost of goods sold rose as a share of sales for the nine-month period, which management attributed primarily to geographic and end-market mix and reclassification of certain labor costs from SG&A. SG&A included higher payroll and volume-related costs, a bad-debt charge involving a Canadian customer that ceased operations, and gains from sales of certain long-lived assets.
- Management expected 2018 capital expenditures to exceed 2017 levels and planned to direct excess cash toward growth initiatives, acquisitions, debt reduction and share repurchases. It said operating cash flow and available facilities should meet foreseeable needs, while noting there can be no assurance. No specific earnings or revenue guidance is provided in the filing text.
- The board increased the share-repurchase authorization from $300 million to $400 million on October 31, 2018. During Q3, WESCO initiated a $25 million accelerated repurchase; final share delivery was not yet settled at quarter-end.
- Management reported no material change in market-risk exposures or previously disclosed risk factors. Routine commercial and employment litigation was disclosed; management did not expect pending matters to materially affect financial condition or liquidity, though a period’s results could be affected. Annual goodwill and indefinite-lived intangible impairment testing was planned for Q4; no interim triggering events were identified.
- The company adopted the new revenue-recognition standard in 2018 with no material impact. It expected to adopt the lease standard in Q1 2019; the evaluation was incomplete, and the standard will add right-of-use assets and lease liabilities to the balance sheet.
Important facts for investors to verify
- Whether sales growth and margin trends persisted after Q3, particularly given weaker gross margin percentages and reliance on favorable tax effects for earnings growth.
- Working-capital conversion and cash generation, including the $104.2 million nine-month cash use from higher trade receivables.
- Debt repayment, leverage, covenant headroom, and the company’s ability to maintain liquidity as the revolving and receivables facilities approach their September 2020 maturities.
- Final settlement and total share delivery under the accelerated repurchase, and use of the expanded $400 million authorization.
- Potential financial effects of foreign-cash repatriation, Canadian customer credit exposure, litigation, and implementation of the lease-accounting standard.