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WESCO International, Inc. (NYSE:WCC)

Q2 2011 Earnings Conference Call

July 21, 2011 11:00 ET

Executives

Dan Brailer – Vice President

John Engel – President, Chairman, and Chief Executive Officer

Richard Heyse – Chief Financial Officer

Analysts

Adam Uhlman – Cleveland Research

Deane Dray – Citi Investment Research

Sam Darkatsh – Raymond James

David Manthey – Robert W. Baird

Brent Rakers – Morgan Keegan

Scott Gaffner – Barclays Capital

Noelle Dilts – Stifel Nicolaus

Chris Parkinson – Credit Suisse

Jack Atkins – Stephens Inc.

Ajay Kejriwal – FBR

Jack Stimac – BB&T Capital Markets

Tony Kure – KeyBanc

Steve Tusa – JPMorgan

Operator

Good morning, and welcome to the WESCO Distribution Inc. Second Quarter Earnings Call. All participants will be in a listen-only mode. (Operator Instructions) After today’s presentation, there will be an opportunity to ask questions. Please note this event is being recorded.

I would now like to turn the conference over to Dan Brailer, Vice President. Please go ahead.

Dan Brailer – Vice President

Thank you. Good morning, ladies and gentlemen. Thank you for joining us for WESCO International’s conference call to review our second quarter financial results. Participating in the earnings conference call this morning are the following officers; Mr. John Engel, President, Chairman, and Chief Executive Officer; Mr. Richard Heyse, Vice President and Chief Financial Officer. And also attending is Mr. Steve Van Oss, Senior Vice President and Chief Operating Officer.

Means to access this conference call via webcast was disclosed in the press release and was posted on our corporate website. Replays of this conference call will be archived and available for seven days.

A supplemental financial presentation has been produced, which provides a summary of certain financial and end market information to be reviewed in today’s commentary by management. We have posted this presentation on our corporate website and filed it with the Securities and Exchange Commission.

The 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 SEC filings, including the risk factors described therein. The following presentation may also include a discussion of certain non-GAAP financial measures. Information required by Regulation G with respect to such non-GAAP financial measures can be obtained via WESCO’s website at www.wesco.com.

I would now like to turn the conference call over to John Engel.

John Engel – President, Chairman, and Chief Executive Officer

Thank you Dan and good morning everyone. Our second quarter results are excellent and reflect a continuation of the strong business momentum that we have been generating since early last year. Organic sales net of acquisitions and foreign exchange grew 13% in the second quarter marking the fourth consecutive quarter of double-digit organic sales growth. This sales trend is continuing in July.

Backlog which also grew double-digits was up 21% versus last year and up 9% sequentially in the second quarter. Execution of our growth strategies is on track and is producing positive results. We are encouraged that customers are responding well to our One WESCO initiative to actively shell and support our entire portfolio of products and services across their operations.

We experienced organic sales growth in all four of our end markets and in all six of our major product categories in the second quarter. Sales in new industrial construction utility and CIG end markets grew 18%, 13%, 6%, and 3% respectively versus last year. Sales outside the United States and Canada grew 20% versus last year and sales to government customers were up 25%.

The U.S. construction sales were also up double-digits and grew 12% versus last year, despite a very weak end market. Sales of our data communication products were up 11% on a year-to-date basis and 1% in the second quarter versus prior year. We significantly built backlog in data communications during the quarter growing over 30% sequentially and backlog is currently at a record high. We are in the middle of a successful conversion of the information and technology platform of our data communication operations. While the conversion is going very well, it did impact billings for the second quarter. We are seeing a rebound in billing with rates through the first half of July up low double-digits.

We expanded gross margins to over 20% in the second quarter against the backdrop of what continues to be a very challenging competitive environment. The second quarter results highlight the effectiveness of our sales and marketing programs and demonstrate our continued ability to take advantage of growth opportunities, while profitably capturing share and improving our market position. The three acquisitions that we made over the last year are also exceeding expectations and have strengthened our business. Acquisitions contributed approximately $0.10 to our reported earnings per share in the second quarter and contributed a total of $0.19 in the first half, which puts us at a run rate well above our full year expectations.

Our acquisition pipeline is the largest that it has ever been and we see excellent opportunities to contribute to strengthen our portfolio in 2011. In addition we continued to de-leverage our capital structure and increased our liquidity in the second quarter. We have the capacity and financial flexibility to fund our strategy of above market organic growth plus accretive requisitions. Overall, execution of our sales growth and margin improvement initiative have translated into strong financial results. Operating margins of 5.6%, net income of $50 million, and EPS of $1 in the second quarter were up 150 basis points, 81% and $0.40 respectively over last year.

The operating margin expansion was the result of an effective combination of gross margin expansion and operating cost leverage. Operating profitable pull through was over 60% for our core business in the second quarter and is above our long-run target of 50%. The strength, diversity and operating leverage of our business model are clearly reflected in the improving profitability of our business.

We entered the second half of 2011 with positive momentum and a robust pipeline of growth opportunities. Our long-term outlook remains unchanged. We expect the economy to continue to recover slowly over the next several years. We remain focused on continuing to execute our One WESCO growth strategy and further improve our market position against this economic backdrop. We are ahead of schedule in achieving the financial goals that we outlined last year in our first-ever Investor Day. We will host our 2011 Investor Day on August 9 in New York where we will report on our progress in more detail and provide our strategic and financial plan for the next three years.

Now Richard Heyse our CFO will provide details on our second quarter results and our third quarter and full-year outlooks. Richard?

Richard Heyse – Chief Financial Officer

Thanks John. First I will share with you our second quarter results and then conclude with our outlook for the third quarter and the full-year. Our second quarter sales were up 21.1% compared to last year including a 1% positive impact from foreign exchange and a 7.4% positive impact from acquisitions. Our organic year-over-year growth rate for the quarter was therefore 12.7%. This is our fourth consecutive quarter of double-digit organic growth. Year-over-year price increases for the quarter had a favorable impact of approximately 3%.

Sales increased 6.5% sequentially including a 0.9% positive impact from acquisitions and a 0.4% positive impact from foreign exchange, resulting in a sequential organic growth rate of 5.2%. This organic growth rate also include the 1.6% positive impact from one additional work day. Quarter end backlog excluding the impact of our three recent acquisitions was up 21% over last year second quarter. This increase exceeded our Q2 organic sales growth rate of 13% and is up 16% from the end of 2010. Backlog represents firm orders in hand for future delivery and provide some indication into future sales activity for the next several quarters.

Our second quarter gross margin was 20.1%, up 80 basis points year-over-year. The increase in our second quarter gross margin reflects the positive impact of our margin expansion initiatives and was driven by acquisitions, improved cost activities, price realizations, supplier volume rebates and inventory management programs. Sequentially, gross margin was up 10 basis points.

SG&A expenses for the quarter were $214 million or 14.1% of sales compared to $186 million or 14.8% of sales in the comparable 2010 quarter. Approximately $12.2 million or 44% of the year-over-year SG&A increase related to our three recent acquisitions. Sequentially, sales were up 6.5%. However, there was no increase in second quarter SG&A expense dollars compared to first quarter levels.

Second quarter operating profit was $85.0 million or 5.6% of sales versus $51.3 million or 4.1% of sales for the second quarter of 2010, a year-over-year increase of 66%. Our operating margin expansion of 150 basis points was driven by a combination of 80 basis points of gross margin expansion and 70 basis points of operating cost leverage.

Operating profit pull through measured by incremental operating profit dollars divided by incremental gross profit dollars is the financial metric WESCO uses to gauge the effectiveness of leveraging sales growth, gross margin improvement and cost management. Our second quarter core operating profit pull through which excludes acquisitions was 62% significantly above our long-term target of 50%. Core operating pull through for the first half of 2011 was 52% even after adjusting for the unfavorable 2010 first half impact of $3.8 million of non-cash charges associated with our LADD joint venture divestiture.

As we invest in our growth initiatives, we continue to focus on delivering above market profitable sales growth while ensuring effective leverage of our operating cost. Our first half year-to-date sales growth of 20% plus combined with year-to-date core operating profit pull through of over 50% demonstrates our ability to deliver both sales growth and operating cost leverage objectives.

Our second quarter effective income tax was 29.4% compared to the 28.2% rate experienced in the comparable 2010 quarter. Second quarter net income grew 81% to $50.2 million and resulted in an EPS of $1 per share on 50.3 million fully diluted shares outstanding. This compares to reported net income of $27.8 million and an EPS of $0.60 per share on 46 million fully diluted shares outstanding in the second quarter 2010. As John noted our three recent acquisitions contributed an estimated $0.10 per share to our second quarter results.

Second quarter free cash flow was the use of $20 million compared to the use of $4 million in last year second quarter. On a year-to-date basis we have generated free cash flow of $7 million. Assuming normal second half seasonality patterns, we believe that full year free cash flow will be at or above our expected target of 80% of net income. Our in-cash salary cost for the quarter including commitment fees was 4.6%. Liquidity defined as investment cash plus committed borrowing capacity at $414 million improved from $338 million at year-end and $354 million in the first quarter. As of quarter end, our pro forma financial leverage ratio was 2.9 times total par value debt to EBITDA. This compares favorably to last year’s ratio of 3.7 and is well within our target leverage range of 2.0 to 3.5 times.

Now, I’d like to discus our third quarter expectations. We experienced strong second half growth rate in 2010 with sales up 15% in the third quarter and 18% in the fourth quarter. That positive momentum is carried into 2011 where we have grown sales 25% and 21% respectively in the first two quarters versus last year. Our July month of sales trend is also consistent with second quarter growth rate. Typical third quarter sequential sales growth rates have been in the 0% to 3% range. Our outlook is that third quarter 2011 sales are expected to increase at least 18% from third quarter 2010 levels and at least 2.5% sequentially.

Our sales growth estimate includes the impact from acquisitions and our growth initiatives, but it seems that pricing and foreign exchange rates remain consistent with second quarter levels. Third quarter gross margins are expected to be at or above 19.8% or up 30 basis points year-over-year or down slightly sequentially due to expected inventory reserve rates and supplier volume rebate rates reverting the typical third quarter levels.

Our third quarter operating margin is anticipated to be at or above 5.4% of sales. The sequential change that is consistent with our gross margin expectation and represent an operating margin that is an improvement of at least 80 basis points over third quarter 2010 levels. Our third quarter interest expense assumption is more modest reduction in expense from the $13.9 million amount in the second quarter. We are increasing our anticipated tax rate to 30% to 32% for the third and fourth quarters due to the profitable growth of our Canadian and international operations and their associated impact on our overall corporate tax rate.

Next I’d like to turn to our full year outwork. Due to our strong first half performance and our outlook for the second half of the year, we are raising our full year 2011 estimates for the second time this year as follows: Full year sales growth is expected to be at or above 19% up from the 17% growth estimate provided last quarter. This expectation assumes second half pricing and foreign exchange rates are consistent with those experienced in the second quarter.

Gross margin for the full year is expected to be at or above 19.9% an increase of 20 basis points from our Q1 earnings call estimate. This will represent an increase of 20 basis points on a full year basis versus 2010. Operating margin is expected to be at or above 5.1% an increase of 20 basis points from our last earnings call. This would represent an increase of 90 basis points on a full year basis versus 2010 and is above the 50 to 70 basis point improvement goal we outlined in our Investor Day last year. Our full year effective tax rate is now expected to be in the range of 29% to 31%. We expect free cash flow to 80% of net income for the full year.

In conclusion, we are pleased with our sales and profitability momentum and our outlook for the remainder of the year is favorable with growth upon our year-to-date results. I would now like to open up the conference call to your questions. Operator?

Question-and-Answer Session

Operator

Thank you. (Operator Instructions) Our first question comes from Adam Uhlman of Cleveland Research.

Adam Uhlman – Cleveland Research

Good morning. I would like to start with the increased revenue growth outlook for the year, 19% the prior was 17%. I’m wondering where you are feeling better about the business and the various end markets that you serve.

John Engel

Adam, I’ll just frame it this way, and I’m sure we’ll get into lot more discussion by end market vertical. But, the industrial recovery is continuing, so the industrial markets and markets are still continuing to grow albeit it’s at a lower growth rate, but they still continue to grow. Now we’re very pleased with our performance against that end market backdrop, very strong growth in the industrial end market segment for us in Q1 and now again in Q2 with 18%. Construction recovery has not started yet. We’ve been consistent in our view that recovery would be 2012 at the earliest. So, we are not forecasting it, an improvement really fundamentally in end market. However, our construction performance continues to be very strong with our first and second quarter results this year and we grew backlog significantly which is a good indicator, otherwise our sales will be directionally over the next several quarters.

And then utility we had, we had maintained a forecast that we thought the second half of 2011 will begin to see an uptick or an improvement in the end markets. We are pleased with our improvement in the second quarter versus where the business had been tracking. We did have some tough comps for a while there, but just overall sequentially the business grew 9%. In Q2 over Q1 it was up 6% versus prior year. So we feel good about kind of the end market starting to begin the recovery in utility. I’m sure we’ll talk much more about this as we go through the call.

Adam Uhlman – Cleveland Research

Okay, great thanks. And then just a clarification on utility, was there any benefit from storms this quarter or is that sort of roll through next quarter?

John Engel

I would say it’s de minimis.

Adam Uhlman – Cleveland Research

Great, thank you.

John Engel

Yeah, thank you Adam.

Operator

Our next question comes from Deane Dray of Citi Investment Research.

Deane Dray – Citi Investment Research

Thank you, good morning everyone. While we were just on the different end markets, could you comment on data center that got called out last quarter and I would be curious as to what you are seeing in terms of activity there, especially in light of some news this week that the government was going to consolidate some of their data centers in total over the next couple of years.

John Engel

So, first one we comment, Wallstreet Journal had an article two days ago that talked about the government significantly collapsing on number of their data centers and it was 800 of their 200 plus data centers and for us and so where we play in the market that’s outstanding to this. Because it really a shift to cloud computing and so I think in net-net result of that, is going to be increased infrastructure investment ultimately and not everyone to going with the cloud computing concept. But cloud computing is going to represent a very nice positive end-market catalyst for our Datacom oriented product and service portfolio. So, that will be the first comment.

And the second comment is, I would say our Datacom results still at very solid on the first half basis. We were down in Q2. It’s our own issue. We went through this conversion. We are tracking very well. You can see by our backlog growth, our backlog growth in Datacom, Datacom purely Datacom. Not broadband communication, purely Datacom. That is. CSC plus core Datacom was up over 30% sequentially. So, which is impacted the timing of our billings. It’s one of our growth engines. It’s one of our major growth drivers over the next four to five years. We’re still very bullish on Datacom.

By the way, broadband communications, which is our TVC acquisition, we didn’t comment on the script. But that backlog is up over 30% since December of last year. And we didn’t have TVC in our results last year, but I have made that comment. So, we’ve got a very nice strong and growing backlog in data and broadband communications and we are seeing still very nice, what I will call local activities in the end-market.

A final point, which I think will portend very well for us is, when you look at stimulus spending, Broadband Technology Opportunities Program is what’s called BTOP. There is over a 90% of the fund still to be paid out for that set of stimulus programs and that sees right in to our broadband and Datacom sweet spot. So, I think I’m sure we will talk more about government stimulus in the call, but we had been maintaining and this would be a very strong year for stimulus as we move through the year.

Deane Dray – Citi Investment Research

You mentioned in TVC and if we look at the numbers it looks like you’re trending above that $0.30 initial accretion estimate, are you in a position yet to call out how much accretion I think you will be getting from this transaction.

Richard Heyse

We haven’t given our full number, but we feel very good about the first half. Your insights spot on, the $0.30 for TVC, we never really outlined an accretion number for RECO or for Telecom. But it was in a very gain of $0.01 or $0.02 kind of range. We never really outlined. But they were very, very small.

But when you look at the first half, at $0.09 approximately in Q1, $0.10 in Q2, $0.19 in first half if it were linear and we haven’t given our full year forecast. That’s a $0.38 kind of run rate. So, we feel very good being about they done the integration of those, how well they are going and they are exceeding expectations.

Deane Dray – Citi Investment Research

And just last question for me if I could, you commented about the pipeline never being as well. The idea on either other TVCs out there and is it just a continuous opportunity to consolidate this fragmental space.

John Engel

Here is the point, I would like to make. I mean, we have shown ourselves to be good acquirer for a quite sometime and so it’s been a part of our strategy experienced downtime, going downtime we shut up the acquisition engine. I think first what is different at this time is all part of our playing offense of investing in the business. We have added a few dedicated resources to our M&A team. So, the quality the depth and breadth of our pipeline, the size that is never been as larger than it is and so we are always considered a good acquire.

As properties come on the market they contact us, but I think we are proactive activities now are better than ever. And as Richard mentioned, our leverage ratio is coming down nicely as we expected and forecasted as we improve our operating results and our operating profit generation. So, it is part of our strategy. We signaled return the engine back on being hits on and we are in the hunt.

Deane Dray – Citi Investment Research

Great to hear you. Thank you.

John Engel

Thank you.

Operator

Our next question comes from Sam Darkatsh of Raymond James.

Sam Darkatsh – Raymond James

Good morning, John, Richard, Steve, how are you?

John Engel

Good morning Sam.

Richard Heyse

Good morning, Sam.

Sam Darkatsh – Raymond James

Couple of quick of questions here, first off from me, I know you guys are typically very conservative, when you give expectations, but it looks like the fourth quarter implied growth rates moderating a bit sequentially versus Q3, is that due to something that you might be seeing whether it’s shrinking vendor lead times or something in your order book that is showing that or is that being conservative?

John Engel

You used the word conservative, we wouldn’t use that, but that’s just a comment. Let me say this Sam that last year, we had very strong results Q3 to Q4 sequentially as you recall. And then on a year-over-year growth rate basis, we had very strong results. So I think that we provided an outlook for Q3. We have also provided a revised full year outlook. We’ll be dialed in on a tighter outlook for Q4 in our next earnings call. We do have a more challenging comparable. It’s just – when you look at typical seasonality for us and then what we are able to deliver against typical seasonality, which Q4 is typically below Q3. Historically, we will look at what we did last year, very essentially up, slightly sequentially, and very strong year-over-year results. So, I think that’s what really plays in. It’s just at this point at the mid-year point, Q4 is a tough comparable.

Sam Darkatsh – Raymond James

Last question, the pull-through of 62% on a core basis, and well again, we can back into the – what the pull-through might look like next couple of quarters, but for the out years, what are your expectations there and does they changed?

John Engel

They have not changed. We maintain our 50% operating profit pull-through as our long run target. What we have said and we are consistent with, look there could be a given quarter or two, where we might be below it or a little bit above it. We are encouraged that we had a nice quarter this quarter, a little bit above it. Q1, we are a little bit below it. On a first half basis, we are right on. We are a few 100 basis points above 50 through the first half. So, that’s our target and we maintain that. And we think our operating model very comfortably yields that.

The difference this time is and we are very encouraged. And I think it was a question on behalf of investors quite frankly. With our strategy of playing offense and increasing our investments, I know, I and Dan and Richard, we are getting a lot of questions of well what we are able to deliver the pull-though as well and we are very encouraged that we are able to show that we can deliver this pull-through while still investing in the business.

Sam Darkatsh – Raymond James

Thank you much.

John Engel

Yeah.

Operator

Our next question comes from David Manthey of Robert W. Baird.

David Manthey – Robert W. Baird

Hi, guys. Good morning.

John Engel

Good morning.

Richard Heyse

Hi Dave.

David Manthey – Robert W. Baird

First off, in terms of the backlog up 9% sequentially, I know that includes a bump from Datacom, but if you look at that 9%, how does that compare with normal first quarter to second quarter seasonal trend that you have seen historically?

Richard Heyse

It’s – David, and good morning by the way. It’s up a little bit. It’s up few points above what we would see typically.

David Manthey – Robert W. Baird

Okay. And that would include the Datacom right, so you caught a tailwind there?

John Engel

David, it’s inclusive of the Datacom, but if you kind of decompose our backlog growth, I would say, it’s very nice and strongly balanced. It does include the Datacom, yes. And the other thing, the way we look at backlog is again it’s just – we are not a backlog driven business, but it’s a good indicator. And it’s a good indicator if you measure relative growth rate. So, when you look at 9% sequential and up 20%, 21% versus mid-year point last year, I mean, I think that portends very well relative to what our future construction business will look like. Because what’s in backlog for us again and I know we have said this, I want to reinforce it is we don’t lay into our backlog, an MRO supplies contract, an alliance agreement or anything like that, it’s bonafide hard orders, they are booked orders. And by and large, it’s construction projects or other types of projects. So, it’s – we are consistent with that definition. And when you look at, I think, the way they really look at our results is you look at sales growth plus the backlog growth, look at those two kind of together. When you look at that relative to construction, we got very good momentum.

David Manthey – Robert W. Baird

Got it. It sounds good. Second, in terms of the organic growth rate, you gave it to us overall, could you give us, I am not sure how you have broken these acquisitions across the different segments, but could you give us industrial and construction organic growth year-to-year in the second quarter?

Richard Heyse

Hi, Dave. As far as, in our supplemental we breakout in the slide the end markets, which is core which excludes our acquisition. So, you can go through in each of those, for example, the core was 5% sequential growth and industrial sequential growth was 4.9% and so on. So, those are all broken out in our supplemental.

John Engel

Dave, I’m glad you mentioned that. When I went through the front end of my comments, let me just emphasize, when I was talking about the growth by end market segment, in my opening comments, it was for core again. It was ex acquisitions. And as Richard said, again, our end market slide, that we’ve been using in the supplemental now consistently for some time is, those numbers are without acquisitions. I think it’s incredibly important that we focus on it that way. And once an acquisition is our sales for a full year that’s when we will then include it as part of the core, for that supplemental chart reporting purposes.

Richard Heyse

Foreign exchange effects etcetera, you can apply those across the business.

David Manthey – Robert W. Baird

Yes, got it, okay. And then last question just quickly, could you talk about gross margin, it came in stronger than you expected. What were the key factors behind the strength? Was it based on mix or delivery method or what?

John Engel

I would say it’s not one item. It’s a combination of things. We didn’t talk a lot about it, but it’s tougher pricing environment, as we have ever seen we continue to face challenges with inflationary cost pressures, suppliers trying to push their price increases to and through us. Most recently, we are now seeing the effect of the rarest impact in China’s ability to kind of control that supply chain. You may have seen, I think it’s been prevalent that all the large global lighting manufacturers are significantly increasing their pricing on fluorescent, fluorescent based lighting products due to phosphor and the impact of rare limitations on phosphor supply and manufacturing. So, these are very large increases. They’ve targeted in the range of 25%, 25% plus increases for those product categories and anticipating and desiring to push through in the third quarter.

So, I would tell you that pricing environment has challenges as it has ever been. With that said, I’d say the combination of we’re working hard on pricing, we’re working hard on supplier cost side. We saw an impact on supplier volume rebates as a result of our growth rates in the second quarter. We continue to focus on inventory management. We had strong results in our inventory management as reflected in our reserve rates and then we’re getting a benefit by, I think it’s on the order of a little, yeah, 25 basis points plus or minus due to the acquisitions that we did and that’s consistent with our strategy. When we acquire a company by and large we’ve been targeting companies with better gross margin, better operating margin characteristics.

I’d say very much as a result of a combination of a lot of things. It’s not one item. As I have noticed last year’s Investor Day we really focused on our growth engines and how we are going to try to take share consistently. We’ll spotlight a few different growth engines this year versus what we have talked about last year. But, one of the major priorities that we’re going to address in this year’s Investor Day is our margin expansion. Steve has laid out a framework for that a year ago, we’re going to take that and develop that much further in this year’s Investor Day in August.

David Manthey – Robert W. Baird

Got it, right. Thanks very much.

Operator

Our next question comes from Brent Rakers of Morgan Keegan.

Brent Rakers – Morgan Keegan

Yeah, good morning. I was hoping you could just maybe expand a little bit on the lost revenues in the quarter from the Datacom business, as to whether you think – I think you seemed to suggest you don’t think that’s a market based issue, but if you could maybe elaborate a little bit more and some specifics there.

Richard Heyse

Yeah, we grew low single digits. We grew basically 1%, 1.5%, 2%. It’s basically just stuff shifting to the right. It’s not an end market issue at all. I mean look, as Deane mentioned earlier the Wallstreet Journal article, it’s an indication of what’s kind of an end market-driven growth opportunity. It’s prevalent, our backlog still there are some terrific data center projects and Datacom and broadband projects and the backlog is up significantly. Our backlog for pure Datacom is at an all time record high and with that kind of growth, we’ve not seen that kind of growth rate ever. So, that’s about all we’re going to say there. We are not going to get into any specifics. We are in the middle – except to say we are in the middle of this IT conversion. We have taken our time doing it. We expect that conversion will be completed substantially completed in the third quarter. Some may roll into the fourth quarter, but we have got a good piece of it behind us now. And so far in July, the results are encouraging, because our sales are up low double-digits in the first few weeks in July.

Brent Rakers – Morgan Keegan

John, I am sorry, just to clarify do you think though the reduction in the revenue growth rate was specific to WESCO related to this conversion being a distraction or do you think it was projects slipping from Q2 to Q3?

John Engel

It is a WESCO issue.

Brent Rakers – Morgan Keegan

Okay, great. Thanks.

John Engel

And let me just, I am going to say that, I think what we have tried to do philosophically is provide great insight into our end markets, our product categories. We have been clear about our strategies and how we are executing. You could take a look at our results and in the aggregate, we think they are outstanding and then we think all the pieces are really strong. This is one area that I mean we would have expected and would hope that would have been high single to low double-digits in the quarter. It wasn’t. It’s a self-imposed issue, but it’s temporary. And as I said, the conversion is going exceedingly well that just had some impact on billing rates.

Brent Rakers – Morgan Keegan

John, just related to that, is there any cost issue tied to that conversion in the second quarter?

John Engel

Zero.

Richard Heyse

No.

Brent Rakers – Morgan Keegan

Okay, great. Thank you very much.

Operator

Our next question comes from Scott Gaffner of Barclays Capital.

Scott Gaffner – Barclays Capital

John Engel

Good morning.

Scott Gaffner – Barclays Capital

Just going back to the acquisition front a little bit, I wanted to get some more details on the financing flexibility we have got right now, how much room do you have available and I guess the 6% converts are have a right for conversion during the third quarter. Does that have any impact you think on your financing flexibility for any of these potential acquisitions in the pipeline?

Richard Heyse

No, as far as the right to conversion, it doesn’t make economic sense to convert the 2029 so we don’t expect to see conversions on that front. They have the right, but it doesn’t make sense. As far as financing flexibility, I mean, we have said before in the past that for the right acquisition, we would consider leverage modestly north of four to four times leverage. So, we have adequate room in our balance sheet. So, what we are looking at and that for the right acquisition, we have a really strong track record as far as capital market transactions that we would be able to arrange the financing needed to fund. Any acquisition that we think strategically a good fit?

Scott Gaffner – Barclays Capital

Okay. And then just on the stimulus spending, I mean, I think you said 400 million plus of stimulus pipeline still and government sort of through those both together, I mean, how much longer do we have to go until that number sort of starts to come down, do you think?

Richard Heyse

Yeah, this is an area where when ARRA was conceived and then passed. We got a lot of questions about. I am glad you asked about this. And we maintain very consistently that where we play in the value chain, number one, number two for the types of projects that would benefit WESCO that we would see the benefits starting in the mid to latter part of the timeframe over which stimulus funds would be spent. And by and large that’s what we are seeing.

And so we have very nice contribution last year and we are seeing it this year. Basically, 45% of the funds targeted for targeted programs have not been spent yet relative to stimulus. And depending on what area you look at, the electricity delivery and energy reliability set of programs, which where Smart Grid is included. 75% of those funds remain to be spent and paid out.

As I mentioned earlier, the BTOP, Broadband Technology Opportunities Program, over 90% of those funds remain to be paid out. Energy efficiency, renewable energy, which under that is wind, LED lighting, solar, etcetera. 60% of those funds remain to be paid. This is all public information that you can refer to. So, we feel very, very good about our approach to the government market and government customers. And stimulus is benefiting us and we would expect to benefit in 2012, 2011 and as we move into next year. With all this said, you can take a stimulus as a bubble. And you can think of stimulus as a bubble and as the bubble starts to bleed down. We see still a terrific opportunity quite frankly in the government markets and the reason is and this is why a major growth engine for us. We have been traditionally and historically underrepresented in terms of our share position and government.

We started investing in government pre-stimulus. We had indentified that is the growth opportunity after we acquired CSC. So, we still see ex-stimulus later when stimulus that bubbled us kind of that we see significant opportunities to continue to strengthen and grow our government business.

Scott Gaffner – Barclays Capital

Fair enough. Just switching gears a little bit here very quickly, you said Utility Distribution Grid spending I think you said it was starting to improve. I mean was it sequentially better as we move through the quarter or was that just sort of steady run rate throughout the quarter maybe a little bit more color there. So, we can count right that.

John Engel

For utility we grew 9% sequentially Q2 over Q1. And I would say, we are predominately biased towards the [DF GND] because that’s what gets sold through distribution. With that said, we have a nice generation support business we can support generation projects, but that would show up in the form of construction. And we are increasingly trying to play in a transmission space, so with projects and service offerings. I’d say, relatively balanced. We feel really about good about the 9%.

On the Transmission side, we have got both material supply and services supply capabilities and I think we had identified a strategy for transmission to put ourselves in a position that play an increasing way in that part of the power chain, generation through transmission substation and distribution. I’m very encouraged with our results in that. I will tell you one of the areas, where we are going to drill down a little more detail in our investor day this year is utility. So, we are going to kind of drilling that a bit, show exactly what we are doing across the entire power chain in terms of the strategy and offerings and the progress we are making.

Scott Gaffner – Barclays Capital

It sounds good. See you in a couple of weeks.

John Engel

Okay.

Operator

Our next question comes from Noelle Dilts of Stifel Nicolaus.

Noelle Dilts – Stifel Nicolaus

Hi, good morning and congratulations on a nice quarter.

John Engel

Good morning.

Noelle Dilts – Stifel Nicolaus

I would like to go back to two of the prior questions and just get a little bit more detail. First going into the growth profit margin improvement, I understand that came from the number of sources, but could you comment specifically on how much do you think came from your margin initiatives and also discuss about what happened with product margins in the quarter.

And then secondly on the government side of the business, I understand that there is still strong pipeline, but you have been looking I think for this year, looking in kind of mid-teens growth and you had flattish sales to government contractors in the first quarter, 3.4% growth in CIG this quarter. So, at this point, is that moved out to more of 2012 issue or a 2012 growth or are you expecting pickup in the back half of the year...

John Engel

Noelle, I’ll take the second part of your question and I will let Richard to address the first. CIG showed 3% or 3.4% growth organically if you look at the supplemental. That’s on the page five of the supplemental. What’s important to note is, our government sales, more importantly said our sales the government agencies and government contractors show up in CIG, but they all show up in construction to the extend they are sold to construction oriented contractors, that ultimately sort of the government is the end user.

Our government sales, when you look at all entities in that value chain were up 25% in the second quarter. They were flat in the first quarter, if you recall on our last earnings conference call we discussed that and we mentioned in our last earnings call that, we did have challenging comparable in Q1 of last year and we were highly confident that we would grow our sales of the government agencies and contractors double digits in 2011. So, we are very happy to say, here we are quarter later and we grew 25% in the second quarter. So, in the first half bases we're essentially up double digits nicely and we would expect to do that for the year.

Noelle Dilts – Stifel Nicolaus

Okay, great. Thanks for that clarification. I see where I missed that.

John Engel

Okay.

Richard Heyse

As far as the margin expansion, there were several factors. For example, as we target acquisitions. We look for acquisitions that have margins that are at or above our current level and that was the case for the acquisitions we have done in the last year. So, significant piece of our margin improvement was due to the improved mix driven from our acquisitions. We have increased our growth rate expectations for the year that also improves the rebates, which we get due to reaching the growth targets with our suppliers, and also another factor was our inventory management programs and reduced loss rates in the quarter. So, there were number of factors that really drove the gross margin expansion, and really hard to point any single one.

Noelle Dilts – Stifel Nicolaus

Okay, and can you comment on your product margins specifically, did those expand in the quarter?

Richard Heyse

Yeah, sequentially product margins were expanded modestly. Again with the acquisitions year-over-year product margin were up significantly.

Noelle Dilts – Stifel Nicolaus

Okay. Thanks.

John Engel

So, I think, sort of put a fine point on that. We think this still represents one of the biggest opportunities over the mid to long term for WESCO and we outlined in last year’s Investor Day kind of a 200 basis point opportunity in core gross margin expansion over, as we look out into the mid to long term. That’s an area we’re going to detail in this upcoming Investor Day.

We think that the fact that we’re holding product billing margins kind of flat to slightly improving and we have been doing that through the recovery portion is economic cycle we are more facing the most challenging pricing environment that we have ever faced. We feel very good about the ability to do that. That is the result of our margin initiatives.

Richard Heyse

And that’s (indiscernible) should have been clear, for example recovery price increase that we’ve continued our track record of recovery in the price increase that we have been, seeing from our suppliers. If we didn’t do that the natural, it’s a pressure occur. If we didn’t make a lot of progress by the very nature of how our business works where margins would compress over time because suppliers are increasing pricing and customers do not want to accept price increases by and large. We have to sell them on, why that’s important and the value associated with it. So, we have to return devices we have margin compression over time in this type of challenging environment. It ought to be flat to slightly up. We feel good about it. And when we look at margin, it’s billing plus, it’s product margins because all the elements would impact gross margin. That’s our focus as the entire equation supports gross margin.

Noelle Dilts – Stifel Nicolaus

Okay, great. Thanks so much.

Operator

Our next question comes from the Hamzah Mazari of Credit Suisse.

Chris Parkinson – Credit Suisse

Good morning. This is Chris Parkinson on behalf of Hamzah. Most of my questions have been answered. Can you just add a tad more color on what other lines of businesses you would look at on the acquisition front? I know you can’t mention specific, but given a lot of other distributors that are diversified guys are running onto adjacent product lines, what would be primarily of interest to you in addition to Datacom?

John Engel

We’re not going to name two or three categories. I will answer this. We think our capabilities and business model extend horizontally to many other types of product categories. Look at that what we have done in communications for data and broadband communications. On a run rate basis, exiting last year we had a $1 billion position in that combined product category. We are in fact in 2005 before CSC it was under a $100 million. So that’s a great example of how acquisitions coupled with organic growth strategy supported called a more richer portfolio from a product mix perspective. The other acquisitions that we have done over the last five or six years Fastek, J-Mark were product category expansion and strengthening place, and I could go on and on.

So I think our track record has been that and it will continue. You’ll recall last year Investor Day and Richard and I have been show it in our presentation in various investor conferences, we have a chart on acquisitions that shows the MRO key slope in all the various categories and we’ve outlined a few that are particularly attractive. But I would say we don’t feel constrained to any of those. I think we have shown the ability to extend our model horizontally.

Chris Parkinson – Credit Suisse

Okay. Thank you. And just a quick follow-up, based on your guidance range and the implied gross margin pull through, can you add a little more color on how you are thinking about additional growth initiative and SG&A as we progress into the back half of the year and how should we think about that sequentially?

John Engel

Again we’ve got our 50% pull through target. We have outlined our growth initiatives. We are making decisions every day in terms of where we add incremental sales resources and where we add locations. We have added – now, we have added total of 20 locations that are Datacom oriented since we acquired CSC. We added an additional one in the quarter. So, we continue to do that and look the model is working. We are showing that we can deliver about 50% pull-through while trying to step-up for investment in sale resources and additional locations. So – and that’s been our strategy and our target.

Chris Parkinson – Credit Suisse

Perfect. Thank you.

Operator

Our next question comes from Matt Duncan of Stephens Inc.

Jack Atkins – Stephens Inc.

Good morning guys. This is Jack Atkins on for Matt. Congratulations on a good quarter here.

John Engel

Good morning Jack.

Jack Atkins – Stephens Inc.

Thank you. My first question is with regard to your various in markets, are there any particular markets within your industrial business that stronger than others? And then as a follow-up to that construction was up 12% in the U.S. this quarter, could you maybe comment on what drove that strong growth?

John Engel

So, let’s start with the second one first. It was – we have very good balanced growth in construction for a variety of different types of projects. Again, our backlog grew nicely and when you look at in the U.S., I think that was your question, a 12% growth in the U.S. When you look at it geographically, we had very good balance across the U.S., so we are encouraged by that. When you look at the different types of projects, it was myriad of projects. So, I wouldn’t say to any one particular area.

In terms of industrial, we actually feel – it’s good as we feel about construction, we probably even feel better about industrial. You look at the growth rates we have imposed in the last three to four quarters, a very strong momentum. It’s driven by our global accounts and integrated supply business models and the execution of those. And I will make a comment that we are beginning to see capital spending start to rebound. Industrial companies are spending capital as opposed to hiring permanent headcount. And we are beginning to see some of that rebound depending on what end market segment you are talking about.

We have not had the benefit of that yet in our sales growth. Right, so I think that’s another good indicator. I would say in terms of the end market, it’s been – we have had good balance, but I would say in general oil, gas, metals, mining, core industrial OEM type markets government, big drivers in terms of the end market segments where we are seeing particularly nice growth.

Jack Atkins – Stephens Inc.

Okay, great. Thanks for the color on that. And then my final question here with regard to your non-residential construction market, you commented in the supplemental that you think a recovery in that market is 12 to 24 months out, but the market is stabilized. Could you maybe talk for a moment about what you anticipate that recovery will look like once we get to see? Do you expect a slow and steady recovery there or maybe something more and more rapid once it takes hold?

John Engel

We don’t – we are not planning for rapid we are planning for slow and protracted. I think we are going to see – that’s our planning construct for non-residential. And classically, you would see non-residential lag or kind of come after residential recovery. It’s pretty clear, resi grew 6% to 8% last year and now it flattened out. So, I think not that we had a high resi exposure, we don’t, but my point is we may find a little different dynamic between the resi and non-resi interplay this cycle. It will be interesting to see how it unfolds, but clearly, residential recovery is not within the next year too. That’s going to be very extended. At least that’s our view, that’s our planning construct and we are saying over the next three to five years. And so we think there is going to be a long slow recovery. All-in-all, the markets are very large and I think we are demonstrating our ability to deliver very strong results against a market right now that’s still declining. The non-resi market was down double-digits in 2009 and 2010 and its down 9% in terms of starts in the first half. And so yet we are still posting very strong results. So, that would be our objective to continue to do that.

Jack Atkins – Stephens Inc.

Okay great. Thank you for taking my questions.

Operator

Our next question comes from Ajay Kejriwal of FBR.

Ajay Kejriwal – FBR

Thank you. Good morning.

John Engel

Good morning Ajay.

Ajay Kejriwal – FBR

Just wanted to follow-up on that construction point you are making obviously been very solidly for several quarters now, even though the markets declining, so you are gaining share. I would be curious to hear what you are seeing with respect to competition from smaller businesses. So, as credit eases, are you seeing any change in competitive dynamics there or expectation that those businesses have come back.

John Engel

I’d say we haven’t seen in a material way any structural changes yet. I know that there was some potential or beliefs that with this very steep downturn and it was protracted recovery and depending on the shape of the credit market recovery is some of the small players may begin to wither away.

I would not say we are seeing a fundamental structural change in the composition of structure of this. It’s a very competitive market. I think I would summarize this way, supply and demand, demand is not picked up. It still down. The end-market yet supplying capacity in the form of manufactures through distributors still hasn’t been fully rationalize, which is feeling a very, very challenging pricing environment. That is current state. I don’t see that changing in the short-term.

Ajay Kejriwal – FBR

Good. And then on your comments on the utility markets could be curious, what you are seeing with regard to high voltage transmission and renewable power I think there was a comment in that presentation that you are seeing some uptick there?

John Engel

Well, energy demand was down in 2009-2010. Energy demand is now increasing in 2011 after being down those two years, driven by the industrial recovery. The growth in investments we are seeing are being led by transmission projects and alternative energy. We thought it would occur in the second half of this year, we are starting to see it. We don’t break out the numbers in terms of our wind and solar projects, but we are seeing very nice growth and in terms of transmission, where we have been focusing on that and so it’s our hope and desire. Again we will develop this more fully in our Investor Day because utility will be one of growth engines that we spotlight next month.

But for transmission, on the material supply standpoint, we provide sourcing procurement and related distribution services for a whole series of products like insulators, connectors, cutouts, grounding material, security and monitoring equipment that applies to transmission and then on the services supply standpoint we are offering, we provide project management support, packaging/kitting and other services. So, we focused on and we have talked about that before we had this downturn about our strategy to be much more than just [DFG&D] and we are encouraged by some of our, I called initial results in that regard. We will develop that more fully next month.

Ajay Kejriwal – FBR

Good and maybe one last one on pricing, so just to clarify first half you’ve seen about 3%, slightly more than 3% pricing year-on-year, is that your expectation for the second half or is it different number?

Richard Heyse

We haven’t given a specific number. What we said is our guidance, what we estimate for Q3 and Q4 is, we are assuming consistent with first half levels.

Ajay Kejriwal – FBR

But consistent low single or I mean is that possible to put a number around that or?

Dan Brailer

We can follow-up. We would like to get, there is a few more people left. We are running out of time and we can follow that up after the conference call Ajay.

Ajay Kejriwal – FBR

All right.

John Engel

Let’s go to other.

Dan Brailer

Yes, we got three more callers, we would like to get. We do have three more callers and we want to get through all three so. Let’s keep going.

Operator

Our next question comes from Matt McCall from BB&T Capital Markets.

Jack Stimac – BB&T Capital Markets

Good morning guys. Thank you for letting in. This is actually Jack Stimac in for Matt. I had a quick question about the lighting business you would call that out last quarter as king various strengthen and this quarter you only really talked about some kind of the where supply chain issues. Could you give us an update there and do you think the supply chain issues and kind of that intending pricing increase maybe pulled forward any orders in to the quarter?

Richard Heyse

I don’t think pulled forward any orders because that whole 25% plus advertised pricing increase is literally occurring in the last couple of weeks. So, it didn’t occur in the quarter and couldn’t have a meaningful effect in the quarter. I’m glad you brought this up, we kind of picking shoes what areas we want to drill on. But we did grow our lighting product category 14% in the second quarter. We feel very good about our results and my momentum there.

I think this represents an outstanding long-term growth opportunity for us and we have talked about and that’s why its one of our growth engines and that is also in area that we are going to drill down on more in next month’s Investor Day. Last year what we talked about was global accounts, when we have our Investor Day that is data communications and government and so we are going to talk about few of the other growth engines this year, while I providing an update on communication, but still highlight our two of the items we are going to talk about.

Jack Stimac – BB&T Capital Markets

What order patterns consistent through the quarter that we hear from some suppliers that I think the kind of slowdown to start the quarter and kind of accelerated the finish in the July that consistent with what you saw?

John Engel

Yes, I read a number of reports, various channel checks I found they are interested in, we were very consistent through the quarter. When you look at our growth rates, our sales growth rates versus prior year, we were very consistent through the quarter. We did not see that at the aggregate level of that phenomenon.

Jack Stimac – BB&T Capital Markets

Okay, great. Thank you very much.

Operator

Our next question comes from Tony Kure of KeyBanc.

Tony Kure – KeyBanc

Hi, guys. How are you today?

John Engel

Good morning Tony.

Tony Kure – KeyBanc

Just couple of quick questions, more on the secular trend on the datacenter side, one of the things you have talked about I think in last year in your Analyst Day was gaining some traction combining the electrical business with the Datacom products for some folks, who might be interested in out setting a datacenter with one distribution. Can you just give an update on how that’s progressing and if you have seen any traction related to that?

John Engel

We are seeing excellent traction and that is a portion and kind of an underlying strategy is part of what we call our one WESCO initiative. In the one WESCO initiative for a given customer, we would like to make sure, we can bring our entire portfolio products and services to bear on that customers operations, whether is to MRO needs on the indirect material, whether its direct material needs or OEM, whether its their capital projects, new construction, retrofit renovation and upgrade in the form of lighting upgrade or a wireless upgrade for example. So, we are seeing very good traction and that is just a one piece of the one WESCO initiative, but it is a big one. It’s a big one. So, yes I’m glad you asked about that. There is no doubt that’s driving some of our electrical and corresponding to our Datacom growth

Steve Van Oss

One more thing, if I could add real quick too. Also our TVC in the broadband one of the things that we are pleased with the acquisition is that we are seeing that same combination of teams between our broadband teams and our utility teams, our broadband team and Datacom and we've got a number wins because of those kind of joint venture. There is no equivalent supplier, who can offer WESCO is offering in that space.

Tony Kure – KeyBanc

Okay. Just to drill down a little bit more in the Datacom and then I’ll let you go I guess that last question. Do you have any visibility to what products go in to the enterprise versus datacenters themselves or does that all go to one big bucket as far as your concern?

John Engel

There is a broad array of products that go in to the datacenter in to datacenters. And I don’t understand I guess understand the second part of the question.

Tony Kure – KeyBanc

Meaning on the enterprise being goes in to KeyBanc for instance distributing accordingly KeyBanc versus?

John Engel

So, when you look at maybe the KeyBanc is called as an end-user customer, so KeyBanc has a datacenter, but then also what’s their backlog. Is it a backlog, is it wireless, is it distributed system within their facility. So, there is additional products beyond to your question I think I understand now. Thank you.

Beyond the datacenter for KeyBanc that are part of our Datacom portfolio. So, yes like securities products are our key product for us. And fiber optic connectivity products and supporting wireless etcetera yes.

Tony Kure – KeyBanc

Okay. Thanks guy.

John Engel

Thank you.

Operator

The next question comes from Steve Tusa of JPMorgan.

Steve Tusa – JPMorgan

Good morning, guys. This is Raju in for Steve. Most of my questions have been answered and I will keep it quick, but just finish it up with one utility, you see upward trends from the utilities embedding came from this, weather historically driving acceleration of some of thing, some things you have seen, something not the driver for the second half and maybe kind of calibrate that between underlying trends for these transmission products on the utility side?

John Engel

I’m not going to spike that out. It didn’t drive us from Q2 and we are not particular going to foreshadow or point to that is a driver in Q3. I think the way we run our utility business historically is, we never forecast or make prediction based upon potential weather impacts. With that said, utility side are very designed and after the major partner the utilities, we are quick responders.

I mean the first line of response, if there is hurricane, an ice storm in the winter, tornado, floods just what, you know, power you got to get power backup and running in that particular area. So, we support utilities so that. I would say that what we see just an overall trend of it because energy demand is up again. That’s a fundamental driver and we are seeing a huge need, which we have been talking about quite frankly to improve reliability and integrity of high quality power from generation through transmission and distribution. So, that’s the drivers.

John Engel – President, Chairman, and Chief Executive Officer

Well, thank you very much today. I know we went few minutes over and I want to make sure that everyone had an opportunity to get their question answered. And I thank you for your time and your continued support. Let me cap by saying, we are very encouraged by our positive momentum and results in the first half. And we are continuing to invest in our business and our people. We remain focused on producing improved shareholders returns and we look forward to delivering a strong second half to close out the year. Thank you very much. Have a great day.

Operator

This conference is now concluded. Thank you for attending today’s presentation. You may now disconnect.

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