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WESCO International, Inc. (NYSE:WCC)

Q3 2008 Earnings Call

October 21, 2008 11:00 pm ET

Executives

Daniel A. Brailer - VP, Treasurer Legal and Investor Relations

Roy W. Haley - Chairman and CEO

Stephen A. Van Oss - SVP and CFO

John J. Engel - SVP and COO

Analysts

Matt Duncan - Stephens Incorporated

John Baliotti - FTN Midwest Securities

David Manthey - Robert W. Baird & Co.

Shannon O’Callaghan

Sam Darkatsh - Raymond James

Curtis Woodworth - JPMorgan

Brent Rakers - Morgan Keegan

Deane Dray - Goldman Sachs

Adam Uhlman - Cleveland Research

Steven Gambuzza - Longbow Capital

William Nobler

Operator

Good day ladies and gentlemen, and welcome to the Quarter Three 2008, WESCO International Earnings Call. My name is Norah and I will be your coordinator for today.

At this time, all participants are in a listen-only mode. We will be facilitating a question-and-answer session towards the end of this conference. (Operator Instructions).

I would now like to turn the presentation over to your host for today’s call, Mr. Daniel Brailer, Vice President and Treasurer of WESCO. Please proceed sir.

Daniel Brailer

Thank you Norah. Good morning ladies and gentlemen. Thank you for joining us for WESCO International’s conference call to review the third quarter 2008 financial results.

This morning participating in the earnings conference call are Mr. Roy Haley, WESCO’s Chairman and Chief Executive officer; Mr. John Engel, Senior Vice President and Chief Operation Officer, Mr. Steve Van Oss, WESCO’s Senior Vice President and Chief Financial and Administrative Officer.

Means to access this conference call via webcast was disclosed in the press release and was posted on our corporate website. Replay to this conference call will be archived and available for seven days. This conference call may include forward-looking statements and therefore actual results may differ materially from expectations.

For additional information on WESCO International, please refer to the company’s annual report on Form 10-K for the fiscal year ended December 31, 2007, including the risk factors described therein, as well as other reports filed with the SEC.

The following presentation may also include a discussion of certain non-GAAP financial measures. Information required by Regulation G with the respect to such non-GAAP financial measures can be obtained via WESCO’s web site at www.wesco.com.

I would now like to turn the conference call over to Mr. Roy Haley.

Roy Haley

Good morning to all, and thank you for joining this mornings earnings call. Wow, what an amazing quarter this has been. Just amazing, but I am glad to say that it’s been a good quarter for WESCO despite strikes and plant closings, hurricanes, and financial and commodity market gyrations, most of our end markets have held up well, and WESCO achieve good sales results, while also maintaining a record backlog of firm but unscheduled, rather firm but scheduled future shipments.

Over the last five or six years, our company has become strong, and I believe that we have further strengthened the organization during this third quarter. As you know, we have blue chip customer base that is highly diversified, and we believe that the deep customer relationships that we develop with large organizations leads to increased sales and service opportunities, and increased stability over the long-term for our business.

We have been continuously successful in competing for long-term preferred agreements with Fortune 1000 companies, and this quarter we added to our roster. Also during the quarter, and for the past year, we had excellent free cash flow, which I believe demonstrates the strength and quality of our underlying operations and earning stream.

We are realistic and cognizant of multiple data points and forecasts that point to declining markets. But the industries that we serve are large and fragmented, and we’re approaching every day as an opportunity to secure additional business and take actions that can improve the long-term prospects for WESCO.

Steve will now take us through the financial results for the quarter.

Stephen Van Oss

Thank you Roy. I’d like to provide a few comments to put the quarter’s performance into context. First, we produced our best ever top line performance and our second best ever earnings per share result. Our cost controls were effective, as we reduced our overall employment levels during the quarter, while continuing to add to our sales force.

Working capital performance improved over year end, and the third quarter of last year. We discussed last quarter the pressure exerted on our gross margins due to a significant run up of supplier price increases and the time required to work the increases through the channel. We do not see the absolute degree of improvement we have lagged in the quarter, but we did make progress over the June rate.

With the recent drop off in commodity prices, we are seeing a reduction in supplier price increases, and we are in fact experiencing gross margin expansion in October month-to-date. Our SG&A expense as a percent of sales, was consistent with last year’s third quarter, and this years second quarter, after adjusting for swings in foreign exchange gains and losses. On a consolidated basis, earnings per share for the third quarter of 2008 were $1.53 versus $1.54 last year.

Normalizing for tax rate differences and the impact of foreign exchange in both quarters, the comparable 2007 third quarter earnings per share would be a $1.36. Our share repurchase program was designed to capitalize on our earnings and strong free cash flow and deliver sustainable earnings accretion. Since February 2007, when we announced the first of two $400 million share repurchase authorizations, we’ve repurchased 9.1 million shares or 18% of our outstanding shares or a total of $506 million.

The earnings per share impact to this program on the third quarter of 2008 results was favorable by $0.13, despite incurring additional debt and interest expense associated with the share repurchases.

Given the heightened sensitivity to liquidity, debt and cash availability, I would like to review the positive characteristics of WESCO’s free cash flow generation throughout a business cycle.

With our low level of capital expenditures and good working capital performance, WESCO is able to generate more than enough free cash flow to fund expansion needs during the growth phase of the business cycle, and we generate an even higher level of free cash flow during the economic down cycle.

WESCO has historically generated 90% of net income as free cash flow, when significantly growing to top line. With more modest top line growth during the last three quarters, free cash flow was approximately 115% of net income. Favorable cash flow trends will continue during the fourth quarter. WESCO’s cash flow characteristics result in a very durable business model with ample liquidity in times of economic contractions.

Now for a more detailed look at our third quarter results. As discussed earlier, we posted company’s best ever quarter sales results. Adjusting for LADD, consolidated sales were up 7% over last year’s third quarter, driven by sales gains in our non-residential construction and utility end markets. Gains in utility followed the growth trend established last quarter and were aided by hurricane activity.

Manufactured housing and recreational vehicle end markets remained depressed, given tight credit and the continued weakness in residential constructions. Sales per workday increased sequentially throughout the quarter and were at record levels in September. Adjusting for price realization and additional workday, acquisitions, and the positive impact of foreign exchange, our sales were up approximately 2% for the quarter.

Backlog, which consists of firm orders for future delivery was well balanced and increased more than 17% over last year’s third quarter, and 16% over year end. Consolidated gross margins at 19.4% were down 90 basis points from last year and 10 basis points from this year’s second quarter.

LADD and mix accounted for approximately 40 of the 90 basis points decline from last year. Sequentially, mix was not a significant factor. SG&A expense as a percent of sales was flat sequentially and adjusted for foreign exchange gains and losses, was flat quarter-over-quarter.

We are continuing to invest in marketing programs and sales personnel, which we feel will provide for sales growth and market share gains as we move forward. The cost associated with the sales force expansion was approximately $3 million in the quarter.

Productivity gains were achieved as we’ve have reduced our overall appointment levels in each of the last two quarters. We will continue to drive our cost containment programs and for the remainder of the year, we are targeting a net reduction of personnel from current levels, while still maintaining a bias toward sales additions.

Strong net income and improvements in working capital performance absorbed the cash requirements associated with the higher sales volume and resulted in free cash flow of $76 million. Free cash flow was utilized to reduce debt, net of cash by 56 million and fund $14 million of share repurchases during the quarter, while reducing financial leverage.

Our all in average borrowing cost are low at approximately 3.6%, and along with good working capital performance have allowed the company to reduce interest expense $400,000 sequentially and by $5.5 million from last year’s third quarter.

With liquidity at approximately $350 million, and strong free cash flow projected, we continue to have ample capacity to fund multiple growth initiatives, while maintaining targeted levels of leverage. In the near-term, our primary focus will be on building liquidity and debt reduction.

At this time, John Engle, our Chief Operating Officer will provide additional commentary on our end markets and initiatives we are undertaking to strengthen organic growth. John?

John Engel

Thanks Steve. I’ll be providing a performance summary for each of our major end markets, but let me first start out with few key highlights. Construction sales were up 7%, industrial sales were up 6% and utility sales were up 9% versus the third quarter of last year, comprising an overall WESCO consolidated sales growth rate of 7% without LADD. The net impact of hurricane Ike and Gusta, within the range of 15 to $17 million, and equates to 1 percentage point of growth.

Now beginning with construction, we saw positive momentum in the quarter with sales of construction customers up 7% versus last year. All geographic regions posted positive sales growth, and this is despite a 22% decline in sales to manufactured structures customer.

Backlog remains strong in the quarter, and is up 16% versus year end, and is up 17% versus the third quarter of last year. Despite forecast of the declining construction start continuing in ‘09, and recent reports of project delays and cancellations in some markets, non-residential construction continues to present project opportunities across the major market segments that WESCO serves.

We have seen bidding activity began to slow in certain markets, and some evidence of project delays, but our backlog remains at record levels, and we have not experienced any major project cancellations. While most construction segments are forecast to contract in ‘09, the good news is that the construction industry is very large and with our sizing capabilities, we had major opportunities to increase our participation rate in the available business.

As evidenced in our results, we are gaining traction with national and regional contractors, including engineering procurement construction companies by applying our national accounts model to service their project management and supply chain needs across their many locations.

And finally, we’re continuing our capacity expansion program to selectively add sales personnel and increase our sales coverage, an attractive growth vertical and geographies, while driving additional penetration at new and existing customers.

We saw growth in the third quarter with data communication sales as well, growing low single-digit driven by strong sales to government and enterprise customers. This was partially offset by continued softness in low voltage audio visual products.

Backlog grew in the quarter and is up double-digits versus year end. Our sales and marketing initiative remained focus on combining CSC’s expertise in network infrastructure, data communications and internet technology based physical security product with WESCO’s electrical and power capabilities, our geographic footprint, and our national accounts position to provide solutions for construction and industrial customers.

We are making progress, and we are encouraged by third quarter wins and multiple industries including government, healthcare, energy producing and financial service. Our long term demand outlook is for increasing bandwidth demand in commercial, government, residential, fiber-to-the-premise applications, as customers continue to migrate to higher capacity network architectures, invest in data centers and improve the securities of their facilities and IT networks.

Now moving to industrial, sales to our national accounts, and integrated supply customers showed positive growth in the quarter and we’re up 6%. Bid activity levels remain high and a national account opportunity pipeline expanded to an all time record level in the third quarter. Our national accounts business model continues to demonstrate its effectiveness in the quarter with major customer’s renewals and two new Fortune 500 customer wins.

We’ve maintained our 100% contract renewal rate in 2008, and currently have a majority of Fortune 500 Companies as our national account customers. We’re prioritizing our customer facing initiatives to provide value added services and sell the complete WESCO portfolio products to serve our customers needs, in electrical and non-electrical MRO, capital projects and OEM materials and value added assemblies.

Now shifting to utility. In the third quarter, sales to utility customers showed positive momentum for the second consecutive quarter. Overall utility sales were up 9% versus Q3 of last year. Consistent with last quarter, sales through investor owned utilities and utility contractors were up double-digits, offset by declines with public power customers.

Overall utility spending continued despite the residential construction downturn. The customers are prioritizing their capital spend towards transmission related and alternative energy projects, which’ re primarily being served direct by manufacturers.

The utility market remains active with bid request and interest on national account and integrated supply capabilities remains high. We anticipate that end market levels in the fourth quarter of 2008 will be down sequentially, consistent with the typical end of the year seasonality. We are confident that our share in this market is steady, and we remain well positioned to capitalize on future investment in the nation’s electric power grid infrastructure.

So in summary, we are encouraged by our improved sales momentum in the first three quarters of 2008 and are continuing to make the necessary adjustments, including more aggressive sales execution and cost management actions.

Despite an economy that’s weakened, our emphasis and focus as we close out the year remains on sales and marketing execution while keeping tight controls on our overall cost structure. Continuity plans have been developed and will be executed as required in response to WESCO’s performance and end market activity levels in 2009.

We remain confident in our ability to execute in a tougher economic environment.

Now back to Steve.

Stephen Van Oss

Thanks, John. Couple of comments on general pricing, and then we’ll look at the fourth quarter. Our best estimate of the overall price realization for the quarter is in the range of 3% of sales, of which over half was comprised of general price increases with the remainder attributable to commodity based products.

Looking ahead, we expect that lower commodity prices will, if maintained, work their way through the market and the overall effect of pricing will reverse itself. We would expect to see a negative impact on sales in the fourth quarter, and on a comparable basis through the first nine months of 2009, as copper prices remain at current levels. We have an established policy of marking up our inventory to current market levels, and we are generally able to sell through commodity price declines.

We do not anticipate taking an inventory write down based on the current price levels, although margin levels on these products will be compressed as we sell through the higher priced inventory.

So look at the remainder of 2008 now. Typically, our seasonality is such that the first quarter has the least sales, second and third quarters are similar and the strongest, and the fourth quarter is down sequentially from the third quarter. Past seasonality indicates approximately 5% sequential impact on the fourth quarter.

At this time, the consensus view of most economists is that the overall market activity levels will be lower for the remainder of the year, and throughout 2009. We are confident that our sales and marketing initiatives, and our strong market position will enable our company to perform better than the end markets, as we maintain or improve current positions and grow with new customers.

For the fourth quarter, even with seasonality lower end market activity, and declining commodity prices, we expect to see sales growth rates quarter-over-quarter in the range of 1.5 to 2.5%, after adjusting for LADD joint venture accounting.

LADD sales were approximately $24 million in the fourth quarter of 2007. Gross margin percentage should show a slight improvement sequentially. Operating margins are expected to be in the range of 5.4 to 5.8%, given the seasonal impact of lower sales volume on operating leverage, the anticipated impact of declining commodity prices, and lower seasonal joint venture income.

Our tax planning activities have been very effective. At the present time, we anticipate that the 2008 full year tax rate will be around 30%. Working capital productivity should be maintained and free cash flow over the next several quarters will be directed at debt reduction and WESCO share purchases. Based on share repurchases to-date, share account for the fourth quarter of 2008 is anticipated to be approximately 43 million shares.

In summary, we have a strong quarter, and are encouraged by our progress on sales initiatives and are working hard on the margin front. We are looking forward to setting record breaking performance and best ever earnings per share for the year. Our view for the remainder of 2008 calls for more aggressive action on the sales front, and will require us to continue to capitalize on sales opportunities to offset macro end market negatives.

We are confident in our ability to execute in a tougher environment and expect to grow our core business at an above market rate. At this point, Norah can you please open the session up for a question and answer period.

Question-and-Answer Session

Operator: Thank you. (Operator Instructions). First question comes from the line of Matt Duncan of Stephens Incorporated. Please proceed.

Matt Duncan - Stephens Incorporated

Good morning guys, and congrats on a good quarter.

Roy Haley

Thank you.

Matt Duncan - Stephens Incorporated

The first question I’ve got, may be John this probably is for you, can you talk a little bit about what you guys are seeing and hearing from your customers in your various in market to kind of looking at construction, industrial utilities and the data? Maybe if you could expand a little bit on what your customers are saying and maybe have their purchasing attitudes change and what kind of negative headlines we’re seeing and the weakness we’re starting to see here in October?

John Engel

Okay Matt, Good morning. First, let me say, based on our results and through the quarter backlog has been maintained at record levels, our sales per workday strengthened through the quarter, and so far in October our results are consistent with September. We’ve not seen any of the, let’s call it the retroact that we’re reading in every public piece of communication that’s out in the market. We’re not seeing that effect in our results as of yet.

So, we are actually encouraged by the progress we’re making in terms of delivering value to our customers. If you look at the various segments, our industrial business held up very well. I mean, we’re growing above 5%, we’ve been in a upper single digit range at momentum is holding well. We’re maintaining our contract renewal rate, and I would highlight that it is our belief that as the economy gets tougher, and as those customers that are sophisticated, look at improving their supply chain and looking for cost and productivity benefits, we think that’s going to increase demand for our products and services.

Our pipeline for national account like opportunity is at a record level, where we saw increase in the quarter or then what we call a five phase process and two of the early phases discovering meetings and proposals to middle. That’s where we saw the pipeline increase significantly through the third quarter.

We’re getting more inquiries in terms of let’s call it our value added or value solutions under our national accounts type model. We’re also applying that to utilities. We are seeing good traction. Our growth was up double digits. With that said, we are getting some indications from some of these utility companies that they’re beginning to tighten up their capital spending.

It remains to be seen, how much that will be and to what degree that will occur. But, we really do believe that that’s going to occur. We also think in terms of seasonality the fourth quarter is typically lower than third. So I think we’re well positioned.

Finally in construction, I would say it depends. We are seeing indications of project delays, and for example one of our executives was in Florida earlier this week and met with a half dozen contractors, and bid activity in general is down.

They’re seeing more remodeling and renovation activity versus new construction. These were large contractors that we have good relationships with. They see resi only contractors trying to compete for commercial projects. We’ve talked about this in the past that dynamic.

But, but the takeaway, and Florida has been particularly hard hit from the housing downturn. They’ve got sufficient backlog. This half dozen contractors -- they think will carry them through -- at least through mid next year.

Matt Duncan - Stephens Incorporated

Okay. Thanks for the color. Maybe going back to the utilities for just a second, you said the hurricane impact in the third quarter was 15 to 17 million. Do you expect an impact from those again in the fourth quarter as things continue to walk through.

John Engel

That was our net number. The actual positive was a little bit higher than that. We have some offsets where utilities were down, we’re recovering. We don’t see any material impact for our utility business. Those customers in the fourth quarter, in terms of impact on our industrial customers and contractor base and in terms of rebuild activity is something we would see over a three-to-four quarter period.

It remains to be seen how large that will be, given the economic environment we’re operating in. It’s going to depend by facility. But, I think there’re some facilities in the Gulf that will see some renovation and rebuild activity to get back online.

Matt Duncan - Stephens Incorporated

Okay, Steve, going back to maybe your comments on price. Copper down where it is, it sounds like you guys think the next four quarters, so kind of 4Q ‘08, and in if the first three quarters of ‘09. Do you think overall pricing could be negative for you guys or was that really just a commentary on the impact of copper, but maybe you’ll still be passing through some supplier price increases to offset that?

Stephen Van Oss

Generally speaking, I’d say the price increases that we see across the broad base of products that we’ve achieved this year will hold forward to next year, so there’ll be a net positive. Copper, I have to give you a (inaudible) tell me what copper is going to be and for how long.

We just look at the early numbers in October -, first 13 days of October this year, 13 days of October last year and see copper futures have swung dramatically. Our sales and margins are essentially identical for that period of time. We’ve talked about in the past that there can be a significant amount of time before street pricing goes to where the future pricing is and that future pricing moves all around, so it have to be a long period of time, but if it stays at this lower level for long period of time, we’ll see negatives on that.

Matt Duncan - Stephens Incorporated

Fair enough. A last thing here and I’ll jump back in queue. You talked a little bit about kind of your planned usage of free cash, sounds like the top of that list is probably now debt reduction versus share buybacks. I’m curious, if you guys have ever considered paying a dividend with a very heavy free cash flow you’ve got right now? Is that something that would ever potentially enter your discussions?

Stephen Van Oss

We’ve certainly discussed this over the period of time, and as the company has grown and our free cash flow has grown, it’s a option that is available to us at this point in time. We continue to believe that we have significant opportunities in growing our top line through investments in the sales force organically, which we’re doing now, and we’ve demonstrated over the past a good ability to do accretive acquisitions. So that still has been our past, and probably be our near term prolog, at these share price levels our buyers will probably be more towards share repurchases than a dividend at this point in time.

Matt Duncan - Stephens Incorporated

Okay, thanks guys.

Roy Haley

Just a quick remainder, so that we can get as many questions, which will be respectful to everyone, that we appreciate the questions and want to hear from everyone. We will just ask everyone to try to keep it to one question with a quick followup with that.

Operator

And our next question comes from the line of John Baliotti, FTN Midwest Securities. Sir, please proceed.

John Baliotti - FTN Midwest Securities

Good morning guys. I was just wondering maybe you could talk about what you are seeing from feedback, maybe through your suppliers or just what you’re hearing from customers with respect to how the fragmentation of your competition is doing. Are you seeing any difference in terms of competitiveness of your larger competitors versus the smaller ones in this environment?

John Engel

John, good morning. This is John. I would say we’ve got a pretty good sense of at least from our supplier relationships, how we think we’re doing. I would tell you that with respect to utility, we’re confident that we’re holding our own. We are in a hold/take share position depending on what region you are looking at across the U.S.

In terms of our industrial business, we feel very good about how we’re holding our own, and I think if you were look at our performance at a general level versus a grand level, we’re comfortable when you adjust for their government business and take that out.

I think, on the construction side particularly with this quarter with our backlog being at record levels and our recent performance, we feel good about our results. I’ll tell you that our suppliers are telling us by and large that we are at least holding our own if not taking share with our relationship with them, them with us through to the channel.

John Baliotti - FTN Midwest Securities

So that would mean that since you are commenting on some of the bigger guys being similar then it’s probably that some of the smaller guys that are having a little bit harder time right now?

John Engel

I mean, you can infer that, yes.

John Baliotti - FTN Midwest Securities

Yeah. Okay, thank you.

John Engel

Next question Norah?

Operator

And your next question comes from a line of David Manthey of RW Baird, please proceed.

David Manthey - Robert W. Baird & Co.

Hi guys, thanks. Just a couple of quick ones upon you. Steve, when you’re talking about 1.5 to 2.5%, you said quarter-over-quarter I believe, are you talking about year-over-year there or sequentially?

Stephen Van Oss

Year-over-year, fourth quarter last year adjusted for LADD versus the fourth quarter coming up.

David Manthey - Robert W. Baird & Co.

Got it. And then GP, where you were talking about it being higher, I believe you said quarter-over-quarter again, was that sequentially or year-over-year?

Stephen Van Oss

That would be sequential.

David Manthey - Robert W. Baird & Co.

Okay, I thought so. All right. Another factual question here. The 200% increase in your sales force, what percentage increase does that represent approximately?

Stephen Van Oss

Of our sales force?

David Manthey - Robert W. Baird & Co.

Yes.

Stephen Van Oss

It’d be around 10%.

David Manthey - Robert W. Baird & Co.

Okay, all right. Quickly here, in terms of your outlook, I am just - I am wondering as you look at the surveys that are out there, and some of the indices. What do you think about what happened back in the last recession, sort of, '02 when non-res construction was down 20%.

Do you think '09 is going to be better or worse than that as an industry, overall? And then were you talking about your current momentum and you mentioned a plan B sort of what you would implement if things got worse. Could you give us a little bit of color on what might happen if things start to deteriorate?

Roy Haley

Let me try to take that one if I can, Dave. The outlook from a variety of sources puts the non-residential construction market broadly in the down 10% territory; some forecaster on either side of that number, but around 10%. And that takes in a variety of categories as you know.

Our business has been dramatically strengthened in the intervening period, since 2001 to 2003, with a major broadening of our base of contractor or customers. We have developed a really strong relationships with a growing number of engineering and construction firms.

We have more in the way of large regional and national firms. We are working on a variety of projects, but a lot of them are, they don’t fall in the category of four storey office buildings and things of that nature. These are large projects that have significant backing behind them. From our vantage point, we think that we're a lot better positioned than we were for sure a few years ago. And we see that getting even stronger.

The numbers are in the range of down 10% in the aggregate and the differences will be in the category. If you're looking at petrochem even at current pricing levels, our feedback from our customers is that they're moving forward with most projects, there have been some that indicated some scaling back, but we don’t expect to see that until well into 2009.

The power generation market is still very strong. There are other major infrastructure kinds of projects that every indication we get from direct contact with customers is that they have a lot of work and they’ve got big backlogs and this is moving forward. So, despite the recognition that the industry as a whole will be down, we feel pretty good about where we are right now.

David Manthey - Robert W. Baird & Co.

Okay. Thanks, Roy. I don’t mean to monopolize here. But if you can talk about the plan B, sort of, what you would put into effect if things slow down? I'll leave it there. Thanks.

John Engel

Dave, this is John. Over the last two quarters, sequentially, Q2 and Q3. We have been taking very strong managerial control, we've always had it, but we've tightened up the controls in terms of how we're managing costs and our various expense categories.

As Steve mentioned, we've checked down headcount at the end of Q2 versus the beginning -- versus the end of Q1, we took down headcount at the end of Q3 versus the beginning -- again, at the end of Q2. So over last two quarters, sequentially, we’ve taken headcount down. We have gone out and we have developed specific plans by that are tailor. This is not a hatchet approach; it’s more of a scalpel approach.

We’ve developed specific plans that are tailored by end market sets of customers and by function. We’ve got various triggers set based upon current business and outlook on business activity levels. So, we will pull the appropriate triggers as we move through time. That’s the approach, it’s very specific, and it’s specifically tailored based upon various operating groups and functions.

Operator: And your next question comes from the line of Shannon O’Callaghan. Please proceed.

Shannon O’Callaghan

Good morning, guys.

Roy Haley

Good morning.

Shannon O’Callaghan

Can you give us a little flavor of how you expect, I know you give the guidance around gross margin for next quarter. You’ve got your supplier price increases coming down. You’ll feel some of that pressure yourself. Where do you think - I mean, you’re going to be able to maintain gross margins or can you put a wide range around where you think these are going to go and are they bounced around quarterly or how do you see it?

Roy Haley

I think you’ll see more stability than not. We feel that with the slowdown of price increases that puts us in a better position to get us through the channel in orderly fashion. In fact, if you go back or way back in time you’ll look at the ‘01 to ‘03 downturn, we actually improved our gross margins during that three year period. So, we wouldn’t expect to see any wild gyrations in the gross margins line at this point.

Shannon O’Callaghan

Okay. You mentioned the points about free cash flow and generation of downturn. What about your own inventory levels at this point? As you start to think about a slower world here. Are you starting to take them down or how are you approaching your level of inventory?

Roy Haley

Working capital is in very good shape. We’ve maintained good controls over that; and for many, many years. So, we watch that by category and by activity levels and so it is adjusted regionally and almost on a branch by branch basis as appropriate. We watch that carefully, I don't see a significant issue there at all.

Shannon O’Callaghan

You are not trying to take those levels down more aggressively given the headlines you are seeing.

Roy Haley

We are always doing that and we are pushing to bring the inventory down. The challenge there is to take inventory down, you take down what's selling quickly at your replenishment rate, so we’re watching our fill rates and availability rates. That’s the key thing that we look at. We’re actually working harder on the slower moving items to bring those down into an absolute component. So we are trying to set of words gone with that but our sales activity levels have been good and we have a history of matching our inventory with our activity levels.

John Engel

And the other thing - this is John, Shannon. The other thing, I think the optimizing variable for us is customer service.

Shannon O’Callaghan

Yeah.

Roy Haley

We think it's even more important in these challenging times, particularly as competitors may have more of a challenge that we super serve our customers. The final point I’d make, if you look at our inventory by and large, I mean these are products that don't go obsolete. There is good fundamental demand for them, so we've got a very detailed and mature process as Steve mentioned, but it’s focused on keeping our customer service levels where they need to be.

Shannon O’Callaghan

Okay, great. Thanks a lot.

Operator

Your next question comes from the line of William Nobler of (Vespo). Please proceed.

William Nobler

Hi, congratulations on excellent execution.

Roy Haley

Thank you.

John Engel

Thank you.

William Nobler

Did I understand correctly that your sales expansion courses are up $3 million this year and is that the 10% increase in sales force you are referring to?

Roy Haley

That's a quarterly number, Bill. It's approximation of where we’re at on a growing basis. We’re not completely done with our sales force expansion, but as - that represents the quarters impact of where we got into, since about this time last year when we started the program.

William Nobler

Right. And, you also said you are looking for, if I understood correctly, a record EPS this year. Is that versus 464 the prior year?

Roy Haley

That would have been -versus - last year’s record, this year we should be on top of that.

William Nobler

Okay. What do you use as last year's figures, since different people adjust differently?

Roy Haley

Reported, from the reported figure from last year.

William Nobler

Okay. One comment I wanted to make about a dividend. I realize it's very tempting and correct to buyback the stock at four times earnings or whatever the multiple is. But, it would seem to me that with the cash flow that the company generates, there are institutions who cannot buy your stock because of no dividend, and I would think you'd want to continue to broaden your shareholder base, and thanks very much for the good work.

Roy Haley

Thank you. And thank you for your input.

Operator

And next question comes from the line Sam Darkatsh of Raymond James. Please proceed.

Sam Darkatsh - Raymond James

Good morning, gentlemen. How are you?

John Engel

Good morning.

Roy Haley

Hi, Sam.

Sam Darkatsh - Raymond James

I hate to blabber this question, and I’m going to get some eye rolling from the other listeners, but I want to make sure I understand the gross margin impacts over the next, now and next quarter, Steve, but over '09 perspectively. As I understand it, you've got supplier price increases that went through that it has taken some time for you to pass those through to your customers, and you are now beginning to do that which is a beneficial impact.

And that in Q4 is going to be partially offset by lower mix and also the commodity deflationary effects. And so, you're going to have only a proportion, now that’s why I want to make sure I understand - you're going to have a little bit of a sequential improvement in Q4. In '09 however, I would suspect that if you're still going to have weak end market demand and deflationary effects of commodities and mix degradation or against mixed degradation on gross margins, why would gross margins expand in '09 under that scenario? I'm confused.

Stephen Van Oss

A couple of comments. On the commodity based products, if they move rapidly in a relatively short period of time, we'll see some compression on that and some pressure as we sell our way through the higher cost inventory. That generally fixes itself, gets to equilibrium in a every quarter or so. And then, normally bounces right back to maintaining kind of what we call the standard margin on that regard. We saw that and in the downturn '01 to '03 in that regard.

The general price increases that come through tend to be permanent instead, unless you’re going to see a wholesale change in the commodity prices? Again, I would remind you that the street prices are what we pay and what the suppliers push through to us, aren’t what you see on the future prices. Sometimes they move in different directions in the futures budget, but over an extended period of time, if they're widely different, we would expect to see that perhaps go through.

Our suppliers are working very hard to maintain the prices that they put in, they were unable to get price increases through to the degree that commodities may have temporarily spiked you. So there's a lot of pressure on the supply side to try to maintain that.

Sam Darkatsh - Raymond James

So, if, as long as commodity prices do not continue to deflate in '09, you expect general stability and gross margins due to existing supplier price, or I'm sorry, existing wholesale price increases that you are making at present. That’s in a nutshell.

Stephen Van Oss

Basically, the fact is that. When there is an adjusted period up or down, we can see some expansion or contraction in a short period of time.

Sam Darkatsh - Raymond James

All right.

Stephen Van Oss

To snapback to maintain the margins, the other question would be, is it maintains a very low level it could have some impact on the top line going forward. But again, we’re not - we saw similar sales activity and profitability in a short period of time in the October period this year versus last year with significantly different numbers on the commodity prices.

Sam Darkatsh - Raymond James

Okay, I got it. Just a couple of real quickies here. Number one, the FX losses do you expect it with the commodity given that the exchange rates having shifted fairly rapidly? Do you expect those losses to continue, Steve or Dan? How should we look at those over next few quarters?

Stephen Van Oss

On the top-line we have an FX loss in the P&L and they are pretty much coming in line. We are doing a good job of matching our liabilities and assets on our foreign operations to try to negate that for the most part. But there will be small ones in there. From a top line impact, we actually had a positive impact we would expect to see that from our Canadian operations, and we expect to see that perhaps going mildly the other direction.

Sam Darkatsh - Raymond James

Okay. So, no real P&L impact going forward that’s of a material nature?

Stephen Van Oss

I wouldn’t think of a material nature. The real change from last year is, last year was extremely positive. We had $5 plus million of favorable impact. So, since then we’ve tightened up our matching of assets and liabilities to mute the impact of currency swings.

Sam Darkatsh - Raymond James

Okay. Lower fuel costs, have they cycled through yet and have aided margins at all or you have yet to see that yet?

Stephen Van Oss

Not seen at this point in time.

Sam Darkatsh - Raymond James

Last question, the hurricane happened late in the quarter. Do you still believe your net benefit -- the net result was a benefit to top line?

Stephen Van Oss

I mean, it's really hard to tell because we have -- certainly, we can point out couple of customers in the utility business that business really went up. What you don't see, we have roughly 50 branches that were kind of in the past of the storms. What happens to our facilities might have happened to their construction or industrial business as they get slowed down. We believe it's a net positive, this is not a big number.

Sam Darkatsh - Raymond James

Thank you.

Operator

Next question comes from a line of Curt Woodworth, JPMorgan. Please proceed.

Curtis Woodworth - JPMorgan

Hi. Good morning.

Roy Haley

Good morning

Curtis Woodworth - JPMorgan

A hypothetical question. If we were to assume that 2009 gets potentially dramatically worse than what you’re thinking today? If we were to say that sales were 500 million lower in '09 than they are this year, it's about an 8% decline. Realistically, what would your SG&A look like, sort of, if 500 million down that's probably, call it 95 million lower gross profit, I know, some of the SG&A is obviously tied to the gross profit metric. Clearly probably will be cutting headcount at the end of the year if that become a reality. Just give me a sense for what -- realistically what SG&A would like under that scenario?

Stephen Van Oss

What happens is the SG&A will go down and will go down as fast as the sale, if you’re saying sales goes down rapidly. We have -- it's a hypothetical question, we have some realized experiments on the head in 2001 and 2003, where it took and we had a deteriorating top line in the first year of 6-7% a little bit higher in the second year and kind of leveled off forward it down in the third year. We chased the headcount versus the top line all the way and into that point in time, caught up with it. In 2003, and when the cycle came back, we essentially kept our headcount the same.

Wwe look at it on normal terms as good growth environments. We look to be at the 50 that our headcount or SG&A cost grow at half to two-thirds the raise of the top line growth. When you have a rapid decline, it takes you out to catch up and then actually goes, probably the inverse of that for a period of time.

Curtis Woodworth - JPMorgan

So, if you’re down 8%, do you think SG&A would only fall by 3%?

Stephen Van Oss

You know, 3 to 5

Curtis Woodworth - JPMorgan

Okay.

Stephen Van Oss

It depends on the speed of it, Curt.

Curtis Woodworth - JPMorgan

Then on - in terms of the direct ship business, it seems that's probably the most at risk from an economic standpoint in 2009. How much lower the gross margins on that business is then, you know, kind of the branch based sales?

Stephen Van Oss

In other words, it is 30, 40% lower. I think the piece on that I would say, it's different than your modeling exercises. Our project business as a percent of our total business is less than what it was five years ago, and then the elements of our project business have changed a fair amount with the addition of our communication supply acquisition, which goes into that category.

But we believe there is a different end market driver being more bandwidth driven than new constructions. So, we think that fundamentally the company is a different company than it was five or six years ago and we will see how we deal with this upcoming economic environment. We are a lot better positioned.

Curtis Woodworth - JPMorgan

I was just trying to think about what the mix benefit will be to gross margins next year. If the direct ship business falls off, likely more dramatically…

Stephen Van Oss

It would improve the gross margin.

Curtis Woodworth - JPMorgan

Compliance.

Stephen Van Oss

I can tell you, looking at the past as a percent of our sales, the direct ship versus our stock business has not materially changed over a five-year period, and even during the downturn, while we saw it mix improve a little bit in that regards. It wasn’t a big step function change.

Curtis Woodworth - JPMorgan

So you would expect the project and then the branch based businesses to decline at a similar rate next year, in a recession?

Stephen Van Oss

No we would not. It would be -- the mix would be slightly more favorable.

Roy Haley

Right.

Curtis Woodworth - JPMorgan

Yeah, okay. All right. Thank you.

Operator

Next question comes from the line Brent Rakers of Morgan Keegan. Please proceed.

Brent Rakers - Morgan Keegan

I wanted to go back to the initial part of the call when Steve talked about a Q3 revenue number of 2% adjusted for somethings and then 7% overall, could you take me back through the components of getting from the 2 back up to the 7?

Stephen Van Oss

Yes. There were several factors in that. We talked about price realization, we talked about impact on of one additional workday in the quarter, some holiday impact on acquisitions and foreign exchange.

Brent Rakers - Morgan Keegan

And the impact, Steve, on acquisition. Could you remind me again what LADD was, and then what maybe the three smaller acquisitions contributing on the positive side?

Stephen Van Oss

LADD was around $25 million the previous year. So if you look at our reported sales were 5.3, we adjust to a 7% number, that difference is LADD. Acquisitions, they were small acquisitions, one of them is already -word missing? that we already passed the one year period, so it was half a percentage of sales or less.

Brent Rakers - Morgan Keegan

Great. Last question, again given what’s going on with the Canadian currency in particular, it looks like sequentially possibly revenue is down 20 to 25 million or so from that. Could you maybe walk through what the impact of that was outside of just straight lower revenues, lower GP dollars. What par SG&A would move with that?

John Engel

Can you repeat your assumption there, I didn’t follow you on that one.

Brent Rakers - Morgan Keegan

I mean just in terms of September even versus where the trend line exchange rate is with the Canadian dollar, in terms of the impact on revenues, as it goes to a year-over-year negative impact on the revenues from currency. Once again, lets say 20 to $25 million or so fourth quarter versus fourth quarter last year. How would SG&A be affected by that number?

Stephen Van Oss

Everything, we track the same on that. That’s a wholly owned subsidiary, so the ratios would be identical from gross margin SG&A et cetera. It was slightly favorable in the quarter, but if you use those type of rates, you’re looking $20 million type of a number, so you’re not too far off from that number.

Brent Rakers - Morgan Keegan

I guess one last question. Could you - what was the average interest rate on the AR facility, and then what do you see that as of the month of October.

Stephen Van Oss

The security rates in the 4, 4.5% range. We’re seeing to go up a little bit in October, but we’d expect to see it come down again as commercial paper rates are now coming back down.

Brent Rakers - Morgan Keegan

Great. Thanks Steve.

Operator: Next question comes from a line of Deane Dray, Goldman Sachs. Please proceed.

Deane Dray - Goldman Sachs

Thank you, good morning. Just like to have a clarification on some of the answers you have given on the cost structure. Can you clarify what type of top line environment you’re structured for today? You've done additions to the sales force, you've tweaked back SG&A, so given that the present structure, what's the top line environment that you’re optimize for today?

Stephen Van Oss

Right now, we’re pretty well placed in the position for the top line you are seeing. We don't -- we've not put in a big bench of second to call them up the bench, bringing them into the game type of the scenario.

And as John talked about, we've got contingency plans in place that are formalized, but frankly a not whole lot different then how we operate on an ongoing basis. We are tweaking headcount in particular branches or operating entities up or down based on their specific activity levels.

Roy Haley

The big variable Deane is the fact that we have added to our sales organization and there is some ramp up with that and as we continue to add, we will see sort of multiple layers of ramping up, depending on when people were hired. But, we basically look at our sales personnel, if they cover their cost in the first year, we've done a pretty good job, we really expect performance out of them in the subsequent year.

The reason for that is we bring them on Board, we've got a lot of company training, we've got product training, and we’ve them introduced to new customers or market segments. There isn’t clearly a ramp up to basically to cover the cost in the first year with growth coming after that.

So there is some, if you will latent capacity being developed in this process, and we are absorbing that cost as we go forward. So on a go forward basis, we have, we should have additional capacity that's really going to show itself two or three years out, as we accomplish sort of this multilayering of this year's people coming up to speed and then adding another group on top of that. So it’s not a huge number, but it is building, and we are building that into our cost structure.

Deane Dray - Goldman Sachs

That's helpful, Roy and just -- that's on the sales side. On the SG&A side, just to clarify, Steve said there is a little bit of a LADD effect as you pull back on some of the SG&A cost. What period of time you’re talking about, is that a quarter or two before you see the effect?

Roy Haley

It's the quarter or two is a reasonable number. But it also depends on where the activity levels changes. If it's changing in the project business, we can’t take as many people out, because there is not as much activity inside the company versus stock or MRO based activity, which is something that we’d bring it into the warehouse, pick-pack, and ship it on our trucks. So there is a little bit of that mix component into that. So, it really depends on which area it’s coming, so if it’s coming from the project business, the percent of sales impact could be a little bit higher on the SG&A, although the dollars wouldn’t change as much.

Deane Dray - Goldman Sachs

Got it. And then, just last question on leverage. Where do you expect to end up in December on leverage versus your goals.

Roy Haley

We are right where we need to be right now. We’re at under three times levered and with plus or minus two tenth of return to that probably not on the plus side.

Deane Dray - Goldman Sachs

And if you are paying down, it would be down through the inventory revolver.

Roy Haley

Inventory revolver first, and securitization second.

Deane Dray - Goldman Sachs

Very helpful. Thank you.

Roy Haley

Okay.

Operator

And next question comes from the line of Adam Uhlman of Cleveland Research. Please proceed.

Adam Uhlman - Cleveland Research

Just a couple of clarifications. First of all, Steve you said that headcount would be worked down again in the fourth quarter, what would headcount look like at the end of the year on a year-over-year basis then?

Stephen Van Oss

We probably would be flat. We had a bit of a build in the first quarter, really driven by kind of a jump start on our sales force additions. You may recall at the end of the first quarter, we talked about continuing to look at additions, but to be even more forceful on our execution of productivity actions and that's what we did, and we’d expect to see kind of a similar to what we average in the second and third quarter reduction in the fourth - basically put us flat for the year on higher sales.

Adam Uhlman - Cleveland Research

Okay. Great. On the gross margin side, can you talk about what's been unfolding with supplier rebates and incentives? You guys have been growing pretty nicely. Have you picked up any benefits from that or are those yet to come?

Stephen Van Oss

Pretty much flat for the year, and if you look at how these programs work, their jump growth components in that, so you have to have some growth each year to maintain parity as a percent of sales. So it's pretty similar to what we had last year. I wouldn’t expect it to be any pickup or momentum going forward in the fourth quarter on that. We keep it pretty tight all throughout the year and typically don’t have any big quarterly adjustments to that. So it should be neutral.

Adam Uhlman - Cleveland Research

Okay. Great. Thank you.

Operator

And your next question comes from the line of Steven Gambuzza of Longbow Capital. Please proceed.

Steven Gambuzza - Longbow Capital

Good morning.

Roy Haley

Good morning

Steven Gambuzza - Longbow Capital

On the backlog numbers that you put out, specifically on the power side, I believe you talked about the change versus the prior year as well as versus year end. What was the change sequentially?

Roy Haley

It was flat.

Steven Gambuzza - Longbow Capital

Flat sequentially. And the supplier rebate question that was just asked, if you do see next year being down year in terms of sales and kind of the 5 to 8% range, what would kind of the headwind on margins associated with the roll-off of the incentives you booked this year. What were that kind of - how would that hit the gross margin line, what was the magnitude?

Stephen Van Oss

It depends as well, but if nothing changes in the program, it’s kind of 20 basis pointish type of a number, but every year we try to look at those programs and get structural improvements, as well as on existing programs, as well as add new programs to the mix. And so, depending, and we’re writing that process right now. Depending on success on that it will help negate if sales slowdown.

I’d add one more point, if sales slowdown on the top line would necessarily correlate directly with the rebates because it depends on what type of products and which suppliers we’re doing, to the extent we’re able to shift purchases where this is multiple sources, fuses or wiring device type of lines to a preferred supplier what was coming from a non-preferred, we could negate some of that.

Steven Gambuzza - Longbow Capital

Okay. You mentioned nine points of organic growth at the, in the power business this quarter. Can you just quantify how much of those points were hurricane related? I know you give the absolute dollar amount hurricane, if you can kind of breakout the nine points in hurricane price and volume

John Engel

Specifically inside utility and it was principally with three major customers. It was around, approximately $20 million, and that would equate essentially seven plus to eight point of the overall nine points of growth for utility, so if you take hurricanes out from a utility perspective, utility have positive growth in the quarter versus Q3 of last year, and I would say the momentum was similar to the second quarter.

Steven Gambuzza - Longbow Capital

So seven to eight points hurricane.

John Engel

Yeah. Second quarter if you remember, we grew utility, but prior to second quarter Q1 of this year, Q4, 3, and 2 of last year, we had negative utility sales.

Steven Gambuzza - Longbow Capital

Okay.

Roy Haley

Just to remind you that, if you say we take the hurricanes out, we had 50 branches that would have had some impact of loss business and higher cost as a result of hurricanes, so you just have to recognize the right way to look at is to look at in the aggregate.

Well let me close now, we've reached the noon hour. Steve and John have indicated, October is off to a good start although the sales line and on margin improvement. We've had a good number of major customers who have clearly indicated that they are proceeding with the major developments inside their companies and capital spending programs.

There have been some large companies that we are aware of that are not our customers, who have been announcing cut backs, but so far I’m pleased to say, we haven't taken direct hit. We are actively proceeding with our development programs. We are hiring new sales personnel, we are staffing new leadership roles and market segments, where we believe that there is significant future growth potential.

We are proceeding with the most expensive set of new internal training programs in part to make sure that our sales organization is better equipped then ever before, and we’re investing in information systems upgrades and enhancements in a number of different areas. So we've got a lot going on. We recognize that these are tricky times. But we are focused on what's going to make our business strong, both short term and in the long-term.

So, we want to thank you for your continued interest and support of WESCO. Have a good day.

Operator

Ladies and gentlemen, thank you for your participation in today's conference. This now concludes your call. You may now disconnect. Good day.

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Source: WESCO International, Inc. Q3 2008 Earnings Call Transcript

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